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The charts and themes from the past week that tell an interesting story in markets and investing…
1) The Next Generation
A startling 78% of Americans surveyed by the Wall Street Journal said they don’t feel confident that life for their children’s generation will be better than their own. That’s the highest share since the survey began asking the question every few years in 1990.
Why are people feeling so negative about the future?
Inflation, it appears was the number one reason for the angst, noted by over two-thirds of respondents. Rising housing costs, rising healthcare costs, and wages not keeping pace with rising prices were all cited.
Valid concerns, to be sure. But how did we get there?
As it turns out, the same generation that is worried about their children’s future chose to continually borrow from that future to spend more money today.
A look at federal government spending tells the story, with a 185% increase over the last 20 years, far greater than the overall rate of inflation (64%).
That policy of borrowing and spending combined with artificially low interest rates and money printing led to a devaluation of the dollar, which in turn led to a massive boom in asset prices and more recently, a surge in overall inflation.
What’s the solution?
Do the opposite, which will be painful at first but pay dividends in the long run. If we live within our means (reduce deficits) and let free markets dictate supply and demand (stop subsidizing industries and artificially boosting asset prices), the future will be bright. But that’s not a platform that will get you elected, so it’s going to be an uphill battle to fight.
2) The Right Direction
Speaking of trading short-term pain for long-term gain, the US Money Supply continued to contract in February and is now down 2.4% year-over-year. That’s the largest 12-month decline on record with data going back to 1959.
This is a good sign as the record money supply surge was one of the leading causes of the inflationary spike on the way up. The recent move lower is coinciding with declining rates of inflation which should continue in the coming months.
The big question, though, is how much of an impact the recent bank failures have had on M2. We don’t have data yet from March but a move higher is to be expected. The question is by how much and is a merely a short-term increase or the early stages of a move back to easy money. Over the last two weeks, the Fed’s balance sheet has reversed part of post-SVB liquidity injections ($101 billion decline), suggesting the emergency may be over for now.
3) Housing Market: Slowly Repricing
Speaking of easy money, the housing market had been a major beneficiary of these policies for over a decade. But with the end of easy money in 2022 came a peak in home prices. Since then, we’ve seen 7 consecutive monthly declines (case shiller national index) for cumulative depreciation of 5%. While this is the largest 7-month decline since 2011-12, prices are still 38% higher than they were 3 years ago.
Which means we would have to see a much larger decline before housing becomes affordable again. Real-time data suggests that further weakness is likely, with a 2.1% YoY decline the largest in over a decade.
There are now four cities in the Case-Shiller 20-City Index with home prices lower than a year ago (San Francisco, Seattle, San Diego, and Portland), the first time 4 major cities in the index were down YoY since 2012.
4) Reducing Rents
Home price appreciation isn’t the only thing that’s falling. US rents were up 2.7% from last year’s prices, the smallest increase since April 2021.
The average rent in the US peaked last August and is 2.6% lower today.
With vacancy rates rising to their highest level in two years, we should see further declines in rent growth in the coming months.
And more supply coming to the market as well with a record number of multi-family units currently under construction.
5) Falling Inflation Expectations
US Consumers seem to be noticing the moderation in inflation, and adjusting their expectations accordingly. From the New York Fed’s latest survey, the 1-Year ahead expectation is now at 4.2%, the lowest since May 2021 and down from a peak of 6.8% in June 2022. Meanwhile, the 3-Year ahead expectation is down to 2.7%, the lowest since June 2020 and down from a peak of 4.2% in October 2021.
Actual inflation continues to fall as well. The PCE Price Index moved down to 5%, its lowest level since September 2021. The peak was 7% in June 2022.
With the Fed Funds Rate firmly above Core PCE (the Fed’s preferred measure of inflation), the Fed seems to have room to pause if they so choose at the May meeting.
And by then the Fed should have even more evidence of a decline in overall inflation, with the Cleveland Fed’s model predicting a drop down to 4.3% for PCE (from 5%) and 5.2% for CPI (from 6%).
6) Summer Ease?
The market is now expecting another 25 bps hike in May (to 5.00-5.25), but then a 180 degree shift to rate cuts starting in July. By the end of 2024, the market is saying that the Fed will cut rates back below 3%.
These expectations have lead to a record inversion in the US yield curve, with the 3-month Treasury yield (4.91%) now 1.61% higher than the 10-year yield (3.30%). With data going back to 1962, we’ve never seen a more inverted yield curve than today.
7) The Manufacturing Recession
Looking at the recent manufacturing data, one could make a strong case that we are headed for recession. The last 3 times ISM Manufacturing was this low, the US economy was in or about to be in a recession. You have to go back to 1995-96 to find a lower reading with no recession.
But manufacturing is just one part of the economy, and only 11.1% to be exact. Therefore, as we saw in 1995-96, you can have a downturn in manufacturing without a broader US recession.
The difference between then and now: we didn’t have an inverted yield curve back in 1995-96, we didn’t have an inflation problem, and we didn’t have rapidly tightening lending standards. On that last point, we’re now at levels that have coincided with recessionary periods in the past.
