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Wages Are Losing The Race & Discretionary Stocks Reflect It

CAMS Weekly View from the Corner – Week ending 6/17/2022

June 20, 2022

Throughout various editions in the previous year we have shared the developing socioeconomic storyline of how building price inflation would ultimately challenge households to the point of turning their discretionary consumer choices into “forced” choices as wage growth rates would be unable to keep up with price inflation. As the building price inflation turned into upward spiraling price inflation the above issue has become front-and-center culturally and certainly economically. While the employment landscape throughout has been strong and is often pointed to as a counter to the price inflation backdrop, wage growth rates, while up, are comparatively weak when placed against price inflation. Placing the two together and thinking of them as in a race against one another we can see below price inflation is winning by a large margin.

The above chart encompasses the previous ten years. The red line reflects the percentage growth in the Consumer Price Index (CPI) while the blue line depicts the percentage increase in Average Hourly Earnings. Per our red horizontal arrow we see approximately a year ago a tremendous disconnect occurred in that wage growth rates went sideways while price inflation increases rocketed higher. With this wages have fallen far behind price inflation. This has led to on-going household pressure in managing expenses which circles back to our above statement in that purchasing decisions on the basics leaves little room for discretionary purchases. As time unfolds, if the above disconnect continues, odds of economic recession increase. The Market Gives Her Opinion Just over four months ago we shared a View of how market participants, with their forward looking focus, were certainly not missing the above storyline and how they thought it would be playing out relative to companies whose products fit under the banner of Consumer Discretionary purchases. We shared how the basics, think food and energy, had continued to perform well in the front part of 2022 while Discretionary companies were leading the charge on the way down. When Discretionary companies are leading the market lower that is worthy of attention. At the time, the beginning of March, said companies collectively were negative nearly 15% just two months in on the 2022 clock. As the above price inflation/wage growth rate disconnect has continued market participants have continued up to current day to express their forward concerns for Discretionary companies which continues to raise thoughts of economy wide concerns down the near-term timeline. As a brief aside on the economy wide concerns several major retailers have recently rang alarm bells of lower sales, building inventories and lower profit margins as a result.

Click for Larger View:  https://schrts.co/tkPxgvRt

The above chart reflects 2022 year-to-date.  The black line represents the Dow Jones Industrial Average while the blue line represents the broad Consumer Discretionary sector.  Our red vertical lines depict the disconnect between the two that began early this year and has continued to current day.  This underlines the message from market participants that their forward view remains in place that consumers, with their challenged wages net of price inflation, will struggle to consume outside of the basics.  Simultaneously, there is an inherent recession concern emanating from the price behavior of these companies. We Continue to Watch the Bond Market Message Relative to market participant messaging in regards to their forward view of the general economy we take another look at the bond market’s view on the topic.  Just over a month ago we shared the below chart and offered we would be keeping a close eye on the bond market relationship it entails. That is, as bond participants become more concerned that inflation/interest rate risk will impact the forward health of the general economy they sell High Yield bonds in droves being they already represent higher risk on the credit quality front.  Historically we have seen High Yield bonds go down dramatically in comparison to Treasuries when bond market participants become more and more concerned about recession risk.  It is their way of signaling recession risk is building.

Click For Larger View:  https://schrts.co/jqURKSTk

Above is a view of High Yield bonds relative to the performance of 7-10 Year Treasury bonds for the previous fifteen years. When the above line trends lower we can view this as one message coming from the bond market that it is increasing its concerns for the forward health of the general economy. Left-to-right, our first two blue circles highlight the activity of this bond market relationship as we went into economic recession with the housing bust and then with the Covid crisis. Our far right circle highlights current day where we can see it is bouncing a bit albeit within a pretty tight range. This indicator can send its message rapidly so we continue to watch it closely. Stock Market Significance Realize with recessions come slower economic activity which parlays into lower sales, higher inventories, lower profit margins and lower stock prices similar to our aside note above relative to some recent major retailer announcements. The obvious here is price inflation needs to come down notably and soon. If it does not this will continue to underline how far behind the price inflation curve the Federal Reserve remains and hence will place additional pressure on them to raise interest rates rapidly and consistently to catch up. This scenario will be a hard pill to swallow for markets generally from this point. If we do see price inflation to begin to notably decline the key question will be is it occurring because the economy is withering rapidly which in this case will present additional challenges to the general market landscape. For our part we continue to respect the delicacy of the general landscape – both the broad economy on through to markets which means the assets under our care remain in safe harbor. This has served our clients well thus far in 2022. We will continue to operate with caution until we can find opportunities that offer a proper risk-to-reward ratio rather than all risk and no reward. I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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