"Experience is the name we give to our mistakes."
– Oscar Wilde
Like most of the senior members of my firm, as Oscar Wilde would say, I have accumulated a lot of experience. It’s difficult not to when you’ve been in markets long enough.
The real mistake of course, is not in making the mistake in the first place, but rather not learning from it for the next time. Now that being said, it can be rewarding to not make the mistake in the first place. A good place to start in this effort is by simply being curious.
There’s a great scene in Ted Lasso where Ted is goaded into playing a high-stakes game of darts by former AFC Richmond owner Rupert Mannion. Ever underestimated, Ted goes on to beat Rupert, and gives him a bit of an education along the way. The relevance is that he makes a similar point about the importance of being curious.
Had Rupert asked Ted whether he’d played a lot of darts, Ted would have told him, “Yes sir. Every Sunday afternoon at a sports bar with my father from age ten until I was 16 when he passed away”. Barbecue Sauce.
Back to the Global Macro Grind…
Back in early March, I wrote an Early Look entitled “What Comes Between Q and S?”. It was a look ahead at the rising probability of recession through the lens of rising oil prices and interest rates. I looked back to the 12 recessions since 1946 and found that 11 of those were preceded by oil price shocks. I then looked at the association between recessions and short-term rate increases back to 1954 and found that 10 for 10 of those recessions were preceded by increases in short-term rates.
Here we are now almost exactly 5 months later having just reported two back-to-back quarters of negative Q/Q SAAR real economic growth, but beyond that, consider the following:
- The 2-10 yield curve – a classic and generally reliable recession indicator – is now inverted by around 35 bps, the most in at least 20 years.
- Inflation most recently registered a print of 9.1%.
- The Fed is raising rates at the fastest pace in decades while the banking system is tightening financial conditions at the fastest pace since at least the GFC.
- QE has slammed into reverse and is now QT, and that QT is set to double in less than 4 weeks’ time.
- The economy just registered its second consecutive quarter of negative Q/Q SAAR growth.
- The labor market is now showing increasing signs of slowing.
- And the market is rallying because it expects the Fed to soon turn Dovish.
While it’s always important to be curious, we’re at a moment in time when it’s arguably more so than usual.
To that end, I was curious about the nature of historic lead/lags with respect to Fed timing vs market price inflections and Fed timing vs labor market inflections. So, I dug into the history for more context.
Here is what I found.
Contrary to prevailing narratives about the imminence of a Fed pivot driving a sustained rally in risk assets, the data I reviewed suggests that time is more likely still far enough down the line that the market is likely well over its ski tips.
I first dug into the lead/lag relationships historically between the end of Fed tightening cycles and the associated trough in equity prices. I looked at 9 prior periods of rate hiking cycles peaking: 1957, 1959, 1969, 1974, 1980 Part 1, 1980 Part 2, 1989, 2000, and 2006. I found that in just 3 of those 9 periods (1957, 1974 and 1980 Part 1) the trough in risk asset prices was close in time to the final rate hike of the cycle. However, 6 of those 9 periods (1959, 1969, 1980 Part 2, 1989, 2000, and 2006) all saw risk asset prices ultimately trough only long after the Final rate hike. The average market price trough for those 6 periods came a full 21 months after the last rate hike, with a minimum of 10 months afterward and a maximum of 41 months. In the 3 cases of nearer proximity, two of the three troughs occurred 2 months after the Final rate hike and in one case – 1980 Part 1 – the market bottomed one month ahead of the Final rate hike.
I found it interesting that in two-thirds of historical examples, Fed rate hikes have ended long before the bottom in market prices. Or said differently, markets continued to decline long after the Fed finished tightening. As the market is still pricing in another pair of 50 bps hikes at the next two meetings – September and November – this would imply that the likely earliest bottom in prices would be in October-January, but more likely (based on the history) would not occur for a year or more after the Fed’s Final rate hike of this cycle.
It’s also worth noting that the trend has been higher over time. The four longest periods between peak Fed Funds and market troughs were the four most recent cycles.
