The first two weeks of July have come and gone. With them the massive fear of recession/inflation / Russia/China has seemed to abate. As a result, this has provided breathing room for both the stock and bond markets throughout the world. In the most recent notes, I have made an attempt to focus on what historically happens during this time of year, during this time in the US election cycle, and a very granular look at what is happening with our economic reports. Looking back, the historical precedents have held true, the seasonal market actions have held true, and the expectations for interest rates and stock prices have held true.
In this week’s note I want to touch on once again what has happened in 1982 vs. now, the US Dollar, interest rates, gold, and (what I believe is most important) the opinion on the “impending recession.” So let’s begin with the 1982 comparison. I choose 1982 since this was a point in time when interest rates were rising, inflation was still rampant, and a pending recession was in the offing. Paul Volker was the Fed Chairman and he seems to be quite similar to our Jerome Powell of today.
Volker talked about ending inflation in October and stocks went almost to new all-time highs. I am not inferring that all is wonderful, and we are going to new all-time highs, but rather that our current markets seem to be acting very similar to 1982 and the set of circumstances are quite similar as well. The one point that few seem to be pointing out is the still HUGE amount of cash on the sidelines coupled with the amount of money that has opted for the fear trade of going into short-term (under 1 ½ year maturity) CDs and US Treasuries. 2022 was a painful experience and both bond investors and stock investors endured substantial pain. This was the first time in a very long time that bond investors endured pain and it had also been a number of years since stock investors had endured this level of pain for this extended period of time. I say “period of time” because during COVID, the stock markets of the world swooned but in a small period of time bounced right back and continued. Many will say, “Ya, but this is because the Fed came in and rescued the markets.” True, but my point is simple, it happened. So now, we are faced with an even larger Fed-induced situation. How long will this last? One never knows, but people have hung their hats on the notion of a pending recession caused by an attempt to squash inflation. I will go into this in a moment, but for now, let’s look at the cash levels currently existent and then what happened in 1982 following the above bounce:
I’ve used the above chart before, but I want to stress that this cash needs a home. It found a home initially in short-term CDs and US Treasuries, but eventually, if the feared recession either happens or doesn’t happen, it needs a longer-term more concrete home. This home seems to be manifesting in real estate and high-quality growth stocks. So now let’s look at what happened after the initial bounce in 1882:
In a word, WOW! This is a big move. This is what was reported in the press back in October of 1982:
But as I have been saying, these fears have not really materialized this year and things actually seem to be improving as more companies are joining the “Magnificent Seven.” When the number of companies rising increases in number, and the sectors that these companies represent also increase in number, this is called positive breadth, and this tends to point to higher prices going forward.
Last Week and Today
We are now in the throws of earnings season. This is being catalyzed by the inflation measures of last week and the continued drumbeats of recession. Earnings have just started for the second quarter. The major money center banks kicked off this season with a very positive bang last Friday and this week we have had more earnings trickle in. Over 80% of the earnings reported thus far have surpassed expectations- a good thing. At the same time, one would expect that if earnings are better than feared, and inflation is still a scary monster, then interest rates would be reflecting the fear of additional “market-killing” interest rate hikes. But low and behold, both the CPI and PPI last week, along with more labor numbers, showed that inflation isn’t gone- but is clearly in check. So, interest rates have begun to trail off and show declines. I often look for confirmation of this in the prices of gold and the US Dollar. If rates really are in a new phase of decline, the US Dollar should exhibit weakness as the demand for US Treasuries should decline with falling interest rates. Gold should creep up as a tradeoff to the US Dollar as a medium of exchange (not taking into account the inflation concept). Both of these are happening as expected.
This leaves us with the biggest elephant in the room, the impending recession. If the Fed did too good of a job squashing inflation, then the economy should slow and possibly go into a recessionary trend. This is what the “inverted yield curve” (short-term interest rates higher than long-term interest rates) has continued to say. But could Jerome Powell actually orchestrate an inflation moderating “soft landing?” It will be some time in late 2024- 2025 before we can factually answer this, but according to Goldman Sachs, he seems to be doing a masterful job. My fear, to be honest, is that he takes a break- too soon and it allows the inflation boogie man to get back to work. Quite possibly a hike this coming week and the intention of another possible one later will keep this genie in the bottle! But back to the recession fear. This came out from Goldman Sachs earlier this week:
There you have it. So let’s now take a look at where the recession expectation is vs. other measures:
As can be seen above, consensus still has a recession probability at 55%, and Goldman is now down to 20%. Thomas Lee of FS Insights was quoted on Tuesday morning as saying, “Conferring with institutional investors, 90% still believe a recession is in the wings.” This is still a very fearful percentage and is very illustrative of the stock market continuing to climb its “Wall of Worry.” In my conversations with older investors, they are totally convinced that a recession is coming. What I keep on harping on with all investors is the concept of $5.5 trillion sitting on the sidelines. Recession or no recession, this never-before-seen bucket of cash NEEDS A HOME. I want to end with the expectations of future interest rate hikes as charted by Goldman Sachs:
As shown above, Goldman on 7/17/23 lowered their odds of recession to only 20% and that compares to 55% for consensus. Goldman’s base case is for the last rate hike in July, and no need for additional in November. Whether this happens or not I don’t believe is important as the current earnings for the second quarter have to say. If earnings show resiliency, prudence, and growth- beyond forecasts, the equity markets should be able to continue their ascent. A breather is clearly due, but this breather should not only be short-lived but most probably shallow, bearing a black swan that could always be in the wings.
Have a great week and enjoy this summertime weather. How quickly we forget about the dreadful cold and rain of this past winter and now, just as expected, fears of wildfires are now abounding. Does it ever end!!??
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