CWS Market Review – December 14, 2021

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The Worst Inflation in 40 Years

Last Friday, the government released the inflation report for November and it confirmed that the U.S. is now having its worst bout of inflation in 40 years.

Remember how Fed Chairman Jerome Powell kept telling us that inflation is merely “transitory”? Well, that’s all out the window. Now it looks like the Fed may ramp up its tapering bonds. (My apologies for the confusing syntax. By this I mean the Fed will reduce their bond purchases at a faster pace than before.)

First, let’s look at the numbers. For November, headline inflation increased by 0.78%. That’s actually a slight decrease from October’s rate of 0.94%. For its part, the Federal Reserve puts a lot of the blame on the supply-chain crisis. In other words, the Fed says it’s not the fault of the Fed.

I’m reminded of this quote from Milton Friedman:

Central bankers always try to avoid their last big mistake. So every time there’s the threat of a contraction in the economy, they’ll overstimulate the economy by printing too much money. The result will be a rising roller coaster of inflation, with each high and low being higher than the preceding one.

Personally, I’m not so worried about supply issues. As long as there’s money to be made, someone will come along and fix it. That just takes time. I’m more worried about consumers becoming used to higher prices. Once that mentality settles in, it’s hard to shake loose.

Over the past year, consumer prices have increased by 6.88%. That means that if you have a $1 million portfolio, inflation eats up $68,800 every year. That’s the highest year-over-year rate of inflation since June 1982.

The “core rate” of inflation, which excludes volatile food and energy prices, was a little better behaved. For November, the core rate was up by 0.54%. Over the past year, the core rate is up by 4.96%. That’s the fastest core rate in 30 years.

By the way, the core rate comes in for a lot of criticism. It’s not that we ignore food and energy costs. That’s obviously an important part of every family’s budget, especially lower-income folks. Inflation is an especially cruel tax on the poor and those on fixed income.

The problem is that food and energy can be highly volatile. As a result, the month-to-month prices may not give us an accurate measure of the trend in inflation.

For example, here’s a surprisingly optimistic fact. November’s rise in core inflation was the fifth highest in the past eight months. That could suggest that inflation may already be cresting. I think it’s far too early to say that conclusively, but it’s something to take note of.

There’s still more evidence of high inflation. Today we learned that wholesale prices are up 9.6% over the last year ending in November. That’s the highest on record which sounds impressive, but the data series only goes back 11 years. Still, it was higher than Wall Street’s estimate of 9.2%.

The wholesale numbers are important to watch because higher inflation would hit this sector first before wending its way to consumers. Businesses generally do their best to make prices for the consumer as stable as possible.

Inflation has an unusual impact on businesses and, in turn, on stocks. Not all earnings are the same, and inflation exacts a heavy toll on asset-heavy businesses. Companies with high assets relative to their profits tend to report ersatz earnings.

Inflation has an impact similar to putting a magnet near a compass. Everything gets a little screwy. Historically, stocks have not performed well during periods of high inflation. Investors who lived through the 1970s will certainly recall that. During the entire decade of the 70s, the Dow gained a grand total of 38 points.

While inflation has been tough on stocks, there’s only one thing worse for stocks, and that’s deflation. What the market truly loves is low consistent inflation. In other words, pretty much what we had over the last 30 years, minus 12 months.

Of course, the recent inflation numbers haven’t scared off stock investors. On Friday, the S&P 500 closed at an all-time high. Our 67th record high this year. Last week was the second-best week for the S&P 500 all year.

However, the problem isn’t inflation per se. The threat for stocks is really the threat from bonds. Inflation doesn’t impact the stock market directly. Instead, inflation wrecks the bond market and that throws sand in the gears of the stock market. The higher bond yields are greater competition for stocks.

The last time inflation was this high.

The Federal Reserve is meeting this week, today and tomorrow, and I think there’s a good chance that the Fed will change its taper policy. Previously, the Fed said it will reduce its pace of bond buying by $15 billion each month. They may double that. That means the Fed would be on pace to wrap up its bond purchases by March of next year. We can assume that rate hikes would come shortly after that.

The bond market is already pricing in the rate increase. The futures market now sees three rate hikes coming next year. This is a sudden change from only a few months ago. On June 3, the two-year Treasury was yielding just 0.09%. Now that’s all the way up to 0.66%. That’s still very low, but it’s higher than where it was. Over the same time, the three-year yield has jumped from 0.16% to 0.95%.

It’s as if the bond market is saying, “rates aren’t rising now, but they soon will be.” The Fed will release its policy statement tomorrow at 2 pm.

The Stock Market Is Still on Defense

I’ve become a broken record on this topic, but it’s too important to set side. The stock market has become much more defensive over the past month. Riskier stocks have been feeling the pain. Meanwhile, the stable stocks are doing just fine. Even though the surface of the stock market appears fairly staid, the undercurrents are quite dramatic.

On our Buy List, stocks like Church & Dwight (CHD) and Hershey (HSY) have been at or near new highs. But former high-fliers like Nvidia (NVDA) and Tesla (TSLA) are down sharply. Tesla is more than 20% off its recent high.

Here’s another look at the S&P 500 High Beta Index (red) compared with the S&P 500 Low Volatility Index (blue). Since November 8, the Low Vol Index is up by 3% while the High Beta stocks are down over 8.3%.

This is a direct result of the Fed’s willingness to tackle inflation. Once the Fed gets tough, rates will go up. That’s why the defensive stocks are prospering. Already this year, we’ve had more than one rotation. Those have petered out. This one may not.

Apple’s Lost 20 Years

Every so often, I tweet this fact: “If you had invested $10,000 in Apple (AAPL) on June 6, 1983, by April 17, 2003, you’d be sitting on $8,400.”

I’ll usually get a few responses telling me that this can’t possibly true. Or I obviously left out stock splits. Nope, the numbers are correct.

It’s remarkable to consider that Apple, which is on the doorstep of a $3 trillion valuation, didn’t do much for nearly 20 years. I think there’s an important lesson for investors in that.

Even if you’re right about the stock, you can get the timing all wrong. It even took a few years after Steve Jobs had returned to Apple for it to turn around. It’s also a reminder that companies are always changing. Sometimes for the better, but not always.

Oh…by the way, that $10,000 investment is now worth more than $6.2 million.

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 December 14th, 2021 at 6:53 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.