Thursday, February 9, 2023

Unemployment rate falls to the lowest level since 1969 – a 53-year low. Do we have to destroy the economy in order to fix it?

From the Desk of Joe Rollins

The title of this posting sums up my views regarding how there could there be a recession this year with virtually everyone who wants to work having a job. One of my biggest mistakes in 2022 was that I did not believe that the average investor would accept the fact that recession was imminent in 2022, as the so-called experts were projecting. In fact, I was correct, and they were wrong. There was no recession in 2022. But the big question now, as we sit here in February, is there a recession expected in 2023?

I must admit I was surprised by the huge January 2023 rally in the financial markets. More than anything, it was just a reversion from the oversold market in 2022. But there are some very interesting trends going on that confound investors, which I will try to explain in this posting. I also want to give you an update on employment, which has been extraordinarily strong and the resurgence in Europe and China that will make this year better than most people expect.

Carter and Josh Rollins in Chicago with festive Foster and Freddy
I also want to teach a remedial course on the valuation of the dollar and international commerce and the effect it had on corporate profits in America in 2022. I have so many interesting things I want to discuss in this posting, but I must report on the excellent month that we had in January.

The Standard and Poor’s 500 stock index was up 6.3% for the month of January after being down 18.1% for all of 2022. The NASDAQ Composite stock index was the winner in January by being up 10.7% after being down close to 30% in 2022. The Dow Jones Industrial Average stock index was the laggard at 2.9% for the month of January and in comparison, even the Bloomberg Barclays Aggregate Bond index was up 3.2% during the month of January. By all standards, the month of January was an excellent month and both stocks and bonds made money.

It is hard to draw a conclusion from just one month’s performance; you really need to look at a longer time span to judge an index. As an example, the S&P 500 stock index for the 10-year period ending January 31, 2023, was up 12.7%. The NASDAQ Composite stock index was up 15.1% and the Dow Jones Industrial Average stock index was up 12% for the 10-year period. These are annual returns, not cumulative returns. Only the Bloomberg Barclays Aggregate bond index had a dismal 10-year performance at 1.4%. It is clear to see that even with the huge losses we incurred in 2022, these indexes produced double-digit returns for the full ten-year period.

Shane and Alexandra Jarmin hanging out
with Cameron, Mickey and Cooper!
Understanding the excellent news on the performance in January, the result of the performance for 2023 will hinge upon whether there is in fact a recession in store for the U.S. economy this year. As I have been arguing for the last two years, there are no obvious indicators that would imply recession is imminent in 2023. I fully recognize that in 2022 we had two negative GDP quarters. Just as a refresher, in the first quarter of 2022, the economy was down 1.6% and was down 0.6% in the second quarter. But then suddenly, the GDP turned around and in the third quarter, the U.S. economy expanded on an annualized basis at 3.2% followed by a 2.9% growth in the fourth quarter of 2022.

The old standard was that if you had two back-to-back negative GDP quarters, you were in recession. However, the strong comeback of GDP in the last half of 2022 belies that old standard. In fact, if you review the entire year of 2022, you will note that GDP increased by 2.1% for the year, which is quite a satisfactory performance given the very difficult Covid-19 situation and the worldwide increase of interest rates.

Partners Danielle, Robby, Joe and Eddie
still waiting for you to come see them soon!
I must admit that I was totally amused when they announced that the GDP for the fourth quarter of 2022 was 2.9%. All these so-called experts on TV rushed to explain that they were not wrong about a recession in 2022, it was just postponed. Their thinking, even though we were able to dodge the recession in 2022, almost assuredly it will occur in 2023 as they proclaimed. These “experts” were predicting basic carnage to the U.S. economy, which I assume included bread lines and mass unemployment. I’m beginning to wonder if maybe those who found their way onto TV are not as well-educated in the signs as older economists like me.

The last really bad recession we had in the United States was in 2008. We have had some small blips along the way with Covid-19, etc., but 2008 was a bona fide recession. Perhaps these so-called experts that appeared on TV were just not around during 2008. Remember, that was 15 years ago.

Can you imagine their disbelief when the employment numbers for January were reported at an almost unbelievable growth of 517,000 jobs? January, for the most part, has always been a negative month for obvious reasons. In many years in the past, retail will lay off a sizeable number of their employees after the holiday season. Therefore, retail almost always suffered negative trends during the month of January. But, not so during the month of January 2023. Virtually every segment of the employment market showed net increases in jobs in January except for the tech industry. Maybe what we are seeing here is that it is so hard to hire people in this full economy that employers are holding on to them rather than suffering the risk of not being able to hire others when needed. As a reminder, the same has been true for almost one year.

