Goings-on in the sausage factory aren't bothering the markets.
We’re moving from peak growth to mid-cycle, from national elections to midterms. Mid-anything sounds boring. But with the Dems’ slimmest of majorities (more below) and both parties bickering among themselves, midterms this time promise to be anything but boring. Maybe we get an infrastructure deal. Maybe we don’t. What we do know is a reduction in monetary stimulus is coming, as is a fiscal cliff. When is less clear. But whenever it starts, the Fed is going to be very slow withdrawing stimulus, while pent-up demand, the lagged impacts of the unprecedented surge in consumer net worth, excess savings being put to work and the ongoing reopening are supportive of continued economic momentum. Evercore ISI thinks real GDP growth will slow from almost 10% this year to 4% in 2022, which would still represent the fastest growth in 20 years, this year aside. Soft landing comes to mind. Wall Street is still coming up short on future earnings. It’s missed badly the past few quarters and next month's reporting season likely will see more of the same. Markets have never seen such unprecedented fiscal and monetary responses to a crisis, and aren’t fully appreciating that the coming “slowdown” will be off this year’s outsized growth, the most since at least the early 1980s.
Pandemic lockdowns and layoffs have driven a doubling in new business formations. Companies had to rethink how they operate. Workers, too. The result has been a boom in capital expenditures (capex) and productivity. We’ve almost closed the output gap with nearly 8 million fewer workers. Strategas Research thinks the future path of stocks will depend on continuing these output-per-hour gains. They let profits and wages rise together and help maintain or even increase margins. This capex cycle has been abetted by a decade-long manufacturing renaissance that Trump administration policies accelerated. The White House has said it wants to build on these gains, meaning it must tread carefully with corporate taxes (more below). Foreign direct investment in U.S. factories has been rising since 2010. Cornerstone Macro counted 250 onshoring announcements in 2020, with production coming largely from China (also Japan and Europe). So far this year, it has counted 137 more. It’s a broad trend, with industries spanning transportation, industrial and medical equipment. Most are heading to the Midwest or South. Another catalyst: the crackdown on tech entrepreneurs by China’s Communist leaders and that country’s worsening credit crisis. Bloomberg reports onshore delinquencies there already are the third highest on record less than six months into the year.
A crackdown on tax cheats is among the pay-fors for the $1 trillion infrastructure deal. (Oh yes, waste, fraud and abuse. Where have I heard this before?) Its fate, of course, lies with progressive Dems intent on a budget reconciliation bill that could total $6 trillion. (Good luck with that with midterms just around the corner.) With the bipartisan plan alone, the level of new spending when already passed Covid measures are added still easily surpasses the output gap. I’m reminded, again, of a paper fixed-income colleague Don Ellenberger co-authored. It noted for the first since the U.S. Treasury and Fed agreed in 1951 to separate government debt management from monetary policy, the Fed is using its presumably infinite balance sheet to underwrite trillions of dollars of Treasury debt. From 1957 to 1998, every time a country’s central bank became such a “buyer of last resort,’’ high inflation followed. Yet long-term yields remain stuck. Where are the bond vigilantes? ISI surmises all the Fed’s buying is distorting yields. Perhaps. Sipping morning coffee and flipping through financial channels with the Mister, who is tired of my MMT schtick, we hit on a commentator who said, “You know, every time Modern Policy Theory comes up, people’s eyes glaze over.” What??! It’s Modern Monetary Theory! Trillions more in spending and it could become a household term. Maybe we dodged a bullet. Maybe. The N.Y. mayor’s race indicates moderates could be gaining ground. But Biden says he won’t sign an infrastructure bill without a reconciliation bill in front of him. Cornerstone says it’s never seen anything like it. Please. The sausage factory is alive and well over in the swamp. Thursday’s bipartisan display was all about optics. It looks like nothing is likely to happen until maybe September, which is that much closer to midterms. Ticktock. Gridlock. Now, that’s bullish.
- The economy is booming Markit’s flash manufacturing PMI rose to a new high and the companion services gauge posted its second-highest reading ever. Elsewhere, Richmond Fed new manufacturing orders matched 1997’s record high and May durable goods orders jumped. Global activity is accelerating, with the euro area composite PMI surging to a 15-year high.
- Jimmy Choo’s are almost $1,000! Credit card data show spending on clothing and at department stores is surging, a sign we’re refreshing our wardrobes as we prepare to go back to our offices. Americans also are switching from big-ticket purchases to vacations and fun—Bank of America says restaurant spending has improved across all metro areas.
- Americans almost over it The weekly Langer Consumer Comfort Index rose to its highest level since late March 2020, and June’s Michigan sentiment gauge posted its second-highest reading since the pandemic began. Both are indicative of accelerating activity as states fully reopen and new Covid-19 infections keep dropping.
- Housing “slowdown” in context New and existing home sales fell again in May, but the underlying market remains strong. Excluding the South, new home sales set a record and among existing homes, all regions saw large year-over-year (y/y) increases. Supply constraints remain the issue, with some builders purposely restricting sales to further prop up already record prices for their unsold inventory. As potential buyers pull back, the supply-demand dynamic should help moderate price increases.
- When, and at what level, might transitory inflation settle? Monthly PCE prices moderated somewhat in May, although y/y increases rose at both the headline and core levels. Elsewhere, copper and lumber prices have cooled. There’s broad agreement that much of the inflation over the last few months will prove temporary. The more difficult question is, where will prices settle once transitory factors subside?
- I believe we can make it on our own Consumer spending was flat and personal incomes slipped in May as March’s American Rescue Plan pipeline ran dry. Still, both spending and income came in better than expected, a sign the strengthening economy is helping pick up where stimulus fell off.
Energy having its day Oil prices are closing in on 2018 highs, abetting an Energy sector that is experiencing the best internal trends in the market. Renaissance Macro notes energy stocks hardly corrected during last week’s broader sell-off as the sector retained its leadership position.
Dems’ midterm path very narrow The midterm elections under Presidents Hoover in 1930, Obama in 2010 and Trump in 2018 were the only three in U.S. history when the House flipped but not the Senate. Republicans need only 1 seat to retake the Senate and 5 to reclaim the House, and that doesn't include redistricting that should benefit benefit the GOP.
This may be why the market doesn’t seem to care about the goings-on in the sausage factory Odds of a corporate tax hike before midterms are fading; they’re now 40%, less than half April’s 90%, according to Strategas. Guess the stock market has its money on the moderates and the bipartisan infrastructure deal that doesn’t include new taxes.