Don't Bring Me Down

October 7, 2024

By Mark Oelschlager, CFA

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Jeff Lynne, the driving force behind Electric Light Orchestra (ELO), recently came through Ohio on his tour.  The 76-year-old was accompanied by a dozen or so others, and while his voice understandably has less strength than it used to, the show’s production created an incredible experience.  This shouldn’t be surprising, as Lynne is a very accomplished producer, having produced music with/for Tom Petty, George Harrison, Paul McCartney, Roy Orbison, and of course ELO – where he brilliantly blended classical and rock music. Lynne is not ultra-famous and not your typical rock star; he likes to keep a low profile.  But if one could calculate a ratio of achievement to notoriety, given his record of composition, songwriting, production, and performing, his might be one of the highest.

 

In the third quarter the showdown between bulls and bears took an interesting turn, as the economy finally looked like it might be brought down.  The ISM Manufacturing Survey missed estimates two months in a row, as did the employment numbers.  In addition, job growth from earlier months was revised dramatically lower.  This briefly caused panic all over the world.  While the S&P 500 declined 8% in a couple weeks, Japanese stocks fell about 20% in a matter of three days!  The catalyst for the latter was the unwinding of a bit of strange magic – a crowded strategy of borrowing in Yen and investing in Dollar-denominated assets.  The Bank of Japan has abandoned its longstanding policy of negative interest rates and followed up with additional hikes.  At the same time, US markets have been pricing in more aggressive easing by the Federal Reserve (Fed) due to a weakening economy and falling inflation.  All of this served to strengthen the Yen and weaken the Dollar, thus leading to the turmoil.

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Subsequent economic releases were not as bad as feared, which prompted stocks to rebound.  The focus then turned to the Fed and its meeting on September 18.  Chairman Powell (Mr. Blue Sky?) reassured the market about the economy’s strength – and then delivered a cut of 50 basis points, placating investors and driving stocks higher.  The ½% cut in rates wasn’t entirely unexpected, but it is unusual in a time of relative calm.  Normally the Fed operates in a more incremental fashion (25 basis points) outside of crisis, but the progress on inflation in combination with a weakening economy provided the justification for a “jumbo” cut.  Just as importantly, the Fed signaled that it intends to cut rates by an additional ½% before year-end – and another 1% in 2025.  This was music to the market’s ears.  Remember though that there is often a large difference between the Fed’s forecast and what it ultimately ends up doing.

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If you can’t get the upcoming presidential election out of your head, it may be because the airwaves have been inundated with ads.  We are often asked how this election will affect the market, and our answer is the same as it usually is before such an event: we don’t know.  There are certain sectors that could be positively or negatively impacted depending on who is elected, but even that doesn’t always play out the way one would think.  And the call on the market as a whole is anyone’s guess.  We could construct a bullish or bearish case for equities no matter who wins.  A valuable lesson occurred in 2016.  When it became clear on election night that Donald Trump was going to defeat Hilary Clinton and become president, stock futures sold off dramatically.  The next day – the first day of trading – stocks finished up more than 1%!  In other words, the losses in the futures market were reversed and then some – in one day of trading.  Not even the market was sure what to think!

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One disappointing element of this election, aside from the screen-worthy acting and childish rhetoric, is the race to the bottom on various economic policies.  Each candidate seems eager to outdo the other on poorly conceived economic strategy.  This is all in the name of protecting jobs, which is a noble goal but whose unintended consequences tend to outweigh the benefits.  Subsidization of industry in an attempt to improve competitiveness leads to a misallocation of capital, as China has discovered.  Tariffs raise the cost of goods, which are passed on to consumers in the form of higher prices.  It also leads to retaliation by other nations, which hurts our export businesses.  Free trade raises the standard of living because it allows the most efficient producers to produce the most of a given product, which results in consumers paying less for a basket of goods.  The protectionists might have a case if the generally-free (though they are becoming less so) trade policies of the last few decades had led to 25% unemployment in the US.  But we have 4% unemployment.  People may quibble with how that number is measured, and the dynamism of our economy undoubtedly causes pain for many – and that should be addressed – but the narrative that restricting trade and subsidizing industry will lead to economic Shangri-La doesn’t match history.

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One element that is often overlooked, especially given the magnitude of the trade deficit, is that there has been a boom in the US in areas that are harder to measure.  All those apps in your phone require coders and software developers.  The semiconductors that are the brains in more devices than you can think of require engineers.  These workers aren’t necessarily manufacturing anything, but they are creating tremendous value for society – and the economy.  The world’s most dominant/valuable companies: Apple, Alphabet, Amazon, Microsoft, Nvidia, Metaverse…all were formed in the US.  It’s remarkable when you think about it.  And along the way they have created millions of jobs in this country.  Yet our politicians are stuck in an old mode of thinking.

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Speaking of old modes of thinking, China continues its perpetual game of economic whack-a-mole.  Late in the quarter it announced massive new stimulus in hopes of reviving its economy.  Chinese stocks, which had been in the doldrums for years, rebounded by 27% in the last couple weeks of September.

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Swinging back to the Western Hemisphere, recent events in Argentina caught our attention and serve as the perfect example of well-intentioned policies gone wrong.  For years Argentina imposed strict rent-control laws, obviously in an attempt to make housing more affordable.  Instead, rents soared.  Less than a year ago, Argentina’s president Javier Milei decided to shine a little love on the housing sector and repealed the law.  The result?  A dramatic increase in supply, which has reduced rents and allowed more people to find a residence.  In Buenos Aires, supply is up almost 200% and prices are down 40% in real terms.  With housing affordability down in the US, politicians are toying with the idea of rent controls.  Hopefully there is a telephone line between Washington and Buenos Aires.

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Something that has always struck me is how various ideas catch on, are then discarded after their negative effects become clear, but then resurface a generation or two later.  This has happened throughout history.  It’s as if we need to keep relearning history the hard way.  Try as they might, politicians have yet to repeal the laws of economics.

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Mark Oelschlager, CFA  

Oelschlager Investments ​

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