Ava in Quebec City, Canada – “C’est le fun!”
We will get back to the same equation that I have been discussing for the last two years. With the unemployment rate at 3.4% and at a 53-year low, virtually everyone in America that wants to work is working. Job openings in December jumped up to 11 million and the total number of unemployed dropped once again to 5,694,000. Once again, this month showed that there are twice as many job openings as there are unemployed; but with the lowest unemployment rate in 53 years, there is just no one to fill that many job openings.

The so-called experts are now saying that unemployment will accelerate as the year goes forward and that we might see as many as 600,000 job losses monthly. I find that assumption to be almost absurd and should be taken with great skepticism. Just run the numbers and you can see exactly what I mean. There are 5,694,000 people unemployed, yet there are 160,138,000 people employed - divide the two numbers and you get, short of rounding, the unemployment report.

Patrick Reaves, Josh and Joe on Hole 6 at Pebble Beach Golf Club
In order to reach the recession numbers that the Federal Reserve is forecasting at 6%, there would have to be 9,608,000 unemployed Americans. Note, that even at this level, there are still enough job openings for every unemployed person. But in essence, that would mean that there would need to be four million additional unemployed people in 2023 to meet the Federal Reserve’s goal of 6% unemployment by the end of the year.

With the announcement of over 500,000 new jobs created during the month of January, the Commerce Department also increased the number of new jobs in both December and November. If you take that 90-day period, the average increase in jobs monthly has been 350,000 new jobs per month. What is astonishing and almost hard to believe is that this number is higher than the number of jobs that were being created in 2019 prior to the Covid-19 outbreak in 2020.

The reason that I am so skeptical about these numbers even being obtainable is that people seem to forget that we are in a Presidential election cycle, even today. Already, there are announced candidates and the election is only 18 months away. To think that the Federal Reserve would orchestrate the unemployment of four million Americans over the next nine months, during a Presidential election cycle, borders on absolute insanity.

Joe Rollins and the late, great Craig Sager at
the Lonely Cypress at Pebble Beach
I think what we will see coming up is that the Federal Reserve will propose another increase of 0.25% at their next meeting in March, which will meet their goal of having the short-term interest rate at 5%, and then they will go away. The reason that the Federal Reserve does not want to be held accountable for problems in an election cycle is that they deem themselves to be anti-political. If they can achieve their goal of reaching 5% Federal funds rate in March, it would be fully understandable that they would take no further action for the rest of 2023. The very day that the Federal Reserve announces that they are through with rate increases, you will see a substantial movement to the upside in the equity markets.

The downward drift in the market during 2022 was no doubt substantial and followed a previous year filled with wild and crazy speculation. Who can forget the GameStop fiasco of 2021 that ran the stock from $10 a share to $360 a share to subsequently drop 90%? This was a company that was never profitable and certainly did not deserve those types of valuations. But when you have rampant speculation without any type of financial analysis, you are going to get those wild swings.

“When I was your age…” Joe Rollins with his first computer in 1983.
$6,200 with 12% interest
As we were watching substantial losses being accrued on our mutual funds in 2022, I took great confidence when reviewing the holdings of the mutual funds and noting that they held the same stocks that were being targeted in concerted effort by professional traders. Despite moving technology down close to 30% in 2022, there was a massive rebound in technology stocks in January of 2023 from the oversold positions of 2022, allowing investors to feel a little vindicated.

There are many interesting things occurring in 2023 that will offset some of the negativity that we suffered through in 2022. It was projected early in 2022 that the European countries would suffer a severe energy crisis after Russia invaded Ukraine. In fact, it was noted that virtually all the natural gas and oil in Europe were sold to them by Russia. Many so-called experts projected that the European continent would freeze over the winter with no natural gas to heat their homes. Further, the long-term stability of their economies in Europe would be compromised since they had no natural resources of their own. Absolute chaos would attack the European countries since they could not heat their homes, factories or produce goods and services.

Client Scott Weiss celebrating with grandsons,
Cooper (1) + birthday boy Cameron (4)
In China, the country was working on a zero Covid-19 mentality. Even if they only had a few cases in a particular city, the Chinese government would shut down the entire economy. For long stretches, many of the major cities were not allowed to work. In fact, they were not allowed to even leave their homes to get food. The Chinese government was imposing essential embargos around the world and the citizens of China were suffering without normal goods and services. How quickly have things now changed?

In 2023 we now know that Europe did not freeze over the winter. Now it is reported that they have obtained enough natural gas to fill 90% of their storage. A great deal of that natural gas came in from the United States in the form of liquified natural gas. Also, the European countries have cut off all purchases of oil from Russia and it was reported that the oil pipeline from Russia directly to Europe has had its capacity cut by 90% with virtually no oil flowing from Russia into Europe. Here we have a situation where at the anniversary of the first year of the Ukrainian War, Europe has dealt a major blow to Russia by no longer purchasing oil through Russia, thus cutting off a major economic stimulus.

