Transcript:
Tom Vaughan:
So I’d like to start the show though with a summary of what I saw happening in the market this week. I’m actually going to talk about kind of a year to date thing as a summary, because there’s some pieces here that are crossing over quite strongly between these two weeks. And so I kind of have two things to discuss today. One is kind of well called the bad news that’s happening, that’s creating some of the problems in the stock market, and then some of the good news. So I’ll start with some of the bad news. And of course, this week, we found out that inflation for December of last year versus December of the year before 2020 was up 7%, which is a really big number is the highest inflation number we’ve had in 40 years. So obviously, the market is trying to digest that and deal with that. We also got notification today that manufacturing was down in December, retail sales are down in December, we’re hearing stories about restaurants being you know, kind of a lot less people in them. As far as that goes. They’re talking about the supply chain issues that are coming through, you know, like the manufacturing number was down a lot on autos. And so autos are talking about not being able to get semiconductors and what have you to last Friday, we saw the labor job report come out for December, not that many jobs were created compared to what was expected. Most of this can be kind of tied into this Omicron wave, less people willing to come out to work that creates more shortages, more people catching the virus having to stay home for at least a little while, that creates more shortages, as far as that goes. And so you know, when you have a lot of demand coming in for product and what have you, and then you can’t really supply that at the right level, that creates a pretty high inflationary situation.
So one of the biggest catalysts, though, that we’ve seen the last couple of weeks to the downside is all of the things that have been coming out of the Federal Reserve, they have dramatically change their tone, since roughly Thanksgiving, about you know how they’re going to fight inflation. So they’re cutting back on their bond purchases, or increasing interest rates, maybe at a faster pace, and even maybe even shrinking their balance sheet, which wasn’t talked about until the minutes released in this last week, last Wednesday. So all of these things are kind of tamping down on the market and really creating all of this kind of negativity. And almost all of the news that’s coming out is seen as negative to the stock market. But here’s what’s kind of interesting in all of that, if you were to line all that up in a normal market, you’d see a pretty good downturn. And yet, if you look at the total stock market index, with Vanguard ticker symbols, VTI, I use it as a broad market indicator of what’s going on with the stock market. I really like it because it has over 4000 stocks in it. So it covers everything. It’s only down 2.7% year to date, which is less than I would expect with all that bad news.
If you look at the total stock total bond market index, which is ticker symbol BND. From Vanguard, again, I use that as a broad market look at what’s going on with the bond market. Because there’s over 10,000 bonds in there. That’s down 1.2%. Again, not as bad as you’d think for all of these things that are happening. So why is that? Why is the market not falling even more in face of all of this bad news. And one of the things that keep bringing up is the fact that first of all, you have some history here, when there is a 20% year in the year prior, which is what we had, you know, 20% or more last year, on the S&P 500. If you look back throughout history, all the way to World War Two, every time we had that happen, the average rate of return in the next year, which is this year, was 10.4%. So that’s good, not 20 something but still 10.4. More importantly, the market went up the S&P 500, it has a positive rate of return in 80% of the chances after that. So you know, these people that are running around saying the markets gonna fall in 2022, because of all this bad news, they’re actually on that other side right there in that 20% group. If I’m going to be a betting person here, I’d rather bet on the 80% group, you know, until proven otherwise, and what have you as far as that goes.
So there are some things to look forward to this year that I think could create that positive return, or that maybe even positive 10.4% average return. Number one is the stimulus money that was pushed out last year, isn’t coming out this year. So that’s going to continue to kind of burn off throughout the rest of this year. Because one of the things that’s happening is we have this high demand. And so if we bring demand down to a more reasonable level that could help inflation, so stimulus money coming down. I think one of the other things is that the pent up demand with everybody was sheltering in place and locked in their homes. And some people are still doing that, but we’re seeing much more motion and things that are moving around. You know, maybe a little bit of a backtrack here with the Omicron. But nonetheless, I think that pent up demand isn’t going to be quite as high throughout this year, and maybe even the second half of this year, as far as that goes. So that brings down demand, and you have the Federal Reserve doing all of these things. First of all, the first thing that Reserve does to try to print out demand is talk about it. And so they’re talking about raising rates, or talking about cutting back on bonds, talking about shrinking the balance sheet, all of these things have driven up interest rates, actually on a lot of different areas, including mortgages, and all these different things without them even having to do a lot of those things are talking about.
