The Return of FOMO and Catch-22
Last week, HAI referenced a letter to clients penned by Elliot Management. In it, the world-class hedge fund warned its clients of an “extremely challenging” situation for the global economy and for financial markets in which an “extraordinary” set of financial extremes has made possible a set of bearish outcomes that “would be at or beyond the boundaries of the entire post-WWII period.” Many investors perceive these risks, but, underneath a veneer of caution, the collective mind of the market is still captive to ironclad bull-market muscle memory and an unwavering faith in the ultimate safety provided by the infamous and assumed, Fed “put.” Even though most investors rationally fear the bearish potential imbedded within this “extraordinary” environment, their behavior is still overwhelmingly governed by an even greater terror—the catastrophic “fear of missing out” on an expected imminent resumption of the bull. While such an investor dynamic unquestionably fuels bear market rallies, historically it’s not a dynamic that births bear market bottoms.
Proof of this market’s terminal case of FOMO came this week in the form of an absolutely historic everything-surge in the wake of the latest signal that consumer prices are modestly backing-off peak levels. On Thursday, the Bureau of Labor Statistics released the second softer-than-expected monthly Consumer Price Index (CPI) inflation reading since the Fed began raising interest rates. Year over year (Y/Y) CPI for October registered 7.7%, down from 8.2% in September and less than the 7.9% expected. Month over month (M/M) consumer price inflation increased by 0.4% vs. the 0.6% expected. October core CPI, less food and energy, came in at 6.3% Y/Y, down from 6.6% in September and less than the 6.5% expected. On a monthly basis, core CPI increased 0.3% vs. the 0.5% expected. Tumbling used car prices and a one-time drop in medical insurance resulting from a technicality were key contributors helping to keep overall CPI price increases somewhat in check.
All in all, better than expected and improving, but make no mistake, outside of Wall Street’s magical world of make believe, a 7.7% CPI read is severe and unresolved inflation. Recall, it was a year ago that the Fed was no longer able to ignore the inflation problem with CPI running at 6.2%. Last November the Fed ate a very large and public helping of crow and was finally forced to retire the word “transitory.” That event marked the start of the Fed’s preparation for a hawkish policy shift and inflation fight. In short, inflation is still running far hotter than the lower level that initiated the Fed’s hawkish warpath in the first place.
Monthly prices continue to increase for both headline and core measures at rates that still reflect significant broad-based price pressures. For perspective on the rate of improvement, consider that this month’s 0.4% M/M headline increase was stronger than July’s 0.0% M/M reading, and this month’s 0.3% core M/M increase matched that of July’s. Furthermore, nearly 60% of the sub-categories that feed the CPI saw a three-month rate of acceleration that exceeded their year-over-year rate of change. In other words, the inflation dragon still breathes fire, and the battle to quell the beast is anything but over.
While HAI won’t get ahead of itself by declaring a premature victory over inflation and fantasizing over an imminent dovish Fed policy pivot that perfectly sticks an economic soft-landing, the same can’t be said for countless legions on Wall Street. After repressing bullish instincts for the majority of 2022, market bulls, absolutely foaming at the mouth with a pent-up burning desire to buy stocks, finally exploded into action on the CPI news Thursday. All it took was a two-tenths better than expected CPI to induce a breathtaking eruption of feverish buying of all things. The S&P 500 surged 5.54% and the Nasdaq 100 gained a whopping 7.49% on the day. In other words, for the indexes, it was a solid year’s worth of gains on one Thursday in November.
There’s an awful lot of relief in this “relief rally” and at least temporarily the party is certainly back on at the corner of Wall and Broad. The jukebox is plugged back into the socket, the disco ball is spinning anew, and markets are dancing again. With partygoers already inebriated on the mere expectation of the imminent spiked punchbowl the Fed is presumed so certain to deliver, it’s time again for HAI to spoil the mood and point out the great contradictions imbedded within the market’s flawed and short-sighted rally thesis.
The market is surging because a softer CPI print, in theory, encourages a more imminent dovish Fed policy pivot and increases the chances of a soft landing. The higher stocks go, however, the more financial conditions will loosen. The more financial conditions loosen, the more commodity prices increase and broad inflationary inputs re-accelerate. The more inflationary inputs re-accelerate, the harder it is for the Fed to slow rate hikes, pivot, and deliver the party punchbowl the market is already celebrating—the very same easy-policy punchbowl the rally itself is predicated upon. The longer these market rally dynamics perpetuate sticky-high and persistent inflation, the more the Fed must dole out interest rate poison at higher levels for longer. Rather than a dovish pivot and a soft landing, the grand result is no pivot, a worse recession, and an even harder landing for the economy and markets. It’s a tragically self-defeating catch-22.
As for that looming recessionary tsunami, signs of its imminent landfall continue to mount. Last week, HAI cited aggregate job cut tracking data from DailyjobCuts.com as an indication that despite still positive headline jobs numbers, the labor cycle is already starting to turn south. HAI reported that, as of Thursday, the 3rd of the month, “the November tally of cuts stands at 4,215. Just three days into the new month, we already have nearly a quarter of October’s total of 17,857 and more than half of September’s total of 7,657 cuts.”
