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Could Small Caps Be In Trouble In 2022

"Small caps," or small-capitalization companies, could be in trouble next year if signs from the NFIB survey are correct.

In September 2019, I wrote "NFIB…



This article was originally published by Real Investment Advice

“Small caps,” or small-capitalization companies, could be in trouble next year if signs from the NFIB survey are correct.

In September 2019, I wrote “NFIB Survey Trips Economic Alarms,It was just a few short months before the U.S. economy fell into a deep recession. The latest NFIB survey sends a strong warning to investors piling into small-cap stocks.

However, let me recap why the NFIB data is essential to investors. (Data via SBA.Gov)

“There are currently 32.5 million small businesses in the United States. Small businesses (defined as fewer than 500 employees) account for 99% of all enterprises, employ 61 million people, and account for nearly 47% of private-sector employment.” Data as of Dec 2021 

The chart below shows the number of firms that have employees versus none. (Non-employer firms account for tax-shelters, trusts, estate plans, etc.)

A Word On The BLS Employment Report

Notice that the number of firms that have employees remains relatively unchanged. The data below shows the number of births and deaths of businesses over time.

birth death of small business

That data is crucial in calculating the employment data for the U.S. When the BLS reports employment data, part of the calculation includes an “adjustment” based on the births of new (small cap) firms. In theory, if the economy is birthing new businesses each month, those businesses should hire at least one employee. However, as we see above, the vast majority of firms, and the only type growing in number each year, have ZERO employees.

Such goes to answer why there is also a significant discrepancy between the labor force participation rate and the BLS’ report of “full employment.” We can see the problem if we assume the SBA’s data is correct and then adjust the BLS data for lack of growth in businesses with employees.

small business employment adjustment

Despite all the headlines about Microsoft, Apple, Tesla, and others, the critical point is that small businesses drive the economy, employment, and wages. Therefore, what the NFIB says is relevant to the economy, and eventually, the stock market.

NFIB Shows Confidence Drop

In December, the survey declined to 98.4 from a peak of 108.8. Notably, many suggest the drop was “politically driven” by conservative-owned businesses. While there was indeed a drop following the election, the decline continues what started in 2018.

NFIB Small Business index

That decline in confidence has much to do with the artificial supports put into the economy following the pandemic-driven shutdown and the subsequent surge in inflation. As a result, the number of firms expecting an economical improvement over the next 2-quarters has steadily declined dramatically.

NFIB small business expecting economic improvement

Such should not be surprising given the surge in inflation pressures on input costs. Notably, it isn’t easy for smaller businesses to pass these higher input costs, particularly as waning fiscal stimulus impedes future consumption.

NFIB Small Business expecting inflation

Planning & Doing Are Two Different Things

As noted, since the pandemic-driven shutdown, the massive flush of liquidity created a “demand boom” that outstripped manufacturers’ ability to produce “supply.” That imbalance of “pull-forward” consumption created an inflationary surge which offset the benefits of the “free money” given to lower-income households. As shown, real disposable incomes crashed back to the long-term trend, which will slow future consumption rates. (The gap above the trend in retail sales will close)

Retail sales vs DPI

Small businesses are highly susceptible to economic downturns and inflationary surges since they don’t have access to public markets for debt or secondary offerings. As such, they tend to focus heavily on operating efficiencies and profitability. In other words, when answering surveys, business owners are always optimistic; otherwise, they would not be running a business. However, there is a big difference between “saying” and “doing.”

If businesses expect a massive surge in “pent up” demand, they will prepare for it. Such includes increasing capital expenditures to meet anticipated demand, increasing employment, and stocking up on inventories. While CapEx improved modestly from the pandemic shutdown, as would be expected, the downturn in economic optimism suggests a reversal in 2022.

NFIB Small Business Cap Ex

There are important implications to the economy since “business investment” is a GDP calculation component. Small business capital expenditure “plans” have a high correlation with real gross private investment. The plunge in the economic outlook will suppress “CapEx” spending. It should be no surprise to see gross private investment on the decline.

