When Is Good News Bad News? When There Is Too Much Good News? Weird, Right?
This morning I read that the US economy added 315,000 jobs in August extending a 20-month streak of jobs growth following the Covid recession of 2022 when 10M people lost their jobs. Over 525,000 jobs were added om July. Unemployment is solidly below 4%. This is good news, right?
During the second quarter of 2022, over 75% of the companies making up the S&P 500 reported company profits above what they had been estimating. 70% of those same 500 companies have reported revenue higher than expected. Good news? This represents an earnings growth of over 13% from the same period in the previous year. This means that for the sixth straight quarter, year-over-year growth for the S&P 500 has been over 10%. More good news, right? 1
In “normal times,” I would enthusiastically say yes, this is great news.
However, as with sugar, alcohol, and sometimes even exercise or too much time together with loved ones, too much of a good thing can ultimately be a bad thing.
It is common to hear that “the economy is running hot.” Wages are going up due to a shortage of workers. People have no fear of quitting a job because they are confident of finding another with higher pay. The companies in which we invest are making more money now than last year. This trend has continued since the Great Recession of 2008-2009 with only a couple of exceptions. All good news, right?
When people have jobs that are paying more money, they are inclined to spend more. When people have been stuck at home and not going out to eat or travel or buying cars or furniture or new clothes and now, they have more money, they want to spend…and are willing to pay higher prices.
All of this spending and growth leads to inflation which is currently near 9%. This is a very bad thing. Growth is good…to a point. Growth, like sugar, beyond “that point” is very harmful. Short spurts of high inflation can be overcome (remember the inflation of the late 70s and early 80s) just like you can survive a whole bag of cookies or a quart of ice cream in one sitting on very rare occasions. But you cannot do it every day without severe consequences.
Whose job is it to fix inflation? That responsibility rests firmly on the Federal Reserve. Their responsibility is to monitor and measure the economy and then raise or lower the amount of money in the economy. They do this by raising or lowering the “discount rate” or the money they charge banks to borrow money from the Fed. These changes in interest rates flow through to bank customers and the rates banks charge their customers to borrow: home & auto loans, credit cards, borrowing to build hospitals, bridges, roads, or to finance research and development for new products. When it costs more money to borrow money, individuals and companies become less likely to borrow and to spend. When people and companies spend less, inflation goes down.
So now what?
The Fed has increased interest rates several times this year already. Early in the year, the consensus was that rates would need to be increased by 3%. This has slowed the “rate of increase” of inflation a bit and the prices of some items like gasoline which is down from it’s high. However, the bad news is the inflation is “very sticky” and has not responded in a meaningful way to the rate increases so far.
What does this mean?
The Federal Reserve will do what they need to do. This probably will mean several more “meaningful” rate increases during the remainder of 2022 and perhaps into early 2023. Not .25% or even .50% rate increases but 0.75% or even 1% if necessary one, two or even three more times. If they act with conviction, the economy will get the message and inflation will go back to a more sustainable level of 2 to 3%. Without conviction, inflation will remain high longer. After inflation is meaningfully lower, the Fed will gradually lower rates. (See history of 1980s)
It is like the medicine our moms gave us when we were little. It tasted awful and smelled worse and we didn’t want to take it. But Mom insisted because she knew we would feel better sooner if we took the medicine.
These higher rates will lower the amount of money circulating in the economy. Consumers will spend less. Companies will delay growth projects. It will get harder to get a new job or negotiate for higher wages. Real estate will stop going up so fast. Finally, your investment portfolio may go down. But maybe not. Wall Street often looks through the recession to what the economy will be like later. (See the dates and recovery numbers below)
Allow me to pause and take a breath. Now I will repeat what I believe to be a “truth.”
Stock market declines are temporary. Markets go up…often for extended periods. Then they go down….often for shorter periods. Then they go higher than they had been before. Repeat the cycle.
A few illustrations from the S&P 500 index 2:
- May 18, 2007 (before the financial crisis): 1,522
- March 9, 2009: 677 ---- down 845 pts or down 55% from last high
- January 31, 2020: 3,225 -- up 1,703 from previous high or 112%
- March 23, 2020: 2,237 -- Down 988 pts or 31% from recent high
- Sept 1, 2022: 3,995 --- Up 1.2 times from the high in 2020, Up 1.8 times from low of 2020, Up 6 times from the low of 2009, Up 2.6 times from the high of 2007
Bottom line. Economies ebb and flow. The economy grows then a recession follows….then grows again. It is a cycle. So does the stock market.
Plan your cash flow. Know when you will need money from your investment portfolio and hopefully how much. Keep these funds in a safe, secure and low- to no-risk place. How much will you need for the next three years? Five years? Ten years? How much money will you need if you are still living 20 or 30 years from now? Plan for it. Act on that plan. Don’t allow yourself to deviate from the plan to eat that entire quart of ice cream in a single sitting.
Call to talk about questions, comments or concerns.
Wollman Wealth Designs, Inc is a financial services firm in Escondido, CA partnering with families, friends and clients in San Diego County and around the country. Please visit our website, call the office or send us an email with your comments or questions.
1 "S&P 500 Earnings Season Latest Update: 87% of index companies have reported results for Q2 2022." Financial Express, https://www.financialexpress.com/investing-abroad/featured-stories/sp-500-earnings-season-latest-update-87-of-index-companies-have-reported-results-for-q2-2022/2619776/
2 "S&P 500 Index - 90 Year Historical Chart." Macrotrends, https://www.macrotrends.net/2324/sp-500-historical-chart-data
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