Economists know that consumers spend more when their wealth increases, even if their income remains the same. However, if wealth decreases, the opposite occurs.  

 

The concept, known as the wealth effect, has spurred the economy for well more than a decade as savers' 401(k) and other retirement accounts increased year after year. At the same time, real estate values have also risen. Of course, most of the time these gains are only paper profits unless you sell your house or withdraw money from your portfolios.

 

Nonetheless, there is a behavioral element to this concept. People tend to spend more when stocks and housing prices continue to climb because they feel wealthier and become more optimistic. It is one of the reasons why, in the U.S., consumer spending continues to remain robust — until recently.

 

The Federal Reserve Bank, in past efforts to control inflation, focused on removing the supply of credit to the financial markets. They did so through hiking interest rates and slowing bond purchases. However, this time around, the Fed is targeting the demand side of the economic equation as well. Reducing demand in this case would require reversing some of the wealth accumulated over the last 10 years or more.

 

During the COVID-19 pandemic, stock portfolios and home prices soared, thanks to the huge governmental monetary and fiscal stimulus that occurred. America's top income earners, who were working from home, splurged on home remodeling, new autos, durable goods and all sorts of electronics. Trillions of dollars in stimulus checks and unemployment benefits supercharged consumer spending for those who made less.

 

As a result, all income groups increased spending at rates far faster than before the pandemic. The most recent government survey of retail sales for April 2022, indicated that retail sales outpaced inflation for a fourth straight month. And while inflation climbs, higher earners, who already account for a large share of overall consumption, seem willing to keep spending, at least for now.

 

That retail sales data doesn't tell the whole story. Low-and even middle-income households are already cutting back. Demand is falling as the wealth effect appears to be working in reverse. Almost 60 percent of U.S. consumers, according to a survey by brokerage firm Jeffries conducted in April 2022, said they have reduced the number of items they typically buy. In every category, low- and middle-income consumers were cutting back far more than those in higher income groups.

 

In addition, the National Retail Federation identified that 47 percent of consumers they surveyed last month (April 2022) were switching to cheaper products and alternatives as well. I have already pointed out this trend in past columns. Consumers are reducing meat consumption, or choosing cheaper alternatives such as chicken, pork, or fish. Supermarket sales of private label brands are booming as well.

 

But inflation is not the only variable that is impacting consumers. Interest rates are also playing their part. Mortgage rates are the most obvious victim of a rising interest rate environment. Borrowing costs have jumped for 30-year mortgages from a sub 3 percent level last year to 5.25 percent today. New home sales in April 2022 fell 16.6 percent from March and well below forecasts, which was the slowest pace since April 2020. Existing home sales were also falling for the last three months according to the National Association of Realtors.

 

Auto leases and loans and credit cards are also big areas where higher rates hit the consumer. Most credit cards and car loans are priced off the prime rate, which is in turn closely tied to the Fed funds rate. Consumers can expect those rates to climb higher, since the Federal Reserve Bank is planning to raise the Fed funds rate at least two more times in the next two months.

 

The big question most economists are asking is when will the combination of higher inflation, declining stock markets, and a possible downturn in the housing market start to reverse engineer the wealth effect at the higher income levels.

 

So far this year, many investors have suffered anywhere from a 20-30 percent decline in their portfolios and retirement savings. People are already having to rethink their retirement date as a result. Inflation and supply shortages are crimping remodeling and housing plans even as higher interest rates are expected to put a dent in housing prices soon. As a result, many Americans are starting to feel less wealthy than they did last year.

 

The Fed is counting on all of the above to change the psychology of consumers from spending like drunken sailors to something a bit more moderate (but not enough to have them swear off entirely). Tinkering with the wealth effect can have unpredictable reactions. How far is too far when you are trying to dampen down demand? It is a fine line, and the Fed's tools to accomplish this feat are far from perfect.  If they get it wrong, the economy will likely suffer. Let's hope they get it right.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Over the past decade, as interest rates declined, some home buyers gravitated towards interest-only loans. However, times are changing, and borrowers should be careful in considering this kind of mortgage loan.

