change in stock markets
Universal Values Advisor
With financial conditions easing for much of January and early February, financial markets now believe that taming inflation may not be the bull’s eye that third and fourth quarter data suggested. In addition to the exaggerated seasonally adjusted wage and retail sales earlier this month, the last three inflation indicators (consumer price (CPI), producer price (PPI), personal consumption expenditure (PCE)) were all hotter than expected. (Note: We believe one month’s inflation data is not a trend, especially given the rapid downward trend in inflation over the past six.)
However, as discussed in our last blog, bond markets threw in the towel last week (February 17), acknowledging that the Fed is on a mission to raise rates and keep them higher for longer.
This week (February 24th) stock markets started to rally. The chart shows that the major stock indices marched higher in January and, apart from a slight hesitation in the Dow Jones, continued to rise into the week of February 17 on the back of payroll and retail sales. Then, like its fixed-income brother, the stock markets appear to have doubts about near- and medium-term economic conditions. Note that while all indices are still positive for the year except the Dow (penultimate column in table), they are all down about -3% of their value last week (last column of table).
Interestingly, on Friday morning (February 24) at a monetary policy forum sponsored by the University of Chicago’s School of Business, a paper authored by several well-known economists, including former Fed Governor Frederic Mishkin, said:
- There is no post-1950 precedent for a sizeable one
- … disinflation that does not entail significant economic casualties or a recession.
- We find no case in which a central[bank] induced disinflation occurred without a recession.
- … our analysis casts doubt on the Fed’s ability to stage a soft landing, with inflation returning to the 2% target … without a mild recession.
It’s not that there isn’t a ton of evidence strongly correlating with the recession (like the Conference Board’s Leading Economic Indicators, the inverted yield curve, or the business surveys). We wondered why it took so long for the financial markets, especially the equity side, to recognize the impending recession. Yes, the payroll and retail sales numbers appear strong, but in both cases the underlying raw (ie non-seasonally adjusted) data was staggering (-2.5 million jobs; -$100 billion retail sales). The seasonal factors are changing very slowly and do not take into account recent behavioral changes caused by the pandemic. In the household survey we find that no full-time jobs have been created since last May. And after the poor Christmas sales, more unwanted goods were sold than in previous years. Because the seasonal factors cannot deal with such matters, the seasonally adjusted data are not reliable indicators of the underlying trends.
Real (inflation-adjusted) retail sales
Real investment advice
In the chart above, note what the annualized changes in retail sales look like after adjusting for inflation (red box on the right). The free money stimulus is clearly in the rearview mirror.
US existing home sales in millions
Universal Values Advisor
Housing has always been a reliable indicator of the health of the economy. The chart above shows the precipitous decline in existing home sales, which are now falling below the lows of the 2020 pandemic economic shutdown and are approaching the lows of the financial crisis 15 years ago. And when demand drops, prices naturally follow. The chart below shows the annual percentage changes in the median home price. It fell from +25% (June 2021) to just positive now compared to last year’s level. Undoubtedly, this will become negative in the near future.
US median price of existing home sales year-on-year
Universal Values Advisor
credit
Arrears are on the rise for both credit card and auto loans. The chart below shows subprime auto loan arrears. Notice how similar the current “up” pattern happened to what happened during the Great Recession. This is a reliable indicator of the health of the working middle class.
Outstanding Subprime Auto Debt (30 Days or More Past Due)
Moody’s, Wall Street Journal
Now look at the bank loan. The left-hand side of the chart below shows that demand for auto loans and mortgages has fallen since the Fed began raising rates in the second quarter of 2022. Demand for credit cards and commercial loans remained buoyant for a while but has now also slumped.
Banks with stronger credit demand & domestic banks are tightening commercial real estate standards … [+]
Capital Economics & Universal Value Advisors
Mortgage applications fell at double-digit rates for the week of February 17 (-13.3% over the previous week) as mortgage rates abruptly reversed as fixed income markets changed course and financing conditions tightened. As mentioned in previous blogs, banks are now rapidly tightening their lending standards (right side of chart). These do not bode well for a credit-dependent economy.
commercial real estate
In Tuesday’s (February 21) Wall Street Journal, a headline read: Office landlord defaults escalate as lenders brace for harder times. The article cited recent office building defaults, one in LA, the other in NYC. According to Owen Thomas, CEO of Boston PropertiesBXP, “The commercial real estate markets are currently in a recession.” The growing number of distressed office buildings reflects the realization on the part of both owners and lenders that the office’s robust rate of return is unlikely to materialize becomes. The office vacancy rate is now 12.3%. Before the pandemic, it was 9.2%. In addition, the sublease offers are the highest ever recorded.
Final Thoughts
GDP grew by +2.7% in the fourth quarter. Like the jobs and retail data, the headline is misleading. The two sources of perceived strength were falling imports (less money being spent on another country’s production) and rising inventories. Falling imports are actually a sign of consumer stress, and rising inventories are only a sign of strength when they were intended. In this case, rising inventories were undesirable. Business surveys are now showing lower production schedules and shipping rates are now below pre-pandemic levels. Housing construction collapses and the banks shy away from new loans.
Both industrial production and capacity utilization declined in the fourth quarter. In the labor market, average hourly wages fell -0.2% in January and -1.8% yoy, much of which appears to be due to US employers’ shift to part-time jobs. The yield curve is inverted and the Leading Economic Indicators have been negative for 10 consecutive months and 11 of the last 12 months. All of these indicators have a 100 percent track record of predicting a recession.
In this scenario, the Fed keeps raising interest rates! As we’ve noted in these blogs, the Fed has backed itself into a corner in its move toward “transparency.” Communicating its interest rate intentions to the market helped the Fed in its initial phase of tightening as markets quickly moved rates to where the Fed said they were headed. But as the economy showed signs of slowing and the Fed “reversed” its rate hikes (from 50 basis points to 25), markets anticipated an end to rate hikes and possible rate cuts. As noted above, markets eased financial conditions in January, much to the Fed’s dismay.
Luckily for the Fed, January payrolls, retail sales and inflation numbers came in hotter than markets were expecting. That and the continued banter of the Fed governors convinced the Bond vigilantes that interest rates will be higher for much longer. Market interest rates have risen and now stock prices appear to be on shaky ground.
Despite recent studies by reputable economists stating that the current stance of monetary policy has resulted in a 100% recession, this Fed continues to pursue increasingly restrictive policies, not only through rising interest rates but also through contraction of the monetary aggregates. History shows that a shrinking money supply is another surefire predictor of recession (and disinflation).
(Joshua Barone contributed to this blog)
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