Reminiscing – Client Liz Mercure surprising Ava
at the Aquarium on her 6th birthday
Also in 2023, China has now completely reopened and has basically taken the opposite position from before, letting Covid-19 run through the population so they can put the country back to work. It is now projected that the GDP of China will be up closer to 5% in 2023 given their reopening. You do not have to look far to know that the Chinese economy is virtually the same size as the U.S. economy. The fact that they are now reopening, and their citizens are now consumers will greatly enhance the economy of the entire world. It is really difficult to buy iPhones if you are not able to leave your apartment as was the case in China. Certainly, the fast food restaurants of the U.S. companies located in China were unable to sell product during the shutdown.

Now all that has changed and there will be a surge in consumer purchasing throughout Asia due to the opening of China. Do not forget that much of the growth from Asia has been in Southeast Asia. When you see the growth of Vietnam, Malaysia, and Indonesia, this is growth transferred out of China during the Covid-19 shutdown. Once China is back up and running at full speed, along with the strength of the South Asian countries, you should see a dramatic increase in economic activity from Asia. One of the most powerful countries in the world in the next decade is likely to be India. With their huge population and their technological innovations, India should become a major consumer along with China in the coming years.

In recognizing this trend, we are starting to reallocate substantial assets of ours to emerging markets where these companies are represented. I think you will notice that we are buying a great deal of international investments. What is clear is that whether the U.S. has a recession or not, there will be a slowdown in growth in 2023 which is the sole goal of the Federal Reserve. So as the U.S. slows down, the rest of the world will speed up.

Josh and Carter Rollins in Hawaii – A hui hou!
Do not be surprised to see the economic rate of growth in Asia and South America exceed that of the United States in the coming years. That is a natural evolution of their economies starting back up as ours slows down. The U.S. has enjoyed extraordinary growth in the last 10 years, but to contain inflation, it is not only correct but important that we slow growth down for the economy to catch up. Inflation is not good for anything other than making you feel better that your assets are growing year over year. But it also diminishes the value of everyone’s lifestyle by making necessities more expensive.

I cannot emphasize enough the importance of everyone working, not only in the United States but in China and Southeast Asia. It is the little things that make a difference in the economy. One additional job creates income to that employee and he passes down that income to not only his family, but to local merchants. He spends that money at the grocery store and the grocery store pays their employees. He buys gas at the gas station and the gas station employs more people.

The most important component of increasing GDP is to keep everyone working. As long as everyone has a job, they have discretionary spending and that discretionary spending increases GDP. For the Federal Reserve to want to decrease that consumer buying, they will have to destroy jobs for millions of employed Americans over the next 9 months. I think the odds of that happening are close to zero. No president could survive with unemployment growing.

Joe’s favorite picture of little Ava (5)
If you review all the numbers that are now currently available, you would have to squint to see a recession anywhere close to being around. There is just too much strength in the economy to turn that battleship around over such a short period of time. I am not saying it cannot happen, but it does seem highly unlikely. I projected a huge increase in our performance during the start of 2023 and quite frankly a good portion of that in January has already been realized. I feel sorry for those investors that drank the Kool-Aid and got out anticipating that recession in 2023. They really missed out on a fabulous month during January.

In the recent Apple report for the 4th quarter of 2022, the so-called experts were astonished that the revenue for Apple actually decreased in the 4th quarter by 5%. They were visibly baffled since this was the first time that Apple has decreased revenue in several decades. However as often is the case with stock analysts, either they did not understand the effect that foreign currency has on corporate America, or they just elected to ignore it for whatever reason. As mentioned above, a great deal of the public that would buy the Apple products were locked down in China and could not get out to purchase new iPhones. But the main reason for the decline was the strength of the U.S. dollar compared to the rest of the world.

For a remedial lesson in currencies, we must look back to the beginning of 2022. In March of 2022, the Federal Reserve decided that it had been behind the curve on increasing interest rates. At that point, they launched the largest increase ever in interest rates in one year. They significantly increased interest rates all 2022 and even into the early weeks in 2023. When they did that, they strengthened the U.S. dollar since money goes where it is treated best. Suddenly you could get 4% on Money Market rates in the United States and money flowed from all over the world into the U.S. currency system.

