November 15, 2021
My favorite holiday is coming up next week, and that’s Thanksgiving. Wow! This year has flown by and as I like to say, “the days are long, and the years are short.” What I love most about Thanksgiving is that it’s a time for family, food, and fellowship. Thanksgiving gives us a chance to reflect on how great we have it here in the United States, and a time to be grateful for all of the blessings bestowed on us as individuals and as a country. With that being said, I have a bone to pick, and I’m not talking about a turkey bone.
I have a silly question: why don’t we just stay with Daylight Savings Time vs Eastern Standard Time? I would rather have more daylight in the evening than in the morning. What this nonsensical time change instruction brings up every year is why can’t we build products and create instructions that a normal human being can understand? I have a master’s degree, but I doubt highly that even a Rocket Scientist with a PHD can figure out how to change the clock on my mother’s wall oven. For my questions, I actually know this answer- it’s that we don’t build these products here in the U.S. and the instructions, or what I like to call “destructions”, are more than likely written by someone who is not a native English speaker. When people create instruction manuals, why don’t they just use pictures like IKEA?
Moving forward, what scares me more than inflation today is the Great Resignation. The Great Resignation is an informal name for the widespread trend of a significant number of workers leaving their jobs during the COVID-19 pandemic; it’s also called the Big Quit. The Great Resignation is typically discussed in relation to the U.S. workforce, but the phenomenon is international. We had 4.3 million Americans quit their jobs in September, and an additional 4.4 million in October. Millions of workers voted with their feet and walked out of their jobs—many without having another position already lined up.
All of that said, I hope that everyone takes some time during this Thanksgiving season to be thankful for our many blessings in the United States. Have fun, stay safe, and we’ll talk soon.
Three Market Drivers
We focus on three market drivers that lead to notable movements in the stock market: economic fundamentals, technical environment, and investor sentiment.
Our fundamental indicator follows 19 economic datapoints that track the underlying health of the US economy. From unemployment to homebuilding, changes in these economic datapoints tend to confirm recession or recovery after the technical and sentiment indicators have already reversed.
Dynamic Asset Level Investing, or D.A.L.I., is a technical indicator that compares each of the major asset classes, sectors, and sizes and styles against each other to discover emerging trends in the market. D.A.L.I. compares daily price action of each of these elements on a point-and-figure chart to illustrate momentum. The chart at the bottom of this page shows the current leadership in D.A.L.I.
Our sentiment indicator tracks how everyday investors currently feel towards the U.S. economy and the stock market. Between our own polling and professional surveys like the American Association of Individual Investors (AAII) Investment Sentiment Survey and Citigroup’s Panic/Euphoria Model, we track the two most dangerous emotions for investors: fear and greed.
Here is a breakdown of where each market driver currently sits:
The U.S. inflation rate came in at 6.22% for October, the highest level since November 1990. While the year-over-year data comparisons are still reflecting a pre-vaccine world, it remains to be seen if the Federal Reserve will eventually be correct in their assessment that the majority of this inflation is transitory.
The RSI, or Relative Strength Index, measures recent price changes to determine undersold and oversold conditions. Unsurprisingly, the S&P 500 and Nasdaq-100 both pulled back slightly after reaching RSI levels greater than 70, implying an overheated market.
The University of Michigan’s Consumer Sentiment survey registered a reading of 66.80 for November, the lowest level in the past 10 years. While put/call ratios show investors incredibly confident in the stock market, consumers seem much less enthused about our current economic conditions as a whole.
Inflation and The Stock Market
If you have been to a gas station or grocery store lately, you may have noticed some intimidating price increases. These price increases throughout the sectors of the economy are known as inflation. Last Wednesday, it was announced that inflation in October had registered a reading of 6.22%, which is the highest level in over 30 years. Despite this, many in the Federal Reserve continue to claim that this current spike in inflation is “transitory,” or temporary. While these increases in inflation are never fun for consumers’ wallets, the main question on investors’ minds is how inflation historically has impacted the stock market.
As we mentioned in a previous newsletter, interest rate changes are used as a response to inflation- when inflation is increasing, interest rates tend to rise, and vice-versa. However, when inflation remains in check and relatively low, there is little incentive to increase interest rates, which is the type of environment the U.S. economy has been in ever since the 2008 Financial Crisis. This low interest rate economic environment is why we saw growth stocks outperform value stocks significantly over the past decade-plus, as growth stock valuations are heavily weighted towards future potential earnings that are discounted at these current interest rates. In contrast, when interest rates and inflation rise, these future earnings projections are reduced, hurting growth stock valuations and making present-day earnings much more valuable. As such, this emphasis on present-day earnings is why value stocks tend to outperform growth stocks in rising rate environments, as they did between the Dot-Com Bubble and the 2008 Financial Crisis.
