The Reawakening of Mr. Market? – September 10, 2021

The Reawakening of Mr. Market? – September 10, 2021
Morgan Lewis Posted on September 12, 2021

Weekly Hard Asset Insights
By David McAlvany

All of the major market indexes closed lower this last holiday-shortened week, with the selling accelerating into the close on Friday. The S&P 500 ended lower each day last week. Both the Russell 2000 small cap index and the Dow Jones Industrial Average closed the week below their 50-day moving averages. Gold and the entire precious metals complex were significantly lower, reversing last week’s gains. Not all commodities suffered the same fate, however. Copper, aluminum, nickel, zinc, oil, and natural gas all gained.

The Federal Reserve’s “transitory” inflation thesis took another hit this week. According to the US Labor Department, the August headline Producer Price Index rose 0.7% month-over-month vs. the 0.6% expected by economists. On a year-over-year basis, the increase in PPI has now reached a rather jaw dropping 8.3%. This latest number represents the strongest annual increase in producer prices since November of 2010 when the data series was first initiated. Core PPI, excluding the more volatile items of food and energy, also rose faster than expected with a 0.6% M/M gain translating to a 6.7% Y/Y increase. This was the 9th consecutive month of core PPI price increases.

Interestingly, prices for intermediate demand goods are still outpacing price increases in final demand goods, indicating that higher prices may continue flowing through to final products in the months ahead. The ongoing surge in the input prices producers must pay is very likely to eventually have significant negative impacts on businesses. If high producer prices continue, this fly in the corporate ointment will manifest one way or another. If businesses fully pass these high prices on to the consumer, they threaten to materially weaken sales volume and revenues. If businesses don’t increase their final product costs, they may protect sales numbers, but only at the expense of profit margins. In either instance, company stock prices and corporate valuation multiples would likely face increasing pressure.

One of the primary arguments made by the Federal Reserve and other market observers for minimizing inflation concerns as “transitory” has been the expectation that supply chain bottlenecks and goods shortages would quickly resolve themselves as the world emerges from the worst of the Covid-19 pandemic. Despite these expectations, recent reports sing a different tune as the chaos that has become the commercial shipping sector continues to worsen.

According to data from Hackett Associates and the National Retail Association, US ports handled 2.37 million imported shipping containers in August, which is the most since records were first kept in 2002. At the same time, the most recent figures from the Marine Exchange of Southern California indicate that the number of anchored container ships waiting to offload cargo at the ports of L.A. and Long Beach in California have been climbing once again. In fact, the number of cued vessels has now surpassed the previous record number set back in early February at what was hoped to be the peak of supply chain disarray. 

As the wait times for the bloated number of vessels to offload cargo continue to rise, so, too, do the total costs of commercial shipping. The port congestion is also growing along the East Coast, with anchorage numbers and wait times increasing from Georgia to New York. Meanwhile, labor shortages at ports are significantly contributing to the congestion, wait times, and resulting sky-high shipping rates. All of these factors are feeding directly into broad inflation pressures. 

The bottom line of this story is the erosion to corporate bottom lines as the increasingly excessive cost of doing business proves stubbornly persistent and non-transitory. At the moment, the optimistic prospects for a quick fix are looking dim. According to the Wall Street Journal’s Paul Berger, port managers are suggesting the supply chain issues will likely extend beyond the summer of 2022. The longer these issues remain, the greater the accumulated corporate strain.

Adding to inflation and corporate cost concerns was the July Job Openings and Labor Turnover Survey (JOLTS) report out on Wednesday. The Labor Department survey reported that labor demand, as measured by the number of job openings, surged to a record 10.9 million openings. That is the highest level since the series began in the year 2000. In light of the strong JOLTS data, last week’s poor August non-farm payroll numbers carry new implications. If the weak non-farm payroll numbers were not about businesses’ lack of demand for workers, but rather were disproportionately the result of employers’ inability to find and attract workers to fill needed positions, the clear implication is future wage inflation. Unless the cessation last week of enhanced unemployment benefits dramatically changes the attitude of the American worker, businesses in need of labor will have to start paying more to get it. If a wage inflation spiral begins, that could add significant fuel to the inflation fire and further concerns for corporate costs and profit margins.

