Never wise to fight ...
Russia-Ukraine conflict taking its toll.
… on stage. Audrey Hepburn and Grace Kelly would be rolling in their graves. Chris Rock, in his first public comments, said he’s “still processing” the infamous slap. Will Smith can’t sleep easily just yet. Investors can’t either. The rip off early March lows came on growing optimism for a relatively quick resolution to the Russia-Ukraine war. But the week’s news suggests that may be wishful thinking. Meanwhile, the conflict is taking its toll. Since Russia’s invasion, eurozone sentiment and German Ifo expectations have plunged to early pandemic lows. In the U.S., Michigan sentiment is at a decade-low and Conference Board inflation expectations are soaring. Eurozone inflation jumped a record 7.5% in March, while in the U.S., price indexes were at 40-year highs (more below) before the war’s surge in oil and commodities. Fed futures are pricing 200-225 basis points of additional hikes this year, and parts of the yield curve have inverted. Bonds’ broad sell-off saw the Bloomberg US Aggregate Bond Index yield soar 90 points in less than 90 days, its steepest rise since 1994, with Q1 the worst quarter for the 10-year Treasury in 40 years. Inversions tend to be good indicators of recession 18-24 months out. But it matters where along the yield curve they occur. The best signal comes when the 3-month Treasury tops the 10-year yield. There’s a +180-point gap between the two currently. A lot of room to flatten. S&P 500 returns typically are stronger when the curve is flattening versus steepening. Will this time be different?
… the “tape.” A 3-week rally tested resistance in the upper 4,500s on the S&P, with nearly 94% of issues above their 20-day highs. This strongest short-term momentum reading since the Covid low was driven by small investors. Retail equity purchases topped $5 billion this past week, 1.1 standard deviations above their 1-year average of $3.4 billion, with Big Tech the big winner. Nasdaq 100 inflows were 2.8 standard deviations above their 1-year average. The S&P and gold also saw above-average demand. Even so, the recent price action is consistent with 10-15% gains in past episodes after the Fed initiates tightening, JP Morgan says. So, with the S&P already up 9% from its early March low, there may be minimal near-term upside. At the least, with the broader market failing to follow the S&P and Nasdaq (up 13% from early March lows), expectations for a move to new highs seem premature. Wolfe Research shares that since 1977, less than a quarter of 122 Nasdaq rallies of at least 10% beneath a downward sloping 200-day moving average went on to recapture their 200-day average over the next month. Sentiment’s mixed, with institutional puts declining relative to calls and retail investor gauges less negative. Since 1950, April has been the best month for stocks. (Not an April Fool’s joke!) The coming earnings season could be a critical tell on whether companies are confronting more difficulties in passing along ever-higher costs. Negative preannouncements are running nearly 3-to-1 over positives, which historically has been bullish. It never has paid to fight the tape … unless and until we realize the Fed is not successfully bringing down inflation.
… the baby boomers. One of my favorite Wall Street sources, Empirical Research, shares that over these two pandemic years, members of my generation collectively said, “I’m done.” In droves. Baby boom retirements accounted for nearly 3 million voluntary resignations since 2019 and, along with immigration restrictions, two-thirds of the excess shortfall in potential workers. With the number of unemployed to job openings at a 70-year low and workers quitting at a record rate, there’s no slack in the labor market. (Can’t be overemphasized.) Median wage growth is three times what it was in 2011 and wage increases aren’t slowing down (more below). Companies are so desperate for help that even part-timers are getting the same higher wages as full-timers. Short of a steep, unexpected recession, there are no quick fixes to these cost-push pressures. They tend to fade slowly and, along with elevated and still rising rents and record high home prices, make for “sticky” inflation. Even before the invasion, the Fed was behind the curve. Its position has only worsened. Another 200-225 basis points of hikes may sound like a lot, but on a relative basis, that would still take the funds rate to levels historically considered loose. (Since 1990, the funds rate has averaged 2.7% and since 1960, 4.8%.) And real rates almost certainly will still be negative, which is bullish for stocks. But in these unusual times, it’s not clear how relevant past experiences may be. Strategas Research thinks returns for the rest of the year are a flip of the coin. Empirical says we are in a neutral regime … however, so many experiments running at the same time. All unprecedented! And the labor-market tightness has nothing to do with interest rates. It’s really not wise to fight on stage or in Ukraine. Nor the tape. And don’t ever fight the boomers. Hit Chris Rock? Why that’s just uncivilized.
