“All the Right Moves,” starring Jerome Powell

Join Chris Perras for the 3/19/2021 edition of Stock Talk!

Chris Perras: Good morning. I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group, here in Houston, Texas. Welcome to our March 19th Stock Talk podcast: Keeping You Connected to Your Money. Post yesterday’s afternoon sell-off, the S&P 500 sits around 3,915 or about 2% off its all-time high, hit earlier this week. The technology-heavy NASDAQ, which has more sensitivity to higher long-term interest rates calculations, is down a little over 7.5% off the highs that it reached in mid-February. Did you sell in late February because of all the noise of the upcoming headlines of inflation or higher interest rates? I hope not.

This week’s podcast is titled, ‘Bull markets: The federal reserve, All the Right Moves So Far’ starring Jerome Powell, not Tom Cruise. A forewarning to my frequent listeners, there will be some repetition of data that we’ve shared over the last three to four months showing how normal this cycle has been and refuting the talk of unprecedented times in the economy or the stock markets because the pattern in the economy in the markets has been pretty standard during early expansionary periods, the last 13 years. Those periods are most similar to both 2013 and 2017, both of which were first Presidential term years.

The data of what has happened the last 12 to 13 years during rising long-term interest rates in the Treasury Market, not caused by the federal reserve raising rates and tightening monetary policy at the short-end of the Treasury Market, tells a story much different than the TV newscasters. Late this week, with the March federal reserve meeting in the books, Chairman Powell released their Fed statement and hosted his usual question and answer session.

Since the words left his mouth, earlier this week, there’s been almost non-stop drone on TV financial networks and by long-term stock bears that the federal reserve is already behind the curve and they don’t see inflation picking up, and that they are acting in an inappropriate fashion, giving ongoing economic rebound that we are seeing with COVID cases slowing, vaccine roll-outs accelerating, and the economy reopening more fully. Specifically, Chairman Powell recognized both an uptick in growth and inflation, but he is currently unconcerned by the current level of inflation.

Once again pointing out, that a large part of the current inflation numbers, he believes, is transitory in nature, stemming from a mismatch in disruptions in short-term supply chains caused by the COVID shut-downs last year, and now demand upticks caused by consumers changing their purchasing habits and getting back out into the economy, purchasing goods. If one is kind, the tone of comments on TV is that the fed is slow. If one is more pointed and direct, the implication is, the fed is flat-out ignorant, wrong, Jerome Powell is out of his mind. The real-time data behind the scene says he knows what he is doing.

As much as someone may not like him, for whatever reasons, his history as a fed chair the last four years shows that he’s made all the right moves except for one since taking office. The one glaring mistake he made was in late October of 2018, when he stated, “We are not even close to being done tightening,” right in front of Christmas, as the economy was already slowing from its post-Trump tax plan sugar-high. After that mistake, the S&P 500 did go down 20% in three months, finally troughing on Christmas Eve.

He, of course, then reverse coursed by the early first quarter of 2019, and both the economy and the markets were covered from a short-term air. Both the economy and the stock markets made new all-time highs. He reverses coursed in early February, and that was right around when Bitcoin was 3,800, but that’s another story. Why am I not concerned or panicked about the rampant inflation rate now? I keep returning to the same answer. That answer, well, we forecast this upturned inflation that has happened a year ago.

How? We saw an upturn in copper and lumber prices happening in real-time, early in April of last year in 2020, almost exactly a year ago, when we first discussed pent-up demand in the housing and auto markets caused by millennial spending. I mean, in listeners back then, no one over the age of 60, even over the age of 50, agreed with me. The argument I got back then was, “Millennials were unemployed. There’s no way they’re having to buy a house, they’re not going to buy a car.”

Exactly the opposite thing happened, and what we’ve seen over the last year is actually a pull forward in demand due to lockdown in COVID, in the economy. A lot of that happened at the end of 2020, in the beginning of this year, and we’re not going to see that pull-forward in demand later this year and then in 2022. In fact, we are looking at charts right now that say, “Commodity inflation headwinds are peaking here in the late first quarter and early second quarter.”

Just yesterday, OIL dropped 8.5% intraday, and their oil prices already below where it stood in mid-February. Recall back in mid-February, that was pre-Texas winter storm that locked down supply, and that was pre-economic reopening with demand increases by airplanes and autos and people driving for spring break. Let me get this straight, I’m supposed to now be worried about inflation after a year of supply-demand disruptions, when real-time leading commodity indicators like OIL is trading lower.

Last night, when Nike said, there were transportation issues at inbound ports that caused almost 750 million in their products not to be shipped this quarter, but they will be shipped into stores next quarter. They said this will likely cause retailers to mark down that inventory to lower prices to move it off their shelf. That’s inflationary, I ask? No, that’s deflationary, and it tells me, in real-time, that short-term worries over raging inflation are very overblown. We can look to the components in bond yields. Look back to the real component in the inflation component.

We can see the inflationary component. Its rate of change has already slowed, and it looks to be peaking opposite, it’s trough exactly a year ago. Two of the other leading commodity indicators look toppy. Lumber prices are sky-high and look like they’re peaking as well, as they usually do during the early spring home-building season. The increase in lumber prices the last 12 months has contributed to a rise in the average cost to build a new home, by rising $24,000 in lumber costs alone. That’s inflationary, but that’s not going to be repeated this year or next.

