Category: Economy

How the Investment Playing Field Can Dramatically Change in November

Posted on by phoffman@channelchek.com
Image Credit: The White House (Flickr)

The Mid-Term Elections are Just One of the SEC’s Concerns

The mid-term elections have the potential to alter the course of the markets. It’s easy to recognize how the possible outcomes can cause changes to the overall economy, including industry sectors, fuel prices, and perhaps even national debt levels. But, one area that is less obvious could also impact investors in a big way, regulation. As election day is now days away, many regulatory changes that have been in the works are quickly coming to a head, with the expectations there may be a change in priorities, power, and philosophy. The push to get things through in the coming days may still be undermined by the U.S. system. Here’s why.

The U.S. Government at Work

Federal regulators are in scramble-mode working to finalize proposed rules before what appears will be a change in the balance of power in the legislative branch. The possibility that there may be a Republican-controlled Congress or the expected idea that the democrats will lose control over one of the branches of Congress would soften their ability to institute their aggressive agendas. As the agencies refine their proposals, they also have to be mindful that it isn’t just the new Congress that will be evaluating new regulations. The Supreme Court has recently taken a heightened interest in agencies overstepping their charter, that interest is likely to continue.

It’s easy to see how Congress whose job it is to decide where money is spent, can dampen the agenda of the Department of Education (DOE), Internal Revenue Service (IRS), Food and Drug Administration (FDA), or Gary Gensler’s plans at the Securities and Exchange Commission (SEC). But, the Supreme Court is also more than a casual observer and has shown how willing it is to make sure everyone stays in their defined lanes. 

Recent SEC Initiatives

The SEC has a three-part mission that includes protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. Under Gary Gensler, it has been working overtime to impact the changing marketplaces. The initiatives are considered by some to be beyond the scope of the SEC’s lawful mission.

Gensler, who was appointed by President Biden, has been extremely active. The former Chairman of the U.S. Commodities Futures Trading Commission (CFTC) and MIT economics professor is proposing or finalizing dozens of regulations. Some are minor alterations to existing rules, but many are complete redesigns of how they are handled now. This redesign may make it past an unenthusiastic Congress, as they have more pressing priorities, but they may experience an aggressive halt from the country’s Judicial branch.

Recent Supreme Court Actions

In June of 2022, the Supreme Court decided W. Virginia v. EPA. The decision struck down an EPA regulation fighting climate change. The decision was made based on the grounds that the rule violated the “major questions doctrine.” The Court had never used that term before, but it seemed evident that the court might use the term and intent of the phrase should it be called on to review other federal agencies and commissions.

The Court has the authority and now recent precedent to unwind regulation that goes beyond the original intent of Congress when an agency was created or any subsequent legal grants of authority. The 6-3 ruling against the EPA explained the Clean Air Act, designed for new power plant emissions, did not extend to existing plants requiring them to shift to wind or solar. It’s a nod by the Court to keep bureaucracies from growing beyond the express original legal reason for being. 

The ruling also is relevant in that it looked at Congress’s unwillingness to legislate and legitimize the way that the agency chose to regulate. One Justice in a concurring opinion wrote the decision was in part based on whether the agency was “intruding” in a traditional area of state law. 

How it Could Impact Investors

Under the major questions doctrine, several SEC efforts may become far more difficult.

One high-profile SEC goal involves environmental initiatives. Climate change activists have supported the SEC’s proposal to require companies to increase their disclosure of anticipated climate risks. But it would be difficult for the SEC to weigh its mission against this initiative and easily demonstrate that anyone has a great impact on the other (orderly markets, investor protection, capital formation). If environmental initiatives are to be carried out, they will need to be enacted by the representatives elected to legislate on behalf of citizens.

It is easy to see how priorities focusing more on fiscal restraint rather than environmental awareness could alter the investors playing field with a power change in the Capital building.

The so-called greening of Wall Street is just one example of how the elections will impact the coming year’s winners and losers in the stock market. Consider the SEC’s proposed rules for swaps, which are financial instruments that some investors use to speculate on securities. The SEC’s suggested rule would require public disclosure within a day of these transactions to the public. The proposed rule can be considered an unprecedented intervention in this multi-trillion-dollar market. The argument is strengthened by the reality that Congress could have authorized disclosure in the 2010 Dodd-Frank Act, but did not. The Supreme Court would be expected to rule on behalf of the laws as written.

Another SEC initiative also at risk is the proposed rule on “beneficial” ownership. Such a definition is important for a host of reporting obligations. The SEC is considering expanding what counts as ownership. But questions of ownership have long been a matter of state concern. Gorsuch may have something to say about the SEC’s effort to expand the definition. 

Another example is Kim Kardashian, who was ordered by the SEC to pay a fine for having touted a cryptocurrency on her Instagram account and the compensation she failed to disclose. The SEC has been in a battle with other financial overseers of the U.S. financial system to regulate and control digital currencies, which may or may not meet the definitions of a security or other language that legally created the commission.

Take Away

Regulatory agencies, including the SEC, are likely to have to contend with increased barriers with both the only branch of government that makes both laws and spends money and the branch that deciphers and enforces laws. Rather than argue if this is what should be, or if it slows down progress when wearing one’s investor hat,” investors may only want to consider what industries and what companies within those industries will be the winners and losers – then how does that fit into your overall portfolio strategy.

If you haven’t registered to receive equity research and thoughtful articles and videos from Channelchek, this is a good time to sign-up in preparation for the year-end and 2023. Click here for free registration.

Paul Hoffman

Managing Editor, Channelchek

Was the Recession Transitory?

Posted on by phoffman@channelchek.com
Image Credit: Andrea Piacquado (Pexels)

Can We Wave Goodbye to Recession Talk Now that Q3 GDP is Positive?

Gross Domestic Product (GDP), the “advance estimate,” has shown we were not in a recession during the third quarter; instead, the economy expanded. This is a dramatic turn-around from the final data for the previous first two quarters of 2022, which show the U.S. economy contracted during each. Since the Spring, in the stock market, bad economic news has been met with buying, and good news has been met with selling. This GDP report has the power to change that back to more normal investor behavior.

The third quarter production report shows the economy expanded at an annual rate of 2.6%  despite nearly 325 basis points of Fed tightening from a base close to zero earlier this year. This report should be great news for the stock market as it shows that a large part of the economy is growing even while stimulus and easy money is being removed. In addition to the headline news related to overnight bank lending rates, each Thursday after the market closes, the Fed releases information on how large its balance sheet is. This balance sheet holdings report can be viewed as how much money they have at work in the system, effectively acting as stimulus. They have been pulling money out at a pace that many expected would also doom growth. It has not, this too should be taken as a positive sign for stock market investors.

This positive GDP report also helps veterans of the market that did not like playing word games by referring to two-quarters of economic recession (lower case “r”) as something other than a Recession (upper case “R”). This definition had in the past always been automatic, without needing the National Bureau of Economic Research (NBER) to decide when to put a light-shaded bar on our economic timeline charts. We expected that they had the same definition.

GDP Plus Recessions in Gray

Image: Gross Domestic Product Product since 1947-Apris 2022. Gray bars indicate declared recessions.

In 2022 market watchers were all expected to say, “I don’t know what a recession is, I’m not an NBER economist.” This is because, for some reason,, the National Bureau of Economic Research decided not to use the standard metric and definition, it decided instead to be less scientific. The bureau, for the first time declared there is “no fixed rule about what measures contribute information to the process or how they are weighted in our decisions.” In other words, every set of economic conditions is different, and there is no specific threshold that must be met before a recession is declared. We no longer have to even talk about a recession until maybe next year.

Will they declare this quarter an Expansion (upper case “E”)? We’ll see.

Why this GDP Report is Important

Economic growth of nations is measured as the cost of all goods and services sold and provided from domestic-based resources. After all, wealth comes from output, not increases in currency in circulation. GDP measures this output. As you might imagine, an entire economy’s worth of output is a lot of number crunching by the Bureau of Economic Analysis (BEA). So they do two preliminary numbers before the final. This allows them a couple of months to harvest all the needed data. The final GDP report for this quarter is unlikely to show 2.6% growth as it will have been revised twice, but it is likely to approximate this first look.  

Source: Investopedia

Take Away

Good news (economic strength) has been viewed harshly by the market this year as it has been looked at with an eye toward the Fed needing to be more aggressive. Bad news has been embraced and actually caused market rallies.

