Weekly Summary – April 24-28
- Even as there were many earnings reports that exceeded mostly reduced expectations, we continue to observe many warning signs that U.S. economic growth is slowing and that inflation rates remain elevated. The Federal Reserve (Fed) will face a dilemma at its next meeting next week. We still expect the Fed to hike the federal funds rate by 25 basis points next week and to then “pause” for a while. But if the U.S. economy shows resilience and inflation remains elevated, we would not be surprised to see another hike. Our base case remains an elongated pause after next week’s meeting.
- As long as much uncertainty remains along with elevated inflation, we expect to see the Fed err on the side of “overtightening.” We are not saying that this is what we think the Fed should do, but only what we think the Fed might do.
- It appears that First Republic Bank (FRC) is about to “fail.” Federal officials have shown that they can “contain” any possible systemic problem. But we can envision a more widespread credit contraction as uncertainties continue to mount. Given the apparent “containment” of the previous banking crisis in March, we do not anticipate that FRC’s travails will halt the Fed’s decision to hike rates next week.
- We continue to believe that due to many uncertainties, lack of conviction among many investors and an increasing divergence of opinions and financial market views, that equity volatility might begin to increase from its rather dormant state in April. We foresee that the latest economic data could change the narrative of financial markets in unexpected ways and at surprising times. We expect that sudden changes are possible at almost any time. We still detect much complacency among many investors. We outlined below a few examples that could lead to more volatility in financial markets.
The Upshot: Our general investment approach remains the same as depicted in last week’s commentary. We maintain our preference for quality stocks with good balance sheets, relatively stable cash flows with stable margins. Volatility across sectors continues to be supportive of a diversified portfolio for long term investors. We continue to stress that stock selectivity in the current environment is of paramount importance.
In addition to sometimes conflicting economic data, the economic data standing alone might also be subject to many possible explanations. A good example of this is the large impact of inventory adjustments on Q1 real GDP discussed below. Pandemic related seasonal adjustments have often distorted underlying economic trends.
Uncertainty Continues to Be an Overriding Theme
This week through Thursday was another week of “mixed” economic data and earnings reports. Earnings reports continued generally to be better than feared. The results of four MegaCap stocks were anticipated in particular. The stock prices of the Microsoft Corporation and Meta Platforms Inc. reacted very positively to better-than-expected earnings reports and positive guidance. Alphabet Inc. (Google) stock had a more muted response to a good earnings report. Amazon.com, Inc. stock initially rose as much as 10% in after-hours trading on Thursday as revenue, profit, margins and guidance all exceeded expectations. However, Amazon stock then reversed those gains and traded as much as 2% lower after cautious comments by Amazon’s CFO Brian Olsavsky about its Amazon Web Services (AWS) cloud unit. Olsavsky stated that AWS customers “continue to evaluate ways to optimize their cloud spending in response to these tough economic conditions in the first quarter.” Additionally, Olsavsky then forecast slowing AWS revenue in Q2. “We are seeing these optimizations continue into the second quarter with April revenue growth rates about 500 basis points lower than what we saw in Q1.” He then revealed Amazon’s investment approach as “we’re not trying to optimize for any one quarter or year. We’re working to build customer relationships and a business that will outlast all of us.” Evidently, this was not what investors wanted to hear. There was simply too much uncertainty. Last week’s commentary highlighted that the overriding theme in regard to the data is one of uncertainty. In our opinion, that theme has carried over into this week. Trying to decipher Amazon’s earnings results and predicting its stock reaction is a microcosm of the prevalence of uncertainty and probabilities of various scenarios.
