Nolte Notes 7.12.21

Nolte Notes 7.12.21

July 12, 2021

“We’re all mad here, I’m mad. You’re mad.” And so down the rabbit hole we go! Just when you think you have it all figured out, the economy and/or the markets throw you a curveball. Maddening, sometimes. But we are in a deranged time where everyone is a bit crazy. We celebrate huge employment gains, yet at the recent pace, it will take another seven months to regain the old employment peak. Job openings continue to grow as companies of all stripes can not find willing workers. Many “consumer-facing” businesses have shortened hours due to a lack of employees. The Federal Reserve believes easy money can solve this problem, so they keep rates at historically low levels while pumping over $100B into the markets every month. “When you have a hammer…”Goods are having a tough time getting to market and prices for nearly everything are rising. Many believe this will work itself out over the next year as companies fully staff up and supply chains are working properly again. Some wonder if the economy is permanently damaged. The coming week will have inflation, retail sales and sentiment indices released. The madness is not likely to get resolved this week!

Worries about the Fed “starting to think about thinking about” cutting back their bond purchases knocked down stocks for a day, but the “buy the dip” crowd piled back in on Friday, pushing stocks to yet another record and 14th weekly gain in the last 19 weeks. Yes, there are some chinks in the armor, but the easy monetary policy is what rules the day. Over those 19 weeks, 90% of the stocks within the SP500 remain above their long-term average price, however the last few weeks, barely 50% are above their short-term average price. Meaning stocks have rallied so strongly that any short-term pullback has done little to dent the long-term picture. Within the S&P500 industry groups, all but telecom are above their long-term average, so until the market “technical” begin to break down in a more meaningful way, the path of least resistance looks to be higher. Growth has been the big winner over the past few weeks as interest rates have declined. Could the rate decline be warning the markets that the best/fastest economic growth has passed? Potentially, however, we would like to see a few more indicators pointing that way before beginning to worry about the next downturn.

The yield curve flattening is a warning sign of slower economic growth. However, without a signification push higher in the yield differential between junk and treasury bonds, long-term worries are not yet heightened. Earnings season gets started this week, and there will be plenty of commentary about what companies are seeing in their “end markets” and their capacity to fill demand. Finally, comments regarding pricing and inflationary pressures could also impact bond yields, pushing them back up if investors believe those pressures are more than just “transitory” as the Fed currently believes.

The quick rotation between “growth” and “value” has been driven by changes in interest rates. As interest rates rise, value does well. As rates fall, growth does well. Both are tied to the re-opening of the economy. If investors believe that the re-opening is going well and pricing pressures are building, value does well. If investors believe the best of the economic growth is now behind us and we are heading back to the recent average growth of 2%ish, then growth will do well. From a long-term perspective, growth is very overvalued, with various companies selling at their highest price to earnings multiples going back to 2000. While value is also expensive in absolute terms, relative to growth, it is about as cheap as it has been going back to the late 1990s. We believe that over the next few years, the overall market will struggle to provide meaningful gains, but that value should shine relative to growth as the economy slowly works its way back to “normal”.

Interest rates have been driving the markets as well as various parts of the markets for the past nine months and that is not likely to change. Hence, we will be watching yield differences between various asset classes for clues as to when markets are likely to make a significant shift. Not yet in the cards but watching closely!

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.