Mark Twain wrote in 1907, “There are three sorts of lies: lies, damned lies, and statistics.” The variations in opinion about tender or laborious landings heart on how traits are measured, information accuracy, revisions, seasonal changes, and which information to comply with. I present Chart #3 of what I’m monitoring over the subsequent six months because the story about tender or laborious landings unfolds.
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Readers who need help {that a} recession is coming ought to learn Recession Signal As Consumers Struggle To Pay Bills at RIA Recommendation by Lance Roberts. For many who need to learn help for a tender touchdown, I counsel What recession? Inflation, GDP offer hope for ‘soft landing’ by Tobias Burns at The Hill. Stacey Vaneck Smith at NPR factors out the center floor of a gentle recession in Is the Economy Headed for Recession Or a Soft Landing?
Lies, Damned Lies, and Statistics
Chart #1 illustrates numerous strategies of decoding inflation utilizing the Client Worth Index. The strong black line is the uncooked CPI index, and the dashed black line is a development line from the beginning in July 2020 via the height in June 2022. Clearly, the development of inflation started to peak in June 2022. The year-over-year change in CPI (blue line) reveals that inflation is 6.4% in comparison with a yr in the past; nonetheless, the shortcomings are that it compares inflation at this time to circumstances a yr in the past and doesn’t emphasize the short-term traits. The purple line is the constantly compounded annual price of change within the CPI. The markets received the jitters in February as a result of the January studying was increased than anticipated, partially on account of revisions. The fourth quarter development indicated inflation of three.3% setting excessive expectations for disinflation till the January quantity jumped to six.2%, impacting fears of upper price hikes. Lions and tigers and bears, Oh My! The issue is there’s an excessive amount of noise within the information to depend on a single month.
Chart #1: Three Views of the Client Worth Index
Supply: Writer Utilizing BLS Information from the St. Louis Federal Reserve (FRED)
The bond market is now aligning extra with what the Fed has been saying about inflation, however the inventory market is slower to simply accept. Some costs are “sticky,” and it’ll take time to appreciate the lag within the impact of price hikes as these costs, like labor prices, are sluggish to fall.
Paul Donavan at UBS provides an excellent, transient abstract of the calculations about seasonal changes and their large impression in “Please Adjust Your Data Set.” He factors this out utilizing employment for instance, “In January, the variety of jobs within the U.S. fell by greater than two and a half million. It was reported as an increase of simply over half one million.” Critically?!
One of many causes for seasonal impacts on Labor is layoffs and discharges, which are usually highest throughout December and January and lowest in February and the summer season months, as proven in Chart #2. On common, since 2001, there have been a mean of 1.9M layoffs and discharges per thirty days, however 2022 was uncommon, with just one.4M per thirty days. The development could also be altering, although. In December of final yr, twenty p.c of the layoffs from 2022 occurred in comparison with an extended historic common of 9 p.c for December. Is that this a one-month aberration or the beginning of a development? The U.S. Bureau of Labor Statistics will launch the Job Openings and Labor Turnover Survey for January on March 8.
