By Maurice Stouse
Financial Advisor and Branch Manager
The US economy is on a tear so to speak. Economic growth is considered by some to be beyond red hot (Fidelity recently called it “white hot”). Corporate profits have been growing at record paces, despite higher prices for materials and labor. Yes, American companies are continuing to make record profits despite the biggest spikes in inflation in almost 40 years. So, many are wondering, can it continue? That ‘it’ is economic growth and along with-it productivity, profitability and ultimately stock prices, real estate prices, and other asset prices.
Americans continue to increase their spending (US companies too) and they continue to increase their savings. Access to capital has never been so advantageous to corporate America, its citizens and its governments. Is that what has been driving inflation? Some argue it has not. They argue it is the (temporary) disruptions in the supply chain that is causing significant spikes for everything from semiconductors (computer chips) to clothing, building materials, and just about everything that relies upon shipping and delivery.
We, along with everyone else, hear and see a lot of what is going on and draw conclusions and formulate opinions. We will share them with you in this edition of Research and Commentary from The First Wealth Management.
We think it is going to take a lot to significantly slow down this economy and start to hurt corporate earnings. Starting with inflation, we think that it will sustain itself at 5% (not the 3.5% that the market is implying or the 6.8% of the Consumer Price Index). That rate by the way is more than double – in fact it is almost triple – what inflation has been in the past 20 years or so. Inflation at these levels can threaten productivity and profitability for sure. However, we think not enough in this scenario to reduce profit growth below 10%. We aren’t alone in this thinking, but it makes a lot of sense to us. Stock prices would benefit commensurably in this scenario. Stock prices tend to follow profits or profit growth, but some stocks get way ahead of themselves and get overvalued (Electric vehicle stocks or crypto exchange companies, for example). Some stocks continue to suffer a lack of interest or momentum and hence become undervalued. Believe it or not, energy stocks are still considered to be undervalued even though the sector is up over 50% for the year.
Next, the money supply. Fed stimulus and the growth of the balance sheet would have to slow down significantly or even reverse. It is important to point out that the Fed has slowed its pace of asset purchases (which has been increasing the money supply, kept rates low, created greater liquidity, made credit more available) but still has continued to grow its balance sheet and the money supply. Banks, as most depositors know, are not trying to increase deposits through higher rates on savings and CDs. Banks have access to a lot of capital. One reason bank stocks have performed strongly, and we think overall the sector will continue to do so, is simply put this way: Bank profitably grows when banks borrow on the short end (at close to zero) and lend on the long end (not close to zero, more like 3% and beyond). So, if rates or yields do go up, banks might grow their revenues and their profits more quickly.
The role that the Fed plays probably shouldn’t be understated. Recently Global X (an investment management company of exchange traded funds) called 2020 the year of the virus, 2021 the year of inflation and 2022 the year of The Fed. We tend to agree. They went on to say that yields and economic growth will be key focuses for the Fed. That included commentary on which sectors rise with an increasing 10-year US Treasury note rate and oil prices: Those are Financial Services (banks and financial services), energy (mainly oil companies but also oil services and energy transportation) and Industrials. Industrials encompasses a lot: Transportation (air, freight, rail, trucking) auto and equipment manufacturers, defense companies among others).
Economic contractions (recessions and depressions) are the result of restriction of credit. That is not happening right now and hence has been the wind in the sails of the economy. Left unchecked however that can lead to prices rising too rapidly (inflation) but also it can lead to asset bubbles. A greater supply of money pushes asset prices up and leads to higher levels of speculation. Question for readers to ponder: Is crypto currency a store of value and hence its rapid rise or is it also impacted by speculation because of the huge increase in the money supply? We think it is the latter and that investors should take caution when considering crypto as part of their asset mix.
What about Covid? Approximately 62% of the US population is vaccinated. As newer variants emerge will they evade vaccinations, cripple mobility, demand and ultimately economic growth? We think the proof is in the lockdowns or the lack there of. Most governments and nations tend to be looking to how to live and continue to grow through this virus and begin to accept it as part of life in these times. We think that Covid will continue to temper economic growth (and even take a point or two out of inflation) but not freeze it or reverse it.
Because of economic growth the demand for energy (green or fossil fueled) will continue to grow. World demand for liquified natural gas alone (to generate electricity, heating and cooking) is seeing significant increase and now some are projecting that the US, within the next year, will be the leading exporter of the fuel. And that while areas of the world, namely Europe pronounce that its energy mix will be close to 80% green energy by the end of this decade. Energy stocks and funds represent less than 3% of the value of the S&P 500. While their profitability and stock prices have grown, they still don’t have anywhere near the percent of the market as say technology stocks do at 27%.
Also, don’t forget about infrastructure growth. There are industries, companies, and sectors that could be the benefactors (along with their shareholders) of the significant investments being made into infrastructure (roads, bridges, 5G, railroads, the shoring up of flood zones and rising sea levels). There are mutual funds, exchange traded funds and individual stocks that investors could look at if they see this as an area of growth and profitability.
Regarding productivity: How can corporate America, and the corporate world keep up with higher costs of materials and labor shortages (inputs). Labor shortages are likely to continue because so many people have left the workforce, population growth has slowed significantly, and the worker participation rate is near its lowest level in history. We think the advances being made every day in automation, artificial intelligence and outsourcing – when juxtaposed with higher cost of labor – deliver that badly needed productivity to remain or grow profitability. The Kiplinger Letter recently cited the demand and growth of so called cobots or collaborative robots that “work side by side with workers” as one example of technology boosting or improving productivity. This could be an answer to the not only the growing cost of labor but the shortage of labor as well. Investors have more access than ever to directly participate in these technologies or sub sectors through individual securities or through the funds that represent them.
In the end, until there is an opposing shift, we believe the economy will continue to grow.
At The First Wealth Management we encourage our clients, when considering changes, to make changes over time versus making them overnight. While we appreciate the old saying that at first you must concentrate to create wealth, we also appreciate that investors should look to diversify in order to preserve wealth. We are not looking to be right with market commentary but rather to be ready for changes and to work with our clients on making those over time.
The First Wealth Management is located at First Florida Bank, a division of The First Bank, 2000 98 Palms Blvd, Destin, FL 32541. Branch offices in Niceville, Mary Esther, Miramar Beach, Freeport, and Panama City. Phone 850.654.8122.
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