A slower pace
Perhaps Wall Street can take a cue from Main Street and just chill.
Spent part of the week in Wichita and Hutchinson, Kan. “Flyover country,’’ some call it. Seems disrespectful. Wichita (not the Kansas-side of Kansas City) is the largest city in the state. Known as the “Air Capital of the World,’’ it’s the birthplace of Beechcraft, Cessna, Learjet, Mooney and Stearman (and where Pizza Hut and White Castle got their starts). Some 300,000 aircraft have been built here, more than any other place on the planet. Hutchinson, to the northeast on the Arkansas River, is nicknamed “Salt City” for huge salt mines dating to 1887. Locals call it “Hutch.” Its links-style course, with rolling hills reminiscent of Scotland’s seaside courses, ranks 25th among Golf Digest’s “100 Greatest Golf Courses” in the U.S. The simple, small towns around here belie big farms (wheat for cattle feed and corn for ethanol), oil, gas and cattle dollars. With price volatility top of mind, these mainly well-to-do farmers naturally invest conservatively. They listened stoically to my concerns about the ’70s redux. These farmers reminded me that, while Wall Street analyzes every policy utterance and macro report, Main Street has more important things to do.
An “on the one hand, on the other’’ kind of week. On the one hand, reports on jobs and manufacturing (more below) hardly seemed to reflect an economy on the verge of recession. Even with consumer sentiment mired near pandemic lows, nominal consumer spending climbed at an annualized 10.7% rate in the year’s first half, and Evercore ISI surveys of retailers and restaurants reflected further improvement this week. Just as most developed economies were near full employment on the eve of the pandemic, meaning stimulus measures served to raise inflation, Bank of America thinks the inverse may turn out to be true: as aggregate demand falls, inflation may decline with little negative impact on output or employment. On the other hand, underlying macro strength gives the Fed more ammo to hike higher for longer. Early this afternoon, fed futures were pricing 58% odds of another three-quarter-point hike this month, and 50-50 odds of a 4% fed funds rate by year-end. In more normal times, investors would welcome a strong labor market. More jobs mean more spending and growth. But with labor in painfully short supply, it’s all about the inflationary implications. Treasuries and equities have been moving in lockstep on those concerns, selling off after early summer rallies. The 10-year Treasury yield at this writing was up 63 basis points since Aug. 1, the 2-year note was near 2007 highs and the S&P 500 had given up roughly half its 17% mid-June to August gain. Societe Generale notes bond yield volatility is the year’s big story so far. But the focus may be shifting to deteriorating profits and stocks. While sales growth ex-Oil remains robust, earnings are slowing down. Yardeni’s net earnings revisions gauge—a 3-month moving average of forward earnings estimates rising less the number declining—registered -9% in August on top of July’s -1.9%, which had been the first negative reading since July 2020.
A slower pace is the way my host described Wichita. Reminded me I’m glad to be an American. We aren’t dealing with an economy about to fall off a cliff. Indeed, with still so many more jobs than job seekers, we think the U.S. can skirt a recession next year (rest of the world, not so lucky). Laid-off workers getting rehired quickly is a bad sign for inflation, though today’s report of rising labor force participation is a welcome data point for the Fed. The Fed is still walking a tightrope, however, trying to limit the “pain.” There are a lot of similarities with the ’70s (the “terrible ’70s,’’ as some put it), when supply shocks and a wage-price spiral couldn’t be defeated without double-digit policy rates and back-to-back recessions. On the other hand, household and corporate balance sheets are in much better shape now than they were then, and the nation’s ability to control its own energy destiny is much stronger. And importantly, the massive millennial generation is just now surging into its prime productivity and earnings years. We are entering historically the worst month for returns and the worst two months for market volatility. And seasonality traditionally has skewed to the downside when beginning the month in a downtrend (as is the case today). After that, the midterms (more below). Post-election returns in midterm presidential cycle years tend to be strong. The “terrible ’70s?” I had a great time!
- Good, not great, news on jobs In line with expectations, and that’s good from the Fed’s perspective as nonfarm payroll growth slowed and was revised lower the prior two months. Meanwhile, the jobless rate ticked up on increased participation, and hourly earnings rose at their slowest pace in four months. Elsewhere, job openings jumped in July to 11.2 million, ending three months of moderation. But the quits rate slipped and continuing jobless claims rose.
- Manufacturing surprises The August ISM held steady vs. expectations for a decline, as new orders rebounded back into expansion territory and input prices slowest to their lowest reading since June 2020. S&P Global’s final read on the month also was revised higher. Factory activity continues to benefit from auto demand that far exceeds supply, with the inventory-to-sales ratio hovering at half a month—a fifth of the typical 2.5 months. Shortages are particularly acute among fuel-efficient models.
- Supply chains are normalizing Bottlenecks are improving at a rate of about 0.5 standard deviation per month, and in aggregate are now just 1.2 standard deviations from normal, vs. nearly 5 last October, UBS says. August marked a fifth straight month of improvement following the March/April stall due to the Russia-Ukraine war and Covid restrictions in China. Delivery times and shipping costs are improving rapidly, backlogs of electronic components are back to long-run averages and orders/inventory ratios have swung from historical highs (96th percentile) to historical lows (5th percentile).
- Housing slump deepens Construction spending fell more than expected in July as sharp declines in starts in late spring and summer spilled over into residential construction, with single-family home spending down 4%. Multi-family spending also slipped. The slowdown in part reflects the impact of rising mortgages rates, which are discouraging buyers and, in the process, slowing home price appreciation, as reflected in the latest FHFA and Case-Shiller reports. On the other hand, that could bode well for rents down the road.
- Food prices aren’t letting up While gasoline prices keep declining and are now entering a seasonally weaker period, food price inflation has been more persistent. Both food at home and food away from home continue to accelerate on a 3-month annualized basis, and at 13.5%, food’s share of the CPI is almost twice as big as energy’s 8.8%, which peaked at 41.5% year-over-year in June.
- Bad news on global manufacturing Unlike the U.S., factory activity is contracting in much of the world, with just 28% of countries tracked by Renaissance Macro showing new orders above breakeven 50 and more than half of the world’s manufacturing PMIs contracting. Excluding the pandemic, this is the weakest since the European sovereign debt crisis.
Red wave? Bloody unlikely GOP hopes of sweeping both houses of Congress in the midterms are fading fast, harmed by the Dobbs Supreme Court case, falling gasoline prices (Gallup found Americans to be significantly less negative about the U.S. economy than they were in July) and the FBI’s raid of Mar-a-Lago. With the 2022 midterms becoming a choice election between the two parties and not the usual midterm referendum, polls show Republicans failing to regain the Senate while their prospective gains in the House have shrunk considerably.
Consumers continue to pay up Never in the post-war era have household rainy-day funds exploded as dramatically as the last couple of years, Leuthold Group shares. Cash holdings as a percent of debt have ballooned to 25%—the most since 1970. Indeed, even with recent declines, the real purchasing power of wages is superior to the early 1990s and near its previous post-war peak of the early 1970s.
Where is everybody? Fundstrat notes the employment-to-population ratio is stuck at 60%, 120 basis points below where it stood at year-end 2019. Since then, the population of Americans age 16+ has risen 6.4 million, yet the number of working-age Americans (16+) who are employed hasn’t budged.