'Welcome to Pittsburgh, Ohio ...'
It's not just the pilot who is confused as markets wrestle with yields.
… said the pilot of our flight from Denver. What?! Never heard that before—love a red-letter day! This after a delightful week of travel. First, to Tulsa, Okla., where the advisors and their clients are warm and friendly. Two advisors, one from Chicago and the other from Iowa, studied at Oral Roberts University and never left. The university’s architecture has a futuristic look, including the “Prayer Tower,” reminiscent of Seattle’s Space Needle (Oral Roberts visited Seattle in 1962 and was inspired). The advisors’ vibe is chill, as they invest conservatively for their clients. “Undersell and overdeliver,” I was told. Student loans, rising credit card delinquencies and such were what most people I met were worried about. Nothing about the exploding federal debt (more below). It was a year ago Thursday that the S&P 500 put in its closing low for the 2022 bear market. Now, the index is up roughly 22%—with three oddities: 1) only 44% of the S&P is above the 200-day moving average; 2) small caps are up just 5% since last year’s low, their worst showing in history by a mile, according to Strategas Research; and 3) a complete absence of banks, down for the first time (-18%) in the first year off an S&P low in 100 years of market history. Fits with a stock market run-up that in many ways has been a big head fake. Strip out gains from a handful of mega-cap stocks, and the equal-weighted S&P and Russell 2000 are flat to negative YTD. The advisors I met with this week said many clients weren’t aware the market’s move has been largely limited to the Magnificent Seven and were surprised at the relative underperformance of their portfolios.
Lots of questions in Tulsa about where we really are in the economic cycle. Citigroup’s Economic Surprise Index shows macros continuing to come in stronger than expected. The Atlanta Fed’s tracking gauge for Q3 GDP growth this week topped 5%! Hard to argue a recession’s imminent, particularly with S&P forward earnings estimates touching June 2022’s record highs. (One very dubious advisor during our visit scoffed when I suggested the forward estimate was at an all-time high. He doesn’t believe in forward figures. Moreover, the inversion of the 2/10-year Treasury yield curve is narrowing rapidly. Inverted yield curves typically dis-invert during recessions, not before them, as the Fed cuts rates to revive economic growth. This time, long rates are rising faster than short rates. Yardeni Group thinks this raises the odds something may break in credit markets. Maybe a recession after all! Following a dinner event at Oklahoma Joe’s BBQ, where I received hugs, requests to be on my distribution list, and met a couple who shared both my Italian heritage and ties to Duquesne U, one of my alma maters, I was off to Denver. The airport was a sea of humanity, as was the national conference at which I’ve presented for many years. The longest-term concern I heard was from an advisor in Denver whose Floridian retirees are worried about such geopolitical events as conflict in the Middle East and a dysfunctional Congress. “What does this mean for the safety of our portfolios?” What about runaway debt?
The bond vigilantes are sure paying attention. Studies suggest much of the increase in long-term rates represents compensation investors are demanding to buy Treasuries, raising questions about the role increased issuance, an unsustainable budget outlook and political dysfunction are playing in the rates outlook. Each percentage point increase in rates costs the government nearly $3 trillion over the next 10 years and as much as $30 trillion over three decades. Empirical Research estimates U.S. yields are running 100 basis points above where they should be and puts the blame on the enormity of the deficit. It doubled to $2 trillion the past 12 months to 5% of GDP, a level associated with recessions and significant labor market stress, not full employment. Combined with the higher rates, the flood of red ink has net interest costs at 14% of tax revenue, historically an inflection point where stimulus turns to austerity. This means a fiscal showdown may loom in an election year, prompting much discussion in Tulsa over whether the Fed will be pressured to cut rates sooner. This as it continues with quantitative tightening, which combined with Treasury demands is dropping $10 billion of government debt on the markets daily. Almost as mind-blowing as my pilot saying Pittsburgh, Ohio! Thankfully, it was said on touchdown.
- A global soft landing? Near-term recession risks continue to recede on a broad easing in global financial conditions since midyear, with positive growth momentum in labor markets and manufacturing, as suggested by improving PMIs and September’s unexpected jump in Taiwanese exports, its first increase in a year. Better news on income & balance sheets in Europe and developed markets generally bolsters the soft-landing case, as do FOMC minutes that revealed policymakers and staff were becoming more optimistic they could bring inflation back to the 2% target without recession.
- But is China turning? The so-called Golden Week at the start of the month saw holiday tourism and consumption data improve, while declines in trade moderated and Chinese authorities reportedly were preparing additional fiscal stimulus and taking steps to stabilize property markets. China’s lackluster recovery from the Covid shutdowns has been among the big drags on Europe.
- Q3 earnings could determine market behavior the rest of the year It got off to a good start this morning with upside surprises from Citigroup, JP Morgan and Wells Fargo. Bank of America is expecting the start of an earnings recovery, with a sizable 4% beat vs. the typical 2%. Oil and rates suggest growth is strong and de-stocking is over, indicating EPS will outpace GDP. The key question is, will margins hold up amid higher oil, a stronger dollar, a tight labor market and a diminishing ability to pass along price increases.
- Consumers’ fiscal cliff Government aid, which increased the past 12 months despite low unemployment and remains more than 60% above pre-pandemic levels, is rolling off much faster than consensus expects—down $7 billion in just the first few days of the month vs. all of last October. Student loans, food stamps, tax refunds and Medicaid are among the cuts, further squeezing lower-income households where cash savings are running out. The cliff comes as consumer moods are souring—Michigan’s initial take on October sentiment plunged to a 5-month low.
- Higher for longer CPI, PPI and import prices were generally hotter than expected, though longer trends for core CPI and PPI still suggest inflation is cooling. One concern was that stickier services components firmed, though hotels shot up at a very questionable 51% annualized rate. While headline & core CPI inflation ex-shelter rose just 2%, that’s a big “ex” as shelter inflation shot up 7.2%. The good news is rents have been falling for a year, causing inflation on new leases to plummet 3.2%. The bad news is the decline in new rents is moderating.
- Higher for longer September’s NFIB survey of small business owners showed they’re still depressed. Apparently, their businesses are OK on the whole but they can't find enough workers—43% said they have job openings, even on elevated wages—the Atlanta Fed says they’re tracking at +5.1%. While concerned about future credit conditions, only 8% reported said they found credit harder to get.
The yield curve is merely a technical indicator And macro technical indicators aren’t working in this unique post-pandemic cycle. With the curve behaving so differently this time, TrendMacro sees no reason to take it seriously as a recession warning.
What about the coincident indicators? Amid 17 straight monthly declines in Conference Board leading indicators, no one’s talking about the companion coincident indicators. The index has risen to record highs over the same period, Yardeni Group notes, with payroll employment one of its four components. Hard to have a consumer-led recession when job growth is rising to record highs month after month.
Did you know? Bank of America shares that seven in 10 people do not know what a “deepfake” is, more than 700k cybersecurity workers are needed to fill open positions in the U.S. (enough to fill 50 NFL stadiums), and the first reported physical death because of a digital cyber-attack occurred in Sept. 2020 when a ransomware attack caused IT failure at a hospital in Düsseldorf, Germany.