Rationality Returns to the Stock Market
The stock market’s recent slide may seem irrational to the casual observer. “If high growth tech stocks are the future,” they ask, “then why is the NASDAQ Composite Index down 30% this year?”
The short answer to that question is that future profits must be discounted to a greater degree when interest rates are rising. In other words, forward earnings multiples are going down thereby driving down share prices.
In that regard, the stock market’s recent behavior is entirely rational. Investors don’t mind irrationality when it is working in their favor. When all of the major stock indices hit record highs six months ago, nobody complained.
But now that investors find themselves in bear territory, the rationality of the stock market is being called into question. However, the closer you look at the reasons for the current correction, the more you have to agree with those reasons. Don’t fret; there’s still a way to make money in this market by owning stocks, as I explain below.
First, let’s start with inflation. A year ago, I was one of the few stock market analysts warning about the commodity price increases about to come.
Now, the impact of higher commodity prices is obvious to everyone. In May, the Consumer Price Index for All Urban Consumers (CPI-U) rose 8.6% over the previous year.
This month, gasoline prices hit a record high and are expected to go higher during the summer driving season. That’s good news for oil companies but bad news for everyone else that consumes energy.
Food prices are also escalating quickly. During the past year, the cost of “food at home” (i.e., groceries) jumped by 11.9%.
More money spent on gasoline and groceries is less money spent on everything else. That’s one reason why the retail sector took a big hit last month.
Rising Interest Rates
It isn’t just inflation that is on the rise. So are interest rates, which drive up the cost of borrowing money to purchase homes, cars, and other big-ticket items.
During the past year, the average 30-year fixed-rate mortgage increased from 2.96% to 5.23%. Over that span, the monthly principal and interest payment on a $400,000 mortgage went from $1,678 to $2,204.
That’s why the real estate market has cooled off so fast. According to the National Association of Realtors, “Existing-home sales fell for the third straight month in April 2022. Sales were down 2.4% from the prior month and 5.9% from one year ago.”
As property values drop, so does new construction activity which in turn lessens demand for the furniture and appliances that go in them. That’s one way to alleviate the global supply chain problem, albeit one of the least desirable ways to do it.
Broken Supply Chain
Speaking of supply chain bottlenecks, that problem may be here to stay longer than anyone thought when it first emerged last summer. For that reason, the Federal Reserve Bank of New York (FRBNY) has created a Global Supply Chain Pressure Index (GSPCI) to track its progress.
Until a year ago, the index rarely vacillated more than one standard deviation from its average value. Last fall, it jumped three standard deviations on the plus side and spiked above four standard deviations in April.
By far, the single largest contributor to changes to the GSPCI is “Asia Outbound” shipments. According to the FRBNY, “recent developments related to geopolitics and the pandemic (particularly in China) could put further strains on global supply chains.”
Also not helping are record-high gasoline prices, which have increased the cost of transporting goods once they arrive on our shores. For those reasons, it may not be until sometime next year that the global supply chain is back to normal.
If you think the coronavirus pandemic has run its course, think again. As of last week, the daily new case count in the United States was above 125,000. That’s its highest level in four months and more than two years ago when COVID-19 was thought to be raging out of control.
Thus far, the mortality rate is not rising along with the new case count. But the longer the virus continues to circle the globe, the greater are the chances that it may mutate into a more lethal strain.
If the virus does become more deadly, severe quarantine restrictions may need to be reimposed. That could be the death knell for many businesses in the travel industry that are still making up for lost ground over the past two years.
Since peaking above $27 last November, the ALPS Global Travel Beneficiaries ETF (JRNY) fell below $19 last week after the CPI figures for May were released. Even worse, Miami-based cruise ship operator Carnival Corp. (NYSE: CCL) is down more than 50% this year and sinking fast.
Call Me When it’s Over
In all likelihood, profit margins for most businesses will be squeezed by the factors described above for the remainder of this year. For that reason, I feel that the stock market’s reaction to them has been rational.
What is not rational is to believe that the problems currently weighing on the stock market will never go away. Eventually, inflation will slow down, interest rates will level off, the global supply chain will be restored, and the coronavirus pandemic will fade away.
But until that happens, investors will need to think outside the box to rack up big gains in the stock market. One way to do that is using a technique known as covered call writing, which works well in all stock market environments.
If you’re looking for a way to generate steady income via covered call writing, consider our premium trading service, Rapier’s Income Accelerator, helmed by our income expert Robert Rapier.
Even in the face of worsening inflation, rising interest rates, tech selloffs, overseas war, and anything else this market throws at you, Robert’s trades are income-generating machines. Click here for details.