Stocks finished lower yesterday as investors awaited the meeting at the White House between the President and leaders of Congress and this morning’s CPI report. Unfortunately, the meeting, which took place after the market closed, produced no headway. We are now within three weeks of a debt default although we have seen this movie before. If you are old enough to remember the Saturday morning serials at the movie theater, the hero, who appears to be falling over the cliff, somehow is rescued by the next episode. So far, markets buy that outcome, but as the deadline gets closer, investors will agitate if some progress isn’t forthcoming.
One can understand the logic from both sides. The debt ceiling relates to yesterday’s bills. On the other hand, if your kid uses up his credit limit on his credit card, is your response simply to raise the limit? That’s the quandary politicians face but it is the outcome that investors have to deal with. For markets, it’s still too early to panic, but if we get to the final few days without any headway, history shows that markets could have a hissy fit.
Away from the debt ceiling discussion, there is little else moving markets. There are a few stragglers reporting earnings and, for them, the results make a difference. Retailers will start reporting within the week, but for most others, earnings season is over. As for the economy, data is rather consistent. It is still growing but the growth rate is slowing. As for inflation, it’s slowing as well but the pace of decline still keeps the Fed concerned. The next Fed meeting remains weeks away, and there is still a lot of data between now and then. The strong consensus is that the Fed will pause in June but it also remains data dependent. If inflation is still too high along with rapid job growth, another increase in Fed Funds rates can’t be ruled out. CPI numbers to come this morning could be market moving, but there will be other data to come before the next FOMC meeting. Thus, today’s number will have to be read in context with data yet to come. It could move markets today but one-off CPI numbers only matter if they are part of a meaningful pattern.
I often talk about a vacuum period between earnings seasons. We are entering that moment. But this time, the debt ceiling debate interferes. Assuming, however it happens, that we again avoid default and the debt ceiling is raised somehow, the real question will shift to whether we have a recession, and, if so, how severe.
Since this would be a recession of the Fed’s creation, the real question is the Fed’s response. If one listens to the Fed, the answer is not until next year at the earliest. If you listen to the market and Fed Fund futures, the answer is late summer and again before year end. Markets ultimately have to resolve this dilemma.
All economic evidence suggests some sort of recession is coming. Unemployment claims have edged up noticeably in recent months. That has never happened post-WWII without an ensuing recession. Leading economic indicators lead to the same conclusion. Thus, it is logical to expect some sort of real slowdown in the second half of 2023. The question becomes, has the market already discounted this? At 18x forward P/Es, the answer should be not completely. Bull markets rarely begin before recessions begin. Right now, there is tension between investors trying to find the economic bottom and those who see valuations high for the start of a new bull market. That battle will take time to play out.
The net is that, in the short run, all hangs on the outcome of the debt crisis negotiations. We have never crossed that barrier, but politics has never been this bifurcated. There’s always a first time. With that said, if we do reach the debt ceiling without a resolution, everyone in office will be blamed. Whether the White House chooses to default or pay less to Social Security recipients, or whether soldiers go unpaid, every elected official will not only share short-term blame, but the fact that they let us default will haunt reelection campaigns. There will be no winners.
If everyone is an apparent loser, default shouldn’t happen. Hopefully, it won’t. So far investors are willing to make that bet. As the deadline approaches, reactions will change and fears are likely to rise. Yesterday gave us no reason not to expect at least an eleventh hour solution leaving the possibility of default open.
Today is a day for one-name singers. Bono turns 63. Donovan is 77.
James M. Meyer, CFA 610-260-2220