Thursday, December 14, 2023

The “Goldilocks Economy” Has Finally Arrived

From the Desk of Joe Rollins

For the last two years, I have been expressing my opinion in these postings that the economy needed to slow down in order for us to realize future stock gains. That is precisely what is taking place at the current time and that is a very good thing. The Federal Reserve has increased interest rates numerous times over the last several years, thinking that higher interest rates would slow the economy dramatically and therefore would reduce inflation. While the economy has slowed down for sure, it is also true that the economy continues to be strong, with employment and earnings continuing to be excellent.

This week, it was announced that the economy during the month of November added 199,000 jobs and the unemployment rate fell from 3.9% to 3.7%. These substantial employment numbers seem to shock these so-called experts since they have for years forecasted the country would go into recession almost immediately after the Federal Reserve began increasing interest rates. It is clear now that they were very wrong and my opinion that recession would not occur was clearly evident in my postings.

Penny’s first Christmas!
But what is most interesting about the employment report is that suddenly, the number of employed people in the United States is going up. Year over year, the number of employed has gone up 2.17% over the last year in an economy that was forecasted to be going down. As I have pointed out on numerous postings, the more people working, the better for the economy. When you have more people contributing to the economy by paying taxes and using their salaries to promote their own family’s well-being, it is better for the economy for everyone.

In this posting, I would like to cover some topics that are interesting to me and, hopefully, will interest you. One of the things that I would like to cover is the high likelihood that the Federal Reserve has now engineered a “soft-landing” and that this soft-landing would not result in a recession. Also, I would like to discuss the upcoming GDP going forward and what to expect in 2024. I would also like to review the Supreme Court's recent ruling indicating that the commissions on real estate houses were anti-competitive and, therefore illegal.

Caroline and Reid know how to pose for a photo -
especially when Christmas is right around the corner.
I would also like to cover all these truly interesting items, but first, I have to give you the results for November, which was an excellent month for both stocks and bonds. As I indicated to you, we were “locked and loaded” going into November, which is historically the strongest time of the year for equity investments. I could not have been more correct in forecasting a strong November since it was quite a spectacular performance during this month.

For the month of November, the Standard and Poor’s Index of 500 stocks was up 9.1% and its year-to-date performance is 20.8% for this year so far. Once again, it emphasizes the ten-year record of this index, which is at 11.8%. The NASDAQ Composite was up 10.8% for the month of November and year-to-date is up 37%. The 10-year average on this index is 14.5%. The Dow Jones Industrial Average was up 9.1% for the month of November and is up 10.7% for the year 2023. The 10-year average on this index is 10.9% annually.

Once again, for the month of November, the Bloomberg Barclay’s Aggregate Bond Index was up at a very satisfying rate at 4.5%. To date, this index was up 1.7%. For the 10-year period, this index averages 1.4% annually. As you can tell, the three stock indexes above reported double-digit returns, while the bond index over the last 10 years has come nowhere close to covering inflation. Therefore, holding bonds you are losing wealth to inflation.

Ava and friends all dressed up and ready to go!
There is so much on the financial news that is either misleading or downright incorrect. The one news item they continually report is how bad the real estate market is. Rightly so, they indicate that the market is terrible because sales are down 50% year over year. However, to assume that the statement means the real estate market is bad is not only absurd, but it is also incorrect.

One of the reasons home sales are down is that during the pandemic, many homeowners refinanced and are now sitting on mortgages that are 3% or lower. Why would they be willing to upgrade their housing to go to a mortgage that is closer to 7% from 3%? Therefore, there is basically a seller strike on selling their homes, which is creating adverse numbers. But correspondingly, there is also a shortage of houses for people to purchase, meaning that in many cases here in Atlanta, people are paying above asking prices just to get into the doors. The real estate market is as strong as ever today, but there are just not as many houses selling, therefore leading to the misplaced perception that the real estate market is bad.

Harper and Lucy standin’ on the dock of the bay in Tampa
It was recently ruled that the real estate commission of 6% was anti-competitive and therefore illegal. For many years, I have personally questioned this 6% rate, where it came from and why it was not price fixing among the real estate agents. To give you an example, the thought pattern is if you found your own buyer for a real estate transaction on your home and therefore there was no buyer commission, you would still pay the 6% rate. This means that the agent would get the entire 6%. In many cases, the commission rate really has no correlation to the amount of work the agent puts into actually selling your home. As indicated, I recently had a client sell a home where they had 10 bidders over the listing price. This had nothing to do with the talent of the agent, but more with the nature of the real estate market today.

There is no question that the trial attorneys will now sue every real estate agent in America to recover prior commissions. How successful they will be is a mystery. What is good for the economy and good for home ownership is that going forward, real estate commissions will be fully negotiable and there will be no fundamental 6% rate. This is good for consumers and good for real estate, but not so good for realtors.

