“The international intermodal supply chain continues to experience congestion related to high demand and constrained capacity, particularly drayage and warehouse operations in major markets” - Union Pacific Operations – July 1, 2021
Overview
We are in very interesting times. Some large and very well-respected investment houses will tell you that we are still in a recession. They point to metrics like unemployment numbers, slowing vaccination rates, “underemployment”, and other dubious figures to justify their recession thesis. These views are put forth during the current period of record high housing prices, stock markets that have exceeded their pre-pandemic highs, commodity prices either back to or exceeding those reached last year, and generally broad pent-up demand across much of our economy.
This comment from Lazard in their July 2021 outlook is typical, “With the US economy still in recession, our analysts are closely watching job growth”. Personally (and we try to keep personal commentary to a minimum), I am very confused as to what metrics some analysts are using to come to the conclusion that we are still in a recession. Normally, two consecutive quarters of GDP contraction constitutes a recession. While we experienced a decline in GPD for 2020 of 2.2%, this is, as they say history. The Congressional Budget Office recently doubled (yes doubled) its forecast for U.S. economic growth in fiscal 2021 to 7.4%, and first quarter’s GDP was reported 11% GDP at an annual rate. These numbers are far from what most would call recessionary. To say we are in a recession by pointing to unemployment numbers seems painfully shortsighted and could be construed as irresponsible in the context of investment counseling.
Yes, there are still pockets of COVID economic hangover and this is to be expected. As mentioned last quarter, specific areas like leisure, travel, hospitality and in-person retail have been slow to recover. But, if we look at personal savings rates (or consumer balance sheets), GDP growth, and incentives employers are giving out to lure employees back to work, we are clearly in an expansionary environment that should support continued growth.
Economic Commentary
Accurate projections from economists on where the economy may be headed with any certainty has proven time and time again to be nearly impossible. In the short-term this group is routinely wrong. Recent projections by economists regarding a recovery in the job market, new job growth and where we are headed post-pandemic would have us believing we will be in a permanent recession. To the contrary, the recovery in job growth and the economy has been swift. The Bureau of Labor Statistics (BLS) compiles employment numbers into the JOLTS report (Job Openings and Labor Turnover). This may come as a surprise given the current media reports, but available job openings have never been higher. We believe the most accurate measure of employment (which ties directly to the real economy) is the number of current unfilled job openings. The unemployment rate, as is most often cited when talking about the labor market, can be very misleading and prone to inaccuracies. Plus, government stimulus and unemployment benefits have increased many hourly workers income to levels above when they were fully employed, thus suppressing employment.
So, who are we to believe when trying to find accurate economic indicators when making investment decisions? Do we believe media reports that seem to constantly cite an “elevated” level of unemployment and a reported one million plus people still unable to find work after the pandemic? Or, do we believe the data driven JOLTS report and our own experience of traveling through airports that are packed with people and when finally arriving at a destination, hotels that are virtually at 100% capacity? These facts, coupled with elevated home prices and equity markets, strong consumer balance sheets and pent-up demand tells us that we are not in a recession. Far from it.
Now, are there potential downside risks to the economy? Of course the answer is yes. Many point to extraordinary stimulus measures during the pandemic that have artificially pumped hundreds of billions into the economy, which has in turn pushed up asset prices as a “real risk”. This seems to be a distraction from more relevant issues. The important figure that is being ignored in this discussion is cash on consumer balance sheets. Much of the stimulus that was distributed has not been spent; it is sitting in consumer’s bank accounts. So, even disregarding both elevated housing and stock prices consumers have never been better off than right now. While we can point to the potential of rising rates and inflation as potential roadblocks to longer-lasting economic recovery, they may only act to dampen a multi-year boom in consumer and business spending. The chart below shows us how much cash has piled up with consumers and is sitting at the nations banks (note, the chart below looks very similar to the job openings chart above).
In 2020, we experienced an unprecedented shutdown of our economy and now that lockdowns have virtually been eliminated, how growth plays out from here will be important. Will we have a durable and even recovery, or will we be coming down off of a stimulus-induced spike going into 2022? We believe growth will moderate, but a coordinated economic recovery among most developed economies has become the consensus view as consumers venture out and drive spending growth. This scenario seems all the more likely when we add in cheaper interest rates that have helped consumers through lowering mortgage and credit related payments.
One potential spot of long-term headwinds is the national debt. While we do not see this derailing either the current economic recovery or stock market gains, this is obviously something that will need to be addressed in the future. Pandemic deficit spending last year seemed appropriate to prop up the economy, but in light of the positive factors mentioned above, deficit spending has now become political theater. Neither political party wants to make any hard decisions to either increase revenue through higher taxes and/or cut spending (likely both are necessary).
But, within ever-increasing national debt levels it should be noted that the stock market has continued to march higher. So, to say that the growing national debt level will derail the stock market defies logic. In the future, higher corporate taxes (which can reduce earnings and dividends paid to shareholders) can have a very real negative effect on valuations (meaning yes, this could cause a correction in the market). Given the gridlock in Washington, the prospect of drastically higher corporate taxes happening anytime soon seems remote.
Outlook
As previously mentioned in past quarterly commentaries, there is often a disconnect between the “real economy” and equity markets. But, there is an important correlation between continued earnings growth and positive equity market performance. Currently, we are likely mid-cycle of an economic recovery which should allow companies to grow earning for another year or two (possibly longer). The market has looked far past the recent damage done to the economy from COVID and has priced in a full recovery. But, this is not to say we won’t see the equity market continue to grind higher, even in light of high valuations for publically traded stocks. In a world of choices between bonds, stocks and cash (sitting on the sidelines) with an economy and corporate earnings that are still growing, we believe stocks are still a likely good place to be.
In the heading of this quarterly’s newsletter we quoted Union Pacific who made the very unusual decision to suspend shipment due to high volumes. There literally is so much shipping that they cannot store it all and move it through some of their freight yards. They went on to say, “Union Pacific has strived to maximize container shipments between ports and inland ramps, but available parking space at Chicago’s Global 4 ramp has been consumed due to slow outbound drayage processing.” This is again, an example of an economy not in recession, but experiencing such a strong rebound that constraints are likely holding back even stronger growth.
Equity markets, while expensive, are not priced for perfections. Yes, there are pockets of very expensive companies (technology would be a good example), but again, when we look at the next one to two years, a growing economy will allow companies to continue to grow as supplies chains and labor markets adjust to a post-COVID world. Expect some volatility as we continue to look for areas of value in the equity markets and expect that later in the second half of the year we will again see the markets move higher from here.