Once again, after dedicating several hours to preparing a message to you, the assassination attempt on former President Trump on Saturday July 13, and the uncertainty as to whether President Biden will be the democratic candidate for president put everything on temporary hold for a few days.
Several years ago, I learned an insightful definition of uncertainty: "When a number of outcomes may result, but only one will." As human beings, we tend to abhor uncertainty. We cling to the belief that if we can foresee the future, we can take measures to safeguard ourselves, our families, our wealth, and our health.
In my 41-year career, I've never experienced a time devoid of uncertainty. I would characterize most of that time as a state of "normal uncertainty." However, there have been a few exceptions that stand out, such as the aftermath of the 9/11 attacks, the fourth quarter of 2008 and the early months of 2009 during the Great Financial Crisis, and the ongoing COVID-19 pandemic.
This is unquestionably one of those times.
What’s the Market Going to Do?
We want to emphasize that we monitor the companies in your portfolio with a two-to-three-year outlook.
That said, we are frequently asked, “What do you think the market is going to do?” Therefore, I offer the following:
Major U.S. equity market indices continue to rise. Despite several crosscurrents, investors' “can’t lose” attitude is likely to persist for the foreseeable future based on the belief that either the economic outlook is going improve, and/or the Fed will start cutting.
The consensus opinion seems to be that this applies until the November election.
In our opinion, it's anything but a “market” currently. By now, you are probably aware of this. This has been the case since early 2023. The top 5 names by market cap are responsible for nearly 60% of the YTD gains in the S&P 500. In addition, more stock prices are in a downtrend than up.
As of 7/16/2024, only 119 of the companies in the S&P 500 index are beating the market year to date. So, don’t be deceived when the media beats the drum about the market making new highs. Remember that the only benchmark that matters to you is having the money you will need to fund your future goals.
Economy – Signs of Slowing – Slowly
Consumers are pulling back a bit on discretionary spending and becoming more price-conscious, which explains why major retailers and some fast-food chains are cutting prices. That’s good news on the inflation front.
The labor market is cooling. Several regions reported that wage growth is normalizing back to the pre-pandemic trend
Consumer balance sheets may be weaker than they appear. Credit card delinquency rates are at 11% up from 8% this time last year.
The labor market is showing clear signs of cooling and economists believe this gives the Federal Reserve cause to lower interest rates to help engineer a ‘soft landing’ for the U.S. economy.
Businesses are shedding temporary help.
Due to these trends in addition to others, the Futures Market is currently projecting a 100% probability that the Fed will cut the Fed Funds rate in September. Importantly, it can be assumed that the cut is already priced into the markets.
Inflation
Consumers should be forgiven if they think the rate of inflation is higher than reported. The Consumer Price Index is up over 16% over the past 36 months. That’s 5.27% annualized. A long way from the 3.1% recently reported.
There are numerous elements influencing the CPI calculation, and I have consistently argued that the headline CPI number doesn't fully capture the underlying reality.
- Currently auto insurance rates, which were up 20.3% for 2023, continue to contribute significantly up 22.6% year over year through April.
- Another contributor is what is called “shelter inflation”. It is determined by the rate of increase in rents. This is over 30% of the CPI formula.
That is not a very good measure if you own your home. Forget about trying to buy one.
- The cost to insure your home is up an average of 20% unless you live in an “elevated risk” area. Earthquakes, hurricanes, tornados, wildfires, etc. Astoundingly, this expense is not included in the Consumer Price Index.
The following is courtesy of John Mauldin, Mauldin Economics.
- From Jan. 2020, auto repairs are up 32%, new cars up 20%
- Household appliance repairs up 42%
- Nutella 26 oz. jar, up 81%
Obviously, this can vary drastically from city to city.
Interest Rates
If you're under 40, this might surprise you. Many people believe interest rates are currently high and are frustrated that the Federal Reserve isn't lowering them. This perception stems from a psychological phenomenon known as Recency Bias, which often leads to distorted perceptions based on the most immediate experiences.
The 10-year U.S. Treasury bond rate is quite close to the historical average since the government began issuing bonds. More specifically, the average rate over the past 25 years is 4.39% (Microsoft Bing), while the rate as of July 17, 2024, is 4.19%. Our perception is skewed by the fact that the rate has been below 4% since October 2008 until early 2022.
Recently, I heard an opinion that I think answers the question "When is the Fed going to cut rates?" quite well: "When the Fed finally cuts rates, the reason will be clear." In my opinion, we’re not there yet, but as noted above, getting close.
Reason for Optimism
Earnings growth has been accelerating since the end of 2022, and we forecast further acceleration over the next several quarters. Not only is growth accelerating, but critically, it’s also broadening out.
Over 32% of the companies in the S&P 500 are growing earnings by at least 25%.
Though not happening yet, there is optimism, which I share, that AI will boost the rate of worker productivity growth (e.g. more value generated by a given worker in the same amount of time than they are now).
This would likely generate higher incomes, more tax revenue, and higher corporate earnings. Surprisingly, it has also been suggested that such productivity gains could help reduce carbon emissions.
AI and Weight Loss Drugs
I would be negligent to not offer insights on what I have learned about AI and the new weight loss drugs so far.
I’ve asked analysts who cover the companies whose weight loss drugs have been approved by the FDA, mainly Eli Lilly and Novo Nordisk, and analysts of the companies leading the AI evolution if it is even possible to project the future earnings of these companies to determine a reasonable price for their stocks.
They indicated, “Not really.”
Michael Dell in Fortune; “It feels every bit as big as previous waves, but probably bigger". After a pause, he said, “You know, maybe quite a bit bigger.” He pauses again adding, “I don’t know for sure. Nobody knows. “
As mentioned above, it’s no surprise that AI will structurally change the way people live, and a big economic impact will be on productivity. To put it in perspective, today's businesses produce approximately 9x what they did in 1947 with only minimal increases in working hours, thanks to substantial productivity improvements. However, productivity saw a decline following the Great Financial Crisis.
In the next 15 years, the population segment over 65 is expected to increase from 16.8% to about 22%, highlighting the critical role of AI in compensating for a diminishing workforce.
You Want to Talk About Inflation?
Twenty-two amateurs met in July of 1877 to compete in the first tennis tournament at the Wimbledon Lawn Tennis Club. Adjusted for inflation, the purse was 2.5 pounds. This year, the purse is 2.7 million pounds. I calculate that to be an increase of 9.91% annualized!