Friday, January 13, 2023

Predictions for a slowdown in the world economy continue to appear to be premature. This may go down as the most predicted recession in history. We are not denying the possibility, we believe IF it comes, it is a late 2023 or 2024 event. How severe a recession is also open for serious debate. We are in the mild camp. Employment continues to be strong. Wage gains are becoming common place. Yes, high tech companies over hired in the boom. With the cost of money being almost free, they expanded into business areas they knew little about. The result of this is layoffs and terminations of employees. However, this “bad sign” for the economy seems to be unique to the high-tech area. Other industries continue to hire employees. The labor shortage is a long way from over. With more people working and earning more money it is a “good sign” for the economy.

On the inflation front there is no doubt inflation, for now, has slowed. But slowing inflation is not, solved inflation. A drop from 9% to 6% inflation is hardly anything to celebrate. The Federal Reserve target rate is 2%. We expect the Fed to continue to raise interest rates and keep them higher for longer. Some of the progress on inflation comes from a strong U.S. dollar. This makes buying on the international market cheaper. Recently, as talk accelerates about interest rates in the U.S. topping, the dollar has weakened. This can reverse the progress made on inflation. It becomes a classic catch-22 problem. Raise rates inflations slows. Lower rates inflation returns. This is the basis of our higher for longer prediction. The best outlook for inflation is the fact the growth of M2 money supply has slowed dramatically. The Fed is no longer printing money. We hope they maintain this discipline but must acknowledge political pressure could sway them. .

Investment markets, in our opinion, are moving towards being a little too bullish. Participants seem to believe inflation, interest rates, the economy, corporate earnings, the budget deficit, Russia, China, the crypto meltdown, the liquidity crunch is select areas, are all going to work out without any major problems. It is a leap of faith. We are most concerned about corporate profits. Past earnings were inflated by cheap money. It allowed firms to make acquisitions to grow profits. Re-financing billions in debt at lower and lower interest rates certainly helped. The environment now is completely different. Labor costs are surging. Cost of materials are higher. Cost of insurance, transportation etc. are all higher. It's difficult to see any growth of corporate profits. With higher interest rates calling for lower multiples on flat profits, we remain in the cautious camp towards stocks. The current bond market is fascinating. Investors are convinced inflation is coming down and thus interest rates will follow. They expect interest rates to go back to 1.5% on the short end and 2.75% on the long end. We completely disagree with this. Many pundits are calling for investors to buy 20- and 30-year bonds to lock in the rate at the 4% level. We are convinced this is exactly what an investor should not do right now. That area of the bond market produced 25% plus losses in 2022. .

We are bullish on gold. Relative to the destruction in value of paper currencies, gold is not expensive. We are NOT perpetual gold bugs. We only purchased gold stocks two years ago. For now, they are paying excellent cash dividends and generating good free cash flow. .

We are bullish on steel stocks, particularly CLF. There is much discipline in this area and the stocks are selling as if a horrible recession is already here. We like the fertilizer stocks. Prices of potash and phosphate are down. This appears to be fully reflected in the stock prices. .

After earnings season is over in the next 4/5 weeks, we will re-evaluate on thoughts. Bank stocks are intriguing. They are also selling in some cases as if the recession is here and they will be writing off millions in bad loans. They also benefit from higher interest rates. As mentioned, many are looking for lower interest rates. We disagree with this narrative and will monitor the bank stocks for increasing cash dividends and potential stock buybacks.

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