I ain’t happy, I’m feeling glad
Song: Clint Eastwood by the Gorillaz
I got sunshine in a bag
I’m useless but not for long
The future is coming on
It’s coming on, it’s coming on
Source: Musicmatch
Songwriters: Damon Albarn / Jamie Hewlett / Earl Daley / Brown Huford Benjamin
I ain’t happy… the stock market is all stormy
I’m feeling glad… bargains to be had
I got sunshine in my bag… I got growth companies in my bag
I’m useless but not for long… I’m useless but my companies ain’t wrong
The future is coming on… the earnings are coming on
It’s coming on, it’s coming on…. earnings are coming on, they’re coming on
“I ain’t happy”.
Two weeks ago, the U.S. Central Bank, or Federal Open Market Committee (FOMC), announced that the Bank will accelerate the reduction in economic stimulus it has been injecting into the U.S. economy and begin raising interest rates in the New Year.
This will begin in January with the purchasing of $60 billion of bonds per month down from the $90 billion it will have purchased in December and will look to end the bond purchasing program by March next year, unless the economic outlook changes.
This is ahead of increasing the short-term interest rate to help tame inflation.
The Fed officials also stated it anticipates as many as three interest rate increases in 2022, two in 2023 and two more in 2024.
“I ain’t happy”.
The Bank also increased its inflation outlook for the year for all items to 5.3%, up from 4.2% in September.
Looking to 2022, the Bank expects headline inflation to reach 2.7%.
“I ain’t happy”.
Lastly, the Fed now expects GDP to grow 5.5% in 2021, compared to their previous projection of 5.9% projection but did increase its GDP prediction for 2022 to 4%, up from 3.8%.
“I ain’t happy, I’m feeling glad
I got sunshine in a bag”.
In the UK, two weeks ago, The Bank of England, raised interest rates for the first time since the onset of the pandemic, increasing to 0.25% from its historic low of 0.1% as inflation pressures mount.
U.K. inflation hit a 10-year high in November as the Consumer Price Index rose by an annual 5.1%, up from 4.2% in October and well above the central bank’s target of 2%.
“I ain’t happy”.
In Europe, whilst inflation in November hit a high of 4.9%, the European Central Bank decided to leave interest rates unchanged. It will also keep its Pandemic Emergency Purchase Programme in effect through March 2022.
Germany’s economy is also decelerating. The Institute for Economic Research expects Europe’s largest economy will contract 0.5% in the fourth quarter and is on the brink of recession.
“I ain’t happy”.
Further the bank said it would maintain its key interest rate at negative 0.5% until it ends its bond purchasing.
I would add that China’s economy is also slowing down. Retail sales in November were disappointingly only up 3.9%, missing expectations for 4.6% growth.
It would seem that other than the European, the world’s central banks are moving to rein in inflation (interest rates rises), leaving many investors wondering what 2022 will bring for the markets.
“I’m feeling glad”.
In the U.S. according to a survey conducted in November, there were approximately 11 million available jobs in the United States, compared to 6.9 million unemployed people actively looking for work.
Unemployment for 2021 fell to 4.3% in September, with the committee saying, “Job gains have been solid in recent months, and the unemployment rate has declined substantially.”
There are plenty of opportunities for Americans looking for work or looking for a job change. It’s also great time to negotiate higher wages. Indeed, a recent survey by the Conference Board found that U.S. companies are setting aside an average of an extra 3.9% of total employment costs for wage increases in 2022.
Retail spending has been strong with analysts expecting U.S. November-January retail sales jumping by approximately 10% from a year ago, bringing the total to as much as $850 billion or more. (Wall Street Journal).
Finally, household finances are also in solid shape. In a recent poll conducted by the Associated Press, 64% of respondents described their finances as good.
Many households saved and paid down debt over the course of the pandemic, and total U.S. household net worth was up to $2.4 trillion by the end of the third quarter to $144.7 trillion. (Federal Reserve)
By these fundamental measures, the economy appears to be in great shape.
Many would appear to be “feeling bad”.
According to the American Association of Individual Investors (AAII), the past month indicates more bearish investors than bullish ones when looking out at the next six months.
But “I’m feeling glad”.
The U.S. economy is largely in strong shape, but most people are unhappy about it.
What started as a year of investor and consumer enthusiasm for an economic boom has largely faded into a broad feeling of concern and disappointment – perhaps frustration with supply chain issues, shortages, Covid still being with us (Omicron) and more restrictions then topped off with interest rates rises or indications of.
There were frothy signs a few months ago, the SPAC boom, retail investors pouring into “meme stocks” and cryptocurrencies, etc. and all have lost their lustre, with sentiment turning negative.
Taken together, I believe that means we have a very unloved economic recovery/expansion and stock market, which is usually good news for shares.
“I’m feeling glad”.
Inflation is the bogeyman and forced the interest rate dilemma.
“I ain’t happy”.
But I think the inflation backdrop will slow in 2022.
1. Supply chains are improving
A large driver of inflation in 2021 has been supply chain constraints brought on by the Covid-19 pandemic. However, global manufacturing activity has vastly improved over the last few months. This will continue and persist in 2022 leading to a more normal supply chain. That will remove one of the biggest inflationary pressures from the global economy next year.
