“To me, a wise and humane policy is occasionally to let inflation rise even if inflation is running above target.”
- Janet Yellen
I recently enjoyed reading Malcolm Gladwell's book, "The Bomber Mafia" where Gladwell walks through the evolution of air combat into World War II.
The most interesting part of the book for me is related to the Norden bombsight. At the time, it was heralded as one of the most advanced developments in warfare, with the potential ability to finally implement precision bombing from high altitudes. Unlike its predecessors, the Norden used an early tachometric design that measured the aircraft’s ground speed and direction, while older bomb sights were basically unable to accurately measure. It also used an analog computer that continuously recalculated the bomb’s impact point based on changing conditions.
While the Norden bombsight was certainly a major advancement, it turned out to be only effective in practice. Due to unforeseen conditions (like heavy winds over Tokyo) it didn’t really work that well. In fact, it ultimately proved to be similarly successful in terms of accuracy when compared to other Allied and German bombsights at the time.
If you're utilizing an ineffective bomb sight, your military campaigns likely won’t have the intended outcome! Similarly, if you are using an inaccurate model or process to find investable targets in a specific market environment, you will likely also yield unfavorable results...
Imagine if you had not been positioned for #Quad4 growth slowing in recent weeks. That would be an unmitigated disaster. In fact, January 2022 is likely to the be the worst start to a year for the SP500 ever. And "ever", as they say, is a long time.
The only major U.S. equity sector not down on the year? Energy. It's up +18.3% and has some specific inventory and geopolitical issues driving it. On the other end of the spectrum, consumer discretionary has been absolutely pounded down -12.9%.
We did have a bit of a snap back rally on Friday. It was driven (at least in part) by Minneapolis Fed President Neel Kashkari saying the Fed will likely raise rates in March to tamp down on too-high inflation, but that “a rate hike pause is conceivable in the spring” due to the still “muddy economic picture”. We shall see if this “humane” target holds.
Back to the Global Macro Grind…
Kashkari isn’t right about everything, but he is on target with the muddy economic picture.
Consider some of the key U.S. economic data we’ve received over the week or two:
- January 28th – U.S. spending for December decelerated to -0.6% M/M and U.S. Personal Income decelerated to +0.3% M/M;
- January 28th – U.S. Michigan Consumer Confidence for January decelerated to 67.2;
- January 27th – U.S. Durable Orders for December decelerated to -0.9% M/M, from +3.2% in November;
- January 25th – U.S. Consumer Confidence for January decelerated to 113.8 from 115.2; and
- January 24th – U.S. Flash Manufacturing for January decelerated to 55.0 from 57.7 in December and Services decelerated to 50.9 (almost contractionary) from 57.6.
That’s not cherry picking, but simply the results of all key U.S. economic data last week. And the result was a deceleration in every key economic data series. In part, as we’ve seen since the beginning of the pandemic, the Omicron wave may have been responsible for some of this slowing. So it’s possible with U.S. COVID cases down -38% W/W as of this morning that we do get a reprieve. But we also have to bear in mind that economic comparisons into Q2 are very challenging, especially for consumer spending.
To the last point, in the Chart of the Day we map out pandemic support and household income relative to February 2020. As the chart shows, we are basically entering a period that is not comp-able due to the largest allotment of stimulus coming in the end of Q1 and early Q2 2022.
In fact, as the PCE report showed last week, personal consumption expenditures were up a staggering +15.7% and 19.3% Y/Y for Q1 and Q2 2022, respectively. With consumer spending being roughly 70% of U.S. GDP, that is about to become a headwind real quick . . . especially if the Fed stays on “target”.
Will the Fed be tightening into an economic slowdown? So far that sure seems to be the case. In fact, the revered Goldman Sachs is expecting some 5 rate hikes this year. (Of course, Goldman also expected the Fed to raise rates 4x times in 2018 and by 2019 the Fed was cutting rates). It wouldn’t surprise us to have interest rate cuts back in the cards into the back half of 2022.
Interestingly, global economic data has been holding in a bit better than U.S. data in terms of rate of change slow down. This morning the China PMI data, though, came in disappointing. January Caixin Manufacturing for January decelerated from 50.9 to 49.1 (contractionary) and official Composite PMI decelerated to 50.1 in January from 52.2. On the positive side for China, central bankers are easing monetary policy into this growth slowdown.
So, what to do from here?
Well, with economic growth slowing, volatility trending, and the Fed tightening . . . it’s probability not the best time to load up the old portfolio on NFTs and meme stocks. Keep those exposures tight, trade the ranges, and focus on #Quad4 type exposures. Opportunities to make money on the long side will eventually come, just make sure you are using an accurate target.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 1.69-1.89% (bullish)
UST 2yr Yield 0.93-1.21% (bullish)
SPX 4 (bearish)
NASDAQ 13,203-13,996 (bearish)
RUT 1 (bearish)
Tech (XLK) 147-162 (bearish)
Consumer Staples (XLP) 73.77-77.26 (bullish)
Utilities (XLU) 65.45-69.91 (bullish)
Financials (XLF) 37.07-39.83 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
