Connect with us

Spread & Containment

The Odds Are Stacked Against Investors In A Post-COVID Economy

The Odds Are Stacked Against Investors In A Post-COVID Economy

Published

on

The Odds Are Stacked Against Investors In A Post-COVID Economy Tyler Durden Mon, 07/20/2020 - 10:20

Authored by Lance Roberts via RealInvestmentAdvice.com,

Since the March 23rd lows, retail investors have jumped into the equity market with little concern about the potential risk. The “Pavlovian” response to the Fed’s massive monetary interventions has pushed “risk-taking” to extremes. Unfortunately, the odds are stacked against investors in a post-COVID economy.

In a recent newsletter, we discussed our process of “taking profits” in positions that had reached more extreme overbought conditions. As is usual in a market where “momentum” is in vogue, we received numerous emails about the “folly” of selling our technology holdings.

It Isn’t Folly.

It is a usual practice of mitigating risk to protect capital for our long-term investment cycle. Interestingly, while there is little doubt that patience is a virtue for investors, exercising prudence is equally important. Despite the basic math, and historical evidence proving its usefulness, investors typically ignore prudence, especially when it is required most. The “siren’s song” of a momentum-driven market fueled by a “speculative greed” is inevitably too compelling for many investors.

Such is particularly notable in the Nasdaq where several signals from option speculation to a buying climax last week. As noted by SentimenTrader:

“The reversal in the Nasdaq 100 coincided with the 2nd-largest number of buying climaxes in those stocks. Only early 2018 had more.”

However, for investors, there is a more significant concern longer-term. On the heels of the first quarter’s GDP release, it is clear the economy has slid into a recession. That recession will worsen markedly when we begin to see the second-quarter results here soon. What investors haven’t fully grasped is the corresponding relationship between the economy and corporate profits.

The Relationship

“There is currently a ‘Great Divide’ happening between the near ‘depressionary’ economy versus a surging bull market in equities. Given the relationship between the two, they both can’t be right.” – RIA

Throughout history, there has been, and remains, a close relationship between the economy, earnings, and asset prices over time. The chart below compares the three going back to 1947 with an estimate for 2020 using the latest data points.

Since 1947, earnings per share have grown at 6.21% annually, while the economy expanded by 6.47% annually. That close relationship in growth rates should be logical, particularly given the significant role that consumer spending has in the GDP equation.

The Consumption Function

While stock prices can deviate from immediate activity, reversions to actual economic growth eventually occur. Such is because corporate earnings are a function of consumptive spending, corporate investments, imports, and exports. 

Unsurprisingly, there is a precise correlation between PCE and GDP. If consumption contracts due to high levels of unemployment, then economic growth declines.

However, when it comes to investing, exports are a critical factor. Exports comprise roughly 40% of corporate profits, and also have a high correlation to consumption and related economic activity.

It should be evident that corporate earnings and profits correlate highly with economic activity. While Business Investment and Government Spending do have an input into the economy, consumption ultimately drives profits.

A Post-COVID Economic Recovery

While I have addressed these points above previously, they are an essential context for where we are in the current market and economic cycle.

Investors are currently under the assumption the economy will make a “V-shaped” recovery and return to pre-pandemic levels. Given the surge in debts and deficits, a continuing demographic shift, and the lag of employment recovery, it is unlikely such an optimistic recovery will be possible in the short-term.

Furthermore, we have experience with post-crisis recoveries. Before the “Financial Crisis,” the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.

Given the “COVID-19” crisis led to a debt surge to new highs, such will retard future economic growth to 1.5% or less. As discussed recently, while the stock market may rise due to massive Fed liquidity, only 10% of the population owning 88% of the market will benefit. However, for corporate earnings and profits to fully recover, it requires 100% of the economy to participate.

Importantly, as noted above, the economy has not and will not grow at an annualized pace of 6.47%. As such, lower returns from the market long-term due to the inherent relationship between the market and the economy, will plague investors.