 

During the past two years, many financial lenders have tightened credit standards across most loan types. The combination of the coronavirus pandemic, supply shortages, inflation and the impact of the Ukraine war has created a drag on the U.S. economy. A slowing economy increases the risks of lending, thus tighter standards emerge.

 

Fannie Mae and Freddie Mac, the two government-sponsored enterprises that back most mortgages exclude interest-only mortgages. And while standards have been raised since the 2007 subprime collapse for these kinds of loans, there is a perception that standards may be more relaxed than conventional loans. Lenders, for the most part, keep these mortgages in their own portfolio or sell them to institutional investors.

 

An interest-only mortgage is one in which you initially only pay the interest on the loan for an allotted period, usually five, seven or ten years. As a result, your monthly payments are cheaper, since you are not repaying principal (the total amount borrowed). However, once that initial period concludes, you will still owe the same amount on the mortgages as you originally borrowed. Typically, these loans charge higher interest rates than conventional mortgages.

 

Interest-only loans are popular right now in this booming real estate market. One mistake would be to take out such a loan simply to qualify for a home you otherwise couldn't afford. Others believe they can afford larger homes with steeper asking prices because their monthly payments could be lower by several hundred dollars a month. 

 

Another mistake is to dismiss future risk by arguing that by the time the interest-only period expires, interest rates will have fallen further, or they will be making enough income to afford future payments, whatever they may be. It would be better to take a worst-case scenario and see if you can live with it.

 

Let's say you had a 30-year, fixed interest-only mortgage that you entered in 2012. Your initial interest-only period was ten years. That time is now up. What happens? You still have the entire principal to repay, only now you have only 20 years to do so. That means your monthly payments will rise simply because of the math. By exactly how much should also be of concern.  

 

Payment terms for the remainder of the loan may vary, but your new interest rate is usually determined by whatever the prevailing rate is at the time. Some loans are capped, so that the new interest rate you will be charged can be increased by no more than 2 percent. Other loans may not have a cap. In a rising rate environment that can spell disaster for borrowers.

 

In addition, remember your monthly payments now include principal repayments, plus a higher rate of interest and a shorter time period to repay the entire mortgage. This can mean your new monthly payment could cost you 2-3 times what you had been paying during the first ten years of your loan, according to the Federal Deposit Insurance Corp.

 

Ask yourself what would happen if mortgage interest rates, which hit a 30-year low last year, continue to rise over the next decade? There is a real risk that rates could rise to a point that the added costs to borrowers could present a default risk.

 

Granted, if payments become that expensive, there is always a chance that the loan could be refinanced, or the length of the loan might be extended, but at what cost? My advice is taking the necessary time and effort to analyze whether an interest-only mortgage is right for you or just a tempting alternative that fails to make economic sense in the long term.  

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The bears are prowling the corroders of Wall Street. No one questions that, but rallies in downtrends can be breath-taking. Look for one of those short covering relief rallies in the coming week.

 

Do I know that will happen? Of course not, but when we get as oversold as we are now, the chances are high. If we do bounce in a relief rally it would trace out the first up to the center of my "W" pattern. The bounce won't last long, maybe for a few days or, at best, next week. And then down again. For those readers who may be hoping that at some point we will resume the bull markets of the last decade, give up that notion.

 

I fully expect another low that may match or break the year's low of S&P 500 Index of 3,877 made this week. Readers were forewarned last week that the index could (and did) break my 4,000 targets. There were several reasons for this bearish behavior.

 

The inflation numbers were the key trigger. On Wednesday May 11, 2022, the Consumer Price Index came in hotter than expected at 8.3 percent. For the month, the index gained 0.6 percent. The data disappointed traders who were gambling on a cooler set of numbers that might confirm that inflation was peaking.  But instead of carrying the market up 5 percent, or more, the opposite occurred.

