Q1 24
“Stock Market Surges to Start the Year: 22 Record Highs in 3 Months
The S&P 500, rising 10 percent, set the pace as investors looked forward to interest rate cuts” The New York Times declared on 3-29-24. It is tempting to reference the Energizer Bunny when observing U.S. economic activity and market performance. We have a domestic economy that continues to grow and innovate in the face of persistent challenges.
From the article:
“The Russell 2000 index of smaller companies, a measure of firms more susceptible to the ebb and flow of the domestic economy, also rose over the first three months of the year, but by just 4.3 percent. It’s a reminder that the biggest companies are driving the stock market higher — especially those surfing the wave of optimism over artificial intelligence.”
“The so-called Magnificent Seven group of stocks that drove the market higher last year continued to have an outsize impact, responsible for almost 40 percent of the S&P 500’s rise over the first three months, according to data from Howard Silverblatt at S&P.”
Long term investors must temper their enthusiasm as rising prices will ultimately run into conditions referred to as “overbought” markets. The recent growth of equity portfolios must be taken with a clear vision of the ebb and flow that is market reality.
_____
In the run up to the Super Bowl, theories regarding pop star Taylor Swift and a football player named Travis Kelce circulated widely. The idea was that the National Football League sought to attract legions of “swifties” through manipulation of football game outcomes. Through a series of hard-fought playoff games, the chosen Kansas City Chiefs produced the victory the league would have wanted. Despite the lack of any actual evidence, documentation, audio recordings, or cell phone videos, the conspiratorial rumor mill made hay with this story for weeks. Conspiracists have no time for research, facts, or evidence. A storyline with as many shiny objects as possible is the key.
A rational view of any National Football League game would conclude that the outcomes would be difficult to manipulate. There would be many people required, along with some of the most unique athletes on earth risking career ending injuries to alter their performance.
Economics would also suggest that NFL manipulation of games is highly unlikely. Forbes magazine estimates that the most valuable team, the Dallas Cowboys, is worth $9 billion. The Cincinnati Bengals are the least valuable team, estimated to be worth $3.5 billion. The business of the National Football League generated 18.6 billion dollars in 2022. It would be insane to put that type of a business at risk to garner additional fans or publicity. These numbers along with the absence of any proof refutes ridiculous allegations. The games are over, interest has gone dormant for the offseason, and provocateurs seeking attention will move on to the next compelling storyline.
The human mind is particularly vulnerable to the construction of storylines for explanation of the complex and random world that we inhabit. Celebrities and athletes have historically formed actual romantic connection and opportunities for synergistic brand expansion. It is interesting to think of powerful operators attending secret meetings where they pick winners and losers, yet this is rarely how the world functions. The investment world runs rampant with conspiracy theories about the all-powerful staging of events to proceed in their favor. Nearly all this speculation is noise.
_____
In the fascinating book, “Last Call: The Rise and Fall of Prohibition” author Daniel Okrent documents the fascinating government experiment from 1920 to 1933. This illuminating era of American history has many lessons that can be useful in broadening our perspective in 2024. Okrent delineates how Prohibition merged with other issues of the period: the growing political power of the women’s suffrage movement, which allied itself with the antiliquor campaign; fear of immigrants by small-town citizens; anti-German sentiment of the period; and a variety of other dynamics of the era, from the rapidly growing automobile industry to the origin of the federal income tax to replace lost revenue from taxation of liquor.
It is unlikely that current political movements would spend any time considering the unique period of Prohibition. Activist endeavors are often blinded by a righteous sense of mission for their worldview. The ill-conceived notion that the United States could change realities in Indochina in the 1960s, or George W Bush suggesting that the United States needed to go to war in Iraq post 911 are tragic examples of this situational blindness. The current trend for trade protectionism is a particularly unfortunate example that is unlikely to benefit American workers, consumers, or global economic stability in general.
Prohibition is the marquee example of federal government overreach into people’s personal lives. The massive effort involved in amending the constitution based on puritanical control of human vice proved unworkable. The development of black-market distribution known as bootlegging was the predictable response to the heavy hand of federal government control. The notion that once the constitution was amended an alcohol-free society would be the new reality for the foreseeable future was grossly mistaken. Enforcement was underpaid, corrupt, and largely ineffective.
