The guest commentary below was written by Joseph Y. Calhoun, III of Alhambra Investments on 7/17/21. This piece does not necessarily reflect the opinions of Hedgeye.
Investors crave certainty. They want to know that there are definitive signals for them to follow as they adjust their investments to fit the current market and economy. They want to know that A leads to B leads to C. Tea leaf readers are always in high demand on Wall Street and they continue to find employment despite their almost universally dismal track record.
In this case, it is demand that drives supply rather than the other way around. The constant demand for answers creates an audience for those willing to give them and also drives engagement on social media.
You don’t get Twitter followers with a series of posts that effectively say “I don’t know”. I can attest to that personally. Prognostication in the investment business is more about drawing an audience than providing actual, useful advice.
We got some bad inflation news last Wednesday with the CPI report and it was confirmed by more bad inflation news on Thursday with the PPI report (although that one wasn’t as bad).
The inflation fears led to concern that the Fed would raise interest rates by a full percent when they next meet and that in turn produced selling in stocks. The negative inflation reports were complemented by a report of rising jobless claims and fears of recession. High inflation and slowing growth is about as lousy an outcome as is possible in economics.
And stocks were reacting negatively to the data; at the lows Thursday morning the S&P 500 was off by 4.5% for the week and it was looking like another big leg down in this relentless bear market. New lows have outpaced new highs for 34 weeks in a row, a streak only outdone in the past 16 years by the 2008 bear market.
Then, we got some good news. Friday morning retail sales were reported up 1% in June, much better than expected and relieving some of the recession fears. The report was even strong ex-autos and gas, up 0.7%. There were questions about how good sales were in light of the high inflation reading, although I’m not sure how accurate it is to use CPI to inflation correct retail sales.
The CPI calculation includes a lot of things that aren’t in retail sales. But if you want to see something negative, you’ll see something negative. The Empire State manufacturing survey was harder to dismiss but for some, there’s always a cloud even if it’s tainted by a silver lining. Here’s what the NY Fed said about the report:
|
Business activity increased modestly in New York State, according to firms responding to the July 2022 Empire State Manufacturing Survey. The headline general business conditions index climbed twelve points to 11.1. New orders increased marginally, and shipments expanded significantly. Unfilled orders edged lower for a second consecutive month. Delivery times lengthened at the slowest pace in months, and inventories picked up. Labor market indicators pointed to a solid increase in employment and a slightly longer average workweek. While still elevated, both the prices paid and prices received indexes moved significantly lower, pointing to a deceleration in price increases. Firms turned pessimistic about the six-month outlook, a rare occurrence in the survey’s history. |
The report is filled with positives but ends on a down note. It is indeed true that the survey’s six-month outlook has only been negative only 2 other times since its inception in 2001: September 2001 (9/11) and February 2009.
You might note, as I did, that both of those dates were pretty good times to buy stocks. From the 9/11 lows the S&P 500 rallied 24.5% over the next 4 months although the bear market of that era was far from over. As for February 2009, we were within a few weeks of making the post GFC lows; from the February ’09 close to the following April, the S&P 500 rallied 65%.
While that is comforting, it really doesn’t say much about what happens from here; it merely tells you that this negative reading is rare and the two past times it happened the market outcome was positive. Two data points may make a line but they don’t make a trend.
The good news continued with readings on import and export prices both of which rose much less than expected, although I don’t think many people took notice. These reports come out every month but are always overshadowed by the CPI and PPI reports. Import prices, in particular, probably deserve a little more respect considering our trade deficit.
Next up was Industrial Production which fell by 0.2% versus an expectation of a modest rise. That certainly isn’t a positive but it doesn’t tell you much about the odds of recession. Negative readings on IP are quite common during a business cycle as growth accelerates and moderates as it normally does.
That doesn’t mean the reading should be ignored but it has to be put into context and given the weight it is due, which isn’t all that much based on history.