Another narrative or talking point we’ve heard referenced is that of the peak in inflation correlating with risk asset price troughs. Specifically, the reference is made to the 1970s/1980s sky-high inflation period as the best comps. Let’s consider those examples. The mother of all inflation bonanzas in the US peaked in March 1980 at 14.6%. Markets, however, didn’t ultimately bottom out until July 1982 – a full 27 months after the peak in inflation. To be fair, there was an 8-month rally from March through November 1980 that saw the S&P 500 rally +29% before then declining -33% to new lows some 20 months later.
What about the case of 1974? This is the one that seems to fit the narrative quite well. Inflation began climbing from its low of 3% in the Fall of 1972 to finally peak two years later at 12%. During that 2-year period, markets dropped by more than half (-55%), ultimately bottoming in the Fall of 1974, right in-line with the eventual peak in inflation in timing terms.
So, in this case you have an N of just two and one of those examples seems to corroborate the narrative while the other does not.
Looking ahead to the data, this morning at 8:30 we’ll get Nonfarm Payrolls for July. Last month saw +372k jobs added, while the expectation for July is a more modest +258k. Looking back through history, we found that NFP peaks have trailed peak rates by an average of 6 months. In other words, it’s not exactly a leading indicator, but it does drive reflexive follow-through on the economic data side, and it’s often that follow-through that drives the long-delayed risk asset price bottom. In RoC terms it’s quite clear that initial jobless claims have begun their march higher, having risen from the lows of 175k in April to now just over 250k. Make no mistake, that’s still very low. Historically, things have started to get interesting around the 400k mark, so there is a long way yet to go on that front, but again, labor is the lagging indicator.
The other data that will certainly be of interest to the market is next Wednesday’s July CPI reading. We’ve addressed what (and why) we expect from inflation over the coming year in our macro themes deck, which coincidentally we’ll be revisiting as we host our Q3 Macro Themes Mid-Quarter update call also on next Wednesday August 10th.
Finally, I’d like to call out the latest quarterly Fed Senior Loan Officer Survey. We have found that when 2 out of the 3 C&I lending questions turn contractionary, it has preceded a recession every time, going back to the inception of the series. That also just happened with this week’s release.
There seems to be a growing amount of data suggesting a real slowdown and rising probability of recession and a healthy amount of data to suggest that historically, market troughs have tended to lag rate peaks significantly, at least most of the time.
Our outlook currently expects four Quad 4’s (in a row) between now and Q2 2023. For reference, the last time that happened was from Q4 2000 through Q4 2001 (5 Quad 4’s in a row!).
We’ll explore all of these concepts in detail when we host our Q3 Mid-Quarter Macro Themes update call next Wednesday, August 10th. Let know if you would like access.
On another note, I’m looking forward to meeting many of you in person at our investing event in Los Angeles this September. I’ll be joined by seven of our research analysts, as well as our Risk-Manager-In-Chief Keith McCullough and our Director of Research Daryl Jones. We will obviously have no shortage of important topics to discuss.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 2.57-2.96% (bearish)
UST 2yr Yield 2.81-3.18% (bullish)
High Yield (HYG) 74.95-78.99 (bearish)
SPX 3 (bearish)
NASDAQ 11,451-12,905 (bearish)
RUT 1 (bearish)
Tech (XLK) 132-149 (bearish)
Utilities (XLU) 69.30-76.24 (bullish)
Healthcare (PINK) 25.15-26.19 (bullish) `
Shanghai Comp 3142-3287 (bearish)
Nikkei 27,175-28,235 (bullish)
VIX 20.55-25.96 (bullish)
USD 105.14-108.01 (bullish)
EUR/USD 1.011-1.028 (bearish)
USD/YEN 130.65-138.01 (bullish)
Oil (WTI) 88.08-98.70 (bearish)
Nat Gas 7.45-8.95 (bullish)
Gold 1 (bullish)
To your continued Success,
Josh Steiner
Managing Director
