We’re six months into 2022 and the backdrop on paper appears to be even worse than the environment we just clawed our way out of in the previous two calendar years. Inflation is surging, bears are running amuck, a recession is looming (some might tell you we’ve been in one for months), people are being priced out of their own homes, and a culture war has hit a new level of tension just as we’re stumbling towards a mid-term election. It feels like a decade ago we had a raging pandemic, a global economy essentially turned off overnight and riots in the streets. These Roaring Twenties are not it, fam. This wouldn’t be much of a quarterly letter if we simply piled onto the seemingly infinite mountain of FUD (Fear Uncertainty and Doubt). Headlines this year have felt awfully similar to the ascension higher on Space Mountain at Disney World. Complete darkness with no understanding of when the ride stops. But what if we took a second to separate the sentiment from the data we’ve been receiving? Is it possible that our human brains have been triggered beyond repair?
Hearsay
The danger of following the herd is you run the risk of falling into the trap set by the social proof bias. Allowing the masses to interpret data and tell you how to comprehend your environment, and subsequently how to feel about it is a pretty disempowering place to be. We fall into this trap because we often times face significant risks when we opt to stand alone in our beliefs. We’re also prewired to seek community in just about everything we do. So, marching to the beat of our own drum triggers a flurry of uncomfortable emotions we’re forced to face if we choose the road less traveled. Unfortunately, most of us haven’t had enough therapy to learn how to become more comfortable with ambiguity. Despite this, for this exercise, we’re challenging readers to check their preconceived opinions at the door and observe the following data as objectively as possible.
Five Signs the End Isn’t Near
For starters, the prevailing wisdom has reached such pessimistic levels across a multitude of benchmarks. Investor anxiety has created an overwhelming sense of an end of days scenario for the economy and just about every investment principle that has steered the market over the last 10+ years. This has forced the bar so low in order for our immediate future to be brighter than we’ve collectively grown to believe it will be. Michael Jordan infamously used the phrase “the ceiling is the roof” a few years ago when speaking to the UNC basketball team. Even with the context that he was in an arena, and he was alluding to the championship banners hanging in the rafters, the phrase doesn’t make a ton of sense. Today, I think Michael Jordan would agree that the bar is the floor. I also think he might take what I just said personally.
The sentiment we’ve seen thus far in 2022 has been largely driven by two variables: the stock market and inflation. At the trough in June, the S&P 500 eclipsed the bear market threshold when it closed off its most recent high (January 3rd) by more than 20% (-22%)1. This alone has sent investors back in time to 2008 and 2000 when making their comparisons of our current reality to not so distant history. But a major difference when considering this bear market to the two bear markets that accompanied the recessions of 2008 and
1 Data provided by Bloomberg database.
2001 is the fact that by the time the equity market had reached bear market territory in those two examples, the economy was already in a recession. Shouldn’t we ask ourselves if we’re not in a recession right now, or not going into one next month, if our environment is better than we’re thinking it is? I’ve buried the lead enough, now onto the real time, hard data that should make us question the consensus.
Inflation is the biggest problem facing the economy at the moment. The Federal Reserve came into the year already with a tall task as they began their rate hike cycle, and so far, we’ve had to weather a market that is desperately trying to price in exactly how long and steep this cycle will be. Traditionally hiking cycles are pretty straight forward when trying to assess these two variables. But the persistency of the inflation we’ve seen since the back half of the pandemic has proven more difficult than the Fed anticipated it’d be.
The biggest drivers of the inflation we’ve been experiencing is something the Fed doesn’t have any influence over. It’s commodity prices, its supply shortages, and its shipping prices. Its supply side forces. Bearing in mind that inflation reports are released on a 1-month lag, it would behoove investors to look at the real time data for some of these inputs in order to try and have a grip on where inflation is headed, as opposed to where it’s been.
Perhaps the best example of these supply shortages is what role used cars has played in inflation reports dating back to 2021. In the 20 years leading up to 2021, used car prices carried a muted 0% contribution to inflation reports on average. However, in the 12 months ending 1/31/22, the input added 100 basis points to the total headline inflation number2. Have you ever tried pushing a string? No amount of monetary policy can reign an anomaly like this in. But time heals all wounds. What we’ve seen in the last 5 months is a persistent decline in prices for used cars, and in some recent reports the input has been outright deflationary in terms of its contribution to headline CPI3.