Chart of the Week

November 29, 2021

 Inflation | Banking on this time being different

A new Covid variant is once again scrambling attempts to project where the economy is headed. Before Omicron, there was the hope that the US economy would continue to expand quickly next year while the inflation rate would retreat from over 6% back towards 2%. Barring further Covid disruptions, there are logical reasons inflation should decline – e.g., used car prices will surely eventually stop rocketing to the moon; however, it would be a historical anomaly for inflation to decelerate as much as expected while the economy continued to expand at a fast rate. Indeed, over the past sixty years, every year-over-year decline in CPI inflation of 3% or more has been accompanied by an economic recession. Policymakers at the Fed believe this time will be different – or they are in reality OK with inflation remaining higher for longer than they can explicitly admit. How Covid will continue to scramble historical comparisons and the future is anyone’s guess.

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Sources: YCharts, BEA, BLS, AOWM calculations

November 22, 2021

 Corporate Profits | Will gravity take hold?

Corporate profits continued to exceed expectations last quarter with nearly 80% of the companies in the S&P 500 beating the consensus forecast. (The recent historical average before the pandemic was around 70%.) After falling 33% in 2020 due to the brief, sharp Covid recession, reported GAAP earnings per share for the S&P 500 are expected to more than double this year to a record high level. Earnings growth is anticipated to slow next year but remain a solid 8%. In nominal or real terms, corporate profits are at the high end of their historical growth range. The expansion in profitability over the past decade has been impressive with current earnings over 50% above their 10-year trailing average adjusted for inflation. The last two times in 2000 and 2007 that earnings got this far above their recent historical average, gravity took hold. At the very least, earnings growth seems likely to slow and remain relatively tame for the foreseeable future. The stock market could continue to roll higher without significant earnings growth, but it would require investors to pay even more for a dollar of earnings when they are already paying a historically high price.

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Sources: YCharts,, S&P, BLS, AOWM calculations

November 15, 2021

 Real Earnings Yield | All-time low...

Inflation continues to prove less transitory than hoped or expected with the Consumer Price Index up 6.2% in October compared to the year before – the highest level in over thirty years. At the same time the trailing real earnings yield for the S&P 500 Index (i.e., earnings divided by the price minus one-year inflation), fell to its lowest level on record, below negative 2%. The previous times the trailing real earnings yield has fallen below zero a significant market drawdown of at least 20% hasn’t been far off. However, history has been a notoriously bad guide over the past year and a half. If the current expectations for corporate profits are met (and earnings have generally exceeded expectations in recent quarters) and inflation retreats towards 2%, the current negative real earnings yield may just end up being another unprecedented artifact of the Covid market.

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Update on consumer sentiment: Last week we noted the divergence between consumer sentiment and market valuations. The latest reading from the Surveys of Consumers performed by the University of Michigan released on Friday showed the divergence widening further with consumer sentiment falling to levels last seen during the great financial crisis over a decade ago. If curious about what is asked to compile the consumer sentiment index, here’s the link to the survey questions from which the index is derived: 

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Sources: YCharts,, University of Michigan, S&P, BLS, AOWM calculations

 Consumers | Less bullish than investors

November 8, 2021

The jobs report released last week showed continued improvement and tightness in the labor market with the unemployment rate falling to a relatively low 4.6%. At the same time, the Federal Reserve recommitted to maintaining a highly accommodative monetary policy until more individuals are able and willing to rejoin the labor force with the expectation that the current high level of inflation will naturally subside. The encouraging signs of strength for the economic recovery coupled with the extended long good-bye for extreme monetary stimulus helped to push interest rates down and the stock market to a week of one all-time high after another. Despite the strength of the economy, consumers have been less sanguine than investors in their outlook – at least as measured by the University of Michigan’s Surveys of Consumers. Valuations in the stock market have historically tracked well with consumer sentiment as psychological waves of optimism and pessimism wash broadly over the economy. That has not been the case since the pandemic bottom as stocks have gone to the moon while consumer sentiment has remained grounded – a divergence in sentiment that is not likely to persist indefinitely.  We’ll get another read on how the consumer is feeling at the end of this week when the University of Michigan releases its preliminary survey results for November.

