Saturday, August 13, 2022

Why are employers continuing to hire like gangbusters if we are in a recession… because we are not!

From the Desk of Joe Rollins

There has been no subject more ornately debated in the financial news than whether the U.S. is currently in a recession. I have been saying for some time the economic evidence does not suggest that we are. However, you saw the effect on the stock market when it sold off broadly in June in anticipation of a recession. But the good economic news came on Friday when the employment report reported that employers added 528,000 jobs during the month of July, and that the two previous months had been revised upward showing more hires. We now officially have more jobs than we had before the pandemic began in 2020. It took two months at the beginning of the pandemic for nearly 2.2 million jobs to disappear. We have now climbed back and regained every single one of those jobs, with the unemployment rate now at an impressive 3.5%. With such strong economic news, why do we still have the so-called experts on Wall Street predicting a recession this year?
Drew Malone and his wife, Nicholle, enjoying the beautiful sunset

I want to discuss the items above in this posting, but I also want to share my thoughts on Russia, GDP, corporate earnings, and other matters. Before I go into detail about those most-interesting topics, I need to report on the excellent month of July which basically surprised everyone. As mentioned before, there was a huge sell-off in June in anticipation of corporate earnings reflecting a deep recession. When those negative earnings did not show up, the market rallied back to recover most of June’s losses. Not to say that this year has been great, but at least we are heading in the right direction at the current time.

For the month of July, the Standard and Poor’s Index of 500 stocks was up 9.2% but continues to be down 12.6% for the year 2022. The Nasdaq Composite was up a sterling 12.4% during July but is still down 20.4% for the year. The Dow Jones Industrial Average was up 6.8% but continues to be down 8.6% for the year 2022.
Joe’s replica Braves World Series Rings
and Georgia Bulldogs Championship Ring

I thought I would give you some interesting information to reflect on considering the losses we have incurred in 2022. The S&P 500 over the last five years has averaged 12.8% annual gains and over the last 10 years 13.8%, and these numbers include the current losses. The NASDAQ Composite over five years is up 15.4% per year, and 16.7% per year over 10 years. The Dow Jones Industrial Average is up 10.9% over five years and 12.3% over the last 10 years on an annual basis. These very strong returns should indicate to you that staying invested, even in downturns, is to your advantage. Trying to time the market at a downturn when economic information is confusing only leads to locking in losses and, unfortunately, tax gains.

Even the bond market was positive in July with the Bloomberg Barclays Aggregate Bond Index up 2.4%. It is however, still down 8.1% for the year 2022. Its five-year numbers are 1.3% annualized and 10-year numbers are 1.6% annualized. As you can see, bond returns as compared to stocks is virtually nonexistent.

Shelley Fietsam’s son, Cameron Funna (15), eager for his first day
as a sophomore! Hope that smile lasts…

The employment report on Friday was a true stunner to virtually all economic observers. The final number was roughly double what the so-called experts were forecasting. In fact, the 3.5% unemployment rate was the best unemployment rate in over half a century. Think about that and put it into perspective. If we were in a recession or going into one, how would we have such a low unemployment rate? There was one interesting observation in the employment report - there are 623,000 fewer people in the workforce than before the pandemic. It makes you wonder why those people are not working when clearly there are a substantial number of jobs for them to take. I believe that a vast majority of these people probably received economic help during the pandemic and at the current time have no desire to return to work. As those employees run out of savings surely, they too will return to looking for a job.

You would think with the impending “recession” the job openings would have gone down. While they have declined marginally from last month, there are still 10,698,000 jobs available with a total of 5,670,000 currently unemployed. Once again, this month the number of job openings is twice the number of people currently unemployed. In the last one-year alone, the unemployment rate has gone from 5.4% to currently 3.5% which is the lowest level since the pandemic. This is also a 50-year low for unemployment.

The current pilot shortage is worse than we thought:
Caroline (8) and Reid (6) ready for take-off

Sometimes you must put economic ratios into practical everyday thinking. Why would employers anticipating a downturn in their business go on a hiring spree such as they did during the month of July? What rational and reasonable businessman would continue to hire people knowing the potential for the business to turn down? Although there are some notable companies currently laying off workers now, the overall hiring throughout the country quickly consumes those unemployed and gives them another job. It may not be a better job than what they had, but at least they are working. With the revised data reflecting a larger number of employees hired over the past 2 months, there is no question that there is an extraordinarily strong labor market in the U.S. today. One employer told me yesterday that they had 4.500 open jobs at the current time that they could not fill.

