Inflation is through the roof.
There is an oil crisis. An impending food crisis. You say it.
War is raging in Europe.
The president of Russia is beginning to sound unhinged. And now the headlines link it to chemical weapons and nuclear weapons.
Ohmyhgaad- Ohmyhgaad- Ohmyhgaad!
Things are so bad that stories that would normally be front-page news, like waves of Covid cases and deaths, China shutting down cities, and North Korea firing long-range missiles, barely deserve a mention.
It’s no wonder the stock has plunged this year.
US consumer confidence numbers are at lows only seen during the global financial crisis and crises of the 1970s. Indicators like the American Association of Individual Investors weekly opinion poll and the CNN index Fear & Greed show that investors are at extreme levels of misery.
If you’re tempted to withdraw stock funds from your IRA and 401(k) accounts and hide under your desk, you’re not alone.
But before you do… listen to Jim Paulsen.
He is the chief investment strategist at Midwestern money management firm Leuthold Group. And he recently he did a presentation to clients that could have been called—with apologies to the late Ian Dury—“reasons to be cheerful.”
In a nutshell, Paulsen argues: Things are not as bad as you think. He thinks the economy is in much better shape than the headlines would say. The stock market will go back up, sooner rather than later. Oh yes, and there are good profit opportunities available to any individual investor.
Take it or leave it, but Leuthold is not your usual Wall Street bookmaker. The Midwestern firm is a pretty skeptical, down-to-earth place. He even runs a “Grizzly Short Fund,” which bets on falling stock prices. They are usually not mindless cheerleaders.
What is the Paulsen case? Here are your 3 key reasons to look on the bright side.
everything is reopening
The big news of the moment, largely forgotten in the current Eastern European news panic, is that the pandemic is over. Policymakers, and even the media, have finally come to accept that Covid is not going to go away, but will have to be managed: it will be “endemic”, rather than a pandemic. Net result: The world is reopening. Business is starting up again. People are going to travel. They are going shopping. They go out to restaurants.
Oh, and most importantly: stores will have to restock their empty shelves, after two years of supply chain crisis. Inventories are at record lows compared to gross domestic product, he notes. The trade order backlog is near 30-year highs. Plus, he adds she, consumers have about $1.5 trillion in extra savings because they’ve spent less money in the past two years.
While the Atlanta Fed’s real-time GDP tracker shows a drop in first-quarter growth, Paulsen notes that Citi’s US economic surprise index is rising. And it has a track record of leading where GDP follows. Meanwhile, corporate earnings look extremely healthy and estimates have been revised higher since the start of the year.
As for the humanitarian disaster unfolding in Ukraine due to the Russian invasion, the actual effects on the US economy are likely to be smaller than the headlines and temporary suggest, argues Paulsen. And that’s true whether the war ends soon (hopefully) or turns into a prolonged stalemate.
Jobs! Jobs! Jobs!
The US economy created 1.2 million new jobs in the first two months of this year alone, an impressive achievement, and it was achieved despite the persistent drag from the Omicron Covid outbreak. There is still a lot of room to grow. We are still more than 2 million jobs short of the pre-Covid peak, and Paulsen points out that after every recession since World War II, the job market has risen to new highs, often well above the previous peak.
Figures from the US Department of Labor suggest the economy could add another 7 million jobs just to get back in line with the growth trend seen just before the pandemic. Paulsen notes that the unemployment rate has plummeted in the 44 states with the smallest economies, but not yet in the “Big Six” that actually contain the most jobs, namely California, New York, Texas. , Illinois, Florida and Pennsylvania.
Meanwhile, wages are booming. The Atlanta Fed’s proprietary “wage record” shows annual wage inflation soaring to 5.8%, higher than at any time since at least the 1990s. But as Paulsen points out, most of this wage growth occurs among less skilled and lower paid workers, who ultimately get (slightly) higher wages. So we’re hiring millions more workers and they have a lot more money to spend, especially those who are more likely to spend.
This brings us to the cliche of £800 in the room, namely inflation. This is the current source of panic, and much is made of 1970s-style “stagflation.” The official inflation rate hit a horrendous 7.9% in February, the highest in decades. Federal Reserve Chairman Jerome Powell is officially alarmed and has stopped calling himself a “transient.” Paulsen says that’s probably the biggest risk right now. If the Fed doesn’t cut inflation, he says, the recovery will be over pretty quickly.
But… well, as Paulsen says, “inflation hysteria is everywhere, except in the financial markets.” Despite all the panicky headlines, the bond market isn’t worried about inflation. Neither is the stock market, nor the currency markets.
In the 1970s, for example, when inflation hit 6%, the bond market responded by demanding an 8% yield on 10-year US Treasuries to reflect the risks. Today that yield does not even reach 2.5%. In the 1970s, rising inflation brought stocks down. This time, there has been a correction, but so far it is reasonably modest. Oh, and in the 1970s, rising inflation sank the US dollar in the currency markets. This time the dollar is rising.
The Atlanta Fed says current inflation is mostly due to highly flexible priced things like cars, fuel, clothing and food. Those prices can go down as fast as they go up. The rate of inflation among “sticky” items like rent or health care, where prices tend to stay the same once they rise, is just 4%, he says. Meanwhile, the San Francisco Federal Reserve estimates that most of the current inflation is due to reopening and supply chain issues following the two-year crisis.
The key inflation measure to watch is the so-called five-year “breakeven rate” on US bonds, a technical measure that is effectively the bond market’s own five-year inflation forecast. And it’s up, it’s been up for over a year, but it’s still 3.57%, or less than half the current rate of inflation. In other words, the bond market continues to forecast inflation to fall to half of these levels, and reasonably quickly. If you know something the bond market doesn’t, go out and get rich.
Reasons to be optimistic? Maybe, maybe not. But as sentiment is already near peak pessimism, logic suggests that the next move is more likely to be up than down.