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Sources: YCharts, BLS, University of Michigan, S&P, AOWM calculations

November 1, 2021

 Growth & Inflation | Diverging outlook

At the beginning of July, economists were expecting the rapid economic recovery to continue in the third quarter with growth anticipated to be around 7% annualized. Instead supply bottlenecks weighed down the consumption of goods and the Delta variant slowed the recovery in the service economy, all of which reduced economic growth to a mere 2%. The consumption of goods remains well above the growth trend it was on before the pandemic even with the supply chain issues; thus, while goods consumption may rebound some as supply chains normalize, it is unlikely to add much to economic growth for the next couple of years. Looking forward, growth will be dependent largely on individuals returning to their pre-Covid spending habits and their consumption of services – which should happen if the pandemic mercifully continues to recede. Nevertheless, even as the stock market surged to new highs in October, the bond market highlighted the challenge facing the economy and policymakers. The yields on short-term debt increased in anticipation of the Federal Reserve needing to raise interest rates to rein in inflation while the yields on long-term debt with maturities of 10 years or more barely moved or even declined, likely reflecting concerns about growth. At the very long-end, the yield curve even inverted with the yield on the 30-year Treasury bond falling below the yield on the 20-year bond. Across the real yield curve for Treasury Inflation-Protected Securities, real inflation-adjusted yields fell in October, providing another indication of bond investors' twin concerns for higher inflation and slower growth. The policymakers at the Federal Reserve will give some indication this week of how they plan to navigate the diverging outlook for growth and inflation as they look to begin winding down the Fed's asset purchases as a first step in normalizing monetary policy.

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Sources: YCharts,, US Treasury, BEA, AOWM calculations

 Stocks | Minting new highs

October 25, 2021

After a mild pullback in September, large-cap stocks were back to minting new all-time highs last week even as small-cap stocks continue to trade largely sideways. A slew of earnings reports this week will test the strength of the current rally as roughly a third of the companies in the S&P 500 representing almost half the index’s market value report over the next five days. So far third quarter earnings have largely continued to exceed expectations. Inflation and wage pressures have yet to dent corporate profits but pose an increasing risk to the current outlook for sustained high profit margins.    

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Sources: YCharts, AOWM calculations

 Workers | Increasingly confident and hard to find

October 18, 2021

The number of individuals quitting their jobs has ratcheted higher in recent months. In August, more than 5 million workers left for greener pastures. At the same time, it is taking companies longer to fill positions with the number of open positions relative to new hires at its highest level in the past twenty years. The current ratio of openings to hires is 1.7 which suggests it is taking nearly two months on average for companies to find a new employee. The strong labor market is a clear sign of the economy’s strength, but also perhaps a sign of the pendulum beginning to swing back towards workers having greater bargaining power for higher wages.   

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October 11, 2021

 Energy | Another Inflationary Pressure

Energy prices are spiking across the globe as the Covid pandemic continues to be the long transitory tail wagging the economy. A colder than normal winter could send energy prices even higher, which would be deleterious for economic growth and inflation. Fossil fuel prices may also persistent at a higher level than in recent years as the push towards renewable energy and the generally negative view of carbon-based fuels has decreased investment in fossil fuels and raised the price needed to attract the new investment necessary to increase supply. The fact that the stock prices for many energy companies remain below their pre-Covid levels despite the increase in oil and gas prices shows investors’ continued wariness about the industry and the simultaneous challenge of smoothly transitioning to renewable energy for a world that still predominantly depends on fossil fuels to function.

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Sources: YCharts, World Bank Energy Price Incdex (, MSCI ACWI Energy Index includes large and mid cap securities across 23 Developed Markets (DM) and 27 Emerging Markets (EM) countries, S&P GSCI serves as a benchmark for investment in the commodity markets and as a measure of commodity performance over time.

October 4, 2021

 Bonds | Waning diversification benefits?

The ever so mild market turmoil in September saw the S&P 500 stock index fall 5% for the first time in eleven months and long-term interest rates increase. The simultaneous decline of both stock and bond prices highlights a concern that the diversification benefits of bonds may not be as great as they have been in the past as both asset classes trade at historically elevated valuations. Over the past twenty years bonds have nicely zigged when the stock market has zagged; however, ultra-low interest rates have created an environment that makes both stocks and fixed income securities more susceptible than they have ever been to a sell-off if rates rise significantly. Nevertheless, if investors ever again adopt a true risk-off mentality for some reason other than inflation, US Treasuries are likely to continue to serve as a perceived safe port in the storm, and the forty year downward trend in yields may not be over yet.