The most recent GDP report has the power to change this. Despite the historically aggressive Federal Reserve tightening, the economy has grown. Perhaps fears of a deeper recession will pass, and stocks will regain their historic trend of always reaching new highs.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.forbes.com/sites/qai/2022/09/22/when-will-this-officially-be-called-a-recession/?sh=357b1a558a0b

https://fred.stlouisfed.org/series/GDP

https://www.investopedia.com/terms/g/gdp.asp#:~:text=GDP%20can%20be%20determined%20via,approach%2C%20and%20the%20income%20approach.

The Truth About the Fed Pivot Rumors

Posted on by phoffman@channelchek.com
Image Credit: Camilo Rueda López (Flickr)

A Lack of Fed Pivot Doesn’t Have to Equate to Lower Stock Prices

The Fed is not likely to have suddenly indicated a pivot.

Despite the stock market rally and fresh news stories suggesting the Fed is indicating a more dovish stance, the notion has one problem. There are limits placed on Federal Open Market Committee (FOMC) participants and whether they can grant interviews or give speeches before policy-setting meetings. They can not interact on the subject of policy. The current blackout period began October 22nd and will carry through the November 2nd final meeting day. So, investors may wish to consider other reasons if the stock market is rallying. Earnings, oversold conditions, year-end rally, perhaps news stories created by bloggers or journalists that don’t possess experience or understanding.

Image: Number of times “Fed Pivot” was searched using Google 

Current State of Tightening

This year the Fed has been tightening aggressively after having brought interest rates down aggressively a couple of years back. For many investors, a tightening cycle, ending with interest rates a safe margin above the inflation rate, is not something they can recall. This is because the Fed has been stabilizing employment during tricky times in a way that has lifted the markets out of whatever trouble there may have been. Rates have been well below the average 6% to 8% range. This has been going on since at least 2008 –  by some measures, way before.

There have been five times since late Spring that investors and TV’s talking heads were convinced the Fed has gone too far and will now begin bringing rates back. So far, all the hoping has done nothing to help; the track record stands at zero for five. While it remains to be seen and heard what to expect from monetary policy starting mid-next week, the current inflation rate and words that the Fed board members have said indicate another 75 bp hike in funds.

Looking Forward

Can this change? We get a look at third-quarter GDP on Thursday. This measures U.S. domestic production. A bad number could cause the Fed to rethink aggressive tightening. However, the expectations are that it will be higher than it has been all year (2.3% growth rate) which gives the Fed even greater ability to hit the brakes. Also, the PCE Price Index, viewed as the Fed’s preferred inflation indicator, is released Friday (6.3% YoY expected).

The Federal Reserve’s, monetary policy does not cater to the stock market. It does consider it because, of the wealth effect. The wealth effect is where consumers feel poorer because of declines in asset values, and while their disposable income may not have changed, they hunker down and spend less. This secondary impact to spending is the only attention the Fed officially pays to stocks.

Interest Rates

Real interest rates are still negative. Imagine buying a bond knowing that despite being exposed to maturity and credit risk, while tying up money, your spending power will almost certainly be less when it matures. This isn’t why people invest; in fact, if that scenario remains and inflation persists, the best use of savings may be to consider any large purchases you think you may incur in the coming few years and make them now. At the moment, inflation hasn’t shown signs of abating, something has to give; bond investors are going to require higher yields, Japan has already experienced a bond-buyer “strike.”

Where Do We Go from Here

For now, the consensus view is that inflation should drift back down to 3% or even lower by 2025. If energy continues to decline, supply-chain issues are resolved, and a strong U.S. dollar persists, the consensus may be correct. But one should be aware there are very bright economists that deviate from the consensus by plus or minus 300 bp or more.  

The markets may have already priced in bad news; rates heading back to normalcy (upward) doesn’t immediately mean a bad stock market. We can easily rally through the end of the year and still experience a sixth time the Fed has refrained from pivoting but instead has made sure its words were cleansed of anything that can be construed as reversing course.

Paul Hoffman

Managing Editor, Channelchek

We’re in an Energy Crisis According to the IEA

Posted on by phoffman@channelchek.com
Image Credit: Steve Jurvetson (Flickr)

How Deep and How Long Will the Global Energy Crisis Last?

Are we in a global energy crisis? The Executive Director of the International Energy Agency (IEA), Dr. Fatih Birol, is sure of it. He referred to the global situation as a crisis on Tuesday (Oct. 25), speaking first at a conference, and later in an interview on CNBC. He explained that tighter markets for liquefied natural gas (LNG) worldwide and major oil producers cutting supply, have put the world in the middle of “the first truly global energy crisis.”

Our world has never witnessed an energy crisis with this depth and complexity,” according to the IEA head. He explained that until February 24, 2022, Russia was the number one fossil fuel exporter in the world. What has occurred since has been a major turn in oil and natural gas markets. Birol expects the volatility in oil and gas markets will continue throughout the world. When asked on CNBC Internaational if he thought it would be a prolonged war, he made clear that this is not his area of expertise; however, he believes there won’t be a “smooth transition into the next chapter for both oil and natural gas of the energy event.”

U.S. vs OPEC+

As it relates to the U.S. and OPEC being at odds, with OPEC managing toward supply-demand issues, and the U.S. being challenged by inflation, Birol says the two billion barrels cut by the oil-exporting nations is unprecedented. He believes it goes against their ambition to maximize profits as it works against economic growth in a world that is flirting with recession. He also pointed out it isn’t the U.S. that will experience hardship, rather, the emerging and developing countries will be hit hardest.

Image: Fatih Birol, IAEA Imagebank (November 2021)

On the same day, speaking at the Singapore International Energy Week, he shared that higher oil prices would push inflation higher and growth and production to shrink.

IEA projections show global oil consumption growing by 1.7 million barrels a day in 2023. Russian crude will be needed to bridge the gap between demand and supply, Birol said.

Russian Connection

The reduced Russian supply is a result of U.S. and the European Union’s decisions to place partial bans on Russian oil imports after Russia’s invasion of its neighboring country. The current proposed plan as the region heads into the heating season is to institute price caps on Russian resources. That would limit Moscow’s potential profits from oil exports while still allowing modest deliveries. Estimates are that these measures would leave space for between 80% and 90% of Russian oil to flow outside of the price cap. Birol expects this would help to make up for expected shortfalls. “I think this is good, because the world still needs Russian oil to flow into the market for now,” he said.

Oil Reserves

IEA members have built a stockpile of oil reserves that can be released if there’s a need to boost supply or temper prices, according to Birol. “We still have a huge amount of stocks to be released in case we see supply disruptions,” he said. “Currently, it is not on the agenda, but it can come anytime.”

The IEA head says that Europe will get through the winter if the weather remains mild, though somewhat battered. Birol said. “Unless we will have an extremely cold and long winter, unless there will be any surprises in terms of what we have seen, for example, Nord Stream pipeline explosion, Europe should go through this winter with some economic and social bruises.”

Take Away

The Executive Director of the IEA was in Singapore, speaking at a conference and giving media interviews. He did not sugarcoat his expectations. He expects oil and natural gas prices to remain volatile, and believes the emerging markets will be hurt most by OPECs cutting output. As for the upcoming winter, Birol says we are experiencing the worst global energy crisis in history, and it won’t resolve itself soon.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://bdnews24.com/business/7y637b19aj

https://www.iea.org/contributors/dr-fatih-birol

https://www.usnews.com/news/top-news/articles/2022-10-24/world-is-in-its-first-truly-global-energy-crisis-ieas-birol

https://www.youtube.com/watch?v=RZEYUXbcYzI

The Coming Market Hiccups, What’s Your Strategy?

Posted on by aweinsoff@channelchek.com
Image Credit: Mateusz Dach(Pexels)

Planning for a Changing Market Environment is Not Without Risks

There are two upcoming events, one scheduled and one not. They each have the potential and perhaps are even likely, to jolt or shift financial markets for a period longer than the ordinary disruptions traders and investors experience over the course of any month. These two items are the U.S. elections, which are approaching quickly, and a resolution of the Russia and Ukraine war.

