Freedom is the freedom to say that two plus two make four. If that is granted, all else follows. George Orwell, 1984 I have said many times and believe deeply that our job as investors is not to predict the future but merely to interpret the present as accurately as we can. I’ve also said and believe deeply that doing so isn’t nearly as easy as it sounds. We have numerous cognitive biases working against us, way too many to name here. I probably have a cognitive bias that affects my ability to recognize cognitive bias. Our political beliefs – our tribal loyalties – affect our ability to see things clearly. Our hopes and dreams and of course our fears all affect our view of the past, present, and future. For those of us who write about markets regularly, there is the issue of our past
Joseph Y. Calhoun III considers the following as important: 1984, Alhambra Research, bonds, CFNAI, cognitive bias, commodities, construction, CPI, currencies, Dollar Index, durable goods orders, Economy, employment report, George Orwell, housing market, inflation, Interest rates, markets, payrolls, Stocks, US Dollar, Yield Curve
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Freedom is the freedom to say that two plus two make four. If that is granted, all else follows.
George Orwell, 1984
I have said many times and believe deeply that our job as investors is not to predict the future but merely to interpret the present as accurately as we can. I’ve also said and believe deeply that doing so isn’t nearly as easy as it sounds. We have numerous cognitive biases working against us, way too many to name here. I probably have a cognitive bias that affects my ability to recognize cognitive bias. Our political beliefs – our tribal loyalties – affect our ability to see things clearly. Our hopes and dreams and of course our fears all affect our view of the past, present, and future. For those of us who write about markets regularly, there is the issue of our past observations which will, at some point, make us look foolish. And God knows that is one thing we do not want to do so we tend to find data points that support our past views. Which means we aren’t seeing the present through clear eyes anymore. Egos are a bitch.
What I try to do every week is look at things as they are and forget what I’ve said in previous weeks. That has gotten easier as I’ve gotten older (that’s a joke but one that is based on real-life). I don’t spend a lot of time trying to figure out why things are the way they are because I’ve found over many years of doing this that it isn’t possible with any degree of accuracy. Do we know why, for instance, the quits rate is so high and why there are so many new businesses being started? Not really. We can guess about people’s motives and someday we may have enough data to look back and say, aha, that’s what was going on. But right now? Nah. It’s just guessing and while it is interesting it isn’t particularly relevant for our mission as investors.
The freedom that George Orwell speaks of is the freedom to think for ourselves, to perceive reality on our own terms rather than have one imposed upon us.
There are four lights!
Jean-Luc Picard, Start Trek, Next Generation
As investors, it is hard to tune out the noise, the cacophony of data masquerading as information. Most of what we see and hear on a daily basis lacks context and the people trying to provide it often have an agenda. And sometimes the data just doesn’t capture reality.
These tortillas are the same brand, same packaging, same description, same price for a ten count package. They even claim to be the same weight. They were bought a few weeks apart. The newer one is on top. Inflation is transitory, right?
So, are the inflation statistics we get from the BLS accurate? Does the latest reading of the CPI or the PCE deflator really matter all that much? Or is it just noise? I’ll let you in on a little secret. Inflation has nothing to do with any index produced by the government. It doesn’t matter one whit what the BLS says about inflation. The only thing that matters is how others react or overreact to the data. Inflation is actually about the value of the dollar (or whatever your local currency is). And there are better ways to measure that than the CPI.
As I said last week, most of what goes on day-to-day is just noise. It doesn’t matter and the more you pay attention the more likely you are to make a mistake. Two weeks ago it was the Federal Reserve altering its expected timeline for rate hikes. It moved the markets for part of a day before it was forgotten. If you want to know when the Fed will hike rates, I’d suggest watching the market, not the Fed or the talking heads on CNBC or Bloomberg. The Treasury market will always be better at predicting future Fed moves than the Fed or anyone else. Wisdom of crowds and all that. Just for the record, based on where rates are right now, the market is suggesting tapering by the end of the year and rate hikes in 2022. That is news worthy of the name and most people are still thinking about what Jerome Powell said last week.
