Commodity Bull – Now or Later?
This week, major market indexes were mixed. The Dow Jones Industrials dramatically underperformed, the S&P 500 was also negative, but less so, while the Nasdaq managed modest gains. Bonds were higher, the dollar was lower, but both were little changed. Commodities broadly were up on the week, with oil and copper higher again while natural gas continued to collapse, reaching its lowest levels since June of 2021. Gold was up slightly, but silver, platinum, and palladium all suffered losses. The yield curve remained deeply inverted, and continues to flag recession. Financial conditions tightened slightly on the week; however, according to the Goldman Sachs Financial Conditions Index, they remain about as loose as they were back in June despite the fed funds rate currently being 275 bps higher.
Currently, the market is in a sort of temporary Goldilocks state. As Deutsche Bank puts it, we’re in a “sweet spot” between, on the one hand, market perception (right or wrong) that we are past peak-Fed hawkishness and policy uncertainty and, on the other, what DB describes unequivocally as “the eventual recession.” Ominously this week, the German bank suggested “enjoy the sweet spot…while it lasts.” Other than mixed Fed-speak ahead of the pre-FOMC blackout period starting Saturday, corporate layoff announcements, earnings, and a flurry of economic data took center stage this week.
Occasionally economic data hits with a shock. This week’s New York Fed Empire State Manufacturing Survey delivered just such a jolt. The headline survey number took a nosedive to -32.9 in January, smashing the -8.7 consensus. The number crushed even Bloomberg’s lowest estimate of -15.5. In fact, if you add the survey’s December -10.2 variance from consensus estimates to January’s -24.2 undershot, the combined -34.4 point two-month miss was the fourth worst relative to expectations since the survey’s 2001 inception.
Underneath the headline number, things didn’t get any better. Empire State New Orders took a -28-point elevator ride straight down to the sub-basement with a -31.1 reading—the worst ever outside of the pandemic lockdown and great financial crisis. Furthermore, the survey offered more leading indications of developing cracks spreading throughout the labor market as workweek hours dropped significantly. In addition to December PMI data and last week’s December NFIB small business survey, mark January’s Empire State Manufacturing Survey as the latest indicator of a rapidly deteriorating economy.
Further spicing the recessionary data dish, this week also delivered negative surprises on capacity utilization, industrial production, and the production of business equipment—which is now the weakest since lockdowns shut the economy. Summing up the economic data dump of recent weeks, JPMorgan Asset Management CIO Bob Michele stated matter-of-factly that the strong economic headwinds now in place are “starting to bite the economy, and they’re biting hard.”
This week’s final brushstroke on the recessionary picture the data is painting came from retail sales data. For many months, the primary holdouts on the shrinking island of economic strength have been the lagging labor market and resilient retail sales. This week, however, December retail sales significantly disappointed and the November number was also revised sharply lower.
We’re finally starting to see the expected cracks in consumer strength. For the first 10 months of 2022 through October, retail sales averaged better than a positive 0.8% growth rate. In December, retail sales came in well below estimates at -1.1%. The weakness was broad-based across both goods and services. In addition, the negative November revision dropped sales for the month to -1% from -0.6%. The December decline was the largest month-over-month drop since July of 2021, and it marked the first consecutive monthly retail sales decline since 2020.
The slowing consumer is no surprise, but what is perhaps most revealing about the tired state of the consumer is that the drop-off in retail sales is occurring while consumer credit is surging. People aren’t turning to credit because it’s so irresistibly cheap. According to LendingTree, average credit card interest rates on new card offers have now swelled to a record high 22.91% as of December. As the retail sales data confirms, all that consumer credit isn’t being funneled towards booming retail frivolity. Consumers are clearly turning to credit out of necessity—the necessity to pay for essentials.
A deteriorating consumer has been anticipated. As of December, consumers endured their 21st straight month of negative real (inflation adjusted) wages. Furthermore, in both November and December, the personal savings rate averaged a minuscule 2.3%. That is the lowest savings rate in nearly 65 years of data, with the exception of one lonely month preceding the great financial crisis. For perspective, in the last month before Covid lockdowns, the savings rate was 9.3%.
The combination of negatively trending retail sales amid surging consumer credit at record high credit card interest rates is a strong indication that the consumer has reached an unwanted inflection point. Savings are gone at the lower end, and increasingly depleted in the middle of the income bracket. Credit as a solution is unsustainable, and has already been tapped. Like the infamous image of Wile E. Coyote running in the air for a time after dashing off a cliff, the consumer is slowing up, looking down, and succumbing to financial gravity. Meanwhile, the “solution” of turning to historically expensive credit to make ends meet is getting long in the tooth, and banks know it. This week, as all banks are rapidly increasing loan loss provisions to prepare for a default cycle, Goldman Sachs conceded seeing “signs of consumer credit deterioration.”
Along with retail sales data this week, retailer Nordstrom provided added evidence that the consumer may be starting to crack. On Thursday, Nordstrom slashed its performance guidance after a wave of promotional activity failed to deliver the intended sales boost and instead backfired by simply squeezing margins. Given the drop in sales volume, Nordstrom drastically cut its adjusted EPS guidance from the prior full-year 2023 range of $2.30 – $2.60 per share to a new range of $1.50 – $1.70. That revision is more than a minor “oops.” As the Nordstrom CEO put it, “The holiday season was highly promotional, and sales were softer than pre-pandemic levels. While we continue to see greater resilience in our higher income cohorts, it is clear that consumers are being more selective with their spending given the broader macro environment.” In other words, despite dangling heavy discount incentives in front of consumers, sales still sagged below pre-pandemic trend. A consumer that previously had been punching well above its weight suddenly becoming “more selective with their spending” spells big trouble for an economy in which the consumer-spending engine drives 70% of GDP.
