Chart of the Week
May 3, 2021
Economic Growth | Things and more things
Initial estimates released last week by the Bureau of Economic Analysis indicate that the economy expanded at an annual rate of 6.4% in the first quarter, up from 4.3% in the previous quarter. The economy in aggregate has already quickly made up much of the ground lost during the pandemic, and economic growth is expected to continue to accelerate in the current quarter. It was an unusual recession, and it has been an unusual recovery led by a dramatic increase in the consumption of goods that has stressed supply chains and pushed the prices of many goods higher. Inflation-adjusted goods consumption is up nearly 13% from its pre-Covid level, while the inflation-adjusted consumption of services, which is typically more stable, was still down about 6% in the first quarter. The recovery in the service sector is expected to pick up steam as the economy continues to reopen. Whether the pandemic has led to a permanent reduction in the demand for parts of the service economy remains an open question. Similarly unknown is whether the splurge for goods has merely pulled demand forward from the future or constitutes a structural shift in consumers’ spending habits. Eventually there are too many things.
Demographics | The winds have changed
April 26, 2021
Demographics and globalization produced an unprecedented increase in the world labor supply over the past forty years. The working age population between 15 and 64 more than doubled during that time with China representing a large piece of that growth, especially as it became more integrated into the world economy and transferred more of its working age population from the countryside to urban cities. This large increase in workers (who also tend to be savers on net) has been a powerful tailwind for asset prices helping to decrease inflation and interest rates and increase profit margins and valuation multiples. However, the winds have now changed direction. The growth rate of the global working age population is slowing significantly and has actually already turned negative in China and Europe. At the same time, the number of individuals over 64 (who are spenders, not savers, on net) is increasing rapidly. Globalization is also becoming less politically popular, while the Covid pandemic has highlighted the vulnerabilities of supply chains that only seek to maximize profit margins. Demographics are a slow moving juggernaut and are not even necessarily destiny as productivity gains and medical breakthroughs that enable individuals to live and work productively longer could counteract the largely inevitable population statistics. But the tailwind that has benefited investors so much over the past several decades appears to have become a headwind for the decades to come.
Source: United Nations - AOWM calculations
April 19, 2021
Stock Valuations | Starting on third base
When the dramatic Covid recession quickly reached its nadir last April, the stock market was already on the road to recovery as investors were optimistically looking forward as they are wont to do. However, unlike other previous recessions, the market’s valuation never sank to an overly depressed level. As a result, the market started the economic recovery at an unusually elevated level. Since then, stock valuations have only soared higher and pushed valuations to the highest they have ever been this early in an economic expansion. Expected earnings for the S&P 500 Index for 2021 and 2022 are still 5% to 10% below where they were when the market peaked pre-Covid on February 19, 2020, but the market has increased over 23% from that previous highwater mark. Thus, it is hard to say that the swift economic recovery rationally justifies current valuations. Yet we may still be in the middle innings of a market bubble which can be rational in its own way - however risky it may be. That long-term stock returns will be depressed by current high valuations may be the only good bet.
Source: ; AOWM calculations
April 12, 2021
Housing Market | Reasonably crazy
Stocks have not been the only asset to shoot higher in value over the past year. Home prices are up more than 11% and are back to where they were at the peak of the housing bubble in 2006 after adjusting for inflation. A number of factors have caused a perfect storm of high demand and low supply which has pushed home prices higher. While the housing market seems to have gone as loco as the stock market, it is more reasonably crazy. Unlike the stock market, home values are less likely to continue melting upwards in a spiral of irrational exuberance, and they are also less likely to decline significantly if interest rates increase back to more normal levels. For the moment, lenders are not exhibiting the loose lending standards that led to the last housing crisis. Without the extra juice of loose credit, it is difficult for home prices to get too divorced from what individuals can afford to pay. Ultra low mortgage rates have made it possible for families to pay more for a house but still keep their monthly house payments equal to a manageable percentage of their income. However, rising home prices eventually make it difficult for families to fund the initial down payment, and home prices may be approaching that natural ceiling now. If mortgage rates continue to increase, that will be another clear headwind to further price increases as well. And yet, with the strong mortgage underwriting that lenders are doing now, there is unlikely to be a collapse in home prices similar to what occurred after the housing crisis even if rates do trend significantly higher. Real home prices may decline in the coming years, but that is more likely to be a function of higher inflation than a significant decline in actual home prices.
Source: ; ; ; ; AOWM calculations
April 5, 2021
Economic Growth | Gaining momentum for a big year
The jobs report for March showed a stronger than expected increase of 916,000 in employment with the unemployment rate falling to 6% as individuals temporarily unemployed in the sectors hit hardest by the pandemic begin to get called back to work in larger numbers. The economy is gaining momentum as the easing of pandemic restrictions and unprecedented government stimulus boost economic activity. At the current pace, much of the economic ground lost due to the outbreak of Covid-19 may be made up by the end of the year. Projections for economic growth this year are likely to continue to be revised higher towards the upper end of current estimates above 7% which would be the fastest growth since 1983. Starting later this year, policymakers may have to quickly switch gears towards worrying about an economy that is running too hot rather than too cold; however, the powers-that-be in Washington have made it clear they will keep doing everything they can to jump-start the economy until they see smoke coming from the engine.
March 29, 2021
Stocks | A Record Trip Around the Sun
The S&P 500 Index ended last week at another all-time high, which is the 15th time the index has closed at a record high so far this year. Last week also marked one year from when the US stock market hit its Covid-19 pandemic panic bottom on March 23, 2020. The S&P 500 rose 74.8% over the course of that year - a record for the index which has been tracking 500 of the largest companies in the U.S. since 1957. The second largest one-year rally for the index occurred after the great financial crisis when the S&P 500 Index rose 68.6% from March 9, 2009 to March 9, 2010. That rebound kicked off one of the best decades for the U.S. stock market. It will be difficult for the market to replicate another such performance, primarily because of elevated valuations which find the market at least a third more expensive now than it was in March 2010. The prevailing high valuations make sense and will likely be maintained only if investors expect and accept that high current valuations go hand-in-hand with low future returns.
