Take a breath

A travel-filled week, and my Jimmy Choos were up for the task. First stop, Birmingham, Ala., where the bankers in the gorgeous Vestavia Country Club ballroom nodded in agreement with my stubborn inflation message. A fellow boomer reminisced with me afterwards about Paul Volcker’s methods to vanquish the beast. Then off to sunny Bonita Springs, Fla. This fabulous resort was crawling with people seemingly not worried about anything. Yet another packed flight. I rarely even glance at my plane mates, so when the captain announced, “Federal guidelines no longer require the wearing of a mask, so that is your personal decision,” I turned to joke that I wonder how many years they will be making that announcement! A near gaffe averted. Mr. and Ms. were wearing theirs … although, quite a bit of coughing going on in this plane! Discussions centered around how much damage is already priced in and how to invest while we wait for evidence inflation will fall sufficiently for the Fed to have engineered a soft landing (or “softish,’’ as Chair Powell put it Wednesday). Policymakers are trying to balance lowering job vacancies enough to curb wage pressures without cutting jobs/causing a recession. Good luck with that. This labor market is so tight that openings outnumber unemployed by a record 2-to-1. Record numbers of workers are quitting and changing jobs. Unable to find workers, businesses are pushing wage growth to its fastest pace since the 1960s (more below). Markets are increasingly concerned. April was only the fourth month in half a century that the S&P 500 fell more than 5% and Treasuries returned less than -2%. The start to May hasn’t been any better. So far, it’s been the worst year for the 10-year since 1788! OK, let’s take a breath.

Why are investors sweating bullets when Q1 is seeing earnings beat estimates by almost 7%, with earnings per share on pace for nearly 12% growth, analysts’ estimates setting record highs and rising, and macro data signaling an economy that continues to power ahead (more below)? Yardeni attributes the pessimism to the Fed “put” going kaput due to an inflation problem that hasn’t been this serious since the 1970s. The S&P P/E multiple has already contracted 3.8 points this year (the 13th-sharpest drop since the 1930s), putting valuation at levels that historically start discounting a recession. Meanwhile, of the Q1 beats, roughly a third came from revenues versus two-thirds from margin upside. Indeed, excluding Financials, margins were up 5% year-over-year, rising in seven of 11 sectors. Still, the performance of cyclical versus defensive stocks suggests a sharp slowdown—Consumer Staples was the only S&P sector to post a positive return in April, and cyclicals led this week’s sell-off. Sentiment data among individual investors paint a picture of increasing fear, often interpreted as a buying opportunity. But surveys of institutional investors, which tend to better capture market moves, are closer to neutral.

My last stop was a client event in Fort Worth—NOT Dallas, as my local guests emphasized. They love their city, “best kept secret … best rodeo (I’ve been promised a ticket for next time) … very nice people … low crime.” They don’t need to catch a breath, as they are chill. A local business owner, with customers going back 40 years, will not charge above list for industrial equipment (business is booming), because “money isn’t everything.” The market is becoming increasingly narrow—100% of constituents in the top-performing decile year-to-date are in the Russell 1000 Value Index, with Energy making up 38%. Equity price trends tend to decelerate before they reverse. Hard to get a reading on that given the past week’s volatility, with two high-volume, deep sell-off days and a VIX above 30. Strong post-Fed rally on Wednesday reversed into one of the worst days on Thursday (only 5% advancers and 8% up-volume). Such back-to-back hugely volatile days are rare, Renaissance Macro shares. The last one occurred near the Covid lows of 2020, and prior to that, we never saw one before the global financial crisis. This suggests to Renaissance Macro that bounce calls are toast and that the market may be getting into a liquidation environment. Those often burn themselves out, but usually get hotter before they do. Volatility is welcomed by traders and stock pickers. But for most investors, it’s not welcome at all. The Fed thinks it can deliver “softish” landing. OK … after the week we just had, let’s just take a breath. The market’s closed on weekends!

Positives

• U.S. services ramping up … April’s ISMs showed services activity accelerating. While the headline reading slipped, that was largely due to difficulties in finding workers (more below). The activity component jumped to a 3-month high as Americans began enjoying a post-Covid world (even if it’s not one yet, more below).
• … global services too Despite the Russia-Ukraine conflict and rising prices, global services PMIs improved, with 14 countries in expansion and the percentage of gains rising to 80%. By region, the strongest April readings came in the euro area, led by Spain and Italy. The U.K.’s fell but was still a robust 58.3, while Australia and Germany slipped off their initial readings.
• People want to own a home (if they can just find one) Despite record high home prices and a 30-year mortgage rate that has jumped 225 basis points this year to 5.54%, mortgage purchase applications are rising as strong income growth, increasing household formation and limited supply continue to keep housing strong.

Negatives

• Feeding the wage-price spiral Despite another strong jobs report (up 428K in April), the participation rate fell. (Where are all the workers? What do you think, my 3 million early-retirement boomer friends? Want to come back to work??) Also, jobless claims continued to hover at 1970 lows, March’s record high job openings widened the jobs-workers gap to 5.6 million (also a new high), and Q1 unit labor costs boomed 11.6% y/y. At 5-6%, annualized wage growth is the highest since Nixon was president.
• Manufacturing moderates more For the second straight month, the manufacturing ISM fell back, though it remained at a historically robust and expansionary level. The reading reflected intensifying supply chain bottlenecks, with the Russia-Ukraine war and Covid lockdowns in China lengthening supplier delivery times and pushing prices to their highest reading in the history of these estimates that started in 1997.
• Trade’s drag grows The final tally for March came in even worse than expected, with the trade deficit reaching a record $109.8 billion as surging import growth swamped increases in exports, which also rose by a record amount. Much of this widening was anticipated given last week's advance report for goods trade reflecting bottlenecks of unloaded container ships working through U.S. ports; March’s sharp rise in energy prices also was a factor.

What else

Smells like a bear While pundits attributed Wednesday’s bullish turn to the Fed taking 75 basis-point hikes off the table, there were indications the price action simply reflected traders taking advantage of the opportunity. Leuthold Group notes that while the number of stocks trading above 10x sales has decreased, it’s only back to its Tech bubble peak! A tenth of S&P stocks still exceed that threshold, making for what Leuthold calls “a target rich” environment for short sellers. A “garden variety” bear could drop that count by two-thirds or more. And Strategas Research shares that 77% of the 99th percentile gains such as Wednesday’s come in weak or bear markets.

Tone deaf? That’s what Evercore ISI called Thursday’s mid-morning announcement that the White House would be buying oil back into the Strategic Petroleum Reserve. Yields surged on the inflation-feeding news, accelerating an equity market sell-off that had been rather mild up until that point.

The coughing wouldn’t stop on my flight to DFW Covid cases are quietly creeping up again—up 20% to 435,087 over the past 7 days compared to the prior week. Almost all states are reporting increases, led by New York, California and Illinois. Also, there are now more people under lockdown in China than the entire population of the U.S.

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