The extremes lost Tuesday night
Maybe everyone, including markets, could use a little boring.
So said one of the early morning political pundits the day after midterms. Another described the elections as “meh.” Americans split their tickets, voting on individual candidates and their positions. Back on packed planes this week, and wading through packed airports, to start in San Diego, where I spoke before a large group of financial advisors. Their key concern: ballooning debt and the crowding out of federal revenues just to service the debt—which is facing much higher interest rates. “You can’t raise taxes enough to pay for this!” One advisor blamed inflation on spendthrift consumers. So far during President Biden’s tenure, “about $4.8 trillion in excessively stimulative fiscal spending has poured into various sectors of the economy,” Yardeni Research says, with the most significant tranche “released in an indiscriminate manner to a large swath of the adult population.” This “acted like a jolt of espresso to household wealth and consumer spending,” helping fuel an inflationary environment the Fed is trying to tame. Indeed, U.S. households amassed $2.1 trillion of excess savings relative to the pre-pandemic trend, of which an estimated half is still around and won’t be used up until 2023’s back half. And when all consumer bank accounts are tallied, it’s estimated households are sitting on $4.7 trillion. Why wouldn’t the consumer spend? In the ’70s, we referred to the phenomenon as “too much money chasing too few goods.” The good news: this consumer strength has Q4 GDP tracking at a 4% annualized rate, the Atlanta Fed says, the fastest pace in a year. The bad news: far too fast for the Fed.
Financial conditions eased sharply on Thursday’s massive rally after October’s CPI surprise (more below). The report breathed new life into the notion the Fed may pivot or pause. But core inflation over the last three months is still running close to 6% annualized. Hardly tame. Indeed, Renaissance Macro challenges what it calls the market’s “immaculate disinflation” interpretation of the CPI report. It thinks investors should rent, not own, the market as it sees good reasons to think the run-up won’t last. For one, falling goods prices, which helped drive the moderation, were the easy part. Services prices (particularly “sticky” wages and rents) are the hard part and look to stay elevated until the labor market cools considerably. This reinforces the imminent recession argument (the Fed’s unlikely to put down its hammer until job growth stalls) and implies more pain ahead even if seasonality and typical post-midterm rallies get investors through the holidays. Historically, the S&P 500 doesn’t trough until halfway through a recession and doesn’t start pricing recovery until 75% of the way through. So, 2023 is setting up as a race between easing inflation and financial conditions versus the coming hit to growth and earnings. At $235, consensus forward EPS looks high. Yardeni’s range is $210-215. Many believe it could go lower. Thursday was a tail event to the upside. Since 1962 (or 15,877 trading days), the S&P has risen by more than 5.54% in a single day just 14 other times, Piper Sandler shares. The Treasury market’s 27 basis-point drop in the 10-year yield has been matched or exceeded only 46 times. Interestingly, about half of the previous outsized drops in yields occurred in ’80 and early ’81, when the market thought the Fed was done tightening and inflation was vanquished. It was wrong. Hmm.
It's all about when bond investors begin fearing a recession more than inflation. Over any three-month period since ’87, whenever bond bears (rising rates) expanded relative to bond bulls (falling rates), Leuthold Group says the 10-year yield rose 68% of the time by an average of 0.68% annualized. Conversely, whenever there were more bond bulls than bears, the 10-year yield declined 72% of the time by an annualized average of -1.11%! What happens—and more accurately doesn’t happen—in Washington will matter. A GOP House majority, regardless of its size, and narrow Democratic Senate is an outcome most likely to produce a legislative stalemate in Congress. No more stimulus packages. The markets would love that. For the back half of the week, I was treated to the swagger and plain talk of Houstonians savoring the Astros’ World Series victory. “Dallas doesn’t even think Houston exists, even as it’s just a bunch of credit card millionaires.” Here they boast of the Energy Corridor and the Chemical Coast, filled with refineries and shipping channels, though Houston is far more diversified an economy than just the energy patch. “There is a lot of money in this town.” Throughout numerous meetings, my colleague asked what these advisors are hearing from their clients. Most are “staying the course,” though a few mentioned client requests to generate cash. The midterm election results were a disappointment to the many conservative Houstonians I met. Speaking of the political climate, one advisor said she’s “never seen people voting out of sheer anger.” And whither the Senate? Another advisor suggested “Herschel (Walker) wants to keep politics exciting.” Yes, and this has been the problem! I’ve been toying with the title to my upcoming 2024 political presentation I’ve settled on “Make Politics Boring Again.” How do you love it?
- “Pause” talk is back The magnitude of October’s deceleration in CPI (the smallest rise in the core rate since September 2021) sent the 10-year Treasury yield plunging. This caused the 10-year/fed funds curve to invert, historically a sign Fed tightening is about to end. Futures are still pricing a half-point hike in December but the terminal rate pulled in, hovering around 5%. In the CPI report, medical care services posted their biggest drop in decades, while apparel and other goods prices contracted as retailers now find themselves stuck with too much inventory.
- The labor market is strong Payroll employment in truck transportation and temporary help services, two areas of the labor market that are highly correlated with leading indicators, rose to new record highs during October. Despite recent tech layoffs, payroll employment in information industries also grew to their highest level since April 2006. Good for the economy; maybe not so much for the Fed.
- The consumer is strong … In addition to a stockpile of savings (see above), consumers are starting to step up their use of credit card debt. A popular argument is such a rise often is a sign of stress. But it’s more like a sign of confidence as, relative to disposable income and consumer spending, revolving credit appears to be normalizing to pre-pandemic trends, with delinquency rates remaining low.
- … but increasingly worried Preliminary Michigan sentiment disappointed, falling to its lowest level since July. Both current conditions and expectations fell, while inflation expectations ticked up a notch, with the year-ahead rate hitting 5.1%. The Fed won’t like that. Meanwhile, consumers continue to lose interest in durables, reinforcing the CPI report that saw goods prices contract amid bulging inventories.
- Global recession watch The OECD’s widely followed global leading indicators declined again into recession territory, with activity weakening in the U.K. and the euro area, particularly Germany. But China is the biggest drag. Its October trade data was a big miss as exports and imports contracted. A significant recovery in Chinese demand in coming months appears unlikely until spring at the earliest.
- Small businesses sound recession alarm NFIB optimism slipped for the first time since June to a 3-month low. It’s now near 1990 recession levels and below 2000 recession levels, with the percentage of firms expecting the economy to improve the lowest in the 50-year history of the series.
Don’t blame the farmers Prices for food “at home” and “away from home” may be surging, but it’s not really due to the run-up in prices for commodities. The USDA estimates that for every domestic dollar the consumer spends on food, only 16 cents reflect the actual farm value, with the remaining 84 cents consisting of the “marketing” costs—labor, energy, transportation, wholesale and retail margins, etc. The farm value is 23 cents for food and home, but only 4 cents for food away from home.
Has housing hit its nadir? Despite another bump up in the 30-year mortgage rate to 7.14%, more than double a year ago, mortgage purchase applications rose in the latest week, the first increase in seven weeks. With mortgage rates appearing to flatten, home prices pulling off cycle highs and sales prices back below asking prices, housing demand may have hit a floor.
BTW, a 7% mortgage isn’t so bad House prices arguably were even more “expensive” than today in the early ’80s, when 30-year mortgage rates hit an all-time high of 18.63%. Affordability plummeted back then, too, but interestingly, house prices only leveled off and didn’t fall. Deutsche Bank would be stunned if home prices behave the same way again. But if they do, it’d be another headwind for the Fed.