I don’t know why the market believes rate hikes are coming next year. It could be that inflation won’t prove transitory which, based on the recent action in the dollar, doesn’t seem likely. Of course, the dollar could – probably will – change, and with it my views on inflation. Maybe the market is focused on growth. As I said, all we can really do is try to figure out where we are right now. For economic growth, one pretty good way to do that is the Chicago Fed National Activity Index which is a weighted average of 85 monthly economic indicators. If you want to know what the data actually says about the economy – no agenda, no political spin – you can look at this one number every month and get a pretty good idea. I actually monitor the 3-month moving average to smooth out the month-to-month changes. A CFNAI reading of 0 means the economy is growing at trend, a positive reading is above trend and a negative one is below trend. Generally, a 3-month average of -0.75 is consistent with recession. At the nadir of the virus recession, the 3-month average fell to -7.32 which was, by far, the worst reading ever (-2.54 in January 2009). The rebound was pretty spectacular too, rising to 4.36 last July (peak rate of change). The latest release was last week and currently, the 3-month average is 0.81. That sounds puny compared to the peak in July but it is actually a pretty extraordinary reading. Outside of the pandemic plunge and recovery, you have to go back to 1984 to find a comparable reading.
There are certainly reasons to doubt the current level as being artificial and highly temporary. After all, we did just have another round of government checks go out a few months ago. So it will probably fall back in the coming months. Or maybe not. We can’t say for sure since there is so much we don’t know. Maybe all those new companies being formed is important. Maybe the end of extended unemployment benefits is important. Maybe the changes wrought by the virus will have a lasting and positive effect. We just can’t know. What we do know right now is that the economy is growing well above trend. How long that lasts and what happens afterward is not something we can know right now. The only thing I know for sure about the future is that the markets will see it before I do. If you want to become a better investor, turn off the TV, get off of Twitter and watch the market in silence. In fact, I’d suggest that you stop reading all market commentary, too. Except ours of course.
The housing market appears to be finally coming off the boil. Both new and existing home sales have dipped in recent months. Sales are still well off the lows but the peak rate of change has passed. Other parts of the economy are obviously offsetting the slowdown in housing.
This week we’ll get some more news on the construction industry. Housing is slowing but residential is only part of construction spending. A slowdown in residential investment will hurt growth but in theory, it could be offset by non-residential although there is no evidence of that so far. We’ll also get an employment report which will be revised so many times over the next year that whatever gets reported this Friday can probably be ignored. But it may move markets for a few hours so let’s all tune in to see what Rick Santelli and Mark Zandi and all the other heads in boxes think the number will be. Just don’t actually do anything to your portfolio because of it.
The value trade that everyone thought was dead the day of the Fed meeting, made a big comeback last week. If the market is right about when the Fed will actually hike rates, I’d expect the value trade to continue to be a winner. Value tends to outperform when the yield curve is steepening and if the economy warrants a tapering by year-end and rate hikes next year, I’d sure expect the curve to steepen. The dollar has an impact on the value vs growth argument too, though, so keep an eye on the currency markets. The dollar index was down a small fraction last week but we’re still in that range I keep writing about. Bonds were down last week (10-year yield up 5 basis points, TIPS up 1 basis point) and momentum for lower rates has faded. The pullback in yields may well be over.
All the cyclical stuff that got hammered after the Fed moved up last week. Financial and energy were the big winners but almost everything was up last week.
I had been looking for more of a pullback in stocks but the economy is doing pretty well right now so maybe not. The average stock did quite a bit worse than the averages so we worked off some of that overbought condition at least at the stock level. Two-thirds of stocks in the S&P 500 were trading below their 50-day moving average a couple of weeks ago. After last week 55% of the S&P 500 was back above the 50-day, but that is still way off the 93% that prevailed in April.
We put a little capital to work last week in some individual names that we’ve been watching: a below the radar automaker with user base loyalty that approaches cult status, a streaming/content play that we think is finally ready to pay off, and a rapidly growing online retailer whose customer service is becoming legendary. And all of these will benefit from an economy growing above trend.
Forget what the talking heads are saying about the economy and the markets. Forget what Jerome Powell and all the others on the Fed Open Mouth Committee are saying. Concentrate on what matters, on what really is. Two plus two still makes four.