Nolte Notes 3.22.21

Nolte Notes 3.22.21

March 22, 2021

The days are longer than the nights and the weather is beginning to warm up. Baseball starts in 10 days! Summer is just around the corner. The economic “issue” is that inflation is beginning to heat up as well. Getting lumber or copper for homebuilding or gas for your car is costing a whole lot more than a year ago. As a result, interest rates are rising and pushing the Fed to recognize that an ill wind that blows does nobody good. Inflation, in the words of the Fed, may be transitory, but for how long? Expectations are for an economy to be blowing hot during the summer as economies open around the world. With all the stimulus and people going back to work with extra money in their wallets, inflation may be around for something more than a transitory period. To be fair, the Fed has pulled the punch bowl from the party well ahead of things getting out of hand, but this time wants to wait until they start seeing the party really rolling before raising rates.

Last week’s economic data was less than stellar, but the key report will not be showing up until April’s jobs report. The weekly jobless data is stuck in low gear, without much change since Halloween. However, the continuing claims are about double that of early 2019 and about two-thirds of the peak in 2008/09. Other data points are indicating the economy is healing, albeit very slowly. The coming jobs report will be informative as to the type of jobs coming back. In early March, the jobs report showed a large pick-up in hospitality jobs, restaurant, hotel, and bars. The trend is expected to continue as various states are loosening the restrictions of the past six months or so. Commodity prices are beginning to roll over a bit, energy prices have dropped from their recent highs and agriculture prices are down for March. So, while inflation indices could continue to rise in the months ahead, some prices are beginning to decline. As vaccinations increase and economies open, the main debate is how much pent-up demand is out there. Many are hungry to get out, others remain cautious. Trying to guess human behavior after this year is a fool’s errand. We will watch how things unfold rather than trying to guess.

The direction of interest rates has been the focus of investors over the past month as rates on the 10-year bond is now at the highest level in over a year. However, looking back at the 10-year yield, rates have been in a range between 1.50% and 3% since mid-2011. Before collapsing to under 0.60% last summer, the yield on 10-year bonds was near 2%. The concern today is that inflation is going to spike, and the Fed will have to step in to raise rates. The Fed has stepped in early, anticipating the inflation that never came. Today, they want to see inflation before beginning to tighten rates. They should be on the sidelines until sometime in 2022.

The battle between growth and value continues to rage during March and has been dependent upon the direction of interest rates. When rates rise, growth stocks falter. When rates ease, growth races higher. Growth stocks are all about future expectations for earnings that get discounted back to a price today. As rates increase, that discount rate also increases, pushing today’s value lower. More cyclical stocks that are tied to economic growth benefit from a better economy. They tend to be very leveraged to economic growth, doing very well as the economy recovers and booms, and collapsing when the economy hits a recession. We have been concerned that growth stocks have “discounted” every possible bit of good news in their price, so any change could mean much lower prices if those expectations are not met. While not necessarily as egregiously priced as the tech bubble in 2000, many growth stocks are still priced for perfection and could fall dramatically if those expectations are not met. Meanwhile, little is expected of the consumer related stocks in the face of the pandemic. As the economy opens, many will do very well as consumers return and spend money. That rotation from growth to value is likely to continue in the weeks/months ahead as people start to feel better about mingling with others.

Interest rates are likely to continue to rise as economic growth should also rise dramatically over the summer months. While that growth may be temporary, investors will still fret about potentially higher inflation and a Fed that may begin to tighten monetary policy and push interest rates higher still.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.