- Labor market tighter than a drum March nonfarm jobs were a slight miss but still solid 431K gain, with big increases the prior two months revised up further. The jobless rate fell to 3.6%, a tick below its pre-pandemic 50-year low of 3.5%, and continuing claims dropped to 1969 lows. In February’s JOLTS report, the jobs-to-available workers gap was just off a post-World War II high while the Conference Board’s confidence survey (more below) said the spread between consumers saying jobs were “plentiful” versus “hard to get” set a record high.
- Manufacturers carry on Markit’s U.S. manufacturing PMI for March was revised slightly higher on the strongest growth in factory activity in six months, faster increases in output and new orders and higher domestic and foreign demand. The ISM gauge was less bullish—it unexpectedly slipped (but remained elevated) on slowing factory activity amid soaring prices and in some cases worsening supply challenges. Respondents reported they remain “strongly optimistic” regarding demand. The closely watched Chicago PMI unexpectedly soared in March on rising inventories and new orders.
- Consumers carry on Nominal consumer spending accelerated to nearly 14% year-over-year (y/y) in February, though rapid inflation halved the real increase. There was weakness in goods spending, which was expected and was mainly in durables, as consumers shifted toward services as Covid cases plunged and the economy further reopened. Conference Board confidence mildly surprised to the upside on a jump in its present situation component. Expectations slipped on inflation worries.
- Inflation is episodic Nominal wages and salaries surged a strong 11.5% y/y in February, and this morning’s jobs report showed hourly earnings rising at their fastest pace since 2007. Elsewhere, February’s core PCE prices moderated slightly but were still up the most since 1983, while a spike in energy and food costs drove the annualized headline rate to a 40-year high.
- Inflation is everywhere Austin’s airport is warning of jet-fuel shortages amid a rush of travelers. Farmers have seen fertilizer prices surge to new highs as supplies tighten and input costs soar. And while consumers are struggling with the highest nominal gas prices in history, food costs also are skyrocketing—an even bigger problem for lower-income Americans. Food at home for households in the lowest income quintile accounts for about 11% of overall spending (versus about 7% for the highest quintile). By contrast, expenditures on gasoline represent 2%-3% of spending across the board.
- Housing headwinds The rapid run-up in the 30-year mortgage rate this year—up 180 basis points in just three months—is making an already significant affordability shock even worse. Combined with record-high home prices, the National Association of Realtors says affordability has plunged a record 30% y/y to the lowest since 2007, when the housing bubble was bursting. Every 100 basis-point move in mortgage rates requires a 10% downward adjustment in home prices to keep payments unchanged.
Way too early to fret about recession The yield curve works as a recession indicator because it tells us when policy is too tight. If anything, Jefferies says today’s Fed remains way behind the curve. The money supply is growing at an 11% annualized rate, and the spread between 10-year Treasury/fed funds yields is wide. Even with aggressive tightening, it’s hard to see the 10-year/funds curve reach neutral until Q2 2023. Add the typical 10- to 12-month lead time before growth tends to turn negative, and that puts the next recession in 2024/25.
Bond sell-offs don’t last As bad as the first quarter was for bonds—investors’ positioning transitioned to pre-Lehman crisis norms after 14 years of bond overweights—JP Morgan notes that historical experience suggests severe bond fund outflows rarely last more than a quarter outside crisis periods.
Thanks Uncle Sam! State and local governments posted a budget surplus of 1.2 percent of GDP, an 80-year high. Federal aid, largely from Covid relief, represented 34% of all their spending, a new record.