Transcript:
Tom Vaughan:
I’d like to start off with this kind of summary of what I saw happening in the market this week. As usual, this week was very fascinating. This has been, you know, ever since this pandemic started week after week, it’s been a kind of a little bit of a different story in a fantastic stock market all together, which has been really fun to talk with and to invest in. But this particular week, we had quite a few different crosscurrents.
We had the situation with this new variant, this Omicron variant that came out, and the market, you know, last week took a hit because of that. Seems like that fear is fading somewhat, they’re done some testing found out that the vaccines are, you know, at least decent against this particular variant. And the case is so far up and mild, I think we have some room to grow there in terms of our knowledge about what’s happening. But I will say in general, one of the things that’s happening, if you look at the data, people are moving around again. And economic growth is happening, regardless of what’s going on with the different waves of the virus. Every wave that has happened, the economy has been affected less. Essentially what is going on is we are living, we’re learning how to live within this virus. And so economically, unless something changes pretty radically, I’m not sure the virus is the biggest story.
The bigger story really, right now, my opinion is kind of twofold, and they go together. One is inflation. So they just reported the inflation number for November was 6.8%, higher than last November. So that’s a big number got to go back to 1982, to find a number that’s bigger. And then the second issue has to do with the Federal Reserve and what they’re going to do about inflation. So let me try to describe kind of what’s going on here in this kind of teeter-totter situation that we’ll find ourselves in. And there’s some opportunity here, and there’s some risk here. And it’s important to kind of understand, you know, what’s going on.
So the risk to the market with inflation just has to do with the fact that as inflation goes up, and up and up and up, if it keeps going up and unchecked manner at these rates, it’s going to strip out the power of the consumer. So, if inflation goes up 6.8% And somebody has 6.8% more money, and they can still buy the same things, that doesn’t affect earnings in the end. And that’s the key got to always focus on earnings and what might affect earnings. And we saw that pretty much in the third quarter earnings reports: we had a 36% jump in earnings, you know, over the third quarter from last year, even though we had an inflationary environment, that just means that the consumer can kind of keep up with that. And what we’re seeing right now, some interesting data, if you look back to January 2020, before the pandemic started to now, consumers are spending 25% more, just saw this study today. That’s a huge jump. And so the consumer is very healthy as far as what they’re doing in terms of expenditure.
And I saw another report today that said household wealth here in the US grew 36 trillion, that’s with a T, trillion dollars since the end of the first quarter of 2020. So basically the bottom of the pandemic, as far as the economy in the market goes to now. So there’s this huge wealth build up, there’s an income buildup, there’s all kinds of different money that people have to spend, even if costs go up. But eventually costs can go up too much. And get past the ability for the consumer, whether that’s a business consumer or personal consumer to spend. And then you get this scenario where that would affect earnings.
So on the other side, you have the Federal Reserve, and their objective is to try to stimulate the economy up to a certain point and still keep inflation kind of in that two, maybe even 3% range. And so how are they going to respond to this. And so when you hear about inflation, really what you want to focus on, in my opinion, is how the Federal Reserve responds. Historically, at least for the last many, many years here, inflation has not been the thing that has brought the stock market to its knees, it’s really the Federal Reserve and ultimately, it’s because they’re over raising rates. So if you go back to 2000: 19 rate increases, we end up with a giant bubble burst. You go back to 2008: 21 rate increases, we end up with really the second biggest downturn and you know, since the 1900s. And if you look at even 2018. Many of you probably don’t remember this, but we had nearly a 20% drop at the end of 2018. We had this kind of trade war going on China, the economy starting to slow down and the Federal Reserve in their infinite wisdom continued to raise rates and we ended up with the stock market downturn until the Federal Reserve finally woke up and said, “Okay, things are slowing down.” 2019, they started lowering rates, and we ended up having a really good year in 2019.
So I would focus more of my energy on what the Fed is doing. And they made a pretty radical change last week, and that had to do with the fact that they had very clearly spelled out what they were going to do in terms of rate increases cutting back on these bond purchases, and they decided to become much more aggressive and cutting back on those bond increases. Although it hasn’t been officially announced yet, the meeting next week with the Fed Reserve, they’ll probably come out and say that they’re going to cut back on their purchases of bonds, you know, $30 billion cut back instead of $15 billion cutbacks per month.
And so that’s the environment that we’re in. So there is this kind of Goldilocks zone, where the Federal Reserve does enough, you know, cutting back on stimulus and raising interest rates, to allow things to continue to grow at a nice pace, and inflation doesn’t end up at a high spot. But we’ve got this crazy teeter-totter right now, where you’ve got this potential inflationary environment that could bring down earnings, if it gets out of control, or you have a federal reserve that could get a control raise rates too much. And so we want to find that kind of middle ground. And it’s going to be complicated a bit for the Federal Reserve, because we’re in the middle of a pandemic, so they could be slowing down, you know, the economy, and then we get a virus, it ends up slowing down the economy. And so they’re going to need some flexibility there. And I think that’s what we’re seeing. Right now, if you look at the bond market, the 10 year treasury bond market is fairly hot, it’s come down off of its highs. And again, that just usually means that the bond market looking forward is expecting inflation to be somewhat more moderated than it is right now.
We’re even seeing what they call the yield curve: the 2 year, 10 Year, 30 year kind of flattened out, that’s generally a sign that there is some economic slowing in the future, which might be a good thing, because the economy’s really hot right now. That’s what’s causing some of this. So these are good problems to have in terms of what we look at in the stock market. Demand dropping is a problem. So actually, I look at what’s happening in China, and with this Evergrande, a company that has this huge real estate portfolio and $300 billion worth of debt. They’re suffering from demand dropping, there isn’t enough demand for all of their apartments that they’ve made, there isn’t enough foreign demand for the bonds that they’ve got. That’s a bigger issue to me: when demand drops. And those are the issues we saw certainly in 2008.
But what we’re seeing right now is actually demand, you know, overall, across the world, and here in the US, is pretty high. Again, there’s 36 trillion more dollars in American households, it’s not evenly distributed, that’s for sure. But there’s more dollars in American households than there was, and so that gives some more buying power and that allows, you know, at least so far, people to kind of keep up with inflation, and not impact earnings. But that will be the big picture looking forward is how does this play out.
So really look forward to talking to you some more as we go. Very fascinating time. This is the time to start keeping your eye on the ball. Because this scenario we’re going through right now will be more difficult than what we’ve been through in 2020 and 2021. We’ll probably see more volatility in the market. But if rates are still low, and you see volatility, and as starts to come down, those might be some buying opportunities until those rates start to get higher, or they start to really get aggressive, even in their you know, talking points and such too. So that’s what we’ll be watching for and we’ll see how this plays out. So, you know, look forward to seeing what’s going to happen next week.