Chart #2: Seasonal Layoffs and Discharges by Month
Supply: Writer Utilizing St. Louis Federal Reserve (FRED) Database
Frosted Crystal Balls
I attempt to filter out the noise from the media and hearken to the extra researched and unbiased opinions. The Convention Board is a company with a protracted and respectable observe document. I quote Ataman Ozyildirim (Ph.D.), Senior Director of Economics at The Convention Board:
“Among the many main indicators, deteriorating manufacturing new orders, customers’ expectations of enterprise circumstances, and credit score circumstances greater than offset strengths in labor markets and inventory costs to drive the index decrease within the month… Whereas the LEI continues to sign a recession within the close to time period, indicators associated to the labor market—together with employment and private earnings—stay strong to date. Nonetheless, The Convention Board nonetheless expects excessive inflation, rising rates of interest, and contracting client spending to tip the U.S. financial system into recession in 2023.“
Supply: The Conference Board, February 17, 2023
I created Chart #3 of the financial system and monetary markets to take away a number of the frost off my crystal ball. The K.C. Fed Labor Market Conditions Index, Momentum Indicator (double inexperienced traces) reveals Labor Situations have peaked and are softening. The Weekly Economic Index (Lewis-Mertens-Stock) (strong purple line) reveals that financial development is under historic traits. The S&P 500 Earnings Per Share (strong blue line) peaked within the fourth quarter of 2021 and is declining. The Federal Reserve Financial institution of New York Yield Curve Leading Indicator (black dotted line) estimates the chance of being in a recession by January 2024 to be 57%. The Smoothed U.S. Recession Probabilities (strong black line) is the Marcelle Chauvet and Jeremy Max Piger mannequin, which is correct and coincident with out a lot lead time. It’s beginning to present that recession threat is rising. Lastly, there’s the dashed black line which is the variety of months that the 10-year/1-year unfold has been inverted. A Wells Fargo study discovered that there’s an 80% probability that the upcoming recession will probably be longer than historic whether it is inverted for 12 months or longer. It has been inverted for seven months now. The three black traces are the metrics that I’ll pay essentially the most consideration to over the subsequent three to 6 months to gauge the chance and severity of a recession.
Chart #3: My Brief-Time period Crystal Ball
Supply: Writer Utilizing St. Louis Federal Reserve (FRED)
The Actual-Time U.S. Recession Possibilities will probably be up to date by Jeremy Piger, Professor of Economics on the College of Oregon, for January across the finish of February.
Okay, so how robust is the patron? Chart #4 reveals the inflation-adjusted Retail Gross sales, Private Consumption Expenditures, Service provider Wholesalers Gross sales, and Complete Enterprise Gross sales, which comprise many of the sub-indicators in my Spending Indicator. They’re set to 100 in April of 2022 when Actual Retail Spending peaked. Inflation is taking a chew out of spending, and for the previous ten months, the patron is just not maintaining with inflation. Pandemic-era financial savings are being depleted, bank card purchases are rising, and delinquencies are rising, together with banks tightening client mortgage lending requirements. Slowing actual gross sales, softening labor circumstances, and falling earnings might lead to corporations having extra layoffs or deferring hiring.
Chart #4: Client and Enterprise Spending Traits
Supply: Writer Utilizing St. Louis Federal Reserve (FRED) Database
Melissa Repko appears past the info traits by studying retailer firm stories in “Retailers Could Face Cost Cuts and Slower Sales This Year” on CNBC. She notes that vacation gross sales had been under expectations, retailers are rising cost-cutting measures, together with layoffs, bank card balances have risen, and client habits is changing into extra conservative.
Steadiness Between Aggressiveness and Defensiveness
Howard Marks, the co-founder of Oaktree Capital Administration, wrote in Mastering the Market Cycle: Getting the Odds on your Side:
For my part, the best strategy to optimize the positioning of a portfolio at a given cut-off date is thru deciding what steadiness it ought to strike between aggressiveness/defensiveness. And I imagine the aggressiveness/ defensiveness ought to be adjusted over time in response to adjustments within the state of the funding atmosphere and the place quite a few components stand of their cycles.
A number of years in the past, I created Chart #5 of my favourite momentum indicator, the Transferring Common Convergence Divergence (MACD), utilizing a spreadsheet linked to the St. Louis Federal Reserve (FRED) database. It’s based mostly on exponential transferring averages and produces a “Purchase and Promote” sign. The MACD generated a “Promote” sign on February 10. I don’t do short-term trades, however the MACD could be helpful for entry and exit factors in addition to a actuality verify for “Worry of Lacking Out (FOMO).”
Chart #5: S&P 500 Momentum
Supply: Writer Utilizing St. Louis Federal Reserve (FRED)
Doug Noland’s Weekly Commentary on Searching for Alpha is a painfully detailed and extremely informative assortment of article summaries that dive into the small print of the info usually earlier than their traits turn into obvious. He summarizes an article on Bloomberg by Farah Elbahrawy on February 13 that explains why the S&P 500 is shedding its momentum. Ms. Elbahrawy states, “U.S. shares are ripe for a selloff after prematurely pricing in a pause in Federal Reserve price hikes, based on Morgan Stanley strategists.”
