Stocks rebound 7% from September low. Now what?
David Edwards:
Good evening, it's David Edwards in New York City. Buff Parham inKiawah Island, South Carolina, and it's the Halloween edition of the Heron Wealth webinar series.
Kind of a quiet month or so, in that the stock market did not go down.
Buff Parham:
Nope.
David Edwards:
Actually went up 8%. And let's recap the year, US markets were at all time high, December 31st.
Last year, the bank stocks, Facebook, Apple, Amazon, Netflix, Google leading the way and then staggered a little bit in January, February, rallied back in March.
Then crypto crashed and burned and the markets fell to a low for the year in June 15th, rallied back July and August, fell again sharply into September. Had another new loaf for the year officially in bear Market territory down 23% on the S&P 500 down more on the other indices. This time a month ago, we had a webinar. Is there any reason for hope at all?
Last month, we noted that the markets were about 20% undervalued according to the Morningstar fair market model that we like. The CNN Fear and Greed Index is showing extreme fear. Those are both good contrary indicators indicating the market should go higher and indeed, it did. It went straight up for the next four weeks. Even so, it's still 15% undervalued.
Our forecast for all of 2022 was that the market would gain 4 to 6%. To achieve that from this level, we'd have to rally another 25%, and that's just not going to happen in two months. But we are setting ourselves up for a pretty good year next year. And the reason why is because we are now closer to the end than the beginning of the Fed tightening schedule.
Right now, the Federal Reserve Bank of the United States is raising rates more aggressively at any time in my entire career. We've had three raises of 75 basis points, 0.75% so far this year, another one is arriving momentarily. That would be 3% in six months, that's the fastest, most aggressive rate of increase in my entire career. But we also know that by June of next year, those raises will be done.
Fed funds that are currently 3.5% will settle in at about 4.5%, maybe even 5%, which is high compared to the level that we saw between 2009 and 2019, but was normal for most of the '90s and the 2000’s up until 2008. And in fact, Fed Fund rates have been much higher in years past and the economy's done fine. What is most interesting to me is how many senior economists, how many presidents of banks are insisting that we're facing a terrible recession. And I just don't know what they're thinking, other than they're thinking “My portfolio is down. So there must be recession coming”.
We have 3.5% unemployment. That is a generational low. We have 10 million new jobs created in the last two years, that's an amazing number. There isn't a restaurant in the country that doesn't have 'help wanted' signed in front of it. In fact, many restaurants I know have cut their hours back because they can't staff up. Every single business owner that we have as a client has the same complaint. They can't get good help and you just don't get recessions when people are employed.
Here's something else that's important, for the time period from 2000 to the present, most of the gains in the economy from productivity increases went to the upper half of US households. People like me, one-percenters, people like our clients, mostly all one-percenters. But now, in the half of the households that make less than $60,000 per year (a really staggering low number) are seeing real increases in income for the first time since 2000. And so, that feeds into the inflation problem we have right now. Everybody wants to know why is inflation so high?
Well, we've talked about this before. We've got war inflation. The war on COVID, the war against Russia over Ukraine, both disrupt supply chains. The war in Ukraine in particular has disrupted food markets and energy markets and you can't hide from that, it just creates an inflation. But also, when people have money in their pockets for the first time in a long time, they go out and buy stuff and they want to buy stuff that's currently stuck in a port in Long Beach or still trying to get into a container in Shanghai.
The Fed will raise rates as aggressively as they can, but I don't think it's going to make a difference until all these more bigger problems, the war problems and the supply chain problems work themselves out. The other thing that's interesting is that here, we are in corporate earnings season and the earnings are fine. They're not amazing, they're not shooting out the lights, but they're not shrinking catastrophically.
In fact, the last time we saw a big selloff in earnings, and I'm ignoring the COVID stretch, was back in 2009 when corporate earnings fell off 50%. So, I'm going to call this a “muddle through” economy.
