Order Now — Week of October 18, 2021

As of market close October 15, 2021. Returns in percent.

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An “October Surprise” is a news story used in politics to sway voters at the last minute. Conditioned to bumpy Octobers, we are wondering if October’s first half is more trick than treat. Normally we would expect blah reactions to bank earnings and choppy markets to carry over from September. Instead, Thursday and Friday’s jumps hurdled key resistance levels and give us some optimism that a Christmas rally may be early. The major indices finished at least 1% higher and through mid-month are anywhere from 2.8% to 4% higher. At Friday’s close, the Dow Industrials index sits less than 1% below its all-time high. The laggard is the mega-tech heavy NASDAQ 100, which is still 3.7% below its high.

What do those numbers tell you? That October’s rally to-date is driven by financials, materials and value-oriented stocks at the expense of growth and interest sensitive sectors like utilities. Energy is still the star, piling on gains of nearly 11% this month. Natural gas and fuel oil demand continue to outstrip supply. The end of the summer driving season is not cooling gasoline demand; pump prices are 7% higher since June.

On that note we would point out the supply chain news is “real” and is going to make for a challenging Christmas. If you have not already gone shopping, this would be a good week to get gifts ordered. Delivery times inside the U.S. continue to trend higher, thanks to a lack of truck drivers. We are increasingly seeing evidence that supply chains may be clearing over the next year. Even bitcoin and the crypto world bounced higher, thanks to consideration by the SEC of a possible futures exchange for some crypto contracts. 

The Buzz

The new buzzword is “stagflation.” This is a ’70s-era retread, doomed to bad feelings normally associated with disco. Rising from the no-growth crypt, it has sunk its scary claws into the media and experts. Let’s take a moment to declaw the beast and send it back to the financial graveyard.

The “stag” comes from stagnant growth in the economy. “Flation” was the consistently rising prices brought by OPEC oil shocks, union strikes and rising interest rates. It became the label for the early 1970s as back-to-back oil price hikes by OPEC stalled most of the developed world. The U.S. slid into recession that lasted five quarters and sent unemployment to 9% by May of 1975. Three keys to that period were the dependency and surprise of foreign oil and the power of private unions.

Contrast those initial conditions with today. Growth is falling from a very high Recovery Race peak to above trend 4% levels this year and next. Inflation is higher than the last three decades but appears to be peaking. Finally, unemployment is slowly falling amid record job openings. So why the talk of stagflation? Remember recent economic data shows a definite slowdown from the spring’s reopening. We discussed in these pages that a slowdown to 4% or 5% GDP growth should be expected. The delta variant had other ideas, likely throttling growth down to 2% to 3% for the quarter.

Backward-looking pundits are extrapolating July and August’s slower than expected activity into the future. September’s retail sales, manufacturing data and factory orders were all at or above expectations. Weekly Johnson Redbook retail sales figures continue to be above trend. We believe 4th quarter GDP growth will likely come in above expectations, driven by a post-delta bounce.

Elevator Up

Fuel shortages and higher raw materials prices have been a constant refrain over the last three months. This will continue. Coal shortages in China caused rolling blackouts and factory shutdowns last month. This month the key coal producing region of Shanxi experienced near-record rainfall, flooding some coal mines and taking them out of production. Lower-than-expected wind speeds in the North Sea continue to hamper electricity supplies in Europe. The most worrisome aspect of the shift to renewable energy is Europe’s very low levels of natural gas stored for this winter.

Natural gas futures are trading above $5.40 per million Btu. These prices were routine back in the “China-buys-all-commodities” boom of 2003-08, but otherwise rare in history. Crude futures for next month's delivery closed at $84.75 on Friday and have now spent five weeks above $70 per barrel. Domestic producers are noticing these higher prices, having activated over 1,600 wells that were drilled but uncompleted over the last year. The Baker Hughes rig count rose by 10 last week to 543, its highest since April 2020.

The demand shock of the pandemic shutdowns led to production stops at all levels. The Recovery Rebound has been uneven but not surprising. The February storm in Texas likely had more impact on oil-related supply chains for plastics and paint than crude production last year. We think the energy demand story is in its early stages. Expect to see Europe reopening some coal plants in the coming months.

“Flation”

Producer prices, what manufacturers pay for raw materials and other items, have risen faster than consumer prices all year. See above for commodity prices. Reopening sectors, such as autos and restaurants, appear to be peaking in terms of price changes. Food and housing costs have not peaked. Supply chain issues are another piece of the puzzle. Shipping costs to the States have already rolled over. The Drewery World Container Index is just above $8,000, well below its August peak of just over $12,000. Note that it averaged $2,000 for several years prior to the pandemic. The University of Michigan consumer inflation expectations survey has an impressive track record. Its most recent reading of five-year inflation dropped for the first time in four months. Overall, inflation should be peaking in the coming months, if not now.

Wrap-Up

The pandemic was an accelerator for trends that started, in some cases, decades ago. The shutdown reactions have throttled economies up and down. Markets do not like uncertainty or surprises. The Fed has done an admirable job of telegraphing its coming bond purchase reductions. Supply chain problems have been around for a year and likely will be for another. Of the earnings calls this month, supply issues have been mentioned over 3,000 times by management. The Deere strike and airline worker issues may be more politically related than old-style power plays. The modern “strike” is not to picket, but merely quit and go to another employer.

Our view is that forward-looking markets are sensing that D.C. drama may be watered down, supply chains are getting handled and folks are continuing to spend. This matches our economic dashboard, which is still bright green.

Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary's University School of Law. Follow him on Twitter here. Greg Kalb is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts from The University of Texas at Austin.

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