Bob’s Journal for 12/26

Post-Election Rally Fizzles

Investor enthusiasm after the election ran too far ahead of events. The unexpected election results were followed by rallies in a range of risky assets, such as stocks and bitcoin.

But December hasn’t been as kind to the riskier assets. Indeed, it hasn’t been a good period for any of the major asset classes.

One reason probably is that investors began to realize the proposals of the election’s winners might lead to stronger economic growth but also could be accompanied by higher inflation and interest rates.

Another factor is that Federal Reserve officials made clear that the economy was stronger than expected when they began reducing interest rates in September. They began walking back some of their concerns about slower economic growth and their confidence that inflation was tamed.

Whatever the reasons, stock market returns weren’t pretty through the first 20 days of December.

The major stock indexes and the few large growth companies that dominate them held up well for most of the month. But even they weakened in the last week or so.

For example, the S&P 500 closed last Friday 3.8% below its December high. The Nasdaq Composite was 4.1% lower than its December high.

The average stock and most sectors were fading before the major indexes followed them down.

More stocks declined than advanced for a record 15 straight days.

Every sector in the S&P 500 was down at least 2% over the five trading days ending Dec. 20, according to Bespoke Investment Group, and three sectors were down more than 6%.

Even bitcoin finally fell more than 5% in the last week, though it’s still up about 50% over three months.

Before panicking, consider a longer-term perspective.

The recent declines are from all-time highs for many of the stocks and indexes. Even those that weren’t at all-time highs had strong rallies before the correction.

The Nasdaq and S&P 500 still are higher than their pre-election levels. The equal-weighted S&P 500 is down only 0.05% over the last three months. The Russell 2000 smaller-company index is up 0.81% over three months.

However, the energy sector is down 4.43% over three months (and 12.66% in the last four weeks). In contrast, the financial sector is up 6.63% over three months.

The last few weeks likely are a correction, shaking out the excesses that occurred right after the election. Investors should focus on fundamentals and margins of safety, while ignoring the mini-rallies and corrections that accompany short-term news events.

Tough Times Continue in China

China’s economy is struggling under a number of burdens developed over the last 10 years or so.

Those burdens dramatically reduced the economy’s growth rate in the last few years.

The Chinese economy has an extraordinary amount of debt. The debt was accumulated over the years to generate what turned out to be artificial growth. The primary borrowers were local governments that built housing, infrastructure and factories that now aren’t needed or used.

The combination of excess debt and overbuilding has the country on the verge of a deflationary downturn.

The national government implemented a range of stimulus measures in recent months to prop up growth, but those were short-term measures. They don’t address the fundamental problems.

Complicating matters is that China’s actions against other countries and a range of international companies caused a sharp reduction in foreign investment in the country.

Growth used to be around 10% annually. Now, it is half that at best, and the government says it plans to keep the growth rate in the lower range.

Consumer confidence and spending in China are very low, and pessimism seems to be increasing.

The government leaders say they believe the country will recover from its current economic problems through more government-directed investment. But the new investments will be in different areas.

The country’s new focus is on select areas of technology. For example, it is producing low-cost electric vehicles that are dominating many global markets.

But the vehicles and other exports are sold at low prices, probably lower than their cost to produce. The government is subsidizing many of the producers. China effectively is exporting deflation by selling its excess production in other countries.

China also faces a significant problem that is little discussed in the form of its rapidly aging population. Due to its one-child policy that was in effect for many years, the country has perhaps the world’s oldest population, and the average age is rising rapidly.

Countries with aging populations tend to be less productive and have lower economic growth than others.

China’s leaders continue to prioritize state control of activities and actions that benefit the Communist Party. Instead of encouraging the private sector to innovate, the government further restricted the private sector.

The government seems convinced that its new investments and policies are paying off and will generate enough growth to overcome the previous mistakes.

But the policies haven’t been kind to stock investors. After rallying more than 35% in the last 12 months, the iShares China ETF (FXI) still has a negative 4.60% annualized return over five years and negative 0.37% over 10 years.

Congress Accelerates Demise of Social Security Trust Fund

Congress passed a change in Social Security benefits that the Congressional Budget Office estimates will accelerate the depletion of the Social Security trust fund by at least six months.

