I'm a glass half-full kind of girl
Contradictory data offers something for optimists and pessimists.
Are you an optimist or a pessimist? Lots of data for either side this week. In the labor market, JOLTS saw declines in job openings, voluntary quits and hiring. ADP payrolls grew the least since 2020’s job losses. Small businesses and retailers shed jobs. In manufacturing, a disappointing Dallas miss confirmed weak May readings of four other regional Fed business surveys. May vehicle sales also set a low for the year. In housing, mortgage purchase applications fell to December 2018 lows and Case-Shiller prices jumped to another record high. More homes out of reach for more households. This came as oil prices spiked to 2-month highs (an OPEC pledge to produce more notwithstanding, more below), and gasoline set all-time nominal highs. Not good for a consumer pocketbook where a savings rate that two years ago was at a record high has collapsed to a 14-year low. On the other hand, May’s jobs report surprised (more below), May Challenger job cuts fell to a 3-month low, weekly jobless claims declined to 1969 lows and job openings to unemployed remained near historic highs. May’s manufacturing ISM unexpectedly rose (more below), and Chicago’s PMI surprised to the upside, casting a shadow over the weaker regional Fed readings. Daily vehicle sales actually hung near prior months’ levels, with the monthly tally hit by a late Memorial Day and supply-challenged inventories. And prices for wheat, gold and other commodities beyond energy are well off their highs, with copper, platinum and lumber down year-over-year (y/y).
The question is, what have the markets priced in? Hard to say. Until the data provide a clearer answer on whether the Fed can rein in inflation without a recession (history would suggest not), it’s going to be volatile. The past few weeks have seen some signs of an end point to Fed tightening and 40-year high inflation, as fed futures and TIPS breakeven inflation rates pulled back from late March-early April highs. The 10-year Treasury yield also is off its recent peak, hovering around 3% at this writing. For now, U.S. stocks (down 19% from their January peak to the May low) appear to be pricing in a “softish” landing. It is almost unheard of to have a bear market (a 20%+ decline) without a recession—the last time that happened was in 1987 (and all on one day, Black Monday). Most of today’s traders are too young to remember that. Bank of America says the average money manager is 45 and has seen Growth outperforming Value the majority of the time. She/he doesn't remember the Cold War, gas rationing in the ’70s or 13% mortgage rates. (Or disco music—my dance partner and I commanded the floor. Sigh.) JP Morgan says technicals favor potential near-term upside into resistance at 4,300 on the S&P 500. From there, who knows? Renaissance Macro views recent breadth and up-volume flows as a reaction to oversold extremes and concludes, “This still looks and smells like a bear market rally.” A half-emptier.
It comes down to inflation. How much can it moderate without a hard landing? And how much can the economy slow when the job market is still historically very strong. With oil prices on the rise again and gas prices on track to top $5 a gallon, energy is nearing the same stress levels for the U.S. economy as in 2008 during the Great Recession. Hard to see global producers allowing prices to go much beyond that for fear of feeding another global crisis. Strategas Research thinks continued strength in the Energy sector suggests consensus may be offside in declaring the inflation spike over, and is closely watching its favorite economic barometer, the equal-weight Consumer Discretionary relative to Consumer Staples ratio, for signs of stabilization. It currently is in a firm downtrend. After a 2-year spurt that saw M2, the broad gauge of money supply, surge 40%, the Fed this week initiated quantitative tightening, which is expected to shrink its balance sheet by 10% over the next 12 months. This opens the possibility that the money supply will contract y/y, which has never happened, and at minimum, argues for slower inflation. I am an optimist. Why not? Life is short. After a massive V-shaped recovery fueled by money and vaccines, growth is falling but still elevated. Like a roller coaster! Do you raise your arms with confidence? Then you are an optimist!
- Half full May’s manufacturing ISM surprised, topping a solid 56. New orders were the highest in three months, and the percentage of respondents saying their inventory levels are too low rose to a 5-month high, both signs of underlying forward strength. Employment slipped to its lowest level since November 2020 but production rose, a sign productivity growth is picking up (good for inflation).
- Half full May nonfarm payrolls rose a more-than-expected 390K but were still the smallest gain in 13 months as 2022’s job gains continued to moderate. Leading components were solid—temporary employment, workweek and household employment all rose. The y/y gain in average hourly earnings moderated to a still historically elevated 5.2%, and labor force participation eked higher. All told, a solid report that signaled some moderation in inflation pressures but underlying strong economic growth.
- Half full Evercore ISI’s proprietary trucking and homebuilders surveys cooled but remained at elevated levels, as did the Conference Board’s Consumer Confidence Index, which slipped in May after rising in April. Consumers’ views of business conditions improved, but purchasing intentions for cars, homes, major appliances cooled, reflecting higher costs and a pivot from big-ticket items to services.
- Half empty May’s ISM services reading disappointed, posting the slowest increase in the services sector since February 2021. Growth in production, inventories and backlogs slowed relative to April, though new orders and employment both rebounded. Prices eased but remained elevated.
- Half empty The U.S. Energy Information Administration estimates refinery utilization is about 90%, signaling there’s not much that can be done to boost capacity. Ordinarily, higher prices would fuel more investments, but the anticipation of a transition to cleaner sources of energy has caused some firms to pause given it can take up to 20 years to recoup the initial investment. If the Ukraine conflict goes on, more Russian refineries could close, adding to supply problems.
- Half empty The Fed’s Beige Book contained further evidence of a decelerating economy, with labor market difficulties and supply chain disruptions the biggest problems cited by survey respondents. Eight of the dozen regional Fed districts reported diminished expectations for future growth, with contacts in three raising recession concerns.
Much ado about nothing That’s how Piper Sandler characterized this week’s hullabaloo over OPEC’s pledge to accelerate by two months the return of the remaining 1.3 million barrels of daily production from previous cuts. The additional volumes failed to move the price needle as they are unlikely to fully compensate for Russian export losses or fix problems caused by crippling refinery shortages. Indeed, at this writing, both West Texas Intermediate and Brent crude were higher for the week.
A lot of yellow flags BCA Research expects record-high home prices will soon give way to declines as this most interest-rate sensitive part of the economy confronts a 200 basis-point rise in 30-year mortgage rates. Negative real wage growth is further discouraging buyers and causing retail sales to fall y/y in real terms. It also notes some companies are starting to slow hiring and initiate layoffs, a shift illustrated by the employment component falling below 50 in May’s ISM.
Markets love gridlock With Biden’s approval rating stuck in the mud and inflation impacting households across the income spectrum, the base case puts 70% odds of Republicans taking both the House and Senate in November. Add in the filibuster that remains in effect and midterm electioneering that leaves little room for the people’s business, not much is likely to get done until after 2024.