NFIB Small Business Cap Ex vs GPI

As stated, “expectations” are very fragile; as such, we are seeing important diverges where it will matter the most.

Employment To Remain Weak

If small businesses think the economy is “actually” improving over the longer term, they would also be sharply increasing employment. Given business owners are always optimistic, over-estimating hiring plans is not surprising. However, reality occurs when actual “demand” meets its operating cash flows.

To increase employment, which is the single most considerable cost to any business, you need two things:

  1. Confidence the economy is going to continue to grow in the future, which leads to;
  2. Increased production of goods or services to meet growing demand.

Currently, there is little expectation for a strongly recovering economy. Such is the requirement for increasing employment and expanding capital expenditures. Not surprisingly, actual hiring is running well short of expectations.

NFIB Small Business Employment

Now you can understand the biggest problem with artificial stimulus.

Yes, injecting stimulus into the economy will provide a short-term increase in demand for goods and services. When the funds are exhausted, the demand fades. However, small business owners understand the limited impact of artificial inputs. As such, they will not make long-term hiring decisions, an ongoing cost, against a short-term artificial increase in demand. 

Employment gets driven by demand, which we can explore through reported sales.

The Big Hit Is Coming

Retail sales make up about 40% of personal consumption expenditures (PCE), roughly 70% of the GDP calculation. Each month the NFIB tracks actual sales over the last quarter and expected sales over the next quarter. There is always a significant divergence between expectations and reality.

NFIB Small Business Actual Sales

As noted, stimulus leads to a short-term boost in consumption; the impact of higher inflation, lack of wage growth, and weak employment growth will suppress consumption longer-term.

The weakness in actual sales explains why employers are slow to hire and commit capital for expansions. As noted, employees are among the highest costs associated with any enterprise, and “capital expenditures” must pay for themselves over time. The actual underlying strength of the economy, despite cheap capital, does not foster the confidence to make long-term financial commitments to anything other than automation.

Despite mainstream hopes, business owners must deal with actual sales at levels more commonly associated with ongoing recessions rather than recoveries. 

Of course, this remains our argument over the last couple of years. But, while the media keeps touting the strength of the U.S. consumer, the reality is quite different. If such were indeed the case, there would be no requirement to inject billions of dollars in stimulus to keep individuals afloat.

So what does all this have to do with small-cap stocks?

Small Caps May Disappoint

This background makes it easier to understand why small-cap stocks failed to keep up in 2021 and may continue to underperform in 2022.

Small Caps vs SP500

At the beginning of 2021, the expectations were for surging economic growth, and business confidence was high. However, as the reality of deficit-based and non-productive spending set in, confidence waned. The subsequent deterioration in business confidence is not surprising, and importantly, small-cap stocks have a high correlation to small-business confidence. 

IWM vs Confidence

The reality is that despite media commentary to the contrary, debt-driven government spending programs have a dismal history of providing the economic growth promised. As a result, the disappointment of economic and earnings growth over the next year is almost a guarantee.

Rising inflation, surging labor costs, and concerns over additional socialistic policies and mandates from the White House will continue to weigh on small business confidence. Business owners need stability within which to operate and a constructive environment to make long-term commitments to employment and business development. When those concerns get coupled with weak growth in actual sales, you can understand their caution.

Most importantly, there is a massive difference between “getting back to even” versus “growing the economy.” One creates economic prosperity by expanding production, which creates consumption. The other does not.

Please pay attention to small-business owners; they may tell you something fundamental about 2022.

The post Small Caps Could Be In Trouble In 2022 appeared first on RIA.


Author: Lance Roberts


Good Time To Go Fish(er)ing Around The Yield Curve

It should be as simple as it sounds. Lower LT UST yields, less growth and inflation. Thus, higher LT UST yields, more growth and inflation. Right? If nominal…

It should be as simple as it sounds. Lower LT UST yields, less growth and inflation. Thus, higher LT UST yields, more growth and inflation. Right? If nominal levels are all there is to it, then simplicity rules the interpretation.

