December Investment Comments
Democrats are making a late-year push on tax and spending increases but have struggled to find a strategy that unites the party. Some of the more ambitious revenue (tax) measures have been eliminated, which is probably good for American business. Ironically, government dysfunction usually is.
Pfizer had a good month. The FDA authorized the company’s Covid-19 vaccine for children as young as 5, while its oral antiviral for already-infected patients demonstrated excellent trial data, following on similarly strong results from a Merck antiviral last month. Meanwhile, the wave of infections associated with the Delta variant appears to have peaked across the nation, although trends vary by region. There appears to be a strong seasonal component underlying the infection statistics. Once we get past the winter cold and flu season it seems reasonable to expect that we will start to put Covid behind us.
While the Delta wave was still sweeping the nation, third quarter GDP grew just 2.0% according to a preliminary estimate, which was possible cause for concern, but more recent data suggests a brighter current outlook. On the heels of a disappointing September jobs report, the employment picture improved dramatically in October. The unemployment rate fell to 4.6%. 531,000 jobs were added, more than double September’s statistic, while prior month numbers were also revised upward by 235,000. The third quarter Productivity and Costs report showed hours worked up 7% and productivity down 5%, the lowest productivity reading since 1981. There is an inverse relationship between productivity and jobs growth because a growing economy will tend to hire marginally fewer and fewer productive workers, while a contracting economy will tend to lay off the least productive workers first. Therefore, the historically low productivity reading demonstrates the halo of an improving economy extending to more and more potential workers.
Consistent with an accelerating economy, inflation is continuing to accelerate. October’s CPI report showed a 0.9% one-month increase. The 12-month increase was 6.2%. Last year’s report showed a 1.2% 12-month increase, meaning that on a two-year stacked basis the average rate of increase is about 3.7%. The CPI number is being pulled higher by some volatile components that may relax, but it is also being held back by a housing (shelter) component that operates with a long lag. The Case-Shiller home price index increased 19.8% over the last twelve months. It has now increased at a 3-year annualized pace of 9.4%. When housing prices increase rapidly, as they have recently, it takes time for the increases to seep into the CPI, implying that further inflationary pressure is baked into coming statistics.
The recent Federal Open Market Committee meeting went largely as the market anticipated, with the Fed signaling it will finally wind down its bond buying between November and June while also confirming that it remains reluctant to increase short-term rates until late next year at the earliest. The Fed changed some of its language around inflation, no longer invoking the roundly-mocked “transitory” label. Rather, the Fed now admits inflation will persist into 2022. It blames global supply chain bottlenecks, rather than its own dovish monetary policy. The central bank’s attitude toward inflation is reminiscent of the boy who broke the window. He claims he wasn’t there; but if he was there then somebody else threw the stone; but if he threw the stone then it was an accident. The Fed is currently in the middle phase of that argument. Yes inflation is becoming a problem, but it’s not their fault.
New frontiers in money printing have helped stoke a rise in speculative trading. Swaths of the market seem ungrounded. Tesla shares added about $300 billion in market value in a two-week span, stoked by a press release that bankrupt rental agency Hertz planned to purchase 100,000 cars to modernize its fleet. The total revenue from a purchase like that would be perhaps $5 billion, and responses from Tesla call into question whether the purchase is even real.
The cryptocurrency phenomenon has been going on for years at this point, but the excitement seems to have ramped much higher recently. We have noticed an uptick in spam emails and text messages hawking cryptocurrencies and crypto-adjacent services. Your author was walking past a construction site the other day and overheard two workers discussing the relative merits of various crypto coins. The Fed saw fit to publish a warning about speculative trading and market bubbles. It drew special attention to so-called “stable coins,” which bridge the gap between digital currencies and the traditional financial system, but which are not regulated as banks.
The bond market remains surprisingly quiet. Shorter-duration yields have risen throughout most of 2021. The FOMC meeting caused a brief rally in shorter-dated bonds—a decline in yields—but this burst was soon snuffed out by the inflation data. Longer-duration bonds are not showing much fear of persistent inflation. The 30-year Treasury still yields just 1.94%, and this is quite high by global standards. German sovereign yields are only barely positive at 30 years. Japanese 30-year yields are less than 1%. Bonds look like obvious money-losers with inflation rising and central banks gradually taking their thumb off the scale by tapering their balance sheets. The endurance of low yields may speak to investors’ demand for safe haven assets in a very uncertain world. Ironically, however, the more that investors rely on bonds as a safe haven, the less safe they become. When too much money flocks into risk assets we call it a classic bubble. When money flocks into safe assets we simply get a bubble of a different sort.
So what is an investor to do? Equities continue to look superior to bonds. The risk of losing 10% or even 20% during a stock market drawdown may be higher than in the bond market, but the risk of losing 10% or 20% of one’s purchasing power over the next 10 years in the bond market looks very, very high. We would rather buy real assets like equities than paper assets like bonds and ride out the volatility. In a bubbly environment, we warn investors not to chase hot stocks and not to become too complacent with their biggest winners. The old maxim “let your winners run” is good advice until your winners dominate your portfolio. There comes a time to take some profits and diversify as well.
Miles Putnam, CFA