Broker Check

Rebalancing The US Economy

November 09, 2022


The tsunami impact of shutting down the US, the world's largest economic engine, for nearly nine months in 2020, and in some cities' continual restrictions, has understandably created a tsunami wave of financial imbalances. The first wave that hit the shores of world economies was the lack of supplies as manufacturing production dropped significantly in 2020. Their recovery was limited in 2021 due to a lack of material supplies from foreign countries that maintain their severe restrictions to this day.

 Wall Street Journal reported today about China the following:

“Chinese officials have grown concerned about the costs of their zero-tolerance approach to smothering Covid-19 outbreaks, which has resulted in lockdowns of cities and whole provinces, crushing business activity and confining hundreds of millions of people at home for weeks and sometimes months on end. But they are weighing those against the potential costs of reopening for public health and support for the Communist Party.

As a result, they are proceeding cautiously despite the deepening impact of the Covid-19 policies, the people said, pointing to a long path to anything approaching pre-pandemic levels of activity, with the timeline stretching to sometime near the end of next year.”

China's timeline stretching to sometime near the end of next year?!? I trust you are very thankful you live in a free country where citizens are not entirely removed from the process of sweeping restrictions and inconceivable zero covid tolerance policies. Can you imagine if Washington and CDC announced all businesses must shut down every time anyone is diagnosed with covid? It would be a total economic collapse.

I imagine it will be decades before China's economy and society recovery from these draconian measures enforced by the Chinese communist party. Not only are their youths not getting proper education and young adults dangerously idle without jobs, but international companies have been moving their entire workforce from China to other countries to avoid these restrictions.

A November 2021 article by Market Realist reported that 76 percent of US companies with factories in China were in the process of or considering moving operations to other countries. More disturbing is UBS Evidence Lab report stated that the majority of those infected by Covid in China are asymptomatic. It's not just manufacturing companies relocating out of China. Other industries leaving include Apple, Foxconn, Microsoft, and Yahoo. Other recent departures included US retailer Gap Stores and earlier this year, McDonald's closed its last store that, prior to its close, had massive, long lines (standing 6′ apart, of course) to have one last Big Mac.

China is only one of the many countries experiencing self-inflicted wounds. The European Union countries potentially face energy shortages this winter and soaring prices due to their dependency on Russian oil and gas and closing energy-producing plants, Mexico has extensive gang warfare, and Japan remains in a 30-year recession. This may explain why domestic and international investors, hedge funds, and institutional managers continue to maintain large allocations to US currency, bonds, and equities. The US dollar, the world's primary currency, continues to rise as investors divest riskier non-US currency.

I project that the US economy and stock market will maintain a key position in most institutional portfolios for many decades until foreign governments resolve their monetary and fiscal policies that limit their country's growth.

More importantly, the world will be acutely aware when the US stock market begins its next positive trend. I anticipate the positive up trend will be assisted by eager institutional managers worldwide investing in US stocks to recover from their losses.

The worldwide reset of economies caused by the pandemic has created imbalances in almost every region and industry. The lingering challenge of supplies and distribution channels appears to, at least in the US, begin to stabilize. The evidence on local levels is full shelves in the stores. Last week the Bureau of the Census, US Department of Commerce released September's US Factory Orders Report. Trading Economics provided this analysis:

“New orders for US manufactured goods rose by 0.3 percent in September of 2022, picking up from the revised 0.2 percent uptick in the prior month and in line with market expectations. Orders for durable goods rose by 0.4 percent (vs. 0.2 percent in August), largely due to increased orders for transportation equipment (2.2 percent vs. 0.5 percent). A steeper expansion was prevented by lower orders of primary metals (-1.9 percent vs. 0.4 percent) and machinery (-0.1 percent vs. 0.7 percent). In the meantime, demand for non-durable goods rose by a slower 0.2 percent, unchanged from last month's rise.Excluding transportation, factory orders fell by 0.1 percent in September, edging down from the 0.1 percent rise in August.”

August continued the longest run of increasing factory orders in 30 years. During prior recessions, factory and manufacturing industries have recovered but none compared to the consecutive increases experienced since the summer of 2020. After the 2008 Great Recession, factory and manufacturing growth had 13 consecutive months of increased production compared to the current period of 23 consecutive monthly gains.

Increasing US factory and manufacturing growth will resolve the supply disruptions and provide businesses around the world with the necessary supplies to meet demand. The balancing of supply and demand will result in price stability and efficient end-user product distribution. The slowing of prices is exactly the objective of the Federal Reserve that will eventually lead the Federal Open Market Committee to slow or end their rate hike policy.

What Does This Mean to Me?

This year has been painful watching trillions of stocks and bond asset values decline. However, the Federal Reserve rate hike policy is implementing the very policies to stabilize the US economy and stock market and, more importantly, position it for multi-year sustainable growth. I believe the Fed's rate hike policy saved the construction, housing, and lending industries from another financial collapse of epic portions if mortgage interest rates were left at sub 3%. The dramatic interest rate rise has crushed mortgage lending and stalled the home-buying market resulting in soft home prices. All necessary for these industries to rebalance. Lenders can't make a profit on 2% fixed mortgage loans that stay in their portfolios for decades, causing billions in losses.

Another benefit to the Fed's raising rates is creating a margin for the next recession. Janet Yellen, former Federal Reserve Chairwoman, at the scorn of almost every financial analyst, began raising the discount rate in 2010 when every central banker around the globe was still reducing rates and some going to negative rates (lender pays the borrower). As a result of her actions, Jerome Powell, current Fed Chairman, had rates lower in 2020 to assist US businesses and households through the devastating pandemic.

Finally, rising interest rates are providing investors with alternatives to stocks. The mantra for the past 20 years has been NBS (nothing but stocks). The 10-Year treasury bond at 0.5% in 2020 was no reward and yielded well below inflation. However, now the 10-Year treasury yield is around 4%, which provides investors with a reasonable option for their fixed-income portfolios. Also, banks will begin raising their money market and Certificate of Deposit (CD) interest rates that will offer investors an option for short-term low-risk accounts.

The rebalancing of American industries and the economy this year has been painful. However, the disruption of 2020 was significant, and the rebalancing process would understandably be of equal or greater recourse. Our view is the process is never pleasant but necessary if the goal is sustainable economic growth. Most stock portfolios have had a net profitable annualized return since January 2020, even with this year's -20%+ decline, and should provide some consolation even though no one enjoys watching their accounts decline.