Visiting with George Gammon last week, he confessed to committing this sin of omission. Rates have gone up, he reasoned reasonably, therefore it would seem to follow how the market must be shifting expectations toward the more optimistic and favorable economic case.

To some, perhaps many, they’ve taken their interpretation of same a step (or twelve) further by claiming the bond market is in the process of a radical change in outlook, finally surrendering to the Great Inflation 2.0 after having been stupidly bearish on prices and macro for almost the entire span of last year.

But the yield curve is not now, nor has it ever been, so simple. There are, in actuality, three variables to always keep in mind whenever interpreting.

The first, which we won’t delve much into today, is the relative nominal level. Even if everything is going right and the other two factors moving favorably, should the entire curve stay historically low that’s already a red flag.

What follows is the second element, that which was proposed at the outset: the relative direction of any changes in yields.

Third, to me the more if not most important is the curve’s shape. Steep or flat, how LT rates are behaving in the context of ST yields and rates.

So, it’s not as simple as: down = bad, good = up; though you can easily understand why that impression lingers in the public consciousness. If, on the contrary: 1. Rates overall stay low; 2. Even as LT yields may rise; 3. Should those LT rates be rising because of those in the ST; then that’s not the same at all.

Breaking down yields is a pretty simple process, too. We start with easy Fisherian decomposition which you can put in some kind of fancy econometric format if you desire. For our purposes here, there’s no need since we can effortlessly just eyeball the thing.

Unlike standard orthodox theory, we’ve no need for term premiums because, well:

Term premiums are not science nor really math. They are made up and more than that they are rationalizations, truly Orwellian, intended to deny the obvious and straightforward signals coming from the very fundamental building blocks of all finance and economy. The entire notion is purposefully shrouded in unnecessarily complex concepts whose only true use is to attempt to answer for the otherwise inexcusable.

As I often write, Economists don’t understand bonds. But they know just enough of them to understand that they had better change the subject.

You can read the explanation why at the link above.

This leaves us with just two basic pieces: the expected path of ST rates and then what Irving Fisher realized more than a century ago, forward longer run expectations about growth/inflation. The LT yield is some mixed up combination of those two.

The long-sought transition to global normalcy – from money to finance to real economy – should have looked like, in the bond market, what you see above. The expected path of ST rates contributes more to LT yields as does the commiserate improvement about perceived growth and inflation prospects; the two actually reinforcing one another (assuming, of course, the Fed is right about why it’s influencing ST rates).

From ultra-low LT yields post-2008, these were supposed to move closer to what they used to be. They never once did for equally obvious reasons; the economic prospects for growth and inflation never materially improved despite anything the Fed did to the contrary (especially 2017-18).

But what about 2020 and now after?

What you easily find is how the initial reflationary period (defined loosely here as dating from the August 2020 lows through the first BOND ROUT!!!! topped out in mid-March 2021) was absolutely consistent with the good pattern – if only in two out of the three dimensions.

The expected path of ST rates was up if ever so slightly (represented by the 2-year UST yield which only ticked higher while the 5-year moved much farther) while growth and inflation expectations obviously then improved. The curve steepened and nominal rates across it were going higher.

But the curve never traveled that far upward, meaning it didn’t actually break out in terms of our first criteria. Red flag. Topping out with the 10s at jut 1.74% wasn’t as much of a shift as it had been made out to be.

Even so, the fact that in early 2021 the curve was meeting the other two conditions was at least a modestly good sign; that the market was judging the future to be materially better than 2020 – low standard – if still a long ways from normal.

The argument, such that there may be any, is how the market has performed since that point. I think you can literally see why it isn’t or shouldn’t be much of one:

At each respective top along the way, expectations for ST rates (confirmed by eurodollar futures) have moved up, though especially so going back to October.

Because of this, it leaves expected growth and inflation to have shrunken materially since that mid-March inflection entirely consistent with the third criteria. Flat curves mean flat curves and unless they are flattening in accordance with at least Criteria #1 (because curves aren’t supposed to be steep, but they are supposed to go flat at a normal, healthy interest rate level far, far above what you see here) then essentially that’s the ballgame.

