Market Moment 5-01-2023

“The markets climb a wall of worry.”  It’s a phrase that has existed since I was a young trader in 1989; and I’m sure it was around long before then.  It describes the financial markets’ ability to overcome and continue to rise in the face of negative news and economic factors.  It gets to the root of the other phrase that says, “The markets are a discounting mechanism.”  That is, the markets historical tendency to look past or “factor in” negative news and obvious obstructions and turn upward or continue its positive direction and behave as if there is an end to bad news (or that the bad news is behind us).  Turn on your tele or radio and you’ll have your share of bad news in several minutes (or less).  So, let’s climb this wall of worry and process this like a discounting mechanism.

• March Core PCE (personal consumption expenditures price index) printed its most favorable result in 5 months, last week, at +0.28% (this is less than the +0.30% consensus). The figure demonstrates a lower level of consumer spending on goods and services in the USA.  The PCE is the FED’s preferred measure of inflation, and this demonstrates that the economy is slowing and thus inflation is slowing (further).  This is how the FED sees it and they like this print.

• The largest influence of PCE has been housing which added to the March PCE by +8.3% (within the index) from this time last year. As I’ve noted in prior Market Moments, this and other economic factors are lagged (for many of the published government indexes) and present a disconnect (due to this lag).  One of the most renowned measures of housing inflation was created by Yale’s Robert Shiller and two other economists.  Shiller was awarded the Nobel Prize in Economic Sciences in 2013.  Shiller’s index states that housing prices are flat (0% rise) from this time last year and Redfin documented that rent is down for the second consecutive month.  The government index will remain irrational or incorrect for as long as it wants because that is how government stuff operates.  I’m more inclined to believe Shiller’s index and Redfin as a more current representation of this component of inflation and when this component catches up to reality in the government data, the FED will have another piece of evidence to alter their inflation narrative.  The markets are discounting how the FED sees things and are leaning into Shiller’s work and Redfin data.  Note: there always have been and always will be areas of the US real estate market that don’t align with these national averages and can disprove these averages but this is the nature of “averages” they do account for rising prices in one area and excessively falling prices in another.  On average however, using these more current metrics suggest that the market likes the falling real estate inflation.

• In January 2023 the CPI (consumer price index) spiked (back to 8/31/22 levels!) and it surprised market commentators and traders alike. Why?  There are 2 theories that have floated around.  First are “seasonal adjustments” that is economic speak for {something irregular happened months (or a year+) back and this data is adjusting to that irregularity}.  Answer “Covid.”  And the second theory is a rumor that Haver Analytics was hacked as part of a ransomware attack and Haver reported inaccurate data to the FED for their January committee meeting.  Haver data suggested that inflation was excessively hot and caused a sell-off in markets because it was expected that the FED would be on war footing to raise interest rates back to their 0.75% posture at future meetings.  The markets didn’t like this (for about 2 weeks).  Yet again, back to the markets discounting and climbing the wall of worry…the market then looked past the negative impact of seasonals and possible inaccurate data and have gone up.

Year to Date and since 10/12/22, the trend of the equity market has been up.  Trends technically become trends when moving averages (lines) slope up and to the right.  It takes a bunch of stuff for that trend line to change direction, but it has been moving in the good direction for over 6 months.  The FED meets Tuesday and Wednesday this week and will likely increase the FED rate by +0.25%.  It’s further thought that this is possibly the final hike in this interest rate “hiking” cycle.  There is another meeting in June and for sure there is a possibility rates can be raised yet again at that meeting.  However, the chatter in the markets about the FED “easing/lowering” interest rates (before the end of 2023) is being discussed the most in the past week since rates hikes began in March of 2022.  The markets have been taking note of this and have continued the positive slope trend.

I’m going to share an area of economics that does have me questioning how the metric is measured and that is the Unemployment Rate.  It’s presently at 3.5%, far lower than the 15%ish peak during the pandemic and well below the peak of the financial crisis of 2009/2010.  The pandemic, in my opinion, changed how a massive amount of the working population works.  Can a factory worker, work from home?  No.  However, there is a very large segment of the employed work force that I don’t feel is being measured accurately.  I also don’t have a solution for this but believe that the unemployment rate is going to become a metric that is ripe for making FED derived inflation mistakes if used in its historical context.  The FED won’t state that they are comfortable with another 1 – 1.5 million people losing their jobs; but it would historically fit the FED’s narrative that the unemployment rate must rise to reach their target level of inflation.  I’m not in this camp and in my opinion, pegging inflation tightly to an unemployment rate is going to be about as difficult as trying to catch a monkey with your car keys.  You know someone (or yourself) who works from home full or part time.  You know more people have returned to an office since the pandemic but what does the new work week look like?  Skyscrapers in cities around the USA are reporting that “key fob swipes” (a measure of people entering their parking garages or buildings) are on the rise.  When you come from zero swipes, a rise isn’t surprising. Do people swipe out after they’ve been at the office for 30 minutes to water their Ficus plant and then go to Starbucks to work using their Wi-Fi?  How much work is being done more efficiently than before in less time or how much work is being done inefficiently and taking equally as much time even though a commute has been eliminated?  I was in Target this weekend and saw 7 cashiers.  6 of them were checking customers out in the traditional sense.  1 of them was assisting/monitoring the “self-check-out zone” which has 8 kiosks to do it yourself.  If unemployment is tied to an inflation metric yet productivity isn’t falling but prices are, then I think inflation and determining its longevity and impact needs to be re-calibrated. 

Last and not least, developed economies have lived with inflation forever.  Inflation is not evil or something that must be extinguished, it’s out of control inflation that must be addressed.  The media has terms like “hard landing, soft landing, no landing” to refer to how deep or shallow a possible recession will be.  A recession is defined as a downturn in economic activity and marked by 2 consecutive quarters of negative gross domestic product.  The media metaphor of 2 different versions of “landings” implies that the (like a plane) the economy took off, flew to a destination, and landed “smoothly or hit down hard.”  In these two cases, the flight ended.  But an economy doesn’t start and finish like a plane flight.  An economy exists in perpetuity and never lands, so let’s agree that there will be no landing, but the economy will continue to exist, and we will ALWAYS experience periods of smooth flight and bumpy flight.  So, inflation, why is it such a polarizing word?  Because the media made it this way.  Again, it’s out of control inflation that must be cooled.  We don’t have out of control inflation indefinitely and while some components of our economy did experience excessive price increases resulting from the pandemic; most of those prices have fallen and are continuing to fall.  Keep in mind all the types of inflation you’ve witnessed over the course of your life (which are quite mundane) and how the economy you live in has not burned to the ground.  Like what? The price of a stamp, a gallon of gas, the value of your residence, or your wage for working.  Or how about the fact that I’ll bet you used to drink your water right from the tap and now don’t think twice about paying for pallets of bottled water.  Yes…you voluntarily began paying for packaged water and will pay even more if it has a flavor (hundreds of flavors).  There is another thing that you forget about inflation that is simply part of the underlying mechanics of an economy that also must exist for growth, and this is profits.  Profits result from efficiency and from prices that are greater for the sale of a good or service than it cost to manufacturer them.  So, to the inflation you look forward to, rising stock and rising bond prices.  This is also a result of inflation and is quite normal as the vast majority time, in our developed economy, stock prices do “inflate.” And after a cycle of rising interest rates, it will also be rather normal for bond prices to also inflate.

Regards,