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Sources: Federal Reserve, S&P,, AOWM calculations of monthly average data

September 27, 2021

 Monetary Policy | Normalizing at a deliberate trot

Last week the Federal Reserve indicated it is likely to normalize monetary policy slightly faster than it had previously anticipated in the face of inflation that has proven more persistent than policymakers had initially forecasted. The Fed’s purchases of Treasury and mortgage debt may now be fully wound down by the middle of 2022, and the majority of Fed policymakers now expect the Fed’s target short-term interest rate, the Fed Funds Rate, to begin increasing next year instead of 2023. It will still be a relatively slow adjustment in policy from an extremely accommodating starting point that has the real Fed Funds Rate adjusted for inflation in uncharted territory. Policymakers, however, may not have the luxury of a such a slow normalization of interest rates (to a level that just a few years ago would have been viewed as still rather accommodating) if the labor market continues to tighten, inflation remains stubbornly high, and asset prices continue to elevate above historical norms.

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September 20, 2021

 August Inflation | Succor for the transitorists

Inflation slowed in August giving succor to the general consensus view that the recent rapid pace of price increases will slow and prove to be merely transitory. The Consumer Price Index (CPI) was still up over 5.3% compared to last year, but monthly inflation decelerated to 3.3% on an annualized basis (and monthly core inflation excluding food and energy prices slowed even more to 1.2% annualized). Current monetary policy and valuations in both the equity and fixed income markets are banking heavily on inflation continuing to cool in the coming months. One item that might keep inflation running higher for longer than desired is the likely increase in the largest component of the CPI – the price of shelter which makes up over 30% of the index. The estimated housing inflation incorporated into the CPI has remained fairly subdued in recent months despite significant increases in house prices and market observed rents. As economists at the Dallas Fed have estimated, there is a good probability that the official housing inflation number will increase significantly in the coming months which could offset the decline in the pandemic-related transitory components of the CPI and keep overall inflation elevated at an uncomfortable level. However, the cost of housing has just half the weight in the Federal Reserve’s preferred inflation metric, the Personal Consumption Expenditures (PCE) index, compared to the CPI (15% vs 31%), which may partly explain policymakers' confidence that they have ample time to slowly remove the punch bowl. The CPI generally measures inflation to be higher than the PCE, and that has been even more so the case in recent months.

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September 13, 2021

 Charitable Giving | Record year

Americans are estimated to have given away a record $471.44 billion (~2.2% of GDP) in 2020 despite the recession caused by the Covid-19 pandemic. Giving was up 5.1% from 2019 thanks in no small part to the strong stock market and significant government relief payments, which undoubtedly helped prevent the usual decline in overall charitable giving experienced during a recession.  A Gallup survey performed in April of 2020 did show a decline in the number of individuals giving to charities especially among lower income households. Nevertheless, nearly three quarters of Americans still indicated that they had donated money to a charitable cause in the past year. If the stock market can make it to the end of the year without any major hiccups, charitable giving seems poised to hit another all-time high in 2021. Donor-advised funds remain an increasingly popular way for individuals to convert appreciated securities into charitable gifts with total assets in approximately one million DAFs approaching $200 billion. 

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September 6, 2021

 Labor | Scarce and underemployed

Labor remained both scarce and underemployed last month as job growth slowed significantly but the unemployment rate continued to decline to 5.2%. Since 1980, it has taken longer with each subsequent recession for the labor market to regain the jobs lost during the economic downturn. This time around, the downturn was both quicker and deeper; however, even with the slowdown in August, the economy is on pace to potentially recover the lost jobs in a little more than two years, as opposed to the six years it took to recover from the last recession. Nevertheless, there are still over five million fewer individuals employed than before the pandemic, but an unusual element of this downturn is that the labor force also declined significantly and still had three million fewer workers in August than before the recession. As a result, some sectors have struggled to find individuals to hire even as the labor market in terms of total jobs remains more depressed than it was at the trough of every downturn over the past sixty years excluding the recession that accompanied the 2008 financial crisis. While the end of extra unemployment benefits may encourage more individuals back into the labor force in coming months, many workers may have permanently left the labor force for one reason or another.