The market is both rejecting taper and rate hikes and simultaneously, because of it, forming what’s very clearly shaping up as Conundrum No5.

There are any number of pretty obvious and damning pieces of evidence why this would be, and have been for nearly a year already, most of which we’ve documented over the traverse of these specific months in question – starting right from the beginning with Fedwire.

So, 2022 begins with modestly rising, suspiciously modest rising yields but flattening curve (not good) at still obscenely low nominal levels (more not good).

The meaningful difference between rising yields late 2021/early 2022 is night and day from rising yields late 2020/early 2021:

The curve, as always, could change but why would it now? What has changed lately in any material fashion? According to the vastly more important shape, even as rates are pushed up from below there is no steepening in it anywhere. On the contrary, flatness is over the past week or so pushing new levels of flat.

And this is hardly the first time (see: 2018).

I’m obliged the usual disclaimer: this does not mean imminent recession or even necessarily recession at any point. That’s not what we’re really talking about here, not yet. All we can definitively conclude, for now, is that there is and has been no change in bond market perceptions about the balance of future probabilities that, with low nominal levels and an increasingly flat shape, are tilted decidedly toward the not-inflation and unfavorable for whatever the latter might end up.

Instead, the only thing which has changed between the early to middle part of last year and this year is the Fed. Again.

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Lacy Hunt: Negative Real Rates Are A Strong Recession Warning

Lacy Hunt: Negative Real Rates Are A Strong Recession Warning

Authored by Mike Shedlock via,

In his 4th Quarter Review and Outlook,…

Lacy Hunt: Negative Real Rates Are A Strong Recession Warning

Authored by Mike Shedlock via,

In his 4th Quarter Review and Outlook, Lacy provides some interesting charts on negative real rates and recessions.

Please consider the Hoisington Management Quarterly Review and Outlook Fourth Quarter 2021Emphasis Mine

Real Treasury Bond Yields

Real Treasury bond yields fell into deeply negative territory in 2021. In elementary economic models, this event, taken in isolation, would qualify as a plus for economic growth in 2022 and would be consistent with the strength indicated by fourth quarter 2021 tracking models.

Lacy a different view however. His analysis shows that negative real yields are associated with recessions. 

Debt overhang and demographics make the matter worse.


Since 1870, the starting point of reliable data, only 24 full yearly averages were negative, or just 16% of the 152 readings over this time span.

Detailed parsing of the series reveals that 12 of those occurrences fell in the spans from 1914 to 1920 and 1939 to 1953, both of which were dominated by major military engagements and their subsequent demobilization – World Wars I and II and the Korean War.

Excluding the 1914-20 and the 1939-53 periods from the post 1870 sample still leaves a robust sample of 130 readings. During this lengthy span, cyclical and secular economic conditions resulted in a negative yearly average for real Treasury bond yields twelve times, or just 8% of the time. In the eleven cases prior to 2021, nine of the negative real yield periods coincided with recessions – 1902-03, 1907, 1910, 1912, 1937, 1974-75, and 1980.

Real long maturity yields were negative in 1934, which while not a recession year, happened during the horrific conditions of the Great Depression (1929-1939). In only one case, 1979, does the negative real yield happen during an economic expansion when the economy is not in a highly depressed state.

Debt Overhangs and Real Interest Rates

The level of indebtedness of the economy is another of the critical moving parts in assessing future economic growth. Based on empirical evidence, theory and peer reviewed scholarly research, the massive secular increase in debt levels relative to economic activity has undermined economic growth, which has in turn, served to force real long-term Treasury yields lower. This pattern has been evident in both the United States and the more heavily indebted Japanese and European economies.

Real 10-Year Government Bond Yields 

Economic research provides additional insight and evidence as to why interest rates fall to low levels and then remain in an extended state of depression in times of extreme over-indebtedness of the government sector. While differing in purpose and scope, research has documented that extremely high levels of governmental indebtedness suppress real per capita GDP. In the distant past, debt financed government spending may have been preceded by stronger sustained economic performance, but that is no longer the case.

