| 4th Qtr.
| 12 Mo.
|10-yr Treas. yield||1.51%||1.48%||+0.03%||0.917%||+0.593%||+0.593%|
|Fed funds rate||0 – 0.25%||0 – 0.25%||n/a||0 – 0.25%||n/a||n/a|
(stock indices are before dividends; yield and rate changes are absolute changes)
The US stock market lived up to its reputation for looking forward, combining strong recent corporate earnings with a view beyond supply chain problems and the uptick in COVID cases, hitting record highs in the last week of the year. (The NASDAQ hit its high in mid-November.) The US dollar finished the year moderately stronger against major currencies, while the leading crypto-currency bitcoin hit a record high after the introduction of a bitcoin exchange-traded fund, only to retreat sharply. Interest rates went on a bit of a ride, shooting up at the start of the quarter, retreating well below the starting point and finishing right where it started. Congress raised the government debt ceiling in the nick of time after a temporary measure, and the $1 trillion infrastructure bill passed while the much larger Build Back Better legislation failed.
Inflation was the big news for the quarter, with the core inflation measure (excluding food and energy) favored by the Fed jumping 4.7% in November, the biggest increase since 1983. Both the broader producer and consumer price indices grew even more. Social Security will increase by 5.9% for 2022 while Medicare Part B premiums will jump over 14%. It seemed nothing was immune from price increases, with the annual PNC Christmas Price Index up 5.7%, the most since 2013, led by turtle doves and geese at over 50%. Inflation projections for 2022 also increased to 2.6% from 2.2% in September.
Despite a disappointing November jobs report, with only 210,000 jobs added after October’s 546,000, the unemployment rate continued to fall to 4.2%, its lowest since before the 2020 recession. (Nebraska recorded the lowest state unemployment ever at below 2%.) Labor participation is still lagging, with 2.4 million less workers than two years ago. Weekly unemployment claims dipped below 200,000 for several periods. The tight labor market supported a jump in hourly earnings of nearly 5% for the last 12 months. Although overall consumer spending slowed in November with higher prices (spending was flat after adjusting for inflation), the overall holiday shopping season was up 8.5% from 2020 and 10.7% form 2019, reflecting consistently strong consumer confidence readings.
Growth in China slowed considerably due to power shortages, supply chain problems, COVID and staggering debt for property developers. No Chinese real estate companies have formally defaulted but they have missed payments and the Chinese government is trying to wean the economy off its long addiction to real estate debt. In the US, both services and manufacturing indices remain strong, although the prices paid by manufacturers soared. Residential US real estate continued its recent rends with very low supply (around two months’ worth) and price increases (between 13% and 19% compared to a year ago, depending on the measure). First-time buyers are still having difficulties in the tight market, accounting for 25% fewer purchases than last year.
The final GDP increase for the third quarter was 2.3%, a slight increase from the initial estimates, but projections for the first half of 2022 were reduced due to the Omicron variant. Looking very long term, so far there has been no “pandemic baby boom”. US population grew by only 0.1% in 2021, the lowest on record, and the net growth was 393,000 after averaging 2 million/year over the last decade. With COVID deaths and a gradually aging population, life expectancy actually fell by 1.8 years.
Typically, the issues addressed in Looking Forward, if not resolved, have enough progress to become a bit less uncertain, and we move to the next uncertainty. Sometimes, though, the issue takes on a different complexion and is still serious enough to warrant an update.
In the First Quarter 2021 Review, we discussed the end of the “nothing is cheap” environment, noting that when and how are unknown. In the Second Quarter 2021 Review, inflation was the issue, with the definite possibility that consumers would just have to learn to live with it. The Fed is a big factor in both of those issues, but now the Fed and its actions are front and center.
The Fed’s position that inflation will be “transitory” (Webster’s definition: of brief duration, tending to pass away) has been sorely tested by persistent supply chain problems and the tight labor market. Also consider that a contributor to inflation is too much money chasing too few goods (Economics 101). The combination of Fed actions and stimulus payments has increased the money supply at an annualized rate of 18% since February 2020, nearly three times the long-term average. By comparison, during the recessions of 2001 and 2008-2009, government and Fed policies caused money supply growth to only briefly touch 10%.