The stock market is always looking 12 to 18 months ahead. So I think the stock market has reached the point now where everybody who wants to sell or has to sell has sold. All there's left for other people that like to bottom fish, like our firm for example, and without selling pressure, the market's just naturally moving higher again. Up in October, don't see why I shouldn't keep rising in November and December and frankly don't see why it wouldn't go up 15% in 2023. The other market that we care about is the bond market. So stocks are affected by corporate earnings and interest rates. The bond market is only affected by interest rates. And because of the super steep rise in federal reserve big funds, the whole yield curve has shifted higher.
What that means is that we're now able to get 4.5% on a one year treasury note, which a year ago was 0.3%. Whoa. All right, so the good is we're getting actual returns on bonds for the first time in a couple years. That bad news is, it temporarily depresses fall of the prices of bonds, whether it's governments or agencies or municipals or high grade corporates or high yield corporates are preferred stock. They've all been slammed as hard as stocks this year. And this has been the year where neither stocks, nor bonds have evidence. They plate to be investor and we have to tough it out. And with that, I know we had some questions.
Buff, why don't you jump right in.
Buff Parham:
Yeah. You mentioned inflation, we know it persists, but can you put your finger on one root cause at this point?
David Edwards:
Everybody wants to see, is there one reason why inflation is high this year? And it is multiple things. Number one is COVID. Number two is Ukraine. Number three is supply chain issues, particularly China. But then also, you get some inflationary expectations. I always personally keep track of a couple different things for my personal gauge of inflation because everybody has different things. And I used to spend an average, when I used to buy groceries, I would buy weeks worth of groceries and this was 20 years ago. And on average I paid $25 for a bag of groceries. So whatever was in that bag, which might be produce, might be detergent, whatever, at times family size, 10 bags of groceries, the average was $25. And then 10 years ago, it was more like $50 a bag. Okay, well, whatever. Well, recently, it's $75 a bag and it jumped pretty dramatically for let's say, $65 a bag to $75 a bag just in Latin last year.
Now, I'm financially well off. My clients are financially well off. Nobody is going to be suffering because they had to pay an extra $10 a bag for groceries. But at the other end of the economic spectrum, family's going to make 60 grand a year or less per household. That extra $10 a bag is brutal and it means you got to take something out of the bag and put it back on the shelf before you check out. Gasoline energy prices, we were over $5 a gallon in the US earlier this year. I think in June, was probably the highest point. The high point of year was $5 a gallon nationwide, we're back to 360 a gallon nationwide. And the OPEC, I met a couple weeks ago and decided to cut production by 2 million. Yes, prices briefly trickled up and then came right back down again, and it continued to go down.
That 2 million barrels a day is really a million barrels a day, because not everybody was at full capacity. And people respond to higher prices by energy by driving less or carpooling or switching to electric vehicles. So you can't point energy necessarily as the cause of inflation. I do think that the labor issues in the US are part of the problem. If you need to pay up for a good help, then you do, which is a fact, right? I believe that the United States should have arms wide open, skilled immigrants from every corner of the planet, grab all the good people and bring them here. That's not politically realistic right now. But also, inflation is not just a US phenomena, it's also a phenomena in Europe.
So, at the end of the Great Depression, which was the 1930s, prices were very depressed. And then World War II began, and it was inflationary everywhere and the inflation did not end until the war ended in the late 1940s. So, everybody wants a single thing that they can attack to end inflation and a bunch of things have to get resolved before inflation gets under control. So we're just...
Buff Parham:
A multi-head snake to say the least. We talked about corporate earnings for a second and then pretty much in line with what's expected, although it looks as if PEs are coming down, PE ratios. Does that trend pretend another upside rally in this bear market?
David Edwards:
Yeah, so the big driver of the stock market in 2021 was a handful of companies, Amazon, Netflix, Google, Apple, Facebook stumbled dramatically. They're down by half, Amazon's down by a third. Apple's doing pretty well down 25% or so. And that's just kind of the prices coming back to reality. You mentioned PE ratios, a PE ratio is a quick and dirty way of evaluating stock. If the PE is 20, it means it will take 20 years to earn back a dollar of earnings. If you put $20 in to buy the stock, you'll take 20 years to earn back that investment of 20 bucks. If a PE is a 100, it could be a 100 years and Amazon has a PE still of 105. So that means that it's a price to perfection and it should come down. But other parts of the S&P 500 PEs of 12, 10 and 8, pretty good value. So our approach historically, has been to shy away from the really expensive companies and buy some of the lesser known, more attract valued companies and we'll get by.