To update and underscore the point that momentum in the labor cycle is turning and indeed accelerating to the downside, the November month-to-date job cut tally, just one week later, has now risen to 23,751. That’s already a third higher than October’s total and more than three times that of the full month of September. With the lagging impact of previous rate hikes still hitting and the Fed continuing to tighten, expect this recessionary trend to accelerate and broaden into the new year.
So, while Wall Street parties on punchbowl hopes and pivot dreams, real job losses are notably picking up the pace in a real economy rapidly accelerating toward recession. Elsewhere in the real economy, stress on the consumer builds. According to data released this week, real “inflation adjusted” wages have now been negative for an unprecedented 19 straight months. At the same time, the savings rate is in freefall. In fact, the savings rate has fallen from 9.3% pre-pandemic to a current rate of 3.1%. That’s the lowest savings rate seen in data back to 1958 outside of a handful of months preceding the Great Financial Crisis. To put the challenges faced by today’s consumer in further perspective, when Americans battled the last great inflation in the late 1970s and early 1980s, they had the benefit of facing those inflationary pressures with a savings rate of roughly 11.5%. Not surprisingly, given that rapidly increasing labor market uncertainty is now adding another serious dimension to pre-existing consumer stress, the University of Michigan Surveys of Consumers reported on Friday that consumer sentiment, already deeply recessionary, plunged a further 9% from the October reading.
Until recently, increasingly squeezed consumers have largely maintained their spending by turning to credit cards and taking on ever-greater amounts of debt. That “solution,” however, is quickly becoming far more difficult. Senior loan officer surveys from commercial banks reveal that the number of banks tightening their standards for credit card loans is surging. As recently as Q3 2021, we had an all-time record number of banks, by a wide margin, easing standards for credit card loans. That script has now decidedly flipped. The latest data reveals that the net percentage of banks now tightening their standards for credit card loans has now surged to levels that have historically always been accompanied by recession. In fact, the current net 18.8% of banks tightening standards surpasses the levels seen at the onset of the dot.com recession, the Great Financial Crisis, and the Covid recession. This is equivalent to turning off the spigot for credit-based consumer spending, and, as in the past, it points squarely toward recession.
Ominously, the exact same phenomenon of rapidly tightening lending standards seen on the consumer side is also apparent within the corporate sphere. Senior loan officer surveys demonstrate that banks are tightening standards for commercial and industrial loans at an astonishing clip. A record number of banks were loosening their commercial lending standards in Q3 2021. It wasn’t until Q2 of this year that banks, on net, began to tighten their lending standards. Amazingly, just since the second quarter of this year, the net percentage of banks actively tightening standards for commercial and industrial loans has already reached 39.1%. That’s a high level that has never been reached outside of periods either immediately preceding a recession or during an active recession. In addition, the transition from Q3 2021’s record loosening to the current recessionary level of net percentage of banks tightening is the fastest such swing in data since 1990. Just as on the consumer credit side, this tightening of corporate lending is likely to significantly restrain commercial and industrial spending in the period ahead, slow the economy, and, as it has in the past, contribute to a deepening incoming recession.
While for the time being both financial assets and hard assets are rallying together, HAI suggests that the pending impacts of recession are likely to weigh increasingly and disproportionately on financial assets. HAI will be watching for a performance divergence to develop between these asset classes. Growing signs of a China Covid-zero reopening in the spring, worsening global geopolitical tensions, and incredibly tight supplies for natural resources should partially offset recessionary demand destruction dynamics in many commodities. Economically insensitive gold is already benefiting from increasingly strong demand and appears poised to thrive as its tested, unique, and unparalleled safe-haven characteristics shine amid growing concerns over counterparty risk. By contrast, financial assets appear squarely in the recession’s crosshairs. While HAI is without the benefit of a flawless crystal ball, given the overwhelming indicators of incoming recession, one thing is certain: financial asset bulls, soft landing enthusiasts, and recession doubters are all making a dangerous and infamous bet that “this time it’s different.”
Weekly performance: The S&P 500 surged by 5.90%. Gold was strong, up big by 5.54%, silver was up 4.28%, platinum gained 8.08%, and palladium jumped 10.17%. The HUI gold miners index outperformed big, up 13.02%. The IFRA iShares US Infrastructure ETF was up 4.00%. Energy commodities were big underperformers on the week. WTI crude oil lost 3.94%, while natural gas was drubbed by 8.19%. The CRB Commodity Index was lower due to energy, down 0.61%, while copper had a big week, up 6.16%. The Dow Jones US Specialty Real Estate Investment Trust Index was up by 8.16% on the week, while the Vanguard Utilities ETF (VPU) gained 1.71%. The dollar was crushed, down 4.16% to close a very volatile week at 106.16. The yield on the 10-yr Treasury was also hammered, down 35 bps to end the week at 3.82%.
Best Regards,
Morgan Lewis
Equity Analyst & Investment Strategist
MWM LLC