The bill, dubbed the Social Security Fairness Act, passed both the House of Representatives and the Senate by wide margins and is expected to be signed by President Biden.

The bill increases the Social Security benefits of some state and local government workers and their surviving spouses by reversing two provisions enacted in the 1980s Social Security reforms, the Windfall Elimination Provision and the Government Pension Offset.

The commission that produced the 1980s reforms determined that under the old benefit formula, local government employees who weren’t subject to Social Security but spent part of their careers in the private sector where they did pay Social Security taxes, were receiving greater benefits than comparable private sector employees.

The reforms reduced the Social Security benefits of those workers to account for the years they earned state or local government salaries. Details are in my book, “Where’s My Money: Secrets to Getting the Most out of Your Social Security” (Regnery Capital 2020).

The new law eliminates those reforms and increases Social Security benefit payments by an estimated $196 billion over 10 years.

Some people suggest that Social Security could be made solvent by raising the retirement age to 70. The Congressional Budget Office estimates the savings from that change would be about half the cost of the new law.

The Data

The Leading Economic Index from The Conference Board increased in November for the first time since February 2022, rising 0.3% to 99.7. It had declined 0.4% in October.

The Conference Board said the index now indicates GDP will grow 2.0% in 2025. It had been predicting a recession for most of the last few years.

The Consumer Sentiment Index from the University of Michigan rose to 74 in December, its highest level since April, from 71.8 at the end of November.

The expectations segment of the index rose while the gauge of current conditions declined.

The Consumer Confidence Index from The Conference Board fell 8.1 points in December to 104.7. The index has been between 100 and 120 since 2021.

The Present Situation component of the index fell by only 1.2 points to 140.2 in December. But the Expectations component dropped 12.6 points to 81.1. A level of 80 or lower on the Expectations component often precedes a recession.

Personal income increased another 0.3% in November after rising 0.7% in October. Compensation increased 0.6% in November while income from assets fell 0.1%.

Personal consumption expenditures were 0.4% higher in November, following a 0.3% rise in October.

The Personal Consumption Expenditure (PCE) Price Index rose only 0.1% in November and 0.2% in October. Over 12 months, the PCE Price Index was higher by 2.4% through November and 2.3% through October.

The core PCE Price Index, which excludes food and energy prices, increased 0.1% in November and 0.3% in October. The 12-month increase in the core PCE Price index was 2.8% through both November and October.

Existing home sales increased by 4.8% in November, following a 3.4% increase in October. The number of existing homes sold in November was the highest in eight months.

The median sale price of an existing home in November was $406,100, which is 4.7% higher than the $387,800 median price 12 months earlier.

New home sales increased 5.9% in November, after dropping 14.8% in October.

The Philadelphia Fed Manufacturing Index was negative 16.4 in December, its lowest level since April 2023, a decline from negative 5.5 in November.

The Kansas City Fed Manufacturing Index was negative 5 in December, down from negative 4 in November.

The Richmond Fed Manufacturing Index improved to negative 10 in December from negative 14 in November.

Durable goods orders declined 1.1% in November after rising 0.8% in October.

Excluding defense and transportation orders, which is a good proxy of business investment, durable goods orders increased 0.7% in November following a 0.1% decline in October.

GDP grew at an annualized rate of 3.1% in the third quarter, according to the final estimate. That’s a small increase from the 3.0% rate in the second estimate.

New unemployment claims fell by 22,000 to 220,000 in the latest week.

Continuing claims, which lag a week behind new claims, decreased to 1.874 million from 1.879 million.

The Markets

The S&P 500 lost 1.67% for the week ended with Monday’s close. The Dow Jones Industrial Average dropped 1.88%. The Russell 2000 declined 5.27%. The All-Country World Index (excluding U.S. stocks) retreated 2.27%. Emerging market equities decreased 1.28%.

Long-term treasuries lost 2.85% for the week. Investment-grade bonds dropped 1.66%. Treasury Inflation-Protected Securities (TIPS) fell 1.02%. High-yield bonds decreased 0.98%.

The dollar gained 1.31%.

Energy-based commodities fell 0.61%. Broader-based commodities lost 0.51%. Gold declined 1.58%.

Bob’s News & Updates

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