Around 1PM on Wednesday, with the markets testing 3-month lows, news broke that Senator McConnell offered Democrats two options for defusing another DC standoff related to paying our bills. Everyone knew the debt ceiling would eventually be raised, but constant bickering and political posturing caused some chaos in T-Bill rates and equities. Although thoughts of an actual default or late payments were minimal, risk measures were adopted, which meant selling stocks for some.
Briefly, Republicans offered the Democrats a short-term reprieve that would raise the debt ceiling enough to last until December. No layoffs, no missed bond payments and no furloughs. Their second offer was to reduce any time constraints/filibusters related to Democrats using reconciliation to increase the debt limit. Under normal circumstances, political parties use every opportunity to obstruct or delay a reconciliation vote. A politician’s desire to show fiscal restraint and maybe some media coverage on “doing the right thing” for their constituents is hard to pass up for either party. Don’t hate the player, hate the game as kids say!
Democrats are accepting the option to increase the debt ceiling thru December. Either offering does little to improve their position. Clearly, they don’t want to be saddled with blame on bills already owed for money spent in prior periods. Republicans don’t want to be revered as allowing this regime to spend another few trillion dollars and making the Government even bigger. In politics, optics are everything. I highly doubt anyone going to the voting booth next year is basing their decision on who voted for a debt ceiling increase, but here we are. Kicking the can down the road a couple of months only means we are likely to see more partisanship later and another tit-for-tat battle over reconciliation. For now, markets are happy and Democrats can focus on the two large spending bills awaiting votes, which will be positive for stocks.
This takes care of the D in my STIMIED acronym under debt ceiling. The market is finding difficulty progressing higher. We will need to get past numerous concerns before being fully comfortable in projecting new highs. Here are the other issues:
• Shipping and freight costs are outrageous and will crimp earnings. However, containers being shipped from China have already seen prices peak this week, showing the first sign of congestion slowly alleviating. We’re not out of the woods yet.
• Taxes are likely to be increased. How much is the question. With debt ceiling concerns put on the back burner, DC will focus on its spending and taxing plans. Answers should come before year-end. Markets hate uncertainty. Simply knowing what the tax rate will be is an improvement, even if its 25% for corporations instead of Trump’s tax cut that brought them down to 21%. Certainty is more important than a small increase.
• Inflation has been anything but transitory. However, price spikes today are mainly driven by supply disruptions stemming from Covid-induced closures, not excessive demand. That will be fixed over time. Getting inflation off the front page is likely a 2022 story though.
• Multiples are at peak levels for most stocks. Earnings growth over the coming quarters will bring P/E’s down, but that takes time as well.
• International events keep popping up, from China in particular. Dozens of emerging- market central banks are raising rates, while developed economies are slowly pulling the punch bowl. We’re all interconnected so it bears watching, especially China’s actions with respect to Taiwan and a threatening invasion.
• Earnings comparisons are going to start becoming increasingly more difficult. Peak growth is behind us. Input costs are rising. Margins can’t keep leaping higher. Earnings reports this month could create volatility…and opportunities, but we need more information which starts with big bank reports due out next week.
• Debt Ceiling is fixed, for about two months. There could be another showdown unless the Democrats start thinking about using reconciliation.
There are other concerns, but I cherry picked the phrase stimied since our equity rally is finally hindered by a slew of factors which haven’t really concerned investors over the past 18 months. New leaders will emerge from here, led by quality. As each concern gets relieved, equities can respond like the 3.5% bounce since Wednesday’s debt ceiling concessions.
Today’s market-moving news will be tied to the all-important jobs update for September, which will have a direct impact on inflation and multiples. It is a foregone conclusion that tapering will start soon, whether it is November or December matters very little. A low jobs number similar to August would only delay the inevitable by a month. Fed officials realize that purchasing exorbitant amounts of Treasury and MBS are not necessary today. Positive employment conditions have “all but met” Chairman Powell’s target for pulling back some stimulus. No amount of money printing will fix supply chains. An inline report would not be market moving and is preferred.
In an odd way, a really strong number of newly employed, coupled with spiking wages, could be seen as a negative for stocks. Anything that disproves “transitory” inflation, like spiking wages, brings forward rate hikes which are not expected until 2023. The past 7 recessions were preceded by 4%+ increases in wages. We’re there now. The longer it sticks, the more likely inflation becomes a true, long-term concern and Fed Funds will be on the upswing. Bringing rate hike expectations into 2022 will have ripple effects on growth stock multiples and therefore stock prices.
There are 7 million people off unemployment assistance since the Rescue Plan stimulus extension ended. Some have saved excess cash, while others are not able to reenter the workforce for numerous reasons. Not many are getting laid off either. Jobs should be plentiful for the next few months, pushing unemployment rates back to pre-Covid levels. This cohort should keep wage growth from getting out of hand. Unemployment claims have already collapsed as well:
Ideally, an inline report of 500k jobs and solid wage growth near 4% annualized will relieve some more of the STIMIED pressure. Having interest rates gradually glide higher is much preferred to spikes like we saw in September. This gives more fuel to an equity rally as concerns abate. We’re not out of the woods yet, but encouraging signs are around us for now. A rising tide may lift all boats, but at this point in the economic cycle we shift our preference from high beta / early cycle to quality growth companies.
Bruno Mars turns 36 today. Actors Chevy Chase, Sigourney Weaver and Matt Damon are now 78, 72 and 51 years young.
James Vogt, 610-260-2214