Notes on the Week Ahead

The quantity of money was a big issue in the background of my childhood. There were no money machines or credit cards (at least in our house). So every Monday, my father would write a check for cash, usually for less than 100 pounds, and hand it to my mother for housekeeping for the week. She would then drive to the bank, cash it, put the notes in her purse and slowly dole them out as the days went by and she tried to keep a family of seven fed. Throughout the week, as she shopped and worried, she would know how much, to the penny, was left. The quantity of money was a binding constraint in her life.

It seems like a distant memory now, but in the decade before the pandemic, the main preoccupation of the Federal Reserve was boosting inflation, as measured by the headline personal consumption deflator, to 2%.  Inflation undershot this target in ten of the twelve years between 2008 and 2019. 

Eliud Kipchoge, the only man to ever run a marathon in under two hours, is in town for next week’s Boston Marathon. In the runup to the race, reporters will no doubt ask him about whether he is worried about any particular competitor. He will predictably reply that he is not - but that he has to focus on his own fitness and his own decisions in running the race. As with all individual sports, the keys to success or failure lie largely in the athlete’s own hands.

In three weeks, I will once again have the honor of running the Boston Marathon as a member of the gasping geezers division of the Dana-Farber Marathon Challenge team. A year ago, as I clambered up the Newton Hills, I resolved that, if I was ever fool enough to do this again, I’d lose a few pounds before attempting it. Admittedly, a few miles later, I made a sterner vow that I would never be fool enough to do this again, which made the first resolution seem irrelevant.

A good set of brakes is a very comforting thing.  A gentle tap of the foot should produce a quiet and gentle deceleration, as brake pads press up against disc rotors, in a smooth but firm action.  When I drive these days, I take this technology for granted.

 

However, the vehicles I drove as a young man offered far less assurance.  There were times when applying the brakes unleashed a cacophony of shrieking, squealing and grinding noises as worn-out pads battled with rusty rotors.  The braking action would be either be frighteningly nonexistent or of a sudden, whip-lash intensity.  Of course, in those vehicles, the acceleration wasn’t great either.  However, any temptation I might have had to drive more quickly was quickly squashed by doubts about my ability to slow the car back down again when I needed to.

One obstacle to assessing the direction of the American economy is the difficulty in getting a handle on how many people live in this country and how fast that number is growing.  It would seem to be a very elementary problem – surely the Census Bureau provides timely data on the size of the population, as well as births, deaths and net migration?  But it does not.  So far as I know, there is no official consistent measure of any of these numbers on a monthly, (or for that matter an annual basis), going back over the decades.  Moreover, the last time the Census provided a projection of the future path of these vital statistics was back in 2017.

Over the years, my standard approach to analyzing corporate profits has been to think of them as the last slice taken from a big national income pie.  The growth of the pie itself is important.  But so is the size of the other slices, such as labor costs, interest costs and corporate taxes.  Once every one else has had their slice, what’s left over is corporate profits.

 

It’s a useful model for analytical purposes.  However, it has one glaring flaw, namely that it assigns to corporations a purely passive role, meekly accepting the slice left after all the other factors of production have taken theirs’. In reality, American corporations are muscular and sharp-elbowed, growing profits by enhancing productivity but also by beating back the demands of labor, lobbying for a more favorable tax and regulatory environment and seducing customers into buying more goods and services than they really should, based on sober calculation.

It was 60 degrees in Acton yesterday, as our normally frigid Massachusetts winter continued to be a no-show.  Not that I have any problem with this, since running, rather than skiing, is my exercise of choice.  But this weirdly mild season is leaving nature very confused with streams gurgling, buds swelling and birds twittering loudly, presumably about their nest-building plans.

There is a slowdown lurking.  It is currently hiding so well, in the long grass of statistical anomaly, that many observers, including the Federal Reserve, don’t seem to notice it at all. However, investors need to recognize it and have a clear view on the outlook for economic growth, jobs, inflation and profits, how the Federal Reserve may react to a slowdown, and what this could mean for investment returns over the next few years.

In investing, as in life, it is important to learn from the past, appreciate the present and plan for the future.  This is particularly true at turning points.

In the early weeks of the New Year, we do appear to be at an economic turning point.  Fourth-quarter GDP and consumption deflator data, due out this week, may give the impression of continued solid growth with still strong year-over-year inflation.  However, a more real-time assessment of the economy suggests a significant cooling in both, with monetary and fiscal tightening contributing to the slowdown.  That being said, it should be recognized that an environment of slow growth, low inflation, low interest rates and strong profit margins is likely to re-emerge in 2024, providing support for higher asset prices.  While there are too many short-term risks to justify a very aggressive strategy today, it still likely makes sense to prepare for this environment rather than trying to time market swings in what will likely be a very volatile 2023.