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Sources:, YCharts, BLS, AOWM calculations

Corporate Profits |  Poised to mean-revert?

August 30, 2021

After-tax profits as a percentage of National Income reached an all-time high in the second quarter. On a pre-tax basis, profits hit a level as a percentage of National Income that has only been exceeded three times since 1947 -- which is as far back as the Bureau of Economic Analysis goes in providing quarterly national accounts data. Over the past twenty-five years, corporate profits have taken an increasing share of the National Income while the percent of National Income going to employees has declined. Current market expectations are for profit margins not only to remain at their current historic level, but for them to continue to expand higher. At the same time, investors are also putting historically high valuations on that outlook for earnings -- all of which leaves investors with little margin for safety, especially as some of the demographic, inflation, interest rate, political, and globalization trends that have aided the expansion of margins over the past few decades appear unlikely to be as favorable going forward.

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Sources:, BEA, AOWM calculations

August 23, 2021

Risk Aversion | Increasing beneath the surface

While the stock market quickly bounced off another mild downturn last week, there are creeping signs of growing risk aversion among investors. Last month, the amount of margin debt borrowed to buy stocks declined for the first time during the market’s epic run over the past seventeen months. At the same time, activity in the options market shows signs that some investors are beginning to hedge their positions (or bet on a decline). The number of stocks participating in the market’s climb higher has also been declining, and the valuations of riskier small cap companies have largely traded sideways over the past five months while large cap stocks have continued to head higher. Along those same lines, many of the theme and meme plays that retail investors have been enamored with have begun to see the air come out of their balloon over the past six months. And even in the credit markets, which the Federal Reserve has largely lulled to sleep, the riskiest debt has seen yields tick higher since the end of June, while long-term US Treasury yields have declined. All of this may simply be some healthy rationalizing of investor behavior; however, in the short run, increasing risk aversion among investors would serve as a headwind for the market to surge significantly higher from its current lofty level.   

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Sources: YCharts,, FINRA, CBOE, AOWM calculations

Stocks | Smooth sailing...

August 16, 2021

On March 23, 2020 at the depths of the Covid market panic, the S&P 500 closed at 2237.4, down 33.9% from its closing value on February 19, 2020. Last Friday, August 13, 2021, the S&P 500 closed at another record high of 4468.0 – just 6.8 points or 0.3% away from doubling in value in less than 17 months. The last time the stock market doubled so quickly was the 1930s as the market was still languishing 40% to 70% below its 1929 high; today the market is 32% above its pre-Covid high. The S&P 500 would need to decline by 24% to around 3400 to get back to the average historical market rally after a decline of 30% or more. In addition to being an unusually rapid and large increase in the market, it has been a relatively smooth ride as well with no pullback reaching 10% and no 5% declines since last October. A period of above average stability, however, can often be followed by one of above average volatility. As the economist Hyman Minsky put it, “Stability leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits.” 

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Sources: YahooFinance, AOWM calculations

August 9, 2021

Jobs Report | The recovery continues

The jobs report for July released last Friday indicated that the economic recovery remains on a solid trajectory. The economy added around 940,000 jobs with the unemployment rate falling to 5.4%. There are still about 5.7 million fewer people employed than before the pandemic, but if the current pace of job gains continues, that gap could be made up by January and the labor market could be back on its pre-Covid growth trajectory by this time next year. Adding further strength to the recovery in the job market is the high demand for workers as indicated by the significant increase in job openings which were estimated to be around 10 million in June. (See first graph below comparing job openings to the current number of unemployed.) One minor note of caution in the jobs number is the seasonally adjusted estimate for the increase in employment by local schools which accounted for 220,700 of the estimated new jobs. The seasonally adjusted estimate for local schools proved to be overly optimistic last summer (see second chart). The trend for local school employment is nevertheless positive compared to last year, which suggests the seasonally adjusted gain is likely directionally correct. But that component demonstrates the challenge of gauging the strength of the recovery given the continued uncertain disruption caused in life and the data by Covid-19.    