Source: YahooFinance, AOWM calculations
March 22, 2021
Households | Bullish as they've ever been
At this time last year, few would have predicted what stellar shape household balance sheets would be in today -- at least on an aggregate level. After dipping by about 6% in the first quarter last year, the aggregate net worth of households in the US ended up rising by over 10% in 2020 to about $123 trillion thanks to stimulus checks boosting bank accounts, the epic rebound in the stock market and rising house prices. At the end of 2020, equities as percentage of total household assets exceeded the previous peak reached in 2000 and has likely only increased since then with the gains in the stock market so far this year. The stock market is definitely benefiting from a tailwind of very positive investor sentiment and an interest by retail investors in stocks that has not been seen since the heady days of the late 1990s. How long this current era of good feelings will last is anyone's guess.
Stimulus | Turning it to eleven for that extra push
March 15, 2021
With the enactment of the $1.9 trillion American Rescue Plan Act of 2021, the federal government has continued the most expansive fiscal policy since the Second World War. Federal outlays are projected to exceed 30% of GDP for the second year in a row with the deficit continuing around 15% of GDP. With outlays expected to approach $7 trillion, approximately half of the budget this year will be paid for with borrowed money (of which a significant portion will likely be effectively purchased by the Federal Reserve in the hopes of keeping interest rates low). With the economy already on the rebound, this extra push should significantly accelerate the recovery. Investors are always looking to see what is coming over the horizon. Over the past year, their net aggregate optimism about how quickly the economy would recover from the Covid-19 pandemic appears likely to be proven justified. With the economy now taking off, it will be interesting to see in the coming months investors' collective prediction for how successful policymakers will be in orchestrating a soft landing.
Source: Office of Management and Budget, Congressional Budget Office, AOWM calculations
March 8, 2021
Policymakers | Aiming for the eye of the needle
The jobs report released last week showed a faster than expected increase in employment in February thanks to a rebound in the leisure and hospitality sector. The official unemployment rate declined for the second straight month to 6.2%; however, the number of individuals in the labor force is still 4.2 million lower than a year ago, and over 9 million fewer people have jobs. (See the first chart below.) The number of jobs in the hard hit leisure and hospitality sector is also still down 20% despite the gains in employment last month. (See the second chart below.) Given this slack in the economy, Congress is pushing ahead with significant additional fiscal stimulus, and policymakers at the Federal Reserve remain committed to keeping interest rates low and the money supply growing briskly with the goal of threading the needle of engineering a fast recovery without overshooting and sowing the seeds of the next downturn. With that stimulus and the decreasing restrictions related to the Covid-19 pandemic, expectations for economic growth this year have been increasing with some economists projecting the economy could grow by more than 7% this year, which would be the fastest growth since 1983. This growth is expected to generate a burst of inflation in the short run which has led to some rumblings in the stock and bond markets recently. In general, though, investors still appear to have faith that policymakers will find the eye of the needle. Expectations for inflation over the next five years as indicated by the market for Treasury Inflation Protected Securities (TIPS) has spiked higher, but longer-term inflation expectations remain well anchored. The third and fourth charts below shows that Federal Reserve policymakers have for the first time in a long time convinced investors that they will successfully create a spurt of growth friendly inflation over the next five years while keeping inflation in check over the long run. Investors need to maintain that faith for policymakers to succeed in effectively guiding the economy out of the pandemic.
Source: YCharts, BLS, US Treasury,
Interest Rates | Headed higher for now...
March 1, 2021
Interest rates spiked higher last week causing some rumblings in the stock market especially for growth stocks with rich valuations based in part on low interest rates. The 10-year Treasury yield has risen from 0.93% at the start of the year to 1.44% as of the close on Friday. That is a noticeable increase, but long-term interest rates remain at historically very low levels and still have a long way to go before the forty year downward trend in yields could truly be said to have been broken. (See first chart below.) Policymakers are certainly doing everything they can to increase economic growth and inflation, which would naturally push rates higher. The question is whether the Federal Reserve will allow rates to continue to increase, which could endanger the rapid economic expansion policymakers are trying to engineer. The Fed (in charge of monetary policy – i.e., interest rates and inflation) and the Treasury (in charge of administrating fiscal policy – i.e., taxing, spending and debt management) are working more closely together than they have in 70 years as the Fed has largely purchased all of the new debt issued by the federal government in the past year and has indicated it plans to continue expanding its balance sheet via such purchases for the foreseeable future. Ironically this week marks the 70th anniversary of the “Treasury-Fed Accord” when the Fed broke free from its commitment to peg the interest rate on long-term government debt at 2.5% to help the Treasury finance the Second World War. If current policymakers are to be believed in their simultaneous commitment to maximum fiscal and monetary stimulus, real inflation-adjusted yields may be more likely to fall further than nominal rates continue to rise, as occurred around the middle of the last century when inflation increased but the Fed kept the lid on nominal interest rates. (See second chart below.)
Source: Yahoo Finance,
February 19, 2021
Unprecedented | The Stock Market's Covid Year
Friday marked the one year anniversary of the stock market's pre-Covid high. As concern about the pandemic and economic lockdowns set in last year, the S&P 500 Index declined by nearly 34% over the subsequent 23 trading days, from the market close on February 19, 2020 to the close on March 23, 2020, which was the fastest market decline ever of that magnitude. Thanks to unprecedented levels of government stimulus that at least for the stock market more than offset the downside of the government imposed pandemic restrictions, the market then proceeded to recover faster than it ever has before, setting a new all-time high in less than five months from the market low and six months from the previous pre-Covid high. Over the past year, the S&P 500 has returned over 17% while only three sectors - real estate, utilities and energy - are lower today than they were before the pandemic. Some sectors have been clear winners with technology, consumer discretionary, communication services, and materials returning 27% to 34% over the last twelve months. If the market just maintains its current level till March 23, it will have enjoyed a return of roughly 75% in a year's time which would be the best one year return since 1936 when the market was still more than 50% below its 1929 peak.
Source: YCharts, Past performance may not be indicative of future results. The S&P 500 Index is a market-cap-weighted stock market index that includes 500 of the top companies in leading industries of the U.S. economy. SPDR® sector funds seek to provide effective representation of the respective sectors of the S&P 500 Index.
February 12, 2021
Inflation | Still low for now...