On July 29, 1932, the NYT quoted Henry Ford, “FORD SEES DRINKING CUT 99% BY DRY ACT; Prohibition Is a Success and Nation Will Never Abandon It, Auto Producer Writes. HE DECRIES AGITATION NOW Says Country Should Be Talking About Money Reform, Not Liquor — Holds Only Politicians Are Wet.” Mr. Ford famously overestimated his knowledge about just about everything beyond automobile mass production. There were many others that pontificated about higher worker productivity sans drinking, and even medicinal uses for alcohol.
_____
Political narratives continuously seek boogeyman for purposes of vote gathering and political marketing. The complex sequence of events that have led to dramatic shifts in blue collar manufacturing jobs is difficult to articulate in the face of blunt slogans. The idea that political and business leaders in the past sought to specially undermine American workers is less likely than the opportunity of exploiting lower cost workers elsewhere. Labor has always been vulnerable to being undercut by those willing to work more cheaply.
Globalization was pursued under the assumption that people would recognize educational achievement and skills development as a critical component to their future. The stubborn mindset that factory jobs for those with less education should remain indefinitely is not borne out by the history of economic development. Suggesting that the system is rigged, and you have been duped is a dead end. Inspiring the reality that technological skills, engineering, and STEM education is the key to the future is a monumental task. A certain cohort of the population is greatly challenged by the transition to the demanding knowledge economy.
Considering the confounding dynamics of the 2024 presidential election it is easy to slip into a pessimistic mindset. The United States is currently mired in dysfunction at the federal level. We have witnessed a collapse of the Republican Party along with a vulnerable Biden presidency that has proven ineffective at gathering popular support. It is difficult to envision leadership emanating from people significantly beyond their plausible retirement date. It may be helpful here to recognize that these periods often lead to new realities as refreshing personalities arrive on the scene. Just as the 18th amendment to the constitution of the United States was perceived as a permanent change, the environment that we have been slogging through in recent times is unlikely to persist.
_____
The price of money was drastically reduced in 2008. The Federal Reserve embraced the idea that low-cost capital could be injected into the financial system to reduce cascades of financial negativity. As the global financial system began to suffer from ripples of distrust between banking institutions, central banks sought to restore confidence. The process of slashing interest rates to provide aggressive support for banks globally allowed the financial system to take a pause, reset and resume on a path towards normalcy. Thus, a policy that was perceived as permanent, was remodeled rapidly.
For over 12 years, low-interest rates became akin to a financial steroid. This artificial support became ingrained in economic activity around the world. Low rates are also referred to as “financial repression” as they discourage saving and push money towards spending and investment. Easy money and interventionist central banks ran great risks with these strategies. The downside of a developing dependency on low rates was difficult to contemplate. The transition back to higher rates was a most vexing dilemma.
The Federal Reserve and central banks globally were able to transform the low-interest environment through the most aggressive policies in decades. As the year 2022 unfolded it seemed that the worst fears of rising inflation would be realized. The narrative that inflation would soar brought memories of the 1970s, with its double-digit mortgage rates and persistently stagnant economic performance. Markets responded with fear and aggressive selling of stocks, bonds, and real estate. Measured by the S&P 500, the market opened 2022 at 4677 and closed the year at 3839. In early March 2009, the market traded below 670. We are now witness to the index trading above 5200. It has been quite a journey.
The path to interest rate normalization is astounding in its rapid timeline. The idea that you could unwind 14 years of monetary support in 12 months sounds like magical thinking. 2022 was one of the quickest upswings in interest rate history. These interest rate increases have brought historically average rates without a calamitous impact.
Outside of some niche banks and the large event with Silicon Valley bank failure, the banking system has held up extremely well and consumers are adapting. There is historical evidence that the modern economy can function at different levels of interest rates, the problems usually occurred during rapid rates of increase. It is quite early to celebrate victory, but thus far the process has gone extremely well.
_____
Geopolitical images are overweighted with conflict and war. As our hearts weep, how may we contemplate the economic landscape? These conflicts have less impact on market growth than our fears might suggest. After the terrorist attacks of 9/11, the S&P 500 fell by 12% but recovered in less than 60 days. Barron’s Magazine recently noted, “looking back at market reactions to 25 of the most significant geopolitical crises since World War II, the S&P 500 dropped on average by around 4%, bottomed out in 15 days, and recovered in 33 days. Which is to suggest that trading on fear is a strategy for only the nimblest or luckiest of profit-takers. It also reminds us of that most ancient and comforting of investing chestnuts—stocks usually go up.”