Josh sharing basketball tips with “Sir Charles” Barkley
It is pretty easy to understand that in a worldwide economy, in the blink of an eye money can be transferred from countries all over the world into the U.S. When that happens, they sell local currency from wherever they are coming from and they buy U.S. dollars, thereby strengthening the American dollar. Conversely what happens when you sell into those foreign currencies, you receive a reduction of the value of that currency by converting it from U.S. dollars to foreign currencies. The substantial run-up in American dollars put a serious decline in earnings from all U.S. companies doing commerce in international countries. It is believed that the decline was somewhere in the neighborhood of 10% of currency transfers.

Therefore, if you analyze Apple’s sales and you do it on a stable currency like in the United States, their sales were actually up and not down. Now if the increase in the dollar were going to be consistent year over year in the same direction, it would not be beneficial to add back that change. However, now that foreign countries are starting to increase their own interest rates to match the United States, the increase in the dollar is declining. You are starting to see every country, other than Japan, desiring to slow down a recession by increasing their interest rates.

Just compare the numbers. Currently, in the United States the 10-year treasury is at 3.519%, in the United Kingdom that same bond is at 3.046%. In Germany the 10-year is at 2.214% and in Italy the 10-year is at 4.025%. France is at 2.644% and Japan is at 0.486%. As you can see most of the world is behind the U.S., but they are quickly gaining ground. It looks like we will be at the end of rate increases in the United States after the March meeting of the Federal Reserve. As the rest of the world catches up, this will bring the dollar better under control and will increase profits of U.S. companies that deal in international commerce.

Lucky #9 - Happy Birthday, Caroline!
What is also interesting is even though the Federal Reserve has increased interest rates to 1.5% over the last three meetings, bond yields which should be rising are currently falling. Falling interest rates reduce borrowing costs for companies and homebuyers. This helps the real estate market. The U.S. dollar index is off by 10% from its 2022 peak; a boom in earnings for U.S. corporations competing globally. And the most interesting part is that with the decrease in interest rates, the S&P 500 is actually up 16% from its mid-October lows. It is very unusual to see the Federal Reserve increasing interest rates as bond rates are falling. I think it is fairly clear with the action of the bond market that they are anticipating that interest rates will have to fall over the next couple years and the Federal Reserve will have to cut the Federal funds rate.

I found it amusing when the current administration in the White House decided to attack big oil companies because of excess profits. I am reminded that during the late 1970’s the same thing happened in Washington where they accused big oil of exploiting the shortage of oil due to the Middle-East oil embargo and proposed and passed an excess profits tax in the United States to punish them for their excess profits.

May there always be Tradewinds behind you,
Rainbows above you and Aloha all around you!
In a great many ways, the reason why the price of oil went up was, in fact, the very actions of the current administration in Washington. By restricting permitting and not approving drilling on government land, the current administration forced up prices, improving the profit of oil companies and unfortunately enhancing the ability of Russia due to the sale of oil to fund their war in Ukraine. I am not exactly sure whether the administration understands how oil is priced. It is not an election set by a particular company but a worldwide phenomenon with how oil is traded in international commerce.

As an example, Exxon does not price its oil based upon its interpretation of the market, but rather the price of oil is dictated by market conditions. I am not exactly sure what the administration would like for these companies to do, but clearly they have never understood the economics of oil since they were trying every way possible to eliminate fossil fuel production in the United States.

What is interesting to me is that if you look at the oil companies, they are a dying industry. It is absolutely clear that in 20 or 30 years from now, the use of fossil fuel in the United States will have to decline. The evolution of electric cars and other oil reduction techniques will dramatically decrease the amount of fossil fuels needed to run the U.S. economy. That is not today, tomorrow, or even 10 years from now. But clearly that day will come.

Josh and Carter hoping to be recruited by Christmas carolers
But what is even further interesting is that the corporate profits realized by the oil industry are certainly not anywhere near the profits earned by big tech. While Exxon had a $56 billion profit in 2022, Apple had a profit of close to $100 billion.

Even Google and Microsoft had profits greater than any of the oil companies. It just goes to show that if you really want to punish and tax wealth in the U.S. as the current administration does, positioning that target on oil is certainly misplaced.

As we go forward in the next 10 years, I fully expect to see big tech far exceed the profits of oil. I wonder how long it will be before Washington realizes that the true windfall lies within tech and not oil? You cannot forget that tech has distanced the U.S. from the rest of the world over the last decade. Big tech companies are now the most vulnerable companies in the world. It will be interesting to find out whether Washington will attack tech in the same way they attack oil in order to find more tax dollars for them to waste in Washington.

Edna Taylor – a client for 30 years!
If you have an interest in coming down to visit with us, we look forward to seeing you. We are moving into tax season for our Firm, but I will have the time to sit down and review your portfolio, taxes, or anything else you might be interested in.

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.