This week is very interesting as it follows a Holiday week with extremely low volume yet a lot of information. The data from last week seems to be setting the stage for year-end. To begin with, I wanted to go over what we got last week:
- Durable Goods Orders - came in much stronger than expected. The expectation was for a 0.4% rise. They came in at 1.0%. Orders, in general, were up 10.7% year-over-year. Very strong, clearly not indicating an industrial recession in the making. (Bloomberg)
- Unemployment Claims - expectations were for 244,000, but they came in at 250,000. Continuing claims were expected to be 1.52 million and they came in at 1.55 million. (Source; Bloomberg) Numbers show greater unemployment than forecasted. Now one needs to ask, is this an opportunity that is being given to all companies to decrease their headcount given that it is clear that the Fed is orchestrating an economic slowdown? I believe that this is an opportunity for companies to cut back on employees that are refusing to come back to work, are not as productive as desired, or simply are just expendable given the economic environment.
- Longer-Term Interest Rates - the shorter interest rates (three-month to 2-year maturity) are holding firm. The Fed has already forecasted that they are expecting to continue to increase the Fed Funds rate by at least 0.5% at the next Fed meeting on Dec. 13-14. At the same time, the 10-year and 30-year interest rates are dropping. This I find very important. The shorter maturity interest rates are the rates that the Fed has the power to change and reflect their intent to continue slowing inflation and at the same time economic growth. The longer maturity rates reflect the expectation of economic prosperity going forward. These rates appear to be saying that the economy is slowing.
- TSA Flight Volume - the week of Thanksgiving this year finally eclipsed the volume from 2019. This is a clear indication that the consumer is still in full swing. Since the COVID shutdown happened a few months after the 2019 Holiday, looking for a comparative number to the pre-COVID period is relevant and indicative of the strength of the consumer. This as well as the Durable Goods Orders seem to indicate that there is still so much cash sloshing around that the purchasing ability at the manufacturing level and the consumer level are still quite healthy.
The dilemma that we are faced with is whether the Fed is going to orchestrate a soft landing or not. If they raise too quickly and too much they are sure to recess the economy. This would be disastrous as the Fed has taken interest rates up to a point where it is already quite difficult to service the debt (last week I went into some detail on the cost annually for the interest expense on the debt). If the economy slows too much there won't be the tax receipts needed to service the debt and they are then faced with the need to institute another Quantitative Easing cycle. Note that tax receipts are up 19% this year, the highest on record, and still not enough to service the debt. In Barron's over the weekend, it was stated, "As companies lay off workers and batten hatches ahead of a possible economic slowdown, executives from 179 S&P 500 companies mentioned the word 'recession' in conference calls between Sept. 15 and Nov. 16,” according to FactSet. This was nearly 3X above the 5-year average of 63 companies.
The Conference Board conducts a quarterly survey of CEOs and collects various data on their views, but the composite figure is shown below as CEO confidence. This survey has been conducted for nearly 50 years, so it is useful. In October it reflected the lowest number ever- not a good sign for CEO expectations.
Since 1950, we've found the trough in earnings growth lagged the bottom in the S&P 500 by about six-to-seven months and failed to lead the market 75% of the time (Source: Oppenheimer Technical Analysis). What is most important is that if the S&P 500 is having a negative year going into the start of the slowdown, the following 12 months tend to be strong after the recession.
This is even more relevant if the mid-term years are negative before the pre-election years. Aside from 1930, the returns have been quite impressive.
This rally which has been in place since mid-October is not as powerful as the one that happened from June to August. This is not a good sign, it would be preferable to have strength get stronger, not be followed by a less strong move. Yet I believe that if Fed Chief Powell makes any mention that the interest rate hikes are about over, that could be the catalyst for an aggressive market advance.
As seen below, in 1982, the last time that interest rates were hiked by a severe amount as they have been this year, the S&P 500 recovered in four months the decline that it had experienced over the previous 27-month market decline. (Source; FundStrat)
It all comes down to whether inflation is convincingly cooling. The job market certainly is. We will know more if this week's jobs report agrees to confirm the October numbers that showed labor slowing. And this comes at a time when the AAII (American Association of Individual Investors) spread is at its greatest extreme since the data began being collected in 1988. This could provide a coiled spring for a market that could have an explosive move to the upside given a continued easing of inflation numbers.
Much like last week's note, we are not yet confident on a low having been put in in the markets. This is currently just a bear market rally and until the underlying reasons for the declines the markets have been experiencing since a year ago change, we must continue to be defensive. The downside move is having many signs that it has exhausted itself, but until we have a higher level of confirmation that changes are taking place, not being overly aggressive would seem to be the best course of action. As always, please feel free to call with any questions you may have. We look forward to addressing any questions you may have.
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