April, 2024

Viewpoints Archives

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As yet another quarter draws to a close, it’s impossible to overlook the confounding outcomes in economic and market data. Perpetual surprises have become a hallmark, leaving many market participants grappling with more questions than answers. With cumulative experience of over 60 years navigating capital markets as professional investors, we think it’s fair to assert that the current landscape is unparalleled in its uniqueness. While some markets are reaching new highs, inflation is ticking back up and potentially reaccelerating. Unemployment remains near its lower limit, yet retail data and lenders indicate that consumers are strained and overextended. Beneath the surface of these and many other contradictory data points, we discern underlying trends that allow us to distinguish between fact and fiction. One thing is certain: these data points are not as they appear at first glance. All of this culminates in all-too-familiar sentiments of recent years - uncertainty, fear, euphoria, and confusion. Here at SG & Co. we endeavor to navigate through these uncertainties with integrity by adhering to our time-tested process, ensuring that the preservation of our clients’ capital remains our utmost priority.

The Fed’s Dilemma: Inflation and Interest Rates 

Throughout the previous quarter, headlines from various governmental figures proclaimed victory in the war on inflation and a trajectory toward target inflation rates. Contrary to these proclamations, recent reports from the Fed reveal a resurgence in inflationary pressures. From our vantage point, it’s evident that inflation is not only rebounding but also showing signs of re-acceleration after the past two months of consumer price index data. This should come as no surprise to readers of our previous quarterly Viewpoints, as our analysis, rooted in historical parallels and proprietary methodologies, foresaw the potential for a recurrence of the troublesome inflationary pattern of the 1970’s as a plausible outcome (Chart 1). 

Interest rates and inflation are closely intertwined; typically, higher inflation correlates with higher interest rates. However, despite recent market discussions centering on interest rate cuts which contradict the prevailing inflationary trends, the landscape has shifted. Readers of the prior Viewpoints will also recall that previous market forecasts hinted at six rate hikes in 2024, while the current outlook has dwindled to just three—a revision we still regard as optimistically ambitious. In an environment where speculative fervor persists, as evidenced by the continued climb in risk assets like Bitcoin, the prospect of multiple rate cuts this year seems increasingly improbable. While the Federal Reserve’s next move—whether it involves cuts, hikes, or maintaining the status quo—remains uncertain, one thing is clear: the current financial landscape is rife with contradictions. As we approach the upcoming election season, these contradictions are poised to become even more pronounced.

Unveiling Labor Market Realities 

Adding further complexity to the picture is the state of unemployment data and the jobs market. Despite headlines touting a robust current labor market, the reality may be more nuanced. Wage growth serves as a valuable proxy for assessing both labor market strength and economic vitality. As depicted in Chart 2, a decline in wage growth often signifies not only a sluggish economy but also a heightened level of job seekers.

For those seeking insights into the vulnerabilities within the labor market, one need only examine the initial jobs reading, followed by a concerning trend of 11 out of the last 13 months containing downward revisions, as illustrated in Chart 3.

Contrary to the optimistic narrative initially portrayed, leading labor market indicators such as the NFIB Hiring Intentions and the Quit Rate suggest that the job revision data accurately reflects the true state of the labor market. 

Waiting for the Other Shoe to Drop

You might be wondering why, despite all of this concerning economic data, the stock market continues to soar to all-time highs. In addressing this question, we encourage you to delve into our February Special Report, Magnificently Manipulated. This research paper is of such significance that we deemed it necessary to distribute it as our inaugural Special Report to our clients. To summarize the report, the gains in the entire US equity market in 2023 had been driven by just seven stocks (interestingly, since the publishing of the Special Report, the Magnificent 7 has dwindled to the Fabulous Four)—an unprecedented level of concentration that poses significant risks. Remarkably, the remaining 493 stocks in the S&P 500 remained effectively flat over the past two years including the bear market in 2022.

Currently, the foundation of Wall Street is experiencing a seismic shift primarily driven by what we term as “The Machine.” This mechanism is fueled by automated capital from passive investing channels, such as 401K contributions (Chart 4), funneling into predetermined index funds where fund managers are compelled to acquire underlying shares irrespective of their price. Consequently, this dynamic has led to a situation where stock prices have diverged significantly from their intrinsic value, rendering traditional fundamental analysis ineffective. The cessation of this machine’s operation hinges either on the halt of passive 401K cash flows due to factors like unemployment or consumer strain, or an unforeseen external shock. For instance, if Japan, a significant provider of global liquidity, were to unexpectedly raise its monetary policy away from its historically near-zero interest rate range, it could cause far-reaching consequences. Bull markets, especially those propelled by narrative forces like the current one, rely on continuous influxes of liquidity to sustain upward momentum. Therefore, such a policy shift could trigger global ripple effects, given the interconnected nature of financial markets.

IN CONCLUSION

In conclusion, it’s imperative to maintain a critical eye on overly optimistic or nuanced economic data that fuels irrational exuberance in the stock market. Currently, the market appears to be priced for perfection, buoyed by the notion of a ‘Soft Landing’—a concept often misunderstood as an achievable outcome rather than an inherently inertial state. Given the exceptional fragility of the economy, there’s a risk of misinterpreting various data points, from unemployment figures to consumer spending strength. At SG&Co., we refrain from subscribing to the notion that ‘this time is different’. Instead, we adhere to a principled investment strategy that aims to steer clear of market euphoria. The many companies we choose to invest in for our clients are often those that operate under the radar, away from the spotlight of media headlines. This approach aligns with our commitment to quality and resilience in navigating uncertain markets. During such times, we are reminded of Darwin’s sage observation, “Ignorance more frequently begets confidence than does knowledge.”

Michael P. Moeller

Portfolio Manager and Research Analyst