The recently released inflation report showed consumer prices were just 1.4% higher in January compared to a year ago. Inflation has remained relatively low since Covid-19 broke out last February but is expected to pick up in the coming months. Year-over-year inflation may exceed 3% this spring for a few months when prices are compared to last year's lockdown period, but the general consensus continues to believe that will just be a momentary blip higher. Even with significantly more fiscal stimulus in the pipeline and extremely loose monetary policy, inflation is not expected to get out of hand because the economy still has so much room to run to make up for what was lost last year. While investors have been bidding up the price for inflation protection in recent months, sending the breakeven inflation rate between nominal 10-year US Treasury Notes and inflation-protected 10-year US Treasury Notes (TIPS) to the highest level in nearly seven years around 2.2%, long-run inflation expectations remain at a level that does not raise concerns for policymakers. However, if inflation were to remain higher for longer than expected this year and inflation expectations were to continue to rise, Mr. Market could suffer from one of his infamous mood swings as the currently high-flying stock market is soaring on the wings of investors' faith in low inflation and low interest rates continuing for almost as far as the eye can see.
February 5, 2021
Consumers | Primed to Spend or Save?
As Covid-19 cases increased at the end of last year, consumers began to once again reign in their spending as they continued to save a historically high portion of their income. Many households have taken advantage of the government's Covid relief checks to shore up their balance sheets by increasing savings and paying down debt. With more stimulus checks on the way and spending continuing to be pent-up, the general assumption is that consumers will go wild once the pandemic is largely behind us and folks are released from their bubbles. However, there is a good chance individuals will continue to save far more than they have in recent years, which could make the economic recovery slower than expected. With investment returns likely to be depressed in the coming years by ultra low interest rates and elevated asset prices, savers have no choice but to increase the amount they set aside now to meet their future financial goals. Policymakers may ultimately come to realize that supporting asset prices with loose monetary and fiscal policy to extreme levels will weigh down consumption more than support it.
January 29, 2021
GameStop | A Gamified Retail Investor Revolt
GameStop (GME), which seemed to be a dying brick-and-mortar video game retailer that had seen its revenue decline from over $9 billion to around $5 billion over the past six years, is now worth over $22 billion based on its stock's closing price on Friday. The stock has increased by 1737% in just the past three weeks, rising 400% last week with extreme up-and-down swings during which some of the most popular retail online brokerages had to halt their clients ability to buy the stock for a period of time. GME is just the most glaring example of a number of stocks with high short positions (i.e., bets by primarily institutional investors that the stocks would decline in value) that have raced higher recently thanks to a tumultuous cocktail of gamified free online trading, social media rabble rousing, populist resentment, get-rich-quick dreams, momentum investing, institutional short covering, and opaque financial system plumbing. Stocks like GME have left the realm where their stock prices are based on any reasonable analysis of the business fundamentals and reside firmly in the land of gambling and hoping a greater fool will buy at a higher price before the cards come tumbling down. However, while indicative of investors who have thrown all caution to the wind, the wild trading in GME and other stocks may not be a sign of a general stock market top. Indeed, by making it less popular and potentially more risky to short stocks, recent events may only help to inflate rather than deflate any market bubble.
Source: barchart.com, YCharts.com
January 22, 2021
SPACs | As long as the music is playing...
Speculative excesses are bubbling up in a number of places these days. One that has been particularly hot in recent months is the initial public offering (IPO) market for Special Purpose Acquisition Companies (SPACs), which are also referred to as blank check companies. SPACs are formed for the purpose of acquiring a yet-to-be-identified private company, enabling it to go public without having to go through the more rigorous traditional IPO process. Investors in a SPAC are counting on the ability of its management team to effect an acquisition that will ultimately prove lucrative and lift the SPAC's stock price. However, a SPAC's management team is often more incentivized to get a deal done than to be a stickler about the price paid and typically only has 24 months to close a transaction before the funds are returned to the SPAC's shareholders, all of which has historically led SPACs not to generate the best relative returns for investors. Accordingly, SPACs have in the past been a fairly small corner of the financial world. That is until about six months ago when SPAC IPOs started flying off the shelf -- much to the delight of investment bankers on Wall Street. Last year, more than $83 billion was raised in 248 SPAC IPOs, and in just the first three weeks of this year, there have been more SPAC IPOs than in all of 2019 (see graph below). At least for the moment, though, SPAC investors no longer have to count on management's acumen for deal making to make heady returns as SPAC stock prices are being bid higher on merely the rumor of potential deals and FOMO exuberance. In reality, the amount of money chasing deals is all but certain to drive up the price SPACs have to pay for private companies and decrease the return SPAC shareholders can realistically hope to earn in the future. While investors are dancing now, this game of musical chairs may end poorly for many SPACs when the music stops.
January 15, 2021
Options | Everything is awesome
The stock market retreated slightly from its record high this week, but investors continue to display a high level of bullish sentiment. That can be seen clearly in the options market where the volume of call options on individual stocks (i.e., the option to buy in the future) relative to put options (i.e., the option to sell in the future) is back at levels not seen since the peak of the tech bubble in 2000. The light blue line in the chart below shows the daily put-to-call ratio and the black line shows the 20-day moving average since November 2006. The last time the put-to-call ratio reached this level just briefly in 2010, the market pulled back by 16% over the next two months and basically traded sideways with some sizeable up-and-down swings over the subsequent twenty months. If the exuberance on display in the options market is not irrational, it is likely at least indicative of a market in need of digesting some of the optimism that has been built into current valuations before establishing another sustainable trend higher.
Source: YCharts, CBOE, AOWM calculation, light blue lines indicate daily put-to-call ratio, black line indicates 20-day moving average
Job Market | Limping into the new year
January 8, 2021
On Friday, the Bureau of Labor Statistics reported a decline in total nonfarm employment in December as the Covid-19 pandemic slowed economic activity yet again. The decline in employment broke a streak of seven straight months of job gains following the large job losses that accompanied the economic lockdown due to the outbreak of Covid-19 back in the spring. The unemployment rate stayed unchanged at 6.7%, but 4 million people have taken themselves out of the labor force over the past year and the total number of individuals employed is still down by over 9 million since last December. The decline in the labor market over the past year is the worst calendar year on record going back to 1939. See the graphs below of the rolling year-over-year change in total employment in absolute and percentage terms. The news was not all bad, however; the number of permanent job losses ticked lower and the number of individuals unemployed for 27 weeks or more was largely unchanged for the first time since the pandemic began. These positive glimmers coupled with the additional fiscal stimulus being dispersed and the continued rollout of Covid-19 vaccines hopefully mean this month will be a brief bump in the job market's recovery. Nevertheless, it is still likely to take a very long time to fully recover all of the jobs lost in 2020.
