Trouble in paradise
Disasters all over have markets on edge.
To put it mildly. For this new Southwest Florida sunbird, Hurricane Ian literally hit home. Mother nature reminded us who’s boss. Thoughts and prayers to all affected from this gorgeous state. Disasters are being fought everywhere as the major equity indexes bounce around year-to-date (YTD) lows and volatility in fixed-income and currency markets flirt with “peak of panic” Covid levels. Wolfe Research blames “policymakers pursuing confusing, irrational and/or just plain bad economic policies.” In the U.K., the Bank of England reinitiated quantitative easing even as it’s still hiking rates to support a British pound that had plunged to near parity with the dollar. The currency’s collapse came after new Prime Minister Truss unveiled (and over the weekend, pulled) a controversial tax cut that was at odds with global efforts to rein in skyrocketing inflation. The central bank’s pledge to buy bonds in “whatever quantities were needed” came days after the Bank of Japan intervened in currency markets to prop up its ailing yen. Markets wonder if China might be next. Its yuan trades at a 15-year low vs. the dollar. Meanwhile, Germany unveiled more subsidies to offset soaring energy costs. More stimulus amid more rate hikes? A contradiction and recipe for a policy mistake—or worse. Financial crises often occur when foreign central bank reserves at the Fed are declining (check), the dollar’s surging (check) and financial asset prices are falling rapidly (check). Financial accidents don’t have to be a U.S.-centric problem. The 1997 and 1998 Asian and Russian crises were non-systemic. This time, Leuthold Group asks, might Europe blow? Or even China?
Panic has set in, with the Dow back in a bear market and the S&P 500, Nasdaq 100 and Russell 2000 clinging to support at YTD lows and at long-term moving averages that have marked every major bottom since 2009. The flush in breadth the last two weeks is as bad as anything Strategas Research has seen since the fall of 2009 and August 2011. Neither marked the final low, with short-term bounces giving way to lower lows in following months. Bear markets begin to run their course when fewer and fewer names participate on the downside (i.e., fewer new lows), as occurred in 2002/2003 and late-2008/2009. For all the rally attempts this year, missing has been stocks with a +2 standard deviation daily move, nothing close to the 40-60% threshold off major lows. That said, the percentage of S&P issues above 20- and 50-day moving averages is below 3%, quite extreme and suggesting limited further downside. Bearishness is at extremes (more below). Sticky inflation remains the overarching issue for markets. While supply-driven cost pressures have eased (more below), demand-driven ones have not. A tight labor market that explains 75% of the rise in the Cleveland Fed’s median inflation gauge shows little sign of measurable cooling—the latest weekly jobless claims fell to a 5-month low. Empirical Research thinks it’ll take a jobless rate as high as 6% to wring inflation from an economy that’s far less rate-sensitive than in the past. That’s the pain to which the Fed has been alluding.
Things may not be so bad, for the U.S. anyway. While it would be hard to envisage markets returning to the frothiness of 2021, U.S. corporate balance sheets have never been so rich at a time when the dollar is king. U.S. corporate cash flow to GDP is at 13.5%—only slightly below its post-war high of 14% (after the 2008 crisis), and the ratio of U.S. corporate debt to after-tax profits is as low today as it was in the 1960s. The inflation illusion is likely to help nominal top and bottom lines hold up during the earnings season that starts in a week, with the question everyone’s discussing being how well margins—and guidance—fare. Households are in good shape, too. The household-debt to personal-income ratio is at early 2000s levels, and the debt-service ratio is lower than at any time prior to the pandemic. Further, cash represents about 25% of total household debt—the highest level since 1970! With resistance around 4,300 (the S&P 200-day moving average that was approached in August), a financial accident could be good in a manner. It would stop the Fed and offer up a buying opportunity. THE LESSON from this hurricane experience, I can credit to my wise brother—“evacuate!” Paradise is not lost! Now, I’m off to Hawaii for business next week. Who’s blessed ….
- Consumer still strong The final tally for Q2 consumer spending was revised up, and this morning’s report showed August’s increase doubling consensus (albeit against a downward revision to July). Conference Board consumer confidence firmed, rising to its highest since April and corroborated by today’s signal from the Michigan survey that household sentiment is improving. Jobs, wages and declining gas prices drove the improvement.
- If inflation has peaked … The latest Case-Shiller and FHFA surveys show home prices continuing to decline, the former at its fastest rate ever. Prices are still up sharply from 12 months ago, but “sticky” rents are starting to fall—per apartmentlist.com, at their fastest rate in more than six years in September. Europe’s energy-driven spike aside (more below), global CPI gains eased to their slowest pace since December 2021.
- Cap spending contributing … for now Nominal nondefense cap good shipments, which feed into GDP, jumped 13% year-over-year. Empirical Research says if bottom-up forecasts hold, capex will finish the year at a 20% growth rate, double consensus. However, next year’s bottom-up forecasts see that decelerating to a 3% pace.
- Don’t read too much into new home sales surprise It’s thought the 28% month-over-month surge to a 685K annual pace (vs. consensus at 500K) reflected volatility in the data, as the rise brought sales into alignment with single-family permits, with both down about 20% YTD. Permits and mortgage applications continue to slide, and August pending sales posted their biggest yearly drop in more than two years.
- Europe is in trouble German and French consumer confidence fell to record lows, Italy sentiment weakened and Swedish consumer morale fell to the lowest level in 29 years. All worse than expected. More broadly, eurozone economic sentiment fell to a new cycle low, with confidence at a record low on inflation worries—unlike moderation elsewhere, September eurozone inflation hit 10%.
- Contrarians would call this a positive AAII bearishness has only been lower in Q1 2009 and late 1990, both major lows, and CNN’s Fear and Greed Index is at an “extreme fear” reading. Moreover, the post-pandemic run-up in household equity holdings has entirely unwound, with Q2’s 35.5% down six percentage points from Q4 2021’s record high, one of the steepest declines in the history of this metric.
… it could be a good buying opportunity Leuthold Group says historical research shows S&P 1-year price gains following the three major inflationary tops of the 1970s-80s (February 1970, November 1974 and March 1980) were, respectively, 8.1%, 30.4% and 33.2%. Those “post-inflation-peak” returns were earned despite a recession occurring in each case.
… but “peak” is relative History suggests once inflation gets above 5% in advanced economies, it takes an average of 10 years to drop to 2%. Indeed, this morning’s reports showed PCE inflation, while off its highs, holding firm at elevated levels.
Speaking of hurricanes In the U.S., it’s estimated they’ve caused more than $1 trillion of cumulative damage over the past 40 years (Ian not included), Bank of America shares. Perhaps these days, $1 trillion isn’t as shocking as it used to be …