Robby’s first hole-in-one! At Pelican Hill Golf Club in California
The reason that the stock market was so bad in 2022 had little to do with the performance of the stocks, but instead had everything to do with the public's perception that the economy was going into recession. These so-called experts in the field predicted that there would be a long downturn recession in 2022 due to the inverted bond yield and the increase in interest rates by the Federal Reserve. As we now know, two years later, they were incorrect. You would think that they would now revise their projections to a more reasonable projection of the economy.

Just this week, the Wall Street Journal did a survey of economists and the survey indicated that 48% of those so-called experts predicted a recession within the next one year. What is fascinating about this projection is that it is the first time they put the number below 50% since mid-2022. It seems that these economists just will not concede the fact that they were incorrect in projecting a recession. They are going to hold on to their projection so that maybe they could be redeemed by a downturn in the economy. As the old saying goes, “Even a broken clock is right twice a day.” What do we know about the economy based on the information that is readily available? As you are aware, for the third quarter of 2023, the GDP was recently revised up from 4.9% to 5.2%. That was an incredibly sterling report on the economy, but quite frankly, too high going forward. As I indicated numerous times in these postings, we needed to moderate the economy and slow it down.

Penny and Cecilia enjoying the spooky spirit of Halloween… in Joe’s office!
For the fourth quarter of 2023, the Atlanta Federal Reserve is forecasting GDP growth at 1.2%, which is almost perfect. Also, as we know, inflation is falling and is now at 3.2%, which is moving quickly towards the Federal Reserve’s target of 2% inflation growth. Therefore, we have an unusual situation where we have extremely low unemployment, moderating job gains and easing inflation. All of those are extraordinarily positive things for the economy and clearly should lead to a “soft-landing” in 2024. The definition of a “soft-landing” is the time when inflation cools, but the economy does not fall into recession. I really do not see any potential for a recession coming up in 2024.

There is also an interesting set of projections going on regarding the 2024 economy. Even the Federal Reserve is now forecasting that there will be two interest rate decreases during the 2024 year. The so-called experts on Wall Street are taking that even one step further. They are forecasting that there will be a total of four rate increases during the 2024 year. My personal opinion is that I would lean more toward the former than the latter as a moderate projection. These experts are rarely correct.

Rise up, Falcons! Lauren and Jeff enjoying the game
As you know, if interest rates start to fall, it is particularly good for both stocks and bonds. It looks like 2024 could also be another positive year for equity investing. Now, we are seeing forecasts that earnings by corporations will grow by 10% in the year 2024. Put all of this in perspective; we are talking about a year when the economy moderates and does not fall into recession, yet corporate earnings grow and interest rates fall. You could not ask for a better combination for setting equity growth higher.

The reason that the markets climbed so high during the month of November was the realization that the Federal Reserve would not be increasing interest rates any further. As pointed out above, it was the good news of moderating inflation, the economy slowing on its own, yet employment stands high and unemployment stands low. The Federal Reserve has a dual mandate in control in the economy. The first is price stability, which means no inflation and low unemployment. Since they have always had low unemployment over the last three years, they basically had a free hand in increasing interest rates whenever they wanted to accomplish the goal of reducing inflation.

Clients Andree Ljutica and Robin Thurau-Ljutica, along with their son, Julian, and friends. Leaving a little sparkle wherever they go…
As has now been proven, they were successful in reducing inflation and since the unemployment rate today is the same as it was a year ago, they have not increased unemployment. There were so many experts who predicted that we would see job layoffs in the 500,000 to 600,000 number per month back at the beginning of 2022. In fact, over the last two years, we have not had a single month where we had negative job gains. For the year 2023, the stock market has been extraordinarily volatile. We had a major run-up in January and February and then a major pullback in August, September and October. It just seems like a roller coaster going up and down based on every speech given by the Federal Reserve or any reference to higher interest rates.

But November was completely different. We had a period of time in November for 16 straight trading days where the market did not move greater than 1%. We should all like such boring stock markets. Over that 16-day trading period, the index was actually up 1.8%. Even during the start of December, volatility has gone down dramatically and the market has moved up marginally.

Ava and the girls having fun at their Christmas party.
“The sky is full of stars and there is room for them all to shine.”
There are many out there that are forecasting that the market is grossly overvalued and, therefore, is due to a pullback. I guess maybe they do not keep up with current financial information. Currently, analysts are projecting a call for growth in earnings next year in 2024 of 10% to 12 %. While that number seems aggressive, it clearly is obtainable. Remember, going into 2024 many corporations have right-size their employment and with lower interest rates in the economy, the consumer should be again holding the economy to a higher level. But with this increase in earnings, you also have right size the valuation of the markets.

The most important consideration in valuing the stock market is what earnings are going forward, not what earnings were in the past. As of November 15th, the S&P Index was trading at 19.7 times forward earnings. While that may seem high, that is exactly near the average over the last seven years. As I have indicated before, this is the “Goldilocks” where you could not argue that stocks are cheap, but they also do not appear to be overvalued.