Mid-Terms

On the U.S. side of the Atlantic, the mid-term election is thought of as a referendum on the person in the Oval Office and their party. The democrats who are in power in both legislative branches and also hold the executive branch are likely to lose the House and perhaps the Senate. The gridlock that would unfold if this occurs would include many government spending plans that have helped drive some investment sectors since January 2021. However, the party currently controlling both are viewed by many market participants as not “Wall Street-friendly,” so this could also weigh into market direction. And just as critical for investors, it would have the ability to shift which sectors are winners and which investments one may wish to lighten up in.

European War

In Europe, the war means a lot of things to those that live there. Focusing only from a global investor standpoint, one’s mind first turns to the energy sector. If the outcome is one where Russia largely has its way and annexes a large portion of Ukraine, how long would it take for normalcy to resume? And what would that look like? If, instead, Putin, who is leading the charge, loses power or his resolve, what would this mean for stocks, commodity prices, and overall investor mood? Should investors pre-think all scenarios and have a plan for each?

What Investment Experts Say

Channelchek spoke to a couple of highly respected, highly credentialed money managers and investment experts and asked about pre-planning.

Eric Lutton, CFA is Chief Investment Officer, at Sound Income Strategies. Eric doesn’t expect Putin to be removed, but cautions that if he is, depending on what follows, it may not automatically be good for markets. He said, “If Putin was “pushed” out of power,  a highly unlikely scenario, but if it were to happen, it would mean more unknowns for the market, which would probably be taken as another negative.” Lutton, who has spent a great deal of time in Russia and Northern Europe, explains,  “A vacuum of power in Russia would not be a good thing and could escalate the current situation.” Eric believes if a leader chosen by the West was installed, “inflation would fall, and the Fed could ease up on the rate increases.” Lutton does not think that is a scenario we will see any time soon.

The Sound Income Strategies CIO thinks the media overplays any real risk of Putin dropping a nuclear device so close to Russia on land it seeks to annex. But he did entertain the thought, as I pressured him for hypothetical scenario analysis and investment planning thoughts. “As for investors, if a bomb falls, either Putin or a false flag operation, you’d want to be in 100% cash! No place would be safe other than perhaps a handful of industrial defense or war contractors,” Said Eric Lutton.

As it relates to the November 8th mid-term elections, Eric Lutton isn’t expecting a huge “red wave” win. He points to the notion that there are people that would avoid voting red even if it was clear that the policies would better serve the populace.   Eric does, however expect Republicans to gain a majority in the House and Senate. Even if they only gain a majority in one branch, Lutton says, “I do think there will be a slight pop in the market, but short-lived as the main factors will be the Fed, inflation, supply chain and ongoing conflict in Ukraine.”

Robert Johnson, PhD, CFA, CAIA, is the CEO and Chair at Economic Index Associates. He apologetically offered conventional wisdom, suggesting that it could be a mistake for investors to, “…concern themselves with broad market moves or the crisis du jour.” Johnson, instead, recommends more tried and true portfolio implementation. This includes suggesting the creation of an Investment Policy Statement (IPS). Dr. Johnson explains that clearly defining, in advance, and in accordance with one’s time horizon and other specifics, such as liquidity needs and tax situation, will define the ground rules necessary during temporary hiccups in the market.

As it relates to a personal investment policy statement, the Chair of Economic Index Associates says it is best to develop a policy statement in calm, less volatile markets. He says’ “The whole point of an IPS is to guide you through changing market conditions. It should not be changed as a result of market fluctuations.” He did allow for individual changes in circumstances,” It only needs to be revised when your individual circumstances change — perhaps a divorce or other unanticipated life change.”

As added testimony to what Dr. Johnson knew was less than groundbreaking thoughts on the subject of the two future events and what to do in each, he offered, “ I had a former co-worker who, in the run-up to the 2016 election, was convinced that Hillary Clinton was going to win and the stock market was going to crash. So, immediately prior to the election, he sold out of stocks and went to cash. Stocks surged the day following Trump’s victory, and my co-worker bought back into the market — at a higher price.”

Take-Away

Market hiccups are often short-lived.

While it is prudent to keep your eyes open and know what risks and potential rewards may be, it may also be smart to keep investing within specific boundaries. Those boundaries are best defined when volatility and predictability are average. Within the boundaries, there can be room to lighten up or overweight, but not in ways that pull the investor substantially out of line with their original goal while using the predefined arsenal of stocks, bonds, or other financial products.

Paul Hoffman

Managing Editor, Channelchek

Sources

Eric Lutton, CFA

Robert Johnson, CFA

The Week Ahead – Fed Muzzled on Rate Talk, Third Quarter Growth, Earnings

Posted on by phoffman@channelchek.com

If the U.S. Was in a Recession, This Week’s Numbers May Show It Has grown Out of It

A big focus of traders this week will be positioning for the FOMC meeting next week and its announcement on Wednesday, November 2nd. Members of the committee that have commented in recent weeks have left little doubt that the Federal Reserve’s fight against inflation is continuing, and a 75 bp hike can be expected. Additional comments on monetary policy from Fed governors aren’t expected this week as there is a communications blackout period in effect (midnight Saturday, October 22nd through midnight Thursday, October 27th).

There will be global interest rate commotion as more rate hikes outside the U.S. are likely. The first is on Wednesday by the Bank of Canada, followed on Thursday by the European Central Bank. The forecast consensus for each is 75bp upward.

The conversation on Thursday may move from “is the U.S. going into a recession to, has the U.S. just come out of a recession?” While the first two-quarters of receding growth have never officially been declared a recession, the first look at GDP for the third quarter is out on Thursday, and it is expected to show growth during the quarter. If this occurs markets, the stock market could trade, either way, a sigh of relief that the economy is growing or fear that the Fed now has the room it needs to keep applying the interest rate brakes.

What’s on Tap for investors:

Monday 10/24

•             At 9:45 AM Purchasing Managers Index (PMI) flash report will be released. Expectations are for the number to come in around 51.2. This leading indicator of economic activity is an early estimate of private sector output. It contains information from surveys of around 1,000 manufacturing and service sector companies. The flash data are released ten days ahead of the final report and are based on 85 percent of the full survey.

Tuesday 10/25

•             At 10:00 AM, the Consumer Confidence survey will be released. Expectations are for a decline of 2.0 points to 106.0 in October, this would be after it exceeded expectations in September and August.

•             At  10 AM, the  Richmond Fed Manufacturing Index will be reported. The consensus is -3. Last month the report came in at 0.0, which was above the consensus estimates. The headline index number is a composite of the new orders, shipments, and employment indexes in the Richmond Fed’s manufacturing sector. It provides insight into the state of the manufacturing sector.

•             At 1 PM, U.S. Money Supply is released for September. During August M2 rose by $1.8 billion.

•             Noble Capital Markets will host a roadshow in St. Louis with Harte Hanks (HHS). Qualified Investors of all levels, including registered representatives, are welcome to attend at no cost, and with no obligation to invest. More information here.

Wednesday 10/26

•             At 8:30 AM, International Trade in Goods (advance) will be reported. The consensus is for a U.S. trade deficit of 87.8 billion. This would represent a widening of more dollars spent purchasing goods from abroad than goods purchased from the U.S. The numbers may offer insight into the impact that the strong dollar has had on reducing demand for U.S.-made products.

•             At 8:30 AM, Wholesale Inventories (Advance) for September are expected to have shown an increase of 1.1%. If inventories are growing fast relative to GDP, then both production and employment may have to slow down the road. And if inventories are lagging behind growth, there may be an undersupply to be made up for later.

•             At 10:00 PM, New Home Sales are expected to show a rate of 585 thousand during September. This number surprised to the upside the previous period. The report is important to those trading securities as it indicates economic momentum, future demand for goods, and confidence in the ability to afford a big expense. New home sales multiply through other areas of the economy as new homeowners set their homes with furniture, appliances, and services.

Thursday 10/27

•             At 8:30 AM, investors will get their first look at GDP for the third quarter. The number is supposed to show the first sign of growth in 2022. Consensus expectations are for growth of 2.3% during the third quarter. Stock market investors may wrestle with whether the good news is bad news or bad news is good news as the market finds a direction after this report and ahead of a rate decision the following week.

