What I Care About This Week | 2022 July 18

selective focus photography of light bulb
Photo by Johannes Plenio on Pexels.com

by Franklin J. Parker, CFA

The Summary

  • All investor focus has turned to earnings, with big-name companies reporting this week (like IBM, Johnson & Johnson, Netflix, Abbott Labs, Comerica, etc). As it stands, analysts expect 4% growth in earnings for the quarter. While low this is still growth, and it would be unusual to have a recession while corporate profits are growing. Of course, how investors react will also be heavily driven by guidance and how executives discuss inflation. Plenty to watch over the next few weeks!

  • Last week’s data was a mixed bag. Inflation is bad—worse than expected. At 9.1%, inflation is bumping up against double-digits and is at the highest levels since the early 1980s. This is pushing the Fed to act aggressively with raising rates, and investors now expect a 0.75% rate hike at the Fed’s meeting at the end of the month.

    However, some data was positive. Turns out there are more open jobs than previously thought, and the headline unemployment rate continues to indicate a very tight labor market. Retail sales were higher than expected, indicating consumers are—so far, at least—still spending money even though prices are higher.

  • As I discussed a few weeks ago, if we are in a recession it would be the strangest recession on record. That isn’t to say I expect smooth sailing, but it does indicate that we may have generally more upside than downside from here. For investors with cash to deploy, this may be a good entry point, and for investors whose goals are years away, this is likely to be a passing concern. As always, your goals, risk tolerance, and time horizon will govern what you should do in this economic environment.

The Details

There is a somewhat arcane metric in economics called “total factor productivity” (often called TFP for short). In essence, if you add up all of the labor in the economy and all of the capital in the economy, you have some growth left over, and that growth is attributed to TFP.

Economists think of this as the role of technology in an economy. As technology advances, both labor and capital tend to get more productive. So, technological advances add a multiplier to economic growth that would otherwise be constrained (because there are only so many people in the world and there is only so much capital in the world). For example, TFP accounts for the difference between one worker making a pair of shoes by hand in a day, and one worker running a machine that makes 1000s of shoes in a day. 1000s of shoes took the same input of labor (1 day of work), but they took more capital (the machine), and more technology. TFP measures this technology component.

Historically, TFP tends to grow at about 0.68% per year, but there are periods of stagnation. The period from the early 1970s to the early 1980s, for example, was a period when technological adoption through the economy appeared to stagnate (at least, as measured by TFP).

The bottom line is that, as investors, we cannot underestimate the role of innovation in the economy. Without it, the economy can stagnate and run sideways, even amidst population and capital growth. With it, growth can easily outstrip what should be possible with labor and capital investments alone.

Innovation has been—and is very likely to continue to be—the key to increasing our standards of living via economic growth. Especially as the economic waters grow murkier, investors would do well to focus on the basics: companies adding real value to real people in the real world.

Chart of the Week

This week’s chart shows the divergence between expected earnings growth for US vs European companies. In both cases earnings are expected to grow, but analysts have gotten more pessimistic about the growth story in Europe and more optimistic about the growth story in the United States.

Of course, earnings growth is only part of the story. For investors to harvest differences in return also requires exposure to currency risks. With the Euro falling strongly against the dollar, dollar-based investors may be better poised to harvest these differences in return than Euro-based investors.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

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