The Government’s swift actions kept food on people’s tables. It kept folks from being kicked out of their homes and it kept money flowing into the financial markets.
But we all know the handouts can’t go on forever. Eventually, the government will need to remove the guardrails and everyone will be on their own again.
Of course, the Federal Reserve has talked about tapering its purchases of U.S. Treasury bonds for a while, but the central bank is waiting for unemployment numbers to improve before it makes any changes.
And even if the COVID-19 Delta variant gives lawmakers a reason to keep propping up the economy in the short term, the fact is the government’s support will end at some point.
Around 7.5 million Americans who had been collecting $300 weekly payments from Uncle Sam now need to figure out their own way to make ends meet for their families. Millions of jobs are available in the U.S. – especially at small businesses that have struggled to hire workers during the pandemic. You’ve likely seen this firsthand if you’ve ventured out to eat lately. Many restaurants are short-staffed.
Some other government support is set to end soon, too.
For example, the federal eviction moratorium is set to expire on October 3 – about two weeks from now. It was supposed to expire last December, but the government has extended this protection several times since then.
What will our economy look like when all the financial support is removed?
Some folks won’t be able to find jobs that pay as much as the benefits they were collecting. If they can’t pay their rent, they could find themselves out on the streets and they would need to get used to making do on their own again.
After all, we know many people didn’t use the government’s handouts wisely.
They should’ve used the money to get their financial houses in order. Instead, they bought “meme stocks” like GameStop (GME), joke cryptocurrencies tied to dog pictures, and off-the-wall non-fungible tokens… or in some cases, they simply gambled it away.
And the sad truth is many Americans are already up to their eyeballs in debt.
The average U.S. household owes more than $12,000 in student loans, $11,000 in car loans, and $6,000 on credit cards. In total, that’s $29,000 in nonmortgage debt. That’s 50% higher than the $19,000 of nonmortgage debt that the average American owed back in 2007 before the last financial crisis.
According to a Federal Reserve study, around a third of all Americans only pay the minimum amount due each month. That’s a recipe for disaster.
A few decades ago, these minimum monthly payments averaged around 5% of the total amount owed. But banks have lowered them over time to make debt more “affordable”. Today, minimum payments average only around 2% of the credit-card balance.
US Economy
- House Democrats consider a 26.5% Corporate tax rate, less than what Pres Biden wanted.
- The Delta-variant wave has peaked.
- The National Association of Realtors (“NAR”) believes the U.S. is short about 2 million single-family homes and about 3.5 million multifamily units.
- The US economy had 162.8 million jobs at the late 2019 peak. It fell in 2020 and is now recovering, a trend the Bureau of Labor Statistics thinks will continue. It projects 165.4 million jobs by 2030. If correct, this means the economy will spend most of the next decade simply replacing the lost jobs and will show only 1.6% total (not annualized) job growth in the 2020s. Moreover, many of the new jobs will require skills that are presently scarce, so the frustrating situation where millions are unemployed while businesses still can’t find the help they need may continue. It’s one reason GDP growth may be historically low for years to come.
- For the moment, large-cap companies seem well-shielded from inflation pressure and are passing on price increases for higher material costs and maintaining their profit margins.
- The CPI report surprised to the downside, with inflation easing in pandemic-sensitive sectors.
- Nonetheless, price pressures persisted in August as the median CPI gain was the highest in years.
- The Delta variant put downward pressure on some of the “reopening” sectors.
Housing Market Problem
After the housing crisis in 2008, homebuilders practically walked away from the game. Homebuilding rates fell to 50-year lows.
That decline made sense. We were in the worst housing bust of our lifetimes. But everyone knew it wouldn’t last forever, so you’d expect that building would have started up again soon enough.
Unfortunately, it didn’t.
Instead, new housing construction stayed below average rates… for a decade. Take a look…
This chart shows new housing starts between 1961 and 2021. It measures the number of “housing units” that have begun construction in the U.S. in a given month.
This metric includes multifamily units, like apartments, as well as single-family homes. But we commonly use it as a way to look at homebuilding in a broad sense.
As you can see, residential construction fell off a cliff in the wake of the housing bust. The problem was that as the economy improved, homebuilders never ramped back up.
The National Association of Realtors believes the U.S. is short about 2 million single-family homes and about 3.5 million multifamily units.
Looking at the single-family homes alone, that’s roughly $700 billion worth of inventory based on today’s median home price.
Market Valuation
First, let’s take a look at the valuation landscape via the following chart, courtesy of Ned Davis Research. The data, in some cases, goes back to the 1920s. NDR ranks each measure in terms of five quintiles that ranges from Extremely Undervalued (Green) to Extremely Overvalued (Red). As you can see, in looking at the most popular valuation metrics, it’s red across the board.
To put this into perspective, let’s zero in on just a few of the above. The idea here is to show you where you will get more return on your money. Red is bad, green is great.
Median P/E
Price to Sales
Price to Dividend Yield
Cryptocurrency Oversight by the SEC?
Prepare to see some headlines about crypto regulation as SEC Chairman Gary Gensler heads before the Senate Banking Committee for a grilling. Lawmakers are expected to show frustration over the lack of supervision in crypto markets and why it has taken so long to support them. He might also have to explain why the SEC seems averse to approving various crypto assets (Bitcoin ETFs?), as well as stablecoins and other digital assets.
In recent weeks, Gensler seemed to be more vocal about regulation, calling crypto the “Wild West.” It’s “rife with fraud, scams, and abuse in certain applications. If we don’t address these issues, I worry a lot of people will be hurt,” the SEC Chair said in a speech at the Aspen Security Forum. He’s also called for Congress to magnify the SEC’s power in order for it to be effective at managing the $2T digital currency market.
