Employment
While the headline numbers for the jobs report showed results that beat expectations, when you look closely at the report it shows a softening labor market which is exactly what the Fed wants to see. Nonfarm payrolls in the month of November showed a gain of 199,000 which topped the estimate of 190,000 and the unemployment rate fell to 3.7% which was better than the forecast for 3.9%. The growth of 199,000 is below the average monthly gain of 240,000 and it is also important to point out that some of the gain in November was attributed to the end of the UAW and actors strikes. In fact, while employment in manufacturing increased 28,000 in November there was a 30,000 person increase in motor vehicles and parts as workers returned from strike. The employment in information also had a gain of 10,000 in the month, but motion picture and sound recording industries added 17,000 jobs as the resolution of labor disputes came to an end in the industry. The strikes have created volatility in the numbers over the last few months and that can also be seen in the revision to September where total nonfarm payroll employment was revised lower by 35,000. With these major strikes now behind us, we should be able to see a better reading in these job numbers moving forward. Another major area the Fed likely has their eye on is the change in average hourly earnings, which points to wage inflation. In the month of November average hourly earnings increased by 4.0%, which was the lowest reading since May 2021. Overall, this report points to the concept that a soft landing is still a real possibility. I believe the labor market will continue to soften, which should be good news for inflation and our economy.
JOLTs Report
While it may not look like good news when reading the headline number, the JOLTs report showed exactly what the Fed is looking for. Job openings of 8.73 million in the month of October were below the estimate of 9.4 million and showed a decline of 617,000 or 6.6% compared to the previous month. This also marked the lowest number since March 2021. While this all sounds troubling, it shows the labor market is softening which is what the Fed has wanted to see. It also shows that the labor market is still doing alright considering there are still 1.3 job openings to every available worker. Pre-pandemic this ratio stood at 1.2.
Drug Companies
The Biden administration has opened the door to seize the patents of certain costly medications from drugmakers. The administration has unveiled framework that outlines the factors federal agencies should consider in deciding whether to use march-in rights, which take patents for drugs and shares them with other pharmaceutical companies if the public cannot reasonably access the medications. Officials can now factor in the price of a medication in deciding to break a patent. While this may sound like a nice practice, I do worry about the long-term ramifications. While drug companies often do have nice margins on drugs that succeed, people generally do not discuss the billions of dollars that is spent on research and development for drugs that do not succeed. If drug companies cannot offset those costs with high margins on successful drugs, the industry could have major problems. Also, what would the incentive be to spend billions of dollars on research and development for a new drug, when you could just potentially wait for another company to come up with the solution and then use their patent that has been taken from them by the government? This could ultimately stifle innovation in the industry.
Magnificent Seven
Remember a few years ago the FANG stocks? They have now been replaced by what is known as the Magnificent Seven which are Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta. People still believe index investing is a great way to invest and diversify your portfolio, but when you look at the S&P 500 you should realize that the Magnificent Seven have carried the index to a year-to-date return of around 20%. If you look at that equal weight index it is actually only up around 6% this year. Also, in the index 44% of stocks are showing negative results. You may think you had diversification with the S&P 500 but currently the seven stocks account for close to 30% of the index. These companies stock prices have continued to perform, but history has proven time and time again that any equity trading at such high valuations eventually comes back to reality. When that happens investors in these seven stocks, and also the index will have disappointing returns. Unfortunately, I cannot tell you when it will happen, only that history has proven itself to be right 100% of the time.
Financial Planning: Reviewing Income at the End of the Year
As we get closer to the end of the year, it is getting more important to review income levels and make any necessary adjustments before December 31st. When analyzing income, it is helpful to identify the expected level of adjusted gross income (AGI), the number of itemized deductions (if any), the amount of total taxable income, and the amount of taxable income subject to ordinary income rates. Adjusted gross income is the sum of all reportable income which could be wages, capital gains, interest, IRA distributions, and Social Security to name a few. After tallying AGI, next is the itemized deductions which include mortgage interest, state income and property taxes, charitable donations, and medical expenses. Taxpayers can claim the larger of the itemized deductions or the standard deduction which is $27,700 for a married couple in 2023. These deductions act as an expense which reduces the adjusted gross income and results in taxable income (AGI – deduction = taxable income). From there the long-term capital gain and qualified dividend portion of income can be separated from the other ordinary taxable income as capital gains and dividends are taxed at a lower rate (taxable income = ordinary + capital gains and dividends). From this point a taxpayer can determine what tax bracket they will be in, the tax rate of their capital gains and dividends, and whether their income will trigger any additional net investment income tax or Medicare premiums. Finally, action can be taken such as Roth conversions, realizing gains or losses, charitable donations, or retirement contributions to push income in a more efficient direction.
Life Expectancy
I noticed something last week that I’ve never really noticed before, it involved good news and bad news. The front page of the Wall Street Journal on Wednesday showed that investing legend, Charlie Munger dies at 99. Mr. Munger was well known for being the partner of Warren Buffett, the famed value investor. On Thursday the front page of the Wall Street Journal showed that Henry Kissinger had died at age 100. Mr. Kissinger was well known for being an influential diplomat during the 70s and 80s. Then, on Saturday when I picked up the Wall Street Journal, I noticed another famous person Sandra Day O’Connor had died at 93. She was the first woman to sit on the High Court. It is a shame we have lost these three important people who have changed the history of the United States, but it also shows that people continue to live lives into their 90s with some reaching age 100. This feat is not as rare as it used to be. Charlie Munger would’ve been 100 next month on 1/1/24.