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Sources: U.S. Bureau of Labor Statistics,

Economic Growth | Strong but below expectations

August 2, 2021

Initial estimates for economic growth in the second quarter came in below very high expectations with the economy expanding over the past quarter at a healthy annualized growth rate of 6.5% while many economists were expecting growth to exceed 8%. The economy has still recovered amazingly quickly over the past year with the fastest year-over-year growth in seventy years. Inflation-adjusted real GDP is already above the level it had reached before the pandemic, although it still has some ground to make up to reach its pre-Covid growth trend. Assuming the evil Delta variant doesn’t derail things, the economy is expected to continue to grow at a solid pace for the rest of year thanks to the continued rebound in the private consumption of services, which is the largest component of the economy.

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Sources: U.S. Bureau of Economic Analysis,, AOWM calculations

July 26, 2021

Corporate Profits | Wind beneath the market's wings

The stock market experienced a little turbulence at the beginning of last week but quickly recovered to end the week at a new all-time high. Strong corporate earnings reports for the second quarter helped to quell economic growth concerns caused by the Delta variant of Covid-19. With nearly a quarter of the companies in the S&P 500 Index having reported earnings, 88% of them have exceeded consensus expectations for earnings and 86% have exceeded expectations for revenue. Given the tendency of management teams to manage short-term expectations, it is not unusual for most companies to exceed analysts’ estimates with 75% and 65% of the companies in the S&P 500 beating earnings and revenue estimates, respectively, in any given quarter on average over the past five years. However, corporate profits have continued to soar back much more quickly than they historically have thanks in no small part to historically high profit margins. Profits are expected to continue to grow strongly into next year with earnings per share for the S&P 500 forecasted to be up 55% this year to a record level and then another 11% next year. As long as they last, strong corporate earnings should provide lift to the market to counter any prolonged downdraft for, as long as the news is good, there is little cause for investors to re-evaluate the wisdom of placing historically high valuations on earnings derived from historically high profit margins.

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July 19, 2021

Inflation | Is it different this time?

Inflation surprised on the high side again in June with the Consumer Price Index up 5.4% over the past year. Short-term inflation over the past three months hit double digits with both total and core inflation up over 10% annualized for the first time since the high inflation days in the early 80s. Policymakers and investors appear completely at ease in their belief that the recent increase in inflation will be transitory and soon subside once various supply constraints work themselves out. The various unprecedented monetary actions taken by the Federal Reserve since the great financial crisis have led to many doom-and-gloom predictions about inflation over the past decade that have proven to be unwarranted (if one excludes the inflation in financial assets and house prices). This time might be different, however, as the combination of massive fiscal and monetary stimulus has succeeded in increasing the amount of money actually flowing into the real economy (as opposed to what was the case a decade ago when much of the quantitative easing basically just made a round trip back to the Federal Reserve). The economy is a highly complex system that usually humbles efforts to predict the future, but the risk for higher inflation does seem to be increasing given the rising tide of money flowing into the economy and the absence of the globalization or demographic trends that have previously helped to keep inflation in check.  

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Sources:, BLS, Federal Reserve

Junk Bonds | High risk, low reward

July 12, 2021

If looking for another sign these days of investors' current large appetite for risk and their desperate hunt for yield, look no further than the junk bond market where the current real yield on non-investment grade corporate debt has gone negative when the nominal yield is adjusted using the current trailing CPI inflation rate of 4.9%. That is to say, the riskiest part of the corporate debt market is offering no return for investors after inflation. Hopefully inflation won't stay at 5% for long; however, even using the 10-yr TIPS breakeven inflation rate of 2.2% generates a real return for "high" yield debt of just 2% which is a fairly meager return for the risk. But that could be said for much of the financial markets at the moment. The potential silver lining of good news to be found in the strong demand for junk bonds is that there were some rumblings in the credit markets before the stock market peaks in 2000 and 2007, and there are certainly no signs of concerns flashing there now.  Although in the age of quantitative easing by the Federal Reserve, such market signals may not be as reliable as they were in the past. 

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Ice Data Indices, LLC, ICE BofA US High Yield Index Effective Yield [BAMLH0A0HYM2EY], retrieved from FRED, Federal Reserve Bank of St. Louis;
AOWM calculations

July 5, 2021

Investors | Great Expectations

With stocks trading at historically high valuations on historically high profit margins, investors would be wise to temper their expectations for returns over the next decade; however, human nature biases us to project the recent robust returns indefinitely into the future. Surveys suggest investors and even finance professionals are expecting long-run stock returns that have a low probability of being realized. Stocks may still offer good relative returns in a low interest rate world, but the danger of overly great expectations is twofold: one, that investors will fail to save appropriately to achieve their financial goals; and two, that when returns disappoint, investors will bail on stocks at the worst time. While equity investors must always be optimistic about the future, they still would be well served not to estimate future returns with rose-tinted glasses. 

