Markets are always shifting. Over the past year, good news was bad and vice versa. Strong employment and robust earnings pushed up inflation which meant larger Fed rate hikes. Higher interest rates helped bring stocks down, substantially so for long-duration assets (growth). Solid economic news was actually bad for stocks. Finally, this rate hike cycle is nearing its end as inflation consistently moves lower and growth ratchets down. Bad news is starting to become a concern, as is normally the case. The shift today is from a fear of inflation towards the fear of how bad a recession will/could be.
Recent Fed official commentaries have been relatively consistent. Broadly speaking, they are expecting some slowdown to occur over the coming months as previous rate hikes cycle through the economy and tighter lending standards also assist in the battle against inflation. Many want to let the dust settle from the Fed’s rapid 450bps of hikes over the past 12 months. May’s Federal Reserve meeting could be the first in a while with some real dissension. Even if another 25bp rate hike is decided upon, it is beginning to look like the last of this tightening cycle, at least according to several dovish Fed official speeches this week.
In that vein, in-line and improved CPI reports are starting to lose some relevancy. Not many cared about monthly CPI updates for much of the past 5 decades. It would be great to get back to that posture. Following Wednesday’s lower than expected CPI release, futures spiked higher before all major averages finished in the red. Stocks have already priced in the end of inflation, at least the bulk of it. Any update, like the one we got this week, proves this outlook is not new news. Further, Core CPI was not as positive as the headline number. We, and the market, expect this to improve from here (decline further). Stocks, especially Technology and Growth, have already priced in the positive effects of lower interest rates. Fundamentals must follow suit.
The shift in focus is now towards GDP, earnings and jobs. First quarter earnings per share estimates have been chopped down by ~6% already. 2023 calendar year earnings have also been lowered. Today, we get a slew of reports from some behemoths in the eye of the banking storm: PNC, JPMorgan Chase#, Wells Fargo#, BlackRock#, Citigroup and a healthcare company to round out the day in UnitedHealth#. At first glance as I type this at 7:30am bank earnings are much better than feared. JPMorgan is jumping 5% pre-market. Discussions on withdrawal/deposit trends, money-market fund levels, lending standards, default risk, and most importantly, outlooks going forward, will be critical if this market rally is to continue. A healthy banking system is crucial for this economy to achieve its soft landing.
Jobs, Jobs, Jobs:
Employment levels are still in great shape. However, cracks are starting to emerge. Students of history understand that every time the unemployment rate rises by 1% or more, a recession ensues. While the Fed is focused on backward-looking jobs data as a reason to raise interest rates, they should start to shift their attention to what will/could happen over the coming months.
First up are those temporarily employed. When businesses are booming, they tend to hire from wherever they can get talent. If they begin to see slowness in orders or project tighter market conditions down the road, the first shoe to drop from a cost cutting perspective is temporary employees, especially in today’s talent starved labor pool. The past 3 recessions (and likely more, but this is the data we have access to) show a clear slowdown in temp- employees preceding a recession. Once a recession hits, they fall off a cliff. Focusing on backward-looking data, such at the elevated level of temp-help takes away from the forward-thinking outlook of issues ahead.
Even more concerning are projected hiring intentions. Before companies start laying off temporary employees, they slow their hiring plans. Small businesses are the first to see softness, so following their surveys gives a large clue on the future of the USA’s jobs market. Trailing employment numbers show massive gains in just three key areas: Government (taxpayer’s money), accommodation (travel catch-up) and Healthcare (reopening from Covid layoffs). However, small businesses are not participating as much and intend to outright stop hiring in the near future:
Availability and Cost of Credit:
As we have been noting ever since the yield curve inverted, lending conditions will tighten. Most economies depend on an open banking system where money flows from lenders to borrowers. Being able to access credit/cash and build a business is key to growth. When one channel gets shut off, a slowdown will occur. Throw in a few banks collapsing in the span of a few days and you have the recipe for a credit crunch.
Again, small businesses are the first to see this. Apple# can get capital whenever they want. John Doe’s home renovation company relies upon small bank relationships lending them money for their next job. Conditions have simply collapsed to levels not seen since the end of the Financial Crisis:
That does not mean that all businesses are ruined. Plenty have access to existing credit lines, liquid assets, and existing cash flow, or they just have to pay up for that new loan. Again, small businesses are now paying “up” for loans over and above market rates at levels not seen since the Financial Crisis. You can get cash, but at these interest rates, is it worth it?
Adrien Brody turns 50 today. MMA legend, Anderson Silva, is now 48. 80’s comedies star, Anthony Michael Hall, is 55. “It’s Always Sunny in Philadelphia” actor Rob McElhenney is now 46. Lastly, Happy Anniversary to my wife of 11 amazing years. This will serve as proof that I remembered! 😊
James Vogt, 610-260-2214