Consumers Don’t Fear the Fed. They Should!

Consumers may say they are worried about inflation, but they are still out shopping. The majority of economists and 98% of CEO’s expect a recession in the next 12 months, but the service sector, which accounts for more than two-thirds of U.S. economic activity, continues to expand. Airbnb reported its highest quarterly revenue ever. Cedar Fair amusement park is also experiencing record revenues. McDonalds and Chipotle just reported an earnings beat. The airlines are seeing record operating revenues in Q3. Caesars, owner of 8 casino resorts in Las Vegas, said October’s earnings were the strongest month in history. Yet consumer sentiment and inflation expectations are the most negative ever recorded. With this tortuous contrast of extreme pessimism and optimistic behavior, it’s understandable why there is so much confusion among professional and retail investors. The sentiment plunge in 2020 and most of 2021 was all about Covid. In 2022, the continued collapse in sentiment to record lows has been all about the 40-year highs in inflation. In this environment. It’s logical that political parties in power are in trouble.

 While the future fallout from battling inflation weighs on sentiment, present spending behavior is guided by pocketbooks. The inflation so many worry about was caused by excess stimulus which elevated household savings to extreme levels, about $1.5 trillion above trend in the US. This surplus is being spend down in terms of personal savings to very low levels. However, Americans still need another quarter or two to drain their cumulative stimulus pool. Once these savings (black dotted line) fall closer to their pre-Covid trendline, personal loan defaults and unemployment will rise above their current healthy levels. 

Though inflation pressures continue to bubble, mega-cap tech companies all indicate a slowdown in the consumer into January. Amazon expects the slowest growth in their history. Microsoft, Apple and all the chip makers expect slower gaming and computer sales. Retail sales are expected to climb just 5% this Holiday season, down from the 15% gain recorded during the same period last year. It will not be pleasant, but the Fed will not stop hiking until consumers stop spending. The Fed could not be more transparent that they will sacrifice the economy and the stock market to bring inflation close to its 2% target. As seen below, wage inflation and job openings “appear” to have peaked, but it will take months of credit tightening and reduced business activity – pain – before these key measures can touch the normal levels that will please the Fed.

It’s possible major stock market lows arrived in October, where we had forecasted a short to medium term low. However, stocks typically bottom as much as 6 to 12 months prior to an economic bottom and the next GDP cycle low should be another 11 to 17 months away still. This coincides with the sticky inflation and duration of rising borrowing rates that keep us in a defensive posture through the first and possibly the 2nd quarter of 2023 for equity investors. New lows may hold off until December or January, but the Tech heavy Nasdaq has already fallen back this week to within 2% of its 2023 lows upon the Fed rate hike news. Tech is often the main victim in credit tightening cycles to battle high inflation. Healthcare is often the best in this environment. Due to supply chain hurdles and Ukraine, the energy and defense sectors have also been excellent areas we have favored. Unfortunately, it’s too late accumulate these stocks as many are hitting record highs this month. However, there are still some medical device, insurance, utility, staple and small cap stocks that remain attractive for portfolio additions after general market corrections. Our strategy is to keep some exposure to these sectors while maintaining heavy cash allocations over the next 3 to 6 months.





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