When governments accelerate debt over a certain level to improve faltering economic conditions, it actually slows economic activity. While governmental action may be required for political reasons, governments would be better off to admit that traditional tools would only serve to compound existing problems. For a restless constituency calling for quick answers to economic distress and where inaction would be likened to an uncaring and insensitive attitude, this is a virtually impossible task.

Carmen Reinhart, Vincent Reinhart and Kenneth Rogoff (which will be referred to as RR&R), in the Summer 2012 issue of the Journal of Economic Perspectives linked extreme sustained over indebtedness with the level of interest rates. In this publication of the American Economic Association, they identify 26 historical major public debt overhang episodes in 22 advanced economies, characterized by gross public debt/GDP ratios exceeding 90% for at least five years, a requirement that eliminates purely cyclical increases in debt as well as debt caused by wars. They found that the economic growth rate is reduced by slightly more than a third, compared when the debt metric is not met.

Persistent Global Weakness

Advanced Economies (AD)

In 2021, the Japanese, Euro Area and Chinese economies, in comparative terms, underperformed the U.S. economy. This pattern should continue this year. Due to more massive debt overhangs and poorer demographics, real GDP in Japan and the Euro Area in the third quarter of 2021 was still below the pre-pandemic level of 2019. The U.S. in this time period managed to eke out a small gain. The dispersion between the U.S., on the one hand, and China and Japan, on the other hand, may be even greater. Scholarly forensic evaluations have found substantial over-reporting of GDP growth in China and now, similar problems have been revealed in Japan.

Prime Minister Fumio Kishida said on December 15, 2021, that overstated construction orders had the effect of inflating the country’s economic growth figures for years. Consequently, the marginal revenue product of debt is even lower than reported therefore so is the velocity of money for both Japan and China. Interestingly, Bloomberg syndicated columnist and veteran Wall Street research director Richard Cookson makes a strong case that “China looks a lot like Japan did in the 1980s.”

Emerging Market Economies (EM)

The sharp surge in inflation in 2021 has resulted in far greater damage to the EM economies than the U.S. for three reasons. First, a much higher proportion of household budgets are allocated to necessities than in the United States since real per capita income levels are much lower than in the U.S. Second, numerous EM central banks increased interest rates in 2021.

Another problem emerges as most of the EM debt is denominated in dollars. When EM currencies slump as in 2021, the external costs of servicing and amortizing debt add an additional burden on their borrowers.

Growth Obstacles

In 2022, several headwinds will weigh on the U.S. economy. These include negative real interest rates combined with a massive debt overhang, poor domestic and global demographics, and a foreign sector that will drain growth from the domestic economy. The EM and AD economies will both serve to be a restraint on U.S. growth this year and perhaps significantly longer. The negative real interest rates signal that capital is being destroyed and with it the incentive to plough funds into physical investment.

Demographics continue to stagnate in the United States and throughout the world. U.S. population growth increased a mere 0.1% in the 12 months ended July 1, 2021. This was the slimmest rise since our nation was founded in the 18th century, along with two other firsts: (1) the natural increase in population was less than the net immigration, and (2) the increase in population was less than one million, the first time since 1937. The birth rate also dropped again.


Inflation has been one of the most widely reported and discussed economic factors in the past year. Surging energy, rents, building materials, automotive, food and supply disruptions have boosted the year-over-year rise in the inflation rate to the fastest pace in decades. While some see this increase as a good economic sign, its increase actually had the effect of reducing real earnings by 2%. Even though unemployment fell in 2021, consumers became more alarmed by the drop in real wages according to surveys.

With money growth likely to slow even more sharply in response to tapering by the FOMC, the velocity of money in a major downward trend, coupled with increased global over-indebtedness, poor demographics and other headwinds at work, the faster observed inflation of last year should unwind noticeably in 2022.

Due to poor economic conditions in major overseas economies, 10- and 30-year government bond yields in Japan, Germany, France, and many other European countries are much lower than in the United States. Foreign investors will continue to be attracted to long-term U.S. Treasury bond yields. Investment in Treasury bonds should also have further appeal to domestic investors, as economic growth disappoints and inflation recedes in 2022.