 

The Producer Price Index, which was reported the following day, did come in a bit weaker at a11 percent increase year-over-year, and 0.5 percent for the month. The lack of "inflation peaking" evidence squashed hopes that the Fed might be tempted to go easier in their hawkish policy plans, so markets tumbled. 

 

For many investors a bearish assault on the market's "Generals" was of far more concern. The bears have torn apart the Meme stocks, the Cathy Wood stocks, and every other high-priced, no earnings, kind of security they could sell or short. However, this week traders came after the Generals — Apple, Microsoft, Meta, Amazon, Google and even Tesla.

 

As company after company during the last quarter's earnings season provided poor future guidance in sales and earnings, investors are wondering how long it will take for the Generals to add their voices to this growing chorus. Many investors are not waiting around to find out. Price declines in these individual stocks has had a knock-on effect in the market, since they comprise such a large weighting in the overall investments of so many mutual funds and exchange traded funds. As such, the further they decline, so goes the stock market.  

 

I have been waiting for this kind of behavior, because without it there is no hope that we can find a bottom in the stock market. The problem is that this selling has only just begun for many of these stocks. remember that in many cases, the more speculative stocks are down 60-80 percent from their highs.

 

The Generals are nowhere near this kind of decline. Do I think we will see the price of Apple, for example, cut in half or more? Doubtful, but another 10-15 percent might be a real possibility. That is important since Apple is about 7 percent of the S&P 500 Index, and 13 percent of the NASDAQ Index.

 

As I said, I am expecting a relief bounce this week. It is just another bear market bounce, one of many we can expect as markets search for a bottom. Readers may ask where do I see that bottom?  This week we briefly touched my target of 20 percent on the S&P 500 Index at 3,858. The NASDAQ hit my targets weeks ago and has suffered further declines. 

 

I expect we will need to retest that 3,858 level on the S&P 500 Index level. If it holds, I might feel confident that we have made an interim low that could last out to September. That said, May, I believe, is the month to pick up some good bargains as we continue to dip and bounce in this "W" formation. I am hoping that by June, we can see a better market with some hope of putting together a string of higher highs for two months or so.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The impending Supreme Court decision to strike down Roe v. Wade will have enormous ramifications for American corporations. Legal issues, user data privacy practices, and workforce challenges will prove impossible to ignore.

 

Businesses of all kinds face the following facts: most Americans (53 percent), according to a recent Washington Post-ABC News poll, believe the Supreme Court is wrong and that the court should uphold the landmark ruling that established a constitutional right to abortion. Only 28 percent believe it should be overturned.

 

Nonetheless, if the Supreme Court hands down its expected decision to overturn Roe v. Wade, 13 states have trigger laws banning abortion that immediately go into effect. Another 14 states have more restrictive abortion laws that will kick in at the same time. Since about half of the U.S. workforce is comprised of women and given that one in four U.S. women will likely have an abortion by the age of 45, this will have legal ramifications for a vast number of companies.

 

How, for example, will companies domiciled or headquartered in one of those anti-abortion states contend with a female workforce who may disagree with the courts and their resident states' decision? What if a portion of a company's female workforce want to transfer out of these states?

 

And while some states will limit or make abortion illegal, other states such as Massachusetts, New York, and California will be moving in the opposite direction. They are planning on becoming sanctuary states for women who desire abortions but can't obtain them without travelling out of state. That could leave businesses in a political tug of war between various states. Companies such as Yelp, Amazon, and Citibank (among others) have already promised to reimburse employees who travel for abortions. Legally, that may fall into a gray area depending on a state's interpretation of their anti-abortion legislation.

 

Conservatives in Congress have already begun to retaliate against those companies that they perceive as pro-abortion companies. Citigroup, one of the largest banks in the U.S., has been targeted by conservatives who want the House and Sente to cancel the company's contracts to issue credit cards to lawmakers. 