Source: .S. Bureau of Labor Statistics, All Employees, Total Nonfarm [PAYEMS], retrieved from FRED, Federal Reserve Bank of St. Louis; January 8, 2021.
Market Peaks | Keep your eyes on the horizon
January 1, 2021
As the market charged to end the year at a new all-time high with valuations appearing stretched, it is reasonable for investors to be a little apprehensive about what the new year might bring. However, if the past year has taught us nothing, it is that trying to predict the short-term machinations of the stock market is next to impossible. Even when pessimistic about the market's outlook, it is wise to remain humble about one's prognosticating skills such that you remain invested even if at a slightly lower allocation to equities. While certainly preferable not to invest right before a large market decline, investors can take comfort in the fact that the long-term performance of stocks is more often than not still positive even when investing at the top. The first chart below shows the nominal 5-year, 10-year and 20-year annualized returns of the S&P 500 Index with the light gray vertical lines indicating market peaks. The second chart is the same thing, but with the returns adjusted for inflation. While inflation-adjusted returns show more negatives over five and ten-year periods, twenty-year returns have historically remained positive even when investing at a record high that is followed by a bear market. Even when negative in real terms, stock returns typically outperform the alternatives of fixed income or cash when inflation increases. So with the market roaring, be cautiously pessimistic and maintain a diversified allocation to stocks.
Source: AO Wealth calculations
Irrational Exuberance | Not this time?
December 18, 2020
Yale Economist, Robert Shiller, is famous for calling out the irrational exuberance of the stock market back in 2000 based in large part on his Cyclically Adjusted Price-Earning (CAPE) ratio, which divides the market's current price by the average inflation-adjusted earnings over the past 10 years. As seen in the first chart below, the CAPE ratio is once again at levels only seen during that market bubble twenty years ago. This time, however, Shiller is a little more sanguine about the market thanks to historically low interest rates. Indeed he has come up with another metric to support his seeming change of heart -- the Excess CAPE Yield (ECY), which takes the Cyclically Adjusted Earnings Yield (i.e., the inverse of the CAPE ratio) and subtracts the real interest rate (i.e., the nominal interest rate minus expected inflation). As shown in the second graph below, when the ECY is compared to the relative future performance of stocks versus bonds, there appears to be a strong correlation where a high ECY portends that stocks will outperform bonds in the coming decade. At the moment the ECY is a little below 4% suggesting stocks will indeed outperform bonds in the coming years, providing comfort to some that the market is fairly valued. Yet with nominal 10-year rates below 1%, the ECY still implies fairly meager returns for the stock market in the coming decade.
December 11, 2020
Inflation Expectations | On the rise
Inflation expectations, as measured by the 10-year breakeven rate for Treasury Inflation Protected Securities (TIPS), have risen in recent weeks on optimism based on positive Covid-19 vaccine news and the potential for additional stimulus. However, expectations for CPI inflation still remains below the Fed's target of 2% as seen by the purple line in the graph below which shows 10-year expected annual CPI inflation of 1.91% indicating that investors at least still aren't sure the Fed can boost the economy or prices to the level desired. And expectations for the Fed to hit its target are actually probably even lower than that as the Fed's preferred inflation measure is the Personal Consumption Expenditures (PCE) index which usually is lower than the headline CPI inflation number for a variety of technical reasons. What happens to inflation in the coming years will have a big effect on the financial markets as low inflation and interest rates are a big underpinning for the current high level of asset prices.
December 4, 2020
Bitcoin | The real FOMO story is back
While stocks continue to march ever higher despite everything that has happened this year, the real Fear-of-Missing-Out (FOMO) story of 2020 is Bitcoin and other cryptocurrencies which are booming with Bitcoin rising above its previous seemingly bubbly high reached in December of 2017. So far this year, Bitcoin is up over 168% while stocks, as measured by the S&P 500 Index, have returned a meager 17%. What this all means, we honestly don't have a clue. Whether one believes Bitcoin has only yet begun to increase in value or is in for another painful fall seems to be more a matter of faith than objective analysis. But it certainly does feel like the world has become much more prone to financial bubbles of various sorts over the past two decades.
Bitcoin and S&P 500 1/1/2020-12/3/2020.
Bitcoin and S&P 500 1/1/2017-12/3/2020.
Stocks | Higher and higher
November 27, 2020
As stocks have continued to set new all-time highs in recent weeks, the total valuation of the US stock market relative to the size of the economy remains at a highly elevated level. The chart below shows the total market capitalization of the Wilshire 5000 index divided by GDP. This ratio may have appropriately trended higher over time as large multi-national companies have garnered more revenue from outside the US; however, the biggest fundamental drivers pushing it to current levels are rock-bottom interest rates, low inflation and historically high profit margins (or the expectation that those high profit margins will quickly return). If any or all of these pillars were to falter, the market will have a hard time maintaining its outsized value relative to the economy.
Source: Wilshire, YCharts
November 20, 2020
Economic Growth | Headed back to the future
The economy has bounced back much more quickly than expected from the quick, deep Covid-lockdown recession experienced earlier this year. Even with a resurgence of the virus and waning fiscal support likely slowing the recovery, the general consensus is that the economy will continue to grow at a relatively high rate in the coming quarters. Looking beyond that short-term spurt of growth, however, the long-term outlook for economic growth is for a return to the slow pace of the past decade, as the chart below from the Congressional Budget Office indicates. At the end of the day, an economy can only grow as fast as the growth of its labor force and the growth in the ability of that labor force to produce more per person (i.e., productivity growth). The US economy enjoyed relatively fast economic growth during the latter half of the last century thanks to healthy growth in both the number of workers and productivity. However, for various reasons (e.g., slower population growth, lower immigration, and less of a boost from women entering the labor force), the labor force in the US is expected to grow much more slowly in the coming decades while productivity growth is expected to remain relatively stable. After the Second World War, the US was in part able to normalize the large amount of debt it had accumulated thanks to the fast pace of economic growth. Slower growth in the coming decades will make it harder to normalize the high and mounting debt levels in the US. A burst of productivity may yet save the day, or inflation may be invited back to do the job.