Curiosity Charge Alternatives Alongside the Yield Curve
This month, I created MACD momentum charts for Treasuries alongside the yield curve. Rates of interest have risen in response to the “hotter” than anticipated January CPI information level. Chart #6 reveals the adjustments within the Yield Curve over the previous 4 months. The black line is the newest Yield Curve, together with the MACD purchase and promote alerts. The purple arrows present the volatility across the ten-year Treasury yields. My interpretation is that yields are nonetheless rising, which is hurting bond fund efficiency. The Fed Funds price is more likely to hit 5.25% by mid-year. I’ve a screener arrange at Constancy for bullish bond ETFs utilizing indicators equivalent to MACD. Presently, most bullish bond ETFs are short-duration. Money is king.
Chart #6: Yield Curve Modifications with MACD Purchase and Promote Indicators
Supply: Writer Utilizing St. Louis Federal Reserve (FRED)
Let’s not neglect that the U.S. might default as early as June if the debt ceiling is just not lifted. I imagine that neither political occasion needs that, and it’s unlikely however not absolute that it’s going to not occur. On August 5, 2011, S&P downgraded U.S. sovereign debt after issuing warnings. The U.S. didn’t default. In line with Wikipedia, S&P mentioned, “The political brinksmanship of latest months highlights what we see as America’s governance and policymaking changing into much less secure, much less efficient, and fewer predictable than what we beforehand believed. The statutory debt ceiling and the specter of default have turn into political bargaining chips within the debate over fiscal coverage.” Sound acquainted? Round this time in 2011, the yield on the ten-year Treasury fell from over 3% to lower than 2% whereas the inventory market fell over ten p.c.
Chart #7: Time Surrounding S&P Downgrade of U.S. Sovereign Debt on August 5, 2011
Supply: Writer Utilizing St. Louis Federal Reserve (FRED)
As a precaution and in line with my 2023 technique, I anticipate to complete extending durations of Treasury bond ladders earlier than mid-year after which add to intermediate bond funds. Falling yields, like in August 2011, would profit bond costs.
Taking the Lengthy-Time period View
Trying past the short-term frost over our crystal balls, Christine Benz at Morningstar, wrote “Experts Forecast Stock and Bond Returns: 2023 Edition,” the place she gives the next chart of ten-year forecasts. It reveals that the chance premium of shares in comparison with bonds has diminished since charges have risen. Secondly, it reveals that there could also be alternatives in developed markets and rising markets. I anticipate that in some unspecified time in the future after mid-year, to start reinvesting short-term Treasuries as they mature into fairness mutual funds and ETFs.
Chart #8: Forecasts for Lengthy-Time period Asset-Class Returns
Supply: “Consultants Forecast Inventory and Bond Returns: 2023 Version” by Christine Benz, Morningstar
Closing Ideas
It’s going to turn into clearer within the subsequent few months whether or not there will probably be a tough or tender touchdown or someplace in between. Regardless, extremely rated bonds have turn into extra enticing. Harry Markowitz, Nobel laureate and creator of quite a few books, together with Risk-Return Analysis, mentioned that “Diversification is the one free lunch.” My base case stays unchanged that the Fed will elevate charges by 1 / 4 level one or two extra occasions this yr, inflation will proceed to fall however stay above 2% for longer, the financial system will present extra weak spot within the coming months, and a recession is probably going in the course of the latter a part of the yr.
Particular thanks go to my pal, Dave Hogle, who began me on the investing journey by loaning me The Four Pillars of Investing by William Bernstein twenty years in the past, for our quite a few long-distance Costco runs discussing every little thing underneath the solar, and for his insightful ideas for these articles.
I realized from a Reader and member of MFO (Thank You) in January that the MACD and Bollinger Bands can be found on the free model of Stockcharts.com for ten-year Treasury yields, utilizing the image $UST10Y. Bond costs transfer inversely with yields. I adopted up, and the Constancy Energetic Dealer Professional and Stockcharts.com are additionally able to working these metrics for mutual funds, which is a great tool.