Meanwhile, the leading commodity for international growth looks like it’s topped as well. Yes, Doctor Copper even looks like it’s peaking as it is best correlated to the rate of change in Chinese credit markets and Chinese construction demand. Guess what the Chinese government and banking officials are doing? They’re trying to slow their economy. The Chinese started to tighten their credit markets almost a month ago. Why? Because as a controlled economy, their leaders are afraid of all the bad credit they lent out in 2020 in order to combat the virus.

In fact, the last time we touched this downtrend line was, yes, mid-2013 around the same time as the last similar move in yields, inflation, and real growth during the first year of the second Obama Presidency. We’ve referenced this time period literally for six to nine months already. How is this possible, you ask? Well, so far, things year-to-date, are very normal this cycle.

Facts are, this cycle, for the past 12 to 13 years, the overall S&P 500 has benefited from a rising interest rate environment and longer-term treasury yields. Why? Because it foreshadowed a needed uptick in inflation for about nine months and a subsequent increase in real growth for the next 9 to 12 months. During the second Obama Presidential term, long-term interest rates rose 150 basis points. They rose 1.5 percentage points from the election in November through the first quarter of 2014, and the S&P 500 rose 37.66%.

Fast forward to President Trump’s election in November of 2016, and what subsequently happened to interest rates in the overall market under President Trump from the Republican Party with almost exact opposite policies and governing style as Democratic predecessor, the 10-year treasury yield rose almost exactly a 150 basis points, over the next 15 months. The S&P 500 rose 37.87% into the first quarter of the 2018 Trump tax peak.

Okay, that was the overall market. I’m sure tech stocks didn’t perform well because interest rates are rising, you might say. Basing your belief on the non-stop talk on TV networks about sector rotations and growth underperforming value, so tech stocks don’t work. If you go back and look at the data, the second half of 2013 and the second half of 2017, tech stocks led the market. As far as interest rates go, a similar gain in the 10-year interest rate under Biden will put its yield around 2.1% to 2.25% in the first quarter of 2022. A similar percentage move as 2013 or 2017 this year, we put the S&P 500 around 4,500 to 4,600 in the first quarter of 2022. Don’t say it can’t happen. Think about the size of the stimulus programs about to hit positively on the US economy over the second through fourth quarters of this year.

I wonder, back to the question on the effect of higher interest rates on the S&P 500 performance since 2008 and 2009. On this, I asked for help because I can’t find one of a negative correlation. If any of my listeners want a statistics project for this weekend or the week ahead and can find a negative correlation between the overall market, that is the performance of the S&P 500 and higher trending long-term interest rates for the last 12 years, I would love to see that data. For all the talk, I have not been able to find any data justifying these statements over any investment horizon measured in weeks, months, quarters, or years, unless you are an algorithmic short-term trader trading in seconds, minutes or hours. I can’t find one.

The 10-year treasury has risen 125 basis points since early August last year. The S&P 500 has risen 750 points or just short of 25%. It’s hard to find a negative correlation there to me. Overall, we remain very positive on equities for the remainder of 2021. We continue standing by our belief and forecast for 2021 that volatility is declining overall and will continue its decline throughout 2021, except for what should be another spike in short-term volatility near the end of the second quarter into the July 4th holiday period.

Think of this time period as the dead zone in the second quarter, similar to the dead zone we went through in the first quarter, back in late February, early March. A pullback should look very similar to that same depth, maybe a little larger. Those monetary and fiscal programs that have been implemented by the federal reserve and the government should be good for the economy and stocks throughout most of 2021.

As far as we are concerned, Chairman Powell continues to make all the right moves. The collateral damage caused by the repeatedly of the recent rise in interest rates caused the leverage players to sell and to likely miss out on the positive effects of these programs. Next week, we are looking for news out of the federal reserve on the extension of a waiver of the special lending collateral around bank treasury holdings that have contributed to some of the recent rise in long-term interest rates by way of squeezing available collateral.

For the second half of 2021, we are looking for companies that investors should be looking at with the glass-half-full attitude come the second half of 2021 and early 2022, between July 4th and labor day, investors, once again, should be looking forward. They’ll be looking out to the second half of this year and all of next year, and what are they likely to see? They’ll see very difficult comparable for value in reopening universe that many are now chasing very late to that party.

Moreover, they will see higher secular growth companies have stalled for a year and their evaluations have compressed. Now, they look cheap versus their long-term growth in free cash flow profiles. Big investors who have been chasing and pushing up value since July or September of last year will start asking themselves, “Why am I paying peak multiples for peak EPS in the second half of 2021 in these names, 6 to 12 months in advance?” They’ll start asking themselves, “Did the federal reserve going to raise short-term interest rates in the second half of 2022 to slow the economy and who will be hurt most if they do that?”

They will be reaching long-term gains in many of these cyclical names and wondering, maybe we should sell some in case president Biden and Congress raised taxes in 2022. We know the answers in advance of these questions because we’ve seen these rotations and playbooks many times since the great financial crisis in 2008 and 2009. At Oak Harvest, we are comprehensive long-term financial planners. What that means is, as our client, you and your financial advisor should have a financial plan that is independent of the volatility of the stock markets. Give us a call in Houston at 281-822-1350. We’re here to help you on your financial journey through retirement with a customized retirement planning. God bless you, your family, Texas, and America. Have a great weekend.

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