Evan and Alexis dressed to the nines for a holiday party!
There is no question that the economy has been helped over the last several years after the pandemic with the extraordinary spending by the U.S. government. The deficits incurred over the last four years are staggering in their proportion to the GDP of the U.S. economy. There is no question that the economy has benefited from all this money being spent by the U.S. government to support the economy. But it also is true that there will be a day of reckoning to come. The U.S. cannot continue to spend money in such a reckless fashion as they have done recently. It would be easy to argue that the government is justified in spending this money to support the economy after the downturn of Covid. However, it cannot continue to be so extravagant with its spending; otherwise, we will be a net debtor country and that is just not sustainable.

A recent parallel appeared in the papers over the weekend regarding this same matter. The state of California, due to the stock market increases of new technology companies two years ago, had a $100 billion surplus in its budget. This weekend, they are forecasting the current budget would have a deficit of $68 billion and they are projecting a four-year deficit in their budget of $155 billion. Basically, what California did was that during the good times, they expanded their budget to waste a lot of money on social causes and when the financial crutch came, they had overspent and therefore could never catch up. Just to give you an example of the difference, they are forecasting a $68 billion deficit for this year, while the entire budget for the state of Florida is only $46.1 billion. As you can see, the spending differential is enormous and will not be easily covered by future tax revenues.

Reid and Caroline just discovered that
the actual movie came out over 30 years ago!
California has recently decided that the way they could balance their budget would be to tax the rich at a higher level than everyone else to cover their deficits. By enacting a super high tax rate for the wealthy, they have basically run the wealthy out of the state. Two years ago, everyone was fascinated by the fact that Elon Musk decided to sell all of his principal residences in the state of California. At that time, he owned four homes that had a valuation of close to $30 million. Everyone was perplexed as to why Elon Musk would be selling all of his principal residences since everyone has to have somewhere to live.

After selling all of these homes, Elon Musk ended up living in Austin, Texas. As you may know, Austin, Texas is a zero-income tax state as compared to California, which has the highest individual tax rate. In order for Elon Musk to change his residency from the state of California to the state of Texas, he had to sever all financial ties to California, which meant selling all of his principal residences. Shortly after establishing residency in Texas, Elon sold $15 billion in stock, which in California would have cost him $2 billion in income tax. Since he was currently living in Texas, he was able to save that $2 billion that he would have owed.

Still a kid at heart… Happy 51st, Robby!
That is what is happening to many wealthy taxpayers in the state of California. They are severing all ties with that state and moving to a tax-free state in close proximity. You may have heard recently that Mark Wahlberg moved his entire family from Los Angeles to Las Vegas. When you consider the amount of income he earns as an actor and the fact that he can reduce his tax rate by 12.3% since Nevada is a zero-income tax state, you would have to be somewhat illiterate not to make a similar move. So, it can be said that the U.S. economy has clearly moved into the “Goldilocks” economy that we so desired. Inflation is down from 9% to roughly 3.2%. Unemployment has stayed steady below 4% and in fact, we have more people working in America today than we did one year ago. Job openings have fallen roughly 20% over the last year, which is a good thing since employers are finding people to actually do the work.

GDP has fallen from 5.2% in the third quarter of 2023 to a projected 1.2% in the fourth quarter of 2023. This moderating economy will help significantly reduce inflation rates. They are forecasting now that earnings growth is no longer falling but will increase by 10%-12% in 2024. The most important consideration in the economy is that even the Federal Reserve is projecting for 2024 two rate cuts by them, which will stimulate more consumer spending, such as car purchases and new home purchases.

Overall, you could not forecast a more moderate or favorable economy going forward. As I have said many times in these postings, while we all enjoy a strong economy, it is not in the best interest for equity investing to have an economy that is too hot. We are much better off with the “Goldilocks” economy, “Not too hot and not too cold.”

Bobby trying to convert dog years into days
for the countdown to Christmas!
As we start the holiday season, I just want to emphasize again the strength of the equity cycles during the November through May investing period. We started out with an extraordinary month in November and this year has proven to be an extraordinarily good year for investing. I do not anticipate a falloff in the coming months. I would not expect the growing increase in November but rather a gradual move that would push the indexes higher during the coming months.

The title on last month’s posting was "Locked and Loaded." Well, it is time to reload in anticipation of the 2024 year. Roughly two weeks from now, you will be allowed to make a new IRA contribution for the 2024 year. If you are under the age of 50, that amount will be $7,000. Over the age of 50, your amount will be $8,000. Anyone reading this post who has earned income should make an IRA contribution as early as January, if possible. This is a particularly good financial vehicle for children. If your child has any type of earned income, you should make a Roth contribution on their behalf. The earlier you contribute within the year, the more your account will build up to assist you financially in your retirement years.

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.

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