Source: Congressional Budget Office,
November 13, 2020
Stock Market | The Great Rotation?
With the announcement this week that at least one potential vaccine for Covid-19 is proving to be highly effective in late stage trials offering an apparent light at the end of the tunnel, investors accelerated their rotation back into stocks that have struggled the most during the pandemic. To the recent market high on September 2, large cap growth stocks had outperformed small cap value stocks by nearly 49% for the year. Since then, however, small cap value stocks have outpaced large cap growth by about 13%, having picked up nearly 8% just in the past week. Thanks to this rally in small and mid cap stocks along with value stocks, the broader market hit a new all-time high on Friday even while many of the previous winners have lagged a bit.
Source: Ycharts. Past performance may not be indicative of future results. The Vanguard Small-Cap Value ETF (VBR) employs an indexing investment approach designed to track the performance of the CRSP US Small Cap Value Index, a broadly diversified index of value stocks of small U.S. companies. The Vanguard Growth ETF (VUG) employs an indexing investment approach designed to track the performance of the CRSP US Large Cap Growth Index, a broadly diversified index of growth stocks of large U.S. companies.
November 6, 2020
Labor Market | The best and worst of times
While the country continues to wait for the final results of the Presidential election and the stock market has roared back near its all-time high, the latest report on the labor market released Friday continued to paint a picture of an economy on the mend but far from where it was before the Coronavirus lockdowns back in the spring. On the plus side, the economy has added back more than 12 million jobs since April which is by far the fastest six months of job growth ever, the unemployment rate has fallen rapidly for six straight months to 6.9% as employees on temporary layoff continue to be called back to work, and permanent unemployment even declined ever so slightly in October. (See the first chart below where the total unemployment rate is the red line and permanent unemployment is the blue line). On the negative side, there are still 10 million fewer people with a job, the participation rate remains well below where it was in February, and total nonfarm employment is down more than 6% compared to October 2019 – still the largest year-over-year decline in over seven decades. (See the second chart below for the year-over-year percent change in total employment.) Leisure and hospitality remains the hardest hit sector by far with employment still down more than 3 million (~20%). The only area that has seen some growth is the federal government thanks to temporary census workers, but that is winding down. (See the third group of charts below for job losses by sector.) With the pace of job growth slowing and the Coronavirus rearing its ugly head again as we head into winter, it continues to seem likely that it will to take a while to regain all of the jobs lost.
Source: fred.stlouisfed.org, bls.gov/news.release/empsit.t17.htm#ces_table1.f.p
October 30, 2020
GDP | Bouncing to a bad fall
This week initial estimates for economic growth indicated that the inflation-adjusted real Gross Domestic Product for the U.S. bounced higher last quarter at an impressive 33.1% annualized rate after falling at an equally impressive annualized rate of 31.4% in the second quarter. Real GDP remains down 2.9% from where it was in the third quarter last year and is still 3.5% below its recent peak reached in the fourth quarter of 2019. That is only slightly above the previous two worst recessionary drawdowns in 1958 (3.6%) and 2009 (4.0%). See the chart below of historical drawdowns in GDP, both nominal (purple line) and real (orange line). All to say, while the economy has come back a long way, it has only reached where it typically is at the bottom of a deep recession. Nevertheless, thanks to unprecedented fiscal and monetary stimulus, real disposable personal income is actually 3.9% higher than it was at the start of the recession, and spending on goods is up 8.0% (though total personal consumption is still down 2.6% with spending on services down 7.3%). While the economy recovered much more quickly than anticipated last quarter (which may in part explain the rally in the stock market since March), the current consensus is that the recovery is now slowing more quickly than was expected (which may in part explain the market's unhappiness at the moment). Rising cases of Covid-19 and waning fiscal stimulus are certainly serving as headwinds slowing the economy's recovery.
Source: Ycharts. BEA.
October 23, 2020
Growth vs Value | Rhyming if not repeating
The rapid and substantial market rally off of the March lows has offered many opportunities to make comparisons to previous unusual market moves. The recent outperformance of growth stocks versus value stocks certainly lends itself to such a comparison with the most obvious parallel being the tech bubble in 2000. As the chart below shows, growth's relative outperformance this year up to the recent market high on September 2 was roughly equivalent to its outperformance during the final dramatic run-up in the stock market twenty years ago from July 1999 to March 2000. Value has made up a bit of ground since that September high; however, even if September 2 marked the highwater mark for growth stocks, perhaps the only truly reliable lesson from charts such as this is that the path forward will be volatile.
Source: Ycharts. AOWM calculations. Past performance may not be indicative of future results. The Russell 1000 Growth Index® is a market capitalization weighted index based on the Russell 1000 index. It includes companies that display signs of above average growth. The Russell 1000 Value Index® is a market-capitalization weighted equity index maintained by the Russell Investment Group and based on the Russell 1000 Index, which measures how U.S. stocks in the equity value segment perform.
October 16, 2020
Commercial Credit | Banks tighten, Market loosens
Adding to the growing list of things zigging this days as opposed to how they have historically zagged is commercial credit. As has historically been the case in a recession, banks have tightened up their standards for lending to businesses. This tightening of lending standards has historically corresponded with higher credit spreads in the publicly traded corporate debt markets - i.e., an increase in the yield on corporate debt relative to risk-free government debt - as investors require more compensation for the increased risk of default. Not this time, however. As the graph below shows, banks are continuing to tighten credit (the blue line) as one would expect, but corporate credit spreads (the red line), after initially spiking higher in March, have normalized back to less stressed levels thanks to the actions taken by the Federal Reserve to buy corporate bonds for the first time to calm the markets. This has led to record corporate debt issuance in recent months as large corporations with access to the public debt markets have taken advantage of the accommodating market environment and low interest rates. Smaller businesses that rely on banks for loans have not been as fortunate. The growth in total corporate debt usually slows or turns negative following a recession, leading to a decline in corporate debt as a percentage of GDP (see the second chart). The growth of commercial loans from banks looks likely to follow that historical pattern, but the issuance of new publicly traded corporate debt may lead total corporate debt to buck that trend. Much like with the burgeoning federal government debt, it remains to be seen if and when ever higher levels of corporate debt will cause problems.