Thanks to Lacy Hunt 

Thanks again to Lacy Hunt for another excellent Hoisington quarterly review. The above snips are just a small portion of the full article. 

As of this writing, the article is not yet posted for public viewing but should be available at the top link soon.

When Does the Sizzling Economy Hit a Recession Brick Wall?

I addressed many of the same points on January 17 in When Does the Sizzling Economy Hit a Recession Brick Wall?

I discuss productivity, demographics, and unproductive debt.

Something Happened

Something has happened in the last 30 years, which is different from the past,” says Minneapolis Fed president Neel Kashkari.

Yes it has and the Fed is clueless as to what it is.

The answer is unproductive debt is a huge drag on the economy. And the Fed needs to keep interest rates low to support that debt. 

When Does Recession Hit?

If the Fed does get in three rate hikes in 2022, then 2023 or 2024. And it may not even take three hikes.

Also, please see China’ Central Bank Cuts Interest Rates As Consumer Spending Dives

Few believe China GDP statistics.

China posts a GDP target and generally hits it despite questionable economic reports, electrical use, etc., and with a property sector implosion.

Slowing Global Economy

China did not decoupled from the global economy in 2007 and the US won’t in 2022.

For discussion, please see US GDP Forecasts Stumble Then Take a Dive After Retail Sales Data.

Finally, please see The Fed Expects 6 Rate Hikes By End of 2023 – I Don’t and You Shouldn’t Either

*  *  *

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Tyler Durden
Thu, 01/20/2022 – 19:10

Author: Tyler Durden

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Target CEO Says Consumers To Shop Less, Stay Home Amid Inflationary Storm

Target CEO Says Consumers To Shop Less, Stay Home Amid Inflationary Storm

Consumer prices soared the most in 40 years in December, a stunning…

Target CEO Says Consumers To Shop Less, Stay Home Amid Inflationary Storm

Consumer prices soared the most in 40 years in December, a stunning 7% from a year earlier that is crushing real wage gains and sending President Biden’s polling numbers to a new record low. The Federal Reserve is expected to embark on an inflation-crushing mission with the first-rate hike expected in March to tame inflation.

According to Target’s top executive, high inflation eating into wage gains is expected to directly impact US consumers who will be forced to drive less, eat at home, and reduce their shopping habits. 

Chief Executive Officer Brian Cornell told attendees at a National Retail Federation event in New York on Sunday that high inflation will derail consumer spending patterns. Many will resort to cheaper generic-brand goods to save money. 

“Some of the historical ways consumers react to inflation will play out again in 2022,” Cornell said.

He noted consumers would “drive fewer miles, and you’ll consolidate the number of times and locations where you shop. You’ll probably spend a little more eating at home versus your favorite restaurant, and you might make some trade-offs between a national brand and an own brand.”

Compared to the last two years of stimulus-fueled retail spending, Cornell expects spending patterns to change. He said a lot about the consumer would be understood in the next “60, 90, 120 days” in adapting to the high inflation environment. 

As part of the rapid recovery, fueled by trillions of dollars in monetary and fiscal aid, prices for cars, gas, food, and furniture rose sharply in 2021. As consumers increased spending, supply chains became snarled, and prices increased further. 

In the new year, US inflation pressures show very little easing, and some economists predict the peak could be nearing. The high inflation problem has led rate markets to price in 4 rate hikes by December, with the first live meeting expected in March. 

Many consumers have never seen anything like this because they weren’t around in the 1970s and early 1980s of high inflation. It only took then-Fed Chair Paul Volcker to increase interest rates to double digits to tame inflation which sent the economy into a deep recession. 

High inflation has put Biden on the spot ahead of midterms. The latest polling data shows the president’s popularity sunk to a new low this week. 

Consumers feel the pinch around them, from the supermarket to the gas station. Cornell’s outlook for the consumer is gloomy, suggesting they might go in hibernation mode to weather the inflationary storm. 

Tyler Durden
Thu, 01/20/2022 – 18:50

Author: Tyler Durden

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