Things Not Lining Up

Attention clients, this one's important to take in when you have a few minutes.

While I concede that Wall Street’s soft landing narrative – while, in my humble opinion, relying entirely on the Fed – has merit, there’s simply far too much uncertainty yet emerging from the data (not to mention where we are in the cycle, equity market valuations [very high), yada yada] to have us adding risk to client portfolios right here.

Case in point being the latest Fed Beige Book.

Here’s Peter Boockvar with the highlights:

“...the only area of economic growth I see is from the higher income consumer spending on travel, leisure, and hospitality and that includes live entertainment (I did see Pearl Jam last night at MSG and the place was packed), anything related to AI spend, and of course government spending, covering healthcare, interest expense (aka, helping the beneficiaries of all that interest income, particularly that higher income saver/boomer), defense and the CHIPS Act and IRA.

From the Beige Book and I bolded for emphasis:

“Economic activity grew slightly in three Districts, while the number of Districts that reported flat or declining activity rose from five in the prior period to nine in the current period. Employment levels were steady overall, though there were isolated reports that firms filled only necessary positions, reduced hours and shifts, or lowered overall employment levels through attrition. Still, reports of layoffs remained rare. On balance, wage growth was modest, while increases in nonlabor input costs and selling prices ranged from slight to moderate. Consumer spending ticked down in most Districts, having generally held steady during the prior reporting period. Auto sales continued to vary by District, with some noting increases in sales and others reporting slowing sales because of elevated interest rates and high vehicle prices. Manufacturing activity declined in most Districts, and two Districts noted that these declines were part of ongoing contractions in the sector. Residential construction and real estate activity were mixed, though most Districts' reports indicated softer home sales. Likewise, reports on commercial construction and real estate activity were mixed. District contacts generally expected economic activity to remain stable or to improve somewhat in the coming months, though contacts in three Districts anticipated slight declines.”

I’m sure the last sentence is reflecting hope that Fed rate cuts will be an elixir.”

Another being this morning's NFIB Small Business Survey release.

Highlights:

"The NFIB Small Business Optimism Index fell by 2.5 points in August to 91.2, erasing all of July’s gain. This is the 32nd consecutive month below the 50-year average of 98. The Uncertainty Index rose to 92, its highest level since October 2020. Inflation remains the top issue among small business owners, with 24% of owners reporting it as their top small business operating issue, down one point from July.

“The mood on Main Street worsened in August, despite last month’s gains,” said NFIB Chief Economist Bill Dunkelberg. “Historically high inflation remains the top issue for owners as sales expectations plummet and cost pressures increase. Uncertainty among small business owners continues to rise as expectations for future business conditions worsen.”

Key findings include:

• The frequency of reports of positive profit trends was a net negative 37% (seasonally adjusted), seven points worse than in July and the lowest since March 2010.
• Twenty-four percent of owners reported inflation as their single most important problem in operating their business, down one point from July.
• The net percent of owners expecting higher real sales volumes fell nine points in August to a net negative 18% (seasonally adjusted). Real sales volume expectations were the largest contributor to the decline in the Optimism Index along with earning trends and expected business conditions.
• A seasonally adjusted net 20% plan to raise compensation in the next three months, up two points from July.
• The net percent of owners raising average selling prices fell two points from July to a net 20% seasonally adjusted."

The outlooks for sales and business conditions are at historically low levels and continue to get worse. Consumer sentiment (Survey of Consumers, Univ. of Mich.) continues to drift lower, but consumer spending resists joining the “slowdown” parade. Manufacturing remains weak and housing and construction are catching its slowdown. Inflation is closer to 2 percent but not there. However, it is close enough for the Federal Reserve to commit to starting interest rates cuts. Reports of price and wage hikes are falling in frequency but remain historically on the high side with plenty of room to fall. Government spending and hiring remain strong, the “legs” of any fourth quarter growth that might occur.

The Uncertainty Index rose to its highest level since October 2020 (98), rising 2 points from July to 92, 19 points above the January reading and 10 points above June. Clearly, “uncertainty” has been on the rise! The Fed’s commitment to cut interest rates should have been a calming factor, so it’s probably not to blame. Aggregate spending and inflation have been fairly stable, but reports of the net percent with higher sales now rivals what was last seen in the 2020 and 2008 recessions. And the stock market is expressing some unease. Internal strife over foreign policy is strengthening, “family fights,” and the election is just weeks away. Expect more volatility in everything in the coming months.

Here's our chart (red-shaded areas highlight recessions): 

And with regard to equity market valuations...... well:

SP500 Price to Earnings Ratio (top panel) and the SP500 Index (bottom), red-shaded areas highlight past recessions:

SP500 Price to Sales Ratio (top panel) and the SP500 Index (bottom), red-shaded areas highlight past recessions:

SP500 Price to Book Ratio (top panel) and the SP500 Index (bottom), red-shaded areas highlight past recessions:

Market cap to GPD (the "Buffett Indicator"):

The Shiller Cyclically Adjusted P/E (CAPE) Ratio:

And why they matter:

So, yeah, again, I do understand the prevailing bull narrative, but, frankly, there's just too much not lining up in sustainable bull market fashion for us to join that crowd... I.e., risk remains notably elevated right here.

Per the below snip from the latest S&P Global Investment Manager Index (which we participate in [i.e., includes our outlook]), our peers generally (at the moment) sympathize with our concerns, although, as a group, per the last paragraph, they're ultimately a bit more sanguine in terms of recession odds.

"Risk appetite has slumped in September, according to S&P Global’s Investment Manager Index™ (IMI™) survey, as investors fret about valuations amid intensifying political uncertainty and recession risks. Risk aversion is now at its highest since May of last year as investors see the chances of a near-term market fall at their highest since January, albeit with some recovery signaled for the year end.

Sector preferences have accordingly rotated toward defensives, led by healthcare and utilities. Growth worries have meanwhile pushed sentiment for energy stocks to its lowest since late 2020, and also driven favor away from basic materials, industrials, consumer discretionary and tech.

While recession risks are at their highest since last December, the majority of investors still expect the US to avoid recession, aided by lower interest rates."

Stay tuned...