Market Recap
The quarter ended on a downer on Thursday, but stocks were broadly higher in March after losing ground in January and February. Bonds struggled all quarter, and year-to-date loses for the fixed income indexes matched or exceeded those for most equity indexes – an unusual occurrence.
The week was filled with economic news. Some of the highlights:
Labor Market Remains Strong
Another solid report with 431,000 jobs added last month and January and February’s numbers revised higher by 95,000. For the first quarter of 2022, job growth averaged 562,000 per month and the unemployment rate ended at 3.6%, the lowest level since before the pandemic.
The jobs market remains awfully tight with the number of job openings exceeding unemployed by 5.3mm – a new record.
Home Prices Are Still Cooking
Another month another hot housing report. Prices increased +19.2% year-over-year in January per the Case/Shiller report. The chart below shows the remarkable price appreciation that started right after the pandemic hit.
The inventory situation remains very tight. The months supply of homes is near all-time lows and total inventories are down roughly -15% year-over-year.
Of course, this is all backward looking. It is going to be fascinating how inventory levels change now that mortgage rates are approaching 5%.
As is Inflation
The latest inflation number was hot, as expected. Headline PCE was up +6.35% in March while core was up +5.40% – the fastest rates seen since 1982.
Bond Market Flashes Yellow
There were really no surprises in all the economic data. What was surprising was how the bond market reacted. After today’s labor report the yield curve (here I’m using the spread between the 10-year Treasury yield and the 2-year) flipped negative for the first time since 2019.
Normally the yield curve will go negative after the Fed has been raising rates for a number of months. This time it has come awfully early in the cycle. Did this ever get a lot of attention in the press!!!
Briefly, an inverted yield curve means the yield on short-term bonds exceed the yield on longer-term bonds. This is widely viewed as a leading indicator of recession. Back in 2018 we wrote a whole white paper on the subject (let us know if you want a copy). But the main point is shown below.
The same conclusion applies today. Inversions are worth paying attention to, but we shouldn’t overreact just yet. Take J.P. Morgan’s comments on Friday:
“…the (yield) curve remains one of the best leading indicators of recessions. Now, recessions don’t typically start ahead of the curve inverting. From the point of curve inversion to the actual peak of the equity market, which typically takes place around a year later, S&P500 was higher by 15%…Crucially, the flat/inverted yield curve was historically a good cycle signal because it would indicate that financing conditions have become highly restrictive, but we do not see this at present. Real rates averaged +200bp at the time of past curve inversions, vs current negative levels, while bank lending standards are still easing. The start of hikes is typically accompanied by some market volatility, but this initial weakness ultimately gets absorbed, and the market moves higher.”
J.P.’s key insight is that financial conditions today are much different than in the past. The chart below shows the real yield on 10-year bonds (yields adjusted for inflation). During the last inversion in 2007 real yields were solidly positive. Today they are still deeply negative.
Think about mortgage rates today. The inflation chart shown earlier notes that inflation is running at 6.35%. 30-year mortgage rates are roughly 4.7%. So far rates aren’t restrictive adjusted for inflation (you could say you are almost getting paid to borrow!!!).
The other key point that we note in our white paper and J.P. alludes to is the lag between inversions and recessions/bear markets. The table below shows the historical record.
Take the 2006 example. The curve inverted in January of 2006, but the market didn’t peak until October of 2007 and the recession didn’t start until December of the same year. The lags were 20 months and 23 months respectively.
Don’t get us wrong – we aren’t arguing this time is different by any stretch. But a yield curve inversion indicator isn’t a light switch where one moment it’s bullish and the next moment it’s bearish. It’s more like a dimmer switch. In all probability we need to see financial conditions tighten and job growth reverse before the odds of recession become concerning.
Charts We Found Interesting
1. The best investment of the last few weeks – Russian Rubles. Didn’t see that coming.
2. More oil is going to be released from the Strategic Petroleum Reserve over the next six months (oh, right, it’s an election year!!). The US has roughly 24 days-worth of consumption stored in the reserve at the moment. The plan is to cut this by a third.
3. Last week we briefly talked about Europe’s challenging energy situation. More news to support the thesis this week.
4. Diesel costs in Europe are quickly feeding through into the inflation numbers.
5. China’s COVID situation isn’t helping the supply chain one little bit.
6. Avocado prices are at a 24-year high. That’s not right!!
7. What do you do when you can’t enter Russia’s airspace?
Have a good weekend.
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