Low Volatility

As we’ve discussed many times, the volatility in the stock market is barely existent as nothing seems to phase it. This has been caused by a Goldilocks scenario where growth is just right. If it was too hot, there would be inflation and the Fed would raise rates more than they have. If it was too cold, then stocks would fall on bad economic data and weak earnings. The Russell 2000 was down slightly as it pauses before an attempt at a new record. The chart below puts the low volatility we’ve seen this year in context. Unless you’re in your 60s or older, you’ve never witnessed such low volatility in the first 180 days of the year in the S&P 500. As you can see, only two years in the early 1960s were less volatile. The S&P 500 will need to have a large Santa Clause rally to catch up to the year end returns seen in the other low volatility years.

Demographics Matter

The chart below contextualizes the prices of bonds and stocks in the developed market. As you can see, when taking into account bonds and stocks, the financial markets are the most expensive in the past 217 years. That’s what happens when you use low interest rates to justify higher stock prices. One aspect of this chart which is underappreciated is the demographics which are pushing this change as older people own more assets. Even though many people don’t have enough savings for retirement, the advancement of 401Ks still is a factor. It’s expansive use in America was first started with the baby boom generation. Equity markets have been opened up to more people; baby boomers are at the age right before retirement so bonds and stocks are at their peak. If there’s a shift in the next few years, it will be from stocks to bonds, keeping this chart elevated. One of the other aspects to this is low inflation which has supported stocks and bonds.

Demographic shifts aren’t only caused by baby boomers. The millennial generation was an influx of lower aged workers. As I have shown in a chart before, the most common age group in America is in the mid-20s. These younger workers pushed down wages and inflation. The Atlanta Fed wage growth tracker aims to adjust for demographics by tracking the same people. There’s more workers than ever who are over the age of 65; that’s combined with the millennial generation to form a surplus of workers. The influx of millennials is a small change compared to the massive boost in younger workers from the emerging market economies. That boost is also responsible for lower wage growth in America.

The chart below shows the working age to population ratio of the emerging market and advanced economies. As you can see, when the older workers start retiring in droves in the next few years, American millennials will see an accelerated wage gain. Furthermore, the peak of the youth movement in emerging markets will soon occur as the life expectancy of these countries improves with the advancement of their wealth. That could further boost wage growth and inflation. I don’t see aging demographics in emerging markets causing a similar rise in stocks and bonds that developed markets have caused because their wealth isn’t as large. The reason it’s switching to a negative effect for financial markets in the developed world is because wealth peaks in a person’s 60s. As I said, aging emerging markets will boost wage inflation. There will also be an advancement in consumers which could help China shift to a service economy. All of these changes imply that interest rates will be pushed higher in the next few decades which is also bad for financial assets.

Obamacare Repeal Hail Mary

The GOP is attempting a last ditch effort to pass a healthcare bill after failing in July by one Senate vote. The Graham-Cassidy bill has until September 30th to be passed under the reconciliation process which only requires a majority in the Senate instead of 60 votes. The main changes this new plan would implement is giving block grants to the states to decide which healthcare insurance plan to use. Secondly, it would end the Obamacare expansion of Medicaid eligibility in 2020 which will be switched with per capita block grants.

The odds of this new bill passing in the Senate are at 21% in the PredictIt market. The difference between this bill and the last one is that Rand Paul opposes it because he says it doesn’t go far enough to repeal Obamacare and John McCain will likely vote for the bill because his biggest ally, Lindsey Graham, is the co-sponsor of the bill. This leaves us in the same spot as July, the vote losing by one vote. The most important votes to watch will be Collins and Murkowski. They voted against the deal in July. Collins seems to be indicating she will be voting against the bill, meaning it can come down to Murkowski. Mitch McConnell said he won’t put the vote up until next week, so we will have a few more days of speculation before the rubber meets the road. The freedom caucus in the House might have a problem with this bill like Rand Paul, so that could be a second large hurdle it needs to get over.

The good part of the bill is that Obamacare will be cut by $239 billion from 2020 to 2026 which means there will be more money for tax cuts later in the year. This has been bad news for the managed care stocks. Humana stock is down 7.23% since September 1st. It was only down 4.77% in July which might signal there’s a better chance of this plan passing. I won’t be giving a forecast on this plan’s chances of passing because outside of the managed care names, the stock market hasn’t been reacting to the news about this plan. That means you can watch the news this week without worrying about making a trade. That being said, next week, when this plan is voted on, I expect a market reaction.