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A Wall of Worry

Last week, Federal Reserve Chairman Jay Powell cited numerous issues that concern the capital markets, and then proclaimed that none of these issues are a part of the Fed's mandate to worry about. Their mandates are maximum employment and stable prices. The Federal Reserve has a hawkish view on the economy so they will maintain higher interest rates to control inflation and this has the stock and bond market worried. Some of the issues that Chairman Powell listed as things for the markets to worry about included:

  • Higher interest rates will make companies' future earnings noticeably lower as they have to refinance their loans in the next couple of years.

  • Congress will have to worry about how to balance the budget when the interest payments on government debt is repriced to the higher interest rates.

  • Home ownership for American families will be a challenge with higher mortgage rates just as household formation rates for GenX and Millennials are on the rise and they now need bigger homes as they are having children.

  • Corporate real estate businesses will struggle to maintain profits as their loans typically have to be recast every 5 to 7 years, and we are now approaching our 3rd year of higher rates.

  • Political polarization may cause a short-term government shutdown which could cause a disruption in government workers getting their pay, and ultimately cause a slowdown in consumer spending.

We don't pretend to know how each of these issues will be resolved, but we do know that each of these challenges is no greater in magnitude than most issues that our economy and society have faced in the past. Yet the stock market has outpaced cost of living nearly 5 to 1 in the past 20 years.

source: American Funds, S&P, REFINITY

One thing that seems to guide stock prices higher over time is the pursuit of the masses to obtain a higher standard of living. It's impossible to know the next trend that propels our economy, but there are over 30M folks between age 35 and 45 in the USA (source: US Census Bureau) that are coming into the age bands where peak lifetime earnings have historically been a major force on the economy. I believe that the pursuit of a better life will compel this generation to do what it takes to pursue that end. GROWTH CAN COME WHEN IT'S LEAST EXPECTED As the chart above shows, we always have plenty to worry about from headline news. It is very unusual to see news that leads us to believe that noticeable growth is coming soon. But somehow, American history shows us over and over again that growth is a part of the fabric of our society. Here are a few things that could happen in the near term that could provide the next catalyst for growth, that very few investors are pricing into their current expectations. 1) Labor strikes produce 30-hour work week with 2x last year's compensation. The ambitious worker will now be able to take 2 jobs, work a typical business owner 60-hour work week, and get paid 4x last year's wages. That allows for 4x consumption by that one worker and fuels consumer spending to highs 2) Technology advances create more productivity for business than the cost to borrow (currently about 7%) to acquire and deploy new technology. Many are worried that core lending rates in the 7-9% are going to cripple our economy, but let's not be blind to history. Two of the greatest expansions of the US economy in history came when core lending was in the 7-9% range -- 1990 to 2000 (S&P500 10-yr return was 432.2%) and 1950-1960 (S&P500 10-yr return was 467.4%) 3) Government policy changes will shift back to accommodate growth again. It is a short sighted view that current restrictive monetary and fiscal policies will always remain as they are at present. It is very rare in history for any Federal Reserve leaders to push interest rates to make short term rates higher than long term rates. The costs to our government to finance debt will create plenty of motivation in the next few years to create the political will to change this current stance. When this policy shifts, that will intensify the wealth effect on asset prices. These are only a few items on a list of positive possibilities that won't make headlines. Typically media will often broadcast negative outlooks and things that inspire fear to get more viewership. It's just not good press to talk about the things that are improving or have the potential for good. Part of our responsibility as financial stewards is to maintain a balanced view of all the economy and of all things that impact prices of investments. Maintaining that balanced perspective often can help us help our clients not get too aggressive or too defensive at the wrong time in economic cycles.

Bottom Line: For our growth investors, we remain focused and disciplined to not remove significant investments in quality stocks for the long run. History has shown repeatedly that the markets have a way of climbing a wall of worry, regardless of how bad the headlines are from year to year. For more conservative investors, we are maintaining a small to moderate allocation in stocks for long term growth, and also taking advantage of high yields on money markets and corporate bonds. We encourage everyone to be patient while the market sorts through these current concerns. If you have questions, thoughts, or concerns regarding your portfolio, please feel free to reach out anytime. Thank you for the continued opportunity to serve you.


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