We got a relative sharp decline in the stock market yesterday on very poor breadth (8 to 1 negative on the S&P 500), but volume was not very strong (just 2.4bn shares on the composite volume). However, the market closed right on its lows for the day, so that left investors around the globe uneasy last evening.
Sure, we’ve had a few days where the market has closed on/near its lows this summer. However, that hasn’t happened after the market had already declined several days in a row. So far this summer, every time the market has sold-off for a few days, it has bounced-back immediately. Yesterday, instead of bouncing back, it fell further…and the fact that it closed on the lows poured some salt on the wound…and took away some of the confidence that investors has attained over the summer.
The Fed “minutes” got most of the blame for yesterday’s decline. This makes sense given that the decline was only a very mild one until those “minutes” hit the news tape. However, if the stock market does continue to slide lower, it’s going to be hard to put all of the blame on the Fed. They have telegraphed their upcoming “taper” move for eight months, so how anybody could say that they were “shocked, shocked” to hear this news is beyond us.
No, if the market sees a correction in the weeks/months ahead, it will be for a combination of reasons (like it almost always is). The fiasco in Afghanistan is certainly not helping. No, Afghanistan is not an important global economic power, but the criticism that the Biden Administration is getting (from both sides of the political aisle and both sides of the political press) is raising concerns about their ability to get the kind of fiscal stimulus that the stock market has been pricing-in lately.
Another issue deals with the concerns that the new variants of the coronavirus will cause more curbs and lock-downs…and thus slow both economic and earnings growth in the last four months of the year. (It doesn’t help that the Biden Administration seems to be pushing this issue even harder than they otherwise would…so that they can take some attention away from Afghanistan. Of course, if you accuse the Administration of this, they yell, “How dare you!”)
However, an even more important issue in our minds is the growing concerns over stagflation. Let’s face it, as much as we worry that the Administration is pushing the pandemic issue harder than they otherwise would, it is definitely still a big problem! If these variants do cause a slowdown in growth, it will certainly have an impact on earnings for the rest of this year (and into next year). That will make it tougher to justify today’s extreme valuations.
Of course, when growth slows, it usually means that concerns over inflation will decline. However, the key word in that last sentence was “usually.” This does not always happen. Growth and inflation “usually” rise and fall together because prices “usually” rise and fall due to DEMAND issues. HOWEVER, every once in a while, prices rise due to SUPPLY issues! When THAT happens, we get stagflation.
Look at what took place in the 1970s. Oil prices shot through the roof. However, this had nothing to do with a big increase in demand (economic growth). It had to do with the decrease in the supply of oil (with OPEC’s oil embargo back then). Since oil price rose sharply even though there was not a big pickup in demand, it CAUSED growth to slow down……When a big pick in economic activity causes prices to move higher, that’s fine. (It can be described as a healthy rise in prices.) If, however, the rise is prices is caused by a slowing of supply, it is not good at all. It actually CREATES lower demand….and results in a slowdown of economic activity.
We’re seeing a similar situation right now. Instead of an oil embargo causing oil prices to rise (and thus the price of almost everything to rise) like it did in the 1970s, this time it’s pandemic and the disruptions in global supply chains that is causing a “supply-led” rise in prices.
Many experts will say that these supply chain issues will subside soon, so we won’t have to worry about a “supply-based” increase in inflation for very long. However, the supply chain problem had already remained VERY elevated for a lot longer than people thought was possible BEFORE this most recent “wave” of the pandemic hit the world. Now, with China shutting down a major portion of the third largest port in the world, the supply chain disruptions are getting worse again. Therefore, it is very hard to know when these “supply” induced price increases will subside in a significant way.
Yes, we know, we know…a lot of commodity prices are falling right now. However, due to the supply chain issues, the decline in commodity prices is not going to lower prices as much as they usually would.
Okay, we do admit that there is a lot more that goes into explaining what takes place when we go through periods of “stagflation” than the simple description we have just provided. However, it is important to distinguish between a period of time when prices rise due to rising demand…and when prices rise due to declining supply. The latter periods tend to be tough ones for stock prices.
We do agree that this “supply chain” induced rise in prices is unlikely to last as long as the oil embargo did in the 1970s. However, given how stretched valuations are right now, it won’t take a multi-year strain on the supply chain to cause a correction in the stock market. It is likely that it will merely take the realization that supply chains will remain a problem well into 2022 to create enough concerns about stagflation to cause a correction in the stock market.
We can spend a lot of time blaming the Fed, but cutting back on emergency levels of stimulus after the emergency has passed is the right thing to do! (A correction in the stock market is NOT something that falls into the definition of an emergency!) It is not the Fed’s job to keep the stock market rallying without a correction. Instead, we have to face that fact that the problems that have been caused by the pandemic are going to linger for a long time. We have to stop looking to place blame on one person or one group if the stock market does not rally in a straight line. Instead, it is important that we face the realities that exist today…and are likely to exist going forward…and adjust our investment strategy accordingly.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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