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Mitch writes this blog for Resolute Wealth Management, LLC, and some of the content within this blog are opinions on financial products and/or securities that may not reflect the opinions of the firm or be applicable to everyone’s situation. If you have questions about whether this content applies to your specific situation, please reach out to Mitch directly at firstname.lastname@example.org.
The markets these days don’t make things easy on us. The S&P 500 is in a decline and approaching bear market territory. Bond markets aren’t the haven they historically have been in market declines. We’ve even witnessed declines in typical “safe haven” investments like gold and other commodities. Cash has been king since the beginning of the year. But is the economy okay? A large part of my investing process focuses on evaluating the health of the overall economy, and these “leading” indicators determine how I position client portfolios. When a lot of these indicators are positive, I typically expect to see strength in the economy. When a lot of these indicators are negative, I tend to get more bearish and conservative, expecting weakness in the economy.
What’s Going Right
One of the easier indicators of economic strength is our unemployment rate. The Fed generally considers an unemployment rate of 4 to 5% as “full employment,” which was backed up a few months ago by Fed Chair Jerome Powell stating that they would start raising interest rates when they had reached what he referred to as “full employment.” The current unemployment number in April was 3.6%, which is now back to pre-pandemic levels. We are in the middle of what’s been coined the “Great Resignation,” as companies have struggled to find enough workers in a fully employed labor market. This has led to wage pressures as companies are forced to offer more incentives to attract talent, which we will talk more about in a moment.
2) Manufacturing Demand/Industrial Production
When there is demand for companies’ manufactured products, it means that industrial production is strong and can be predictive that demand for products is strong. I measure this by looking at the NAICS Industrial Production Index, which reports monthly. We’ve seen a large jump in demand since the beginning of 2022, with the index going from 101 to 104. The question with this clearly positive data point is whether this is “true demand.” We have heard stories of ships being stuck at harbor and trucks being stopped waiting for products to offload. These supply chain disruptions are likely to be creating this demand and the rise in the index. As some of these supply chain issues slowly ease up, production is able to increase.
What’s Going Wrong
I think everyone watching this video blog would agree that things are getting more expensive. We feel it everywhere, from gas pumps to grocery stores. The core Consumer Price Index year over year change was 8.2% for April, which is a good proxy for how much more expensive similar good have gotten over the past 12 months. We really starting to see a change in inflation about a year ago, as Fed Chair Powell stated that the rise was “transitory” due to the supply chain backups we just discussed. He reversed course at the beginning of this year, stopped calling it transitory, and announced that the Fed would start an aggressive interest rate increase program, reversed course from buying long term bonds to support the economic recovery to a program centered around selling off the bonds on the current Federal Reserve balance sheet, which would remove money from our supply. The big question everyone is trying to answer is whether the Fed moved too late and misstepped in calling the inflation last year transitory. My opinion is that the Fed was slow to stem inflation because the markets were recovering nicely and they didn’t want to take an action that interrupted that momentum. Now they are in a very difficult situation, where they are pressured to raise interest rates aggressively to combat the inflation that is clearly not transitory, but also have to be concerned about overreaching with the rate increases and launching the economy into recession at a time when inflation is a problem.
2) Consumer Sentiment/Retail Sales
It appears that consumers are finally turning negative toward future growth. The University of Michigan’s Consumer Sentiment Index is published monthly and measures a survey of consumers taking their views on current business and employment views as well as future outlooks. This sentiment index has been falling steadily since May of last year, which was the peak level reached since the pandemic began. Consumer sentiment turning negative means they will look to spend less and save more of their income, which reduces the goods and services being purchased. This ties in with inflation, as basic economics tells us that when things get more expensive, consumers buy less of them. That impacts companies’ revenues and profits. Recently, we’ve seen retail companies such as Amazon, Walmart, and Target report missing in earnings. Their commentary has been similar: inflation is causing consumer purchase habits to change, spending less and focusing on grocery items in particular. This looks like a rotation from consumers buying “quality of life” goods and focusing on basic necessity purchases in an effort to trim back budgets and save. Less spending equals a shrinking consumer economy.
What I’m Watching
1) The Federal Reserve
The biggest factor in my opinion on where we go from here is how the Federal Reserve decides to proceed. I mentioned before that they were late to the game on scaling back their economic stimulus as inflation started to rise. They now could be compounding it by aggressively raising interest rates and hampering economic conditions to the point that they send the economy into recession. We actually saw a version of this in December of 2018. At that time, the Federal Reserve was in the process of raising interest rates, and announced a rate increase that the market ultimately viewed poorly. The market declined 19.6% from October 1, 2018 through Christmas Eve, as investors poured out of growth and into safer assets, fearing a Fed-induced recession. The Fed ultimately backtracked on the rate increase, and the market had recovered almost all its losses by the end of April just four months later. The difference this time is that Chair Powell is committing to projected rate increases. If he ends up ultimately being wrong and overincreases, the markets and economy could be in for a rough ride.