•             At 8:30 AM, Durable Goods Orders are released. The consensus is for a .6% increase in the headline number and .2% ex-transportation. Durable goods are new orders placed with U.S. manufacturers for factory hard goods. The report also contains information on shipments, unfilled orders, and inventories. Investors get insight into how busy factories will be in the coming months. This is a leading indicator with direct implications for economic growth

•             At 8:30 AM Jobless Claims are reported for the week ending 10/22/22. The expectations are for there to be 223,000 new claims. Surprises on one side or the other are important as healthy employment is one the Federal Reserve mandates.

•             At 10:30 AM, The U.S. Energy Information Administration (EIA) releases its weekly report on natural gas. Energy supply and demand balance impact prices of fuel that can ripple through the entire economy.

Friday 10/28

•             At 8:30 AM, Personal Income and Outlays are reported. This report includes the PCE Price index that is considered to be the Feds preferred inflation indicator. The consensus for Personal Income is +.3%. The consensus for the PCE gauge is +.3% which would equate to a year-over-year inflation rate of +6.3%.

•             At 10:00 AM, Consumer Sentiment is expected to come in at 59.7; the previous month the number reported was 59.8. Consumer spending accounts for 66% of the economy. Consumer appetite is a big influencer on investments. For stocks, strong economic growth translates to healthy corporate profits and higher stock prices. For bonds, the focus is whether economic growth goes overboard and leads to inflation.

What Else

It’s earnings season, and big market moves can occur should closely watch names miss their expected earnings numbers. On Tuesday this could include GE, Microsoft, and GM. Wednesday Ford reports, Thursday MacDonalds, Merck, Mastercard, and U.S. Steel. On Friday Exxon and Alliance Bernstein will make public their third quarter earnings.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://us.econoday.com/byweek.asp?cust=us&lid=0

www.EIA.gov

New Home Size as a Leading Indicator for Recession

Posted on by phoffman@channelchek.com
Image Credit: Tannert11 (Flickr)

Housing Is Getting Less Affordable. Governments Are Making It Worse

The average square footage in new single-family houses has been declining since 2015. House sizes tend to fall just during recessionary periods. It happened from 2008 to 2009, from 2001 to 2002, and from 1990 to 1991.

But even with strong economic-growth numbers well into 2019, it looks like demand for houses of historically large size may have finally peaked even before the 2020 recession and our current economic malaise.  (Square footage in new multifamily construction has also increased.)

According to Census Bureau data, the average size of new houses in 2021 was 2,480 square feet. That’s down 7 percent from the 2015 peak of 2,687.

2015’s average, by the way, was an all-time high and represented decades of near-relentless growth in house sizes in the United States since the Second World War. Indeed, in the 48 years from 1973 to 2015, the average size of new houses increased by 62 percent from 1,660 to 2,687 square feet. At the same time, the quality of housing also increased substantially in everything from insulation, to roofing materials, to windows, and to the size and availability of garages.

Meanwhile, the size of American households during this period decreased 16 percent from 3.01 to 2.51 people.

Yet, even with that 7 percent decline in house size since 2015, the average new home in America as of 2021 was still well over 50 percent larger than they were in the 1960s. Home size isn’t exactly falling off a cliff. US homes, on a square-foot-per-person basis, remain quite large by historical standards. Since 1973, square footage per person in new houses has nearly doubled, rising from 503 square feet per person in 1973 to 988 square feet person in 2021. By this measure, new house size actually increased from 2020 to 2021.

This continued drive upward in new home size can be attributed in part to the persistence of easy money over the past decade. Even as homes continued to stay big—and thus stay comparatively expensive—it was not difficult to find buyers for them. Continually falling mortgage rates to historical lows below even 3 percent in many cases meant buyers could simply borrow more money to buy big houses.

But we may have finally hit the wall on home size. In recent months we’re finally starting to see evidence of falling home sales and falling home prices. It’s only now, with mortgage rates surging, inflation soaring, and real wages falling—and thus home price affordability falling—that there are now good reasons for builders to think “wow, maybe we need to build some smaller, less costly homes.”  There are many reasons to think that they won’t, and that for-purchase homes will simply become less affordable. But it’s not the fault of the builders.

This wouldn’t be a problem in a mostly-free market in which builders could easily adjust their products to meet the market where it’s at. In a flexible and generally free market, builders would flock to build homes at a price level at which a large segment of the population could afford to buy those houses.  But that’s not the sort of economy we live in. Rather, real estate and housing development are highly regulated industries at both the federal level and at the local level. Thanks to this, it is becoming more and more difficult for builders to build smaller houses at a time when millions of potential first-time home buyers would gladly snatch them up.

How Government Policy Led to a Codification of Larger, More Expensive Houses

In recent decades, local governments have continued to ratchet up mandates as to how many units can be built per acre, and what size those new houses can be. As The Washington Post reported in 2019, various government regulations and fees, such as “impact fees,” which are the same regardless of the size of the unit, “incentivize developers to build big.” The Post continues, “if zoning allows no more than two units per acre, the incentive will be to build the biggest, most expensive units possible.”

Moreover, community groups opposed to anything that sounds like “density” or “upzoning” will use the power of local governments to crush developer attempts to build more affordable housing. However, as The Post notes, at least one developer has found “where his firm has been able to encourage cities to allow smaller buildings the demand has been strong. For those building small, demand doesn’t seem to be an issue.”

Similarly, in an article last month at The New York Times, Emily Badger notes the central role of government regulations in keeping houses big and ultimately increasingly unaffordable. She writes how in recent decades,

“Land grew more expensive. But communities didn’t respond by allowing housing on smaller pieces of it. They broadly did the opposite, ratcheting up rules that ensured builders couldn’t construct smaller, more affordable homes. They required pricier materials and minimum home sizes. They wanted architectural flourishes, not flat facades. …”

It is true that in many places empty land has increased in price, but in areas where the regulatory burden is relatively low—such as Houston—builders have nonetheless responded with more building of housing such as townhouses.

In many places, however, regulations continue to push up the prices of homes.

Badger notes that in Portland, Oregon, for example, “Permits add $40,000-$50,000. Removing a fir tree 36 inches in diameter costs another $16,000 in fees.” A lack of small “starter homes” is not due to an unwillingness on the part of builders. Governments have simply made smaller home unprofitable.

“You’ve basically regulated me out of anything remotely on the affordable side,” said Justin Wood, the owner of Fish Construction NW.

In Savannah, Ga., Jerry Konter began building three-bed, two-bath, 1,350-square-foot homes in 1977 for $36,500. But he moved upmarket as costs and design mandates pushed him there.

“It’s not that I don’t want to build entry-level homes,” said Mr. Konter, the chairman of the National Association of Home Builders. “It’s that I can’t produce one that I can make a profit on and sell to that potential purchaser.”

Those familiar with how local governments zone land and set building standards will not be surprised by this. Local governments, pressured by local homeowners, will intervene to keep lot sizes large, and to pass ordinances that keep out housing that might be seen by voters as “too dense” or “too cheap-looking.”

Yet, as much as existing homeowners and city planners would love to see nothing but upper middle-class housing with three-car garages along every street, the fact is that not everyone can afford this sort of housing. But that doesn’t mean people in the middle can only afford a shack in a shanty town either — so long as governments will allow more basic housing to be built.

But there are few signs of many local governments relenting on their exclusionary housing policies, and the result has been an ossified housing policy designed to reinforce existing housing, while denying new types of housing that is perhaps more suitable to smaller households and a more stagnant economic environment.

Eventually, though, something has to give. Either governments persist indefinitely with restrictions on “undesirable” housing — which means housing costs skyrocket — or local governments finally start to allow builders to build housing more appropriate to the needs of the middle class.

If current trends continue, we may finally see real pressure to get local governments to allow more building of more affordable single-family homes, or duplexes, or townhouses. If interest rates continue to march upward, this need will become only more urgent. Moreover, as homebuilding materials continue to become more expensive thanks to 40-year highs in inflation—thanks to the Federal Reserve—there will be even more need to find ways to cut regulatory costs in other areas.

For now, the results have been spotty. But where developers are allowed to actually build for a middle-class clientele, it looks like there’s plenty of demand.

About the Author

Ryan McMaken (@ryanmcmaken) is a senior editor at the Mises Institute. Ryan has a bachelor’s degree in economics and a master’s degree in public policy and international relations from the University of Colorado. He is the author of Breaking Away: The Case for Secession, Radical Decentralization, and Smaller Polities (forthcoming) and Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre. He was a housing economist for the State of Colorado. 