2. Comparables are getting easier
Throughout 2021, inflation has been running high on a year on year basis, but we need to remember, the comparable periods have exaggerated the reported numbers. Throughout 2020, inflation was averaging below 2%.
However, starting in the second quarter of 2022, inflation will be compared against the 4% plus inflation numbers we’ve seen throughout 2021.
It is much harder for the media to put up big headline numbers against 4%, 5%, and 6% inflation comparables than it is to do it on the 2020 2% inflation comparables. (More on the media later)
These tougher comparisons will naturally suppress headline inflation in 2022.
3. Automation
With many companies escalating automation these new automation deployments start to yield deflationary effects.
According to a recent Deloitte survey, around 73% of companies have embarked on a path toward intelligent automation – a stunning 58% jump from the number reported in the 2019 survey.
What about Covid or Omicron?
I side with Bill Gates. Bill Gates says: the worst part of the pandemic will end in 2022.
This, despite appearances, is not bad news, because the worst is not ahead. The worst, according to Gates, is happening right now, and over the course of 2022, the pandemic will begin to gradually let up.
“I ain’t happy, I’m feeling glad”.
Gates predicts that in 2022, the pandemic will begin to moderate and the world will slowly return to normal, although some of our habits will change irrevocably. For example, the awareness of the dangers of large gatherings of people will remain. Sanitation habits will also remain.
So, “I’m feeling glad” because “bargains are to be had”.
“Be greedy when others are fearful.” – Warren Buffett.
“I’m useless – but not for long”.
The doomsters and the recent fall in share prices suggest increased and increasing interest rates are bad for equities or share prices.
Why?
Investment experts and the financial media obsess about interest rates because the theoretical value of a share is equal to the net present value of a company’s future cash flows or profits into perpetuity. That net present value requires a discount rate, typically the long dated Government bond (interest rate expectations).
The reasoning being that an investor should be compensated for the additional risk investing in a company (shares) has versus investing in something ultra-safe like a government bond. This is the Capital Asset Pricing model.
The higher that interest rate, the higher the discount rate used in valuation models, and the lower the value of a growth share today.
That’s why particularly growth shares have been recently under immense pressure.
Nasdaq, is the growth company index, with constituents such as Apple, Microsoft, Amazon, Tesla, and Alphabet. It is down over 5.5% since mid-November.
The reality is that this has been a year of on and off, “will they, won’t they” raising rates to combat inflation. That has been the fear, the uncertainty, and stock market investors hate uncertainty.
That has passed or, or will pass soon. Most investors will adjust their valuation arithmetic in more confident knowledge of the future interest rate outlook and conclude that gradual 25-basis-point increases in the fed funds target rate don’t actually impact valuations all that much.
Meanwhile, the fact that rates are rising means the economy is doing well, which should mean that growth companies are growing their sales and earnings more quickly.
Net-net, when it comes to growth shares during rate-hike cycles, faster sales, and earnings, growth more than offsets valuation compression, and they end up going higher.
But historically they underperform heading into a rising interest rate cycle.
Growth (Nasdaq) has underperformed the broader market (S&P500). Plus 23% plays S&P up 27.7% year to date.
Still, both had great years. “I’m feeling glad”.
History tells us that once that rate cycle does get started, growth shares will re emerge and outperform.
“I’m useless – but not for long”.
So, despite everyone telling you that growth shares should struggle in 2022 because of increasing interest rates, the best thing you can do right now is to actually buy growth shares.
By the way, unlike 2021, every company in the S&P 500 is projected to make money in 2022.
They’re due for a great 2022. UBS Global Wealth Management expects the S&P 500 to jump 12% next year as corporate profits continue to grow.
Lastly, here is my New Year tip.
Don’t take everything written in the media as gospel. The media and particularly the financial media are biased.
Sensational stories form about 95% of media headlines (The Guardian).
In one survey, 65% of respondents said that most media outlets would ignore mistakes, engage in cover-ups, and purposefully misinform just to capture readership (New York Times).
We are drawn to negative stories. Kinder estimates bad news headlines attract 30% more reader attention.
A Yale University research piece found the media is more likely to cover company earnings announcements if they report poor results.
They estimate the bias in media coverage of a news story to be approximately 22 percent more likely if it is negative.
The media has an important role in investor behavior and it would seem it is negatively biased.
At TEAM we have “sunshine in [our] bag”… “I got growth companies in my bag.”
The future is coming on… “the earnings are coming on.”
It’s coming on, it’s coming on… “earnings coming on, they’re coming on.”
Stay safe and rock (and roll) on 2022.
Stay positive, stick to the facts and hard data. Be selective.
At TEAM, we will continue to adhere to the investment principles that have guided successful risk-adjusted returns for our clients for many years. The typical company in our equity portfolio garners strong brand value amongst consumers of its product or service, boasts an exceptional track record of execution, is innovative, embraces technology and can maintain pricing power through cycles.
These characteristics place our TEAM INTERNATIONAL EQUITY fund on a firm footing as we enter 2022 and the potential range of challenges that lie ahead.
Happy New Year.
Mark Clubb
Chairman
TEAM Jersey