Happy Thanksgiving, and 2023’s Story – November 25, 2022

Happy Thanksgiving, and 2023’s Story – November 25, 2022
Morgan Lewis Posted on November 26, 2022

Happy Thanksgiving, and 2023’s Story

HAI wishes all readers and MWM clients a very Happy Thanksgiving weekend. Family time is a blessing for this author, and as a result HAI will just share a few brief thoughts for the week.

The market ended the shortened Thanksgiving trading week with the Dow, the S&P 500, and the Nasdaq all higher for the week. As has been the case for months, the Dow was the relative outperformer, and it was the Nasdaq dragging its feet with the weakest performance. While money has rotated out of technology, along with economically sensitive consumer discretionary stocks, it’s flowed into defensive stock groups like staples, utilities, healthcare, industrials, and materials. Such defensive flows are warranted.

The economy is weakening, and the data reflecting it is softening at an increasingly robust clip. That trend is symptomatic of the natural spread of damage caused by higher rates in an extremely rate-sensitive, highly debt-laden economy fully acclimated to near-zero interest rates. As interest rate gravity has reappeared within the physics of the financial universe, the first obvious casualty has been housing. Residential real estate transactions have fallen off a cliff, with prices likely to soon follow. That’s a big deal, with substantial negative knock-on effects for related industries and a negative wealth effect on consumers as well.

More recently, the spreading impact of higher rates has finally begun to disrupt the “disruptors.” Higher rates have begun to puncture bubbly valuations throughout tech-land. As easy money becomes a little scarcer, we are seeing that speculative excesses are being unwound within the innovation trifecta of tech, venture capital, and crypto. We are now seeing this cohort outpace other sectors on job cuts. In fact, Challenger, Grey, and Christmas released an unusual mid-month update on job cuts. They reported that for the first half of Q4, tech job cuts reached 40,787. In all Q1 of this year, Challenger’s tally was 267. By mid-month, cuts in November within the tech sector were 31,200. That compares with total job cuts for all industries for the full month of October of 33,843, and that was before this week’s news that Google is planning on laying off about 6% of its workforce—roughly 10,000 people—according to a report in The Information.

The sudden weakening of the tech-land labor market was also on display with the latest announcement from Amazon. The company said that, in addition to the 10,000 job cuts already announced, more will be coming in 2023. As the CEO warned in an email to employees, “Those decisions will be shared with impacted employees and organizations early in 2023.” How many more cuts could Amazon dole out? That answer remains unknown, but consider that in the post-pandemic era of zero percent interest rates and trillions in stimulus dollars, Amazon hired 800,000 employees in 2020 and 2021 combined. In contrast to the easy-money era of plenty, as higher financing costs and negative wealth effects kick-in at an accelerated pace, the ultimate number of Amazon job cuts needed to rationalize the post-pandemic work force boom may accumulate to unexpectedly high numbers.

The story is varying degrees of similar across the interest rate-sensitive economy, and as weakness begets more weakness, the bleeding will eventually spill over at an accelerated pace into the rest of the economy. This process is just beginning.

Initial signs of a broad labor market weakening are becoming increasingly apparent. In a less formal accounting of company job cut press releases across all industries, by HAI’s count, October job cuts increased by over 133% over September numbers. Month to date, November is outpacing October by 153%. Actually, November month-to-date job cuts are already outpacing the combined total of both September and October cuts across all-industries by over 77%. HAI perceives an emerging trend.

This trend may be interrupted by the holiday season. As evidenced by the Amazon decision to re-initiate layoffs in early 2023, most companies will likely aim to avoid unseemly headlines of holiday season firings. That said, expect the new year to usher in a reinvigoration of this trend towards a weaker labor market.

When it does, that trend will be accompanied by PMI data in contraction and still falling, and 6-month forward data that’s deteriorating from current levels in everything from general business conditions, new orders, shipments, backlogs, delivery times (falling meaning weakness), inventories, and average work week (falling meaning weakness).

So while financial markets are taking advantage of very strong positive seasonality and could “Santa rally” all the way into the new year, the recessionary weakening long broadcast by the severely inverted yield curve and by the long-lead economic data is starting to manifest in real time. Keep in mind, as well, that, ominously, far from showing signs of bottoming, the long-lead economic indicators continue to decline.

Higher rates and their negative valuation impacts are the story of 2022. But monetary policy works on a lag. The lagged impact of this interest rate tightening cycle and what it’s going to do to the real economy and corporate earnings—that’s 2023’s story. Barring an imminent 180 from the Federal Reserve—not just a pause on further rate hikes, but a complete reversal of policy—the worst is not behind for most asset classes, but very likely ahead.

The point was reinforced this week by legendary investor and hard asset enthusiast Jim Rodgers, who said that he expects that the market’s next substantial rally, which could be upon us now, will likely be it’s last before rolling over into “a bear market that has to be the worst in my lifetime.” That’s a sobering thought, especially considering that the seasoned pro is in his 80s. The ball will be back in Powell’s and the Fed’s court for next month’s Fed FOMC meeting. All eyes will once again be on the Chairman.

Weekly performance: The S&P 500 gained 1.53%. Gold was nearly flat, down 0.02%, silver gained 2.05%, platinum added 0.36%, and palladium dropped by 6.05%. The HUI gold miners index was up 3.87%. The IFRA iShares US Infrastructure ETF was higher by 2.40%. Energy commodities were volatile and mixed on the week. WTI crude oil was hit again, down 4.78%, while natural gas surged 16.29%. The CRB Commodity Index was little changed, up 0.17%, while copper was unchanged. The Dow Jones US Specialty Real Estate Investment Trust Index was up 2.26% on the week, while the Vanguard Utilities ETF (VPU) gained 3.16%. The dollar lost 0.85% to close the week at 105.92. The yield on the 10-yr Treasury was lower by 14 bps, ending the week again at 3.68%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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