Risk aversion is the driver of a significant portion of human feeling towards finance and investment. Risk aversion refers to the tendency of an economic agent to strictly prefer certainty to uncertainty. Human irrationality is exhibited in the flipping of a coin. It has been demonstrated that if you offer a coin flip for the prize of $100 or zero, vs a guaranteed $50, the bias will be towards the $50. This is of course no different than the coin flip. The technical way of expressing this is a risk averse agent strictly prefers the expected value of a gamble to the gamble itself.
The insights gained from studying how people react to simple propositions are useful in overcoming cognitive bias and counterproductive instinctual behavior. Many individuals will never experience the potential benefits of long-term investing due to the mistaken assumptions that are built deeply into the human psyche.
The modern world dilemmas that we must confront are nothing like a decision to accept the gambit of a coin toss. It is now four years since the initial societal convulsion known as COVID-19. There has been a developing narrative that seems laden with recency bias. It is only with bent logic that the policies of distancing, masking and closures of schools were failures, or even sinister attempts at some type of government control of society. The costs of closures and isolation we’re obviously significant, yet the context of a public health crisis has somehow shifted. These efforts were rational policy responses and far from anything but benevolent efforts to slow the spread of a novel public health challenge.
“Lockdown” is a politically charged reference to the public policy response during the pandemic. The notion that the government was looking to extend its control over our independence and personal lives was a form of catnip to conspiracy theorists and the entire spectrum of fringe political operators. To observe what real government control looks like we can turn to the policies of the Chinese central government. The heavy-handed policies stand in stark contrast to what we experienced as Americans. Chinese citizens were truly quarantined wholesale.
Property rights, legal resources and personal liberty are likely the most significant distinctions between the two largest economies in the world. Without the rights of a separate judiciary, one must wonder what it can be like in China. The premier, or federal executives can commandeer ownership of land, patents, and all manner of assets arbitrarily. The economic comparison is striking as the US economy experiences a continuing trend towards normalization, rising employment, productivity growth, and rising markets while China struggles.
On December 11th, 2001, China became a member of the World Trade Organization. This watershed moment shifted the economics of our world in dramatic fashion. The incredible convergence of lax environmental regulation, massive supply of human capital during a shift away from rural to urban, and a central command form of government primarily focused on economic growth has led to a Chinese economic juggernaut.
Unfortunately for the Chinese population and the global economy, there has been a stark shift from economic focus to nationalism and antagonism towards the West. Production and economic growth rates in China have slowed dramatically. The primary catalyst is likely to be concerns over a pronounced shift towards authoritarian central government behavior.
China is also facing huge demographic challenges. This shift from engagement in the global rules-based economy is likely to derail the Asian economic juggernaut. In a piece titled, “Xi Jinping’s paranoia is making China isolated and insular” The Economist recently reported, “At the most basic level, far fewer outsiders are crossing borders into China. Last year the country recorded about 62m fewer entries and exits by foreigners than in 2019, before the pandemic began—a drop of more than 63%.”
_____
Could it be that the American “Border Crisis” is an incredible symbol of demand for the American way of life and opportunity? Across societies without the advantages of America one can witness the streams of citizens leaving Russia or the recent 500,000 people who fled Cuba. 50% of Argentinians live in poverty.
It is once again the strong opinion of this commentary that many of the current narratives are simply noise that is difficult to ignore in the face of numerous positive trends that are likely to lift the Western capitalist democracy model ever higher. American political discourse has drifted far from the historic premise and promise of a “nation of immigrants”. The economic dynamics of a growing population is recognized to offer many advantages and economic rewards. Across the spectrum of economic activity, from the carpet layer and painter to the engineer and physician, household formation and population growth is likely the key to future increases in living standards and quality of life.
The footage of desperate individuals and families flooding towards the Mexican border is heartbreaking and disturbing. How can it be that there are this many people seeking to risk their lives for a chance to scrub toilets, work construction or mow lawns? One answer may be that they start businesses. The Wall Street Journal penned, “Latinos Are Starting U.S. Businesses at a Torrid Pace”. The article states, “Latin American immigrants are starting businesses at more than twice the rate of the U.S. population as a whole”. This is ironic given that they (allegedly) do this after all the crime and pillaging.
