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Are Economic Conditions Good?

7/22/2024

Yes. No. It depends. Regardless, here are the stock picks to satisfy any point of view.

Economic growth has been steady, unemployment is relatively low, and the stock market is flirting with all-time highs. Yet, 68% of Americans rated economic conditions as fair or poor in a recent survey. Meanwhile, just 32% said the economy was good or excellent.

The problem isn’t the overall economy, but different perspectives based on one’s position in the economy. People owning homes financed with a 3% mortgage rate fixed for 30 years, and little other debt, haven’t felt much impact from the normalization of interest rates over the past 2+ years. Their assessment of the economy is likely to be positive. Over half of U.S. households own a home outright or have a fixed rate mortgage.

This also means that almost half of households rent or have an adjustable-rate mortgage. High interest rates have hurt the pocketbooks of those with adjustable-rate mortgages or credit card debt and delayed the dreams of those trying to buy a home. High rates and a lack of affordable housing have caused rents to rise quite significantly. Charities report receiving more requests for rental assistance than they can handle. People in these circumstances likely rate economic conditions as poor.

U.S. retail sales have been flat to down in recent months, but those are only averages. Restaurants seem to be packed, and demand for travel is robust. The traveling class has money. At the same time, retailers catering to budget-conscious consumers are struggling with inflation. Over the past four years, inflation-adjusted wages are flat. That is an inconvenience for investors who have a portfolio to fall back on and a money-market balance that is finally paying some real interest, but it is devastating to those dealing with above-trend cost increases such as for housing.

These same dynamics also can mislead policymakers who depend on economic data. The core Consumer Price Index rose just 0.2% in May, welcomed by investors who are hoping for interest rate cuts. Over the past year, however, this rate is up 3.3% and well above the Federal Reserve’s 2% goal. Including food and energy, the full CPI is up 3.4% over the past 12 months.

Parsing the numbers, there is simply bad math and bad economics at play. The largest component of the CPI is “owner’s equivalent rent of residences.” At almost 27% of the CPI, it carries the same weight as food, energy, and transportation combined. That’s all the money we spend on groceries, restaurants, fuel for our cars, household utilities, and purchases of new and used cars combined.

“Owner’s equivalent rent of residences” is fundamentally flawed. It is calculated as the imputed rental cost of your own home. True renters fall into a different category, and the inflation they experience is much higher, and very real. But for the majority of Americans who own their home outright or have a fixed-rate mortgage, their perception of inflation is limited to rising property taxes, insurance, and home repairs, all of which are calculated outside the “owner’s equivalent rent” figures. People evaluate their circumstances on cash flow, not an arcane calculation that requires a PhD in economics to understand!

Yet, policymakers at the Federal Reserve see inflation as persistently high because they may not be making the proper adjustment for miscalculated housing costs. Excluding owner’s equivalent rent, the CPI would have been up 2.5% over the past year rather than 3.4%.

High interest rates have had a greater impact on the economies of Europe, Japan, and Canada where long-term, fixed rate mortgages are uncommon. Their growth rates have been lower than in the U.S., in some cases negative. The central banks of Canada and Europe recently lowered their interest rates by a quarter point even though they were already lower than U.S. short-term rates. The Federal Reserve prefers to wait for more confirming data that inflation is approaching its 2% goal before lowering rates. Our point is that we might be much closer than the Fed appreciates.

Even the employment report contains question marks. When investors hear reports that the economy created 272,000 jobs in May, yet the unemployment rate went up, most don’t realize those are two separate reports stitched together. Job growth is calculated by asking businesses about the number of employees. The separate “household” survey determines the unemployment rate and paints a much less rosy picture. Over the past year, households say 376,000 more people are working while businesses report 2.4 million new jobs. Keep in mind that different pools of people are being surveyed and the results can be impacted by people taking on second jobs or by the influx of immigrants in recent years. If the household survey better reflects economic reality, it may help explain why 68% of respondents consider economic conditions only fair or poor.

Questions such as “How is the economy doing?” or “What have stock market returns looked like?” are much more nuanced than they first appear and depend heavily on one’s perspective. Don’t robotically follow the crowd that says interest rates can’t come down; the underlying facts are inconclusive, no matter what headlines say.

Parts of the market appear to be overheated, but many sectors and companies that haven’t kept up with the AI mania appear to offer good growth and reasonable value for investors focused on the long term. Future success is more likely if one follows the facts rather than just the headlines.

The companies profiled in this month's Investor Advisory Service both offer growth and good value at their current prices. Our first pick in the issue is a a member of the Magnificent Seven that offers good return potential despite its price runup. Our second selection is a small business services company that is using its technological advantages to drive excellent growth.

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The commentary is excerpted from the issue of the Investor Advisory Service newsletter published at the end of June. To receive commentary like this in a more timely matter and receive actionable stock ideas each and every month, subscribe today. The Investor Advisory Service stock newsletter was named to the Hulbert Investment Newsletter Honor Roll for the 14th consecutive year for outperforming every up and down market cycle since 2007

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