'I mean, it's one banana. What could it cost? Ten dollars?'
Inflation and recession face off as the market weighs which is worse.
My daughters used to tease me that I reminded them of Jessica Walters (so funny as the mother!) in this scene (and now popular meme) from “Arrested Development.” Hilarious early 2000s sitcom, IMHO. Not much attention paid to inflation back then. Now, it’s all everyone talks about. Record high gasoline prices. Record high prices for homes, rents, new cars, meat, eggs. Even bananas (flat for a dozen years, they’re now up 12% year-to-date to 64 cents/pound). Respondents told the NFIB in June (more below) that small business wage inflation was at a record high by a wide margin—a net 60% could find few or no qualified job applicants. Wednesday morning’s 9.1% CPI shocked (more below), a 41-year high on surging gas and grocery prices, and today’s PPI rose even faster. Notwithstanding this news, the weight of recent evidence suggests the market may be moving on from this “inflation problem.” Core inflation is moderating, albeit slightly, while yields have softened considerably off mid-June highs, copper has topped, crude and gas prices have weakened, used car prices too (more below), with inflation expectations gravitating toward Fed targets (more below). Google searches for “inflation,” “gas prices” and “rents” are down sharply. Still, any deceleration is likely to be a grinding given global disruptions (Covid outbreaks in China, the war in Ukraine) and “sticky” components such as rents (which affect about a third of CPI with a lag) and wages. There’s little to suggest the Fed is going to have (another) change of heart, and that’s worrying markets.
Indeed, recession fears keep climbing. Back in the ’70s, economist Alfred Kahn, who headed the Carter administration’s task force to fight inflation, said, “Between 1973 and 1975, we had the deepest banana that we had in 35 years, and yet inflation dipped only very briefly.” He substituted “banana” for “recession” on concerns the latter makes people nervous and irritable. Yardeni Research is certain it irritated his boss. Consider: over the past 15 months, broad money supply growth has collapsed from 27% annualized to essentially 0% and looks to shrink going forward—extremely rare, even in recessions. In addition, fiscal policy has contracted to 15% of GDP (much due to Q2 tax revenues hitting 20% of GDP, a new record). No other post-war period has come close to these levels. Surely, a recession is on the horizon, possibly severe. Sen. Manchin, who just a year ago put up the stop sign on spending for fear of feeding inflation, is now invoking concerns about the “R” word (recession). Looks like he’s had a change of heart and is ready to spend. Whether anything gets done on Build Back Smaller is debatable. The clock’s ticking, with just a few weeks before August recess and then, midterm elections. As reporting season gets underway, no recession is evident in either S&P 500 forward revenues or earnings. Both are at record highs, and consensus Q2 earnings are up 5.8% year-over-year. How fast earnings growth rates move toward zero, or negative as is typical with recessions, is weighing on investors. The market P/E already has derated 30% off its cycle high, the fifth-biggest downshift since 1965.
Evercore ISI doesn’t think the bear market is done. Not when markets are having to cope with a surging dollar (more below), along with an inverted 2-year/10-year Treasury curve, oil prices around $100, a 10-year Treasury yield hanging around 3%, $5 gas, 6% mortgages, 9%+ y/y CPI, a VIX above 25, both high-yield and investment-grade spreads at wides and a Fed determined to destroy demand enough to rein in inflation and keep it down. PSC Financial’s work puts a tradeable bottom near 3,500, followed by a solid second-half rally to 4,775, underpinned by historically washed-out market breadth readings. Jefferies notes after horrible first halves—this was the worst in half a century—small caps tend to bounce in the double digits. From a technical basis, growth stocks look as oversold relative to value than they have since the dot.com crash. They’re now on par with the 1970-80 inflationary era. A lot of growth stocks have been hit harder than indices suggest—more than half of Nasdaq listings are trading 50%+ below their 12-month rolling averages. Still, while growth may offer some tactical opportunities, Gavekal Research thinks value plays still have the valuation edge. With macro risks becoming more two-sided, it comes down to the interplay between inflation and recession. At the moment, the jury’s out on which side wins. 9.1%! My millennial daughter says Trader Joe’s has bananas for 19 cents each. Unless I want organic, at 25 cents. Not bad. No organic for me, gotta tighten the belt.
