Happy Fall Y’all as we say in West Tennessee. At the end of June, we were hoping for middle ground in the tug of war between interest rate hikes and inflation. The problem with the statistics we all hear in the news is that some of them are leading indicators (present) and some are lagging indicators (past). This causes the news media to pump out mixed signals as to the real health of the economy. There is no question that prices are dropping across the board for American consumers. Google search trends tell us that “how to become a real estate agent” was a top search query from January ’21 to January ’22. That should have been a clue. The easy money from selling real estate, cars, and recreational items is drying up for the time being. So, what does the future hold? Here are a few thoughts to keep us all in the boat and paddling forward.
Inflation could remain sticky — especially in the labor market
While larger ticket items will come down the quickest as prices revert to more normal levels, we don’t believe that labor will. In fact, labor costs are expected to rise 6-7% in 2023. An interesting statistic caught my eye when scanning an article in the Economist Magazine last month. Labor unions are seeing their greatest interest since the early 1960s. The news headlines are full of continuing struggles between management and labor, and it has been a long time since workers have had this much bargaining power and we expect this to continue. As the labor component stays elevated, it will be more difficult to bring prices down. This will lead to a continued push toward automation and the rise of robotics in everything from warehouses to fast food. Of course, prices don’t have to come down for inflation to come down – prices need only stop rising.
Unemployment is on the horizon
The Fed has the goal of containing inflation and understands in that pursuit that unemployment will be inevitable, especially in certain areas of the economy. Google reported earnings last night and missed analysts’ forecasts. One of the key areas of concern was their bloated workforce, especially in the face of weaker earnings. Layoffs have already started in big tech and will accelerate as the economy cools. All of this is the natural progression of events as the Fed reverses a decade of easy money policy. This is the main reason we believe the stock market may underperform its historical growth rate in the near term and why dividend growth and analyzing free cash flow on the companies we own is important to keep our clients ahead of inflation long term. We want the companies we own to be able to sustain and raise their payouts over time even as their costs ebb and flow.
Bonds are becoming attractive again
We have been warning clients for several years to avoid bonds. We are changing our tune. With aggressive rate hikes, the Fed has given more conservative investors hope that they will once again receive decent yields on their safe money. These moves have created interesting opportunities much like we saw in the mid-2000s. With some patience, we should be able to de-risk our models and move back toward our long-term asset mix by using more fixed income. In the meantime, our money markets funds are yielding near 3% and heading higher with more rate hikes.
Stocks still win
We have made more changes in our equity models recently. We believe that the large cap value story will continue to win out in the near term and that the tech darlings will still be an important part of the economy but will be less valuable in the portfolios. We have also cut our allocation to international equities. We like the good ol’ USA, especially as the issues with recession and currency disruptions continue to roll across the globe. As material costs come down and the dollar weakens, multinationals like Coca Cola will reap the rewards. We still like the energy sector tactically, but with the volatile nature of energy markets this trade will never have an outsized impact what we are doing. The old adage still holds true: “It is time in the market, not timing the market, that wins.” We couldn’t agree more.
