70 is the new 50
Amid this week's chaos, good vibes in visits to Atlanta and Nashville.
Headed south this week for five days in Atlanta and Nashville—and music. This week the market had its worst day since June 2020, and in numerous meetings with advisors and individual investors I was peppered with questions. But the positivity was infectious. At a happy hour with advisors, I presented behind heavy drapes, which did not block the loud Latin Rap music—nice touch. In Nashville, aka Music City, I spoke to advisors at a fine restaurant on Broadway Street. As I was being introduced, I leaned over to my colleague to request that the music be turned down. “That’s coming from outside.” Ha-ha, nicer touch! It's hard to remember a multi-day rally getting taken out at its knees as violently as Tuesday (25 down stocks for each one up). The Dow wiped out four days of back-to-back gains of 0.5% or more—a first, going back to inception in 1896. Any lingering hopes for a Fed pivot went pfft with that morning’s CPI report (more below). The Cleveland Fed has measures that the parent Fed thinks are better at forecasting underlying inflation than either core CPI or PCE and they reveal no evidence of “peaking” or even decelerating inflation. In fact, the regional Fed’s median CPI gauge surged the most ever in its 40 years. August saw the largest monthly increase in owners’ equivalent rent in 32 years, and food inflation posted its biggest year-over-year (y/y) increase in 43 years. Prior highs for both, in 1990 and 1979, were years of inflationary and economic stress, followed by a run-up in energy prices. Could happen again, with Russia cutting natural gas flows to Europe and OPEC+ trimming (instead of raising as the White House asked) production. So, maybe CPI rises instead of falls this fall. Risk assets are not priced for that.
Stubborn inflation is forcing the Fed to keep raising its terminal rate. A hawkish Powell at Jackson Hole pushed the consensus to nearly 4.5%. This morning’s fed futures were favoring almost 4.75%. The rate always has exceeded inflation by late cycle. Deutsche Bank thinks a 5-6% range is possible. On top of this is this month’s doubling in the pace of quantitative tightening. Markets may be about to realize what “peak hawkishness” means, Citigroup says. The situation is the inverse of Goldilocks, with recession risks rising every time the Fed tightens. With the S&P 500 still 8% above June’s low at this writing, a retest of that low is likely. Fair value puts the index at 3,791 but the lower bound is at 3,500. The new Blue Chip Indicators put core PCE inflation at 2.5% by next year’s fourth quarter, and 1-year and 10-year forward breakeven inflation rates are near the same level. But what’s the market’s record on forecasts? Over the last 18 months, headline inflation has surprised to the upside 11 times and to the downside only twice. The cumulative net surprise over the past year and half is 2.6 percentage points, more than double the biggest run of surprises (in either direction) going back to 2006. Suggests consensus is underappreciating inflation’s persistence. On the other hand, core CPI has historically lagged money growth by 13 months, and M2 growth has plunged from nearly 30% annualized in 2021 to near zero now. It is on track to soon turn negative for the first time since the 1930s. Maybe consensus, and market expectations of palatable inflation by next year’s end have it right? Applied Global Research thinks that’s possible, but it will take a recession—and a 2.5-3 percentage-point decline in wage growth—to get there.
