Fun While It Lasted
With winter quickly approaching, at least for those of us in the northern latitudes, we might feel some melancholy about the end of autumn, which is arguably the most pleasant season of the year here in Minnesota (notwithstanding the Vikings win-loss record in any given year.) But winter brings new opportunities – whether it is being outdoors for wintertime activities or being quite comfortable staying indoors and cozying up in front of a warm fireplace. Given the stock market volatility of last week, investors might have many of the same feelings. Disappointment around the strong run of the previous five weeks slowing should be followed with optimism for what lies ahead.
The S&P 500 ended the week slightly lower, experiencing its first weekly loss since the last week of September. The primary driver of last week’s market activity was inflation, which continues to be on the forefront of consumers’ and investors’ minds. The talk of higher prices has been accelerating for most of this year, akin to a low rumble quickly building in intensity. Now that rumble has grown considerably louder since consumers see higher prices in many, if not most, goods purchased, especially as the holiday season approaches.
The stock market unceremoniously snapped an eight-day winning streak after a surge in the Producer Price Index (PPI) was reported last Tuesday. The PPI, which measures the change in prices charged by producers for their goods and services, rose 8.6% from a year ago and remains at the highest levels recorded since this measure began in its current form 11 years ago. The markets were spooked even more on Wednesday by the Consumer Price Index (CPI), a measure of the change in prices paid by consumers, which showed a yearly increase of 6.2%. This was above analysts’ expectations and the largest year-over-year increase since December 1990 when the first Bush was in the White House. Core CPI, which excludes food and energy, was the highest it has been since 1982!
These high inflation readings have implications for the stock market, bond market and overall economy. Raw materials producers, such as energy and mining companies, that benefit from higher commodity prices traded higher while companies having to deal with higher input costs did not fare as well. Growth stocks, especially technology companies, also did not fare well since their share prices are based upon expectations for future earnings. With higher interest rates, the present value of those earnings are not worth as much, providing pressure on current stock prices.
Painted In a Corner
Not only do these higher levels of inflation potentially cause stress for consumers and headaches for certain investors, but this also places the Federal Reserve in a difficult position. The Fed has previously maintained that inflation is “transitory,” or short-term, as a result of the pandemic but in recent weeks has acknowledged it is “persistent.” The inflation readings last week led to speculation the Fed will taper the monthly bond buying program faster than announced two weeks ago, resulting in it completely ending earlier than currently expected. This might also prompt the Fed to take action with interest rates sooner than previously thought with the expectations now for multiple rate hikes next year. Frequently inflation is fueled by “easy money” (low interest rates lead to low borrowing costs for businesses and consumers) so increases in short term interest rates, which increase borrowing costs, reduce the supply of money and have the effect of controlling inflation. However, in addition to easy money, inflation is now being driven by supply chain constraints and higher input costs, namely commodity prices and labor costs, which are beyond the control of any action the Fed could take.
Since inflation, which has consistently been viewed at the top of the list of investors’ worries over the past several months, remains elevated there is some concern of a return to 1970s style “stagflation,” marked by prolonged inflation, stagnant economic growth and high unemployment rates. Whispers of stagflation have been gaining in intensity and the past week’s data releases have only added to this fear. With unemployment being relatively low and continuing to decrease we do not see this as being likely, but we are watching for a potential slowdown in economic activity. We are experiencing slowing growth, which is to be expected since it was at such lofty levels coming out of the pandemic, but the fact remains economic expansion continues. Next week’s key economic data releases include retail sales as well as capacity utilization and industrial production. We view current supply chain constraints as the largest threat to the economy so the last two data points just mentioned will provide clues regarding the state of production in the manufacturing sector. If production numbers are lower than expected or slow considerably there is a high probability overall economic growth will follow and slow also. Consumer spending comprises almost 70% of GDP so a slowdown in retail sales would also point towards slowing growth. At this point the economy seems to be (mostly) firing on all cylinders but this could change over the next several months, which would subsequently alter our investment outlook and portfolio positioning.
As we have mentioned in the past, the stretch from November until January is historically one of the strongest times of the year for the stock market. Despite the recent run-up, we do not foresee any reason for it to be different this year. Gains may be more muted than in past years, but we remain optimistic for a continuation of the upward trend. Holiday décor can be seen in stores and Thanksgiving will be upon us next week, reminders that the end of the year is approaching. If you have not yet had a year-end review of your portfolio and financial plan, be sure to give us a call to schedule one. Here in the Twin Cities we saw our first brush of snow last week, reminding us that winter truly is on its way, so best to embrace it, just as it is best to embrace whatever is happening in the markets and position yourself accordingly.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
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