2) Home Sales (new/existing)
One of the big strengths we’ve seen in the economy over the last 24 months has been the surge in housing. Existing home prices have soared, new homes are purchased and built at record paces, and in most markets, homes are bought up within days of hitting the market. Over the past few months, the market data is showing a leveling off. One consequence of rising rates is an increase in mortgage rates that banks offer for home buyers. As mortgage rates rise, this will curb some of the demand in homebuying and refinancing, but will it curb all of it? A sharp pullback in home sales will be an indication that the economy is weakening and would be a warning sign.
Where Do We Go From Here?
No one knows (including me!). The best advice I give to clients in situations like this is that investing is a process. It’s easy to forget about all the good times when things are going up, the sky is sunny, and their investments are growing during times like this. It completely affects investors in different ways. If you’re a younger investor with lots of time left to build wealth in the markets, it’s likely much easier to see the market pullback 15-20% and not sweat it a lot. If you’re an older client retiring or just recently retired, this is the last thing you want to see when your wealth curve is at its peak. I’ve included this chart here at the end. This is a chart of the yearly changes in the S&P 500 from year to year. This chart is a little busy, so let me explain it. The solid blue bar for a year indicates the percentage gain in the index for the year. The light blue bar shows the highest point it reached during the year. For example, in 2016, the S&P 500 increased by about 9%, but at one point during the year it was up as much as 24%. The solid gray bars indicate years when the index finished lower for the year, and the light gray indicates the lowest point the index reached within the year. In 2001, the index lost about 10%, but at one point it was down 17%. The point to this chart is that in every year, there are “ups and downs.” This chart covers the time period 1948 to 2017. In that 70 year time period, the average decline intra-year in the market is 13.4%, and yet despite that bleak out look, the market gained value for investors in 51 out of those 70 years! The market is volatile, but patience is rewarded most years. We don’t know whether 2022 will turn out to be positive or not, but we can’t rule it out. The best thing I do for clients is build investment plans that fit where they are in life and position them to be able to weather market pullbacks of this severity. I’m definitely not the type of investment professional that can tell you where the “top” or “bottom” of a market is, and I don’t try to. I believe my investment philosophy works because my clients have diversified portfolios, strong plans, and are invested to “stay in the game” when markets get turbulent. That means identifying their ability and willingness to accept investment risk and making sure their portfolio reflects that.
Thanks for checking out the blog! If you have questions regarding your portfolio and are concerned if it is properly set up for the markets, I conduct free, no-obligation portfolio reviews on an appointment basis, I’d be happy to set up a time to look over your investments. If you’re younger and just getting started in investing, I work with younger clients to help them get a great start on their financial foundations and set them up for future success. Reach out to me to learn more about how I can help! Have a great week!
About the Author:
I work as a Financial Consultant with my partners Bob Montavon and Tom Schwab for Resolute Wealth Management, LLC. After spending several successful years in business management working with clients in the retail and construction equipment industries, I transitioned into financial services to help make a greater impact on my client’s lives. I work with clients from many different backgrounds, incomes, and situations. By helping clients identify where they are and where they want to go, I serve as a fiduciary and trusted advisor to help them dodge roadblocks, adjust to different situations, and reach those goals. I graduated from Wright State University in 2018 with a degree in Investment Finance, and completed my MBA work at The Ohio State University. I currently hold the Chartered Financial Analyst (CFA®) designation, and serve as membership chair on the Board of Directors of the Dayton CFA Society. In addition, I am a member of the Centerville Noon Optimists of Centerville, OH, a volunteer and social organization working to promote opportunities for local youths in the Centerville/Washington Township communities.
Want to Reach Me?
- https://fred.stlouisfed.org/series/UNRATE, St. Louis Federal Reserve Unemployment Rate
- https://fred.stlouisfed.org/series/IPMAN, St. Louis Federal Reserve Industrial Production Index
- https://fred.stlouisfed.org/series/FPCPITOTLZGUSA, St. Louis Federal Reserve CPI Index YOY Change
- https://fred.stlouisfed.org/series/UMCSENT, St. Louis Federal Reserve University of Michigan Consumer Sentiment Index
- https://topforeignstocks.com/wp-content/uploads/2018/06/Intra-year-Declines-of-SP-500-Since-1948.png, Intra-Year Declines of S&P 500 1948-2017