Perhaps not peak inflation yet, but dollar strength is a concern too (more below). A hawkish Fed is part of the reason. With more Fed rate hikes ahead, might other central banks hike rates to protect their currencies, creating a negative feedback loop that ends in a deep global recession? Or might the consumer come to the rescue? The ongoing reopening from the pandemic keeps feeding pent-up demand for services, cars, travel and fun. An advisor at lunch in Atlanta has a client in the high-end travel business who reports around-the-world 6-month luxury cruises are completely booked through 2025. Talk about a confident consumer! There remains massive excess savings from the crisis (currently estimated at $1.9 trillion) and the red-hot jobs market, with slowing job growth still running at an historically torrid 378K monthly pace the last three months. The latest initial claims slipped to their lowest level since May and continuing claims fell sharply. Room for consumers to take on more credit and draw down savings. Surging wages help (even as they hurt inflation)—up 6.7% y/y, the Atlanta Fed says. Sounds like the ’70s! August retail sales were tepid (more below) but consumption is still running above its pre-pandemic trend, and September’s preliminary Michigan sentiment (which is highly correlated with gas prices) hit a 5-month high. After a call with my favorite Wall Street Research source who views the current investment environment as “daunting,” I left for a client event in an Atlanta suburb which I themed ’70s Redux. My host played the Bee Gees during cocktail hour, appreciated by many of the baby boomers there. A couple is visiting town for the wife’s 50th high school reunion. “It was a great time, but the Mean Girls from the ’70s are still mean!” Another gentleman retired during Covid, having had no intention to do so prior. (Indeed, my Revenge of the Boomers/’70s theme notes that 3 million boomers retired early in the last two years, the major cause of our current labor supply shortage.) I started my presentation. “There’s trouble.” And the group laughed! I may have mentioned that I was a disco queen at Penn, and that was before I could afford a decent pair of shoes. The advisor across the table at lunch in Atlanta is 70 … and looks to be 50! “70 is the new 50, you know.” So, that makes me a youthful ___! Stayin’ Alive!!
- Industrial production stronger than the headline August’s unexpected drop came on a weather-related slump in electricity usage. Ex-utilities, manufacturing rose a second straight month despite a decline in motor vehicle and parts output, which is expected to improve in the months ahead. With aerospace equipment up a third straight month, aircraft output could be a tailwind, too. Autos and aircraft account for 10% of industrial production.
- Retail sales not as weak as reported August’s 0.3% monthly increase beat consensus but sales ex-autos fell and core sales that feed into GDP were flat. Bank of America says underlying sales remain strong and sees three factors behind the core weakness: a rotation from goods to services spending, of which only restaurants are measured (up strongly for the month); payback from non-store Prime Day spending; and a housing slowdown that’s cutting into furniture and related goods.
- PPI wasn’t so bad … The August headline rate declined slightly more than forecast and the core rate rose only modestly, continuing soft momentum that bodes well for retail goods prices in coming months as pipeline price pressures ease.
- … CPI sure was August’s unanticipated acceleration came despite a big drop in gas prices. Fine, but electricity prices soared! Indeed, price pressures were broad-based, led by shelter and medical care, and new car prices reaccelerated, reversing the past several months’ trend. Despite two months of close to 0.0% change in the monthly headline rate, the Cleveland Fed estimates this month's will be 0.3%, making likely another y/y print above 8%.
- Setting up for an expensive winter U.S. natural gas production is at an all-time high on robust demand from Europe and Asia, and acute pressure on global prices continues to mount due to Russia’s Ukraine invasion. Natural gas accounts for the greatest portion of U.S. electricity generation and is trading just off its highs for the year, unlike oil, which is down roughly a third from its March peak.
- Small business optimism worse than the headline The NFIB gauge rose a second straight month in August but has reversed very little of the past year’s decline, with the business outlook plunging to near-decade lows and expectations below all prior recession lows (back to 1986). Plans to hire rose again but the problem is finding, and paying for, workers. Credit conditions have tightened.
China is the second-largest economy in the world and there’s trouble A property sector in its worst slump in years, sporadic outbreaks and lockdowns due to more transmissible Covid subvariants, the worst drought ever and weak demand at home and overseas has the Bloomberg consensus at 3.5% GDP growth this year. That would be the second-weakest reading in four decades. Several Wall Street firms predict even slower growth.
The dollar really is too strong Its melt-up is so big that it’s getting hard to justify by conventional explanations, Gavekal Research says. It thinks the dollar may be in a momentum-driven overshooting phase, making it vulnerable to a sudden reversal. Potential catalysts: unexpected improvement in European or Chinese growth, or policymakers signaling concern about currency volatility.
Will WFH for less Post-pandemic, 1 in 10 companies in the U.K. are seeking to reduce compensation for remote workers. Google, Amazon and Microsoft have similar plans in place here. Not clear yet what employees who may be impacted think about this.