Stock Prices & The Economy

As stated, the stock market often detaches from underlying economic activity over short-term periods as investor psychology latches onto the belief “this time is different.” 

Unfortunately, it never is.

While not as precise, a correlation between economic activity and the rise and fall of equity prices does remain. In 2000, and again in 2008, as economic growth declined, corporate earnings contracted by 54% and 88%, respectively. Such was despite calls of never-ending earnings growth before both previous contractions.

As earnings disappointed, stock prices adjusted by nearly 50% to realign valuations with both weaker earnings and slower earnings growth. While the stock market is again detached from reality, looking at past earnings contractions, suggests it won’t be the case for long.

The relationship becomes more evident when looking at the annual change in stock prices relative to the yearly GDP change.

Again, since the “psychology” of market participants drives prices, there can be periods where markets become detached from fundamentals. However, there is no point in previous history, where the fundamentals catch up with stock prices.

The Future Of Low(er) Returns

It is critical to remember the stock market is NOT the economy. The stock market should be reflective of underlying economic growth, which drives actual revenue growth. However, when investors pay more than $1 for a $1 worth of profits, there is an eventual reversal of those excesses.

The correlation is more evident when looking at the market versus the ratio of corporate profits to GDP. Again, since corporate profits are ultimately a function of economic growth, the correlation is not unexpected.  Hence, neither should the impending reversion in both series.

To this point, it has seemed to be a simple formula that as long as the Fed remains active in supporting asset prices, the deviation between fundamentals and fantasy doesn’t matter. It has been a hard point to argue.

However, what has started, and has yet to complete, is the historical “mean reversion” process which has always followed bull markets. Such should not be a surprise to anyone, as asset prices eventually reflect the underlying reality of corporate profitability.

Valuations

Equity valuations are higher than average by many measures, as shown in the table. Currently, the median is in the 88th percentile, and rate measures are in the 81st percentile. Only multiples from the 2000 and 2008 bubble periods were comparable to today.

Jill Mislinki, via Advisor Perspectives, also produced a similar chart of valuation measures, which shows the same thing in graphical form. The chart below shows two valuation ratios (P/E and Q) adjusted to their geometric mean rather than their arithmetic mean. Unsurprisingly, the range of overvaluation would be from 88% to 157%, up from last month’s 77% to 141%.

Suggesting that equities are at lofty valuations and prices is not an overstatement. Historically speaking, future returns from such valuations have been low and in line with slower economic growth. While in the short-term prices can certainly deviate from valuations and economic growth, as shown, they tend not to stay that way.

By nearly any metric, stocks are extremely expensive. There are limits to pulling forward “future growth.”

Summary

This article provides more supporting evidence that the odds are stacked against equity investors. That does not mean the market cannot go higher and exhibit even greater speculative fervor.

However, as fiduciaries, we must consider the long-term benefit of limiting drawdowns, especially when there is historical reason to believe they could be extreme. While it is not easy going against popular wisdom, we recommend exercising prudence and taking some chips off the table as we did this past week.

Besides, if you take profits, and rebalance risk, what is the worst that could happen?

Read More

Continue Reading

Government

Federal Food Stamps Program Hits Record Costs In 2022

Federal Food Stamps Program Hits Record Costs In 2022

In early January, The Wall Street Journal Editorial Board warned that one peril of a…

Published

on

Federal Food Stamps Program Hits Record Costs In 2022

In early January, The Wall Street Journal Editorial Board warned that one peril of a large administrative state is the mischief agencies can get up to when no one is watching.

Specifically, they highlight the overreach of the Agriculture Department, which expanded food-stamp benefits by evading the process for determining benefits and end-running Congressional review.

Exhibit A in the over-reach is the fact that the cost of the federal food stamps program known as the Supplemental Nutrition Assistance Program (SNAP) increased to a record $119.5 billion in 2022, according to data released by the U.S. Department of Agriculture...

Food Stamp costs have literally exploded from $60.3 billion in 2019, the last year before the pandemic, to the record-setting $119.5 billion in 2022.

