The summer of our discontent
Could it be setting investors up for a glorious winter?
No travel this week, praise the Lord! Five flights over five days last week as I traveled to Cincinnati and Raleigh. Long lines and cancellations everywhere. The weary traveler next to me on my flight from Cincinnati to connect through D.C. asked, “Were you part of the mess yesterday,” referring to his numerous delays and cancellations. On my connector to Raleigh, the weary traveler next to me asked the same question! Americans en masse want to go on vacation this summer, but they face sticker-shock ticket prices, weather delays and lack of staff. Where are all the pilots? Early retirements, forced age-related retirements and “rest” requirements are making travel miserable. But I got through the week unscathed, praise the Lord again. The data is miserable as well. The consumer is slowing down (more below). AAII pessimism is near historic highs. Investors Intelligence bears have outnumbered bulls 17 straight weeks, with financial advisors as bearish as they've been since the global financial crisis. Americans’ feelings about conditions also are at a 14-year low, Gallup says, and Conference Board expectations have fallen firmly into recession territory. Is anyone happy?
This earnings season is all about downward guidance and revisions. Many companies are stuck with year-ago ordered goods that consumers no longer want—Empirical Research says inventories rose in Q1 at their second-fastest clip ever, behind the mid-1970s. Analysts need to adjust, too. Forward estimates have been rising most of the year, despite margins that are coming under pressure. Rarely have P/E multiples found a bear-market bottom at current levels, while cyclicals undercutting defensives and high beta undercutting low beta suggest rallies will continue to be bear-market bounces rather than maintainable moves up. Footing for a sustainable rally will need inflation expectations to re-anchor. Otherwise, Strategas Research sees the potential for “jobs plentiful stagflation.” Even though it may be at a near-term peak (more below), inflation looks “sticky.” Summer’s pent-up boom has services running hot. Fourth of July picnics, too (more below). Within CPI, shelter prices (which have an outsized 33% weight on the index and track home prices with a lag) are accelerating even as home-price increases moderate. Energy and commodities have pulled back, but year-ahead natural gas prices are making fresh record highs and electricity prices are skyrocketing. Most notably, while initial claims have ticked up from historic lows, the labor market remains tight. So, inflation may stay elevated and could even perk up as the economy slows. Wouldn’t be the first time. The ’70s saw inflation “peaks” of 6% in ’70, 12% in ’74 and 15% in ’80, with prices only falling back after Fed-induced “twin recessions.” Could twin recessions be in order again?
Let’s accentuate the positives. The slowing growth/higher inflation narrative isn’t universal. Former Treasury Secretary Larry Summers, who nailed the inflation call, sees prices and the economy falling back to another period of “secular stagnation,’’ akin to the post-financial crisis decade. With the abrupt removal of fiscal and monetary stimulus, TrendMacro thinks the sharp deceleration in money supply growth will equate to core PCE of 1.95% a year from now. And people tactically giving up on stocks is a good contrarian positive. Low potential growth is not incompatible with longer-term robust equity performance. Think of the post-financial crisis market. While higher rates are a headwind, it’s estimated large-cap companies (ex-financials & real estate) borrowed almost 90% of their outstanding debt at fixed rates far below today’s levels, and a third of that doesn’t mature until after 2031. Moreover, the risk of recession and slowing growth are tailwinds for Treasury market performance. Fourth worst start to a year since the ’20s, and the worst in 52 years. You’ve probably been scathed. Surely, the second half of the year can’t be as bad, right? Think you’ll remain unscathed from here? Not bloody likely, IMHO. Here’s to our summer of discontent transforming into a glorious happy winter. Happy Fourth of July!
- Peak inflation (for now) Core PCE prices rose a modest and below-consensus 0.3% for a fourth straight month in May, dropping the annual rate to a 6-month low. Declines in commodity prices pushed global food prices down a third straight month, and ISM manufacturing prices (more below) slipped to a 4-month low. Meanwhile, with microchip shipments now at 95% of their pre-pandemic levels, auto delivery times are improving, adding to easing inflationary pressures. Regional Fed surveys also show supply-chain bottlenecks easing.
- Peak yields? Renaissance Macro shares three things that tend to signal peak yields: 1) cyclicals underperforming defensives (this has been happening for six months); 2) banks underperforming utilities (underperformance has been extreme); and 3) copper underperforming gold (the recent break in copper has led to outperformance in gold). All three conditions suggest deteriorating economic and credit conditions that have seen TIPS breakevens roll over—the yield on 10-year TIPS has fallen back below 2.4%, well within the 1.5% to 2.5% range of the past two decades.
- Q2 tailwinds May’s merchandise trade gap shrank to $104.3 billion—the smallest deficit so far this year—as consumer imports slowed while exports rose. May marked the second consecutive monthly decrease in imports. Also, May durable goods orders unexpectedly rose, and core shipments that track corporate capex accelerated. Pending home sales also surprised, climbing in May for the first time in seven months, and weekly mortgage purchase applications rose a second straight week to a 7-week high.
- Consumers gassed Burdened by high gas prices and dwindling savings, consumers are pulling back. Sharp downward revisions dropped Q1 consumption growth to 1.8%, almost half the prior estimate, and real spending declined in May for the first time this year. The 0.2% nominal increase was the smallest in six months. April was revised down, as well, and the personal savings rate fell to a September 2008 low.
- Manufacturing slows June’s manufacturing ISM fell more than expected to its slowest pace of growth in two years. New orders contracted for the first time since June 2020, and employment declined, though companies reported improving progress on addressing labor shortages. On the plus side, production rose and business sentiment remained optimistic.
- Crypto winter and discontented holders Crypto market capitalization has tumbled below $1 trillion from a peak near $3 trillion just seven months ago. Bank of America data suggest a 50% plunge in the number of active crypto users since then. Its survey found crypto assets currently comprise less than 1% of U.S. household financial assets, and that relatively few people view crypto assets as a reliable long-term investment.
Get your popcorn ready, election season is going to be so much fun Ahead of his 2022 gubernatorial race, Florida Gov. DeSantis has not requested Trump’s endorsement, Politico reports, and he has more than $100 million in the bank and has assembled a campaign team in anticipation of a 2024 presidential run. In 2018, Trump’s endorsement and support was viewed as pivotal in propelling the then-unknown congressman to the top of the Republican gubernatorial primary in Florida. Speaking of Trump, it’s rumored he may announce a run as early as July 4.
Have-nots getting squeezed Inflation hits lower-income far harder than higher-income families, with nearly 75% of expenditures going to food, transportation, housing, utilities and phone service. That’s roughly double what the wealthier pay as a share of their income. Poorer households also tend to have no cash savings, and because they often rely on non-mortgage consumer credit to help make ends meet, they are far more exposed to rising interest rates.
This doesn’t even include the 25% jump in beer prices The American Farm Bureau Federation says this year’s Fourth of July cookout for 10 will cost 17% more than last year’s, with an array of cheeseburgers, pork chops, chicken breasts, homemade potato salad, strawberries and ice cream costing $69.89, up $10 from 2021.