There has been much said about reducing inflation and it appears that the Federal Reserve is bound and determined to push up interest rates to the point of stopping inflation in its tracks. Over the last two months there has been a marked decrease in commodity pricing including the price of gasoline going down over $1 per gallon. However, a major part of inflation relates to labor and housing. The U.S. Department of Labor reported that year after year employees’ wages went up by 5.3%, and of course housing followed that increase. While the decrease in commodity pricing is beneficial and the gasoline price decrease is monumental, do not expect inflation to go down quickly because the labor rate and housing costs will keep it elevated. To truly stop inflation may take several years and several rate increases. While we are not in a recession now, there is no guarantee that the Federal Reserve will not push us into one in the future. However, that could be many good investing years away before we get there. We will be watching.

Ava riding a WaveRunner with her Uncle Chip Tucker

I did not want to get into the technicalities of how the GDP is calculated but given the last several quarters of GDP being reported, some explanation is warranted. You may not recall, but for the 4th quarter 2021 GDP went up at a very strong rate of 5.6%. For the first two quarters of 2022, the GDP was down roughly 1% each quarter. As soon as the second negative GDP report came out, all the pessimists proclaimed the U.S. economy to be in recession since the definition of recession is two negative GDPs in a row. However, the experts thought this early declaration was completely misguided.

One of the components of GDP calculation is the increase in inventories. When inventories go up, the assumption is that GDP is stronger because manufacturing must be productive in order to generate these goods. If inventories go negative, then that is a drawdown of the GDP. 2021 was a most unusual time. Because of supply chain issues, retailers overbought inventory anticipating shortages. To their surprise all these inventories showed up prior to the end of the year and major retailers were stuck with more than was needed. Walmart and Target both indicated that their inventories are far in excess of their needs and will have to reduce prices to liquidate the inventories. These reduced prices help fight inflation because this brings down the cost of clothes and accessories sold by both of those major retail chains. However, it also affects GDP. So, for the first two quarters of 2022 inventories are drawn down reducing GDP growth in both of those quarters. If you would have held inventory steady during the first six months of 2022, the GDP would have been marginally higher.

Long-time clients Lloyd and Laura King visiting Fenway Park in Boston

The GDP is a backwards-looking measure, and not what the stock market is all about. What we want to know is what GDP is going forward. The Atlanta Federal Reserve posted their projections of the GDP for the 3rd quarter and currently that number is 2.5%. They have been particularly accurate over this time in forecasting GDP. Just for reference, the St. Louis Federal Reserve also forecasts GDP and they have forecasted it at 2.45% for the current quarter. Therefore, two major Federal Reserve offices have forecasted a positive GDP growth in the 3rd quarter of 2022. Just maybe the so-called experts on Wall Street will reassess their call for recession, which seems to be premature. If we could get the talk of recession off the news and get back to corporate earnings as we should, the second half of 2022 should be excellent.

The one thing that amazes me is that the so-called economists do not understand the economic effect of putting a half million people back to work in 2022. When you have a great labor market recovery like we are experiencing now, it tends to set off vicious positive cycles. Job gains lead to increased wealth of the workers and robust consumer spending. When you have robust consumer spending, employers are required to hire more employees and therefore creating a double effect, with a renewed need for more employees in retail. I have been saying for some time that this increase in employment will create more taxes for the government. As you decrease income taxes as we did under the last administration, we create more employment not less. More people paying in taxes during a full employment cycle is excellent for government revenues. As you hire more and more people, this creates a competitive nature for jobs and employers must increase wages to retain good employees. Once again, all the positives of full employment that we are realizing today are covered up daily by the financial news’ talks of recession.

Evan Bentley and staff member Alexis Chambers celebrating
the 4th of July in downtown Pittsburgh

As mentioned previously, the month of June was a huge downturn for the markets with the anticipation that corporate earnings would be negative and the projections for the coming years would be catastrophic due to said recession. However, as earnings started rolling in during July it became crystal clear that corporate America was not realizing the negative results as forecasted by the analysts, and the market quickly turned around, gaining dramatically. The numbers are pretty much overwhelming. At the current time there are 432 companies that have reported within the S&P 500 Index. Of these companies, 77% of those have reported better than expected results. The average increase in actual earnings over expected earnings are 5.8% so far this month. Truly an extraordinary performance in corporate profits. What recession?