October 9, 2020
Consumer Credit | Paying off those credit cards
As the powers-that-be in Washington continue to debate additional fiscal stimulus, it is clear that one of the things individuals have done with the first round of Covid-relief checks and extra unemployment insurance is to pay off some of their outstanding credit card balances. As shown in the blue line in the chart below, revolving consumer credit is down over 9% since last year - a much quicker drop than previous recessions. Auto loans and other non-revolving consumer credit (the red line) has continued to grow but is also starting to show signs of slowing down. The second chart shows the monthly flows in revolving and non-revolving credit. The fact that individuals are putting their fiscal houses in order should help set a firmer foundation for the future economic expansion, but to the extent it is indicative of wary consumers and lenders, it may be another sign of a pending slow economic recovery.
Consumption and Savings | An unusual recession
October 2, 2020
The government's unprecedented fiscal stimulus has thus far in aggregate more than offset the decline in wages and income as seen in the first chart below. The government has done a good job in mitigating declines in income during past recessions. This time around, however, the government has more than compensated, leading to a record jump in disposable income in April, and even through August, disposable personal income in aggregate was still nearly 4% higher than it was last year at this time while income and wages were down by more than 2%. That plus the odd conditions accompanying a pandemic have led to some unusual spending and savings numbers over the past six months. In particular, the consumption of goods (the blue line in second graph) has spiked higher while the consumption of services (the green line) has lagged. Typically the reverse is true, but a pandemic makes getting out difficult and buying stuff online more attractive. At the same time, given the uncertainty of the moment and the amount of cash the government has pushed out the door, folks are also saving much more than usual. The personal savings rate spiked to over 30% in April when the government dumped money into bank accounts, but you couldn’t leave your house to spend it. Five months later, the savings rate was still higher than at about any point in the past sixty years. This should provide some cushion for individuals if more government stimulus is not passed, but if savings remains high that clearly will slow consumption and the economic recovery.
September 25, 2020
Federal Debt | Does it matter? We shall see.
In its latest long-term forecast for the federal budget released this week, the Congressional Budget Office (CBO) projected that the federal debt held by the public would increase steadily towards nearly 200% of GDP by 2050, nearly double the previous peak reached during World War II. (See the first graph below.) The CBO’s bi-annual projections have painted an increasingly dire fiscal picture for the federal government with the latest deterioration being driven by the pandemic-induced recession and the massive fiscal spending that has accompanied it. The sizable long-term budget deficits forecasted by the CBO are in large part based on the expectation for rising interest expense as both the amount of debt and the cost of financing it are projected to increase over time. (See second chart below.) The CBO projects that the net interest expense as a percent of GDP will rise from 1.6% today to 6.5% in 2050. For some perspective, the net interest expense on the federal debt was just 3.2% in 1991 when concern about the federal deficit was at its zenith. Lawmakers have been able to ignore the expanding federal debt over the past two decades as declining interest rates have kept down the cost of financing large annual deficits. Even if interest rates never go up again, the CBO projections indicate that the federal debt will continue to grow faster than the economy. But the powers-that-be will likely continue to ignore it, for better or worse, until the cost of paying for the snowballing debt gets high enough to once again grab their attention.
Source: Congressional Budget Office,
Low Rates | Gonna need a bigger piggy bank
September 18, 2020
The Federal Reserve indicated this week that it plans to keep interest rates at their historically very low level until at least 2024. The suppression of risk-free interest rates (and now even risky interest rates with the Fed's recent actions in the corporate bond market) has undoubtedly played a role in pushing asset prices higher in recent months. What the other positive or negative ramifications of the Fed's policies will be remains to be seen. One potential unintended consequence could be increased savings (and in turn lower consumer spending) as the amount of savings necessary to generate income has skyrocketed (see the chart below). The alternative is for investors to move further and further out the risk curve in search of income (and in turn push risky asset prices higher and higher, fostering potential financial instability). Policymakers are in the unenviable position of having to try to untie the Gordian knot of how best to support the economy in the short and long run. The Fed's swift and unprecedent response to the pandemic have helped to prop up the economy and the market over the past six months, but it's possible policymakers are offering up too much of a good thing for the long-run health of the country.
Source: fred.stlouisfed.org, AOWM calculations -- $50k / 10-yr yield
Inflation | Speeding along thanks to used cars
September 11, 2020
How inflation behaves in the coming months and years will play a big role in determining how effective the unprecedented fiscal and monetary stimulus that has been unleashed will ultimately prove to have been for supporting the economy and the market. If high, volatile inflation has been unleashed, economic growth and stock valuations will suffer in the long run. Recent months have seen a jump in inflation, but so far it may just be a reasonable rebound from the unusual decline in prices experienced back in the spring during the lockdowns. August inflation numbers released on Friday saw another healthy month-over-month increase in consumer prices. Monthly inflation was down from July, but core monthly inflation excluding food and energy (the blue line in the first graph below) continues to run hotter than it has since the early 1990s. The high monthly inflation in August was in part due to the biggest monthly jump in used car prices since 1969 when overall annual inflation was running at more than 5% (see second chart below).
Historic Market Rally | Main Street Still Hurting
September 4, 2020
At the close of the market on Wednesday, the S&P 500 Index hit another record high capping a 60% rally off its March 23 low – a five-month rally unlike anything seen since the early 1930s. (See the first chart below.) And those market rallies in the 1930s came only after investors had endured almost three years of falling prices that drove the market down by more than 85%. We just had to endure a 34% month-long market decline, before stocks took off fueled by unprecedented fiscal and monetary stimulus that drove the valuation of the S&P 500 relative to forward estimated GAAP earnings above levels seen during the tech stock boom in the 1990s. But as the last two days of the week suggest, the market may have gotten more than a little ahead of itself. Indeed the latest jobs report for August released Friday, while showing an encouraging drop in unemployment to 8.4% and further declines in temporary layoffs, also reported a new increase in the number of permanent job losses – which is a better indicator for the underlying health of the job market. As the second chart below of the year-over-year change in the S&P 500 and the year-over-year change in permanent unemployment (inverted) indicates, the market does indeed bottom and start to show life before the economy, but the gap between Wall Street’s forward optimism and Main Street’s current pain is larger than normal. Even after the sell-off at the end of the week, the S&P 500 is still up more than 15% over the past year while permanent job losses are up 2.1 million and trending higher.