“Dancing in the Dark” Due to Uncertainties
We suggest that this uncertainty and lack of conviction among investors and analysts has resulted in a wide divergence of opinions on both the current state and future trends of the U.S. and global economies. Most major U.S. stock averages have continued to “churn” for most of this month and have gone mostly “nowhere” while selected individual stocks and sectors have exhibited much greater variance. We surmise that this continues to be a “stock pickers’” market. Due to many uncertainties – including those regarding economic growth rates, inflation and wage growth rates – it is as if we are all “Dancing in the Dark” along with Bruce Springsteen in his song. We might often feel like we “ain’t gettin’ nowhere … [and that] there’s something happenin’ somewhere.” We are hopeful that things will become clearer soon. We are searching for more clarity. In the meantime, “you can’t start a fire without a spark … even if we’re just dancin’ in the dark” with little conviction for many investors and analysts. We would also like to add that the Fed appears to have been “dancin’ in the dark” as well.
QI Real GDP “Advance Estimate” Increases Less than Expected
On Thursday, the Bureau of Economic Analysis (BEA) released the “Advance Estimate” for U.S. Q1 real GDP growth. Real gross domestic product (GDP) increased at an annual rate of 1.1% versus an expected increase of 1.9% and lower than the 2.6% Q4 of 2022 increase. We were not surprised that this report did not provide much clarity for us. Additinally, we thought that many interpretations of the U.S. economy were plausible after this report’s release. Most of the shortfall was attributed to an abrupt slowing of inventory investment, which provided a 2.3% drag to GDP growth. Inventory weakness was notable for manufacturing transportation excluding autos and wholesale machinery, while retail inventories grew modestly. This was in sharp contrast to Q4 where increases in inventories added 1.47% to GDP growth. Nonresidential fixed investment slowed from 4.0% in Q4 to a Q1 growth rate of merely 0.7% . This 0.7% increase was the result of a 7.3% decline in equipment investment that was counterbalance by an 11.2% annualized increase in nonresidential structures investment and a 3.8% increase in intellectual property investment, which was the smallest gain in nearly three years. The leading contributor to the fall of residential fixed investment was new single family home construction. Residential investment created a shortfall to GDP for the eighth consecutive quarter. Real final sales grew at a 3.4% annual rate, which was significantly better than the 1.1% rate in Q4. Most of the favorable final sales figure was attributable to the 3.7% growth of consumer spending. “Within goods, the leading contributor was motor vehicles and parts. Within services, the increase was led by health care and food services and accommodations.” Services spending rose 2.3%, while spending for goods increased at a 6.5% rate – the most in nearly two years. We wish to remind the reader that January was an especially strong month for retail sales before tapering off for the remainder of Q1. Net exports added marginally to GDP growth due to the surprise narrowing of the U.S. trade deficit in March.
Source: JP Morgan, Growth down, inflation up (4-27-2023)
Source: JP Morgan, Capex growth continues to slow (4-26-2023)
The GDP price index rose 4.0% quarter-over-quarter (q/q), which was slightly above an expected rise of 3.7%. The headline Personal Consumption Expenditures (PCE) price index increased 4.2% compared to a 3.7% increase for Q4. The core PCE price index, which excludes food and energy prices, increased 4.9% q/q versus an expected 4.7% and the Q4 reading of 4.4%. Real disposable personal income increased 8.0% q/q compared to an increase of 5.0% in Q4. A one-time increase in Social Security payments was partly responsible for the added increase. The personal saving rate – saving as a percentage of disposable personal income – was 4.8% versus 4.0% for Q4. This compares to a low post-pandemic saving rate of 3.2% and a pre-pandemic average of roughly 7.0%.
Q2 Growth Expected to Slow, But Many Variables Could Affect Outcome
Most economists expect an even slower Q2 GDP growth rate – as low as 0.2%. But we have seen that most economists have had to revise their forecasts repeatedly for quite some time. For example, there could be many explanations for a decrease in inventories. Perhaps with a loosening of supply chain constraints, companies might feel less compelled to hold excess inventories. Alternatively, uncertain future demand for a firm’s goods or services could also be a plausible explanation. Moreover, this could vary depending on the circumstances of a particular industry or company. The tightening of credit conditions, both from the Fed’s tightening of monetary policies as well as from the regional banking crisis might have led to more caution for many businesses. There are many possible explanations for these latest changes in economic trends. We postulate that we still face many uncertainties that could continue to lead to a scenario where the latest batch of economic data could be dispositive as to financial market reactions. Depending on a myriad of possible explanations for the latest economic trends, many plausible scenarios remain possible. Will the economy manage a soft landing or are we heading for a recession, and will that potential recession be mild or more severe? Are we in danger of some form of stagflation – a slowing economy alongside persistently high levels of inflation? Many factors could change the current economic trends in a very rapid manner as well. The U.S. debt limit. The Bank of Japan (BOJ) tightening its monetary policies by changing its yield curve control (YCC) policies. The Fed continuing to raise the federal funds rate, pausing or even cutting rates. These are only some of the possible factors that still could change the course of economic and financial market trends.
