Time heals all wounds
This market has been in a bad place for some time.
So said my colleague to a large advisor group as he introduced me this week in sunny Palm Springs. The group was as warm as the temperature outside (even warmer later in the week for my Detroit audience what with freezing temps outside). So was the young sound guy, who’s going to propose to his girlfriend in Paris next week! He hooked me up with a delicious cappuccino, and I suggested he have one, too, as my topic can be a bit boring. “Not at all, I’m anxious to hear what I should buy! My portfolio’s been hurt.” I replied, “Nothing just yet.” He scoffed and left the room. Sentiment sure is bearish. The Fear and Greed Index is at “extreme fear” levels, AAII bulls-less-bears is lower than 98% of the time since its 1987 inception, the Investors Intelligence bull/bear ratio is at “panic” levels and the 10-day average CBOE equity put/call ratio is at March 2020 pandemic collapse highs. Thursday’s huge reversal aside, the contrary bullish adage hasn’t been working. It’s being bested by an even stronger one, “Don’t fight the Fed.” Markets haven’t seen rate hikes like this since the early ’80s. This week’s unsettling CPI report (more below) almost assures it’s not close to slowing down. Futures are now pricing 75 basis-point moves in November and December. Many blame the Fed and other central banks for unleashing the inflation they’re now fighting. But the Institutional Strategist (TIS) sees unprecedented spending as the culprit. In the U.S. alone, more than $5 trillion of Covid-related stimulus in 2020-21. Too much money chasing too few goods is the classic definition of inflation.
At the end of the day, it’s about inflation expectations. And back-to-back monthly negative CPI surprises are raising fears they may become unanchored, a key Fed worry. (This morning’s Michigan sentiment reading hinted at such, more below). Notably, core inflation’s acceleration to a 40-year high was driven by “sticky” services components (rents, transportation, medical care) that can linger for longer than goods inflation, which has started to roll over. Year-over-year (y/y) owners-equivalent rent and apartment rents, the largest and laggiest of CPI components, jumped 10.1% and 10.6%, respectively. Meanwhile, the tight labor market is keeping wages elevated, feeding a wage-price spiral. Compensation costs are running 8% y/y, forcing companies to raise prices. While openings and job growth have moderated, payrolls are still expanding three times faster than their historic average and the jobless rate seems stuck at about 3.5%, allowing the Fed to ignore this half of its dual mandate. What could cause the Fed to pause if not pivot? If something breaks, perhaps. The hubbub over pensions and gilts in the U.K., not to mention growing liquidity concerns over the lack of buyers for Treasuries (more below), represent potential precursors to an “event.’’ But what if there is a break and the Fed does not pivot, TIS wonders. Might this be a straw in the wind that maybe central banks are about to say to governments, “Get your house in order?”
How much is priced in? Since 1948, the S&P 500 “discounted” recessions by -6.3% on average. In this cycle, it’s already off 25% before a recession has begun (if there is one). This discount for any pending slowdown is much more significant than that preceding any other post-war recession—4.5 times worse than the median return leading up to the last 12 recessions. Investors already have priced in plenty of bad. Same with earnings. Since 1992, the S&P has not deteriorated meaningfully before earnings-per-share (EPS) estimates worsened. In fact, stocks and EPS fell in tandem during 2000-02, 2007-09, 2015-16 and 2020. This time, the S&P has sunk even as forward estimates are near record highs. This suggests estimates could nosedive without significant further deterioration in the S&P. We are reminded that bear markets are a function of price and time. The former is obvious, and the market has taken big hits. On the latter, it’s been 150 trading days with the 50-day average below the 200-day average on the S&P. That’s in the ballpark, historically, for cyclical corrections, which we believe is the case today. Speaking of time, I may have mentioned that I remember having a great time in the stagflationary ’70s—the “dismal decade.” I’d forgotten how relentless and painful the inflation was. That was a long time ago. And that’s the thing about time—it heals all wounds.
- Not all the inflation news was bad Redfin and Realtor.com said rents fell nationwide in September and are decelerating y/y—according to RealPage analytics, to 9% y/y vs. the March peak of 15%. Rent-related costs account for roughly a third of CPI, and declines can take seven months and longer to translate into CPI. Also, import and export prices fell again, global freight prices are down around 70% from their year-ago peaks, supply-chain pressures are easing and money supply is rolling over.
- Small businesses somewhat more optimistic The NFIB gauge rose a fourth straight month and above expectations. But the move is off June’s 48-year lows, with the survey still well below year-ago levels. Inflation and worker shortages remain the two big issues.
- Shout-out to dividends The S&P 500 Dividend Aristocrats Index, comprised of companies that have had 25 consecutive years of increased cash payments, has outperformed the S&P 500 on a relative basis by 1,000 basis points year-to-date.
- Inflation remains elevated all over Y/y core CPI, which excludes food and energy, rose the most since 1982 in September, and the headline rate slowed less than expected. Grocery prices were 13% more expensive than a year ago, with flour, cookies, turkey, and canned fruits and vegetables up the most ever. PPI increased the first time in three months, with the core above consensus.
- A lot of talk about liquidity Bank holdings of Treasuries are at a multiyear low and come as the market needs buyers given the Fed has just launched quantitative tightening. The MOVE index, the bond market’s version of the VIX, is flirting with March 2020 pandemic panic peaks.
- Consumer cools September retail sales were flat, missing estimates, with spending down across goods categories. But August was revised up, and core sales (ex-vehicles, gas, building supplies and food) beat forecasts. Bank of America data shows September credit and debit card spending up 4.4% y/y, well below the inflation rate. Preliminary October Michigan sentiment hit a 6-month high but inflation expectations climbed off September’s 1-year low 4.7% to 5.1% one year out and 2.9% five years out.
Living up to their names Led by goods, “flexible” components of inflation have totally rolled over while “sticky” components such as rents and wages have not. Driving down the latter is hard and historically, has required a recession.
Greenspeak Amid a war that’s threatening European recession (eurozone sentiment is near Covid-panic lows) and a surging dollar that’s creating challenges all over, former Fed Chair Greenspan’s 1998 quote seems prescient: “It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress.”
There’s no gasoline in Paris On top of everything France faces, refinery workers are on strike. Strategas Research reports that in the past week, cars there were queued up at petrol stations by the dozens at 5 a.m. to get what’s available. The other queue in Paris was in front of the Louis Vuitton store—a great place to fuel my proclivities while the Mister refuels.