8) More Jobs Growth, Fewer Job Openings
But can you have an official recession without a downturn in the labor market?
Probably not, and the March jobs report showed the 27th consecutive month of gains.
The Unemployment Rate ticked down to 3.5%, only 0.1% higher than the January reading which was the lowest since 1969.
The Labor Force Participation Rate moved up to 62.6%, its highest level since March 2020. It was at 63.3% before the covid shutdowns and stimulus.
The labor market may be finally starting to loosen a bit. The number of US Job Openings fell to 9.9 million in February, the fewest since May 2021 and a noticeable decline from last month.
And the spread between job openings and unemployed persons has moved down to just under 4 million from a peak of 6 million a year ago.
A looser labor market likely means we’ll see a continued decline in wage inflation. US Average Hourly Earnings increased 4.2% YoY in March, the slowest growth rate since June 2021.
9) The Money Market Boom
Bank deposits have fallen $363 billion since the beginning of March to $17.3 trillion. Where is much of that money going? Into market-market funds, which have risen $304 billion to a record $5.2 trillion.
These funds often invest in the Fed’s reverse repo facility which is paying 4.8% annualized, well above the rates that most banks offer.
So there are two good reasons people are moving money out of banks: 1) fear of uninsured deposits being at risk, and 2) to earn a higher yield.
Of the money that has remained at the banks, we’ve seen a massive shift from small to large. The 25 biggest banks in the US gained $120 billion in deposits in the days after SVB collapsed while smaller banks lost $108 billion over the same period. That was the largest weekly decline in smaller banks’ deposits on record.
10) Small Cap Blues
While smaller banks have been losing share to larger banks, we’re seeing the same trend play out in the equity market.
The Ratio of US Small Caps to US Large Caps is nearing March 2020 levels, which was the lowest we’ve seen since February 2001. Over the last 10 years Small Caps have gained 115% (8% annualized) vs. 214% for Large Caps (12% annualized).
At $4.69 trillion, the market cap of Apple & Microsoft is now $2 trillion higher than the combined market value of all the companies in the Russell 2000 ($2.69 trillion).
Is this gap justified? Depending on whether you’re looking at Revenues or Net Income, you can make the case for either relative cheapness of Small Caps or Apple/Microsoft…
-The combined revenue of Apple and Microsoft was $591 billion over the past year vs. $2.5 trillion for the Russell 2000.
-The combined net income of Apple and Microsoft was $163 billion over the past year vs. $54 billion for the Russell 2000 (>40% of companies in the Russell 2000 reported a net loss).
11) Not Worth the Cost
56% of Americans polled by the WSJ said that a four-year college degree was not worth the cost, a record high.
This likely has much to do with the skyrocketing cost at these institutions. Over the last 30 years, College Tuition and Fees have more than quadrupled while overall Consumer Prices (US CPI) have a little more than doubled.
12) A Bubble of Epic Proportions
Speaking of skyrocketing, the Canadian housing market is completely insane.
Over the last 20 years, Canadian Home Prices have quadrupled while overall inflation in Canada has increased 49%. This is a bubble of epic proportions.
But the air is starting to come out, with the 4.7% year-over-year decline in Canadian home prices being the largest we’ve seen since the 2008-09 financial crisis.
13) Throwing Stones in Glass Houses
At the last FOMC press conference, the Fed chairman chastised Silicon Valley Bank’s management for failing to hedge interest rate risk. Indeed, rising interest rates led to a $1.8 billion loss at SVB from the sale of its longer duration Treasury/MBS holdings. This set off a run on the bank which quickly led to its demise.
The Fed’s comments are interesting given the over $1 trillion unrealized loss on their own Treasury/MBS holdings. The cause of this lose? You guessed it: rising interest rates, which were of course unhedged.
Unlike SVB, though, the Fed never has to sell and they can also create money out of thin air. It’s good to the be the King, where you can live in a house made of glass and still throw stones.
14) OPEC Bump
Crude Oil prices jumped back above $80/barrel after OPEC announced it will be cutting output by 1.16 million barrels per day. Prices were as low as $65 just a few weeks ago. Even after the move higher, though, prices are still down 16% versus year-ago levels.
15) Alibaba Breakup
Alibaba ($BABA) shares got a boost after announcing a split into six business groups, each with the ability to raise outside funding and go public. While investors welcomed the news, the stock remains over 67% below its 2020 peak. Since Alibaba went public in September 2014 it has gained just 10% versus a 531% gain for its US rival Amazon ($AMZN).
16) A Few Interesting Stats
a) The hottest job markets in America…
b) The busiest airports in the world…
c) The Increasing % of Americans Age 65 and Older…
- 1950: 8%
- 1960: 9%
- 1970: 10%
- 1980: 11%
- 1990: 12%
- 2000: 12%
- 2010: 13%
- 2020: 17%
- 2030 (projection): 21%
d) The French Bulldog is now the most popular dog breed in America, ending the Labrador Retriever’s record 31-year run as the top dog.
And that’s it for this week. Have a great weekend and Happy Easter/Passover!
-Charlie
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