What Did We Learn This Week? (12/16/2022)–The Fed, Oaktree, Fusion

I learned three things this week that I think are worth mentioning. First, Chairman Powell told us that while progress has been made, the Fed still has a lot of wood to chop. Second, Oaktree’s Howard Marks made the case that, while the economy is now fundamentally different than that of the last four decades, this is a pretty good environment for savers and value investors. Lastly, we learned the elusive holy grail of nuclear fusion may someday become a reality. Of course, all of these directly or indirectly come back to our favorite topic, inflation.

Let’s start with the Fed. As our regular readers know, we tend to focus on long-term trends and stay away from short-term trading advice, but this week I do have one thought for those of you insistent on active trading: stop betting on a Fed pivot. The one trade this year that has batted a thousand is betting against those who anticipate the Fed will lose their nerve and signal to the markets that they think they are at least close to having done enough. Once again, this week, market participants were sure the Fed would celebrate the lower CPI headlines. There was no celebration. Not surprisingly, the Fed raised interest rates by 50bps but more importantly, the committee made clear that they anticipate wage driven inflationary pressures to persist. They also expect growth will slow to just .5% and the unemployment rate will need to go higher than they previously expected in order to achieve their objective of 2% inflation. The committee sees hikes going higher than they previously thought and they see holding at those higher levels for longer. Equities got smoked.

Powell is saying that inflation really is different this time and the rate of decline that we’ve witnessed over the last few months is likely to decelerate. In other words, the easy part of overcoming inflation may be over. Powell’s concern is the labor market where they have made very, very little progress. During the presser, Powell had this to say on that front, “it feels like we have a structural labor shortage out there where there, you know, 4 million fewer people, a little more than 4 million who were in the workforce available to work than there's demand for workforce.”

Later in the press conference he said, “And it's very fundamentally about the labor market and wages. If you look at wages, look at the average hourly earnings number we got with the last payrolls report, you don't really see much progress in terms of average hourly earnings coming down.”

Finally, Powell, still discussing the labor shortage, concluded, “Part of it is just accelerated retirements. People dropped out and aren't coming back at a higher rate than expected. Part of it is that we lost a half a million people who would have been work — close to half a million who would have been working died from COVID. And part of it is that migration has been lower. We don't prescribe — you know, it's not our job to prescribe things. But, you know, I think if you ask businesses, you know, pretty much everybody you talk to says there aren't enough people. We need more people. So I tried to identify that in my — in a speech I gave a month ago, but I stopped short of telling Congress what to do because, you know, they gave us a job. And we need to, you know, do that job. Thanks.”

That last sentence is telling. Powell is saying all we as monetary policy makers can do is destroy demand through tightening financial conditions when what we need is more supply of labor through higher immigration and whatever else Congress can do to push more people into the labor force.  

Let’s move on to what Howard Marks had to say this week. Marks, for those who don’t know is a billionaire investor most famous for his memos. Warren Buffett once said, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read.” Buffett isn’t alone on that front. I can attest that over my career, I can always remember a lot of excitement and analysis around each and every memo from the legendary value investor. The note he penned this week was titled “Sea Change”.

Marks wrote, “I estimate (Investors) enjoyed the growth of the economy and the companies they invested in, as well as the resulting increase in the value of their ownership stakes. But in addition, they were on a moving walkway, carried along by declining interest rates. The results have been great, but I doubt many people fully understand where they came from. It seems to me that a significant portion of all the money investors made over this period resulted from the tailwind generated by the massive drop in interest rates. I consider it nearly impossible to overstate the influence of declining rates over the last four decades.”

In other words, expected returns should be lower in a world where we can no longer rely on ever falling interest rates, but on a more positive note Marks concludes, “Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets. Lenders and bargain hunters face much better prospects in this changed environment than they did in 2009-21. And importantly, if you grant that the environment is and may continue to be very different from what it was over the last 13 years – and most of the last 40 years – it should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead. That’s the sea change I’m talking about.”

So the point is that while we can expect lower returns, TINA (There Is No Alternative) is no longer an issue. We are in a new world and for those looking to incur risk and achieve spectacular returns, they are likely to have a tougher time, while those who understand that 7% returns means that you double your money over ten years are in the best environment we’ve had for a couple generations.

Finally, regarding the news that scientists have achieved a breakthrough in the field of nuclear fusion, leaps in technologically driven productivity appear just like risk: slowly and then all at once. I’m not claiming that our energy and climate issues are over, but this week’s news is a reminder that we will see step changes in various technologies that promise to solve many of the issues that are currently pushing persistent inflation. Someday, we really will have driverless trucks, cheaper and more abundant renewable energy and AI technologies that return us to a world of higher productivity and higher non-inflationary growth. Unfortunately, those days are likely several years away from now, but we should always be optimistic that hardship begets innovation. Merry Christmas and Happy Holidays.

For more from Tim, follow his podcast The Weekly Bull and Bear wherever you listen to your podcast or read his weekly blog posts here.

Tim Pierotti is WealthVest’s Chief Investment Strategist. 

Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.

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