Regulating the Bull

This morning was that glorious first morning that when you walk outside you are met with just a bit of chill. “A hint of fall in the air”, if you will. Kids are back in school, football season has started, and Costco and Sam’s club are selling Christmas decorations. This is a great time of the year.

Historically, however, September and October are not as friendly to stock prices. The first few days of September this year have been slightly down, but there seems to be more negative news stories the past few weeks. The old saying on Wall Street is that the market climbs a wall of worry.

Well, there is currently no shortage of things to worry about. These concerns include:

  • Spread of the Delta variant
  • persistent supply chain problems
  • Federal Reserve tapering asset purchases
  • Inflation, or even the dreaded stagflation
  • Rising interest rates
  • Terrible news surrounding the pullout from Afghanistan
  • Chinese real estate defaults

Considering the S&P 500 is already up around 20% this year, this risk-off sentiment from investors over the past few days is understandable. Remember, this comes on the heels of very strong 2019 and 2020 returns. Finally, we are well past the second quarter earnings season; so earnings reports won’t be a driving force, one way or the other, for another month.

With all of these worries out there, why is the Oakworth Investment Committee still bullish on the outlook for stock prices?

Remember, the consumer controls about two thirds of all economic activity. Before the pandemic in 2020, the average savings rate for the U.S. consumer the past 10 years has hovered between 6% and 7%. As a matter of fact, the highest single monthly reading on savings rate over the past 10 years, pre-COVID, was 11.6% in December of 2012. This was the only month above 10%. Since February of 2020, the savings rate for the consumer has averaged 16.5%.

That equates to trillions of dollars that the consumer has, and they have 4 options with that built up in cash. They can:

  1. Spend it
  2. Invest it
  3. Pay off debt
  4. Save it (do nothing with it)

All of these are good for the economy. Spending it means strong corporate earnings and a strong labor market. Investing it would be okay for the economy, but good for investment prices as more demand will mean higher prices. The consumers that use it to pay off debt will then have the ability to take on more debt at some point in the future. Finally, they could leave it in checking or money market fund, and do one of the other 3 options at a later date.

Like I said, all of those are good for the economy, but option #1 would have the biggest immediate impact. The problem that we are running into is two of the concerns are restricting the ability of the consumer to spend that cash as quickly as they would like. The supply chain issues and spread of the Delta variant are preventing that cash to be spent quickly. Folks may be hesitant to travel, or that new truck is simply not on the lot to buy. That does not mean that they are not going to take the vacation or buy the truck. It just delays that spending.

COVID has clearly been awful for society as a whole! But could there be a possible small silver lining to this horrible black cloud? Think about that extra consumer cash like medicine in an IV bag. The Delta variant and supply chain problems are the “regulators or governors” that are slowing the medicine (cash). This is reducing the immediate impact, but also will allow the effect of the “medicine” to work over a longer period of time.

Imagine if the COVID and supply chain problems ended right now. How would the economy in 2021 look different? Corporate earnings, which are already very strong, would be off the charts. That would lead to even stronger market returns, GDP growth that may be 15%-20% for the year. This kind of torrid economic activity would force the Federal Reserve to quickly remove their very accommodative policies to slow an inevitable wave of inflation. That would leave 2022 and beyond facing rising interest rates, very difficult corporate earnings to compare to, and a consumer that is tapped out of that cash reserve. We may have been looking at a drop in GDP growth from 20% in 2021 to 2% in 2022. We often hear about the Fed trying to bring the economy down with a soft landing. That doesn’t sound very soft to me.

The good news is the Delta variant appears to be peaking in several parts of the country that have been hardest hit (including Oakworth Capital Banks’s footprint). As we hopefully continue to see falling cases, hospitalizations and deaths, the reopening of the economy will slowly pick up strength. The supply chain problems may be with us for longer that we may have first anticipated, but we are lucky that most truly essential items are available. We are not running out of life saving medicine, so if someone can’t get that new Chevy Silverado for another 12 months, or have to delay their kitchen remodel, we can survive that.

We do understand that the market returns of the past 3 years are not sustainable, and more normalized returns are ahead of us. As that large bag of medicine for the markets and economy is filtered down to corporate earnings over the next several quarters, our outsized conviction to remain overweight stocks relative to bonds will likely diminish some as well.  However, as long as the consumer has trillions to spend, invest, or pay off debt, we will remain bullish on stocks.

They remain the most reasonably valued of all overvalued asset classes.