Thursday, February 8, 2024

Morning Note: An Improving, Yet Dubious, Setup

In thinking through the dynamics of the past few months, I come up with 2 key observations/assumptions.

1. The impressive rally in the equity market last November and December reflexively showed up in some improved data, as it clearly reignited animal spirits among businesses and consumers (the latter in particular).

For example, here are the latest sentiment readings on the consumer: 

Conference Board Consumer Confidence:

University of Michigan Consumer Sentiment:

And on business:

ISM Report on Business (yellow=services, white=manufacturing):

S&P Global PMIs (yellow=services, white=manufacturing):

NFIB Small Business Optimism:

And 2. The positive market action, and sentiment, had virtually everything to do with expectations that the Fed will cut rates aggressively as inflation continues to come off the boil... And that, therefore, recession in 2024 will be averted -- which would be your "soft landing," where inflation comes down to target and the economy sails along at a comfortably positive clip going forward.

As of 12/1 of last year the market literally had 6 rate cuts priced in by January 2025: 

And, with regard to the equity market, indeed, per the following chart, the Nov/Dec move was broad-based (healthy)!

November 1 through December 31 (blue=Russell 2k, green=SP500 Equal Weight, white=SP500):

With regard to current overall general conditions, while still signaling heightened recession odds, our own PWA Index has shown marked improvement the past couple of weeks:

The copper/gold ratio is looking up of late as well (save for the past few days):

And, just for fun, here's Bloomberg's US Recession Probability Forecast (derived from surveys conducted by Bloomberg and from forecasts submitted by various banks):

Now, there's more that I can throw in here, but suffice to say that this is the sort of data we look for as indication that the economy is bottoming and that it's time to begin positioning (buying on the cheap) for the start (the healthy/strong phase) of the next cycle.

Problem is, save for the blip (rescued by $trillions of injections) in 2020, there's been no recession to come roaring out of... And, thus, there's little (in the US anyway) to be buying "on the cheap" at this juncture.

And when we explore similar phenomena historically, we discover that it is utterly critical that we recognize the prevailing setup as these better-looking data begin to arise.

As, per the below, it is not at all uncommon for such spikes to occur just before entering recession.

Here's that Conference Board Sentiment chart again (note the red circles just before past recessions [red-shaded a areas]):

And note the other white circles on the University of Michigan's:

As well as on the ISMs:

And the NFIB:

Even on our own index:

As well as the copper/gold ratio (see yellow arrows):

Now, as I suspect you noticed, in every one of those charts there were also similar spikes during periods between recessions... So, I'm in no way suggesting that the recent improvement in any way signals recession coming, just making the point that it doesn't necessarily signal otherwise... Thus, while our recession-risk light remains lit, prudence demands that we remain diversified, tactically hedged, and relatively liquid.

And to drive home the point that maybe we're not out of the woods just yet (perhaps just entering them, in fact), here's some other stuff to consider:

And here's from BCA senior analyst Peter Berezin, yesterday:
"This question about what's going to happen to consumer spending... The savings rate is abnormally low in the US -- now that wouldn't be a problem if income growth were to accelerate. But we're not going to have the same influx of people into the labor market this year that we had last year; so I think growth is probably going to slow, which means that the only way for consumer spending growth to remain robust is if people continue to borrow.
And here's the chart (featured above as well) that I wanted to show, because I think that it makes a very powerful statement. 
This is based on recently released SLOOS data.  It shows that consumer credit growth is actually going to slow quite materially over the remainder of the year.  Probably not enough to induce recession in the next 6 months, but it certainly does raise the prospect of a recession maybe toward the end of this year, or early next year.
The correlation is quite strong between bank willingness to extend consumer credit and credit growth itself, and the lag is about 12 months there:"

Now, back to what the market is presently pricing -- which, as I stated above, has "virtually everything to do with expectations that the Fed will cut rates aggressively as inflation continues to come off the boil... And that, therefore, recession in 2024 will be averted -- which would be your "soft landing," where inflation comes down to target and the economy sails along at a comfortably positive clip going forward."  

While that is now -- even factoring in the not-so-rosy data featured above -- a distinct possibility, it comes with its own challenges for markets going forward.

Per research firm Variant Perception:  emphasis mine...

"Our US inflation leading indicator is starting to bottom, which is also corroborated by the upturn in the diffusion of all our inflation inputs (120 data series across all major DM/EM economies). 

On a coincident basis, the breadth of inflation components rising more than 0.2% MoM is also now starting to bottom. 

Of course, it is very possible that inflation collapses in a hard landing scenario, but in a soft landing the risks are to the upside for inflation. 

A soft landing would most likely result from continued fiscal easing and draw down in savings (facilitated by Fed cuts).

In this scenario, the persistent fall in the savings deposit would likely create upward pressure on inflation again.

Changes in savings deposits have historically offered a good lead on median CPI. Intuitively, changes in savings deposits reflect changes in spending intentions."

While there's more that I can feature herein to bolster either case (optimism vs caution), suffice to say that the present overall setup bears dubious resemblance to your classic investable economic bottom... That said, we are not dismissing out of hand the improvements we're seeing -- as my own experience (cut my teeth in the industry in 1984), and deep study, demands that we keep an open mind going forward.

Lastly, back to the equity market, that healthy Nov/Dec rally has, alas, given way to a resumption of that very messy (unhealthy) breadth setup that dominated the first 10 months of last year (with the equal weight [green] and the Russell [blue] actually down YTD):

Stay tuned...

Asian equities were mixed overnight, with 8 of the 16 markets we track closing higher.

Europe's leaning slightly red so far this morning, with 10 of the 19 bourses we follow trading down as I type.

US equity averages are slightly higher to start the session: Dow up 24 points (0.06%), SP500 up 0.02%, SP500 Equal Weight down 0.71%, Nasdaq 100 up 0.07%, Nasdaq Comp up 0.13%, Russell 2000 up 0.85%.

This morning the VIX sits at 12.95.

Oil futures are up 2.15%, nat gas futures are down 1.27%, gold's down 0.26%, silver's up 0.48, copper futures are down 1.06% and the ag complex (DBA) is up 0.89%.

The 10-year treasury is down (yield up) and the dollar is up 0.23%.

Among our 33 core positions (excluding options hedges, cash and money market funds), 14 -- led by Range Resources, XLE (energy stocks), PHO (water infrastructure stocks), Dutch Bros and SLV (silver) -- are in the green so far this morning... The losers are being led lower by URNM (uranium miners), AT&T, EWZ (Brazil equities), Johnson & Johnson and EWW (Mexico equities).

"If nature ran the economy, it would not continuously bail out its living members to make them live forever. Nor would it have permanent administrations and forecasting departments that try to outsmart the future—it would not let the scam artists of the United States Office of Management and Budget make such mistakes of epistemic arrogance."

--Taleb, Nassim Nicholas. Antifragile: Things That Gain from Disorder

Have a great day!

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