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AOWM calculations

June 28, 2021

Consumers | Continue spending Uncle Sam's cash

While total personal consumption declined slightly in May after adjusting for inflation, consumers still continued to do their part to lift the economy. The consumption of goods continues to run well above its trend level before the pandemic, and the consumption of services is recovering as the economy reopens more fully for business. Total consumption has exceeded its pre-Covid level even while households have been paying down their credit cards thanks to the massive government stimulus. In the coming months, the consumption of goods is likely to retrench, but the decline is expected to be more than offset by a surge in spending on services as folks re-engage life outside of their houses. How much consumer spending will boost the economy after this year will depend in part on when individuals feel comfortable increasing their consumer debt again. Frugality was forced on many households after the last recession, but there are ample reasons why it would be wise and rational for personal savings to remain higher than expected this go around as well. However, fiscal prudence by consumers need not doom the economy if their savings is funneled into productive investments that would help the economy grow now and in the future. 

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Source:, U.S. Census Bureau,, Federal Reserve,, AOWM calculations

June 21, 2021

Monetary Policy | Between a rock and a hard place

A week after a higher-than-expected inflation report, the Federal Reserve started talking about talking about raising its target overnight interest rate that is currently pegged close to zero. A majority of Fed officials indicated they expect the tightening of monetary policy is still a couple of years away, but that was a year earlier than had previously been intimated. Not surprisingly, short-term interest rates headed higher on the news with the 2-year Treasury yield rising from 0.16% to 0.26%; less expected, long-term interests fell even more with the 30-year Treasury yield falling from 2.20% to 2.01%. It would be reasonable to assume that the Fed increasing its forecast for economic growth and inflation and moving up the likely date that it will stop gobbling up Treasury securities and start increasing short-term rates might all have pushed long-term rates up, not down. That may yet happen, but the initial response by the bond market implies a belief by some investors that the booming US economy (or perhaps just the financial markets) will quickly falter without endless massive monetary stimulus that at the same time is also recognized as being unstainable in itself. In sympathetic fashion, the stock market sold off some at the end of the week as well; although, growth stocks showed relative strength likely thanks to the entrenched narrative that low long-term interest rates justify their high valuations.  

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Source: US Treasury, YCharts

June 14, 2021

Inflation | Prices soar; bond market snores

Inflation continued to pick up speed in May with the Consumer Price Index up 5% compared to last year. Many of the elements driving inflation higher suggest that inflation will abate in the fall and winter as the dislocations associated with the Covid-19 pandemic dissipate. That is certainly the belief of the policymakers at the Federal Reserve and it appears bond investors as well as the 10-year Treasury yield actually declined this week to 1.45% - its lowest level since early March. The spread between current inflation and the 10-year Treasury yield hasn’t been this wide since the truly high inflation days of the 1970s and early 1980s when waves of “transitory” inflation spiraled ever higher. That is the real inflationary danger on the horizon, not that inflation won’t decline later this year – which it likely will – but that the trend over the next decade will be for each transitory spurt of inflation and the subsequent ebb to be a bit higher than the last.     

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Labor Market | Who wants a summer job?

June 7, 2021

The labor market continued to show signs of improving in May with 559,000 new jobs added and the unemployment rate falling to 5.8%. Nevertheless, the number of individuals employed is still more than 7 million below the level before the pandemic. The recovery in employment has not been as quick as expected the past couple of months even while many businesses have struggled to find workers. Extended supplemental unemployment benefits, difficulties with childcare during the pandemic, and lingering concerns about the Covid-19 virus are likely culprits for the labor force participation rate lingering around 61.6%, down from its January 2020 level of 63.4%. One group that has benefited from the Covid job market is teenagers who are less likely to face any of the disincentives or hurdles to joining the labor force. The unemployment rate for individuals 16 to 19 years old fell to 9.6% in May, which is its lowest level since 1953. This age group is also the only group to see its participation rate rise above its pre-Covid level. As with many of the bottlenecks in the economy that have been starting to generate inflationary pressures, the general assumption is that the labor shortages being experienced by many companies will subside in the coming months as supplemental unemployment benefits expire and life returns to normal. However, if the events of the past year permanently decreased the number of individuals in the workforce for one reason or another (e.g., early retirements), Covid-19 may end up accelerating the demographic trends that were already likely to give workers more ability to push for higher wages in the coming decade. If that occurs, the blip in inflation may not be as transitory as hoped. 