The shifting landscape is reflected in two areas. First, the projections for the median level of federal-funds rates (very short-term rates, and the only ones directly controlled by the Fed) by Federal Reserve Board members and Federal Reserve Bank presidents have changed dramatically. In March 2021, the median projection was that rates would still be zero through 2023. In June, the median was for rates to remain at zero through 2022 but increase to 0.5% by the end of 2023. September saw rates increasing to 0.25% in 2022 and then to 1.0% in 2023, and in December the median projection was for rates to hit around 0.9% in 2022 and 1.5% by the end of 2023. Because interest rates set by the market typically reflect a “curve” with longer rates for longer-term bonds, those increases would be felt across the board for investors and borrowers alike.
The Fed also accelerated adjustments to its bond-buying program, which had been $120 billion/month in addition to replacing bonds as they matured. The Fed had the position in September that they may begin tapering those purchases by year-end 2021 but that this statement was not a “direct signal”. By mid-November, the Fed announced they would reduce their purchases by $15 billion/month until they reached a full stop by mid-2022. Shortly after his nomination and confirmation to a second term as Fed chairman, Jerome Powell indicated on November 30 that tapering may speed up due to inflation. That was followed by a mid-December announcement that tapering would double to $30 billion/month, meaning the end of buying by March. Furthermore, the remaining bonds on the Fed’s balance sheet will “roll off” when they mature, meaning the Fed will not buy bonds to replace them and leading to gradual reduction in the Fed’s overall holdings.
Since the start of the pandemic the Fed has been much more focused on its mandate of maximizing sustainable employment than its mandate of price stability (a target of 2% annual increases). Have the Fed’s predictive powers become sharper? Or will they have to make additional adjustments as inflation either fades or hardens.
Our Portfolios (uncharacteristically long for this section, but bear with me)
We have been consistent with the “total return” approach to portfolio management, not veering into sector or style strategies. Still, there are endless articles and opinions touting these strategies, and they can be persuasive enough to lure investors who do not look deeper than the headline.
So, we picked a random example (we swear) from Motley Fool which ran online in November 2021 and is titled “The Smartest Dividend Stocks to Buy With $300 Right Now”. In fairness, Motley Fool makes clear that the article is the opinion of the writer, and it may disagree with the “official” recommendation of a Motley Fool premium advisory service. But the article is under their byline and the author is noted as a Fool since 2010 who specializes in healthcare and investment planning.
The first “key point” is that dividend stocks have a history of significantly outperforming non-dividend stocks and cites a JP Morgan study from 2013 that concluded between 1972 and 2012 dividend-paying stocks returned an average annual return of 9.5% while non-dividend stocks posted a measly 1.6% annualized return. We did not verify that study and would not dispute it but keep this in mind. First, the non-dividend group were stocks that did not pay a dividend over the entire 40-year period. Second, around 80% of the current S&P 500 stocks pay some dividend, and it is likely that the other 20% would eventually initiate a dividend if they are successful. The definition of non-dividend stocks over the long period of the study pretty much defines poor-performing companies.
The second “key point” is that three stocks offer the “perfect blend” of growth and dividend income. Here’s what the article says about the three stocks compared to the real world of investing. (Yield is the annual dividend divided by the current price.)
Annaly Capital Management (NLY): 9.9% yield
The pitch – there’s not a more exciting ultra-high-yield income opportunity (emphasis theirs) than NLY, whose 9.9% payout could double your initial investment in just over seven years if reinvested. NLY is a mortgage REIT, with few surprises and, if you’re worried about another recession, Annaly has you covered.
The reality is not so pretty. The 10-year annual total return (dividends and price change) for NLY is 4.4% compared with 16.3% for the S&P 500. On price alone, NLY actually had a -7.0% annual change, which means the price is now 51% lower than 10 years ago. But that period was a historically good one for the S&P, so you could claim it’s not a fair comparison. Unfortunately, NLY also fell in price far more (75% compared to 34% for the S&P 500) during the COVID market decline in 2020. Over 10 years, NLY is also 65% more volatile than the broad market.
Verizon Communications (VZ): 4.7% yield
The pitch – This is the perfect stock for conservative investors who loathe volatility but still want to outpace inflation. Its two catalysts for the future are the rollout of 5G wireless infrastructure (and its in-home 5G broadband push) and strong consumer loyalty. Still, the appeal is the yield, with modest growth potential.
Like NLY, VZ’s 10-year total annual return is a fraction of the broad market S&P 500 (7.5% compared to 16.3%). Its decline compared to the broad market and its volatility are mixed, depending on the period analyzed, and it did hold up better during the COVID decline. By the way, that total return difference means that $10,000 invested in the broad market 10 years ago is now worth just under $46,000 while VZ would be worth just under $21k, a big sacrifice for the dividend.
