'That's stupid and I'm not doing that ...'
Mounting clues that the economy has reached a turning point.
“…but I’ve got my phone ready to dial 9-1-1 because I know you will.” So shared a lady about her hiking adventure at our Investing for Women event in Columbus this week, followed by meetings in West Chester and Lima, Ohio. This was in response to my data which shows that men generally trade more often than women, just one reason why we tend to be better long-term investors. The ladies at my table agreed that men a more prone to risk-taking in general, perhaps because of testosterone? A retired nurse worked in the head injuries unit where “99.9% of the patients routinely were men.” That got a laugh! Asked in a recent survey if they have “high investing knowledge,” 71% of men said yes vs. only 54% of women. Our fun table loved that stat, agreeing that “men think they already know.” What no one really knows is how much damage the Fed’s record rate hikes already have done. History tells us the biggest impacts should be hitting about now—Jefferies Group expects peak pain this quarter and next. A banking panic likely worsened whatever damage the hikes will have, as cautious lenders are tightening further (more below). The NFIB projects small business loan rates will average 9.5% by summer, nearly double early ’22’s 5%. The likelihood of recession almost doubled since February to 42% in March’s Bank of America fund manager survey. And in just 10 days, the Atlanta Fed’s Q1 GDP tracker has slipped from +3.5% to +1.5%. A turning point, perhaps?
The equity market definitely hasn’t priced a recession. From October 24 through yesterday, the S&P 500 was up 8%. On the other hand, the 10-year Treasury yield plunged 100 basis points over the same period. Which side is right? Easy money made a comeback in Q1, when policymakers injected $755 billion of liquidity into the economy, much of it after banking’s turmoil. That correlates with the performance of Growth stocks over Value and bitcoin’s run. But Strategic Research believes liquidity will reverse in coming months, keeping y/y M2 contracting and weighing on nominal GDP, revenues and profits. With reporting season kicking off, consensus is for earnings to trough in the first quarter, with EPS falling 7% y/y, which would be the largest decline since Q3 ’20 and a significant deterioration from -1% y/y in Q4. We’ll be looking for clues into to the true weakness emerging. The S&P has posted two consecutive quarterly gains, which has never happened in a bear market since at least 1950. So, the burden arguably is on the bears to show this time is different. AAII bearishness has remained exceedingly high, and fund managers in the March Bank of America survey were two standard deviations overweight bonds and two standard deviations underweight stocks—this despite $190 billion of inflows into equities since the start of ’22 and strong anecdotal evidence of high retail buying. One of the “Madnesses” of March was the inability of banking’s turmoil to move the S&P. We’re now in month 6 of the 3,800-4,200 range. Might earnings, and particularly guidance, break that range?
Worries over contracting M2 overlook a key point: there’s still about $4 trillion of excess money supply sloshing around in the economy, supporting growth and potentially keeping the Fed tighter for longer. Policymakers certainly continue to talk hawkish, a dramatic break from how they’ve reacted to financial hiccups since the ’08 crisis. While consumers’ free cash flow production was just 3% last year, a 15-year low and 5 points below the past decade’s average, a lot of this reflected spending on durables and housing construction. The question, Empirical Research asks, is how long can households keep it up? Home equity balances are elevated, and even as savings last year funded nearly half of the growth in spending, the decline in their cash balances has been slow. Job and income growth is still robust, and debt service ratios are low across the board, including among young, less-affluent households. The rise in rents, food and energy prices has hurt this cohort, but those forces are easing. Despite a looming headwind—student loan repayments averaging nearly $400 a month for 40 million Americans could resume in August if not sooner—it’s estimated the bottom 40% still have excess levels of cash equating to seven weeks of spending. Recession seems to be coming but, with 1.7 job openings for every unemployed person, this U.S. consumer will not go down without a fight.
- Inflation is moderating For the first time since August 2020, Citi’s inflation surprise index dipped into negative territory, reflecting inflation prints that are coming in below expectations and ending the longest period of upside inflation surprises since the gauge started in 1998. As for wages, employers told ADP (more below) that pay growth “is inching down.” Last week’s “supercore” PCE deflator (core services ex-housing) for February hit the Fed’s target of 3.3%, its lowest since July 2022, below the 4% 65-year average and close to the 45-year average of 3.1%. Elsewhere, ISM manufacturing prices came in under 50, and services prices decelerated sharply.
- Consumers won’t go down without a fight Annualized light truck and auto sales rose at 15.28 million annualized pace in Q1, their strongest pace since before the chip shortage. A lack of inventories represents the biggest drag on sales, an issue that automakers are working to fix, with faster production planned for this quarter. Elsewhere, Redbook’s weekly survey of chain-store sales rose the most in five weeks.
- Homebuilders are now in a good mood! Evercore ISI’s proprietary homebuilders survey rose to its highest level since October, with builders reporting a “solid” spring selling season so far.
- Historically, jobless claims usually rise slowly, then quickly Initial claims slipped a bit but continuing claims were more problematic, with upward revisions of roughly 130,000 pushing continuing claims to early ’22 levels, marking an obvious uptrend. Meanwhile, ADP small business employment contracted a fifth straight month and the net number of NFIB firms adding workers has now shrunk seven of the past eight months—small businesses historically have accounted for nearly half of all job growth. Also, February job openings slowed to a 21-month low and Challenger job cuts for the quarter hit a 3-year high.
- Manufacturing in recession The ISM, historically strongly correlated with earnings growth, fell in March to 46.3, its lowest since the early Covid lockdowns and only the 16th time it’s been as low or lower since 1950. With Europe’s fortuitous winter of mild temps and lower energy prices now past and China’s reopening bounce leveling off, Piper Sandler’s global PMI model also pointed toward more weakness. The services ISM also came in well below consensus, posting its slowest growth in three months.
- Doing the Fed’s work for it A Dallas Fed survey of member banks found caution, with loan demand and volumes declining and loan nonperformance on the rise. Bank of America said its credit stress indicator, while off mid-March lows at the apex of the turmoil, remains in a zone that historically has seen the flow of credit freeze materially. Most at risk, it says, are assets with “pre-existing conditions.”
Rock and a hard place With the upper bound of the Fed funds target rate at 5%, banks are struggling, given that their estimated interest income on assets is only 4.53%. This leaves them with an unappealing choice: either try to maintain profitability by keeping deposit rates low and watch their deposits flow elsewhere or raise deposit rates to prevent outflows and see their profitability evaporate.
Now what? By “not being in a hurry” to replenish the Strategic Petroleum Reserve at about $70/barrel, as it had said it would do in December, the Biden administration appears to have a made a bad bet. Global storage levels point to crude prices above $100.
Over the long weekend, chew on this Not only does the IMF expect world economic growth to slow in 2023, it warns the global economy is facing years of sluggishness, with medium-term prospects their weakest in more than 30 years.