Buff Parham:
You mentioned some of the bigwigs, the Jamie Dimon, the Larry Summers of the world, particularly a mild recession for some time in '23. Do you agree or disagree with that prognostication?
David Edwards:
So, a recession is officially defined by a bureau of the US government. It's informally defined as two periods of negative GDP. Well, we actually had two periods of negative GDP and then the most recent report on, I think it was Friday or Thursday, was again at 2.6%. Now, the problem with calculating GDP is that it's affected by imports and exports and investments and everything is still ricocheting around back and forth from COVID. In the past, I've described the economy as a giant engine block, suspended in the air by thousands of piano wires that sort of swings and displays like this. And then, reality is the Elf on the Shelf, the pair of wire cutters and the Elf cuts couple wires there. And all of a sudden, the block starts to swing.
Buff Parham:
Filter.
David Edwards:
... and the wires start to break and the whole thing curl like this for a little while until there's a new stasis and then the Elf starts cutting wires again. So we're not even yet recovered from the COVID era and we've still got the Ukraine war era going on, and there's just a lot of uncertainty. But meanwhile, we keep doing our job, which is to keep our clients invested. I've always pointed out that in the 27 years I've been running this firm among all of our clients that are relying on their portfolios for their monthly draws, I've never had to cut anyone's monthly draw. And the reason why is because we always have a year's worth of cash in money markets and CDs, another four years of cash in bonds and then the rest of the money in stocks.
And when stocks are doing well, we overflow the excess into the bond bucket, into the cash bucket into their checking count. But when things are doing badly, the stock was doing poorly. We just stop that little part of the waterfall knowing that we have five years worth of cash flow available between stocks and bonds. And within five years, we'll have forgotten about all this. In two years, we'll have forgotten about all this. Nobody remembers the last bear market, the stock market down 35%, which was March to May 2020, because it was over by September.
Buff Parham:
Yep.
David Edwards:
This bear market, which is already 10 months long is the longest bear market people can remember since 2008 or 2009.
Buff Parham:
Political, the off your election is just around the corner. What's the financial impact of the GOP taking the house, the Dems holding on to the Senate, which seems to be the consensus at this point?
David Edwards:
Yeah, I always feel like I'm on thin ice when I'm talking about politics because people get upset. So let me just say for the record, I was a Republican until about 2004, I stopped being a Republican at that point. I'm not exactly a Democrat either, I'm kind of an independent who places his vote where he thinks we'll get the best results.
Buff Parham:
Yeah, me too.
David Edwards:
It's pretty discouraging to look at the state of political conversation right now. It's just one side hates the other, the thing that people never seem to remember. So right now, the Republicans have the edge getting into Congress because the Republicans historically have thought it would be better on the economy and better on inflation. And the actual facts are the administrations of George Bush Sr. 41, George Bush Jr. 43, and Donald Trump. Those administrations all ended up with the economy in a deep recession. And the administrations of Bill Clinton and Barack Obama, the economy was expanding very nicely. Thank you very much. And Joe Biden, 10 million new jobs in two years and a lot of interesting programs out there for infrastructure and pollution abatement, has a lot to do with why average Americans are actually getting real boost in income. But if we've learned nothing in the last six years, we have learned that facts don't matter at all.
Buff Parham:
No, nor the truth.
David Edwards:
I'm a person who gets upset when I get something wrong by a decimal point. I mean, I live for facts and there's no facts in this political cycle. Somebody turned to me recently and earnestly explained to me how horrible it was that schools now allow litter boxes for children that identify as cats.
Buff Parham:
Saw that.
David Edwards:
And I go, "Oh, my gosh, do you know that's entirely made up? That literally has not happened anywhere in the entire country. That's complete fabrication, totally false, total lie." But meanwhile, there's a senatorial candidate in New Hampshire who repeated that story all over again yesterday. So, I will say this, the Republicans don't seem to have any plan for anything. And the Democrats seem to have some plans, but they have no messaging whatsoever. They literally can't help but fall over their own tongues trying to explain anything to average Americans. So here's what's going to happen, it seems like the Senate will be either 50/50 or 51/49 or possibly 52/48 in favor of the Democrats after next week. It seems probable that the Republicans will regain the house and then what that means is nothing happens for the next two years.