In 2019, the average monthly per person benefit was $129.83 in 2019, according to the U.S. Department of Agriculture. That increased by 78 percent to $230.88 in 2022.

Even more intriguing is the fact that the number of participants had increased from 35.7 million in 2019 to 41.2 million in 2022...

All of which is a little odd - the number of people on food stamps remains at record highs while the post-COVID-lockdown employment picture has improved dramatically...

Source: Bloomberg

If any of this surprises you, it really shouldn't given that 'you, the people' voted for the welfare state. However, as WSJ chided: "abuse of process doesn’t get much clearer than that."

In its first review of USDA, the GAO skewered Agriculture’s process for having violated the Congressional Review Act, noting that the “2021 [Thrifty Food Plan] meets the definition of a rule under the [Congressional Review Act] and no CRA exception applies. Therefore, the 2021 TFP is subject to the requirement that it be submitted to Congress.” GAO’s second report says “officials made this update without key project management and quality assurance practices in place.”

Abuse of process doesn’t get much clearer than that. The GAO review won’t unwind the increase, which requires action by the USDA. But the GAO report should resonate with taxpayers who don’t like to see the politicization of a process meant to provide nutrition to those in need, not act as a vehicle for partisan agency staffers to impose their agenda without Congressional approval.

All of this undermines transparency and accountability for a program that provided food stamps to some 41 million people in 2021. The Biden Administration is using the cover of the pandemic to expand the entitlement state beyond what Congress authorized.

The question now is, will House Republicans draw attention to this lawlessness and use their power of the purse to stop it to the extent possible with a Democratic Senate.

And don't forget, the US economy is "strong as hell."

Tyler Durden Sat, 01/28/2023 - 09:55

Read More

Continue Reading

Spread & Containment

A Royal Caribbean Cruise Line Adult Favorite Has Not Come Back

The cruise line has almost fully returned to normal after the covid pandemic, but one very popular activity hasn’t been brought back.

Published

on

The cruise line has almost fully returned to normal after the covid pandemic, but one very popular activity hasn't been brought back.

In the early days of Royal Caribbean Group's (RCL) - Get Free Report return from its 15-month covid pandemic shutdown, cruising looked a lot different. Ships sailed with limited capacities, masks were required in most indoor areas, and social distancing was a thing.

Keeping people six feet apart made certain aspects of taking a cruise impossible. Some were made easier by the lower passenger counts. For example, all Royal Caribbean Windjammer buffets required reservations to keep the crowds down, but in practice that system was generally not needed because capacities were never reached.

Dance parties and nightclub-style events had to be held on the pool decks or in larger spaces, and shows in the big theaters left open seats between parties traveling together. In most cases, accommodations were made and events more or less happened in a sort of normal fashion.

A few very popular events were not possible, however, in an environment where keeping six feet between passengers was a goal. Two of those events -- the first night balloon drop and the adult "Crazy Quest" game show -- simply did not work with social-distancing requirements.

One of those popular events has now made its comeback while the second appears to still be missing (aside from a few one-off appearances).

TheStreet

The Quest Is Still Mostly Missing

In late November, Royal Caribbean's adult scavenger hunt, "The Quest," (sometimes known as "Crazy Quest") began appearing on select sailings. And at the time it appeared like it was coming back across the fleet: A number of people posted about the return of the interactive adult game show in an unofficial Royal Caribbean Facebook group.

It first appeared during a Wonder of the Seas transatlantic sailing.

Since, then its appearances continue to be spotty and it has not returned on a fleetwide basis. This might not be due to any covid-related issues directly, but covid may play a role.

On some ships, Studio B, which hosts "The Quest," has been used for show rehearsals. That has been more of an issue with the trouble Royal Caribbean has had in getting new crew members onboard. And while that staffing issue has been improving, some shows may not have had full complements of performers, so using the space for rehearsal has been a continuing need.

In addition, while covid rules have gone away, covid has not, and ill cast members may force the need for more rehearsals.

