Are We Comfortably Numb?

Scott Poore

5 days ago

6 min read

It's been a holiday-shortened week, but not one without its fair share of drama. Inflation reports delivered a surprise for markets and investors are fearing the worst

from the Fed meeting next week. Oil has continued to climb higher and interest rates have moved up, along with new Yen "carry trade" concerns. This week we gather inspiration from the hit song "Comfortably Numb." recorded by Pink Floyd in 1979. Here is some trivia about the song:

This song reached #10 on the U.K. charts and sold more than than 1 million copies - pretty good by 1970s standards. This is one of Pink Floyd's most popular songs and was ranked in 2021 as #179 on Rolling Stone's list of "the 500 Greatest Songs of All Time."
Most people think this song is about drug use, but according to the songwriters it isn't. Roger Waters, who wrote the lyrics, claims it to be autobiographical. The line, "When I was a child I had a fever" was literally about a time when he was young and had the flu with a temperature of 105 degrees, feeling "delirious." Later in the song the line, "That'll keep you going through the show," refers to him getting medicated during a show in Philadelphia in 1977 when a doctor backstage gave him a shot to help with stomach cramps.
David Gilmour, guitarist for Pink Floyd, play two solos on this song. They regularly appear on Best Guitar Solo lists.
This song also appears during the 1982 movie "The Wall" where Bob Geldof loses his mind and enters a catatonic state before a show.

Here's what we've seen so far this week...

Feeling Down. Roger Waters relives his childhood experience of being sick in "Comfortably Numb" as the verses recall, "I hear that you are feeling down/I can ease

your pain." Markets are feeling some pain after this week's inflation data. Thursday's release of the Producer Price Index came in as expected month-over-month at +0.4%1, but the year-over-year reading was +5.4% compared to the revised +4.8%.2 After two consecutive months of considerable decline, PPI reared its ugly head yet again. The main culprit - oil. The price of oil was higher in August,3 but more to the point, the price of Diesel Fuel was higher by 35%, reaching an all-time high of $73/barrel.4 This showed up in the PPI categories of Energy (directly) and Transportation & Warehousing (indirectly). Both categories increased at least 3-fold from July to August. This sent markets reeling yesterday as equities sold off in response, as the prospect of a Fed rate hike increased.

Some slight reprieve in bad news came this morning as the August reading for the Consumer Price Index came in as expected. As we have been stating for a couple of

weeks, the Cleveland Federal Reserve had August CPI coming in at +0.4% month-over-month and +3.4% year-over-year, and that's how it turned out.5 6 The lack of change in CPI year-over-year from July to August seems to have calmed markets as equities are trading higher, so far today. Yet, the futures on next week's Fed decision moved yesterday to a 74% probability of a rate hike and as of this writing, have edged even higher to an 86% probability.7 So, with that information, the question becomes what's next? If the Fed is determined to take a slow approach to rate hikes moving forward, equities tend to react relatively calm (as represented by the black line in the graph above). However, if the Fed takes a relatively fast approach to hiking rates, equities tend to perform poorly (as represented by the orange line above). It's possible the exact language in next week's rate decision could be more important than the actual rate decision itself.

Are Investors Comfortably Numb? The chorus of the song reveals that, just as he felt as a child, the singer has begun to feel numb once again. That is perhaps how investors have started to feel in an era of easy returns for equities over the past few years.

Despite the warning signs investors continue to pile into AI-related stocks. In July of this year, the Mag 7 ETF (MAGS) saw a record $11 million in just one week.8 Just before the Dot.com crash in March of 2000, three of the hottest tech stocks - Intel, Cisco, and Oracle - had witnessed unfathomable growth by the likes of 1,479%, 3,491%, and 1,676%, respectively.9 However, by the end of 1999, the Free Cash Flow of those companies began to erode leading to historic losses in those companies during the Dot.com crash.10 11 12 As we stand here today, some of the hyperscalers - Amazon, Google, Meta, Miscrosoft, and Oracle have negative forward free cash flow. In fact, according to J.P. Morgan, hyperscalers aren't expected to turn free cash flow positive until 2028.13 That's a considerable amount of time for those AI-related companies to be judged on their profitability by investors.

In their defense, it would be difficult for investors to find a diversified ETF or mutual fund these days that doesn't have exposure to AI-related stocks or is somewhat concentrated at the top, assuming the fund were market capitalization weighted. The

S&P 500 Index is concentrated at the top, with at least 38% in the top 10 holdings of the index.14 However, it isn't just the U.S. that is concentrated. The graph shown here displays the concentration in the top 10 holdings of indices in the Emerging Markets (38%), EuroZone (30%), and Japan (30%). With these concentration levels, it may only take a catalyst to cause a reversion to the mean. Among the concentration concerns among investors also lies inflation, interest rates, the price of oil, and geopolitics. Noted investor Ray Dalio rans that any one of these could force the Fed's hand to start hiking interest rates potentially leading to such a reversion-causing catalyst.15

Just The Basic Facts. The singer in "Comfortably Numb" mimics the typical questions a physician might ask of a sick patient. Where does it hurt? Give me some information.

Sometimes, during euphoric markets, investors can forget or overlook the basic information needed to make unemotional decisions. Over the past 100 years, when markets get near or exceed the top of their trendline channel, a pullback has resulted, historically. The graph shown here indicates, at least on a monthly basis, the S&P 500 exceeded its 100-year trend channel last year and has yet to experience a considerable pull back. There is no way to know exactly when a pull back might occur. Each market is different. However, revisiting risk tolerance by investors is typically a good course of action in concentrated markets.

As if further evidence was not needed, market cycles can also provide some helpful information. Historically, markets tend to follow cycles, albeit, imperfectly. Over the

80 years of market history, the S&P 500 Index tends to see pull backs when it experiences at least three consecutive years of double-digit returns. In two of those instances - 2015 and 2022 - markets retreated after the third consecutive year of +10% returns (as shown in the graph). In two other instances - 1946 and 1953 - the market pulled back after the 4th consecutive +10% year. Only once - 2000 - did the market make it to 5 consecutive +10% years before pulling back. No one knows how markets will perform in the future. However, given these cycles, investors should assess their portfolios and adjust their allocations according to their respective long-term risk tolerance.

Click here to watch the live version of "Comfortably Numb" with the amazing guitar solos.....

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Disclosures

The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.

Forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.

Any market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general.

Past Performance does not guarantee future results.

Are We Comfortably Numb?

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