Stocks rallied at the end of a dismal September. While growth in September deteriorated a bit thanks to the persistence of the Delta variant of Covid-19, stocks fell due to a combination of issues, a slowdown in growth being just one. Interest rates rose, the Fed hinted at tapering bond purchases before year end, and the political environment was one in turmoil. It remains in turmoil.
“Don’t worry, be happy” – Bobby McFerrin
“What, me worry?” – Alfred E. Neuman
Despite problems with transitions, despite higher interest rates for a few weeks, and despite political turmoil, the economy is strong and likely to strengthen further. The Delta variant is history. How do I know? The lead story on the evening news is no longer overcrowded emergency rooms! Seriously, the impact of the variant is not only decreasing, it is decreasing rapidly, in line with the exact pattern from other spikes. More people are getting vaccinated, booters are arriving, and the herd impact of herd immunity is increasing. Now Merck is on the verge of bringing a drug to market that can lessen the severity of the disease materially. I hope everyone understands this. Fast forward to next spring or summer when the Merck pill (a pill, not a shot) is readily available. If you feel sick, you see the doc, get the pill and the worst that happens is a few lousy days a la the flu. That changes the whole dynamic of the disease. The pandemic ends: the endemic begins. That means Covid-19 doesn’t disappear. AIDS never disappeared. Covid 19 becomes a disease that we can deal with without changing our lifestyles.
Economically, in one word, that means normality. It means parents don’t have to worry that their kids will require virtual learning and they will have to stay home. It means I can go to theatre and know I am not going to face death in a week. It means all the shut downs that are causing supply chain gridlock start to fade. It means supply chain issues are weeks or months from ending. But they will end.
“What, me worry”?
OK, there are still concerns. The Democrats can’t get enough votes to pass close to $5 billion in added spending. They can yell it doesn’t cost anyone anything, but that’s a pile of political garbage. Even if they mean the rich and corporations are going to pay for their entire wish list, that doesn’t fly. How does $2 trillion in taxes and $5 trillion in spending come to mean no cost? So far at least, a few Democrats understand the difference. While the progressives can crow that they delayed a vote on the infrastructure bill (which wasn’t fully paid for), they are no steps closer than they were a few weeks ago to passing anything.
The reality is that the $3.5 trillion (supposed!) reconciliation bill must be cut. It must be cut a lot if it has any chance of passage. The progressives can label Senators Manchin and Sinema whatever they choose, but they aren’t going to get anything near $3.5 trillion across the finish line. Playing political games like shortening the length of programs, won’t fool anyone currently opposed to the bill. The reality is that while parts of the program are popular, the program in its entirety is not. The American public realizes that supersizing the government is going to be a huge long-term cost borne by all at some time, in some context.
Will the Democrats work to tighten the bills? If they want them to pass, they will. The infrastructure bill was cut in half before it gained bipartisan support in the Senate. Can they get Republican support for parts of the reconciliation bill? Unlikely, if Republicans are never asked to participate in its creation. The Democrats took the solo path from the beginning. Are they being held hostage by Sinema, Manchin, and others? I don’t think so. The better response is that Democrats need to find a common center, one that all 50 Senators and all 435 members of the House can agree on. So far, the moderates haven’t given in, and the progressives still want everything. If they can’t find middle ground, nothing will happen. Wall Street would love that!
Back to the economy. It is solid and growing at above average rates. Yes, maybe Covid and supply chain issues have slowed it a bit, but as the Delta variant passes and supply chain issues get resolved, growth will get back on track at levels not seen since before the Great Recession.
Which leaves just one last issue, inflation. The Fed is right that many of the forces pushing inflation higher today will ebb as supply and demand rebalance. What about shelter and labor costs? There is a shortage of available housing that isn’t going away any time soon. That means higher home prices and higher rents. There are workers that will reenter the work force once Covid disappears but there are also a lot of retirees that will stay retired. Higher home values and stock prices ensure that. It is hard to believe that wage inflation is going to disappear.
Thus, we are headed for a reacceleration of growth, maybe a slight moderation of inflation, but the likelihood is that key inflation components (rent and wages) will stay above average for a longer period. That suggests a good market for equities but not a great one. We just finished a third quarter with a great July, a flat August, and a funky September. Transitions create volatility without a lot of direction. In Q4, growth prospects will rise. The key is inflation. 10-year Treasury yields spiked over 25 basis points in just a few weeks. Too far, too fast. Look for some consolidation. Look for higher rates overall in the coming months. Higher earnings and higher rates will keep volatility high, but those aren’t the ingredients for a huge correction or a huge burst higher. Expect the volatile sideways movement of Q3 to continue into next year. Seasonally, however, expect Q4 to recover some from September fears as the Delta variant fades.
Today, Alicia Silverstone turns 45.
James M. Meyer, CFA 610-260-2220