It has been theorized that the core driver of these migrant waves is chronic labor shortages in the United States. In a brilliant WSJ essay on March 1, 2024, Hein de Haas a professor of sociology at the University of Amsterdam, wrote, “More walls and police will never be enough to stop migrants from coming to the U.S. for the lower-skilled jobs the American economy needs.” Professor Haas points out, “The border crisis dates back to policy changes in the late 1980s. Ronald Reagan’s Immigration Reform and Control Act of 1986 was the last major bipartisan immigration reform. It provided amnesty to 2.7 million undocumented, mostly Mexican migrants. But it also fired the opening shot for increasing border surveillance and introduced sanctions for employers hiring undocumented workers.”
“Since then, successive Republican and Democratic administrations have invested massive resources in ramping up border surveillance and collaborating with countries of transit such as Mexico to deter migration. By 2023, the U.S. border enforcement budget had risen to $25.9 billion—more than double the budget of the FBI.”
This is an issue that has been studied from numerous angles. The conservative Cato Institute stated on 10-13-2020, “The results are similar to our other work on illegal immigration and crime in Texas. In 2018, the illegal immigrant criminal conviction rate was 782 per 100,000 illegal immigrants, 535 per 100,000 legal immigrants, and 1,422 per 100,000 native‐born Americans. The illegal immigrant criminal conviction rate was 45 percent below that of native‐born Americans in Texas. The general pattern of native‐born Americans having the highest criminal conviction rates followed by illegal immigrants and then with legal immigrants having the lowest holds for all of other specific types of crimes such as violent crimes, property crimes, homicide, and sex crimes.”
According to the US bureau of Labor Statistics, Foreign-born workers were a record high 18.1 percent of the U.S. civilian labor force in 2022. A growing body of research is highlighting the link not just between demography and economic growth but also between migration and growth specifically. A 2020 International Monetary Fund study found, for advanced economies, a one percentage point rise in immigration relative to total employment tends to boost total output by almost 1% five years later. The research also found that productivity boosts delivered by higher immigration tended to raise the average income of native workers. One plausible reason is: Immigrants tend to bring different skill sets to the labor force, helping the overall economy to grow more efficiently, and faster.
It is difficult to imagine the political charisma that would be required to energize American citizens with this data. Yet tragically we are witnessing precisely the opposite as an entire political movement has been built around the ridiculous notion of building “a wall”.
The challenges of great opportunity are unlikely to be articulated as such in the current environment. There is currently a political competition in who can out do the “toughness” that is required to beat back all the criminals and undesirables climbing and tunneling their way into our precious world. Here’s hoping for a dramatic shift like the fall of prohibition where we can embrace a growing population, economic prosperity, and the true realization of the American Dream.
_____
The NYT recently delineated, “Something unusual is happening in America. Demand for electricity, which has stayed largely flat for two decades, has begun to surge.
Over the past year, electric utilities have nearly doubled their forecasts of how much additional power they’ll need by 2028 as they confront an unexpected explosion in the number of data centers, an abrupt resurgence in manufacturing driven by new federal laws, and millions of electric vehicles being plugged in.”
The above article was published on March 14th, 2024. The same day that Bloomberg proclaimed, “New York Completes Its First Offshore Wind Farm Off Long Island”. The article noted, “New York state’s first offshore wind farm is fully up and running, delivering enough clean energy for 70,000 Long Island homes and businesses.
South Fork Wind, with 12 turbines, is the first commercial-scale offshore project to be completed in the US, according to a statement Thursday from Turn Forward, a clean energy advocacy group. The 132-megawatt project was jointly developed by Orsted AS and Eversource Energy, about 35 miles (56 kilometers) east of Long Island.”
The future for American Society resides in innovation and evolving policies that enhance the American way of life. Living standards have the potential to rise as our energy generation and environmental technologies evolve. It is likely that science and economic opportunity will converge to develop breakthroughs that we cannot currently imagine. Regardless of reckless populist slogans, or federal government overreach into our economy, it is likely that our dynamic system will experience growth beyond expectation.
I am excited to work with all of you and watch this unfold.