- Peak inflation expectations? While a New York Fed June survey put consumer expectations of 1-year-ahead inflation at 6.8%, median 3- and 5-year-ahead forecasts declined to 3.6% and 2.8%, respectively. Further, the 5-year TIPS breakeven rate has fallen below 2.6%, where it stood before Fed hawks unveiled their talons. Despite June’s hot CPI, year-ahead inflation expectations among businesses surveyed by the Atlanta Fed held at 3.7% this month.
- Don’t count out the consumer Wage growth remains strong and consumer balance sheets are in great shape, with total assets of U.S. households near historic highs relative to disposable income, and median savings and checking account balances still well above 2019 levels. As they return from summer vacation, consumers are positioned to respond to any slowdown much better than in previous business cycles, Bank of America says, making the “soft landing” case.
- Used car prices downshift The latest Manheim Used Vehicle Index suggests January was the high-water mark for prices as the 6-month change has contracted 7%. Since 1995, whenever the 6-month gauge turned negative, auto y/y CPI followed, creating a multiyear drag on broader inflation.
- June CPI sizzles The y/y rate accelerated to a more-than-expected 9.1%, its highest since November 1981. Increases were broad-based and led by energy, which rose the most since April 1980 as gasoline spiked 60%. Food costs surged 10.4%, the most since February 1981, with food at home jumping 12.2%, the most since April 1979. Y/y PPI also came in hot, up 11.3%, just off March's record 11.6% spike. On a positive note, energy prices have pulled off their June peaks—gas prices are down 50 cents—and June’s core 5.9% CPI increase slipped below 6% for the first time this year. Core PPI also moderated.
- Down on Main Street The NFIB’s monthly optimism gauge crumbled in June to a 9-year low, plans for capital outlays fell a fourth time in five months, the percentage expecting the economy to improve was the lowest level on record and the percentage reporting now is a good time to expand slipped to the lowest since the onset of the pandemic in 2020. So, what is the Senate considering? A new 3.8% tax on small businesses to raise $350 billion. And Dems wonder why they get little love from the NFIB.
- Dollar strength becoming a problem It’s now at parity with the euro, with the broad dollar exchange rate up 10% so far this year as higher rates in the U.S. relative to other countries, a hawkish Fed that doesn’t look to let up and a crushing war in Europe continue to attract buyers. A rule of thumb is that every 10% appreciation in the greenback shaves three-quarters of a point off GDP growth, with dollar strength creating destabilizing implications across asset classes.
We’re going to hearing a lot about this If the Atlanta Fed’s GDPNow model holds, Q2 real GDP could contract, making for a technical recession (two consecutive quarters of negative prints, given Q1 real GDP contracted 1.6%). But the National Bureau of Economic Research is the official arbiter of recessions, and it considers a range of measures when defining the business cycle, including employment, income, consumption and industrial production, none of which are signaling weakness. In fact, Q1 real gross domestic income, roughly equal to GDP but measured differently, rose 1.8%.
Peak bond yields? That seems to be the consensus view of late. But Strategas Research shares that in the pre-Volcker years, bond yields tended to peak after CPI data did. Notably, 2-year Treasury yields jumped nearly 30 basis points last week, the fourth-largest week-over-week change of the year, and shot up further on the CPI print.
92% of Dems would vote for Biden in 2024 … if he’s running against Trump, that is (and if they were the only two candidates, the New York Times-Siena College poll said). A Renaissance Macro survey said 80% of Dems prefer “Other’’ as their 2024 presidential candidate, above Vice President Harris’ 10% and President Biden’s 7.5%. On the Republican side, 61% preferred Florida Gov. Ron DeSantis to 32% for “Other” and 7% (!) for Trump (national polls still show Trump as the favorite among GOP voters).