Source: Yahoo Finance, fred.stlouisfed.org, AOWM calculations
Monetary Policy | Shooting for more inflation
August 28, 2020
This week the Federal Reserve announced a significant update to its stated longer-run goals and monetary policy strategy. The Fed has moved from having a specific inflation target of 2%, above which monetary policy would likely be tightened, to a flexible average inflation target that would allow monetary policy to remain more accommodating during a recovery. Specifically, the revised strategy statement indicates that "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." Long-term Treasury yields ticked up slightly on the news and the expectation for potentially higher inflation. Long-run market inflation expectations as measured by the spread between the nominal 10-year Treasury yield and the 10-year Treasury Inflation-Protected Securities (TIPS) yield has been grinding higher since the market bottom at the end of March and continued to do so after yesterday’s announcement. The graph below shows the nominal 10-year Treasury yield (the blue line), the real 10-year TIPS yield (the red line), and the expected break-even inflation rate (the orange line) from which we take note of two things: 1) 10-year inflation expectations remain well below the Fed’s 2% target suggesting that investors don’t yet believe the Fed will be able to generate its target average inflation, though their belief that higher inflation is on the horizon grows with each passing day; and 2) while market inflation expectations have been moving higher, nominal rates have remained largely unchanged as real yields decline, all suggesting the bond market has been increasingly pricing in expectations for a period of stagflation (i.e., rising inflation but weak economic growth). How much the Fed’s growing balance sheet is distorting the signals provided by the bond market is an open question as is how increasing efforts to emphasize an extremely loose monetary policy for as far as the eye can see might be inflating asset prices to a dangerous degree.
Stocks | What Bear Market?
August 21, 2020
The S&P 500 Index set a new all-time high this past week, eclipsing its pre-Covid lock-down high on February 19 and officially making the 34% decline in the market that bottomed on March 23 the shortest bear market in history at just 32 calendar days and 23 trading days. The typical bear market over the past 75 years has lasted for over a year with the previous shortest bear market during that period being the market blip in 1987 that lasted 100 calendar days and 71 trading days. The rebound has been equally unprecedented, with the overall market reclaiming all of its lost ground in less than four months when it typically takes years. Again the previous quickest recovery was after the 1987 market decline and that took nearly two years. The trillions of dollars in fiscal and monetary stimulus that have been pumped into economy have helped the market quickly rebound while also potentially pushing some stocks to overly optimistic valuations. The rising market tide has not lifted all boats equally, however, as 64% of the stocks in the S&P 500 are still below their price on February 19 with 47% down more than 10% and 33% down more than 20%. Whether the winners of the past few months will falter to join the laggards or the economy will rebound sufficiently for the laggards to catch up is the big question. Trading technicals and investor sentiment suggest that the general stock market is due for at least a mild correction or pullback, but Mr. Market has proven to be inclined to defy expectations these days.
Source: YCharts, Yahoo Finance, AOWM calculations
Financing the Federal Deficit | No TIPS Please
August 14, 2020
Thus far the US Treasury has largely funded the federal government's record budget deficit this year by issuing record amounts of short-term Treasury bills that mature in one year or less. This has pushed the T-bills’ share of the Treasury’s marketable debt to over 25%. In recent weeks, the Treasury has started to shift its financing out the yield curve by increasing the auction sizes for its long-term Treasury notes and bonds. However, the Treasury is not increasing its issuance of inflation-protected securities (TIPS) despite its massive financing needs and the strong demand for TIPS at the moment. TIPS are harder for the government to payback as their redemption value grows with inflation which forecloses a popular method for paying off the public debt by inflating the value of the currency. TIPS have fallen to less than 8% of the Treasury’s outstanding marketable debt. The charts below show the record net issuance over the last two fiscal quarters of 2020 (the federal government’s fiscal year ends on September 30) and the percentage of outstanding Treasury debt in T-bills, TIPS and floating rate notes.
Source: U.S. Treasury, https://home.treasury.gov/system/files/221/TreasuryPresentationToTBACQ32020.pdf
Labor Market | Encouraging Signs
August 7, 2020
Some encouraging news for the labor market this week. Initial jobless claims, though still over a million, fell to the lowest level since the surge in claims began in mid-March, and the jobs report for July released Friday morning showed the economy added 1.8 million jobs last month as the unemployment rate fell to 10.2% from 11.1% in June and a peak of 14.7% in April. Employees continue to be called back from temporary layoffs (the red line in the chart below), and even more encouragingly the number of permanent job losses (the blue line in the chart) stabilized in July after increasing rapidly over the preceding four months. Whether the increase in permanent job losses has peaked or merely paused is the big question.
Source: U.S. Bureau of Labor Statistics, Unemployment Level - Permanent Job Losers [LNS13026638], retrieved from FRED, Federal Reserve Bank of St. Louis; Level - Job Losers on Layoff [LNS13023653], retrieved from FRED, Federal Reserve Bank of St. Louis; August 7, 2020.
Economic Growth | Historic Decline
July 31, 2020
The initial estimate of real GDP growth in the second quarter is that the economy shrank at an annualized rate of 32.9% and was 9.5% smaller than it was a year ago. While the recovery appears to have slowed over the past month, the annualized growth this quarter is still likely to be impressively strong. The New York Fed recently developed a Weekly Economic Index to attempt to track the growth of the economy in real time. That index currently estimates that the economy is still about 6.6% smaller than it was a year ago. (For some perspective, at the nadir of the last "great" recession, the economy was down 3.9% on a year-over-year basis.) However, even if the economic recovery completely stalls at this depressed level, annualized real GDP growth in the third quarter will still be over 16% based on the current Weekly Economic Index estimate – historic economic growth that may feel like anything but that with unemployment above 10% and weekly initial jobless claims consistently well over one million. The first chart below shows the year-over-year change in real GDP in red since 1948 and the Weekly Economic Index in blue since 2008. The bottom chart shows the Weekly Economic Index over the past year.