The confluence of ongoing cost pressures threatening to hurt corporate profits and an economy seemingly decelerating past peak growth presages stagflation. Meanwhile, potential downstream global implications abound from a credit slowdown and widespread speculative crackdown in China. At the same time, markets must digest a Federal Reserve that stands poised to taper asset purchases. All of these factors are good reasons for market volatility and uneasiness. In recent weeks, major Wall Street banks have been growing ever more cautious on stocks and what they see as increasingly vulnerable market indexes. Bank of America, Morgan Stanley, Citigroup, Deutsche Bank, and Goldman Sachs have all recently expressed various combinations of concern for growth, corporate margins, and excessively stretched valuations.

In recent weeks, we have started to see companies come out with revised outlooks that reflect more of these hard-to-ignore challenges facing the corporate universe. Major US liquor company Brown-Forman cut its financial outlook on expectations of “volatile” results as “more significant” supply chain disruptions crimp margins in 2022. In addition, on Tuesday, paint and chemical goliath PPG withdrew its 2021 guidance due to supply-chain disruptions and high raw-material costs that are weighing on sales and profits. According to PPG, “…sales volumes are being impacted by the increasing disruptions in commodity supplies, further reductions in customer production due to certain parts shortages such as semiconductor chips, and continuing logistics and transportation challenges in many regions…” (For full disclosure purposes: Neither Brown-Forman nor PPG are MWM holdings.)

With regard to the broad market and asset prices, let’s not underappreciate the valuations component. All of the market-relevant factors above rest upon a precarious foundation of record high valuations. Investing legend Jeremy Grantham of investment firm GMO describes companies as being currently overvalued by every measure. In a recent interview, Grantham stated that, “With room to spare…this is the craziest market that anyone, including me, has ever lived through…. We have more potential to mark down asset prices than we have ever had in history anywhere.” Grantham’s view also squares with an observation made earlier this week by renowned investor Leon Cooperman in a CNBC interview. Discussing the current instability of the markets, Cooperman said, “When the market goes down, it’ll move so fast your head will spin.” Taken together Grantham and Cooperman do a fine job of describing the underlying risk in this market that asset allocators must navigate.

Are these record valuations justified? Or are these valuations a reflection of market risk that has been discounted to zero by sustained heavy doses of global central bank liquidity and near zero interest rate policies? The New York City-based Council on Foreign Relations tracks global monetary policy. According to their tracker, as of Friday, all major central banks, with the exception of the People’s Bank of China, continue to administer quantitative easing policies. By their score, the degree of global easing is steady at a “near-record” level, and the score has been maintained at this level or higher since March of 2020. Prior to the 2020 Covid outbreak, the level of global easing had not been as high for over a decade. With the Fed tentatively set to taper asset purchases soon, we may find out just how dependent record-high asset prices are on the sea of global liquidity. 

Economist Ludwig Von Mises wrote extensively on the fundamentally unhealthy impact, especially over time, that a government policy of interventionism has when imposed to subvert free-market phenomena. Mises states that “…the interventionist…cannot help nullifying the very existence of economics. Nothing is left of economics if one denies the law of the market.” Implied in the observations of both Grantham and Cooperman is an ongoing belief in the continued existence of the law of the market. Perhaps, as governments and central banks reduce the extent of market intervention, we all may become more acquainted with the real “Mr. Market.”

As for weekly performance: The S&P 500 closed the week down 1.69%. Gold was off by 2.27% while silver lost 3.63% on the week. Platinum dropped 6.37% while palladium was crushed to the tune of 12.00%. The HUI gold miners index fell 5.77%. The IFRA iShares US Infrastructure ETF was down 2.67% for the week. Energy commodities were higher. WTI Crude Oil gained 0.62%. Natural gas rallied again by 4.88% on the week. The CRB Commodity Index was up 0.15%, while copper was higher by 2.68%. The Dow Jones US Real Estate Index ended the week down 2.72%, while the Dow Jones Utility Average Index lost 1.67%. The dollar was bid higher this week, gaining 0.61% to close the week at 92.59. The yield on the 10-year Treasury gained 2 bps to close the week at 1.35%.

Best Regards,

David McAlvany
Chief Executive Officer

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