Let’s turn to the other remaining pillar of economic strength, the labor market. According to the human resources consulting firm Challenger, Gray & Christmas Inc., the most job cuts in 2022 were in the tech sector, with layoffs up 649% compared to the previous year. Sector job losses in 2022 were the highest since the dot-com crash more than 20 years ago. So far in January of 2023, the bleeding is accelerating. Amazon has said it expects to lay off a company record 18,000 people, Microsoft announced 10,000 job cuts this week, Google just announced a 12,000 culling of its workforce Friday, and more than two dozen US-based tech companies, including Coinbase, Flexport, and Salesforce have said they’ll cut their workforce by 10% or more.
The tech sector, feasting on near zero interest rates and gobs of liquidity, was the top general leading the charge of the credit bubble economy. The Fed recruited and trained that economy with over a decade of the easiest monetary policy in history. It’s no surprise that a rare year of Fed policy tightening has delivered an outsized hit to tech. The faltering sector is a prime contributor to the broader weakening in the service sector economy that, in December, slipped into contraction.
On the manufacturing side of the economy, now also in contraction, both the housing and auto sectors were champions of the Fed-spurred boom. As with the tech sector, however, the boom is turning bust. The fallout from a developing bust at the core of the bubble is beginning to spread.
This week offered further indication that the sickness manifest in the housing market is spreading to commercial real estate. Many commercial real estate markets are now almost frozen. As Bloomberg reports, some lenders are now telling borrowers to sell assets or risk foreclosure amid demands for additional capital from landlords.
As Ian Guthrie, senior managing director of loan advisory at real estate broker Jones Lang LaSalle said this week, “What we have in this downturn is a fairly unique set of economic circumstances. Interest rates are tightening instead of softening the blow for real estate and other corporates,” adding, “You have a pipeline of potentially defaulting loans [where] values are under pressure and cash flows are under pressure.” According to Guthrie, this year “is when those problems will start to manifest themselves.” The implications? Along with introducing another avenue for increased credit stress in 2023, the drop in transactions and development in commercial real estate will inevitably have a negative impact on spending in the real economy, growth, and jobs.
Pulling back and widening the lens, while the official non-farm payrolls from the labor department are still expanding, the pace is decelerating. Furthermore, hours have already been cut drastically (an initial sign of labor market weakness), and the overwhelming majority of new jobs added in the second half of 2022 were part-time—not exactly the hallmark of robust economic expansion.
HAI started tracking press releases for publicly announced job cuts last autumn. There is a pronounced trend, and it’s not a good one for the labor market. October delivered a 133% increase in job cuts over September, while November job cuts jumped by more than 181% over October. December is a unique month for corporate layoffs. Few and far between are the companies that relish the Ebenezer Scrooge-like public relations optics of holiday season layoff announcements. Nevertheless, while December job cuts were half of November’s, layoffs in the holiday season still outpaced those of both September and October. With the holidays behind us, however, the multi-month trend of significantly accelerated jobs cuts has resumed. Just 20 days into January, the first month of the new year has already delivered significantly more announced job cuts than any month HAI has tracked yet.
The deteriorating trend also seems to be reflected in some January survey data indicating a significant drop in the percentage of companies listing tight labor availability as a constraint. All in all, there is evidence to support Bank of America’s call this week for a “delayed, but sharp, weakening of the job market.” The bank warned that the strongest segment of the economy, doing the most to prop up growth, could suddenly “become a weak sector.”
The case for a hard landing is very strong. If the Fed sticks to its hawkish guns, delivering ongoing quantitative tightening and higher rates for longer, the hard landing and a sharp drop in asset prices seem a near foregone conclusion. In addition, under such a scenario, inflation will likely remain in check for a time. If, however, the Fed backs down soon, we could have a very different situation on our hands. China’s reopening is already teed up. That means 1.4 billion people finally ending years of lockdown with somewhat more than a little bit of pent-up demand. It also means the likelihood of massive Chinese government stimulus. If the Fed pivots prematurely into already elevated prices and manages to prop up US economic growth at the very same time Chinese demand is flooding back into an equation in which already chronic, tight commodity supply dynamics are firmly established, the result could be explosive and highly inflationary.
As Goldman Sachs’ Global Head Of Commodity Research Jeff Currie said this week, “You cannot come up with a more bullish concoction for commodities.” He added, “Lack of supply is apparent in every single market you look at, whether it is inventories at critical operating levels or production capacity exhausted.” For demand-sensitive, supply-constrained natural resources, the question is not if a commodity bull market is in store, but rather, does it begin now or later? The Fed policy path from here will be critical in determining the answer to that question. At the February 1st FOMC meeting, all eyes will be on the monetary maestros as they offer the next directional policy hint.
Weekly performance: The S&P 500 was down 0.66%. Gold was up 0.39%, silver lost 1.81%, platinum was lower by 2.30%, and palladium lost 3.59%. The HUI gold miners index shed 0.50%. The IFRA iShares US Infrastructure ETF was lower by 1.90%. Energy commodities were volatile and mixed on the week. WTI crude oil added another 2.23%, while natural gas was hit again, down another 7.17%. The CRB Commodity Index was up 0.92%, while copper added 0.71%. The Dow Jones US Specialty Real Estate Investment Trust Index was off 0.69% on the week, while the Vanguard Utilities ETF (VPU) was down 2.96%. The dollar was slightly lower by 0.22% to close at 101.78. The yield on the 10-yr Treasury lost 1 bp to end the week at 3.48%.
Have a wonderful weekend!
Investment Strategist & Co-Portfolio Manager