 

In Texas, a state lawmaker introduced a bill that would prevent companies who provide their employees with abortion-related benefits from doing business with local governments. In Florida, Disney has already felt the economic backlash of Gov. Ron DeSantis' campaign against the LGBTQ+ community. U.S. Sen. Mark Rubio introduced a bill, the "No Tax Breaks for Radical Corporate Activism Act," which would prevent employers from deducting travel expenses for their workers' abortions. This is in direct response to Citigroup, Apple, Yelp, Levi's, Match Group and Amazon, who have already announced they plan to reimburse travel costs to access abortion if their employees live in a state where it becomes illegal.   

 

Technology companies have even more difficult issues to deal with. Dozens of large tech companies are headquartered in the states preparing to ban or restrict abortions. In the anti-abortion states, legal enforcement of the new laws may mean that user data could be a tool to enforce and pursue those who break those laws.

 

User data is often bought and sold by third parties who then use that information to effectively target advertising. This data normally includes the location of a person's phone, the applications they use, (for instance, ride-hailing), and the user's search history. There is also an array of health tech, femtech and other medical-based applications that track and target women, their menstrual cycles, medications, and sexual activity. All of these apps, while promising privacy, are not immune from law enforcement and a court's subpoena power.

 

Could a local sheriff's department subpoena the IP address of someone or some organization they suspect are violating or have violated the statutes of new anti-abortion laws? Could state authorities demand tracking data from a tech company like Facebook, Apple, or Google that may or may not show visits to an abortion clinic out of state?

 

I know this is beginning to sound like the workings of a police state such as one would find in China or Russia, but given the background, it is reasonable to at least plan for the worst. Companies may try to downplay the significance of this issue, but the end of Roe v. Wade will open up the question of protection of health-care access for their workforce.

 

As has been shown in the past, consumers identify with companies and their brands that support their causes, while an employees' identity can be tied to ethical positions of the companies they work for. About the only good thing one can say is that companies still have a little time to plan and decide their response. The clock is ticking.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Market participants heard from members of the Federal Reserve Bank this week. Their intention is clear: bringing down inflation will take precedence over everything else in the economy. The message went over like a lead balloon.

 

You would think that most investors would have received that message by now.  I know that I have been warning readers of this outcome since last year. But for most market participants this seems to be a shock given the positioning in the stock market this week. It was nothing short of tumultuous.

 

We started the week by retesting the lows we put in for the year. The S&P 500 Index hit 4,062 on Monday, May 2, just 10 points higher than the previous low. 

Stock indexes subsequently careened higher into Wednesday's FOMC meeting, expecting that whatever announcements on Fed tightening had already been discounted. That triggered a "buy on the news" event. It was the same strategy traders used after the last Fed meeting in March that saw stocks gain for weeks afterward.

 

The maneuver worked again — at least for the day. The indexes soared well over 2 percent-3 percent between the time that Fed Chairman Jerome Powell started his press conference at 2:30 and the markets close at 4 p.m.

 

Did he say anything that could have triggered such a move? The only comment that could be construed as new information was Powell's intention to limit monthly interest rate hikes to 50 basis points or less, rather than the 75 basis points or higher many investors expected. On Thursday, May 5, the markets tore down the entire gain and then some. Friday, we continued the downward spiral. What happened?

 

One can only guess that investors were spooked by how much monetary tightening is going to negatively impact the economy and earnings. Investors are now asking at what price level markets should be trading given the unknown future. Obviously, investors determined that level should be lower. How much lower?

 

My own target has already been met for a third time (as of Monday's and again Friday's retest of the lows). Can it go even lower? Yes, some strategists have targets as low as 3,650-3,750 on the S&P 500 Index. In a market where the VIX index is still trading above 30, the swings in markets are such that we can easily overshoot on the downside to those levels.

 

We are now in a period of bottoming that will look like a sloppy "W" pattern that will play out into sometime in June. I suspect it will take a few days for investors to come to an agreement on at what index level stocks represent better value. That level could be around my target low, or somewhat lower.

 

Take that time to pick and choose where you want to "Play in May" as I said last week. I expect that over the next two weeks we could see the 4,370 level on the S&P 500 Index and then down again into early June and then up again. If you can't stand that kind of heat, stay out of the kitchen.      

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.