“Everything was perfectly healthy and normal here in Denial Land.” —Jim Butcher, “Cold Days”
A friend of mine recently came back from a two-and-a-half-week work tour of Europe, where she was trying to raise funds for her private equity fund. I compared her report to my recent two-day trip to New York City (I love New York, but let’s face it – her life is much cooler than mine).
In Europe, masks are practically a thing of the past. You go and do what you want, when you want. In NYC, you must show proof of vaccination to get into entertainment venues and restaurants; several meat-on-stick, sold-on-the-street vendors were selling masks. The activity was normal in Europe. In NYC, the hygiene and safety protocols didn’t feel normal, but the activity was booming!
I don’t know if I have enough information to build a hypothesis on safety protocols and economic activity. But I know that Austria re-imposed a national lockdown last week to suspend its current wave of COVID-19. Now there is chatter that Germany may follow suit.
Austria is under lockdown because, in part, it has the lowest vaccination rate in Western Europe, at only 66 percent. (The U.S. population is 59.1 percent vaccinated.) Last week, Germany detected 65,000 COVID-19 infections, the highest number on a single day since the start of the pandemic. (The U.S.’s population is quadruple that of Germany; the U.S.’s 7-day average of new cases is currently not too far below 100,000.)
Other parts of Europe, such as Italy and Spain, are gaining better control of COVD-19, with high vaccination rates resulting in lower daily cases. Across the pond, here in the United States, things are – apparently – getting back to normal. The Moody’s Analytics & CNN Business Back-to-Normal Index moved up 95 percent the week before Thanksgiving 2021, with 45 states contributing to the gain.
The Back-to-Normal Index is made up of 37 national and seven state-level economic indicators. It ranges from 0 to 100 percent, representing the economy returning to its pre-pandemic (March 2020) level. The Index has a subset that measures states. Massachusetts is at 91 percent, New York is at 87 percent, and Connecticut is 99 percent. There are eight states, including Rhode Island, Nevada, and South Carolina, that are between 100 percent and 102 percent.
The Back-to-Normal Index doesn’t help us gauge all levels of normalcy. I mean, I don’t think I’m supposed to hug anybody anymore, right? And on more than one occasion, my fist bump has been awkwardly met with an open hand. I wear a mask when I walk into the bank — that doesn’t feel normal. But at least I’m stretching my legs and not doing everything online anymore. But that’s only because I barely remember what traveling feels like.
I, and probably you, are feeling exhausted from COVID-19 protocols. More than 1,000 people per day are dying from the virus in the U.S., so, yeah, I’m still going to do what I can to protect them. But — and I feel gross for asking this — for how much longer? I am double-vaccinated and will probably have received my booster by the time you read this. I’ve sheltered in place and reduced mobility. People who think like me are feeling the frustration and are ready to get back to a personal normal (not just an economic normal), letting the unvaccinated protect themselves (or not) at their discretion.
If I start strutting around like I don’t care, and other people do the same, do we risk starting yet another wave that triggers an Austria-like lockdown? At this point, I think it would be a political disaster for the parties in charge to re-impose lockdowns. Call me cynical, but I don’t think politicians will do something that will get them kicked out of office. But maybe? Or maybe non-U.S. lockdowns stall the U.S. economy?
If you asked me how I spend my days, I’d paraphrase Lloyd Blankfein, a former Goldman Sachs CEO. I spend 98 percent of my time worrying about things with a 2 percent probability. Those things with a 2 percent probability could destroy the economy, or portfolios, which is why they’re so important. Given that Austria just locked down and Germany is talking about it, the possibility of a lockdown happening in other countries seems to be at least a 2-percent chance. Given that the worldwide vaccination rate is only 42 percent, I think we can bump that up to a 3–10 percent probability.
Since it’s a global economy, I remain concerned about the fragility of the U.S. economy. I consider the worst-case scenario, so you don’t have to. Today, we focus on the good news – that the U.S. economy is getting back to normal (at least by the numbers) and we can remain invested in the stock market.
The Back-to-Normal Index isn’t the only metric to follow. There is also the tried-and-true Gross Domestic Product (GDP). U.S. GDP before the pandemic, the fourth quarter of 2019, was $21.48 trillion annualized. Do you know what it was for the third quarter of 2021? $23.17 trillion. GDP is 8 percent higher with 1 million fewer workers. That is a massive amount of work performed by today’s employees, technologies, and improved best practices. The amount of productivity is astounding.
In the long run, GDP growth is essentially population growth plus productivity growth. It’s no wonder U.S. GDP is currently running so high. Of course, it’s more about the future than the present when it comes to the stock market. The present may support valuations, but in the short-term, stock prices usually reflect the direction of the economy, not the magnitude.
National COVID-19 lockdowns — even if they’re only happening abroad — threaten short-term prices because they affect the possible direction of the global economy. For years, my equity allocation has been primarily in the U.S. and virtually absent direct foreign exposure (obviously, large-cap multinationals do business overseas). I believe that I can keep equity risk reduced by sticking to countries – like the U.S. – which are not as likely to suffer directly from lockdowns (even if it’s politics keeping businesses open).
That’s defense. The offense is investing in U.S.-based equities.
After a massive run-up for stock prices and corporate earnings growth in 2021, it’s not outlandish to expect moderation in 2022. However, investors want to outpace inflation, which recently hit a 31-year high of 6.2 percent. An expected 8% growth rate of corporate earnings for S&P 500 companies allows us that opportunity. Inflation is generally good for the stock market because the alternative to investing in stocks is losing purchasing power to things like low-paying, non-appreciating bonds or cash.
Additionally, I’ve been listening to company press releases about their earnings. Many of the nation’s biggest companies have been reporting fatter profit margins than compared to before the pandemic. But how? Their prices are undoubtedly higher, just like ours. Companies have successfully raised consumer prices higher than their wholesale and producer prices, thus increasing their per-unit margins. Those higher profit margins support the expectations of higher corporate earnings growth in 2022.
Corporations are bilking consumers out of their excess savings. I guess things are getting back to normal.
This article originally appeared in The Berkshire Edge on November 29, 2021.