Royal Caribbean has not publicly commented on when (or whether) "The Quest" will make a full comeback

Royal Caribbean Balloon Drops Are Back   

Before the pandemic, Royal Caribbean kicked off many of its cruises with a balloon drop on the Royal Promenade. That went away because it forced people to cluster as music was performed and, at midnight, balloons fell from the ceiling.

Now, the cruise line has brought back the balloon drop, albeit with a twist. The drop itself is appearing on activity schedules for upcoming Royal Caribbean cruises. Immediately after it, however, the cruise line has added something new: "The Big Recycle Balloon Pickup."

Most of the dropped balloons get popped during the drop. Previously, crewmembers picked up the used balloons. Now, the cruise line has made it a "fun" passenger activity.

"Get environmentally friendly as you help us gather our 100% biodegradable balloons in recycle baskets," the cruise line shared in its app. 

Read More

Continue Reading

Spread & Containment

What’s Still Missing on Royal Caribbean Cruises Post Covid

The cruise line has almost fully returned to normal after the covid pandemic, but one very popular activity hasn’t been brought back.

Published

on

The cruise line has almost fully returned to normal after the covid pandemic, but one very popular activity hasn't been brought back.

In the early days of Royal Caribbean Group's (RCL) - Get Free Report return from its 15-month covid pandemic shutdown, cruising looked a lot different. Ships sailed with limited capacities, masks were required in most indoor areas, and social distancing was a thing.

Keeping people six feet apart made certain aspects of taking a cruise impossible. Some were made easier by the lower passenger counts. For example, all Royal Caribbean Windjammer buffets required reservations to keep the crowds down, but in practice that system was generally not needed because capacities were never reached.

Dance parties and nightclub-style events had to be held on the pool decks or in larger spaces, and shows in the big theaters left open seats between parties traveling together. In most cases, accommodations were made and events more or less happened in a sort of normal fashion.

A few very popular events were not possible, however, in an environment where keeping six feet between passengers was a goal. Two of those events -- the first night balloon drop and the adult "Crazy Quest" game show -- simply did not work with social-distancing requirements.

One of those popular events has now made its comeback while the second appears to still be missing (aside from a few one-off appearances).

TheStreet

The Quest Is Still Mostly Missing

In late November, Royal Caribbean's adult scavenger hunt, "The Quest," (sometimes known as "Crazy Quest") began appearing on select sailings. And at the time it appeared like it was coming back across the fleet: A number of people posted about the return of the interactive adult game show in an unofficial Royal Caribbean Facebook group.

It first appeared during a Wonder of the Seas transatlantic sailing.

Since, then its appearances continue to be spotty and it has not returned on a fleetwide basis. This might not be due to any covid-related issues directly, but covid may play a role.

On some ships, Studio B, which hosts "The Quest," has been used for show rehearsals. That has been more of an issue with the trouble Royal Caribbean has had in getting new crew members onboard. And while that staffing issue has been improving, some shows may not have had full complements of performers, so using the space for rehearsal has been a continuing need.

In addition, while covid rules have gone away, covid has not, and ill cast members may force the need for more rehearsals.

Royal Caribbean has not publicly commented on when (or whether) "The Quest" will make a full comeback

Royal Caribbean Balloon Drops Are Back   

Before the pandemic, Royal Caribbean kicked off many of its cruises with a balloon drop on the Royal Promenade. That went away because it forced people to cluster as music was performed and, at midnight, balloons fell from the ceiling.

Now, the cruise line has brought back the balloon drop, albeit with a twist. The drop itself is appearing on activity schedules for upcoming Royal Caribbean cruises. Immediately after it, however, the cruise line has added something new: "The Big Recycle Balloon Pickup."

Most of the dropped balloons get popped during the drop. Previously, crewmembers picked up the used balloons. Now, the cruise line has made it a "fun" passenger activity.

"Get environmentally friendly as you help us gather our 100% biodegradable balloons in recycle baskets," the cruise line shared in its app. 

Read More

Continue Reading

Trending