2018_08_22 — “The Wrestling Match”
August 22, 2018
The Wrestling Match
Investment markets are like wrestling matches. Alternating forces firmly push at each other and the victor is not determined till the very end. Conflicting forces usually keep us feeling like we are at a tie; right now, those forces are global growth and tax cuts pushing up versus central bank quantitative tightening and people believing we are overdue for a correction pushing down. Looking forward, other match rounds will occur like Supply vs Demand and the sustainability of 3% growth slowing to 2%.
Long-term rates will go up from here even if inflation doesn’t: Operating earnings will be up 26% this year, but future earnings growth is really what matters for stocks and stock markets. In international, we’ve seen a slowdown, but growth is still okay. The U.S. remains the growth leader, but if this is temporary, then international and emerging market diversification is needed. Volatility will return.
Spend is up: Consumer spending is strong in most everything except homes and new cars. Most consumers spend out of disposable income, and disposable income is up, and that is 2/3s of the economy. Also seeing an investment spending boom — equipment and people — in the shale industry. However, most companies are trying to figure out what to do with all their money; capex, buyback stock, distribute dividends, or invest in R&D. Tariff talk is restraining businesses from making decisions; therefore, over time we will see a flow through of investment spending to help drive economy.
Demand may fade: By late next year, demand may fade if the change in demand fades. Unless productivity measures pick up (which they seem to be doing) the economy may be supply constrained with low unemployment. Declining unemployment has aided GDP growth, but unemployment may only fall a little more. Thus, we may have only one more year to push unemployment down, after which the lack of labor will restrain growth unless more people join or reenter the workforce.
Inflation is up, but not worrisome: CPI picked up with crude prices and the headline PC deflator has crept up, but after a few months, inflation creep will look fatigued. Wages aren’t skyrocketing because there is perfect competition in the labor market, no unions, and the gig and cloud economy gives companies the ability to outsource everything. For reference, look at Japan where unemployment is 2% and wage growth is not even 1%.
Fed is raising rates for several reasons:
- If we are overshooting all our economic targets, we should not have easy money
- Easy money feeds a rising tide more than growth, and it’s done that globally; pushed up asset prices of stocks, bonds, crypto currencies, real estate, and private equity
- The Fed is trying to counteract monetary stimulus with fiscal drag
- Prepare for next downturn so that in a recession or emergency, they could lower interest rates enough to have a positive effect
Theoretically, we could coast through 2019 and 2020 with practically no earnings growth. Profits will still be terrific (versus historical measures), and earnings per share will be good. In such a scenario, if one can stomach potential volatility, one may want to view stocks a bit like long-term bonds, as investments that just throw off cash.
Michael Ashley Schulman, CFA
Disclosure: The opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The opinions referenced are as of the date of publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.