While there is a relationship between inflation and stock styles, there is also a relationship between inflation and economic sectors. Four sectors that have historically outperformed during periods of inflation are energy, financials, industrials, and materials. Energy prices, such as the prices of oil and gas, are a common part of inflation indices, so the positive correlation between the energy sector and inflation should be obvious. Financial stocks, such as banks and insurance companies, see their profit margins benefit greatly from rising interest rates that result from inflation. Finally, inflation tends to imply that an economy is heating up, meaning that there is greater demand for production in both the industrial and material industries.
While the stock market typically has positive returns during both inflationary and deflationary environments, there are notable historic advantages for certain stock styles and economic sectors during inflationary periods. However, the Federal Reserve’s hesitancy to raise rates has caused sectors of the economy that have historically reacted negatively to rising rates to continue to outperform, as the market has interpreted the Federal Reserve’s hesitancy as a green light. Now, if the Federal Reserve changes its tune regarding raising rates, that may be the catalyst for a shift in the economic sectors and their performance. In the meantime, however, investors should remain vigilant and follow the words of The Great One, Wayne Gretzky: “skate to where the puck is going, not to where it has been.”
Large Cap indices
S&P 500: 24.67%
Dow Jones Industrial Average: 17.95%
Mid and Small Cap indices
S&P 400 (Mid Cap): 25.82%
S&P 600: (Small Cap): 30.08%
Russell 2000: 22.12%
MSCI EAFE Developed Index: 10.09%
MSCI Emerging Markets: -0.45%
MSCI ACWI ex-US: 7.82%
Economic sector indices
Basic Materials: 24.05%
Communication Services: 25.13%
Consumer Discretionary: 23.74%
Consumer Staples: 8.77%
Real Estate: 32.13%
Inside the infrastructure bill
On November 5, the House of Representatives officially passed the long-awaited, $1.2 trillion infrastructure bill that has taken up headlines for over half a year. While the bill includes $550 billion in new spending, we would like to go through the bill and breakdown how the bill will invest in each segment of the economy, as well as any additional costs not included in the aforementioned $1.2 trillion price tag.
The largest portion of the $550 billion in new spending will be going towards the construction and repair of new and current roads and bridges, with $110 billion dedicated to this endeavor. The bill also includes $66 billion for railroad maintenance and improvement, although there is no mention of high-speed rail coming to the U.S. anytime soon. $17 billion is dedicated to the expansion of ports, which is top of mind for many investors today as we experience ongoing supply chain issues. Also, airports are expected to receive $25 billion for major expansions at U.S. airports, as well as upgrades to air traffic control towers and systems. In addition, public transit will receive $39 billion to create additional bus routes and to augment public transit to be more accommodating to disabled Americans and senior citizens.
Outside of transportation, the infrastructure bill also looks to prioritize the expansion and improvement of modern-day utilities. The bill includes $55 billion towards water infrastructure, with the aim being to replace lead pipes to avoid instances like the infamous Flint, Michigan crisis, as well as an additional $8 billion dedicated to water treatment and storage facilities in the west to combat drought conditions. $65 billion is included for the improvement of power lines and cables, as well as $47 billion to prevent damage to the power grid, whether it be cybersecurity attacks or extreme natural disasters. Also, in a time where access to the internet is indistinguishable from participating in modern society, the infrastructure bill includes $65 billion towards expanding broadband in low-income communities and rural areas across the U.S.
On the controversial side, the infrastructure bill also includes highly debated spending on the environment and continued shifts towards clean energy. $21 billion were agreed upon as an environmental budget, aimed at cleaning abandoned mines, former oil wells, and brownfield sites, which are sites that were previously used to industrial purposes but have since been abandoned due to hazardous chemicals. The bill also includes continued expansion for the shift towards electric vehicles, or EVs. $7.5 billion apiece has been dedicated to the continued construction of additional charging stations for EVs across the country, as well as the creation of electric school bus fleets.
While Congress will continue to debate additional spending in the Build Back Better bill, the infrastructure bill looks poised to address the majority of the structural issues facing our nation. However, it is not a perfect bill. With the majority of car manufacturers targeting 2025 for their continued transition to EVs, it remains to be seen if the $7.5 billion for EV charging stations will be enough to support a transition of this magnitude for our society. Likewise, there are provisions within the bill that will allow for renewals of certain parts of the bill, meaning that the actual price tag on this infrastructure bill may be difficult to quantify today. Only time will tell, but it appears that the infrastructure bill will help to bring our infrastructure in line with modern times.
Chairvolotti Financial, Inc. dba 401karat is a Registered Investment Advisor.