What is also unusual is that revenue growth in these companies is up 13% for the quarter. It is hard to imagine that if we were in a real recession, we would enjoy a 13% increase in gross revenues in corporate America. Now, all the robust earnings reports have not reduced the potential of a revision of future earnings by these companies. The revisions today are down very little compared to their reported corporate earnings. So, you must ask yourself if you are a reasonable person and a “shade tree economist” analyzing the facts, “Why would corporate America go on a hiring binge in July if they anticipate recession? Why would corporate profits continue to be robust in the second quarter of 2022 if we were already in recession?” I guess it is fairly clear that even the trained economists could now recognize that at the current time we are not in recession, but that does not mean that a recession could be declared in the coming years. We will be the first to report the first signs of recession.

Josh and Ava spending some quality brother-sister time together
on the beach in Florida

From an economic standpoint, we have to drag a term out of the 70’s to define this current economy. The term “stagflation” is now the word to describe where we are. In a period of “stagflation”, you have low economic growth but high inflation. So, assuming that the Atlanta Federal Reserve is correct, and we have 2.5% GDP growth in the third quarter of 2022, that would not keep up with inflation which is projected to be somewhere in the 8% range over the coming year. I would be the last one to tell you that you cannot make profits in an economy with low economic growth. I think the second quarter has already proven that fact. Inflation, in fact, is good for corporate America by increasing the value of their assets without them having to spend money. We are obviously in a fragile time where major adjustments to the economy could be devastating for future economic events. Any proposed increase in taxes would certainly have a negative effect on the economy and would likely lead to layoffs and lesser earnings by employees in America.

I would be hard-pressed not to place the blame directly in the lap of the current administration in D.C. The increase in the price of gasoline in America to meet their environmental wants has created a large tax on all Americans. As pointed out before, when you increase the price of gasoline you automatically increase the price of food - virtually everything is driven by demand and the price of gasoline. Even though gasoline has decreased recently in price, it is still up 100% from the time the current administration was sworn into office.

Caroline Schultz striking a pose in Anguilla

We are now in a situation where we must decrease inflation, but is it going to create massive unemployment in America? Which of the two dual mandates of the Federal Reserve are most important? As you know those dual mandates are full employment and low inflation. We currently have full employment, but high inflation. Are we as a country willing to increase interest rates high enough to reduce inflation at the cost of laying off millions of Americans from their jobs? What we have seen since this administration has come into office, is a mix of trillions of dollars in Federal spending, heavy regulation, and the threat of higher taxes. Rather than continue with the above negative economic policies, why not try the opposite? That would mean slowing interest rate increases and allowing the economy to correct on its own without intervention by the government.

Only in Washington, DC could you define a bill that borrows and spends $700 billion and call it an Inflation Reduction Act. There is nothing in the current bill that will reduce inflation and any time you borrow money, that is a negative for future taxpayers in America. But more importantly, it is a really bad time to increase taxes on anybody with the economy at this stage of barely breaking even. It has been proven by various analysts that the 15% minimum tax on big corporations will hurt manufacturers more than anyone else. For years we have been attempting to bring manufacturing back to the U.S. and now a bill is proposed to increase the taxes on those very manufacturers. You could not have timed a worse increase in taxes on an industry that is susceptible to downturn with every new expense which slows down manufacturing in the U.S.

Fore! Ava and Joe Rollins out for a spin in Florida

The bill also has a proposal that the U.S. government could negotiate prices of pharmaceuticals under Medicare. Can you imagine anyone less qualified to negotiate prices with major pharmaceutical companies than the government? Almost assuredly this will lead to a shortage of needed medicines and reduce the research and development of new drugs in the U.S. A double negative for the economy without question. It is very interesting that before the pandemic we had pro-growth policies which led to a strong economy with steady growth, low inflation and real wage increases of 3% or higher for 19 straight months. Since the change in administration, we have had more spending and more tax hikes that only fueled more inflation.

If you really want to decrease inflation you need to lower the cost of government against manufacturers by cutting regulations which would allow the increase in supply through regulation relief which would once again fund pro-growth. This is not rocket science. If you increase taxes in an otherwise soft economy, the likelihood is that you will hurt the average employee and for whatever good reason the bill is enacted, it will be overshadowed by the negative employment trends if we have to lay off employees due to high inflation.

Getting ready for a new year at a new school! Knock ‘em dead, Ava!

