Two Things That Really Matter
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This week’s video is going to be short and sweet. It’s titled, What “really” matters. Two things as far as I see it and they are intertwined of course.
On Friday, October 14th last year, and with the S&P500 hitting a new low below 3600, our Oak Harvest investment team released our weekly stock talk titling it, “What could go right”? We have a few reasons for our optimism during a time of uncertainty backing it up with historical statistics combined with real-time data series. Trust me, it felt iffy to release it and I’ve been doing this for almost 30 years. I’ve gone through a number of bear markets in the past, and whether you see them coming or not, they never feel good. As it turns out, so far, that week has been this market’s cycle low. And it’s been so far for many of the reasons we listed in the video including a peak and rollover in the Fed’s favorite inflation-watching tools, a China reopening trade after they finally scrapped their Zero-Covid policy, and mid-term election seasonality.
This week’s video is going to be short and sweet. It’s titled, What “really” matters. I am Chris Perras with Oak Harvest Financial Group in Houston, Texas, and welcome to our weekly stock talk podcast, keeping you connected to your money. Before we get into this week’s topic, please take a moment to click on the subscribe button and click on the notification bell so you will be alerted when our team uploads our latest content. We do have a new location for our Oak Harvest Investment-oriented content. You can find it by typing “Stock Talk with Chris” in the Google search window or going to the Oak Harvest YouTube channel and clicking on the drop-down tab labeled “channels” and clicking on “Stock talk with Chris”.
So, what really matters here? As far as I see it, they are intertwined, of course. First, a continued decline in service inflation and a weakening of the jobs market so the Federal Reserve slows and then pauses their rate increases. Goods and overall inflation peaked in June of 2022. We need that to continue. Secondly, we need a continued peak and rollover in the “Real” interest rate component within nominal yields. This is also called the TIPs interest rate. We’ve spoken about these two things a lot over the last 6 months. We will cover them again here.
Inflation. Let’s cover it again. Overall goods inflation peaked in the late first half of 2022. Commodity pricing slumped. Used car pricing collapsed. Container shipping rates collapsed. Most industrial metals are roundtripped. The price of lumber dropped 75%. Lately, fertilizer and natural gas prices have plummeted even with the war in Ukraine and the energy shortages in Europe. Those are great indicators for goods inflation declining, however, America is 70%+ a service economy so the Fed is still worried about the ongoing strength in the jobs market and wages.
The good news for investors is that these are lagging inflation indicators and they looked to have peaked and rolled over. Our latest news or noise piece details how overstated the strength in the jobs market is if one only follows the BLS data. The December BLS jobs report was a positive 233k jobs. However, this data double and triple counts jobs by counting part-time jobs, both second and third jobs, as much as it counts a full-time job hire. To me, the household survey is a better reflection of the jobs market and it only counts bodies. Since March 2022 the two numbers have diverged
dramatically. The overstatement by the BLS now stands at 2.1 million jobs created in 2022.
You may ask, why is there such a huge difference in the two numbers and does it matter? Yes, it does. The surge in employment that the BLS releases in their data have been entirely a function of part-time workers and multiple jobholders in the last year.
According to the Household Survey, the number of full-time workers is exactly 1,000 workers less than in November. At the same time, the data says the number of part-time workers rose almost 680,000 month to month, while the number of dual job-holders, which the BLS data double counts, jumped by 370,000. Doing the math (which the economics group at ZeroHedge has done for us) the cumulative full-time jobs created in the past 10 months have actually declined by -288K while there has been an 886K increase in part-time jobs. What this means is that all the jobs gain the last 3 quarters were on the backs of part-time workers trying to fend off inflation. People hold multiple jobs at the same time. These part-time jobs are less secure, pay less, and usually have zero benefits versus full-time workers. These positions are almost always subject to the last hired, first fired rule of hiring.
Opposite what one hears on TV, continuing unemployment claims are accelerating from very low levels, while average hours worked are shrinking at the same time that the wage inflation calculation has peaked and rolled over dramatically, for both those staying in their current jobs and those job switching. Here’s a chart from ISI on continuing unemployment claims. Up and to the right is bad for workers, but good for the Federal Reserve and investors searching for a peak and rollover in service and wage inflation.
Why does “peak inflation” matter to investors? Because it allows the Fed to slow its tightening bias and eventually the stock and bond markets exhale. Here’s a great chart from Barry Bannister at Stifel Financial showing the lead effect of peak CPI versus the lows and pivot up in the S&P500 since World War 2. The average length of the lag was about 7 months after the peak CPI print. The CPI peaked at +9.1% in June 2022. That would put the timing of the average pivot up starting this January.
The second thing that “really” matters to investors right now is a continued peak and rollover in “real” interest rates. Remember the Treasury yield you get paid by the bank is the nominal interest rate. It is the sum of an inflation component and a real yield premium, also called the TIPs yield. The real yield component of Treasuries goes a long way to determining the risk premium investors pay for equities. When the Fed and other central banks ran a world of zero and negative interest rates, this enabled or forced investors into a world of holding larger equity positions because money was nearly free. It created the notion of “TINA”, or there is no alternative.
Since December of 2021 there has been a very strong and inverse correlation between the multiple on the S&P500 investors are willing to pay and the direction of the 2-year real yield. Here’s an 18-month chart of the 2-year real yield. It troughed in late November of 2021 and pivoted up as many Fed committee members began talking more hawkishly behind the scenes even though Chairmen Powell was out publicly worrying about employment still.
You can overlay a chart of the S&P500 on this chart and clearly see the inverse path on the stock markets in 2022 with an emphasis on the large-cap growth stocks whose valuations are very sensitive to interest rates. Here’s a chart on the S&P 500.
And here’s a shorter time frame chart of 2-year real interest rates. Real yields peaked in early October and yes the S&P500 made its absolute lows the same week.
We have finally broken the 13-month uptrend in this interest rate and low and behold? The S&P500 is starting to carve out what looks like a reverse head and shoulders bottom. What groups and assets have been outperforming since the calendar turned 2023? Large-cap growth, cyclical, international stocks, small caps, and interest-sensitive stocks. Those are not bearish asset classes. Viewers, if you are going to look at one real-time data series your neighbor has never heard of to help you tactically in the markets? This has been the one for about 15 months and will likely remain so for the first half of 2023.
With the volatility that both stocks and bonds in the public financial markets experienced in 2022, our investment team recommends that you get on the phone and give our Oak Harvest team a call and ask to speak to one of our financial advisors and planners. Set up a meeting and sit down with our team. Give us a call at ——– and give our whole
team a chance to help you with your retirement allocation and have our financial planning team model your cash needs and maybe a few of your greed’s too into and through your retirement years. From myself, Troy and Jessica, and the rest of our growing Oak Harvest team, we are here to help you.
– Have a blessed week and a fantastic new year.
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.