Can We Expect a Stock Market Rally After the FOMC Meeting on November 2nd?

Posted on by phoffman@channelchek.com
Image Credit: AlphaTradeZone (Pexels)

Will the November Fed rate announcement cause a stock market rally?

The next time the Federal Reserve is expected to adjust the target range of the Fed Funds overnight lending rate is Wednesday, November 2nd. Few have doubt at this point that this will again be a 0.75% increase. That level is already baked into equities. Stock market strength and direction shouldn’t veer much from the rate move but could dramatically turn as a result of the Fed’s forward guidance. If Chairman Powell & Co. suggests a slower benchmark lending rate increase, it would be a very welcome sign for investors.

Focus on the Post Meeting Announcement

There are already signs the Fed may slow the pace of Fed Funds increases. There are also indications it may alter its quantitative tightening (QT) in a way that could quicken a yield curve steepening. In other words, the speed of QT may increase. To date, the real rate of return on bonds, of most all maturities, is viewed as unnatural as they are below zero (Yield – Inflation = Real Rate). While an increase in QT may do more to raise rates and reduce the money supply, the effect is stealthier; it doesn’t provide a panicky headline for investors to react to abruptly. 

Some Fed governors have already shown signs that they believe the best course from here is to slow the ratcheting up of the funds level and perhaps even stop raising Fed Funds rates early next year. A hiatus would allow them time to see if the moves have had an impact and give members a chance to see if further moves are prudent. The Fed always runs the risk of overreacting and going too far when tightening; this “oversteering” by previous Feds has occurred a high percentage of the time as they contend with a lag between monetary policy shifts and economic reaction.  

Where We Are, Where We’re Going

In the most aggressive pace since early 1980, so far in 2022, the Fed raised its benchmark federal-funds rate by 0.75 points at each of its past three meetings. The most recent move was in late September. This left the overnight interest rate at a range between 3% and 3.25%.

The stock market wants the Fed to slow down. It rallied in July and August on expectations that the Fed might slow the pace of increase. Slowing, at least at the time, would have conflicted with the central bank’s inflation target because easy financial conditions stimulate spending, economic growth, and related inflation pressures. This rally in stocks may have prompted Powell to redraft a very public speech to economists in late August. He spoke about nothing else for eight minutes at Jackson Hole except for his resolve to win the fight against higher prices.

But sentiment related to how forceful the FOMC now needs to be may be shifting. Fed Vice Chairwoman Lael Brainard, joined by other officials, have recently hinted they are uneasy with raising rates by 0.75 points beyond next month’s meeting. In a speech on Oct. 10th, Brainard laid out a case for pausing rate rises, noting how they impact the economy over time.

Others that are concerned about the danger of raising rates too high include Chicago Fed President Charles Evans. Evans told reporters on Oct. 10th that he was worried about assumptions that the Fed could just cut rates if it decided they were too high. He felt a need to share his thought that promptly lowering rates is always easier in theory than in practice. The Chicago Fed President said he would prefer to find a rate level that restricted economic growth enough to lower inflation and hold it there even if the Fed faced “a few not-so-great reports” on inflation. “I worry that if the way you judge it is, ‘Oh, another bad inflation report—it must be that we need more [rate hikes],’… that puts us at somewhat greater risk of responding overly aggressive,” Evans said.

Kansas City Fed President Esther George also had something to say on this topic last week. She said she favored moving “steadier and slower” on rate increases. “A series of very super-sized rate increases might cause you to oversteer and not be able to see those turning points,” according to the Kansas City Fed President.

Others like Fed governor Waller don’t view steady 0.75% increases as a done deal but instead something to be reviewed, “We will have a very thoughtful discussion about the pace of tightening at our next meeting,” Waller said in a speech earlier this month.

The caution surrounding oversteering isn’t unanimous; at least one Fed official wants to see proof that inflation is falling before easing up on the economic brake pedal. “Given our frankly disappointing lack of progress on curtailing inflation, I expect we will be well above 4% by the end of the year,” said Philadelphia Fed President Patrick Harker.

The ultimate result is likely to come down to what Mr. Powell decides as he seeks to fashion a consensus. In the past, votes, while not always unanimous, tend to defer to the Chairperson at the time.

Take-Away

If, after the next FOMC meeting, the Fed is entertaining a lower 0.50% rate rise in December (not 0.75%), they will prepare the markets (bond, stock, and foreign exchange) for the decision in the moments and weeks following their Nov. 1-2 meeting. If this occurs, it could cause stocks to perform well just before election day and perhaps make up some lost ground in the year’s final two months.  

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/speech/waller20221006a.htm

https://www.wsj.com/articles/fed-set-to-raise-rates-by-0-75-point-and-debate-size-of-future-hikes-11666356757?mod=hp_lead_pos1

https://www.federalreserve.gov/aboutthefed/federal-reserve-system-philadelphia.htm

Ready or Not, Here Come CBDCs

Posted on by aweinsoff@channelchek.com
Image Source: usfunds.com

Central Bank Digital Currencies May Be Inevitable, And That’s a Problem

Readers of a certain age will remember Carnac the Magnificent, Johnny Carson’s recurring alter ego. As Carnac, the late-night host would list off three seemingly unrelated words, all of which answered a question that was sealed in an envelope that he held to his forehead.

Today we’re going to play the same game, with the answers being PayPal, Kanye (or Ye, as he’s now known) and central bank digital currencies (CBDCs). And the question: What are the consequences of financial hyper-centralization?

Some of you will make the connections immediately. For everyone else, let me explain.

PayPal, the financial technology (fintech) firm cofounded over 20 years ago by Peter Thiel, Elon Musk and others, was roundly criticized last week after an update to its terms of service showed that the company would fine users $2,500 for, among other things, spreading “misinformation.” A PayPal spokesperson was quick to walk back the update, even claiming that the language “was never intended to be inserted in our policy,” but the damage was done. #DeletePayPal started trending on Twitter, and the company’s stock tanked nearly 12%.

As for Ye, he and his apparel brand Yeezy were reportedly dropped last week by JPMorgan Chase. In a letter widely shared on social media, JPMorgan says Ye has until November 21 to move his business finances elsewhere.

No reason was given by the bank to cut ties with the billionaire rapper, but it’s easy to surmise that Ye was targeted for his political beliefs and outspokenness. I don’t agree with everything he says, nor should you. He’s a controversial figure, and his comments are often erratic and designed to get a rise out of his critics. I’m not sure, though, that this should have anything to do with his access to banking services.

The two cases of PayPal and Ye represent what I believe are legitimate and mounting concerns surrounding centralized finance. Admittedly, Ye is an extreme example. He’s a multiplatinum recording artist with tens of millions of social media followers. But there’s a real fear among everyday people that they too can be fined or have their accounts frozen or canceled at any time for expressing nonconformist views.

This article was republished with permission from Frank Talk, a CEO Blog by Frank Holmes of U.S. Global Investors (GROW). Find more of Frank’s articles here – Originally published October 19, 2022

CBDCs Are Inevitable

That brings me to CBDCs. I was in Europe last week where I attended the Bitcoin Amsterdam conference, and I was honored to participate on a lively panel that was aptly titled “The Specter of CBDCs.”

As I told the audience, I believe CBDCs are inevitable, ready or not. There are too many perceived benefits. These currencies offer broad public access and instant settlements, streamline cross-border payments, preserve the dominance of a nation’s currency and reduce the operational costs of maintaining physical cash. Here in the U.S., millions upon millions of dollars’ worth of bills and coins are lost or accidentally thrown away every year. CBDCs would solve this problem. 

An estimated 90% of the world’s central banks currently have CBDC plans somewhere in the pipeline. As I write this, only two countries have officially launched their own digital currencies—the Bahamas with its Sand Dollar, and Nigeria with its eNaira—but expect many more to follow in the coming years. China, the world’s second largest economy, has been piloting its own CBDC for a couple of years now, and India, the seventh largest, released a report last week laying out the “planned features of the digital Rupee.” A pilot program of the currency is expected to begin “soon.” And speaking at an annual International Monetary Fund (IMF) meeting, Treasury Secretary Janet Yellen said that the U.S. should be “in a position where we could issue” a CBDC.

CBDCs Improve Bitcoin’s Use Case

Due to the centralized nature of CBDCs, however, there are a number of concerns that give many people pause. Unlike Bitcoin, which is decentralized and anonymous, CBDCs raise questions about privacy, government interference and manipulation.

