The guest commentary below was written by Joseph Y. Calhoun, III of Alhambra Investments on 6/12/21. This piece does not necessarily reflect the opinions of Hedgeye.
I don’t know if we’re at the point of maximum pessimism yet but there certainly isn’t a lack of it right now. The S&P 500 fell 5% in two days last week on basically no news.
The CPI report on Friday was the most often cited culprit, the year-over-year rate of inflation clocking in at 8.6% with the core (ex-food and energy) at 6%. Those are not good numbers obviously, but I’m not sure all that much has changed. The year-over-year change in core CPI peaked in March and is coming down, albeit slower than we’d all like to see. And I see no reason it shouldn’t keep falling.
The biggest rise is still in vehicles (new and used) where we have started to see some good news on the supply side. A number of auto manufacturers (Hyundai, Daimler, BMW, VW) have recently said the chip shortage is easing and their plants are running normally.
The biggest contributor to core inflation is shelter (rent) which is really a function of house prices (via Owner’s Equivalent Rent) and with higher mortgage rates doing what they do, I think we can probably count on that rate coming down in the future as well.
As for energy, the reasons to be long energy are numerous, obvious, and well known. Crude oil is up 31% since Russia invaded Ukraine while natural gas prices are up 93%.
Yes, the world has made some very poor policy choices recently that exacerbate the situation but the run-up since the end of February is really mostly about Ukraine. While that mess doesn’t look as if it will be resolved anytime soon, I stand by my original assertion that Russian oil will get to the market even if it goes to new customers (China, India).
But in the short term, oil, like a lot of other things, is priced based on emotion. And right now, the predominant emotion is fear – fear that the supply of energy isn’t going to be able to keep up with demand.
Part of that is because the major suppliers don’t particularly like the US and part of it is that demand just isn’t slacking off despite some slowing in the global economy. Having said that, the contrarian in me is intrigued by the complete lack of skepticism in the energy trade right now. Everyone is long and that usually means we’re due for some kind of correction.
Market expectations for inflation were also basically unchanged on the CPI news. The 10-year inflation breakeven was up all of 1 basis point Friday, unchanged over the last week and still well down from the peak in late April.
Five-year, five-year forward inflation expectations actually fell on Friday. The five-year breakeven did rise by 5 basis points but is also well below its late March peak. In short, the bond market’s expectations for inflation didn’t really change last week. That may be because the money markets priced in a little more Fed tightening but even so, the change was minor.
The macro picture didn’t change last week. The economy is slowing in some areas and inflation is still high but probably peaking. That’s the same as it was the week before and neither is surprising but the Fed meets this week and there is a fear, rampant fear, that they are going to hike rates too far and put us in recession.
I don’t have much – any – faith in the Fed but I don’t think we should underestimate the economy either. What is happening with the economy is not only unsurprising but necessary. Does anyone think that house prices should continue to rise at 20% per year?
Is that healthy in any way? I don’t think so and the only way that was going to change was by slowing the housing market until supply can catch up with demand. Mortgage rates up from 3 to 5% are doing exactly that and while there may be some pain in the short term, this had to happen. 5% mortgage rates are not onerous and buyers, sellers, and homebuilders will adjust.
Retail sales growth has also slowed but, again, is that a bad thing? Retail sales have been running well above the pre-COVID trend since early 2021 due to Biden’s American Recovery Act and the rate of change was not sustainable or, again, healthy.
But falling back to a slower trend from an artificially high one is not a bad thing, especially if it also brings inflation down with it, which it most certainly will. The short-term impact on the economy is certainly negative but how negative?
Will retailers have to adjust inventories? Well, yes, some retailers find themselves overstocked in certain items right now and they’ll do what retailers always do – have a clearance sale or sell to liquidators. They misjudged consumers’ desires and they’ll pay a price for that. Are all retailers in the same boat? I suppose it could turn out that way but it hasn’t so far. Will there be layoffs as the economy slows? Will jobless claims rise? Of course they will.
They are still at lows last seen decades ago when the population was a lot smaller. If claims rose to around 300,000 that would put them around the lows of all the previous business cycles back to the 1970s. Looking at the last JOLTS report, maybe that wouldn’t be such a bad thing.
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EDITOR'S NOTE
Joe Calhoun is the President of Alhambra Investments, an SEC-registered Investment Advisory firm doing business since 2006. Joe developed Alhambra's unique all-weather, multiple asset class portfolios. This piece does not necessarily reflect the opinions of Hedgeye.
