This Market Party Can't Go on Forever
Markets are at all-time highs, largely on the back of better-than-expected economic growth and solid third-quarter results early in the new reporting season -- but I see several risks under the hood.
A look at the numbers, shows that equities rose for the sixth week in a row last week with all three major indexes gaining just under 1% on the week. Small caps notably outperformed their larger cap brethren, with the Russell 2000 up some 2% on the week. (Given how significantly small caps have underperformed so far this year, I could think we could see some catch up action in small caps through year end.)
And, late last week, the Atlanta Fed’s GDPNow bumped up its third-quarter gross domestic product estimate to 3.4% from 3.2%.
But equities are trading at extreme valuations using a variety of historical valuation metrics. So, it is important to remember that a good chunk of this economic growth is "goosed."
As hedge fund manager and billionaire John Paulson stated on CNBC last week: "The strength in the U.S. economy is not surprising. The increase in government spending is basically accounting for all the GDP growth that we have this year. It’s an easy way to get growth in the short term, but it has long-term consequences.”
As to when the markets start to factor in that reality, your guess is as good as mine.
Investors also don’t know what policy changes are ahead, depending on the outcome of the fast-approaching November election. Excessive fiscal deficit spending is among many reasons gold continues to make new all-time highs. Rising geopolitical tensions are another driver of the rally. The yellow metal crossed over the $2,700 an ounce threshold for the first time last week. In retrospect, I wish I would have taken much heavier positions in some of my gold related investment early this summer like Newmont Corporation (NEM) and VanEck Gold Miners exchange-traded fund (GDX) . I will add to these holdings via covered call orders on any significant dips in either.
I also believe the equity market has gotten too lackadaisical around inflation in recent months. Chairman Powell may have cut the Fed Funds rate for the first time since early 2020 in mid-September, but it is way too soon to take a victory lap in regard to inflation. For one reason, true inflation is significantly higher than what is captured in the monthly consumer price index report. This reading excludes things like taxes and user fees and contains myriad hedonic adjustments. And any calculation that inputs health care premiums have fallen on average over the past few years is automatically suspect. Given that the yield on the 10-Year Treasury has backed up significantly since the Fed cut rates in mid-September, tells me the bond market doesn’t quite believe all the happy talk about the battle against inflation being over, either.
I would also keep my eye on a potential wage/price spiral developing that could reignite inflation again in the coming quarters. The striking dock workers union just got an over 60% raise over six years for their members. It also looks like the machinists at the Boeing Company (BA) are going to get a 35% wage hike over four years as management desperately tries to put an end to that worker action, given the myriad other challenges the iconic American manufacturer currently faces. Neither new worker contract is supportive of getting inflation down to the Federal Reserve’s official 2%.
In Wednesday’s column, I will highlight a couple of sectors of the market I would significantly underweight or short and a couple I think should outperform in the quarters ahead.
At the time of publication, Jensen was long GDX and NEM.