'Not worried, but ...'
Looming risks make it hard to assess where markets go next.
[Note from Linda: Got to post a bit early this week—my son’s getting married!]
… obsessed.” This was an investor’s immediate response to my query at a client luncheon in Toledo this week. She checks her smartphone to track her investments frequently. A fellow baby boomer scoffs at the housing unaffordability today. “Nothing like we saw in the early ’80s.” A gentleman keeps cash—“something that the government can’t follow,” in response to my remarks about central bank digital currencies. Shaking of heads over the excessive stimulus moneys, and regarding beneficiaries of the Paycheck Protection Program, “lots of new boats out there!” A very successful advisor’s business is growing rapidly. “There’s so much money out there!” He keeps a “Fear List” counting client calls of concern—only nine YTD. Might 3 summer risks up the tally? 1) An ugly debt-ceiling battle—with the two sides $5 trillion apart, a shortening runway doesn’t seem to be softening anyone’s position. 2) Further tightening in bank credit—First Republic’s seizure/sale should add to rising interbank borrowing costs as banks seek to protect and preserve capital. 3) More hawkishness—despite lending standards near recessionary tights, the Fed and ECB (which today also hiked rates a quarter point) are focused on still stubbornly high core inflation. Each sentence at the end of the first three paragraphs of Wednesday’s FOMC statement highlighted policymakers’ concerns about inflation risk and their commitment to returning inflation to their 2% objective.
Even though Powell ruled out any rate cuts, the good news for bonds and risk assets alike is fixed-income markets are pricing a relatively quick return (12 to 24 months out) to 2% PCE and an outsized dovish pivot. This would come, of course, at the cost of recession. Bank of America equates the current environment to the inflationary ’70s-’80s, when “sell the last hike” worked. Consternation over all the looming risks has spawned significant rotation in the equity markets, with defensives outperforming Big Tech since March, and large caps outperforming everywhere—in growth and value indexes, every single one of the 11 GICS sectors, as well as major markets around the globe. Piper Sandler thinks this is as clear a signal as it gets that investors are turning to stability and risk-off strategies—if they’re staying in stocks. Six-month cumulative mutual fund and ETF flows show the most net redemptions since 2020, and notional net selling in U.S. equity options hit a 3-month high this week, with the aggregate long/short ratio falling to its lowest level in more than 10 years. Recent market breadth also has declined markedly, an occurrence that historically has preceded below-average forward returns and larger-than-average drawdowns.
Earnings and guidance have been surprising, suggesting companies may be learning to adapt to, and in some cases benefit from, higher prices. Margins remain an issue, but with 70% of the S&P 500 market cap having reported, Q1 expectations are for revenue growth of 3.1% and an EPS decline of 3.2%, both better than expected going in. The path of Q2 estimates also is more favorable than the past several quarters. One reason is consumers are still finding jobs and spending (more below). How this plays out against a Fed committed to bringing down inflation is a concern, as is the previously mentioned worries about bank failures. In less than two months, the FDIC has taken over three large U.S. banks with combined assets of nearly $550 billion (the second-, third- and fourth-largest bank seizures in history), representing more than 2% of GDP and rivaling the Great Depression, S&L crisis and the global financial crisis in terms of failed bank assets to GDP. For now, our fixed-income colleagues expect more brush fires than full-blown blazes in banking. Even with formidable resistance at 4,200, Renaissance Macro thinks the path of least resistance remains higher. Not sure that sentiment is shared by the fine people I met with this week. Our meetings were peppered with many unusually great questions. My Ann Arbor host claims theirs is among the smartest counties in the U.S.A., owing to many University of Michigan graduates—my Sparty Mister will disagree!
Positives
- Labor market cooling That was the message some in the market took away this week when the March openings rate fell to a 2-year low and the private quits rate (which captures voluntary separations by employees) declined. Initial claims also ticked up. Powell at his press conference acknowledged wage growth is slowing (though preliminary Q1 labor costs nearly doubled Q4 ’22) and said it’s possible labor conditions could keep loosening without a recession.
- Consumers reign supreme Lightweight vehicle sales rose 7% to a 15.9 million annual rate in April, well above the consensus for 15.1 million. This comes on top of last week’s improvement in April Michigan sentiment and an unexpectedly robust increase in Q1 consumer spending.
- Services are accelerating Not by a lot, but the services PMI for April rose slightly above consensus, recovering a portion of February’s decline. Increases in new orders and supplier delivery delays more than offset softening in business activity and employment. March and April combined still marked a noticeable deceleration from the prior year.
Negatives
- Labor market hot? That’s the message markets took from ADP’s estimate of private nonfarm payroll employment, which nearly doubled consensus with broad gains topped by services and leisure & hospitality jobs. Small firms led the way and have now added jobs three straight months after six months of continuous decline. Faster job growth could make the Fed’s job harder.
- Manufacturing struggling April’s PMI improved over March’s 3-year low but still reflected activity that contracted a sixth straight month. The contraction rates for output and new orders softened while employment stabilized after two months of declines.
- Eurozone sputtering Its manufacturing PMI sank to a 3-year low and into recession territory. The services PMI remained expansionary, although Gavekal Research found the reading deceptive, saying the activity is being driven by European “revenge travel” that’s likely to fade as the monetary noose tightens further.
What Else
Sayonara signing bonuses and free food 19% of this year’s layoffs have been software engineers. And that is before AI threatens further cuts or at least fewer opportunities—this week, for example, IBM said it would pause hiring on expectations that many roles can now be filled by AI.
Might want to clip dividends The S&P ended April at 4,169, flat vs. the year-ago close for the month of 4,132.
The most accessible place in the country by road Perrysburg, Ohio, another stop on this week’s travels, sits along the intersection of Interstate 75, a north-south route, and Interstate 70, an east-west route, recognized as the modern-day “Crossroads of America.”