Stocks rose again Friday, lifted by a late afternoon rally. Bond yields crept higher. Oil prices fell. The tech sector continues to lag, a combination of valuation concerns and deteriorating demand.
This is Thanksgiving week. Markets will be closed Thursday and trading hours will be shortened Friday. More Americans will be focused on travel and family than on the financial markets. There will be lots of Fed speakers, as there were last week. The next FOMC meeting is in mid-December. While odds strongly favor a Fed Funds rate increase of 50 basis points, a strong labor report at the end of next week or an outsized increase in the CPI for November, which will be announced the morning of the two-day meeting, could change that. Now, markets are predicting that the Fed Funds rate will rise to 5.00-5.25% by the end of the first quarter of 2023. That compares to the current rate of 3.75-4.00%. Any deviation in those expectations will be market moving.
I caution everyone to not put too much emphasis on where the futures point at any point in time. To put an exclamation point on that thought, a year ago, Fed Funds stood at near zero and the expectation one year out was that they would rise to 0.75%. The reality is that, despite all the talk of models, the Taylor rule, etc. the future remains very opaque. Almost three years after the pandemic began, no one has a clear picture of how shifting supply/demand caused by the pandemic and subsequent government actions created short- term distortions that will heal themselves over time, versus the impact of ultra-easy monetary conditions and an infusion of close to $5 trillion in fiscal economic support. Obviously, both had an impact.
Clearly, we see exaggerated influences in certain narrow sectors of the economy. The pandemic pulled forward demand for many products that supported a life and working experience from the home, everything from bleach to PCs. Once the world reopened and life started to normalize, demand for bleach and PCs receded. Other influences are less obvious. The most confusing might be the labor market. In January 2020, the unemployment rate was 3.5%. Today, it is 3.7%. There are a few million fewer jobs however, because of higher rates of retirement over the past 2 ½ years. Wage inflation, however, is much higher, a combination of a tight labor market and the demands of workers to get wage increases commensurate with the rate of inflation. Theoretically, as inflation slows, workers will be content with smaller wage increases. However, in a world with nearly two job openings for every unemployed worker, that may not be the case. It’s the key economic dilemma facing markets today.
It would seem obvious to policy makers that to bring inflation back down to 2%, some slack in the labor market is needed. Today, 50,000 jobs or so are needed each month to keep the labor market status quo. So far in 2022, the monthly average increase has been over 400,000 although the monthly gains have been in slow decline in recent months. They could fall under 200,000 for the first time in recent history when November numbers are reported next week. Higher interest rates are affecting credit sensitive parts of the economy including construction and retail sales of discretionary goods. As rates continue to rise, the pressure will increase. So far, there haven’t been a lot of layoffs in either sector as home builders are still working off big backlogs and retailers prepare for Christmas.
Another sector starting to feel pressure on headcount is technology. Many companies, large and small, were far too optimistic about sustainable growth rates. Large companies were running into the law of large numbers and heightened competition. Small companies expanded too fast, ran out of cash, and are now scurrying to survive as angel backers stop funding losers with little hope of future profitability. The slowdown in venture funding will permeate upstream, lowering demand across Silicon Valley, a trend that could last for months if not years.
This morning’s big corporate story is the sudden replacement of Disney’s# CEO, Bob Chapek, with former CEO Robert Iger. Key activist investor Trian Partners chimed in saying it wanted more focus of cost cutting. The stock is up about 7% premarket.
Disney is a very complex company to manage. It is the largest producer of movies, runs the most successful chain of theme parks, and is the second largest streaming video company. It also operates, ABC television, ESPN, a line of cruise ships, and other related activities. While it is complex, this is not a conglomerate of disassociated businesses. All its activities tie together. Mr. Chapek was guilty on two fronts. First, costs got out of control, particularly in its streaming business. Second, while neither Chapek nor Iger are remarkably creative themselves, Iger nurtured creativity much better than Chapek. Iger isn’t the final answer, but he should be a good interim solution. Disney is iconic. Attracting a topflight CEO should not be a huge problem. Its streaming business is fixable. Higher prices and ad-supported alternatives already announced are steps in the right direction. A slew of big movies are on their way over the next several months. This will be a story worth watching.
The other big story that continues to grab investor attention is the turmoil in the crypto marketplace. While parts of the industry are regulated, the rules resemble swiss cheese; lots of holes. Industry leaders, including investors, talk in blather. Few make any sense. The world doesn’t need another “coin”. The dollar, euro, and yen, among others, are all trusted worldwide. Money is already digital. Look in your pocket. You are probably carrying a lot less cash today than you did a decade ago. Just as SPACs and IPOs attracted lots of speculative capital, so did crypocurrencies. All are falling apart simultaneously.
If you watch CNBC, just remember that from 5am to 8pm, they need something to talk about. You can discuss XYZ’s earnings or how much the Fed will raise interest rates at the next meeting for only so long. Just as the Weather Channel will focus on any weather event, or the evening news will tell you 80 million Americans are in the path of sustained drizzle over the next 24 hours, CNBC will latch onto any hyped story and overplay it. It’s no different than MSNBC or Fox News rolling out its lineup of loyal progressives and conservatives to discuss the impending collapse of American democracy. Did you notice that no one complained of election fraud this time around despite all the talk and predictions beforehand? I’m not trying to fault the networks. They simply don’t have enough news to talk about for 24 hours. To keep viewer interest, they must exaggerate the importance of whatever. In some cases, the whatever turns out to be rather unimportant.
There is importance to this rant. Successful investing requires one to separate what is relevant from what is not. Crypto today has absolutely no bearing on the overall economy. Financially, it only impacts those who choose to be involved. Yes, a large bankruptcy within the crypto world could have some impact on a few players, but the crypto market itself has shrunk by over 70% from its peak. If with all the bankruptcies, fraud, and hacking there are some who still want to play the game, so be it. For the rest of us, it has as much overall importance as the Bernie Madoff scandal. Juicy gossip but no real relevance. The only direct lesson to be learned is that hype without substance has no value. Any financial asset’s value is the product of a stream of future cash flows. Crypto produces no cash flow, has no legitimate purpose, and its only value is the possibility that someone will pay you more than you paid for it yourself. I have no idea whether bitcoin is worth $1 or $1 million and neither does anyone else. The hype around bitcoin is no different than the hype around the next great producer of electric cars or quantum computers. As you watch the news, ask yourself whether what you are listening to makes sense. This isn’t just about crypto. It could be listening to someone explaining a bad quarterly earnings report. As an investor, you must strip away the foolishness of the moment to find the real value. It isn’t easy.
Today, Michael Strahan is 51. Goldie Hawn turns 77. Basketball legend, Earl “the Pearl” Monroe, a Philly native, is 78. Finally, Marlo Thomas turns 85.
James M. Meyer, CFA 610-260-2220