No more glorious place than Phoenix this time of year

Dressed for the holidays, Phoenix was heavenly this week as two of my favorite colleagues and I met with some of my favorite advisor groups here. Investor spirits aren’t so upbeat—sentiment is trending bearish again even as consumers have amassed a record $2 trillion in cash. They’ll be spending this cash down as soon as the next quarter as impacts from Fed tightening intensify.  A 50-point hike to 4.5% is baked in for next week’s meeting, with futures pricing a peak rate around 5% by late spring and cuts as early as next fall. But even if 2023 holds no rate cuts, equities historically gain 14% and fixed-income credit 11% on average in the year after the last Fed hike, with EM debt, small caps and Value stocks typically winning big. Whenever more than half of NYSE stocks were at 8-month highs, as is the case now, forward 12-month returns have been positive 13 of 13 times dating to 1942. From a technical perspective, the month’s weak start may be a byproduct of the October-November rally hitting well-defined resistance. Better days for “traders” could lie ahead, as seasonal strength tends to be back-end loaded in December. December-January typically are the strongest two months for flows.

Earnings growth will be key if you’re an “investor.” Rising costs, a strong dollar and deteriorating global trade flows already have seen S&P 500 earnings growth ex-Energy slow 3.5% in Q3, and Q4 projections are calling for an even larger 5.4% decline. But 2023 consensus is still holding around $232 for 2023, a 5% increase over this year. That’s wildly inconsistent with consensus expectations for a recession! Even in a mild downturn, earnings historically have fallen 20-30%. Also, going back to 1991, the year-over-year (y/y) change in fed funds has led profit growth by about two years, another indication earnings will need to readjust sharply in the year ahead. Strategas Research dug into consensus estimates and found margins, which have been contracting, are expected to begin expanding again next year. What?! The opposite typically occurs in recessions. Moreover, trailing 12-month earnings have yet to peak, while operating earnings are down just 3.1% and reported earnings are off only 5.4% from Q1 peaks. At some point, it seems market earnings will have to reprice. We’ve already taken our house forecast down to $200.

Recession signals are everywhere—yield curve inversion, Conference Board indicators, PMIs (seven of the past eight times the Chicago PMI plunged below 40, as it did in October, a recession ensued), more than half of National Association for Business Economics members, and plummeting M2 (November’s 7% y/y contraction was a record except for the 1930s). Monetary tightening works with a one- to two-year lag, meaning it should hit full force next year. To be sure, the remarkable resilience of the consumer has been one of this year’s surprises, plowing through an estimated $1.2 trillion of excess savings. But Deutsche Bank thinks the stockpile could be depleted by the end of Q3 2023, taking away a critical tailwind at the time the economy may need it most. This also is when futures expect the Fed to begin easing again. But can it if inflation it still elevated? Policymakers are operating under the assumption there is no wage-price spiral and that wages have not been a driver of inflation—a thesis that could be tested early next year, when Conference Board and NFIB surveys show generous cost-of-living adjustments kick in. Have you noticed the labor strikes lately? Jovial Phoenix advisors did, along with the crypto crash (“Quantum computing will make blockchain a dinosaur”), the Georgia runoffs (“Most of my clients are conservative and none of them want ‘him’ to run again”) and my shoes (“Thank you for reading my weekly!”). As this is my last full weekly for the year, I’d rather focus on the season. I wish you and your loved ones happy holidays!

Positives

• Disinflation? Q3 unit labor costs were revised down, prior quarters too, putting the y/y pace at 5.3% vs. the previous 6.1%. Growth in compensation per hour over the past four quarters also was lowered to 4% from 4.7%. In services, November inflation moderated across airfares, hotels, banking, insurance, real estate brokers, rental cars, internet services and trucking. In energy, futures are pricing gasoline, already at January lows and nearly negative y/y, to fall another 20 cents a gallon the next six weeks.
• Services surprise The non-manufacturing ISM jumped more than 3 points above consensus in November as business activity surged, employment rose and orders remained elevated. Not the sort of news the Fed wants to see. However, the former Markit services PMI contracted a fifth straight month, painting a mixed picture.
• Factory orders surprise Propelled by strength in nondurable goods and nondefense aircraft, October’s 1% monthly increase blew past expectations. Notably, core capital goods shipments were revised up from earlier estimates to +1.5%, putting capex on course for a solid increase in Q4.

Negatives

• Are autos next? Just like higher prices and mortgage rates (and limited supply) thwarted the housing recovery, the auto industry is running into similar issues. New light vehicle sales declined 6.5% in November to a 14.1 million annualized pace, though that’s still up 7.9% y/y. Next week’s expected Fed hike will drive financing costs up further, and at an average $48,281, new car prices resumed their climb after September’s decline, coming in just below August’s record $48,301. Inventories continue to improve, up 57% y/y and 6.9% from October.
• More pain ahead Even after year-to-date losses of 26% on average (S&P’s Information Technology sector) and worse, valuations on the 50 largest stocks still trade a full standard deviation above the bottom 450 stocks. The five largest, all Big Tech names save Berkshire Hathaway, still represent 20% of the S&P, well above the dot-com bubble peak.
• At least this won’t come up during the holidays Elevated inflation and the extremely slim margins of control in both chambers of Congress could add to the drama when the debt-ceiling issue comes up next year, possibly by late spring. With a new Republican majority in the House facing a sitting Democratic president and soaring public debt, conditions are similar to the disruptive experiences of 1995 and 2011, the latter causing the first U.S. government credit-rating downgrade in history and a steep sell-off in risk assets.

What else

WFH … or anywhere Office occupancy is below 50% of pre-pandemic levels at 2,600 buildings and 41K businesses in Kastle’s back-to-work barometer. And it may be not all the still-remote workers are at home. Air travel has fully recovered from its Covid restrictions (Evercore ISI’s proprietary survey of international revenues surged in the past week to a record), bolstered by a strong dollar, stimulus savings and desire to have some fun … when not working, of course.

Shout-out to active management Nearly two-thirds of stocks are ahead of the S&P 500, and the equal-weighted S&P has outperformed the cap-weighted S&P by 7 percentage points year-to-date.

At least this won’t come up during any of 2023’s holidays 2023 will be the first year of the 21st century without a general or presidential election in any G7 country, making political stability a potential silver lining as we enter a likely tough year (pending recessions, high inflation, energy woes, war, cost-of-living crises, etc.).

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