Later in the morning, we received information on inventories but it is as of May and of little use in real-time. Still, it is interesting that the total business inventory to sales ratio remains low:
The latest University of Michigan Consumer Sentiment poll (preliminary for July) was also released Friday and improved to 51.1 from the all-time low last month. Of more importance was the 5-year inflation expectations reading which fell to 2.8% from 3.1% last month.
You might recall that it was the preliminary report for June that spurred the Fed to shift from a 50 basis point to a 75 basis point hike at the last FOMC meeting, a move that I called panic. That report had shown a jump in expectation to 3.3%, a reading that obviously spooked Jerome Powell. By the time the final reading came out, it was down to 3.1% and now it falls further to 2.8%.
Let it be known that the members of the FOMC are just as vulnerable to panic as the average retail investor. My only question about the U of Michigan poll is who exactly are they polling and whether they are mentally stable. With all the news about the slowing economy and rising inflation over the last month, how did their mood improve and their inflation expectations fall?
From the lows near the open Thursday to the close Friday after all that “good” news, the S&P 500 rallied 3.8% to close the week down a fraction of a percent. There were other things going on as well so it wasn’t just about the economic data.
J.P. Morgan and Morgan Stanley both reported earnings that were less than expected due to a big slowdown in investment banking; they led the way down Thursday with JP Morgan off 3.5%. There were confident pundits all over the news talking about how negative the JP Morgan report was and what it portended for the economy as a whole. That view was reinforced by the company as it suspended its share buyback and raised its provisions for future loan losses.
While Jamie Dimon said that current conditions are quite good – “the U.S. economy continues to grow and both the job market and consumer spending, and their ability to spend, remain healthy..” – he’s worried about the future:
|
“But geopolitical tension, high inflation, waning consumer confidence, the uncertainty about how high rates have to go and the never-before-seen quantitative tightening and their effects on global liquidity, combined with the war in Ukraine and its harmful effect on global energy and food prices are very likely to have negative consequences on the global economy sometime down the road.” |
In other words, the guy who runs one of the biggest banks in the world, with access to research you can’t even imagine, doesn’t have any idea what the future economy will look like.
He’s worried about all the same stuff you’re worried about and he has no better idea how it will turn out than you. I’d add that for us old-timers who have spent a career watching Jamie Dimon be wrong about the economy, his pessimism is quite welcome.
Contra JP Morgan, Citigroup reported their earnings Friday and they were a lot better than expected. The analysts were so wrong on Citi that their revenue estimates were off by over $1 billion in the quarter. If ever there was a reason to listen to Wall Street sell-side analysts I’ve yet to find it. And with that report from Citi the banks led the market higher Friday, as if the Morgans’ earnings never happened. JP Morgan still ended the week down but Morgan Stanley finished up 1.7% for the week, outpacing the market as a whole.
We will continue to get earnings over the coming weeks and the only sure thing is that we’ll see more of this. Some companies and industries will do well and some companies and industries will do poorly. Overall, I’d still expect earnings to rise this quarter but everyone will be focused on what companies say about the rest of the year, as if they have any better idea of what will transpire over the next six months.
I think people forget sometimes that the people providing those outlooks about the next quarter or the rest of the year are human too and subject to all the same failings as the rest of us. Adding confusion to the earnings puzzle is the big drop in commodity prices over the last month. Last quarter’s earnings will reflect high commodity prices that no longer exist. For many companies, those high input costs hurt margins while for others it won’t matter a bit because they were able to raise prices.
Rather than shifting earnings expectations down over the remainder of the year, analysts may be upgrading based on moderating inflation. Much emphasis on the word “may”.
If you hang on every economic report like it is handed down from on high, as if you can discern something useful from every report, you’re going to be in a constant state of distress. Every report isn’t worth your attention.
Most of the breathless Santelli reports from the floor are nothing more than noise. There are some indicators that have been useful in the past and I respect those but even with those, I’m a practicing skeptic.
The economy is a chaotic system that defies prediction. Small things can sometimes have big consequences for markets but only when they reach a critical phase.
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.