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May 31, 2021

Growth vs Value | Slow and steady wins the race?

Value stocks have continued to outperform growth in recent months. The dramatic outperformance of growth stocks through last summer that was only previously match by the tech bubble of the late 1990s has waned, and value stocks have actually returned more than growth stocks over the past twelve months. The relative performance between the two investment styles has tracked similarly to the growth stock peak in 2000, as seen in the first chart below. The big difference this time, as shown in the second chart, is that, unlike in 2000 when value stocks basically held steady while growth stocks saw their high-flying valuations fall back to earth, this time around value stocks have been playing steady catch up with growth stocks that in general have also continued to motor ever higher, just at a slower pace. As a result, valuations for growth stocks remain historically high both on an absolute basis and relative to value stocks. While value stocks are themselves trading at historically high valuations, their relative reasonableness may enable them to continue to regain their historical status as the underestimated tortoise that beats the flashy hare in the long run.  

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Source: YCharts, AOWM calculations

May 24, 2021

Cryptos | Just taking a breather?

Cryptocurrencies are down over 40% in the past two weeks. In January, the total market value of all cryptocurrencies hit $1 trillion for the first time and then quickly soared to nearly $2.6 trillion before falling back to around $1.5 trillion. The spark for the latest round of selling pressure appears to have been increased concerns about potential restrictive regulatory actions especially in China. Cryptocurrencies have always been highly volatile, but the current sell-off is already on par with some of the bigger drawdowns experienced over the past couple of years. Of course, Bitcoin and Ethereum, the largest cryptocurrencies representing about 47% and 18% respectively of the total market at the moment, lost over 80% of their value after the initial big burst of crypto enthusiasm back in 2017 before climbing to significantly higher heights. Cryptocurrencies have been gaining institutional credibility over the past year, but their future as an asset class or reliable store of value remains anyone’s guess. Since they are still a small piece of the total global financial markets, the current turmoil in cryptocurrencies need not spell trouble for other markets unless it causes investors to pause and wonder what over asset prices may have run up too far too quickly over the past year.

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Inflation | A transitory blip or a troubling trend?

May 17, 2021

Consumer prices spiked higher than expected in April, up 4.2% compared to the same month last year. Core prices excluding volatile food and energy prices were up 3.0%, the most in nearly three decades. The increase in inflation was driven by the cost of goods with the prices for used cars and trucks leading the charge up 10% in just the past month and up 21% over the past year. Thanks in no small part to globalization, the prices of goods have served as a deflationary force over the past couple of decades, but the confluence of a pandemic, record government stimulus and strained supply chains have removed that anchor for overall inflation at least for the moment. Policymakers at the Federal Reserve still expect inflation to decline back towards their 2% target in the latter half of the year as the transitory effects related to the pandemic dissipate. However, inflation expectations both in the short term and the long term as measured by the market for Treasury Inflation-Protected Securities (TIPS) continue to trend higher -- expectations that have the potential to become a self-fulling prophecy if faith in the Fed’s commitment to price stability begins to waiver. 

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Source: YCharts,, FINRA, AOWM calculations

May 10, 2021

Margin Debt | In the eye of the beholder...

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.

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Source: YCharts,, FINRA, AOWM calculations

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.

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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.

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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.  

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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. 

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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. 

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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.   

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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.   

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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. 

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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. 

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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.) 

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Nominal and Real 10-yr Treasury

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.  

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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. 

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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.   

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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. 

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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. 

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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. 

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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. 

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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. 

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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. 

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Source: YCharts

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.  

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Bitcoin and S&P 500 1/1/2017-12/3/2020.  


Source: YCharts

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.

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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.  

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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. 

Small Value vs Large Growth Since Sept 2

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.

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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.

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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. 

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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.   

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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.

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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.

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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.

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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.