It is called army golf: Slice the drive to the right, find the ball; hook it way left, find the ball; slice it right…you get the picture. We call that playing army golf because it is just like marching in the army – left, left, left-right-left. That works marching in step with the rest of the platoon, but it is not so great on the golf course. You cover a lot of land without going anywhere.
That is where we are in the market today. Of course, in the stock market it isn’t left-right-left, it is up-down-up. Yet, for all the big moves from week to week, the truth is we are going nowhere. Actually, we are still heading up, just slowly. While the daily and weekly price movements have been dramatic, the trend is still upward.
Why all the volatility? There have been many excuses given by the media (that is their job, after all): The new omicron strain of COVID-19; the slow-down in economic growth; more supply chain fears. All of these things are real issues, but I suspect the reason is simpler than that. Most big investors are just not trading at the moment, and that leaves only fringe players making moves. This tends to exaggerate movements as there are not many people willing to take the other side of any particular trade. Historically this is where brokerage firms would step in with their proprietary trading desks, but that doesn’t happen now, so we get exaggerated moves.
Meanwhile we continue to get inflationary signals. This week we saw labor costs rising and productivity falling. There is nothing wrong with higher labor cost; that means people are making more money. However, what one wants to see is an increase in productivity, or at the very least no change in productivity – this means people are getting paid more and are making more stuff, which keeps inflation down while wages grow, which is what economists call real wage growth. Today, to the extent wages are growing, they are simply being dragged along by inflation. In fact, while workers may have a higher wage, they are losing ground to the cost of living. When wages go up and productivity goes down, we have more money chasing fewer goods…in other words, inflation.
Now that inflation is back, every other economic data point must be looked at in this light. With inflation at 6.2 percent, GDP must come in above that level in order for real growth to be taking place. Wages must grow beyond that level for anyone to actually get a real raise. This is what makes inflation so insidious. The nominal economic numbers will be inflated along with everything else, but in reality, we are going backwards.
From an investor’s perspective, inflation kills bonds and savings. Any return less than the rate of inflation is in reality a loss. Bonds can still play the role of reducing volatility in a diversified portfolio, but they will detract from the long-term return, not add to it. Savings get destroyed, since every day the actual purchasing power of one’s savings drops. Stocks are the hedge against inflation. This does not mean that there will be no volatility and stocks will just climb – that happens only in fantasies. Over time, however, corporate earnings will inflate right along with everything else. It could be real or it might be just because of inflation, but revenues will rise. This, in turn, will eventually be reflected in the stock price.
Ideally, we need policy-makers who were serious about tackling inflation. However, that would mean tightening money supply, reducing government spending, and perhaps most importantly, reforming government regulations that do little other than raise costs. We need Fed chiefs like Paul Volcker, who was nominated by Jimmy Carter. We need administrations who understand that less is more when it comes to government regulation, like Jimmy Carter, Ronald Reagan, and Bill Clinton. We need to once again allow economic reality to trump politics.
That is out of our control, however, so in the meantime we will focus on the hand we are dealt. We may be marching up and down, but the bull market is still intact, and stocks remain the best hedge against inflation.
Chuck Osborne, CFA