Eyes On the Size
The reflection on the surface of the water is often mistaken for the mysteries that lie beneath. Likewise, the reflection of the moon is mistaken for its own light.” – Thomas Lloyd Qualls, Painted Oxen
The 14.4 % decline in the S&P 500 from the market close at year’s end to its low for the month on January 24th is what captured the headlines. Forbes Magazine mused “Will Inflation Cause a Stock Market Crash?” Kiplinger’s queried “Could the Stock Market Crash for Real?” Fortunately for investors, the market rallied from its nearly three week swoon, closing down for the month -5.2%. It may though be in the real world that we inhabit as workers and consumers that the most interesting story of all is beginning to emerge.
It's been nearly forty years since Americans last viewed inflation as a possible threat to their economic wellbeing and it is now cited as item number one on our “worry list,” exceeding even those concerns related to the pandemic. But perhaps we should not view it as necessarily evil in all of its manifestations. Those who pay particular attention to economic statistics may be able to recall approximate rates of economic growth of 6.90% annualized in last year’s 4th quarter. That number is cited as “real” so one might think that is the number that matters most, but at least in this instance, it isn’t the “real” world that we inhabit but rather that of the “nominal”. The real GDP growth number is adjusted for inflation, the nominal rate which we hear about much less frequently was 14.30%, the highest number this century to date. Think about it. Do we adjust the value of our paycheck for inflation? The value of our investment portfolios? The rate of change of revenues in the business in which we have an interest? Suddenly, those rates of growth for the companies owned by shareholders are experiencing very significant increases in their revenues and profits. What might this mean for the stock market?
The US and global economies which, since the Global Financial Crisis of 2007-2008 have been mired in the world of small numbers, are starting to emerge into a world in which those numbers are no longer so small and that may be preparing to change a great deal that we’ve grown used to this past now almost fifteen years. For years, the rate at which money circulates through our economy has been in a state of steady decline, but that too is beginning to change as the rate of change in bank lending that was described with numbers starting with 3s and 4s, increased in December by 14.80%. Simply stated, an extended period of time in which it was difficult to create a real rate of return by investing in the real economy, due to an excess of capacity, may be ending. It may be that fact that will increasingly come to influence the financial markets.
Often forgotten in the obsession in recent years over what central banks are doing, may be preparing to do, or are not doing, is that interest rates are the arbitrators between the demand and supply for money. If the demand is falling due to declining economic growth rates, then interest rates would also be expected to decline. Ten Year US Treasury rates fell to a low of ½% in July 2020. One year ago, they were at 1% and in the past two month have risen from 1 1/3% to now almost 2%. Inflation expectations are falling back rather than rising so that increase is the market’s way of anticipating accelerating economic growth rates. That is good news.
Investors may recall that profits were difficult to come by in the 3rd quarter of last year as the S&P’s 4.65% decline in September offset its gains the prior two months. The market subsequently rose 10% the following three months which made 2021’s 4th quarter the positive experience that it was. It was that same 10% that was consumed in January’s market decline though the markets monumental reversal of 4.4% on the 24th set forth a recovery in the market’s fortunes scissoring that decline by half. The outstanding quality of the market pull back was its variability as the S&P growth stocks fell 9.4% but value 2.2%. Energy stocks, inhabiting seemingly their own universe, rose 17.4%. US small companies declined 8.4% and foreign stocks, which for what has seemingly felt like forever, reversed their irritating propensity to go up less than US stocks in a rising market but to go down more in a declining market, fell a modest 3.6%. 60% equity 40% fixed income portfolios saw declines for the month of approximately 3.25%.
Mark H. Tekamp| February 5, 2022