Innovative Industrial Properties (IIPR): 2.5% yield
The pitch – While NLY is all about the dividend income and modest share price appreciation, IIPR is all about significant price growth and a modest yield with a rapidly growing payout (a dividend that’s grown 900% in four years). Oh yeah, IIPR is a cannabis-focused real estate investment trust (REIT).
This one is really interesting. IIPR has only been around for five years and in that time has far outperformed the broad market ($10k invested in the S&P 500 over that period would now be $23k while IIPR would be worth $159k, a home run). However, volatility is nearly three times greater than the market and the maximum price decline is twice the market. The dividend has indeed grown that much but from a very low starting point and the payout is greater than earnings per share, unusual for a growth company. IIPR has also benefited from the cannabis craze and has a price/earnings ratio of 59 times (the broad market has a P/E of 28, which is considered high). IIPR has been living off issuing more stock, which dilutes (reduces) the interests of prior shareholders.
Individual stocks, even if they pay good dividends and even if the investment is only $300, are not worth the risk. Don’t be misled by the “experts” to expose yourself to unintended consequences. The broader market, with a current yield of 1.3%, is a much better bet.
Stick It To the Man
One of the drivers behind “meme” stocks like GameStop and AMC, and the fascination with crypto-currencies, is the idea that individual investors are somehow beating Wall Street at its own game. Whether it’s the disruption of decentralized finance or the “short squeeze” that caused huge losses for institutional investors who bet that GameStop and AMC would fall in price, these zealots are willing to take huge risks to punish big, bad Wall Street. They proudly refer to themselves as “HODL’ers” (hold on for dear life) or, in the case of AMC, “apes”, a reference to the film “Rise of the Planet of the Apes”.
While those individual investors may have won a small battle or two (really more like skirmishes) they are losing and will continue to lose the war. As it turns out, a mere 0.1% of bitcoin owners own 27% of all bitcoin, and institutional money and venture capital is flooding into all things crypto. Institutional investors own over 30% of both AMC and GameStop, and both companies sold billions in additional stock after their stock prices soared. Whether from skill or just riding the wave created by individuals, the big players made most of the money.
We are no fans of Wall Street either, and not enriching Wall Street is a reasonable objective. But playing their game is not the way to do it. Here are some other, simple steps that support that objective.
• Invest as cost-effectively as possible – Any investing involves Wall Street to some degree, but by keeping costs low and making infrequent portfolio changes, the benefit to Wall Street is minimized. And as we have routinely argued, low-cost index funds representing the broad market will automatically adjust to reflect changes in the market and the economy, so you don’t have to pay some distant “experts” for their opinion.
• Avoid new investment vehicles – Wall Street is very skilled at creating investment vehicles that not only allow them to profit by using other people’s money but that also disproportionately funnel gains to Wall Street and risks to unsuspecting investors. Don’t be fooled by the shiny, new thing unless you fully understand how it works (and not just the “benefits” as suggested by a salesperson).
• If you must trade or speculate, partition – We are not completely humorless, and trading and speculation can actually be interesting, fun and maybe even profitable. If you want to risk some of your hard-earned funds, partition them in an amount that does not derail your long-term financial plans (in other words, only an amount you can afford to lose). Write down that amount and post it as a reminder to keep you from the temptation of adding more money if you have success, because that success will most certainly be fleeting.
• Manage debt carefully, especially credit cards – Borrow only to pursue long-term goals and for things that have lasting value, like education or an appropriately-priced house. Just because you are approved by a lender does not mean that debt is a good idea. And if at all possible, never carry a credit card balance; if you can’t save ahead for travel or entertainment, have the discipline to wait. You’ll get the full enjoyment from the experience without the stress of repaying debt.
• Don’t use bank add-on services – The days of friendly community bankers are long gone. Most services offered by banks beyond simple deposits and transactions are more expensive than readily available alternatives. (Credit unions are a little better but still be wary.) Treat banking services like a commodity and pay as little as possible.
• Minimize social media/keep control – Perhaps the most disturbing recent revelation about social media is how quickly algorithms can lead users to political extremes and expose young users to sex, drugs and eating disorders. The results in investing can be the same, with algorithms reinforcing some initial interest and taking you to extremely risky areas. Read this stuff with a critical eye (see Our Portfolios above) and resist taking action. If you want support in your speculative trading, research and choose one source and follow it.