Prices are rising everywhere ...
Consumers and businesses don't seem to mind too much ... yet.
… so, let’s go shopping! Masks are off. Restaurant, lodging and airline bookings are up. Domestic flight searches are positive versus 2019 for the first time. Hotels, beauty salons, travel and nightlife establishment openings are surging, with the number of new restaurants and food businesses 5% above pre-Covid levels, according to Yelp. Retail sales and bank lending remain strong, continuing jobless claims are at a 50-year lows and homebuilding is accelerating (more below) despite decade-high mortgage rates and record-high home prices. With homes in short supply and household formation rates on the rise, builders say the 6-month outlook is strong. The New York Fed sees consumers responding to higher prices by raising budgets, not by cutting spending. In its March survey, year-ahead household spending expectations jumped to a record high, consistent with growth inflation rather than stagflation. After two years of Covid restrictions, people want to get out and have the means to do it. Household cash has exceeded debt for the first time in three decades. Corporate America is in great shape, too. Profits and cash flow are at record highs. Profit margins are at or near record highs. S&P 500 earnings estimates keep rising. And corporate balance sheets are flush with cash. Businesses’ main concern: a chronic shortage of labor. A supply, not demand, issue.
So, what’s with all the recession talk? Bloomberg’s “recession” story count has surged above 2013-19 baseline levels. According to Google Trends, “how to prepare for a recession” searches nearly tripled in the past week. This is occurring even as the macro data keeps beating consensus. Nonfarm payrolls, for example, rose an average 552K per month in Q1, versus 627K in Q4 and 515K in Q3 of last year. That’s consistent with real GDP growth of 4-5%, a figure in line with Atlanta Fed tracking estimates for domestic demand. All the weakness is in net exports and inventory investment, GDP’s two most volatile components. Moreover, credit spreads are holding at levels that put recession odds 18 months out at just 10%. Inflation is driving the narrative. A Ukraine war that TIS Group thinks could drag out 10 years is becoming increasingly inflationary as it expands into economic warfare (sanctions, supply disruptions and the like). Resultant shortages of food, commodities and rare metals, along with rising outlays for defense and alternative supply chains, indicate new inflation highs lie ahead. This is where recession fears are born—a Fed so far behind the curve that a demand-crushing recession is the only way it catches up. Presidents Carter and Reagan gave Volcker cover to do so. Will Biden do the same for Powell? The Fed chair this week all but said 50 basis-point hikes will start in May, and the market is buzzing today with talk of a potential 75 basis-point hike.
This Wall of Worry is driving multiple compression. The expected next 12-month operating margin has turned noticeably lower, even though Q1 earnings generally are surprising to the upside. Information Technology and Communication Services sectors are dramatically underperforming the broader index, mostly because rising rates have depressed their valuation multiples. The average S&P stock is down about 14%, roughly double the index’s year-to-date decline, in large part due to Big Tech. Seventy-three S&P stocks made new 52-week highs Thursday, and only one was a tech stock. Meanwhile, 16 made new lows, and all were tech stocks. Retail investors who have been chasing momentum, particularly tech and meme names, are bumming. Indeed, only 15.8% of individual investors are bullish, an extreme historically followed by stock price gains more than 90% of the time. Strategas Research also shares that in years following strong equity market gains (the S&P returned 28.7% in 2021), returns after Tax Day have tended to be positive the following three months, as tax selling prior to April 15 (April 18 this year) turns to reinvestment afterward. The final two weeks of April tend to be the second-strongest two weeks of the year. But this week has been ugly and “Sell in May’’ is just around the corner! “Peak margin” arguably has been hit. “Peak inflation?” Sure, so what. For we’ve got a wage-price spiral on our hands! Best of luck to the Fed while we buckle up and invest for inflation, not recession.
- Housing faces a supply, not a demand problem Starts rose again in March to their highest level since June 2006. Permits climbed, too. Even with starts running well ahead of completions, they remain below the level of household formation. Combined with extremely low inventories of new and existing homes, this suggests residential investment is likely to hold up despite a slowdown in sales attributed to record-high prices, decade-high mortgage rates and a shortage of starter homes (more below).
- Still a lot of new money coming in Tax refunds are up 10% over last year, with lower-end consumers benefitting the most. While excess household savings from the $5.3 trillion in Covid stimulus has dwindled among these lower-income cohorts (which have the highest propensity to spend their savings/incomes), they are seeing the fastest growth in wages—6.1% for the bottom quartile, according to the Atlanta Fed’s Wage Growth Tracker, nearly twice as fast as the top quartile.
- Factory activity holding up Markit’s initial take on April manufacturing in the U.S. jumped, easily beating consensus and reflecting the strongest growth in factory activity in seven months. Accelerating output, new orders and employment drove the improvement. Inflation pressures remained a drag, with costs rising the most since last November. The Philly Fed’s regional reading wasn’t as robust, coming in below expectations though at a still-elevated level indicative of solid growth.
- Housing faces a supply, not a demand problem Existing home sales fell in March, dropping the sales pace to its slowest since June 2020 when the pandemic surge began. A big reason was the continued shortage of inventory, in part because many existing homeowners with mortgages well below current market rates don’t want to sell and get stuck with higher rates. The average monthly payment on new mortgages has increased more than 40% in the past year. This is a factor behind the sales slowdown, but not an overriding one, Goldman Sachs says. Its analysis shows existing sales are only one-third as sensitive to changes in rates in a supply-constrained environment.
- A wage-price-rent spiral Other than used cars and trucks, there were no signs of peaks in the latest batch of inflation indicators. Notably, rents, which are highly correlated with wage inflation, rose 4.4% year-over-year (y/y) in March, while wages rose 6% y/y. In other words, the wage-price spiral is a wage-price-rent spiral.
- Unintended consequences To hold down gasoline prices, the Biden administration extended the sale of a cheaper ethanol blend over the summer despite its detrimental impact on the environment. But with corn prices already soaring due to a wet spring and colder-than-normal temps, Americans may save a few pennies on gas but end up paying a lot more for food.
Who goes to the movies anymore? Once considered “recession proof,’’ movie theaters continue to struggle, with the rolling 52-week average of box office sales stuck at nearly half its pre-pandemic level. Seems Americans went on a supersized-TV buying binge and got hooked on streaming during the crisis.
Book that trip to Japan! The yen is trading at its weakest level against the dollar since the start of this century when that country’s economic malaise was dubbed the “lost decade” (and which has since extended to two more decades).
This may be the first global oil crisis that drives prices lower Not initially, as we’ve seen. But if Russia must find buyers for its oil that’s going to Europe, it likely will have to do so at deep discounts along the lines India and China reportedly are already getting, perhaps as much as 25%, TrendMacro says. Steep price cuts, according to Russian Energy Minister Nikolay Shulginov, are less important than keeping the industry functioning by keeping volumes flowing.