The golden rule
If there's no recession in sight, stay bullish.
Off to Maine and New Hampshire, treated to single digit temps, 70 degrees cooler than Florida, where I left the Mister. Lots of complaints about the weather and “remind me why I live in Maine?” comments. But these are very proud “Mainahs.” One advisor is buying rental properties in Florida. Another means to find a place there where he can float his boat. A third has his snowbird home in Florida. Not unanimous, as a very colorful gentleman “hates” the state. Doesn’t “want to back into an alligator or see a poisonous snake slither across his living room …. Not me!” He also has a problem with CPAs—“They think they know everything, and when they start talking, they obviously don’t.” (Hey, the Mister is a CPA!) And referring to clients who voiced interest in crypto, he dismissed them, “Please, just get a dog.” Better not to mention my “Demystifying Cryptos” speech for him …. But all agreed, with up to 2 feet of snow on its way, I should get out of Dodge by Friday. Meanwhile, there’s no escaping volatility. Investors are shedding equities at the fastest pace since March 2020, pushing major indexes into correction. Many sectors are in an outright bear market. Three weeks of pain, and there are signs of capitulation. The S&P 500 post-pandemic P/E multiple re-rating has almost vanished, led by a 4-point collective plunge in eight mega-cap stocks. Small-cap valuations have compressed to 20-year lows, the put-call ratio has gone vertical, hitting the 99th percentile on consecutive days, and the S&P and Nasdaq 100 are below 200-day moving averages for the first time since Covid. Is a replay of 2011 and 2018 “no recession” bear markets inevitable? That would equate with 3,800 on the S&P. Quite possible.
Midterm seasonality—marked by a soft January, relief into early spring, a more challenging April to October period and a strong post-election rally—could be in play. This year has added tensions of Russia/Ukraine and especially Fed liftoff. Powell was vague about the pace and magnitude of rate increases and quantitative tightening, though he strongly suggested faster tightening than past cycles. No soothing “at a gradual pace” words. The 5-year/5-year forward TIPS breakeven rate has collapsed to levels seen last March. This suggests investors have reassessed long-term inflation expectations to the downside—a sign the Fed’s credibility remains intact. A Fed “put,’’ if it still exists, isn’t likely without a lot more pain. The rare instances where the Fed stepped in to calm markets—1987’s collapse of Long-Term Capital Management, 2001’s Tech bubble burst, 2008’s global financial crisis, 2019’s “Powell pivot” and 2020’s pandemic rescue—suggest it could take a 24% peak-to-trough decline, Evercore ISI says. That gets us to 3,700-3,800 levels. With Tech already in a bear market, the Growth premium to Value since Covid began has completely disappeared. Value’s outperformance to Growth—unusual in market corrections—also is being driven by Energy, where some 80% of issues have made a relative high versus the S&P since the market peaked on Jan. 3.
Led by the U.S., bourses that generated 2021’s greatest returns are suffering the biggest losses so far this year, while last year’s losers are 2022’s year-to-date winners—China’s equity market is up 10% so far after underperforming the global benchmark by more than 40% last year. This dynamic suggests investors may be locking in last year’s gains, accentuating the weakness attributed to Fed worries. U.S. equities could begin moving higher as this idiosyncratic effect wanes and investor sentiment reaches capitulation—the AAII bull-bear ratio has plummeted to 5-year lows. Rampant inflation, dissolving employment and output gaps, a Fed playing catch-up and a flattening yield curve are classic recession ingredients, but the economy’s underlying strength suggests a downturn would be a 2024 event at the earliest. Indeed, despite the omicron soft patch, growth surged in Q4 (more below) on strong readings for employment, house prices, home builders, vehicle production, leading indicators, rig counts, bank deposits and bank loans. Oh, and the consumer has $2 trillion in excess savings, just as omicron fades. No recession in sight. At this writing, the S&P is off 8% year to date. In the last 30 years, there have been monthly declines near that magnitude 16 times, nine with the economy in recession. In the other six, the average return two months later was 7.74%. There are traders and there are investors. The golden rule for investors: as long as a recession isn’t around the corner, stay bullish.
- Peak inflation Signs are mounting that inflation is starting to roll over. Core PCE slowed in December versus November, though for the year it still hit a 40-year high. Elsewhere, Q4 employment costs and wages moderated, ISM survey orders-to-inventories data are converging after last year’s divergence, ZEW U.S. inflation expectations are dropping and January Markit flash PMIs showed supply chains smoothing out as prices paid and backlogs fell.
- Americans are buying homes December new home sales surprised, jumping to their highest level in nine months. Unusually warm weather in 2021’s final two months aided builder activity, helping lure buyers. The threat of rising mortgage rates played a role, too. The report follows last week’s jump in existing sales, which rose the most since 2006. Limited supply is still a problem. December pending sales—which don’t close until a month or two later—fell again as potential buyers couldn’t find homes.
- 2021 was a great year At 6.9%, Q4 GDP rose much more than expected, pushing annual growth to a 17-year high. Strong consumer spending and an historic inventory build in October and November were factors, though they stumbled in December (more below).
- Peak omicron December consumer spending fell 0.6%, doubling consensus for a 0.3% drop, and Markit’s initial read of January activity showed services expanding at their slowest pace since July 2020 on labor shortages and employee absences due to omicron. The manufacturing component also slowed but remained robust.
- There are still too many empty shelves Versus expectations for a decline, December’s U.S. goods trade deficit widened to a new record a second straight month and to an all-time high for the year. Big increases in autos, consumer goods and capital goods drove the gap, swamping a rise in exports. The record-setting imports come as companies rush to fill depleted stocks, helping both retail and wholesale inventories rise above expectations in December.
- Peak margins While they continue to hold up in most Q4 earnings reports, the latest business conditions survey from the National Association for Business Economics, conducted the first two weeks of January, found firms expect margin compression this year.
Hopefully that was another gaffe Perhaps more than rate hikes, balance-sheet runoff worries markets. How much was suggested by equities’ rapid and steep reversal immediately after Powell’s “it will just run in the background” characterization of letting balance-sheet holdings to mature without reinvesting proceeds. The market had a similar negative reaction in December 2018 when the Fed Chair said quantitative tightening would be “on automatic pilot.”
Shout-out to dividends Companies that are returning money to shareholders via dividends have begun to drastically outperform the non-payers over the last two months. The most-cited historical comparisons are the back half of the 1960s and the 1970s, periods of rising rates and inflation that saw less-robust price appreciation and dividends accounting for greater than 50% of total returns.
Markets love gridlock Replacing retiring Justice Stephen Breyer with another liberal will eat up scarce Senate time, further endangering a scaled-down Build Back Better agenda without changing the high court’s rightward shift. So, even though he’s just one shy of Reagan’s 40-year record for judicial appointments in his first year, Biden’s regulatory plans for Big Tech, clean energy and labor rules should continue to face a skeptical judiciary.