We seem to being hearing two different stories today. On the one hand, economic data indicates that, because the last two quarters has seen the GDP shrink, we have entered into a recession. On the other hand, many companies are reporting record earnings, increasing wages, and unemployment at its lowest level in decades. I have never seen a contradiction like this in my lifetime. Have you?
It seems the biggest economic concern is inflation, and the Biden administration has made reducing inflation their top priority. The Federal Reserve is raising interest rates and reducing their balance sheet, both actions which fight inflation. The Republicans seem to be making inflation their key midterm talking point.
In the 1970s, as inflation raged to double digits, the economy sank. “Stagflation” was defined as inflation with a stagnant economy, but it was as impactful as an economic recession. Unemployment in the 1970s exceeded 6% and continued to increase during this period of stagflation. Companies struggled to produce profits, and those unable to compete fell by the wayside. Beginning in 1973, wages lagged well behind the price increases on consumer products.
Is the United States, and most of the world, headed toward a sustained period of inflation and recession, plunging us back into an era of stagflation comparable to the 1970s?
The inflation we see today approaching double digits is driven primarily by energy and food. Excluding those two (admittedly very important) sectors, the core inflation over the last year rate rose just 3.7%. Gasoline prices have already begun to decline from their summer high, and the food supply fluctuates with the season. In the meantime, unemployment is declining. Although several large companies are laying off employees, hiring continues to be strong, and help wanted signs are out all over the country. Wages are not only increasing, but employees are quitting to take new jobs at higher salaries. Retail sales have been flat even as gasoline prices have declined. That means people are spending on other goods. What actually appears to be occurring is that companies are passing on their added costs by increasing prices.
The Wall Street Journal recently published an article in which they claimed that the NASDAQ had entered a bull market.1 The increase in the indices is up 20% from the lows of June. Even though we are not setting new highs, a 20% increase is the classic definition of a bull market.
Ben Levisohn, a deputy editor at Barron’s, analyzed, “With 432 S&P 500 companies having reported, aggregate earnings have come in 5.8% above expectations, as 77% of companies have reported better-than-expected profits. Revenue, meanwhile, is growing at a 13% clip, helping to drive those earnings beats. That hasn’t kept future earnings estimates from being revised lower, but the drastic cuts that were expected haven’t materialized.”2
It is true that China’s rapid rate of economic growth is slowing, and in response they are lowering interest rates in an attempt to stimulate their economy. But lowering rates is like pushing on a string; there is little data to show that in a slowing economy lowering rates really has a positive impact. In the 1970s, Fed Chair Arthur Burns lowered interest rates hoping to reverse the recession. It was this decision that led to stagflation.
Don’t be fooled by negative forecasts for stock returns. How often do I hear or read of someone who expects stocks to continue into a bear market. Based on what?
The basic principle for determining stock valuation goes all the way back to Graham and Dodd, who said stock returns are realistically based on three factors:
- Cash paid to the owners (dividends),
- Growth of such payments, and
- Change in the valuation of future payments.
There are weaknesses in certain industries that are interest-rate-sensitive. The companies in housing and finance will feel the pressure and tend to slow or tumble down as interest rates rise. On the other hand, employment is high and consumers are spending. There are many companies that are spending on capital equipment to overcome the supply chain problems.
So, who do you believe? Do you back the economic indicators which could indicate a recession? Or company earnings in certain industries which are growing?
I believe the best strategy is to find those companies that are growing and avoid those who are struggling.
Mike Adams
1. Otani, Akane. “What Will It Take for the Bull Market to Last?” The Wall Street Journal, August 11, 2022. https://www.wsj.com/livecoverage/stock-market-news-today-08-11-2022/card/what-will-it-take-for-the-bull-market-to-last–KUoXR6jZASluj57vd8Yo.
2. Levisohn, Ben. “How the Stock Market Survived July’s Jobs Report-and Lived to Fight Another Day.” Barron’s. Barrons, August 6, 2022. https://www.barrons.com/articles/stock-market-news-dow-nasdaq-sp500-51659744434.
