2018_09_05 — “The Market Boxing Match”

September 5, 2018

The Market Boxing Match

Summary

• Conflicting investment market forces often keep us feeling like we are at a tie
• Asset price volatility will return, eventually; but with a long enough time horizon, you can clip coupons off of stocks
• More people may have to join the labor force for demand to grow
• The Fed is preparing for the next downturn, but that is not a prediction of a downturn

Investment markets are like boxing matches. Alternating forces lob strong punches and the victor is not determined till the very end. It’s the proverbial bull and the bear locked in a fight; winning a round or scoring a few points is not tantamount to winning the match. Conflicting forces usually keep investors feeling like they are at a tie.

Investment markets are like boxing matches. Alternating forces lob strong punches and the victor is not determined till the very end.

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 versus demand, unemployment versus inflation, emerging markets versus developed markets, and the sustainability of slow growth versus no growth.

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 almost everything except homes and new cars. Most consumers spend out of disposable income, and disposable income is up, and that is 2/3rd 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, buy back 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 the economy.

Demand may fade: 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. By late next year, demand may fade if total consumer income growth decelerates. 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 re-enter 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:

I. To restrict easy money since we’ve overshot our economic targets

• Easy money feeds a rising tide more than growth, and it’s done that globally; pushed up asset prices of stocks, bonds, cryptocurrencies, real estate, and private equity

II. To counteract monetary stimulus with fiscal drag

III. To prepare for next downturn so that in a recession or emergency, the Fed 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 volatility, one may want to view stocks a bit like long-term bonds, as investments that just throw off cash.

Michael Ashley Schulman, CFA

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Disclosure: The views and opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The views and opinions referenced are as of the date of initial 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 person’s or 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.

Originally published at https://seekingalpha.com.