CWS Market Review – February 22, 2022

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War and the Stock Market

The headlines have been dominated by war news from Eastern Europe. As I write this, Russian troops have moved across the border into Ukraine. Let me be clear that this news is not be a cause for you to sell out of the market, particularly any of our Buy List stocks.

I’m hardly a national security expert, so I’ll avoid any commentary on that. However, I will touch upon the long and troubling relationship between war and financial markets.

In fact, it’s not a stretch to say that the growth of modern financial markets is a byproduct of war. When countries have had to raise enormous sums of money to keep the battle going, that has spurred the development of financial centers that could sell war bonds at fantastic rates.

At the outset of World War I, the British government thought it could pay for the war with existing revenues. That wasn’t the case. It was the need for funds, particularly in our Civil War, that created the infrastructure that could later be used to raise money for large-scale corporate ventures.

Here’s a famous photo of Charlie Chaplin being held aloft by Douglas Fairbanks at a Liberty bond drive in 1918:

That bond drive was for $4.1 billion at 4.15%.

One hundred years later, at the exact same spot, your humble editor tries to mimic Chaplin’s gesture:

War, sadly, is big business and it’s often good business, especially if you win. The line attributed to Nathan Rothschild is that one should “buy on drums and sell on trumpets,” meaning to buy at the start of a war and sell once peace returns. In 2003, the stock market reached its bottom right as the fighting started.

During World War II, the stock market fell from Pearl Harbor until April 1942. The ultimate low came on April 28, ten days after the daring Doolittle Raid over Tokyo. The Dow closed at 92.92. To add some context, on September 3, 1929, the Dow had been at 386. So more than twelve years after the peak, the stock market was still about a quarter of where it had been.

The war, however, spurred a big rally for stocks. Within two years, the Dow was up 50%, and it doubled by 1945. By 1955, the Dow was up fivefold, and it doubled again ten years later. The market really didn’t see any pause until 1966 when inflation started to have a major impact. Twenty-four years after FDR’s “Day of Infamy” speech, the Dow had advanced close to 1,000%, and that’s not counting dividends.

At the outbreak of WWI, the stock exchange shut down. They didn’t think it was going to last long. Traders soon started meeting in the street outside the exchange. The NYSE finally relented and trading resumed indoors in November 1914.

What about after the war? Post-war periods have often been associated with ugly bouts of inflation. That’s when the loose money policies come due. Many people remember the persistent inflation of the 1970s, but the post WW2 inflation seems to have been lost down the memory hole. In 1946, inflation was 8.3% and the following year, it got to 14.4%. You rarely hear about that but that’s what happens when you hold back demand for a few years.

Here’s an amazing stat. During World War II, how many cars did America make? The answer is 139. Compare that to the year just before America entered the war, 1941, when we made three million.

I was recently on Michael Gayed’s podcast and I said that in many ways, dealing with Covid has been similar, in an economic sense, to going to war. Not in a literal sense, of course, but the government and the Federal Reserve went to extreme lengths to keep the economy afloat.

In this case, we already had inflation at the outset of hostilities. The price of gold is up to $1,900 per ounce. It was over $2,000 over the summer. Oil may soon be closing in on $100 per barrel. On Friday, the government released a very good retail sales report for January. Last month, retail sales rose by 3.8%. This tells us that higher prices aren’t scaring shoppers away. In fact, they may be getting them off the couch.

This news also jibes with the recent jobs report. More people are working and getting paid higher wages. That’s leading to more shopping and higher prices. That’s good for our stocks.

The inflation debate is falling into two camps. One camp, largely sympathetic with the Biden Administration, is blaming the supply-chain mess. The other side is less sympathetic with the administration. I won’t pick a side, but I suspect that it’s a little of both. The supply chain troubles should soon begin to gradually fade.

The Selloff Is Officially a “Correction”

The stock market had a rough day today. At its low, the Dow was off by 714 points. The S&P 500 finished the day at its lowest level in nearly five months.

This is now an official correction going by market closes. That means a drop of more than 10%. Since January 3, the S&P 500 has lost 10.25%. A bear market is a drop of more than 20%. (I don’t know who comes up with these, but that’s the nomenclature.)

Again, we’re seeing more conservative sectors do well. The S&P 500 Growth Index was off by 1.27% today while the Value Index was down only 0.76%.

This trend has been going on for several weeks. Since early December, the S&P 500 Value Index is up by 2.40% while the S&P 500 Growth Index is down by 12.58%.

There’s a Russia ETF (RSX) that trades on the NYSE. It’s mostly oil and gas companies. Four months ago, RSX was at $33 per share. Today it got down to $20. The Russian ruble fell the most in two years.

Although it’s not on our Buy List, I was curious to see the earnings report today from Home Depot (HD). This is an interesting stock to watch in that it’s far from the largest company on Wall Street, but it’s probably one of the most closely tied to the health of the economy. If the economy is happy, then HD is doing well. If the economy is off the rails, then HD is not doing well.

Home Depot is the largest home-improvement retailer in the world. It runs more than 2,300 warehouse stores. The company is also a component in the Dow Jones Industrial Average.

For its fiscal Q4, HD said it made $3.21 per share. That was a three-cent beat. Year-over-year same-store sales rose by 8.1%. At a nuts-and-bolts level (literally), this was a good report. Plus, HD also boosted its dividend by 15%. The company said it expects earnings growth in the “low single digits” for this year.

Still, traders were unnerved as shares of HD lost close to 9% today. I don’t think that’s due to Putin. But why were traders so upset? This is part of the larger rotation away from cyclical stocks and towards defensive stocks. Even good earnings won’t spare you.

But I was still surprised that Home Depot was punished so severely today. In financial markets, you want to pay particular attention to things that don’t seem to add up. There’s a good chance you or the market is missing something.

The fate of Home Depot is closely tied to consumer spending and the housing sector. While things are going very well for housing, I’m not sure how much longer the party can last. This morning’s Case-Shiller report said that home prices are rising at the fastest pace in over three decades. Over the last 12 months, home prices are up 18.8%. That’s the fastest calendar year increase in 34 years. Meanwhile, the supply of homes is at a record low.

Perhaps the market is sensing a coming top in the housing market. Plus the Federal Reserve appears ready to hike interest rates several times in the coming year. On top of that, the 2/10 spread is surprisingly low. The Fed could have an inverted yield curve in a few months.

These are signs that it’s smart to steer clear of cyclical stocks and find safety in defensive names. As much as I like Home Depot, I’m not a buyer at these levels.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

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Posted by on February 22nd, 2022 at 6:54 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.