Buff Parham:
Gridlock.
David Edwards:
No, I guarantee you that the Republicans will run 70 impeachment campaigns against Joe Biden between now and 2024 and then that will die in Senate. And even if the Senate was controlled by the Republicans, it would still die because you need 60 votes. So we'll just waste the next two years, nothing will get done. The other thing that bugs me is the Republican's supposed to be better on inflation. Where's their plan for inflation? Nothing public study publish. So just prepare for good luck, I guess, is my message.
Buff Parham:
I've nicknamed the parties reckless and factless.
David Edwards:
And it could go either way.
Buff Parham:
Take your pick. Our friend Mr. Putin, the blunders continue to pile up in addition to a poorly executed invasion of Ukraine. His assumption that he could choke off energy supply is also a blunder thanks to a glut of natural gas from good ol' US. So what's his next move?
David Edwards:
Yeah, so we've been following this development, me, personally with the eagle eye because my hobby is war and it's fascinating. So we calibrated, we talked about the four possible scenarios. Scenario one, Russia overruns key, even a matter of days that didn't happen, run up the bat. Scenario number two, it's a wretched stalemate. That was the scenario for most of the summer up until September. Scenario three, the Ukrainians are able to push the Russians out and they're able to do that by simple laws of physics. The Russians are throwing down range. Every missile they can, every shell they can, they're buying drones from the Iranians. They're running out of material. There simply isn't enough weaponry left in Russia to keep this thing going.
Meanwhile, the Ukrainians have successfully negotiated with the Americans, the Germans, the French, the British, the Canadians, who else knows. And not only are they getting a continual resupply of weapons, but they're getting really good weapons. The kind of weapons that can target an ammo dump from 50 miles away and blow it at smither rains. So already, the Russians are in retreat and the northeast part of Ukraine lost a big chunk of it in September. Now, the next piece at risk is in the Southwest along the banks of the sea of a Czar. I always used to joke that war is God's way of teaching us geography, and it's so true. I'd never even heard of the sea of a Czar.
Buff Parham:
You've ever heard before.
David Edwards:
Until, this war. And also, we're getting into winter and the Russian soldiers barely have flak jackets and weapons, let alone mittens and hats and sleeping bags and camp stoves. And then, you can simply watch them, the Ukrainians are operating these commercial drones, they've rigged with grenades and that is flat over the countryside look for unsuspecting Russian soldiers. Drop a grenade on them from 200 feet up that they can't even hear the drone and they're just dying. And at a certain point, morale completely collapses and they start running back east back towards Russia. And that's how the Ukrainians got the northeast.
Now, it's very possible that Ukrainians can push the Russians out of Ukraine and even retake Korea. That takes us to the most dangerous element of all, scenario four, where Putin reaches for the nuclear weapons. And there's a lot of back channel conversation going on right now between the US and NATO and their counterparts and Russia saying, "Listen, if you go nuclear, we're going to treat this as an infringement on NATO." And then it's all hell bracelet loose. And what we've learned from observing people like Saddam Hussein and Nicolae Ceaușescu in Romania and Aleksandar Vučić in Serbia, the number one priority of an authoritarian is regime survival. And so, Putin needs to consider, "Well, I may have to go nuclear to ensure the support of my regime, but if I do that and some nuclear weapons complying back into Moscow, well, then, that's end of my regime anyway." So, he is in a very bad shape, running out of options. It is a non-zero risk that this conflict goes nuclear.
I never thought I'd have to worry about that in my lifetime. People have asked me, "Well, David, am I changing my investment strategy based on if it could possibly got nuclear?" No, I'm not. Because if it does, none of this will matter at all. It will matter at all. So we have to go in the assumption that it won't go nuclear and we'll continue to live our lives.
Buff Parham:
Yeah, I'm curious to see what's going on inside the Kremlin in terms of is the opposition to Putin going to make a move, but we'll see. We have a...