In the White House’s own review of digital currencies, issued last month, policymakers write that a potential U.S. coin system should “promote compliance with” anti-money laundering (AML) and counter-terrorist financing (CFT) laws. Such a system should also “prevent the use of CBDC in ways that violate civil or human rights.” Further, it should be sustainable; that is, it should “minimize energy use, resources use, greenhouse gas emissions, other pollution and environmental impacts on local communities.”

Nothing about this sounds inherently nefarious, but then, some of us may have said the same thing about PayPal’s “misinformation” policy (whether intended or not) and JPMorgan’s decision to end its relationship with a polarizing celebrity.

I believe this only improves Bitcoin’s use case, especially if we’re headed for a digital future.

Worst 60/40 Portfolio Returns In 100 Years

With only a little over 50 trading days left in 2022, it looks more and more likely that this will be among the very worst years in history for investing. Since World War II, there have been only three instances, in 1974, 2002 and 2008, when the S&P 500 ended the year down more than 20%. If 2022 ended today, it would mark only the fourth time.  

Here’s another way to visualize it. The scatter plot below shows annual returns for the S&P 500 (horizontal axis) and U.S. bonds (vertical axis). As you can see, 2022 falls in the most undesirable quadrant along with the years 1931, 1941 and 1969. Not only have stocks been knocked down, but so have bond prices as the Fed continues to hike rates at an historically fast pace.   

What this means is that the traditional “60/40” portfolio—composed of 60% stocks and 40% bonds—now faces its worst year in 100 years, according to Bank of America.

My takeaway is that diversification matters more now than perhaps in any other time in recent memory. Real assets like gold and silver look very attractive right now. Real estate is an option. And Bitcoin continues to trade at a discount. Diversification doesn’t ensure a positive return, but it could potentially spell the difference between losing a little and losing a lot.

You can watch the panel discussion at Bitcoin Amsterdam featuring Frank Holmes by clicking here!

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. Diversification does not protect an investor from market risks and does not assure a profit.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 9/30/2022.

Household Income That’s Subject to Taxes Declines Next Year

Posted on by phoffman@channelchek.com
Image Credit: JD Hancock (Flickr)

These Are the New Federal Tax Brackets and Standard Deductions For 2023

Now for the inflation good news. Thankfully, as it relates to federal income taxes, the IRS makes annual adjustments to certain tax provisions. Simply put, the higher the inflation, the more tax credit benefit, which includes tax credits and taxable wages adjusted downward. So, in addition to receiving much higher COLA increases on Social Security payments and earning an interest rate in excess of 9% on U.S. Savings Bonds, those making an income in 2023 are likely to see more take-home pay.

The IRS Numbers Are In

The IRS announced the 2023 inflation adjustments to the standard deduction and other tax provisions for the 2023 tax year. The adjustments affect 60 provisions in the tax code, and leave a few key provisions unchanged.

Highlights of Changes in Revenue Procedure 2021-38

The tax year 2023 adjustments described below generally apply to tax returns filed in 2024.  A higher level of details about these annual adjustments can be found in IRS Revenue Procedure 2022-38PDF.

The standard deduction for married couples filing jointly for tax year 2023 rises to $27,700 up $1,800 from the prior year. For single taxpayers and married individuals filing separately, the standard deduction rises to $13,850 for 2023, up $900, and for heads of households, the standard deduction will be $20,800 for tax year 2023, up $1,400 from the amount for tax year 2022.

 Marginal Rates: For tax year 2023, the top tax rate remains 37% for individual single taxpayers with incomes greater than $578,125 ($693,750 for married couples filing jointly).

The other rates are:

  • 35% for incomes over $231,250 ($462,500 for married couples filing jointly);
  • 32% for incomes over $182,100 ($364,200 for married couples filing jointly);
  • 24% for incomes over $95,375 ($190,750 for married couples filing jointly);
  • 22% for incomes over $44,725 ($89,450 for married couples filing jointly);
  • 12% for incomes over $11,000 ($22,000 for married couples filing jointly).

The lowest rate is 10% for incomes of single individuals with incomes of $11,000 or less ($22,000 for married couples filing jointly).

 The Alternative Minimum Tax exemption amount for tax year 2023 is $81,300 and begins to phase out at $578,150 ($126,500 for married couples filing jointly for whom the exemption begins to phase out at $1,156,300). The 2022 exemption amount was $75,900 and began to phase out at $539,900 ($118,100 for married couples filing jointly for whom the exemption began to phase out at $1,079,800).

 The tax year 2023 maximum Earned Income Tax Credit amount is $7,430 for qualifying taxpayers who have three or more qualifying children, up from $6,935 for tax year 2022. The revenue procedure contains a table providing maximum EITC amount for other categories, income thresholds and phase-outs.

 For 2023, the monthly limitation for the qualified transportation fringe benefit and the monthly limitation for qualified parking increases to $300, up $20 from the limit for 2022.

 For the taxable years beginning in 2023, the dollar limitation for employee salary reductions for contributions to health flexible spending arrangements increases to $3,050. For cafeteria plans that permit the carryover of unused amounts, the maximum carryover amount is $610, an increase of $40 from taxable years beginning in 2022.

 For tax year 2023, participants who have self-only coverage in a Medical Savings Account, the plan must have an annual deductible that is not less than $2,650, up $200 from tax year 2022; but not more than $3,950, an increase of $250 from tax year 2022. For self-only coverage, the maximum out-of-pocket expense amount is $5,300, up $350 from 2022. For tax year 2023, for family coverage, the annual deductible is not less than $5,300, up from $4,950 for 2022; however, the deductible cannot be more than $7,900, up $500 from the limit for tax year 2022. For family coverage, the out-of-pocket expense limit is $9,650 for tax year 2023, an increase of $600 from tax year 2022.

 For tax year 2023, the foreign earned income exclusion is $120,000 up from $112,000 for tax year 2022.

 Estates of decedents who die during 2023 have a basic exclusion amount of $12,920,000, up from a total of $12,060,000 for estates of decedents who died in 2022.

 The annual exclusion for gifts increases to $17,000 for calendar year 2023, up from $16,000 for calendar year 2021.

 The maximum credit allowed for adoptions for tax year 2023 is the amount of qualified adoption expenses up to $15,950, up from $14,890 for 2022.

Brand New for 2023

The Inflation Reduction Act extended some energy-related tax breaks and indexed for inflation the energy-efficient commercial buildings deduction beginning with the tax year 2023. For 2023, the applicable dollar value used to determine the maximum allowance of the deduction is $0.54 increased by $0.02 for each percentage point by which the total annual energy and power costs for the building are certified to be reduced by a percentage greater than 25 percent (but not above $1.07). The applicable dollar value used to determine the increased deduction amount for certain property is $2.68 increased (but not above $5.36) by $0.11 for each percentage point by which the total annual energy and power costs for the building are certified to be reduced by a percentage greater than 25 percent.

Items Unaffected by Inflation Indexing

By statute, these items that were indexed for inflation in the past are currently not adjusted.

The personal exemption for tax year 2023 remains at 0, as it was for 2022, this elimination of the personal exemption was a provision in the Tax Cuts and Jobs Act.

 For 2023, as in 2022, 2021, 2020, 2019 and 2018, there is no limitation on itemized deductions, as that limitation was eliminated by the Tax Cuts and Jobs Act.

 The modified adjusted gross income amount used by joint filers to determine the reduction in the Lifetime Learning Credit provided in § 25A(d)(2) is not adjusted for inflation for taxable years beginning after December 31, 2020. The Lifetime Learning Credit is phased out for taxpayers with modified adjusted gross income in excess of $80,000 ($160,000 for joint returns).

What Else is Impacted

The maximum contribution amount for a 401(k) or similar workplace retirement plan is governed by yet another formula that uses September inflation data. It is estimated that the contribution limit will increase to $22,500 in 2023 from $20,500 this year and the catch-contribution amount for those age 50 or more will rise from $6,500 to at least $7,500.

The child tax credit under current law is $2,000 per child is not adjusted for inflation. But the additional child tax credit, which is refundable and available even to taxpayers that have no tax liability, is adjusted for inflation. It is expected to increase from $1,500 to $1,600 in 2023.

