🎙️ Baby Berkshire

The Berkshire Hathaway annual meeting is in the rearview, but the Markel Group’s (ticker: MKL) shareholder meeting — what some call “Baby Berkshire” — is up next in Richmond, Virginia, from May 21-22.

Our very own Shawn O’Malley and members of The Investor’s Podcast’s Mastermind Community will be on hand.

Some readers of this newsletter plan to be there. If you’re attending, join our WhatsApp group. We’d love to see you and talk about life, markets, and investing!

— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the biggest stories in markets:

• Why rents are sky high and what it means

• The Dow is terrible. But is it telling?

This, and more, in just 5 minutes to read.

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In The News

🏢 High Rents Prevent Fed From Finishing Inflation Fight

One of the Fed’s chief priorities these days: Manage inflation amid a backdrop of ever-evolving housing market dynamics.

Inflation has stabilized, but the Fed is committed to its plan to reduce interest rates eventually. 

But that plan hinges on one fairly big expectation: That housing costs will eventually come down, bringing inflation closer to the target rate of 2%.

Home, sweet home: When it comes to inflation calculations, housing plays a big role: It accounts for about one-third of the consumer price index and around one-sixth of the price index of personal consumption expenditures. 

Historically, housing costs have been predictable, and government statisticians use monthly rents to gauge housing inflation. But recent trends have defied expectations.

• U.S. rents surged three years ago, driven by pandemic-induced demand for more space and low inventories of homes for rent or purchase. Then, when the home-buying market dried up, would-be homeowners rented, driving further price increases. Plus, more renters are renewing their leases instead of buying a home, deterred by high mortgage rates.
  

• While year-over-year rent growth has slowed to 3.4%, it remains higher than anticipated. That’s contributed to the stalling of core inflation, which excludes volatile food and energy prices.
  

• Housing “has not behaved as we thought it would,” Chicago Fed President Austan Goolsbee said last month. “I still think it will, but if it doesn’t, we’re going to have a hard time” bringing inflation back to 2%.

Everything in moderation:  To achieve the target inflation rate of 2%, the Fed needs moderation in all categories contributing to inflation: goods, housing, and non-housing services. While goods prices have returned to their pre-pandemic trend, non-housing services inflation needs to drop, and housing inflation needs to fall. 

• Some economists believe that the slowdown in housing inflation is just a matter of time, as evidenced by the slowdown in new leases that began two years ago. Others are more skeptical about the effectiveness of monetary policy measures.

Why it matters:

Americans recently cited inflation as their biggest financial obstacle — by a wide margin. And rental prices are unaffordable for a record number of Americans: Half of all renters are paying more than 30% of their income on rent and utilities, according to Harvard’s Joint Center for Housing Studies.

From the grocery store to car insurance to healthcare costs, millions are feeling it every day. About 65% of the U.S. population lives in a home they own, and 35% rent.

When could relief be in store for rent?

Last mile: As The Wall Street Journal reports, “Stalled inflation has fanned fears the Fed might have to weaken the labor market, risking recession, to finish the ‘last mile’ of bringing down inflation. But that might not be necessary if prices, such as for housing, reflect economic conditions from a few years ago rather than now.”

Read more

More Headlines

🃏 Blackstone’s big gamble

😮 GameStop surges (again), and short sellers lose $1 billion

🚗 Big Short trader Danny Moses doubles down on bet against Tesla

🎰 Why U.S. healthcare is increasingly like a casino 

🏌 How the pandemic fueled early retirements

👨‍👩‍👦 Mother’s Day surprise: More women with kids working than ever before

📊 The Dow Is a Terrible Index. But It’s Still Telling

The Dow Jones Industrial Average remains stuck in the past. It’s also experiencing the worst period of underperformance of the S&P 500 since the dot-com bubble. 

Could its weak performance of late signal a turning point for markets?

The Dow represents (mostly) companies once considered great, while today’s “best” companies dominate the S&P. 

Parting ways: In times of change, the two move apart: The S&P rebalances toward the newest, big companies, while the Dow doesn’t.

• Take Nvidia, the talk of the town whose tremendous growth has been fueled by the artificial intelligence boom. It contrasts starkly with laggards in the industry represented in the Dow, like Intel.
  

• The performance gap between the Dow and the S&P has widened notably since the pandemic, leading some market analysts to believe we’re approaching an inflection point. 

Flawed design: Dow’s design has flaws, primarily due to its outdated methodology of assigning weights to stocks based on share price rather than market value. 

• That leads to skewed representations of market movements. Though major news networks flash the “Dow” on screens throughout the day, the index is widely regarded on Wall Street as a poor measure of contemporary market trends.
  

• Now, here’s where things get a bit more interesting. History suggests that the Dow's struggles reflect its inability to keep pace with market evolution, often lagging behind significant shifts and failing to capitalize on emerging trends (today, that’s AI; during the dot-com era, it was the internet boom). 

Of note: The Dow has remained this far behind the S&P only twice since the Great Depression, in 1976-80 and during the 1999-2000 dot-com bubble.

• During several periods, companies overlooked by the Dow surged in value while the Dow’s constituents stagnated.
  

• The timing of the Dow's adjustments, often late in response to market changes, further compounds its ineffectiveness as a leading indicator.
  

• The Wall Street Journal reports: "The trouble is that trying to choose just 30 stocks to represent the economy makes the selection committee resist putting in new members until they have been doing so well for so long that it can’t be avoided."

How it works: The selection process for Dow components, driven by a committee, tends to favor established companies like Procter & Gamble, Coca-Cola, and Johnson and Johnson. 

It all heightens concerns about the Dow's relevance as a barometer of market sentiment and investors' overall attitude. A new stock added to the Dow late has often been a contrarian signal, “showing that excitement about it was close to a peak.”

Why it matters:

Should we do away with the Dow?

Interest rates have changed dramatically from super lows. The 40-year bond rally is over. It’s Big Tech’s market (and, in many ways, Big Tech’s world). The Dow doesn’t really recognize these shifts. 

• The Dow’s biggest weights are UnitedHealth Group, the 15th-largest listed company, and Goldman Sachs, the 63rd-biggest. They’re valued at about half a trillion dollars, yet they move the index more than Microsoft, Apple, and Amazon combined ($7.5 trillion). 

Bottom line: There’s a timeless lesson here. As WSJ warns: “The Dow’s history offers a reminder that a small portfolio can easily miss major shifts in the market…Even the biggest companies—Dow components or not—have to evolve or die.”

Read more

Quick Poll

On Friday, we asked: Do you believe private markets offer better investment opportunities compared to traditional public markets?

— The results were almost exactly 50/50. “Better info and regulations make the public market much better,” wrote one reader. “For the individual investor, close scrutiny by the SCC helps investment integrity. That's not available with private equity,” wrote another.

— One reader said private markets are generally better if “you can obtain the factual information you can today from public companies.”

See you next time!

That's it for today on We Study Markets!

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