David Edwards:
I don't know who could oppose him. The oligarchs are all terrified because they're utterly dependent on Putin's good graces for their wealth, and it's been stripped already. Killing him won't get it back for them. Would it be his own military? I don't know.
Buff Parham:
We'll see.
David Edwards:
They've been purged. It's just true believers at this point. So I think by January, we'll kind of know how this thing is going to end. I feel by that point, you'll have the Russian Army in flat out flight East with the Ukrainians in hot pursuit. And I think Putin will just not go nuclear because every Russian Navy ship in the Black Sea would be suck in minutes there. They're already pre-targeted. And so, I don't know, it's fascinating to watch except that little …
Buff Parham:
True. We've got a Ukraine related question from the audience and that specifically is, will the war in Ukraine impact sectors beyond energy and agriculture such as tech?
David Edwards:
Interesting question. The Ukrainians are very smart people and they have a lot of startup tech things going on. For example, the actor who played Darth Vader, what's his name? I'm blanking for a second.
Buff Parham:
James Earl Jones.
David Edwards:
James Earl Jones is now 91 years old, and he no longer feels like he can be the voice of Darth Vader. So he's licensed the recordings of his voice to the Star Wars franchise. And they're using Artificial Intelligence to recreate his dialogue from 10,000 soundbites. And the company that's doing the work is a Ukrainian company and they're doing it from inside a bomb shelter. So there's some smart people over in Ukraine. Now, will it affect Apple in general? Will it affect Amazon in general? No, I don't think so.
Buff Parham:
Another question, China is reverting back to a nationalist insular society. How is that going to affect the US economy?
David Edwards:
So China as a concept is 2000 years old. When we were all in elementary school, we studied Western civilization, we studied the Crusades and we studied the Roman empire. We studied the Greek city states. We studied Egypt. The whole time China was doing its thing and we know nothing about it. There was around a 1,000 AD that the China as a country had the largest GDP on the planet, it was like three quarters of world GDP. And the Europeans were living in mud huts on the edge of the known world. The problem that China faces is that the Chinese communist party just cannot be to let a good thing go, and chooses security over overgrowth at every occasion. And we've had a two decade long stretch where the Chinese communist's grown at a breakneck pace 8% a year. And at 8% a year, you double your economy every 10 years.And you see this incredible leap in longevity statistics and in financial growth, etc. And I was pretty confident that the Chinese economy would be bigger than the US economy sometime in the next 10 years at the latest, by 2030, let's say. Well, now, all of a sudden, this is what's happened in China, they're flattening out. And the reason why is because they've taken this very authoritarian approach to COVID rather than import western vaccines. They've taken this zero tolerance for COVID to clamp down whole sections of the economy, it's been very disruptive. So that's the problem for them. And then also, there's been an incredible amount of state supported lending to real estate development that's still coming to a crash. There's a lot of corruption around how real estate gets developed. And then lastly, they started to emphasize state owned or corporations over private corporations. Again, which something they've given up on by the '90s.
And all of that means that the growth rate in China will come to a screeching halt. Here's another thing that affects China. For two decades, the United States exported a lot of its manufacturing capability to China, to Vietnam, Cambodia, Bangladesh, places like that. Well, now, post COVID, we recognize that actually that's a security threat. It's also an economic threat. So now, we're reassuring a lot of the technology we exported in particularly semiconductors and chips, stuff that really matters, the high value products. So I kind of feel like maybe we'll start rising up again, while the Chinese level off a little bit. And maybe we'll stay there, number one, a few decades longer.
Buff Parham:
I think you're right about that one. That's all the questions we had, David.
David Edwards:
Well, good. We covered a lot of material on 30 minutes and I feel like people should get ready for Halloween.
Buff Parham:
Trick or treat.
David Edwards:
Trick or treat. Good day, Buff.
Buff Parham:
Take care, everybody.
David Edwards:
Bye.
David Edwards is president and wealth advisor with Heron Wealth, a $500 million registered investment advisor based in New York City working with 225 client families across the U.S. and around the world.
At time of publication, Edwards and/or his clients held positions Amazon, Apple and Google.