For those that look forward to capping out payments to Social Security, there is bad news. This has also increased. According to the 2022 Social Security Trustees Report, the wage base tax rate is projected to increase 5.5% from $147,000 to $155,100 in 2023.

Costs are rising, but so are deductions. It’s improbable that the reduced taxes will offset skyrocketing inflation, but at least there is one financial category that is helped by the increases.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023

Small Caps are Bowling Over Large Caps – Here’s Why

Posted on by phoffman@channelchek.com
Image Courtesy of Bowlero (BOWL)

Tailwinds Causing Investors to Love the Small Cap Sector

Investors have been reeling in U.S. small-cap stocks, and many have experienced the market rewarding them. As the U.S. dollar has been unrelentingly strong in 2022, the cost of products in any other currency has increased, this makes sales more difficult for multinational companies. The lower sales, of course, have the impact of weighing on the profits of U.S. companies that derive a large part of their earnings from overseas trade. This puts the smaller stocks at an advantage.

U.S. Dollar Tailwind

Goods valued in dollars, for example, using The WSJ Dollar Index which measures a basket of 16 currencies against the U.S. currency, are now up 16% on the year. This represents the minimum increase of the cost of products sold after the foreign exchange transaction, before inflation.  

This has little impact on small U.S.-based companies that don’t transact as much or at all outside the U.S. borders. This is because companies in the small-cap S&P 600 generate only 20% of their revenue outside the U.S., compared with large-cap S&P 500 stocks that generate 40% of sales internationally, according to FactSet.

This by itself gives small-cap stocks, in the aggregate, an edge over large-cap indexes like the S&P 500. However, small-caps haven’t been unscathed by the overall negative market sentiment this year. But, in recent months, value investors have been putting more upward pressure on the smaller, more U.S.-centric companies than on companies in the Nasdaq 100 or S&P 500. In fact, the small-cap Russell index is the only one of the three indexes showing green over the past three months. It has also been outperforming in shorter periods like one month, 10 days, and 5 days.

Value Tailwind

Wall Street often uses the ratio of a company’s share price to its earnings (P/E ratio) as a gauge for whether a stock appears cheap or overpriced. The small-cap universe, by this measure, is very attractive relative to themselves in recent years and certainly relative to large-cap valuations now.

The S&P 600 is trading at 10.8 times expected earnings over the next 12 months, according to FactSet as of Friday. That is below its 20-year average of 15.5 and well below the S&P 500’s forward price/earnings ratio of 15.3.

The Russell Small-Cap 2000 is up .36% versus the S&P 500, down 3.85%, and Nasdaq 100, down 7.70%. Not shown on the graph below, the S&P 600 small cap index is flat on the period.

Source: Koyfin

According to Royce Investment’s Third Quarter Chartbook, when comparing the stock market segments, four observations stand out. According to their Market Overview, these are:

1) Small-Cap Value, Small-Cap Core, and Small-Cap Growth are the cheapest segments of U.S. equities, 2) These segments are the only ones that are below their 25-year average valuation,

3) While all three value segments (Small-Cap, Mid-Cap, and Large-Cap) have nearly identical 25-year average valuations, their current valuations are vastly different, and

4) Mid-Cap Growth and Large-Cap valuations still have a long way to fall to reach their 25-year average valuations.

The presumption is with the segments all having the same 25-year average valuations and small-cap being below its average, while mid-cap and large-cap has to go down to reach its mean, that not only is small-cheap, but the other segments are still expensive.

Individually, some of the largest companies in the U.S. have shared their individual risks brought on by fluctuations in the currency market. Nike Inc., Fastenal Co., Domino’s Pizza Inc. and some others have pointed to negative foreign-exchange impacts during recent earnings calls. Microsoft warned of these pressures back in June.

Small-Cap Examples

Some standouts, not necessarily in either the S&P 600 or Russell 2000, small-cap indices, but found on Channelchek are, Bowlero (BOWL), with a market cap of 2.4 billion and performance of up 26.6% over the same three-month period shown in the chart above.  For the same period, Comtech Telecommunications (CMTL), with a market cap of 281.5 million, and some international business, is up 12.6%. And RCI Hospitality Holdings (RICK), with a market cap of $705.9 million, has a three-month return of 45.7%. These examples can be found on Channelchek with complete, up-to-date research, alongside many other actionable opportunities.  

Take Away

If yesterday’s trade isn’t working because of factors working against it, perhaps what wasn’t working yesterday is now coming into favor. The tailwind for smaller companies is coming from a few different places; they include having a higher percentage of domestic customers and also the law of reversion to the mean. The continued headwinds for larger companies include being much more likely to have problems that include foreign customer FX, and valuations that are still sitting above the 25-year average.

When researching small-cap stocks, remember that is exactly what no-cost Channelchek was made for.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.royceinvest.com/insights/chartbook/us-small-cap-mrkt-overview/index.html

https://www.wsj.com/podcasts/google-news-update/strong-dollar-boosts-bounceback-of-small-cap-stocks/

Michael Burry Wonders Aloud if Facebook Knows What It Wants to Be

Posted on by phoffman@channelchek.com
Image Credit: Marco Verch (Flickr)  

Is Meta the Wrong Path for Facebook, or is it Just Ahead of its Time?

Not all ideas are good ideas, even when they come from billionaire tech start-up founders like Mark Zuckerberg.

Michael Burry, the legendary investor of “Big Short” fame, has been criticizing the social media giant’s metaverse strategy. Burry joins others in questioning why Zuck would change the Facebook formula and spend billions embracing something that is far from real. Many of Zuckerberg’s critics are other successful billionaires like Elon Musk and Mark Cuban. Other critics are investors that have endured Meta share’s 62.3% ($570 billion) decline since January.  

Burry founded and manages the hedge fund Scion Asset Management. Burry tweeted a message that seems to say Meta management blew it – and suggests they have blown it by historic proportions by taking a deep dive into something that may or may not have legs – the metaverse.

Image: @BurryDeleted (Twitter)

You don’t have to have been alive in the mid-1980s to know what Burry was saying when he posted, “Seems Meta has a New Coke problem.” Any business school textbook lists Coca-Cola’s changing the formula of its best-selling product as the #1 lesson in corporate blunders. It was an expensive change that failed miserably and caused the company to revert back to its original product or risk losing a lot more ground against rivals.

A Sweet Refresher

New Coke was a much sweeter version of the Coca-Cola people had become accustomed to using to wash down their pizza slices, or a burger and fries. It was introduced by Coca-Cola in April 1985 during the cola war Pepsi was waging.

At the time Coca Cola was perhaps one of the most recognized brands in the world. But, Pepsi stole customers after it ran a few Michael Jackson commercials suggesting its sugar water was the “choice of a new generation,” and also backed it up with ads showing blind taste test preferences. Between the taste test science and everyone wanting to be more like Michael Jackson, Coke lost market share. Coke reacted by reformulating its product and did its own blind side-by-side tests that indicated that consumers seemed to prefer the new sweeter taste, similar to Pepsi. The company then decided to market the reformulated recipe – New Coke was born.

Max Headroom was the spokesman for New Coke, Like the Grand Canyon (Flickr)

New Coke was introduced in April 1985, and within weeks they were receiving 5,000 angry calls a day. The number grew from there. Seventy-nine days after their initial announcement, Coca-Cola held a press conference in July 1985 to offer a mea culpa and announce the return of the original Coca-Cola “classic” formula.

Will Zuckerberg Relent?

So far, Facebook, I mean Meta, still wants to identify as a metaverse company, despite there being very few metaverse customers. The company is making sure users have accessories available and just unveiled a new virtual reality headset selling for $1,500 called the Meta Quest Pro. Zuckerberg says lower priced, presumably not “pro,” will follow ($300-$500 zone).

When one has built a business from a college dorm, a garage, or their mother’s basement, and it attains the kind of growth that Facebook, Apple, Amazon, or others have, it’s hard to keep growing at the pace investors and other onlookers have become accustomed to. This leads to a scenario where investors are exposed to a risk best described as the bigger they are, the farther they have to fall.  

And Facebook has fallen, not just in dollar value, but in ranking among its peers. Does this mean Zuckerberg is not right? The game isn’t over, and there aren’t many of us that can say, with honesty, that we are more forward-looking or have more luck than Zuck.

Is Michael Burry Right?

