This too shall pass This too shall pass\images\insights\article\meeting-conference-evening-small.jpg October 20 2022 June 17 2022

This too shall pass

Markets are adjusting to the new Fed regime.

Published June 17 2022

Off to Dallas, the “Big D,” one of the fastest growing metro areas for the last 20 years. They’re enduring 103 degrees and a rare “Saharan dust” this week—coping by teeing off before sunrise. Gas prices are biting hard here. Normally plentiful pickup trucks are scarce on the road, which is increasingly littered with cars on the shoulders that have run out of gas. Triple-A is very busy. First stop, South Lake, the wealthiest city per capita in North Texas, with average income of $240K and an average home price of $1 million. Our advisor client shared that the principal of his firm had plans to retire at 70, but with the last three years of WFH, called it quits at 67 in the Great Resignation. This phenomenon is also delaying mine and my colleague’s home repair projects, and my dentist who complains about a skeleton crew. Etc. “Where are all the workers?” A very warm welcome everywhere I went, as they deal with inflation and continued rocky markets. At our second visit in Dallas, a sanguine veteran believes that this too will pass (agreed), and perhaps quickly (he very well may be right). Except for the labor market, Powell’s description of the economy as “still strong” wasn’t well received. Retail sales, housing starts and permits, builder and CEO confidence, and Conference Board leading indicators all declined this week, and manufacturing slowed (more below). Yet May producer prices jumped at a near-record pace and BCA Research thinks oil will reach $140. This weaker growth/stronger inflation scenario caused the post-FOMC relief rally to fully reverse a day later, with prices back to Wednesday morning lows, U.S. yields nearly back to their highs and, as Strategas Research put it, Bitcoin “about to be a teenager again.”

July CPI may be the next big event for bears. Gavekal Research expects it will show headline inflation accelerating. That matters a lot more to consumers than the core rate on which markets and policymakers focus. Powell appeared to acknowledge as much, talking at length about gas and food prices, oil and inflation expectations (the key Fed worry). Gas and food represent a big chunk of the household budget, and both are soaring, along with housing costs. With no hope for fiscal or monetary relief, many Americans are having to draw down savings to make ends meet. The time when they, and investors, could count on a Fed “put” to save the day is gone. Since late February, the Investors Intelligence bull-bear ratio has bounced around 1, a level that sent very good short- and long-term buy signals from March 9, 2009, through Jan. 3, 2022, when the Fed continually stepped in with stimulus. Now, even though the ratio has been under 1 for seven straight weeks, up volume during rallies has been light. Only 2% of the S&P 500 flashed a 2-standard deviation advance in Wednesday’s fleeting run-up, far short of momentum surges typical of durable moves. Five of the last seven days saw 90% of S&P stocks fall, unheard of since 1928. Investor psychology in bear markets often slides down a “slope of hope,” Gavekal says. Thanks to the Fed’s regime change, hopes are getting quashed. 

With earnings season almost upon us, the market is expecting a wave of negative revisions—a repricing that’s largely been avoided so far. Forward earnings are still near a record, up 7.5% year-to-date, as multiple contraction has driven the sell-off. The forward P/E is now near 15x vs. 21 at its peak. Concerns that earnings may be the next shoe to drop has Fundstrat setting a downside target of 3,500 on the S&P (we agree), with the potential to go lower. If a recession is avoided (what are the odds?), the drawdown already has reached extremes compared to past non-recession post-war bears (the three worst were -26.6%, -28% and -33.5%, respectively, starting in May 1946, December 1961 and August 1987). TrendMacro thinks markets have gotten caught up in CPI headlines and have overlooked other signals of moderating price pressures that could keep the Fed from going full-on Volcker. It notes core prices decelerated a second straight month in May, and that M2 growth has slowed dramatically—from 40% year-over-year (y/y) over the past two years to 6% annualized now. This broad measure of money supply is highly correlated with inflation, with a 13-month lag. That’s exactly in line with when M2 growth started slowing in 2021. With quantitative tightening unfolding, M2 could even contract. TrendMacro sees core CPI falling to 2.49% y/y by next May. Although Bitcoin is off 70% from its November 2021 high (as of this writing anyway), I had the opportunity this week to present on the subject for a Rochester, N.Y., advisor’s YouTube channel. And in the Dallas suburb of Irving, I spoke at an evening event, “Wine, Women” and “Crypto Demystified.” So, animal spirts are still out there! The fun venue was double booked—the other event was noisy! Nonplussed, I turned up the volume on my microphone. Finished just in time, as karaoke and line dancing commenced across the room, no one paying attention to the incessant fire alarm. Good times and great spirit, reminding us that this too shall pass! Now, may I have a glass of the Cabernet, please?


