As regular readers of our newsletters know, we have believed that the COVID pandemic and the responses to it (both private and government) have introduced serious flaws into the data sets that are heavily relied upon by planners and forecasters. One result is that more and more, speculators (even highly paid professionals) have been pushed into believing that ‘the data says what I want (or hope) it says.” We think these are very good times to consider a wide range of thought and remain open to diverse opinions.

Among the pros we expect to have great opinions based on good research and analysis are Brian Wesbury and Robert Stein at First Trust. With their kind permission, we will share with you today some of their current thinking.

~ Ron

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist

Date: 8/22/2022

One thing we must remember when looking at economic data, is that everything is distorted. The US (in fact, much of the world) panicked in 2020. COVID caused governments around the world to implement unprecedented policies. The US borrowed, printed, and spent its way through the lockdowns. We believe, and we don’t think it’s hard to understand, that the economic bill for these policies, is soon coming due.

We don’t expect a recession like in 2020, or a repeat of the Great Recession in 2008-09, but the unemployment rate will eventually go up, job growth will go negative, industrial production will fall, and so will corporate profits. At that point we won’t have a big debate about whether we’re in a recession; everyone will know it. 

In the meantime, before a real recession sets in sometime in 2023 or early 2024, many people will believe the recession is already here. Especially, as the shift away from goods and toward services gathers steam.

Right before COVID started, in February 2020, “real” (inflation-adjusted) consumer spending on services was 64% of all real consumer spending.  With the economy locked down, services fell to 59% of spending by March 2021. That five-percentage point decline represented roughly $700 billion of spending.  Consumers have clawed some of that back with services now up to 62% of total spending, with big recoveries in health care, recreation, travel, restaurants, bars, and hotels. And we expect this trend to continue.

Yes, companies like Peloton and Carvana, where investors apparently projected COVID-related trends to persist, have gotten hammered. Some look at layoffs at these companies, and others in similar straights, as a sign that recession is already here. But these aren’t macro-related developments; they are a realignment of economic activity from a distorted world to a more normal one.

Another distortion from COVID policies was a big drop in labor force participation, which is the share of adults who are either working or looking for work. The participation rate was 63.4% in 2020 but now, even though the unemployment rate is back down to the pre-COVID low of 3.5%, participation is only 62.1%.

Part of the problem might be inflation. “Real” hourly earnings are lower than they were pre-COVID.  So fewer people might be participating, despite low unemployment, because they (correctly) realize the real value of work is less than it used to be. Another problem is that big-box stores and Amazon stayed open, while many small businesses in certain states were closed. Whether this represents a permanent shift in employment and productivity, or a temporary one, remains unclear 

Yet another shift is in housing. Home prices soared during COVID, with the national Case-Shiller home price index up a total of 41.4% rate in the past 27 months (through May 2022). That’s the fastest increase for any 27-month period on record, even faster than during the “housing bubble” of the 2000s. Meanwhile, with the government preventing landlords from evicting tenants, rent payments grew unusually slowly during the first eighteen months of COVID.

But now rent payments are catching up. Expect a major transition in the next few years, with rents continuing to grow rapidly while home price gains slow to a trickle by late this year and then home prices remain roughly unchanged in the following few years.

What a fiasco. More employment at large firms, less at small firms. More renters, fewer owners. Lower inflation-adjusted incomes. Distorted economic data. The costs of the lockdowns, one of the biggest policy mistakes in US history, are absolutely immense.

Voters will react, and at least one house of Congress is likely to go the opposition party this November, meaning legislative gridlock for the next two years as the nation sorts all of this out.

Ron’s Market Minute  – Inflation: Follow the Money

Couple of quick thoughts this morning…

One of the people that I consider an important mentor is Greg Morris. Although he is primarily known for his teachings on Chinese Candlesticks (how many people do you know who teach Chinese Candlesticks to the Chinese – in their own language?) he has had very useful advice for our trading habits over the years. He often has said: ‘Be very wary of trading around Fed announcements!’ He reasons that there is too much market craziness  and much of it is usually reversed within the next few days. I certainly had that in mind as I reduced Nasdaq holdings early this week and replaced with commodities holdings. The technical indicators suggested that Nasdaq stocks would be weak – and indeed they are – allowing us to feel ‘smart’ for a few hours today.  Tomorrow, of course, can be a very different story. 

So on to some thoughts about Powell’s speech today. He reiterated a pledge to ‘forcefully’ fight inflation that is ‘still running near the hottest pace in 40 years’. Today’s ‘money quote’ from the Fed Chief: “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses”.  The Powell Doctrine is thus: These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain. He stresses that the Fed is NOT in a place to ‘stop or pause’ — which is a very unwelcome sign for the many investors who were opining that there would be rate cuts next year.

So back to Morris. He also suggested that one of our greatest assets is to be a strong skeptic — especially of the ‘experts’. And so, here is today’s chart. Before we accept the ‘fact’ that inflation will be a continuing problem, let’s look at the history of REAL investor behaviour, the ‘proof from the pudding’ aka Wall Street. Our chart for today goes back to the 70’s (ask your grandmother!) for the market’s thoughts on gold. 

It’s widely accepted that gold has been a good hedge against inflation. From this chart which shows the relative strength of gold vs. the ‘market’ that the 70s were a time that Wall Street POURED money into gold.  As the chart slants upward, there is more strength and more investor dollars pouring into gold.  This shows pretty clearly that Wall Street had its expectations right, and the dollars flowing into gold were confirming the monstrous inflation to follow. During that time, investors did much better investing in gold than in stocks. That soaring ratio wasn’t theory or just talk, it was actual MONEY flowing into gold. OK now that you see the big inflationary period in our past, have a look at the current two years. We know that inflation has been soaring, just as it was back then.  But where is the money flowing today? Into gold? Not according to the chart. I believe that Wall Street has many very smart minds.  (Much smarter than I am!)  But I can follow the charts which indicate where money is going.  AND IT’S NOT GOLD. Which indicates (in actual dollar terms) that Wall Street is not concerned about inflation- at least not in the longer term. 

Is the Fed about to cause more needless pain?  Just thinking out loud. 

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite D406A
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk


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