I recently introduced the classic board game Axis and Allies to my sons. Michael, my third-grader, asked to be Russia, and I was happy to let him. When it comes to his turn, as head of Russia, the first thing he did was invade Ukraine. I shouldn’t have been surprised – this is the same kid I used to hear randomly announcing (while floating in a sea of bubbles in the bathtub) that Amy McGrath was “too liberal for Kentucky!” Remember those ads? Can’t say he’s not paying attention! The daily flow of nonstop media really does affect us all.
I wanted to start the final month of the year with a market update. It’s been a challenging year (to put it mildly) in which the markets have been impacted on all fronts, whether it’s the Fed and interest rates, inflation, international warfare, or continued Covid/supply chain battles. In short, it’s been a treacherous year to be an investor in the stock market. I’ve had to remind many people that the old adage about not shooting the messenger still holds. We at Family Financial Partners do not decide federal reserve policies, and we certainly can’t affect the markets – one way or the other.
During the pandemic, it seemed like no one wanted to talk numbers – they were more worried about actually surviving to worry about market declines. Now that many things have returned to normal in other ways, people are much more concerned about the downward trend in the markets. In 9 of the 11 months so far we have seen the markets decline, and people have been asking what’s going on.
The Fed said this week that the next rate hike will come this month, but they indicated less of an increase than they first indicated. Here’s what was actually said: “Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.” This could explain why the equity markets rallied so significantly on Wednesday – for the first time in a long time, hope has returned to Whoville. Even the Grinch has said that it might be time to start celebrating.
So, what does this mean for your portfolio? That’s a great question, but first, what does it mean overall? Let’s take the temperature on the economy: What we know is that energy costs are down in the last few months. Since April, transportation costs have dropped. Oil and gas prices have dropped. The supply chain has improved in many industries, and since summer, we’ve had natural gas prices also decline.
Why is it important that natural gas prices are declining, you may wonder? After all, we only use it to heat our homes in the winter. Well, those prices are important year round because most of the manufacturing and assembly line facilities in this country are powered by natural gas. Fifteen or twenty years ago, it was determined that coal was too expensive and dirty to continue to use, so natural gas became the go-to source as, at the time, it was dirt cheap. Due to the pandemic and supply chain disruption, natural gas is still significantly higher than it’s been in recent years despite recent declines from the highs we were seeing.
If you’re still wondering why that’s important to you, think of it this way: that box your cereal comes in, the carton your eggs are in, the cans for beans or the Styrofoam tray your steaks come on are all produced in facilities that rely on natural gas to power them. I’m sure you’ve noticed that your grocery bill has gone up in recent months. That’s due more to the increase in packaging costs than increases in the cost of the actual food. Overall, we are now seeing a reduction in the supply chain and manufacturing costs that have been passed on to the American consumer of late.
Now, what things still need to be improved upon? Housing affordability due to higher mortgage rates is probably the number one thing people would name if this were a Family Feud category. It’s actually the little brother – the rental and leasing market that – is still significantly higher cost-wise, not only year over year, but since the start of 2022.
The next issue is jobs – job markets are tight, and employers are forced to pay a higher and higher hourly wage to attract employees. Oftentimes, even $16/$18 per hour cannot attract and retain a good employee. Heck, I stopped in a Buc-ees recently and noticed that a manager there could make $250k. My first thought was, I wonder if brisket is a bonus…? In all seriousness though, this is great for the employee who’s looking for a new job. It’s terrible for the employers, as that cuts into the business margins, and those higher wage costs have to go somewhere, so they’re passed on to you and me, the consumers.
As we continue to see further improvements in packaging, housing/shelter costs, and wages, I would expect that we will see more enthusiastic market outlooks. Inflation is a killer not only to grocery shoppers, but also to shareholders, renters, and any of you who own stock in the market. As these three areas improve over time, so should our portfolios.
How long with this improvement take? If you want my exact guess, call me. But my belief based on years of experience is that the recovery will be shorter than people anticipate. I say that because over my career, I’ve seen certain trends play out time and again. When I’m hearing from folks that they’re positive this recovery will take years (or will never happen at all), I remind myself that this is coming from the same group that wanted to buy AMC and Game Stop, cryptocurrency, and, going all the way back to 2012, the same group that wanted to buy gold at an all-time high. I’m not trying to suggest that all of the inflation we’re experiencing will go away tomorrow.
I’ve said before and I still agree that this inflation is going to stick around for a while, but the stock market is a discounting mechanism, and a forward-looking mechanism. I’ve seen multiple times in my career when the markets climbed the proverbial wall of worry, and anyone on the street wanted to explain to you why the world was ending, and the US was about to fall like Rome. I suspect this time will be no different.
That said, a year from now we may still see the ongoing war between Russia and Ukraine, and China may still be figuring out whether to vaccinate everyone or nail people into their homes. We will certainly still have political unrest. My guess is that that won’t get better for likely a couple years. So buckle up.
But if inflation does show signs of continuing to improve, the Fed does taper rate hikes, and the dollar – which has been strong this year – continues its decline, then you could find yourself in a solid setup for the markets. Future earnings estimates have lowered of late, and companies may get to a point soon where they can exceed their estimates. And if we get to that situation, I expect the markets to be significantly higher than today, despite all these problems.
Article by David Smyth, Senior Partner at Family Financial Partners — a financial services firm in Lexington, Kentucky.
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