- Martin Sosnoff
A Death Knell For Markets Inflation At 7%
I’m just a lonesome operator who recalls 21 cent gas, not today’s gyrating $4.50 to $5.50 at the pump. The 21 cent toll was a Great Depression phenomenon you don’t want to bring back. Today, the country is rife with consumer goods inflation, even the price of a sugar carton. Give me a break, sugar?
Sooner or later, wages won’t keep up with the Consumer Price Index and that spells recession. At the least, discretionary spending gets cut back. Meantime, our FRB chairman repeatedly broadcasts quarterly point hikes coming for money market rates. This is ludicrous talk of such minuscule bumps. Inflation is bubbling at 7% or more for a range of commodities. Not just energy, but steel, aluminum, copper and nickel. You name it.
As a stock, Alcoa fluctuates 5% or more along with U.S Steel, Freeport-McMoRan and Occidental Petroleum. They act toppy. The amplitude of destruction is sizable, even for polite goods like JPMorgan Chase, down nearly 30% from its 12-month high. Citigroup, too.
These are scary times. As yet, no screaming bargains around, ready to be snapped up. Apple, for example, numero uno on the Big Board, sells at 20 times optimistically projected cash flow 12 months out. Read the financial press, daily, but you won’t find many references to market destruction in a setting of recession.
The market traded near 20 times earnings late in 1972 on the eve of one nasty recession, 1973 - ‘74. This malaise was induced by real estate overspeculation. I bought my apartment in the Dakota, overlooking Central Park for $87,000. Everyone said I was crazy, out of my mind for such extravagance. (Shareholders elsewhere were walking away from high maintenance co-ops.)
Yearend, 1972, growth stock valuation stood as much as 4 times the S&P 500 Index, an enormous premium never exceeded next 50 years. In the sixties, growthies like Xerox and Polaroids sold at 60 times earnings, then flamed out on deteriorating fundamentals. Nikon fielded a great 8 mm camera with fast developing film. Sony, too.
What everyone pays little or no attention to is the “cost of carry” on an investment, namely interest rates which do govern valuation. When you see a 7% cost of carry, assume valuation is headed lower, sooner rather than later. Anyone doing deals is sensitive to this issue. I was paying 8% for deal money 20 some years ago and it broke my back. The cost of carry is bound higher.
Analysts and money managers periodically get caught up in euphoric rationalizations of valuation. We rest in this condition currently. At its peak in 2000 Cisco sold at 100 times forward earnings power. Amazon corrected 90% from its 2000 high point, but still sold at 3 times revenues. Then, Walmart with a near impeccable business model sold at 1 times sales, a bargain.
Lemme deal with the 2% yield today as a necessary stimulus for GDP and full employment. But, the country is riddled with inflationary biases like oil and practically every other commodity in wide usage, everywhere in the developed world.
Inflation for the average family is nowhere near the 2% rate on 10-year Treasuries. Wage earners need 7% increases in take home pay just to keep up and get by. The minimum wage of $15 an hour even for part-timers is a forgone conclusion. Healthcare is another challenge not so easy to meet head-on.
Facing the reality of a CPI straining at a 7% surge, what could or should financial markets look like if this condition persists? Go back first to the market’s benign years. In the sixties stocks sold at 20 times earnings while inflation snaked along at a 4% rate. During Lyndon Johnson’s reign, however, the Vietnam War had consequences. Inflation zipped up to 7% and equity valuations dove into the low teens. Later, the recession of 1973 – ‘74 destroyed growthmanship. Price-earnings ratios fell into single digits. Yes! Single digits.
Consider, decades ago when the Fed panicked over inflation it put interest rates up to 13.5%, money market rates at 15%. The market sold down to 10 times earnings, at book value. The deep basic is markets are combustible and do panic over inflation. It could hit us sooner rather than later. We could easily wobble down to below 15 times perceived earnings power.
Can optimism still hang in the air? If nothing else, I anticipate a sizable contraction in the market’s price-earnings ratio, at the least down to 15 times projected earnings. As to pricey paper, Meta Platforms is a lesson in what happens to a growthie that comes up short of the analysts’ earnings consensus. Same goes for Netflix which gapped down overnight on disappointing quarterly numbers and still fades away.
Somebody give me a good reason to be more than 50% long the market. My high-yield bond portfolio weakens daily, across the board, even with a 6% yield to maturity. This is another signal of recession coming along with higher interest rates.
Let’s hope I’m a wrong-footed Calamity Jane.