For the 2nd quarter in a row the economy contracted. Stocks rallied on the growing recession fears that implied the Fed would soon stop raising rates due to prospects of falling inflation soon. Stocks also rallied a day earlier when the Fed hiked rates 75 points with a Hawkish vow of more interest rate hikes if inflation remains elevated. This positive news response syndrome echoes our comments on July 15th and 16th, just before the S&P 500 Index rallied 8% in 2 weeks after a shockingly high headline CPI inflation report of 9.1%. Back then, with the SP at 3790, we said: “07-15-22 Two red hot inflation reports this week triggered brief market drops that were reversed within hours. … we have a very positive news response syndrome supporting the current summer relief rally (forecast)… between SP 4,000 and 4,300 in August … before seasonality and worsening economic data knock prices down once again“. On July 16th with the SP 500 Index at 3860 we said: “In this uncertain environment, Bearish news of almost double-digit inflation coincided with a modest rally in stocks instead of the expected plunge to new lows … when bad news is viewed as good news. it’s indicative of a market that is primed for a reversal —> higher stocks with lower Dollar and interest rates.” We highlight the more intuitive non-technical tool of market price response to news to provide a simplistic perspective that can sometimes be far more accurate than the 100+ technical oversold indicators that esteemed money managers often rely upon. In a Bear market where false positives on stock market reversals are commonplace, sometimes the simple contrast of negative market behavior to tepid news in June compared to the positive reaction to terrible news in July is a strong anecdotal Buy signal. Our indicators below gave modestly premature stopck market Buy signals at the May lows and again thoruhgout June and early July.
The market action took longer to show upside acceleration than we had presumed, yet the 13% rally from the June lows is 6 weeks old and is now the longest and strongest rally of 2022. Despite a rising stock market and full employment, Consumer Confidence just fell to fresh 9-year lows and the popular Michigan Survey shows Current and Expected Consumer Sentiment reaching all-time record lows. The non-stop negative news has taken a toll and distorted the reality that the jobs market has never been stronger; travelers are overwhelming airports; bank accounts are rising and with hardly a hint of financial distress. This does not preclude a slowing economy and risk of financial hardship months down the road, but currently the positive actions speak louder than the frequent admonitions of alarm.
It’s understandable why the Bearish fervor keeps growing among investors and professionals. Traditional tried and true metrics with 100% accuracy over the decades are flashing red lights all over. Past episodes where we have had stagflation, a negative 10 – 2 Year Yield, sharp roll-over in leading economic indicators, have all led to serious recessions every time. The one most talked about recently has been the forecast of recession with 2 back-to-back quarters of negative GDP. Most Bears extrapolate such events to forecast a lengthy period of rising unemployment with much lower equity prices as consumption and corporate earnings fall. The correlation economists and money managers seem to overlook is that when these indicators are at their current levels, unemployment has always been rising more than a year by now. Business formations and personal consumption are usually falling by now and loan defaults are rising sharply. However, delinquencies, individual bank accounts, retail consumption and business creations are actually great and more indicative of a strong economy, so far. Of course, the biggest question that Bears should be asking is, why is the labor market so strong still? Why this time is so different we have aways assumed is due to the response to the Covid endemic. The size of fiscal and monetary stimulus in the US and around the globe in response to the Covid restrictions has been the problem. Consistent long term personal consumption expenditure trends indicate we are spending $1 trillion to $1.5 trillion a year more than healthy growth rates would target. This excess demand created an historic labor shortage and inflationary supply-chain breakdowns. Once consumption trends return to the normal 3 to 5% growth rates (or we remove a trillion from the economy), we should then see supply and demand come into balance with more normalized inflation rates.
When Covid restrictions faded post vaccine in April 2021, normal 5% consumption growth rates jumped to 30%. They have drifted down to the 8.4% range since the Fed began their rate hikes in March, which remains a hot level fueling inflation. Once personal spending growth slows to a 3 to 5% growth rate, inflation should fall close enough to the acceptable range where talk of rate cuts and stimulus may rise. A new wrinkle in the Fed’s effort to normalize inflation is a surprise series of bills this week totaling over $800 Billion of partisan bills that are being rushed through before the midterm elections. States are also sending out free checks from their $350 Billion stimulus reserve funds. These inflationary efforts to appease voters, along with Russia’s exporting of energy shortages to Europe, will elevate supply chain inflation this winter with higher-than-expected interest rates once the current fall in yields bottom out this summer. Perhaps this partisan spending spree will be one of the triggers for the next leg down in stock prices this Fall. Fed Chair Powell has a good shot at slowing the economy enough by the first half of 2023 to avoid a jobs recession of over 5% unemployment, but political agendas and geopolitics could greatly reduce the odds of success.