“We just don’t have enough investor protection in crypto finance, issuance, trading, or lending,” Gensler said in his prepared testimony. “Frankly, at this time, it’s more like the old world of ‘buyer beware’ that existed before the securities laws were enacted. We can do better.” The SEC is also working with the Commodity Futures Trading Commission, Federal Reserve, Department of Treasury, and Office of the Comptroller of the Currency with respect to investor protection in crypto markets.
Potential Tax Hikes
House Democrats spelled out a series of proposed tax increases last Monday, attempting to piece together enough votes for a sweeping spending package at the heart of President Biden’s economic agenda. Under the proposal, tax increases and enforcement would offset up to $3.5T in spending on the social safety net, like Medicare, childcare and a national paid-leave program. Also known as the “human infrastructure” side of a broader infrastructure proposal, the package would increase renewable energy tax breaks and establish a broader climate change policy.
The proposal would increase the top corporate tax rate to 26.5% (from 21%) and the top individual rate to 39.6% (from 37%), respectively. Meanwhile, the top federal rate on capital-gains taxes would be raised to 25% (from 20%), and – added to an existing 3.8% surtax on net investment income – the total tax bite would be 28.8%. The bill would also impose a 3-percentage-point surtax on people making over $5M and provide $78.9B in funding to the IRS to bolster tax enforcement for taxpayers earning more than $400K a year.
According to the Joint Committee on Taxation, the plan includes about $1T of tax increases on high-income households and about $1T on corporations. Democrats intend to generate another $120B from tougher tax enforcement and $700B from drug-pricing policy changes. The legislation also assumes another $600B in revenue from faster economic growth.
The release of the tax details was the last major missing piece in the Democratic economic plan and will accelerate lawmakers’ negotiations over new spending. Republicans are expected to mount unanimous opposition to the proposal (which would reverse the 2017 tax cuts), while Democrats have few votes to spare in the House and none in the Senate. Just last week, Sen. Joe Manchin (D., W.Va.), an influential moderate vote, penned an op-ed questioning the spending package’s effect on inflation rates, budget deficits and overall debt levels.
The Buffett Indicator: Stock Market Cap to GDP
“The Buffett Indicator is the ratio of total US stock market valuation to GDP. Named after Warren Buffett, who called the ratio “the best single measure of where valuations stand at any given moment”. (Buffett has since walked back those comments, hesitating to endorse any single measure as either comprehensive or consistent over time, but this ratio remains credited to his name). To calculate the ratio, we need to get data for both metrics: Total Market Value and GDP.” (Source: CurrentMarketValuation.com)
I came across this last chart via Twitter. It looks at an aggregate model of eight different valuation metrics. The top section is world market valuations. The bottom section is the US. Dark line is the model return forecast, green dotted line is the actual achieved subsequent 10-year returns. Note the expected negative returns for both US and Global Equity indices.
We could keep going, but you get the picture. Bottom line: The market has never been more overvalued than it is today, except for 1929.
What then, does this mean in terms of coming returns? There are many ways to dissect it. Let’s look at a few of my favorites.
Stock Market Cap to National Gross Income
Focus in on the middle section of the chart. The dotted blue line is the long-term regression trend line from 1925 to August 31, 2021. The orange line reflects month-end value of total stock market capitalization compared to national gross income. You can see that it moves above and below the trend line over time.
Where the Buffett Indicator looks at the total value of the stock market compared to what the U.S. produces, this indicator looks at the total value of the stock market compared to what we in the U.S. collectively earn. Simply view it as another valuation metric.
The benefit to this measurement is in what it tells us about historical returns. If you buy something at a good price, you get more for your money. If you can buy it at a steep discount, you get even more value for your money. If you overpay, you don’t get as much. Warren Buffett uses hamburgers as an example. When the price of hamburger meat goes down in price, you can get a lot more hamburger meat for every dollar spent. When the price is high, you get less meat for every dollar spent. Same is true for investments.
The bottom section looks at just how far above or below the indicator is from its trend line. NDR then does something very effective. They sort the data into quintiles that range from “Top Quintile Overvalued” to “Bottom Quintile Undervalued.”
They then calculate the subsequent returns based on each quintile. Think of the dotted blue line in the center section as the average return the market has produced since 1925, which is approximately 10%. Next, focus in on the upper left-hand data box. What is shown are the actual average % changes in the S&P 500 one, three, five, seven, nine, and 11 years later based on “Top Quintile Overvalued” or “Bottom Quintile Undervalued.”
Logic tells us is that coming returns will be negative for the S&P 500 Index over the next 11 years. This doesn’t mean you can’t make money; it just means probabilities say it won’t come from popular cap-weighted index mutual fund and ETF exposures.
Market Data
- Market breadth has been weakening.
- Individual investors had an average of more than 71% of their portfolios allocated to stocks over the past three months – the highest in more than 20 years.
- Overall, US households are highly exposed to stocks.
- For the first time in more than 200 days, fewer than 75% of stocks in the S&P 500 managed to hold above their 200-day moving averages. That ends the 4th-longest streak of such positive breadth since 1928.
- The advance-decline line has diverged from the S&P 500.
- Fund managers’ views on the economy have diverged from their stock allocations.
- Valuations remain a concern.
- When will the Fed signal the start of taper?
- The S&P 500 is near the top end of its long-term trend channel.
- Small caps have been stuck in a range.
- US equities have significantly outperformed global peers in recent years.
- The SPAC boom is over for now.
Thought of the Week
“The secret of liberty is to enlighten men, as that of tyranny is to keep them in ignorance.” —Maximilien François Marie Isidore de Robespierre (1758-1794)
Picture of the Week
iPhone prices:
All content is the opinion of Brian J. Decker
