'Now I understand why Dad was always in a bad mood'
'70s stagflation made many people grumpy, which is why no one wants a repeat.
This quote was from an advisor in Charlotte who grew up in the stagflationary ’70s. We agreed it was a “modest and humble decade.” My travels this week covered the Carolinas—Raleigh, Charlotte, Columbia and Charleston. Lots of road time with my colleague—we discussed company benefits if we were in an accident while working, or to our spouses in the event of a fatal crash. Also, a clever way to “buy, borrow and die” to reduce taxes. He’s actually got a great sense of humor! As did many of the advisors we met, who generally agreed that we are in a “holding pattern” and that this is the “most challenging environment to navigate” in our careers. But there’s good news! “The Fed doesn’t have to worry about inflation; Congress passed the Inflation Reduction Act.” And, “I’m a glass half full kind of guy.” Of course, there was some salty talk, “we can’t be that stupid,” “most of them are numbnuts,” “Gen Zs will have more money than millennials because boomers will die” and “people are not dying off as fast as others need homes.” Talking about death again?! Hard to escape apocalyptic imagery this week, with extreme temperatures evaporating rivers in Europe, the U.S. and China (where they had to shutter industrial plants to save AC capacity for cities), droughts undermining hydroelectric production and river shipping, and war raising the potential of a nuclear disaster (more below).
The heat and drought have pushed European Union yield forecasts for grain maize, soybeans and sunflowers 16%, 15% and 12% below their 5-year averages, and the ongoing Russia-Ukraine war is only making the situation worse. Meanwhile in the U.S., initial jobless claims declined again, continuing claims fell to a 4-week low and the median national rent rose a 17th straight month to a new high. As a result, “sticky’’ wages and rents are remaining elevated, a dilemma for a Fed that, as suggested by Chair Powell at Jackson Hole this morning, seems loath to repeat the stop-and-go policy error that led to decade-long ’70s inflation. The market is set to enter September—historically the worst month for S&P 500 performance—with no clear direction. Summer’s rally failed to break through resistance, its 17.4% advance from mid-June to mid-August falling just shy of its 200-day moving average. Such swift, interim rallies in bear markets are relatively common but rarely last more than 2-3 months, and once they reverse, tend to fall to a new low as quickly as they rose off the old low. That would suggest a new market bottom could come before year-end, though this would run counter to another long-held market axiom—the midterm election rally. The S&P historically has outperformed the market in the 12-month period after a midterm election, with an average return of 16.3%, US Bancorp says. This is especially true for the one- and three-month periods following midterms.
A British born advisor is troubled by the gravity of Europe’s energy crisis, a view Evercore ISI shares. Russia has slashed natural gas supplies there by 80%, and an outright cutoff is possible this winter, creating the potential for a financial shock/crisis as electricity prices skyrocket. Fighting in and around Europe’s largest nuclear plant in Ukraine, which is occupied by Russian forces but operated by Ukrainians, threatens to make a dark situation even worse. Guns going off near a nuclear plant are never a good thing, TIS Group notes. One of the main casualties of reduced nuclear capacity in Europe would be its economy and for that matter, global inflation. The country most at risk is Germany, which is searching high and low for new gas supplies but faces a nearly impossible task of making up for real and potential shortfalls in the coming months. It will require years and hundreds of billions of euros to create a more durable and secure energy infrastructure. Berlin is attempting to curb demand, including giving states the power to reinstate mask mandates so that people can crowd together in public spaces to stay warm this winter. It’s also possible requirements that landlords maintain minimum temperatures in their buildings will be lifted. “It is going to be a long, cold, expensive winter in Europe,” TIS says, with governments squeezed by demands for “inflation relief” from the energy bills. Wars are inflationary—and this European war is entering a new phase in which economics become a front and center issue. Energy and commodity prices are well off their highs, but for how long? Bulls still hoping for a pivot may not like the answer. Come to think of it, my dad also was pretty moody back in the day.
- Shopping always improves my mood Q2’s initial 0.9% decline in real GDP was revised up three-tenths of a point as fresher data showed Americans enjoying full-fledged summer vacations again after two years of being holed up. June-July retail sales strength suggests the reacceleration carried over into the start of Q3, with real spending on track to advance 1.6% for the quarter. Meanwhile, final Michigan sentiment for August surprised, rising to a 3-month high as falling gasoline prices boosted consumers’ moods.
- Peak inflation is relative July core PCE prices rose less than expected in July, lowering the year-over-year (y/y) rate to 4.6%—still double the Fed’s target.
- Not all the manufacturing news was bad July durable goods orders ex-defense surprised, rising 1.2% y/y. Core capital goods orders and core capital goods shipments also increased more than expected, and the initial August S&P Global PMI for U.S. manufacturing remained expansionary, unlike regional Kansas City and Richmond Fed readings.
- Global recession signs are everywhere Flash manufacturing, services and composite PMIs across the U.S., eurozone, Japan, U.K. and Australia all decreased from July levels, with U.S. services and eurozone manufacturing notably falling deeper into contraction territory and the S&P Global composite hitting 45. All the prints were their lowest since early Covid lockdowns.
- Housing struggles to find a balance With mortgage rates roughly doubling and home prices at new highs, sales have plunged and so have starts—real residential investment fell 14% annualized in Q2, July starts were down nearly 10%, existing home sales hit 26-month lows, July pending sales fell 22.5% y/y and new home sales hit a cycle low. That said, less than 10% of listed inventory has been completed; once done, these homes tend to sell in two months—a sign supply issues (shortages of labor, materials and homes) are as much at fault as demand. Indeed, homeowners with 3.5% mortgages have little incentive to sell into this market. Redfin says new listings across all metros declined 22% in the latest week.
- Rents squeezing incomes Thirty of 37 top markets experienced an increase in rent-to-income ratios in July, with Tampa, Charlotte, New York City and Phoenix tenants the most stretched relative to their pre-pandemic situations. Homeowners fared even worse, as rising mortgage costs outpaced rent payments in three quarters of the nation’s largest markets last month.
What’s in a name? A Penn Wharton Budget Model sees the Inflation Reduction Act as likely inflationary through its first five years, when it will add to the deficit. Not until 2027 does the Act result in net reductions to the deficit, it concludes. Even after the full effects a decade from now, the study suggests any impact on inflation is unlikely to be “statistically different from zero.”
So what? With midterms two months away, Investor’s Business Daily says a study of data back to 1958 finds a divided Congress has the best track record for S&P 500 performance (an average 18.7% 2-year return), followed by a rubber-stamp Congress run by the president’s party (17.3%). The worst? A combination of a unified Congress controlled by the party in opposition to the president (15.7%).
War is going to the dogs Newsweek reports Russian engineers have created a robotic dog that can carry and fire weapons, deliver medications and survey war-torn areas. The U.S. military also has a robotic dog used for security and surveillance and, at a Florida police department, in situations that involve threat to human life. Hong Kong University and Lawrence Berkeley National Laboratory scientists have created Aquabots, soft robots made primarily of liquids that can change shape and enter narrow spaces, including inside bodies to deliver drugs to specific locations.