There is a whole universe of stocks beyond metaverse investments. Huge successful companies like Facebook or even Coca-Cola have ample resources to build and grow but lose nimbleness and growth potential, unlike the potential smaller companies enjoy. Huge companies are also more likely to have a “say yes to the boss, and you’ll be rewarded” culture, rather than a small company culture which is more “show the boss you can make them money, and you’ll be rewarded” culture.

Zuckerberg and Meta may very well be moving forward with a mistake that could be enshrined in textbooks years from now. However, like Coke, they may find that if it’s a lemon, they can make lemonade. Coca-Cola emerged from the brief departure from their main product strengthened as consumers discovered what life was like without their favorite soft drink.

Take Away

Michael Burry is worth paying attention to. He thinks differently and has been correct enough to always listen. The metaverse is new; does this mean it won’t grow and become something only a visionary like Mark Zuckerberg can imagine? It has been an expensive and slow start. I suspect Facebook was much less expensive to get off the ground, and adoption also required ancillary products to be useable by the masses.

A lesson investors should remember from this is how difficult it is for large companies to grow from their current offerings and huge corporate base.

Channelchek is a platform created to help investors uncover the next Apple, the next Moderna, or the next Facebook. It’s a resource to dig deeper into these less celebrated fledgling opportunities and to leave investors with enough understanding to decide whether they should take their own action by buying stock and becoming an owner of something with greater than average potential.

Paul Hoffman

Managing Editor, Channelchek  

Sources

https://www.history.com/news/why-coca-cola-new-coke-flopped

https://www.thestreet.com/technology/big-short-burry-says-facebook-and-zuckerberg-are-in-big-trouble

https://www.nytimes.com/2022/10/09/technology/meta-zuckerberg-metaverse.html

The Week Ahead – Housing, Manufacturing, and Fed District Reporting

Posted on by phoffman@channelchek.com

Could This Week’s Economic Data Impact November’s FOMC Meeting?

There are three economic releases investors will focus on this coming week. These will provide information on housing, manufacturing, and how the economy in each Federal Reserve District is doing (Fed’s Beige Book).

Moving out a little further on the calendar, expectations for another 75 basis point rate hike at the November 1-2 FOMC meeting are widely held. The confidence in the Fed move, even though two weeks away, can be attributed to higher-than-expected inflation reports last week and the constant pounding of the drum by Fed policymakers, saying that taming inflation will remain the FOMC’s priority.

What’s on Tap for investors:

Monday 10/17

  • 8:30 AM Empire State Manufacturing Index, will be reported. Expectations are for manufacturing to have shrank -2.5%. The Empire Manufacturing Survey gives a detailed look at how busy New York state’s manufacturing sector has been and where things are headed. Since manufacturing is a major sector of the economy, this report has a big influence on the markets. Some of the Empire State Survey sub-indexes also provide insight into commodity prices and inflation. The bond market can be sensitive to the inflation ramifications of this report. The stock market pays attention because it is the first clue on the U.S. manufacturing sector, ahead of the Philadelphia Fed’s business outlook survey.
  • 8:45 Noble Capital Markets’ Michael Kupinski, Director of Research, provides indepth report on current state and outlook of the Digital Media segment of the Media and Entertainment sector.

Tuesday 10/18

  • 10:00 AM Housing Market Index will be released. Expectations are for the number to be 44, down from 46 the prior month. The housing market index has consistently been lower than expectations, including September’s 46, which was an 8-year low. N.Y. Fed 5-year inflation expectations for one- and three-year-ahead inflation expectations had posted steep declines in August, from 6.2 percent and 3.2 percent in July to 5.7 percent and 2.8 percent, respectively. Investors will be watching to see if the declining expectations continue. The housing market index is a monthly composite that tracks home builder assessments of present and future sales as well as buyer traffic. The index is a weighted average of separate diffusion indexes: present sales of new homes, sales of new homes expected in the next six months, and traffic of prospective buyers of new homes.

  • 9:45 AM Industrial Production has three components that could impact thoughts on the economic trend. Industrial Production as a whole is expected to have risen 0.1% versus down -0.2% in the prior period. Manufacturing output is expected to have risen by 0.2%, and Capacity Utilization is expected to be unchanged at 80%.

Industrial production and capacity utilization indicate not only trends in the manufacturing sector but also whether resource utilization is strained enough to forebode inflation. Also, industrial production is an important measure of current output for the economy and helps to define turning points in the business cycle (start of recession and start of recovery).

  • Comtech Telecommunications (CMTL) with Noble Capital Markets in NYC in-person roadshow for investors. Interested parties can find out more at this link.

Wednesday 10/19

  • 7:00 AM Mortgage Applications. The composite index is expected to show a decline of -2.0% for the month. The purchase applications index measures applications at mortgage lenders. This is a leading indicator for single-family home sales and housing construction.
  • 8:30 AM Housing Starts and Permits. The consensus for starts is 1.475 million (annualized), and Permits are expected to come in at 1.550 million (annualized). Housing starts to measure the initial construction of single-family and multi-family units on a monthly basis. Data on permits provide indications of future construction. A housing start is registered at the start of the construction of a new building intended primarily as a residential building.
  • 2:00 PM, the Beige Book will be released. This report is produced roughly two weeks before the Federal Open Market Committee meeting. In it, each of the 12 Fed districts compiles anecdotal evidence on economic conditions from their districts. It is widely used in discussions at the FOMC monetary policy meetings where rate decisions are made.
  • EIA Petroleum Status Report. The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the U.S., whether produced here or abroad. The level of inventories helps determine prices for petroleum products, this has been a big focus for investors because of its implications for prices.

Thursday 10/20

  • 8:30 AM Jobless Claims for the week ending 10/15. Claims are expected to be 235 thousand. Jobless claims allow a weekly look at the strength of the job market. The fewer people filing for unemployment benefits, the more they have jobs, and that sheds light for investors on the economy. Nearly every job comes with an income that gives a household spending power. Spending greases the wheels of the economy and keeps it growing.
  • 8:30 AM Philadelphia Fed Manufacturing Index. This index has been bouncing back and forth between contraction and expansion. It’s the former that’s expected for October, where the consensus is minus 5.0.
  • 10:00 AM Existing Home Sales. The consensus is for sales to have been 4.695 million (annualized). The previous number was 4.8 million. The pace has declined every month since January.
  • 10:00 AM Leading Indicators. The consensus is for a decline of -0.3%. The index of leading economic indicators is a composite of 10 forward-looking components, including building permits, new factory orders, and unemployment claims. It attempts to predict general economic conditions six months out.
  • Engine Gaming Media (GAME) with Noble Capital Markets in St. Louis in person roadshow for investors. Interested parties can find out more at this link.
  • 10:30 AM EIA Natural Gas Report. This is a weekly report and has gotten much more attention since the war in Ukraine and gas pipeline issues that impact much of Europe. The abundance or lack of energy impacts prices not just for the consumer, but also manufacturers. This report has the ability to move markets as a result.
  • 4:30 PM Fed Balance Sheet. The Fed’s balance sheet is a weekly report presenting a consolidated balance sheet for all 12 Reserve Banks that lists factors supplying reserves into the banking system and factors absorbing reserves from the system. This report will allow investors to see how far along the Federal Reserve has gotten on its quantitative tightening program.

Friday 10/21

  • 1:00 PM Baker Hughes Rig Count. The expectation is for 985 in North America and 769 in the U.S. It’s all about potential supply; the count tracks weekly changes in the number of active operating oil & gas rigs. Rigs that are not active are not counted.

What Else

This week the Biden administration has plans to take new steps to lower gasoline prices. This includes potentially releasing more oil from the Strategic Petroleum Reserve and imposing limits on exports of energy products. The initiative comes a week after the Organization of the Petroleum Exporting Countries (OPEC) and its allies agreed to cut oil production by up to 2 million barrels per day.

Corporate earnings season starts to heat up with widely watched names that can set the market tone. Those to watch out for include: Monday – Bank of America, Charles Schwab, Goldman Sachs, Barclays, Johnson & Johnson, Lockheed Martin, IBM, Netflix, United Airlines, American Airlines, Procter & Gamble, and Tesla. Investors can also expect a key GDP release from China and a vital inflation reading from the U.K.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.investopedia.com/what-to-expect-for-the-markets-next-week-4584772

https://www.econoday.com/