Monthly Outlook: November 2021
Markets rebounded nicely in October on decent earnings reports and renewed optimism. The U.S. S&P500 rose 6.9% and the international stock index gained 2.7%. That makes up for similar losses in September and global stocks indexes are now back to where they were two months ago. Bonds did absolutely nothing in October as the 10-year U.S. Treasury held steady at about 1.55%. The current stimulus bubble that we are in for financial assets (stocks, houses, commodities) was created by years of monetary stimulus from the Fed and fiscal stimulus from Congress. Despite a robust economy, low unemployment, and rising inflation, the stimulus just continues open-spigot. The Fed jawbones about inflation but does very little to actually taper its stimulus. And Congress, with too many talking heads to agree on any direction, continues its stimulative deficit spending. So, why wouldn’t the markets just keep grinding higher?
Inflation is Transient?
Jerome Powell, Chairperson of the U.S. Federal Reserve, likes to use the term “transient inflation” to describe the current state of prices in the U.S. He says the price hikes are due to supply chain disruptions caused by the COVID pandemic and we’ll be back to normal (and lower inflation) soon enough. If inflation is transient, the Fed doesn’t have to do anything since the situation will take care of itself. But inflation is becoming much more persistent than transient. Even the Fed has started to admit that. It’s basic Economics 101 teaching that price is a function of supply and demand. We have less supply of both materials and labor for various reasons. And we have increased demand from consumers and corporations that are flush with cash for various reasons. The result is rising prices on everything. And I don’t see this supply/demand imbalance fixing itself anytime soon.
In a service economy like the U.S. where we don’t manufacture much “stuff”, labor is often the largest line item on corporate income statements. And labor costs are rising quickly and significantly. According to the Bureau of Labor Statistics (BLS), the labor participation rate is just 61%, a multi-decade low. By their count, there are over 101 million people not in the labor force. For various reasons, people don’t want to or don’t have to work. So, the supply of labor is low and will stay low. Meanwhile, demand is high because there is so much stimulus cash in the system. None of this is likely to change soon and so inflation is likely to be a real problem. The Fed is going to have to fight inflation sooner than later and when it pulls back the stimulus that spiked our financial market punchbowl, it will be time to get protective. The Fed meets again this week and there is strong speculation that they will announce the beginning of a gradual tapering of its current QE stimulus program as soon as November. Investors and analysts already know this, but they don’t act like they believe it yet.
How to Invest Today?
As we close 2021 and move toward 2022, the COVID pandemic is largely behind us (most likely), and the economy has recovered. The massive stimulus programs have worked, but they’ve driven stocks and houses to record high valuation levels. We’re moving from a period of recovery to stagflation and that has implications on our portfolio management. With rising rates, shorter-term bonds will outperform longer-term bonds. For the past decade, with massive stimulus, “growth” stocks in the technology and communication sectors outperformed “value” stocks in the financial, energy, and industrial sectors. Although growth is still outperforming value, that balance is likely to shift, and we may have to switch our tilt to value in 2022. We are watching “real” assets like gold, real estate, TIPS bonds, and others and are open to including them in our portfolios.
We are aware of all these issues, but the market uptrends continue. U.S. stocks continue to outperform international stocks and Growth continues to outperform Value. So, we’re tilted toward both. Only Emerging Markets are down-trending and we’ve trimmed those. Our equity portfolio is 95% invested with very little cash, which doesn’t sound too cautious. But with inflation at our doorstep, the stimulus party is unlikely to last much longer. We’ll remain vigilant for any new downward price trends in any market where we invest. And when it’s time, and not until, we’ll get protective.