BOJ Maintains YCC Policy but Revises Forward Guidance
As was widely expected, the Bank of Japan (BOJ) on Friday maintained its yield curve control (YCC) policy along with its asset purchase programs as discussed in our prior commentaries. In Governor Kazuo Ueda’s first BOJ meeting as chair, the BOJ removed the phrase that it “expects short- and long-term policy interest rates to remain at their present or lower levels” but added that it would “patiently continue with monetary easing” given economic uncertainty. We view the removal of the rates guidance as increasing the scope of the BOJ’s flexibility even as it decided to maintain its stimulative policies in place for now. The BOJ also decided to conduct a broad review of its monetary policies since the late 1990’s. The planned time frame for this review was about “one to one and a half years.” Prior to this BOJ meeting, Ueda had indicated that a precondition to “normalizing” YCC policy would be a relatively high conviction that Japan’s inflation rate of around 2% could be maintained over the next 18 months. Unlike most countries, Japan has been attempting to raise its inflation rate to at least a 2% rate. We judge that once such conviction is achieved, the BOJ could modify its YCC policy to a less stimulative stance. J.P. Morgan (JPM) on April 28 maintained its conviction that the “BOJ will not send a clear signal for a YCC adjustment in advance.” We concur. JPM expects a YCC adjustment to “take place within a few months.” Goldman has pushed out its base case of a YCC adjustment to July from its previously anticipated June time frame. In reaction to the BOJ’s decisions, the yen lost as much as 1.5% relative to USD, its 10-year sovereign bond yield dropped 8 basis points (bps) to yield 0.38% and Japan’s major stock averages rose more than 1%. European sovereign bond yields also decreased by roughly 8 bps. U.S. 10-year Treasury yields traded lower but by a lesser amount. Looks to us like the BOJ continues to be “dancin’ in the dark.”
U.S. Debt Limit “Deadline” Could Be Delayed due to Higher-than-Expected Tax Receipts
Last week’s commentary highlighted that Goldman Sachs’ (Goldman) assessment of the looming U.S. debt ceiling could be approaching more quickly than previously thought due to a shortfall of tax collections through last week. After an unexpectedly large amount of tax receipts on April 25, Goldman on April 26 saw a reduced probability of an early June deadline. Goldman’s latest base case is now a debt limit deadline of late July. This remains a very fluid situation. We remain hopeful that a compromise will be achieved so that the U.S. will not technically default on its debt obligations. The closer we get to the “deadline” without a solution, the higher the probability of an equity downturn. We assume that (on the margin) this could hurt the USD’s “reserve” status in the long term as many countries appear to be trying to embrace a “de-dollarization” policy. Some countries have diminished their holdings of USD reserves while others have attempted to settle cross-border transactions in their own currencies. We assume that U.S. interest could feel upward pressure over the long term as well. Short term movements in USD and U.S. interest rates are less clear since U.S. assets have often been viewed as “safe havens.” We expect that price fluctuations for fixed income securities might vary according to their maturities. In the unlikely event that the U.S. were to default on its debt obligations, the long-term ramifications could be more “harmful” to U.S. assets.
Source: Goldman Sachs, USA: A Big Tax Haul Puts the Debt Limit Deadline More Squarely in July; House Passes Debt Limit Bill (4-26-2023)
U.S. Jobless Claims Fall
Initial claims for unemployment insurance benefits fell by 16,000 to 230,000 for the week that ended April 22 versus 249,000 expected. This was the first decrease in initial claims in three weeks. Continuing “jobless claims” fell by 3,000 to 1.858 million for the week that ended April 15, which was below market expectations of 1.878 million. We characterize these claims as indicating a still tight labor market.
