August 13,2021

Today is Friday the 13th or Triskaidekaphobia Day. So, why is the number 13 so unlucky? Triskaidekaphobia is the extreme superstition of the number 13. The history states that one of the culprits was from 1907, when businessman and author Thomas Lawson published a novel entitled Friday, the Thirteenth about a rogue broker who chose that date to destroy the stock market. Somehow, Wall Street or Washington D.C. is behind all of these shenanigans.

Speaking of Wall Street, why is BlackRock buying the new inventory of single-family homes? The median price of an American house has increased by 28% over the last two years, as pandemic driven demand and long-term demographic changes sent buyers into crazed bidding wars. The Wall Street Journal reported in April that an investment firm won a bidding war to purchase an entire neighborhood’s worth of single-family homes in Texas. Now, analysts have reassured us that big investors like BlackRock remain insignificant players in the housing market. Doesn’t BlackRock have enough money? Yet now they want to spoil the American Dream for first-time home buyers. Something smells fishy here. Stay tuned for how this turns out– all I know is that it won’t end well.

Summer is coming to an end, as kids went back to school this past week. This makes me both happy and sad at the same time. The happy part is that football season is here, and the nasty thunder[1]storms with thankfully stop. At the very least, MooShoo won’t have to hide in the closet until New Year’s Eve now. The sad part for us is that August and September have been historically two of the weakest months of the year for the stock market. We all know that October is known for large market drawdowns, but historically we have four or more 5% market drawdowns annually. Folks, we are long overdue for a pullback, so don’t be surprised if we see one in the next 60 days.

Finally, next week would have been my dad’s 101st birthday. I lost my father on Christmas Day when I was 11 years old. Just like Field of Dreams, what I wouldn’t give to spend just one more hour with him! So, for anyone that’s lost a parent, just remember how precious life is and, as I like to say, “the days are long, but the years are short.” I sure hope my dad would be proud of me, and at least I can say I haven’t lost any laptops in my life. Be safe and see you in a couple of weeks.

Three Market Drivers

Here at 401karat, we focus on three market drivers that lead to notable movements in the stock market: market economic fundamentals, technical environment, and investor sentiment.

Our fundamental indicator follows 19 points 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 US economy and the stock market. Between 401karat’s own polling and professional surveys like the American Association of Individual Investors (AAII) Investment Sentiment Survey and Citigroup’s Panic/ Euphoria Model, 401karat tracks the two most dangerous emotions for investors: fear and greed.

Here is a breakdown of where each market driver currently sits:

July’s inflation numbers came in at 5.37%, almost identical to last month’s level of 5.39%.

On a technical basis, the market remains top-heavy, with the S&P 500 ranking third out of 135 asset classes on a relative strength basis. However, we have begun to see strength return to the growth areas of the market following their double dip pullback earlier this year.

The University of Michigan’s Consumer Sentiment Survey saw a preliminary August reading of 70.2, a sharp decline from the July reading of 81.2. This month-over-month decline was the sixth[1]largest in the survey’s history. Most respondents to the survey cited fears of the Delta variant delaying the pandemic’s ending as the reason for their decline in sentiment.

 

Stagflation Fears

Between July reporting the fourth-highest inflation reading since the turn of the century and concern about the Delta variant slowing down our economic reopening, there is newfound fear of stagflation. Stagflation is known as an economic death knell in which inflation rises sharply while economic growth lags or declines. This term is most commonly associated with the 1970s, in which skyrocketing energy prices caused runaway inflation while the country’s economic growth began to slow. While talking heads in the financial media have begun to reiterate these concerns, we wanted to provide some context.

What makes stagnation so dangerous is that, while people are unemployed and already scraping by, prices continue to rise, further weakening their purchasing power as a consumer. One popular way to gauge stagflation is to use a measure known as the Misery Index. In short, the Misery Index simply combines the current inflation rate with the current unemployment rate; if this number is extremely elevated, it implies stagflation. Since 1970, the Misery Index has had an average level of roughly 10%. The stagflation of the 1970s culminated in a peak in the Misery Index of 22% in June of 1980, and the index didn’t return to the historic average of 10% until the beginning of 1985.

Now, how does today compare to the 1970s peak in the Misery Index? So far, the Misery Index during COVID-19 peaked in April 2020 at 15.1%. However, it is worth noting that 14.8% of that number was strictly due to the unemployment rate, as April and May were when inflation cratered. Today, however, the Misery Index finds itself at 10.8%, higher than the 6.9% we experienced in November 2020 but lower than the peak in April 2020. In fact, as we mentioned above, the Misery Index today is only slightly above the historic average of 10%.

The main difference between the 1970s and today is that many of the inflationary pressures on the economy today are assumed to be transitory, or temporary, in nature. Supply chain bottlenecks and shortages of materials have been arguably the greatest catalyst for this transitory pressure, ranging from lumber to semiconductor chips. When these materials and products experience a shortage, prices are increased and passed on to the consumer, causing inflation. Once these shortages are solved, prices are expected to return to a more normalized level.

While we have yet to see the light at the end of the inflation tunnel, continued improvement to these supply chains in the coming months should help to alleviate the majority of the inflationary pressures on the economy. Also, expiring unemployment benefits coupled with companies increasing salaries for open positions should help to chip away at the unemployment rate. With both halves of the Misery Index hopefully beginning to improve in the coming months, it seems that we are much closer to “normal” than to anything resembling the stagflation of the 1970.

The Weak Season

To this point, 2021 has had a strong (if not wild) year in the market so far. Even with the sector oscillation we have seen this year, the S&P 500 has put together an extremely strong year so far, with the S&P 500 already having been up over 10% by the middle of the year. However, these next two months may fare differently.

Historically speaking, August and September have been two of the worst months for the stock market, with September being the worst performer and August being the third-worst month. Since 1950, August has averaged a return of 0.03%, while September has averaged a return of -0.48%. As an example in recent history, remember that the 2018 correction that saw the S&P 500 decline nearly 20% began in September, as well as last year’s pullback of over 9%. While these months historically have shown weakness, this seasonal weakness is even more apparent following an election.

Following a presidential election, August and September show greater weakness, with August averaging a return of -1.43%, while September averages a return of -0.46%. Also, the consistent timeframe of this weakness may be intriguing for investors. Post-election years historically see the market peak on August 3 and bottom on September 24. Despite this, post-election years tend to see the market rally in the fourth quarter following this weakness.

Historically speaking, the S&P 500 has had a 10% or greater correction every eight months on average; we have not experienced a decline of that size in the market since the crash that occurred early last year. This top-heavy market coupled with newfound consumer fears towards the Delta variant and elevated inflation levels may be the catalyst for this overdue decline. However, as we have seen since March 2020, this market has been extremely resilient, particularly towards healthy pullbacks. Only time will tell if this resilience is strong enough to power through this seasonally weak period.

Chairvolotti Financial, Inc. dba 401karat is a Registered Investment Advisor.