The so-called Inflation Reduction Act passed the Senate on Saturday with a straight up 50/50 vote along political lines. This bill will be hastily enacted prior to the mid-term elections when the majority party realizes that they have little chance to maintain the House and Senate in the midterm election. It is shocking that Congress does not take the time to debate a bill that has such major long-term effects on Americans. Increasing spending and increasing taxes goes against every principle we know in economics. In a slow economy increasing spending increases inflation and increasing taxes decreases the economy. The two difficult issues we have with this economy today this bill moves in the opposite direction from helping and actually hurts everything currently in the economy.

I thought I would throw in some information regarding the Ukrainian War. I keep up with it even though it has fallen out of favor with the national media. There is no question that the Ukrainians have done a fabulous job in holding off the Russians even though they were likely to lose eventually. They could not have done so without the billions in economic aid from the U.S. and other countries. But there is a very important outcome of this war that people are not realizing. Due to the length of the war, Russia is using up a great amount of its military hardware and missile capacity in a failed effort to capture the entire country. It is now reported that Russia has lost over 1,832 tanks in the fighting in Ukraine along with 4,086 armored combat vehicles. In addition, each ballistic missile they fire costs millions of dollars and they have used up a large portion of their inventory of these missiles. Notwithstanding the tragedy of loss of life, it is reported now that more than 40,000 Russian soldiers have been killed in action in this war. Every time I hear a number like that all I can think about is each of those lost lives have families and children that will suffer in the future due to not having a parent. If you can realize anything about a waste of a life, fighting in a country that does not want you makes no sense. This loss of life is a true tragedy for both countries.

Mia Musciano-Howard taking a dip with her two new friends in Jamaica

The most important point is that due to sanctions, it would be very difficult for the Russian military to restock. Much of their military armament comes from components out of the U.S. which they can no longer buy. In addition, the sanctions to their citizens are substantial. Since their currency is not accepted in most places in the world at the current time, virtually none of the Russian citizens can go on their expensive vacations to places like the French Riviera. The hardships created in Russia over a war that makes no sense to virtually anyone is depressing. However, the long-term effects of the military in Russia being disarmed due to a prolonged military operation is extraordinarily beneficial to the rest of the world. They will be weaker when we grow stronger.

I could not believe that so many forecasters were arguing that Russia would take over Ukraine in a few days and then invade Poland. Russia has now been trying to unsuccessfully take over Ukraine for six months and they do not have the men or the equipment to challenge Poland which is a NATO member. Recently Finland and Sweden joined NATO, now leaving the country of Russia completely surrounded by NATO members. Those of you that are not familiar with NATO, it is an organization of countries that would fight for each other in the case of an attack by a hostile country. NATO has 5 million troops, Russia has 900,000. They will not touch Poland.

Interesting fact: Anguilla, not only beautiful but no income tax, capital gains tax, estate tax, or other form of direct taxation on individuals.

The question will always be, can Putin carry out this mission without creating irreparable damage to his country and economy? I think once we get a resolution of the Ukrainian war, we will get a better understanding of what the economic effect will be in Russia. Each soldier that has died is one less person adding to the GDP in Russia. I project that by the end of 2022 there will be a resolution of the Ukrainian war. More likely than not, it will be a draw with each getting certain parts of the country, followed by peace. It is going to be a long time before Russia rebounds from the losses incurred in Ukraine. However, if the U.S. is persistent in keeping the sanctions in place, economically it could bring Russia down during our lifetime.

I have told many clients over the last six months that I still anticipate that the markets will be positive for the year 2022. I understand that it is a high goal given the losses that we have incurred so far. However, when you attempt to forecast the future growth of the market you must take into effect the earnings, the interest rates, and the economy. At the current time earnings are great, the economy is good, and the interest rates are higher. I still believe however that the economy can continue to grow, although modestly, in the coming year but earnings will continue to improve. If I am correct about earnings continuing to grow, the markets should continue to rally, and we should see higher returns coming up. I know after the first six months everyone was down on investing and very depressed. After the month of July and the first week of August, your optimism should be firmly in place. I have seen this kind of market for over 40 years, and it has always recovered. And it will recover again.

As always, the foregoing includes my opinions, assumptions, and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins

All investments carry a risk of loss, including the possible loss of principal.  There is no assurance that any investment will be profitable.

This commentary contains forward-looking statements, which are provided to allow clients and potential clients the opportunity to understand our beliefs and opinions in respect of the future.  These statements are not guarantees, and undue reliance should not be placed on them.  Forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual results in future periods to differ materially from our expectations.  There can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements.