“The mind that is anxious about future events is miserable.”
- Seneca
As stock market operators, we are constantly handicapping future events. If we are too negative about them, we will never take on any risk and thus lose out on returns. Conversely, if we are too optimistic, we take on too much risk and potentially face serious impairment of capital.
On The Macro Show yesterday, we had an interesting subscriber question relating to the extent upcoming events are currently priced into the market. The question focused on the upcoming GDP report, CPI print, FOMC announcement, and earnings seasons; and was implying that a lot of bad news may already be priced in.
On one hand, with most markets and subsectors down meaningfully YTD (the SP500 is down -20% YTD and the only major subsector that is up is energy at +24%), a fair bit of bad news is priced in. On the other hand, we are just now getting into a period where economic growth is meaningfully starting to slow and corporate earnings face their most challenging comparisons.
On the last point of corporate earnings, SP500 earnings were up some +85% Y/Y in Q2 2021 and revenue was up some +23% Y/Y. It seems like a long time ago, but those were the heady days of #Quad2 when everything (particularly consumer discretionary and technology) were crushing expectations. Now, of course, we are on the other side of that in a period where companies have to comp these “uncompable” comps, all while facing economic headwinds (currency fluctuations, high inflation, low confidence, etc).
On the macro front, this morning we will get the U.S. June CPI report. Consensus expectations are for a +8.8% Y/Y increase in Headline CPI, which is an acceleration over May’s +8.6% increase. Whisper numbers have the report coming in higher at 9%+. Betting on one specific CPI report is typically a losers’ errand. After all, they are government reports with limited transparency, and quite often even if you get the number right . . . you will get the market reaction wrong.
Back to the Global Macro Grind...
One thing we do know about inflation is that it continues to accelerate globally. Consider some of the global inflation reports we’ve received over the last 24 hours:
- Denmark CPI accelerates to +8.2% from +7.4%;
- Norway CPI accelerates to +6.3% from +5.7%;
- Portugal CPI accelerates to +8.7% from +8.0%;
- France CPI accelerates to +5.8% from +5.2%; and
- Germany CPI flat with the prior month at +7.6%.
That is red hot global inflation!
To some extent beyond today’s immediate market fluctuations, whether the CPI report comes in light or beats expectations, may not matter so much. The reality is it will remain near generational highs. The problem with high inflation, whether it is decelerating slightly or accelerating slightly, is that it slows growth via lowered purchasing power and tightening financial conditions.
We can see this real-time in sentiment and confidence indicators. Take yesterday’s Germany Zew Economic Sentiment Indicator as a prime example. It fell off a cliff coming in at -53.8 for July, which was a meaningful decline from the prior reading in June of -28. Sentiment and confidence matter because they are leading indicators for future decisions by both businesses and consumers.
We’ve seen this in spades in U.S. Confidence reports as well. As you may recall, the June Michigan Consumer Sentiment report came in at 50.0, which was down -42% Y/Y and -15% M/M to the lowest level on record. In large part, this is due to inflation expectations for both the year ahead and 5 – 10 year ahead being at levels not seen since the mid-1980s.
As we’ve said time and time again, one of the key risks we are facing as investors is the Fed continuing to tighten into a slowdown. In terms of history, the Fed Funds Rate remains well below historical levels (especially for this level of inflation). As many of you history buffs know, the Fed Funds Rate peaked near 20% in the early 1980s!
Getting back to today, the challenge with CPI is that certain components of the report enter on a delay, with housing costs being a prime example. As a result, the CPI report may not accurately reflect what is happening on the ground, or in real-time, as it relates to inflation. Thus, we have the conundrum that happens time and time again, central bankers over-react to events in the here and now and instead of smoothing economic cycles . . . tend to exacerbate them.
Unfortunately, there is probably no real reason to believe that “this time is different” and the Fed will likely continue to tighten into an economic slowdown.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 2.78-3.26% (bullish)
UST 2yr Yield 2.76-3.21% (bullish)
High Yield (HYG) 72.71-75.36 (bearish)
SPX 3 (bearish)
NASDAQ 10,825-11,732 (bearish)
RUT 1 (bearish)
Tech (XLK) 124-134 (bearish) `
Shanghai Comp 3 (bullish)
Nikkei 25,813-26,861 (bearish)
DAX 12,401-13,145 (bearish)
VIX 24.40-31.18 (bullish)
USD 104.97-108.78 (bullish)
EUR/USD 0.993-1.040 (bearish)
USD/YEN 134.92-137.67 (bullish)
Oil (WTI) 94.27-105.82 (bearish)
Nat Gas 5.12-6.85 (bearish)
Gold 1 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
