While the Delta wave was still sweeping the nation, third quarter GDP grew just 2.0% according to a preliminary estimate. At first this may seem a possible cause for concern, but more recent data suggests a brighter current outlook. On the heels of a disappointing September jobs report, the employment picture improved dramatically in October. The unemployment rate fell to 4.6%. 531,000 jobs were added, more than double September’s growth, while prior month numbers were also revised upward by 235,000. The third quarter Productivity and Costs report showed hours worked up 7% and productivity down 5%, the lowest productivity reading since 1981.
There is an inverse relationship between productivity and jobs growth because a growing economy will tend to hire marginally fewer and fewer productive workers, while a contracting economy will tend to lay off the least productive workers first. Therefore, the historically low productivity reading demonstrates the halo of an improving economy extending to more and more potential workers.
Consistent with an improving economy, inflation is continuing to accelerate. October’s CPI report showed a 0.9% one-month increase. The 12-month increase was 6.2%. Last year’s report showed a 1.2% 12-month increase, meaning that on a two-year stacked basis the average rate of increase is about 3.7%.
The CPI number is being pulled higher by some volatile components that may relax, but it is also being held back by a housing (shelter) component that operates with a long lag. The Case-Shiller home price index increased 19.8% over the last twelve months. It has now increased at a 3-year annualized pace of 9.4%. When housing prices increase rapidly, as they have recently, it takes time for the increases to seep into the CPI, implying that further inflationary pressure is baked into coming statistics.
The recent Federal Open Market Committee (FOMC) meeting went largely as the market anticipated, with the Fed signaling it will finally wind down its bond buying between November and June while also confirming that it remains reluctant to increase short-term rates until late next year at the earliest. The Fed changed some of its language around inflation, no longer invoking the roundly-mocked “transitory” label. Rather, the Fed now admits inflation will persist into 2022. It blames global supply chain bottlenecks, rather than its own dovish monetary policy. The central bank’s attitude toward inflation is reminiscent of the boy who broke the window. He claims he wasn’t there; but if he was there then somebody else threw the stone; but if he threw the stone then it was an accident. The Fed is currently in the middle phase of that argument. Yes, inflation is becoming a problem, but it’s not their fault.
So what is an investor to do? Equities continue to look superior to bonds. The risk of losing 10% or even 20% during a stock market drawdown may be higher than in the bond market, but the risk of losing 10% or 20% of one’s purchasing power over the next 10 years in the bond market looks very, very high.
We would rather buy real assets like the equities we recommend in each issue of the Investor Advisory Service than paper assets like bonds, and then simply ride out the volatility. In a bubbly environment, we warn investors not to chase hot stocks and not to become too complacent with their biggest winners. The old maxim “let your winners run” is good advice -- until your winners dominate your portfolio. Then comes the time to take some profits and re-diversify your holdings with new ideas from IAS.
Reprinted from the December 2021 issue of the Investor Advisory Service. For more information, to download a sample issue, or to subscribe to the best investing newsletter in the U.S., visit Investor Advisory Service.