May 2022 U.S. Market Update - Economics & Behavior
What Humans Do When They Don’t Know What to Do
Christopher Gerber, CFA
“It’s like déjà vu all over again!” - Yogi Berra
“Ask 100 economists or market analysts the same question, you will get 100 different answers.” I think I have heard that 100 times in my career, but it is only true with the right question. Here is what I mean: f you give trained economists the same set of data (Economic or market statistics) and ask a question about it, you will get remarkably similar answers. They have procedures like any other profession. The rub is when you ask them what people are going to do in the future about it.
At FIDERE, we rely on trusted professionals to help us evaluate the past as well as future options. We do not make presumptive moves, however. It too often fails in real life. We stay the course adjusting only when the investing playing field has been altered long-term or permanently. The playing field is the key. Who adjusts it? Typically, governments do with tax incentives or law changes. They often change market cycles through their intervention. Sometimes the marketplace makes the change through innovation. Who would have thought 15 years ago that telephone land lines would nearly vanish? The current intervention is interest rates. Interestingly, these changes were priced in by markets months ago.
So, how do higher interest rates get priced in, yet the market acts as if it has never seen them before? Last week the S&P 500 was down 3%[i]. YTD it is down about 17%[ii]. No one invests in the S&P 500 at FIDERE. It is simply a gauge the same way that median housing price is a gauge. The average 30-year mortgage is at 5.49%[iii]. None of us likely bought a house at the median price in the last year but use it as a familiar tool. Interest rates are up. Thirty-year treasury bond rates are 2.99%[iv]. High quality corporate bonds are at 4.2%[v]. Why?
Experience tells me that when economic things must get fixed, they do. Combine overactive government borrowing and spending without equal increases in productivity, pandemic linger (China is partially shut down), war in an area responsible for notable shares of the world’s energy and food, talk of nuclear war, Europe (big place) angling for energy from Russia, hurting US consumers, mid-term elections coming, and we have quite a bouquet of uncertainty. Much of it has appeared day by day in the last 2 months. The million-dollar question is “When does more certainty re-appear?” It is too hard to name a time when risk decreases. One thing we know from the past without variation is that when market prices rebound, they do it with mighty leaps. Not being in the market has always been a mistake.
The heat map below shows where we are and trends it over 2020-present.
Red (bad) fades to orange, then yellow, then green (good[vi]) in many areas from the COVID-19 onset to now. In all areas except inflation, we are far better off than during covid. Any white spots you see are areas where the most recent data is not out yet. This map is up to date as of Friday, May 20, 2022.
Economy: We are generally up in several areas. Slight negative moves are just that and it is unknown if they represent trends starting. Keep in mind covid greatly distorted profits for some and put others completely out of business.
Labor: Non-farm payroll has not caught up to where it should trend yet. All other areas look promising.
Profits: S&P 500 EPS (Earnings per share) are estimates. S&P 500 SPS (Sales per share) are estimates. These estimates are considered good. They are not as good as those immediately coming out of the pandemic but this is to be expected.
Inflation: This part of the chart is backwards. They colored the recent higher inflation rates green. Wrong. They forgot to tell the computer to think backwards for this section. So, in your mind, simply reverse the colors and you pretty much get the picture.
Now for Something Completely Different. Here is the big question: is it normal to see the markets down this much when many economic and profit numbers look this good? In a word, yes. Interest rates, which are temporarily increasing, have a magnified impact on everything. Think of it like this: We always invest in comparable alternatives. When the alternatives to equities (bond yields with their higher interest rates) pay more than before, they are relatively more attractive than they were before. If bond yields decrease even barely, they are relatively less attractive to equities. It is all in the math, which gets fairly involved. Does this mean equities are to dump? No. Timing ups and downs is always an exercise in futility. But also consider this. We are in unprecedented times.
Unemployment is very low. Retail sales are up about 28% versus February 2020. GDP is up 3.6% (after inflation) from a year ago. What’s not to like?! But think of what investors have been through the past couple of years: massive increase in government spending, COVID disease and shutdowns, war, and a huge increase in the money supply. The normal system is distorted. It was turned on low speed during the pandemic. Now it is on high speed. It will take a while for distortion to return to undistorted.
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[i] Source: Standard and Poor’s. [ii] Source: Standard and Poor’s. [iii] Mortgage Bankers Association (MBA); [iv] US Treasury [v] US Treasury [vi] The computer apparently thinks higher inflation is good and colored it green at the service making the heatmap. It should be red on the right fading to green on the left.