Source: Lewis, Daniel J., Mertens, Karel and Stock, James H., Weekly Economic Index (Lewis-Mertens-Stock) [WEI], retrieved from FRED, Federal Reserve Bank of St. Louis; ; U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis;
Notable Trends | Tracking Covid-19's Impact
July 24, 2020
Starting the last week in April, the U.S. Census Bureau began a new weekly survey to measure the impact of the Covid-19 pandemic. Below are the changing responses over the past eleven weeks. The survey indicates that half of the households in the US have now experienced some loss of income since the middle of March, and over a third expect to experience a loss of employment income over the next four weeks – a number that has ticked higher in recent weeks as Covid-19 cases have spiked and the economic recovery has at best slowed. Unprecedent relief payments from the federal government have largely offset those losses in wages to date; however, even with the passage of another government stimulus package on the horizon, the negative economic impact of the pandemic is likely to increase in the coming months for millions of Americans.
Source: US Census Bureau, https://www.census.gov/programs-surveys/household-pulse-survey.html
July 17, 2020
Banks | Deposits up, Loans down
This past week, the biggest banks reported second quarter earnings, which were generally better than lowered expectations thanks to trading profits offsetting increasing provisions for credit losses as the outlook for the economy turned gloomier over the past quarter. On the plus side, bank deposits have increased significantly in recent months because of the significant government stimulus which has left bank accounts flush with cash. The effect of that stimulus has thus far been somewhat muted by the fact that banks have not multiplied that freshly printed cash through the financial system via new loans, excluding loans made as part of the Paycheck Protection Program. Indeed bank loans as a percentage of bank deposits have fallen to their lowest level since the mid 1970s (the blue line in chart below), accompanying a general decrease in the velocity of money – i.e., how many times a dollar circulates through the economy (the red line in the chart below). A decline in the demand and supply of bank credit as borrowers look to pay down debt and banks tighten lending standards in the current uncertain environment would be a headwind to a brisk recovery. However, at the same time, the decline in the velocity of money should also mitigate concerns about inflation, at least in the short term.
Source: Board of Governors of the Federal Reserve System (US), Loans and Leases in Bank Credit, All Commercial Banks [TOTLL], Deposits, All Commercial Banks [DPSACBW027SBOG], Velocity of M2 Money Stock [M2V], retrieved from FRED, Federal Reserve Bank of St. Louis;
Labor Market | Hard to Comprehend
July 10, 2020
The jobs report for June offered hopeful signs of a recovering labor market as unemployment fell to 11.1% and labor force participation moved higher. However, behind the encouraging headlines was the disconcerting rapid increase in permanent job losses which are increasing much more quickly than in the past two recessions. Also hard to square with the falling official unemployment rate is the continuing high number of individuals claiming unemployment benefits each week. Initial weekly claims for unemployment insurance remain above 1.3 million, and nearly 33 million individuals were receiving unemployment benefits as of the middle of June. These numbers may have only worsened in the past few weeks as some states have paused or rolled back reopening in the face of rising Covid-19 cases. How 33 million individuals can be receiving unemployment benefits while official unemployment has declined to less than 18 million is one of the many headscratchers of the current moment.
Source: U.S. Bureau of Labor Statistics, Unemployment Level - Permanent Job Losers [LNS13026638], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/LNS13026638, July 9, 2020.
Treasury Cash Balance | Uncle Sam Seeks Liquidity
July 2, 2020
During the second quarter, the federal government raised an unprecedented $2.8 trillion in cash via new net debt issuances, and the US Treasury cash balance has reached historically high levels over $1.6 trillion. The Treasury has stated that its “cash balance will likely remain elevated as Treasury seeks to maintain prudent liquidity in light of the size and relative uncertainty of COVID-19-related outflows.”
Source: Board of Governors of the Federal Reserve System (US), Liabilities and Capital: Liabilities: Deposits with F.R. Banks, Other Than Reserve Balances: U.S. Treasury, General Account: Week Average [WTREGEN], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WTREGEN, July 2, 2020.
Corporate Debt | Escalation
June 28, 2020
In the first quarter of 2020, non-financial corporate debt grew at a rate of 24%, exceeding its post-WWII growth rate record of 22% set in the first quarter of 1970. In conjunction with its rapid growth, as the chart below illustrates, nonfinancial corporate debt has also now reached all time highs as a percent of U.S. GDP, approaching nearly 50%. Corporate debt was at a high level before the pandemic and has only climbed higher as companies have raised cash to maintain liquidity. The high level of debt could further exacerbate the weak economy if defaults escalate and companies seek to de-lever.
Board of Governors of the Federal Reserve System (US), Nonfinancial Corporate Business; Debt Securities and Loans; Liability,Level [BCNSDODNS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BCNSDODNS, June 26, 2020.
Percent Change | Consumer Spending
June 19, 2020
Opportunity Insights, a research and policy institute based at Harvard University, has developed a real-time tracker of economic activity using anonymized data from several private companies, such as credit card processors and payroll firms. The “Economic Tracker” provides statistics on the economy’s week-to-week recovery from the Covid-19 shutdowns. Among other things, the tracker shows that consumer spending is still down 11.3% from its level in January. Spending had a strong initial bounce from the 33% decline reached in early April, but the pace of the recovery has slowed in recent weeks. The data also indicate that spending in high income zip codes remains more depressed still down 16.8% versus middle income (down 9.9%) and low income (down just 4%). You can find more information at tracktherecovery.org.
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May 10, 2021
A tell-tale sign of excessive exuberance in the financial markets has historically been investors using increasing amounts of debt to leverage their bets on a booming market. And there are signs that may be occurring in the stock market these days. Margin debt – that is the amount of money investors have borrowed to buy stocks – has increased 50% from before the pandemic to hit an all-time high level in concert with the stock market. Margin debt has been running at historically high levels for several years, but the rapid increase over the past year has understandably raised concerns. To alleviate those concerns, bullish investors highlight that when adjusted for the current size of the stock market, margin debt is actually down from where it has been in recent years. They also point out that in 2000 and 2007 margin debt had continued to increase rapidly even as the stock market’s gains slowed, while so far this time around both have been galloping forward in unison suggesting the increase in margin is not excessive or imprudent. Margin debt may not be an unambiguous warning signal at the moment, but frothy valuations coupled with record leverage has the potential to ultimately be the recipe for some rather breathtaking market movements.
Margin Debt | In the eye of the beholder...
Source: YCharts, FINRA, AOWM calculations