Seat Belts Fastened; a Hard Landing Seems Likely
Given the long holiday weekend and travel plans this week, HAI will merely offer weekly prices and a few very brief thoughts.
In short, HAI’s thesis remains the same. The US appears headed for a recessionary hard landing, and we continue to carry the high risk of market crisis eruptions along the way. Inflation remains far too elevated for the Fed to easily pivot to the rate cuts and outright liquidity injections necessary to forestall recession and the outbreak of further crisis. Given the inflationary backdrop and the implications for Fed institutional credibility, the Fed will likely require a recession or an obvious and intense crisis (even more than we’ve seen to date) to respond to before making a full pivot from restrictive policy to aggressive emergency response policy easing.
The bond market sees the pivot coming. Despite what Powell and the Fed have said about not cutting rates in 2023, the bond market is now pricing in multiple rate cuts from the Fed in the second half of the year. Recession and market accidents are the likely triggers for such cuts. The nature of the recession, severity of accidents, and the speed and degree of the Federal Reserve policy response will likely dictate the exact fate of the stock market. But make no mistake, the risk of considerable stock market downside is extremely high.
Events of this week only furthered the thesis. OPEC+ cut oil production by 1.16 million barrels per day. That cut will support higher oil prices, and is not going to help the Fed on the inflation front. At the same time, economic data this week demonstrated considerable deterioration. Manufacturing and services PMI data, JOLTS (job openings) data, initial jobless claim upward revisions, and ADP private payrolls were all significantly weaker than expected.
On balance, the week’s data shows the U.S. continuing to move closer to recession. Still, it’s probably too soon to expect the banking sector turmoil to have landed much of an impact on the manufacturing and services sector yet. So, the already weak data only strengthens the belief that domestic demand growth is set to weaken further and sharply. HAI expects the wider economy to follow the manufacturing sector into recession soon.
Strengthening that view considerably is the fact that early indications are signaling that the banking crisis, as expected, is indeed translating to a sharp tightening of credit and lending. That tightening is on top of what were already recessionary levels of tightening bank lending standards. We will not get the next official Senior Loan Officer Opinion Survey (SLOOS) report until May, but, as stated, early indications point to a significant further tightening in lending. That tightening is the likely confirmation of incoming recession.
This week, the Dallas Fed released its banking conditions survey from March 21-29. This report gives us a heads-up regarding what to expect from the next SLOOS report. The survey reached the following ominous conclusion:
Loan demand declined for the fifth period in a row as bankers in the March survey reported worsening business activity. Loan volumes fell, driven largely by a sharp contraction in consumer loans… Credit standards and terms continued to tighten sharply, and marked rises in loan pricing were also noted over the reporting period. Banking outlooks continued to deteriorate, with contacts expecting a contraction in loan demand and business activity and an increase in nonperforming loans over the next six months. Some contacts cited waning consumer confidence from recent financial instability as a concern.
This Dallas Fed report is a strong indication that recessionary credit crunch dynamics are imminent.
An additional early warning of a recessionary credit crunch came this week from the American Bankers Association’s credit conditions index. The ABA found that “US credit conditions for consumers and businesses are expected to deteriorate in the next six months to their worst level since the pandemic.” According to a survey of chief economists at 15 of the nation’s biggest banks, “the credit conditions index fell to 5.8 in the second quarter from 12.5 in the first quarter.” A reading below 50 in the gauge indicates that the economists forecast weaker credit conditions in the coming six months. All 15 economists see credit becoming less available for businesses over the next six months, while almost all anticipate the same happening for consumers. To be clear, in our modern economy, if you choke off credit, you choke off the economy.
So, already recessionary tight lending is getting significantly tighter. That is very likely the final knockout punch that sends the economy to the canvas. HAI believes that the negative economic momentum already established and in the pipeline will translate to a hard landing for stocks and the economy. The wild card is Fed policy response. As HAI has previously stated, hot inflation remains the sticky pair of shackles binding the hands of policy makers. The stimulative policy pivot needed to postpone our recessionary economic trajectory would be a full can of gas on an already burning inflation fire, and it would be the death knell for central bank credibility—full stop.
In short, the Fed could pivot early into still elevated inflation, but it will probably try to avoid doing so until it determines that it absolutely must. That means crisis response is more likely than preventative medicine, and investors might be wise to batten down the hatches. A storm is coming. As first ballot hall of fame investor Jeremy Grantham put it this week, speaking of the S&P 500, “The best we can hope for is that this market bottoms at about 3,000.” In other words, helmets on and seatbelts fastened because the best we can hope for is another loss of over a quarter of the stock market’s current value.
Weekly performance: The S&P 500 was off 0.10%. Gold was up 2.02%, silver gained 3.88%, platinum was up 1.37%, and palladium lost 0.38%. The HUI gold miners index was up 6.06%. The IFRA iShares US Infrastructure ETF shed 1.26%. Energy commodities were volatile and mixed on the week. WTI crude oil jumped 6.65%, while natural gas was crushed, down 9.25%. The CRB Commodity Index was up 1.59%, while copper lost 1.93%. The Dow Jones US Specialty Real Estate Investment Trust Index gained 1.80% on the week. The Vanguard Utilities ETF was up 2.97%. The dollar was down 0.66% to close at 101.52. The yield on the 10-yr Treasury lost 18 bps to end the week at 3.30%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
