Five — Week of November 15, 2021

As of market close November 12, 2021. Returns in percent.

Five

After rallying for five enjoyable weeks, stocks need a break. Last week’s consolidation of a percent or less is not concerning. Consolidation does not necessarily mean correction is around the corner. This year’s rally has been punctuated by monthly corrections, usually occurring just before options expiration. Conveniently, this Friday is November’s monthly expiration. Option expiration week has only been positive in three of the last 12 months. Bulls will argue that this is the last full week of trading before Thanksgiving. The Dow Industrials have risen 19 times in the last 28 years in this week, so history favors strength. 

The rally has pushed the U.S. indices toward overbought territory by relative strength measures. That is the lone technical measure that would point to consolidation. Most other “market heartbeat” measures are solidly in the green. Stocks hitting new highs have outnumbered new lows since early October. The NYSE Advance-Decline line continues to hit new highs. The percentage of stocks above their 20- and 50-day moving averages is still in the low 70% area, suggesting a good portion of stocks still have room to rally. 

More important than the very short-term is the outlook for this quarter and beyond. Let’s start in the weeds: jobless claims have fallen for six weeks straight. At 267,000, last week’s initial jobless claims are the lowest in 20 months. Pre-pandemic, initial claims ranged from 200,000 to 215,000, consistent with a 4% unemployment rate. October’s 4.6% unemployment rate means the economy is closer to full employment than possibly the Fed realizes. 

Five Again

Full employment is the Powell-led Federal Reserve’s most important goal. For decades, stable money and then low inflation were the Fed’s goals. The prior chairman, Janet Yellen, is a labor economist and certainly played a role in shifting the Fed’s focus away from keeping inflation reigned in. We would like to shift it back to low inflation, please. 

October’s consumer price inflation reading of 6.2% was the fifth month in a row that CPI exceeded 5%. It is the largest jump in consumer inflation since 1982. True, some of the rise in inflation comes from temporary reopening squeezes. Car, car rental and hotel swings are still adding as much as 1.5% to that 6.2%. Those three groups have rolled over in three months and should detract from inflation as their prices fall. 

Increases in the rest of the categories are likely to stick around. Housing prices are adding another 1% and while sales may have cooled a bit with the temperatures, the housing shortage is not easing any time soon. Food prices are reacting to droughts and harvest labor shortages, up 9% year-over-year. Hospital, general medical and home energy costs are running near 10%. Home furniture takes the “rise prize” for October at 20.2%. Consumer goods are either not being made or in “floating inventory” awaiting a berth in Los Angeles. Available or not, goods and gas inflation are clearly weighing on consumers. The University of Michigan’s mid-month check of consumer sentiment fell to its lowest in a decade at 66.8. Higher prices and concerns about lower real (inflation-adjusted) incomes next year drove the lower reading.

Three

We would like to think that the Fed is aware of these non-transitory forces. Chairman Powell stated at the last meeting press conference that tapering would have to be finished before the Fed would raise rates. The speed of cutting their purchases is supposed to be addressed at the January 26th meeting. 

If, as Martin Feldstein opined, that inflation is always and everywhere a monetary phenomenon, the roughly $4 trillion in stimulus that went directly to consumers’ pockets is becoming a great example. According to the New York Fed, only about one-third of the initial rounds were spent. Later injections (e.g., PPP loans) by Congress have not been tallied but we bet larger proportions were spent as things reopened. 

Our read on the data is inflation will moderate over the next few months and settle in the 4% range for most of 2022. If headline inflation falls more quickly into the 3% range, we think the taper proceeds into the summer and the Fed raises rates for the first time in July. Note that changing short-term interest rates cannot improve supply chains. Inflation hanging above 4% would complicate our analysis. 

The key to Fed actions in 2022 is whether Chairman Powell and Vice Chair Clarida are reappointed by President Biden. The remaining Vice Chairman, Randal Quarles, will step down at the end of December. Powell’s term is up in February and Clarida’s ends in September of 2022. Biden could have up to three of the seven Board seats to fill. This presents a rare opportunity to tilt the makeup of the Board toward one monetary philosophy. The seven Board of Governors members comprise the majority of the 12 FOMC voters who decide monetary policy. The remaining five are rotated from the regional Federal Reserve Bank presidents. 

Biden may well tilt the ideological bent of the FOMC. One idea circulating in the media is that a “Biden Fed” would spur hyperinflation by making monetary policy even easier. We are not buyers of this idea for several reasons. Inflation will stay well above 2% over the next few years just due to labor shortages. However longer-run forces should keep a lid on inflation. Productivity continues to expand, serving as a counter to wage inflation. Alternative fuel sources here in the U.S. counter OPEC’s heft. The demographic shifts of an aging population and high national debt are also deflationary.

Wrap-Up

Inflation was always in the background for some of us of a certain age. The three-decade decline in average CPI has been a tailwind for the economy and consumers. A good portion of this year’s price increases are supply chain driven, and those appear to be peaking. The “new” inflation in the coming years will be moderate but factor into investor thinking unlike the recent past. 

This is retail week for earnings. Higher prices and spending on consumer goods should have helped third quarter earnings for Walmart and Home Depot tomorrow. Lowe’s, Target and Kohl's round out the week. 

Gold, the dollar and Treasury yields are finally starting to break out of sideways patterns. These moves could be as much for geopolitical reasons as global inflation. Stocks remain very close to recent highs and may just need to get past Friday’s option expiration to resume their uptrend. 
 

Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary's University School of Law. Follow him on Twitter here. Greg Kalb is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts from The University of Texas at Austin.

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