What Did We Learn This Week? (07/28)—Tim Pierotti, Chief Investment Strategist

Tim Pierotti, Chief Investment Strategist

FOMO Rally -- 7/28/22

As a Portfolio Manager or Financial Advisor, losing money in a bear market can be painful, but in my experience, not nearly as agonizing as losing money or even just not participating amid market strength. The latter comes with a feeling of embarrassment and a sense that everyone is making money except for your clients. But as a fiduciary, the number one goal always must be to preserve capital. Warren Buffett once said, “The first rule of an investment is don’t lose money and the second rule of an investment is don’t forget the first rule.” The aspect of a bear market that can be the most difficult for the prudent, defensively positioned advisor is sitting tight during countertrend rips. Few do it well. Buffett’s partner Charlie Munger once said, “Waiting helps you as an investor and a lot of people just can’t stand to wait. If you didn’t get the deferred gratification gene, you’ve got to work very hard to overcome that.” We are strongly of the opinion that jumping back into risk assets right now is a temptation that must be avoided. Be patient. Inflation won’t die so easily and therefore, the trusty “Fed Put” isn’t coming back soon.

I listened to every word of Chairman Powell’s statement and press conference on Wednesday and must admit I didn’t hear what the market seemed to hear. Limiting forward guidance makes perfect sense to me as the Fed has proven incapable of forecasting future data anyway. I don’t read that as a pivot or in any way dovish. We all remember “transitory”. The Fed is and always has been “data dependent” so the entire exercise of forward guidance and the market’s reaction to that guidance has struck me as just unnecessary noise. So, what drove the huge Wednesday rally, mostly short covering on declining volume. The most heavily shorted stocks led the afternoon rally with a basket of the most heavily shorted names rallying nearly 4% into the close. In other words, the rally was driven by panicky hedge fund traders fearful of falling even further below their respective high-water marks.

To be clear, we don’t profess to have any idea what the next 5% move will be in equity markets. Bear market rallies have a tendency to endure for irrationally long periods making life miserable for the macro fundamental short-seller. But the big picture to us is unchanged. Let’s remember, we only need to go back to late June when Powell said, "Is there a risk we go too far, certainly there is a risk. But the bigger risk is that we would fail to restore price stability." The two most important components of core price stability are wages and shelter and while both of those components have seen declining rate of change in growth, we are a very long ways from seeing the weakness the Fed needs to see to believe that their 2% inflation target is a foregone conclusion.

The massive yield curve inversion and the equity market rally suggest that the macro narrative has shifted to a mild US recession will be enough to staunch inflation and the Fed will be back to easing again in early 2023. We don’t see that narrative as plausible for all the reasons we have discussed in the past. Our demographically driven workforce mismatch is structural and will take more than a mild recession to alleviate still rising wages. Energy underinvestment is reflected in the fact that crude oil and refined product inventories are at their lowest seasonal level since 2008. In other words, get used to $100 oil and $5 gasoline.

Lastly, Thursday’s GDP report illustrated our concern that falling labor productivity is a secular trend that has quietly accelerated. Following the GDP print, former Obama Administration Chief Economic Advisor Jason Furman pointed out that, “The 6% annual rate decline in non-farm business output per hour over the last two quarters is twice as large as the largest reduction ever recorded.” While I assume negative 6% productivity growth is an anomaly, the trend is clear: potential GDP is falling which means that even de minimis future economic acceleration is likely to be accompanied by inflation.

Structural stagflation is upon us and that is not bullish for risk assets.

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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