US Debt
Years ago, we complained about Japan owning too much of our debt and then we complained about China owning too much of our debt. I do agree that we do not want any one country owning too much of our debt because it could be used against us. But unfortunately, with the rate our debt is increasing, we do need someone to buy our debt. On top of the Treasury issuing that debt, the Federal Reserve is reducing the debt on their balance sheet at about $60billion per month. This adds to the supply of US debt that needs to be purchased. Currently foreigners, which includes private investors and central banks around the world, own 30% of outstanding US treasury securities. That is a big decline from 43% 10 years ago. China and Japan are no longer such big holders in purchasing or holding our debt. The problem we are now going to have is the interest rate on the debt will have to increase to attract investors. This adds to the debt because of a higher cost for interest. In my opinion, what we have to do to get out of this situation is increase the GDP with everyone in the country working a little bit harder. It is my opinion that many workers today are more concerned about their leisure time, than they are about working. If we stay on this path, the debt will continue to rise and we will have problems down the road in 10 or 15 years.
Hot Stocks
At our firm we often talk about the concern of buying what is hot because usually it is overpriced. Last year the excitement to invest in anything that had to do with lithium batteries was going through the roof. Year-to-date the price of a metric ton of lithium has fallen to $22,797, which is a decline of 60%. It appears that the excitement for EV’s is on the decline. This could help automakers over the next year or so as they continue to meet demand for vehicles by selling their popular internal combustion engine vehicles. They may even pull back on building more electric vehicles which would help profit margins and obviously they will be paying less for lithium batteries that go in the cars, which would help margins even further.
Short-Term Investing
Over the past few months, investors have remained confused and they have decided to take the short-term easy route out by putting money where they see a greater yield rather than worrying about market fluctuation. I have said many times before, for long-term investors this is a terrible thing to do and that you will regret next year when you see lower rates and higher prices for good quality equities. People have not been listening, in November money market mutual funds reached a record $5.7 trillion yielding around 5%. That may feel good now, but I believe by the end of December 2024 only one year from now investors will be disappointed in short-term rates and many of the good deals in equities will be gone.
Exxon Mobile
I have said this before, but I believe down the road we will still have gas powered cars alongside electric vehicles. Exxon Mobil doesn’t care which direction you go, because while they still are drilling for oil, they recently paid $100 million for 420,000 acres in south west Arkansas to begin mining lithium. It is estimated there could be 4,000,000 tons of lithium carbonate which would be enough to power 50 million electric vehicles. In the future they don’t care if you put gas in your car or have an electric vehicle because by 2027, they will profit from both. In my opinion this is a great move for Exxon.
Gold Value
I saw a headline in the Wall Street Journal recently that gold soars on prospects for Fed cut. My first reaction was did gold really soar? I don’t think so, year to date it is up 11% which isn’t a bad return but over the last six months, it has only gained 3.2%. It also made me question why a Fed cut would cause gold to increase in value. We have always been taught that gold is a great inflation hedge. Well, if the Fed is cutting rates, it’s because there is no inflation. We’re also told that gold does well during hard times. The economy is slowing down somewhat, but no one could really say we’re in “hard times”. One reason I could come up with for why gold is going up is due to global tensions with the war in Ukraine and the battle between Israel and Hamas. I do think there is something more to it, as interest rates have now declined the US dollar has gotten a little bit weaker. This makes it easy for other major countries with a central bank like China, Poland, and Singapore to buy gold. Their purchases are at levels not seen since 2022. Will this continue? Perhaps, but I don’t think we’ll see much decline in interest rates in 2024 until the end of the year around fall. I think investors would be better off investing in good quality value equities that will benefit much more from falling interest rates and also investors will collect a nice dividend yield of maybe 2% - 3%, which you will not get from gold.
Sofi
You may enjoy going to watch a Chargers or Rams football game at Sofi stadium. You may even consider maybe an investment in the company would be a wise move. I like the concept of what they do, which by the way is not that much different than a traditional bank, but when taking a deeper look into the company I discovered some things that were concerning. Sofi has a loan portfolio of about $14.3 billion and based on 2018 accounting rules they mark the value of the portfolio up to what they believe is fair value. Most banks use the old accounting rules of the lower of cost or market value. The company estimates a 5.1% gain is reasonable and marks up their entire $14 billion portfolio by 4%. It is estimated that this fair value accounting has made Sofi’s capital base Larger by approximately 40% or $1.3 billion. The company is not hiding anything, but it is important to note that on their 10K their auditor Deloitte and Touche says these estimates of future cash flows involve significant assumptions. As an investor, everything may turn out fine and the company’s stock could increase dramatically. I myself would rather be a more conservative investor and not invest in companies that seem to be too loose with their numbers. Investors should also know that management’s bonuses are calculated mainly from growth on revenue, loans and customers. In my opinion, management is benefiting from the looser accounting rules. So next time you head up to Sofi Stadium to see a football game, remember Sofi paid $625 million for the naming rights over the next 20 years and don’t base your investment decision strictly on how beautiful the stadium is.