The 2021 Monarch Christmas Lunch Seminar earlier this month was a splendid affair. The Club was fully decked out in Christmas cheer, including the “indoor deer” with a swiveling head, which is so lifelike that Adam was convinced it had just flown in through the chimney. It was the coldest day in December, but the market was hot on this day, as it has been pretty much the whole year.
After Dave introduced the Monarchians and thanked the current Administration for engineering such a good stock market, John reminded everyone of all the tailwinds the economy has enjoyed this year. Consumer spending has been unleashed by pent-up demand, but savings stored up during covid have not even begun to be spent. The following chart shows the amount of income that consumers are socking away every month into savings (AFTER their spending). 7% was the run-rate pre-covid, and it has been generally 15% or higher ever since…that means the consumer is STILL socking away excess savings, and hasn’t touched the last 18 months’ excess savings.
In addition, the economy has benefited from the phased reopening of the service sector, extremely low interest rates, Fed stimulus, and fiscal stimulus from government checks to unemployment benefits to PPP loans (and more!). Sales and profits have soared, as profit margins have continued to climb, justifying the strong performance for stocks. Low interest rates justify high valuations.
Surely this won’t end, right? How could it? Let us count the ways. First of all, by saying “X, Y, and Z can’t get any better” means they’ll probably get less better. Tax rates are poised to rise if King Manchin allows ANY form of the President’s social spending bill to pass. Interest rates probably have only one direction to go…up. And the reason why is that inflation has been persistent throughout 2021, and is not likely to abate as quickly as the Fed hopes.
Here’s the current state of affairs for CPI inflation, followed by “core” inflation, stripping out those bothersome food and energy prices. Note that each reading shows levels not seen in 30-40 years:
This recent picture is from a gas station, showing its gas prices when Biden took office, $1.84 for unleaded.
Hard to believe that was earlier this year!? Shows just how quickly inflation has ramped up this year. But the average consumer has noticed. As we wrote in our October newsletter, to the median American family who has total savings (including retirement funds) of $20,000, inflation costing an extra $1,000 here and $1,000 there is alarming. Surely this consumer has benefited from higher compensation on the job, but is still falling behind. A recent survey from CBS News shows what concerns consumers most about the economy these days. Inflation concerns dominate, expectedly, but at first glance we wondered “where’s covid?” Oh there it is, in 5th place: covid restrictions!
We also showed numerous charts trying to explain the Great Worker Shortage. If you haven’t seen the Job Openings data, here it is:
Where did the workers go? 2 million have retired earlier than they would have otherwise, perhaps a million are from previously dual-earning families trying to rebalance their lives or care for the kids (their child care hasn’t reopened or their kids are still in virtual school), and perhaps another million or two or three are freelancing or working side gigs or started new businesses that haven’t been picked up in labor numbers. We salute entrepreneurs, but existing businesses were hoping to recruit those workers, so those help wanted signs will be with us for awhile yet. What’s the solution? Higher pay, obviously, but even then, are we sure the labor market in its current condition can attract retirees, second earners, and new business owners? Is (legal) immigration the answer?
There are no good answers. Then there’s housing. Thanks to accounting eccentricities, rapid changes in housing and rent inflation affect CPI with a lag of about 12 months. That means that CPI has just begun to see the effects of housing, which started heating up in summer, 2020, and is now hotter than at any time in the housing boom of the 2000s. CPI in 2022 will see a huge impact of housing, which accounts for 1/3 of CPI, regardless of where the housing market goes in 2022. On the chart below, the blue line is CPI-housing (left scale), now moving up to about +3%, but headed up as high as +8-10% because of the red line, which is the change in housing prices year-over-year, right scale:
We’ve tried to delve deeper into what happened to inflation in the 1970s, how it got going in the late 1960s, and how and when the financial markets finally reacted to rising inflation. CPI started rising from 3% in 1967 to a near-term peak of 6% in 1970, throwing the economy into a recession and sending the stock market down 35% from its peak in early 1969 to the low in 1970. Inflation drifted back to 3% before rising throughout the rest of the 1970s. This chart shows how stocks performed during that period:
S&P 500, 1950-1983
We all know high inflation isn’t great for the stock market, although it’s even worse for the bond market, if the 1970s are any indication. Stock valuations regressed substantially, although companies that can pass along cost increases in the form of price increases can still grow earnings and pay a rising dividend. So are stocks a decent hedge to inflation? Yes, because stock investors still made money in the 1970s, unless they panic-sold at inopportune times. True, commodities, gold, and real estate are better inflation plays, but you can still do OK in stocks, if you’re in the right stocks.
Adam then took over and walked us through P&G as a straightforward example of a goods-producing company which saw a big bump in demand during covid, along with beneficial margin expansion. In 2021, P&G has seen a big bump in costs…materials costs (plastics, pulp, chemicals) and labor costs in particular. The company has raised prices, and plans to raise them further, albeit with a lag, because they must be concerned with their customers (large grocers and superstores) and with competitors. Management anticipates price increases along with productivity enhancements will help offset cost increases. Adam has built a model, linked to Bloomberg, which allows us to see what happens to profits under certain scenarios of passing along cost increases and assumptions on fixed cost leverage. We opened up the model to test it out on many other stocks as requested by the crowd. If YOU would like to see how a company looks on the model, don’t hesitate to let us know!
We wish you a Merry Christmas and Happy Holidays! If there’s anything you’d like to chat with us about, don’t hesitate to reach out!