Source: US Department of Labor, Unemployment Insurance Weekly Claims (4-27-2023)
The Conference Board Consumer Confidence Index Declines in April
The Consumer Confidence Index declined to 101.3 from March’s 104.0 level. This was the third decline in the past four months and puts the index below the 104.5 average for 2022. The present situations index increased to 151.1 from 148.9 in March. But the expectations index declined to 68.1 from 74.0. In this survey a reading below 80 has often been considered as indicating a recession within the next year. Expectations have been below 80 for every month since February 2022 except or a slight uptick in December of 2022. Compared to last month, more households expect worsening conditions over the next six months, including fewer jobs to be available. Consumer inflation expectations over the next twelve months were basically unchanged from the prior month’s 6.2% level. Overall purchasing plans for homes, autos, appliances and vacations all diminished in April. The labor market differential increased to 37.3 from 36.5 last month. This measures the difference between consumers’ views of jobs “plentiful” versus jobs being “hard to get.” However, in spite of a slumping consumer confidence, consumer spending has remained strong. Consumer spending accounts for about 70% of the U.S. economy.
University of Michigan Consumer Sentiment – April Final Results “Match” Preliminary Readings
As explained in our April 14 commentary, consumer sentiment in this survey unexpectedly rose in contrast to The Conference Board’s measure of consumer confidence. The unexpected increase in year ahead inflation expectations remained.
U.S. Employment Cost Index for Q1 Higher than Expected
The employment cost index rose 1.2% q/q from a revised higher 1.1% in Q4, which was also expected for Q1. Compensation costs for civilian workers increased 4.8% y/y for the period ending March of 2023. Wages and salaries increased 5.0% for the same period. Compensation costs for private industry workers increases 4.8% for the year ending March and wages and salaries were 5.1% higher over the same period. Fed chair Powell has indicated that 3.5% rate of wage growth would be more compatible with a 2% rate of inflation. Wage growth rates remain very “sticky.”
Source: JP Morgan, Friday morning data wrap-up (4-28-2023)
Fed’s Preferred Measure of inflation – PCE Price Index — Remains Stubbornly Elevated in March
The core PCE price index (excluding food and energy) rose 0.3% m/m as expected and was 4.6% higher y/y as expected and down slightly from February’s y/y gain of 4.7%. The headline PCE price index rose 0.08% m/m versus an expected 0.1% increase and was 4.2% higher y/y versus an expected 4.1% increase and versus a February’s revised 5.07% increase. Powell’s “super-core” inflation measure, core services ex-housing was 0.22% higher m/m, which was the smallest increase since last July.
Personal income was 0.3% higher m/m, matching the prior month’s gain but above the expected 0,2% increase. Disposable personal income rose 0.4% and nominal spending was flat sequentially in March. A $44.9 billion increase in spending for services was partly offset by a $36.7 billion decrease in spending for goods. The saving rate moved up 0.3% to a cycle high rate of 5.1%.
Source: JP Morgan, Friday morning data wrap-up (4-28-2023)
U.S. Housing Data – Relative Stability
House price data for February showed a generally moderate level of price increases and interrupted a seven-month streak of declines. New home sales for March were 9.6% higher m/m but 3.4% below March 2022 levels. The inventory levels of new hones for sale at the end of March represented 7.6 months of supply at the current sales pace and was the lowest level since April 2022. Home construction projects were up about 6% over the past two months after a 26% decline over the prior nine months. Pending home sales (signed contracts to purchase a home) unexpectedly dropped in March, which was the first monthly drop since November 2022. The chief economist for the National Association of Realtors (NAR) ascribed this to a lack of sufficient inventories that acted as a “major constraint to rising sales.” Multiple offers were still occurring on about one-third of all listings and about 28% of homes were selling above their list prices. Although housing starts were 0.8% lower m/m in March, the more important single family starts increased 2.7% as the more volatile multifamily starts were notably lower. Permits for single family homes were 4.4% higher m/m in March. We view the recent housing data that we have analyzed recently as showing signs of a bottoming process in the housing market. We expect the housing market to continue to be very sensitive to mortgage rates.