  • On the one hand, housing … remains relatively healthy. Homebuilders are struggling to keep pace with demand, with authorized but un-started projects up 14% y/y and 815K units under construction, a number last seen during the 2006 boom. Despite May’s plunge (more below), starts are still running above long-term demographic demand and were revised sharply up in April to their best reading in 16 years. Weekly mortgage purchase applications also rose 8%, despite 30-year rates that were closing in on 6%.
  • Peak inflation? Both annualized headline and core producer prices came in below expectations and moderated for a second straight month in May. Philly Fed prices also declined sharply in June. In housing, rents in seven of nine major cities are declining or peaking, while real estate company Redfin reports a 6% jump in active listings with a price drop, a seasonal record.
  • Still some gas in the tank Upward earnings revisions for Energy are in the 10th decile, a level that historically has implied forward 12-month performance of almost +11%. With 14 days left in Q2, the daily average price of oil is 60% above year-ago levels and nearly triple the $40 required for companies to cover operating expenses. Oil at $70 allows for profitably when drilling new wells, Strategas says, and at $100, generates enough additional cash flow to support increased buybacks and dividends.


  • Consumers cool it Retail sales unexpectedly fell 0.3% in May, led by a big drop in auto sales. Ex-autos, sales rose 0.5%, with softness in electronics, furniture and non-store retailers. Restaurant spending also slowed, and sales ex-autos, gas and building materials were flat. The report—reflected in the NFIB’s survey, where respondents expressed concerns about declining future sales—dropped the Atlanta Fed’s tracking of Q2 real GDP growth to 0%.
  • Manufacturers cool it Activity declined slightly in May, the first drop in four months, on pullbacks in durable goods. Regional New York and Philly surveys showed activity in those regions contracting in June, though the underlying data was better than the headline, with rebounds in new orders and shipments in the Empire gauge and improvements in employment and capex in Philly.
  • On the other hand, housing … appears to be losing momentum fast. May starts plunged 14.4%, their biggest monthly drop in two years. Permits also fell a second straight month. While still positive, builder sentiment declined a sixth straight month to a 2-year low. Redfin and Compass announced layoffs this week, and Mortgage News Daily reports skyrocketing mortgages are discouraging home buyers, especially first-timers.

What else

What else can we talk about besides inflation? If everyone stood shoulder to shoulder, the world’s 8 billion people could all fit inside Los Angeles. And, Bank of America shares, if all the empty space in our atoms could be eliminated, humans could fit in the volume of a sugar cube.

We are a long way from a Volcker moment Deutsche Bank’s projected terminal fed funds rate of 4.1% in Q1 2023, higher than the Fed’s own forecast, would still represent a negative real rate based on CPI trends. It also would be some 17 percentage points below the Volcker-inspired early ’80s peak.

Red tsunami brewing? A raft of polls shows collapsing support for Democrats among Asian and Latino voters, a view reinforced by the ouster of progressive school board members and a district attorney in ultra-liberal San Francisco and a Dem loss in an 85% Hispanic district in Texas. So far, primary turnout is up a third for Republicans and down slightly for Dems. Biden’s approval rating is at new lows, with a huge majority of voters thinking the country is on the wrong track.

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Tags Equity . Inflation . Markets/Economy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

M2 is a broad measure of money supply that includes not only cash and checking deposits but also easily convertible "near money" such as savings deposits, certificates of deposit and money market securities.

Price-earnings multiples (P/E) reflect the ratio of stock prices to per-share common earnings. The lower the number, the lower the price of stocks relative to earnings.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Standard deviation is a historical measure of the variability of returns relative to the average annual return. A higher number indicates higher overall volatility.

The Conference Board's Composite Index of Leading Economic Indicators is published monthly and is used to predict the direction of the economy's movements in the months to come.

The Conference Board surveys CEOs at major companies quarterly to gauge their confidence about the economy.

The Empire State Manufacturing Index gauges the level of activity and expectations for the future among manufacturers in New York.

The Federal Reserve Bank of Philadelphia gauges the level of activity and expectations for the future among manufacturers in the Greater Philadelphia region every month.

The Investors Intelligence bull–bear ratio is a measure of market sentiment derived from a weekly survey of individual investors who are asked to rank themselves as bullish or bearish.

The National Association of Home Builders/Wells Fargo Housing Market Index is a gauge of how well or poorly builders believe their business will do in coming months.

The National Federation of Independent Business (NFIB) conducts surveys monthly to gauge how small businesses feel about the economy, their situation and their plans.

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