by Peter Jones, CFA
Senior Vice President
After declining close to 6% between September 3 and October 4, the stock market is back at all time highs. Once again, it appears the market is beginning to climb the proverbial “wall of worry.” Recently, we have been highlighting several factors that are causing concern for investors and that market appreciation should moderate in the coming months. That said, we continue to believe that we are much closer to the beginning than we are to the end of this economic expansion.
Aside from the seemingly endless health concerns surrounding the pandemic, issues that remain top of mind for investors include inflation, monetary tightening, tax increases, the labor market shortage and supply chain issues. General inflation reduces the effective wealth of consumers through a reduction in purchasing power. Monetary tightening slows the supply of money alongside increasing interest rates that make borrowing more expensive. Tax increases for individuals can of course be a headwind to consumer spending and investment but for corporations, tax increases pinch profits and reduce cash flow that could otherwise be available for hiring workers and expanding operations. Fewer workers mean lower economic output and wage inflation. Supply chain issues cause more inflation and delays in economic output.
In isolation, each of these issues can slow economic growth, and all together have caused some investors to question the durability of the expansion. When it comes to predicting the direction of the economy and the gravity of these emerging headwinds, nothing has a better track record than the stock market itself.
That said, what is Mr. Market telling us right now? The expansion is still on a strong path. And given that we do not trust market prices blindly, we want to address each of these concerns in order to justify the market returning to all-time highs.
Inflation:
Inflation has already begun to moderate. High levels of inflation have primarily been driven by areas of the economy that were completely shut down in the early stages of the pandemic such as used cars, rental cars, airfare and fuel. We are beginning to see normalization in these categories.
With inflation broadening out to shelter, dining out and other services, our belief is that the 1 – 2% inflation regime of the last 20 years will move to a 2 – 3% range until further notice. Higher? Yes. Enough to derail the expansion? No.
Source: Bloomberg
Monetary Tightening:
With economic growth still very strong, we no longer need unprecedented monetary stimulus to propel economic growth. Gradual removal of stimulus should easily be absorbed.
Tax Increases:
There is still significant uncertainty into the ultimate outcome of current tax proposals. However, most signs point to tax increases that will be less significant than feared
For example, per the Washington Post this week, the White House told Democrats that the focus is no longer on general corporate tax hikes, but instead on billionaires. The former is a much larger headwind to economic growth than the latter.
Labor Market:
The direction of the labor market is more important than the absolute level on employment. While there are still millions filing for unemployment, that number continues to fall month after month. We are likely to see further improvement in the coming months now that the extra $600 per week of unemployment insurance expired in September, creating a bigger incentive to reenter the workforce.
Supply Chain Issues:
While it might be frustrating that the refrigerator you ordered back in March still hasn’t arrived, production bottlenecks represent demand deferral, not demand destruction. If anything, delays in the production and consumption of goods will smooth out the cycle and prevent unsustainable levels of growth.
Despite our shared view with Mr. Market that the economy is on strong footing, we remain vigilant in our constant assessment of the above watch items and their ultimate impact on this expansion.
Takeaways for the Week
The market has already recouped its September losses, with stock prices back at all time highs
The market has the best track record in judging the seriousness of economic headwinds
We continue to believe that we are much closer to the beginning than the end of this expansion