Source: U.S. Census Bureau, Monthly Residential Sales March 2023 (4-25-2023)
Regional Fed Surveys for April Were Mostly Weak
The Dallas Fed manufacturing survey general business activity index declined 8 points to a negative -23.4 that was its lowest reading in nine months. The Philadelphia Fed’s nonmanufacturing survey suggested a continuing weakening in nonmanufacturing activity. The Richmond Fed manufacturing survey showed a deterioration of business activity. The Dallas Fed services survey’s revenue index was able to only “edge” higher by a small amount to maintain a moderate level of growth. Input and wage pressures were able to ease somewhat. The future business activity index remained rather depressed.
First Republic Bank (FRC) and Continuing Credit Contraction
According to Reuters on Friday, the Federal Deposit Insurance Corporation (FDIC), the Treasury Department and the Fed were trying to put a deal together to rescue FRC. But with little success of a deal emerging, it appeared that the talks were focused on preparing to put FRC into FDIC receivership. We expect further credit tightening and tighter lending standards to emerge from regional banks in particular. We continue to expect uneven and unpredictable effects from further credit contraction.
For the time being we are maintaining our basic investment approach as expressed in last week’s commentary. We continue to prefer high quality stocks that offer good balance sheets, as well as relatively stable cash flows and profit margins. We prefer a global diversified portfolio for long term investors. We continue to stress that stock selectivity in this current environment is of paramount importance. We foresee continued financial market volatility.
Due to the many distortions stemming from pandemic related developments, it is often difficult to “properly” decipher economic data. Changes in the economic environment are often subject to very rapid changes. We could soon be entering a period where changes might accelerate, leading to surprising outcomes. Investors should keep an open mind and maintain a “flexible” mindset.
Source: Goldman Sachs, Seasonality and event risk point to a pickup in equity vol (4-24-2023)
Source: Goldman Sachs, Global Markets Daily: Rates Stand Alone (Chang) (4-24-2023)
Federal Funds Rate – The term federal funds rate refers to the target interest rate set by the Federal Open Market Committee. This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
Headline PCE Inflation – A measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.
Core PCE Inflation – A measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services that excludes food and energy prices. The core PCE gives a more accurate reading of inflation because food and energy are very volatile parts of the economy.
Conference Board – The Conference Board (CB) is a not-for-profit research organization that distributes vital economic information to its peer-to-peer business members.
Conference Board Consumer Confidence Index (CCI) – The Consumer Confidence Index measures how optimistic or pessimistic consumers are regarding their expected financial situation. The CCI is based on the premise that if consumers are optimistic, they will spend more and stimulate the economy but if they are pessimistic then their spending patterns could lead to an economic slowdown or recession.
US Debt Ceiling – The debt ceiling is the maximum amount that the U.S. government can borrow by issuing bonds. The Treasury Department must find other ways to pay expenses when the debt ceiling is reached otherwise, there is a risk the U.S. will default on its debt.
Real GDP – Real gross domestic product (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year. Real GDP is expressed in base-year prices. It is often referred to as constant-price GDP, inflation-corrected GDP, or constant dollar GDP. Put simply, real GDP measures the total economic output of a country and is adjusted for changes in price.
Initial Unemployment Insurance Claims – Initial claims are new jobless claims filed by U.S. workers seeking unemployment compensation, included in the unemployment insurance weekly claims report.
Continuing Claims – Continuing claims track the number of U.S. residents filing for ongoing unemployment benefits in a given week. Continuing claims measure ongoing unemployment benefits, which is in contrast to initial claims, which track new filings for benefits.
Yield Curve Control (YCC) – Yield curve control involves targeting a longer-term interest rate by a central bank, then buying or selling as many bonds as necessary to hit that rate target.
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