Ultimately, though, they will do some of those things. And in all cases, when you raise interest rates, you know, it costs more to borrow. So people will do that less that when mortgage rates go up, people won’t be refinancing and cashing out as much, companies will have less ability to borrow at these higher rates. And that will slow down demand. So when you slow down demand, you know, that could lower inflation. But then the other side of that, which I think is really important and not being talked about enough, is I feel like supply chains will improve throughout the year. Humans are really good at supply chains, we have troubles, we figured them out, we go around them. But companies are even better at it. You know, if I know if I own a company, and I know I have this high demand, and I’m having trouble reaching it, because of my supply chain issues, I’m going to work really hard to try to meet that demand, because I know it’s there. And so I think that’s going to be one of the things that happened. And we have seen some supply chain easing, that’s now been pushed back a little bit because of Omicron. But hopefully Omicron comes down quickly. And we can get back to the supply chain easing. But I think throughout this year, we’re going to see supply chains come down. So if you bring down demand, and then supply comes up, inflation could be lower. So instead of this, you know, six to 7% inflation like we’re seeing now, I think we could see two to 4% inflation by the year, which would be a much healthier environment for the stock market, especially with the Federal Reserve constantly coming out and hammering the stock market with their comments.
Hopefully, those can start to mitigate some, especially in the second half of this year. So the virus is a problem. We’re seeing that right right now with the Omicron. But let’s put it into some perspective as far as that goes. So last year, the virus is a problem had a big spike at the end of year had the Delta virus in the summer. And of course, omicron started, you know, roughly around Thanksgiving, at least the conversations about it. And so very unbelievable scenario that we’re dealing with, yet the gross domestic product was up 6% Last year, that’s a huge number. Now it’s coming off of a weak year and 2020 on a comparison basis. But the average gross domestic product is 2%. And we grew 7.5% in the fourth quarter of last year. So even in the face of all of those things, we’re seeing some growth in the overall economy as represented by the gross domestic product. And I think personally, that, you know, we’re not going to see the big lockdowns and those different types of things that happen. Even if the virus, you know, continues to create new variants that create problems, you know, for the most part will continue to kind of muddle through as far as that goes. So the last piece is the most important, and that’s earnings. So understand that for the fourth quarter earnings reports that are coming out now and kind of the beginning of earnings seasons, the expectation is that we’ll have a 22% growth in earnings for the fourth quarter of 2021 versus fourth quarter 2020. That’s a big number. That’s actually a really big number.
But more important is that for the last six quarters in a row, the companies have done better than expectations. And so whenever they do better, the market jumps upward for those better. So Wall Street analysts that are doing are pessimistic, in comparison to what has happened in reality, companies have been able to increase earnings at an even faster rate, it’ll be harder to increase earnings at those rates, because we’re now going to be comparing to better quarters. It’ll be harder because we have inflation and these different things that are happening. But boy, I sure have a really high level of confidence in American companies, especially these big ones, to be able to kind of manage earnings continue to manage their top line growth in specialty in the face of this pretty high demand. So earnings are very strong correlation in my opinion, in my experience to stock market growth, if we continue to have earnings growth through 2022, which we would have unless we had in flight in a recession, which I’m not expecting. I think we could still have a pretty good year. I do feel like this is going to be kind of a tale of two halves, so to speak this year, this first half of this year, going to continue to get pounded by the Federal Reserve continue to hear about inflation continue to deal with some of these variants and some supply chain constraints and things. But as those start to ease, I think the second half The year could be a lot better.
And we’ll have the election out of the way. Historically, a midterm election does better in the second half of the year than the first half anyway. So I think this may be even more so. So I think we’re gonna need kind of two ingredients this year, number one, kind of keep some positive outlook, it’s going to be really easy to get sucked into the vortex of negativity. Because there’s legitimately some good negative information coming out now that are driving the market down, rightfully so the inflation and the supply chain issues, the variance, those types of things. But there’s awful lot of positive things happening also, with the high demand and the earnings growth and all the things I just talked about. So keeping some positive outlook. And then secondly, I think, unlike these previous years, I mean, we’ve had an awful lot of really good returns, month by month, quarter by quarter very consistent, we’re not going to see that that first half of this year, in my opinion, more patients, in order to kind of get this better rate of return that we might get for the whole year, we’re gonna need some patience, there’s some things that we can do to take advantage with some opportunistic rebalancing, and what have you. But just having a little bit of patience throughout this, you know, churning that we’re going to go through here for a little while. possible that the market goes down further from here before things start to get better and what have you to and that’s going to be part of kind of, you know, having a positive outlook and keeping some patience. So that’s what I see this week. I think it’s still a very fascinating market timeframe. It’s a great time to be an investor. It’s a good time to be learning about investing and learning about what’s going on there. So look forward to talking to you about what’s going to happen next week.