Markets can be a counterintuitive animal. If by some magic you had this week’s major economic news headlines a week ago (I’m channeling Back to the Future here), how would you have bet on the markets? Fed hikes rates to battle inflation, economy is close to, if not in recession, corporate earnings coming in generally on the soft side. Odds are you wouldn’t have bet on a 4+% rally in stocks.
What’s going on? There is certainly a sentiment piece to the story. Bank of America conducts periodic surveys of institutional investors. The results hit unusual extremes recently. For example, most respondents expect a recession.
Probably more importantly, they had positioned their portfolios very defensively. This implies there aren’t many more big investors left to sell and you only need a ‘less bad’ news flow to trigger some marginal buying.
Of course, none of this means this week’s rally is sustainable, but it does illustrate how everyone seems to be crowding one side of the boat.
Tired of the Recession Debate Yet?
Headlines shouted recession this week. The trigger was the fact that growth in the second quarter shrunk once again. Real GDP fell at a -0.9% annual rate in 2Q, falling short of most expectations. This is the second consecutive quarter of negative growth, which will reinforce speculation that the economy was in recession in the first half even though that is not how the NBER—the business cycle’s official scorekeeper—defines recession.
Key points for 2nd quarter growth are as follows:
– The biggest miss was private inventory accumulation, which subtracted a full 2.0% from the headline number.
– Real consumer spending actually did a little better than expected, up at a 1.0% pace. Services were up at a decent 4.1% rate, while goods spending contracted at a 4.4% pace (food was down 11.7%).
– Real government spending continued to leak lower, down at a 1.9% rate last quarter, the third consecutive quarter of contraction.
If you are looking for the good news, it’s in the inventory number. Often times big dips like this are reversed in the next quarter. That’s why the early estimates for 2nd quarter growth are running at roughly +2%, as you can see below.
But this won’t stop the recession debate. You have to go back to 1947 for the last time we saw two negative growth quarters without an official recession being called.
But, as Goldman noted this week:
“[The] official definition of recession is a judgmental mix of levels and rates-of-change across several variables, most of which continued to expand [including nonfarm payrolls, real personal income less transfers, and gross domestic income] in the first half of the year.”
Much will depend on employment. If job losses pick up we will almost certainly see the official recession call. But going back to the very first chart in this piece, such a call would surprise pretty much no one!!
Of course, the other big news of the week was the Fed’s rate hike on Wednesday. As widely expected they raised rates by another 75 basis points, as you can see below.
This was the second 75bps hike in a row, the first time we have seen such a move since the early 1980s.
As usual Chairman Powell gave a press conference after the announcement. What was the key point? Basically, the Fed isn’t going to offer so called forward guidance from here on out. Over the last few years the Fed has gone out of their way to tell the market what they expect to do at upcoming meeting so as not to surprise anyone. Well, no more.
The cynic is me would argue that the Fed has no idea themselves what they are going to do at the next few meetings, so why should they talk about it. Powell was a little more politically correct. Terms like ‘unusual economic uncertainty’, and ‘complex economic interactions’ were used or implied. Basically, any future move in rates will depend on the data that comes out in the next six weeks.
The markets reacted positively to the move, though. There were some hints from Powell that we’re closer to the end than the beginning of this tightening cycle and that rates are at what the Fed thinks is neutral. And that alone was music to investor’s ears. Certainly, market pricing is indicating the rate hike cycle may be getting long in the tooth. Investors are actually betting the Fed might be cutting rates by the spring next year!!
Time will tell.
Charts We Found Interesting
1. GDP growth numbers are usually reported in real terms – that is net of inflation. However, growth numbers are also calculated on a nominal basis. The chart below shows nominal growth – real growth plus inflation. No recession here.
2. We had new home sales data this week. Sales are struggling….
3. …and inventory levels are up significantly. But once again, no surprises given the move in mortgage rates. The homebuilders index is up roughly +25% since mid-June.
4. Europe’s inflation powers ahead.
5. OPEC has missed their production targets for quite some time. Is this a case of won’t produce or can’t produce?
6. U.S. gas prices have climbed to their highest seasonal level for 14 years as hot weather and demand from electric generators has coupled with strong exports to Europe to keep inventories below the pre-pandemic average.
7. Earnings season has been reasonably good – no major earnings shortfalls at the S&P 500 level.
8. Lake Mead in 2000, 2021, and 2022.
9. Water use in Nevada – it’s mostly about agriculture.
Have a good weekend.
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