This daily economic journal is written in conjunction with weekly economics updates for our investment clients at nVest Advisors, LLC, It is copyright and may not be republished in whole or in part without written permission.
This information is also not financial advice, nor a solicitation to do business with me as a financial advisor, though for the right readers, that is available. It is intended solely to provide timely economic data and analysis from the vantage point of a 15-year industry veteran (but also, always still a student) of personal finance and economics.
I highly recommend you read the past few weekly economic updates that I write for my financial advisory firm, nVest Advisors, LLC to get brought current on what’s happening in the broader economy, because this journal will be jumping right in without too much of a primer. I will be writing a primer into this blog as we go, but for now, the best place to catch up on what’s happening (and it’s a lot) is to read the macro blog at nVest.
Monday and Tuesday, April 24-25, 2023
I apologize that it’s been so long since I posted this journal, though our formal weekly economic updates have continued to post up at my firm’s website, www.nvestadvisors.com. I strongly suggest you subscribe to both email lists if the economic data is important to you. My firm is growing very quickly and we are in the process of adding our first two Advisor Trainees, plus marketing aggressively with our college intern marketing team, and converting our internal systems to accommodate rapid growth. Coming back here to a blog that I’d neglected for almost 3 years and providing really good content for our readers here sometimes takes a backseat to the work there.
But I digress.
Last week’s info
Last week provided a mix of economic data. On the upside, housing starts and homebuilder sentiment ticked up slightly and the New York Fed’s Manufacturing number showed a surprise uptick. This happy news was challenged by basically everything else, from a total collapse of the Philly Fed Manufacturing numbers, slowing existing home sales, and a significant number of recession triggers finally signaling. I am firmly convinced we will have a recession declared in 2023, and this will be deeper and more prolonged than most economists are predicting, and certainly worse than the markets have priced in.
You can read that update on my firm’s website (we post a weekly economic digest every Monday) here.
Monday, April 24. 2023
Today we got a different look at the U.S. Manufacturing sector – from the S&P Global Research. This is different than the often-touted ISM data, but is often closely correlated. That S&P reported an uptick in manufacturing activity might mean this month’s ISM shows the same, but it would be in start defiance with the recent Dallas, Philly and Chicago numbers, which showed the U.S. manufacturing sector is solidly in recessionary territory.
I want our readers to get to know two concepts and always remember them when looking at economic data:
A NOMINAL number means the statistic includes whatever inflationary environment we’re in at the moment. A REAL number removes the current inflation so we can see two numbers from different time periods side-by-side with more accuracy (you’ll also sometimes see it referred to as a DEFLATOR). This is so we can see, for example, if a company’s sales are growing because of more product being made and distributed, or if their sales increase is merely the result of charging higher prices.
For example, let’s say your company sells 10,000 widgets at a price of $900 each. You’d report your sales that year as $9 million ($900 x 10,000 widgets).
However, if you raise your price to $1100 but sell only 8,900 widgets, you’d have sales of $9.8 million.
Did you grow as a company? In revenue, yes, but not in actual output. So while sales temporarily looked better, you’ve lost market share, likely laid off employees due to the lower workload, etc. You might actually be more profitable for a time, which would make your stakeholders happy this quarter, but your company lost ground. It shrank. A dumb business owner might cut corners or hike prices to solve a temporary problem, but a Rich Guy knows you need to continue to grow your market share, not just this quarter’s bottom line. It’s a delicate dance, to be sure.
So the Manufacturing sector looked like they’re trending up, which on the surface is good news. But that number is NOMINAL. When we look at price changes, we can see that most of the sector’s recent strength has been by raising prices, not from selling more products:
Assuming the manufacturing data holds and isn’t an outlier, this will mean that the U.S. economy is still punching back against the recent Federal Reserve interest rate hikes. It also means, because prices on manufactured goods is UP, inflation is still around and perhaps ready to make a return appearance. If this GDP forecast is correct – that the U.S. economy is actually growing rapidly again, it means the Federal Reserve MUST do more to fight inflation.
This is the world we’re in: good news, for now, is actually bad news. Resiliency in the U.S. economy with upward pressure on prices means inflation will resume again and make another run. The likelihood of a Fed pause or pivot in their May meeting is increasingly unlikely.
It’s always interesting for me as a journeyman economist and professional money manager, to see if my views coincide with, or run counter to the herd of my peers. I have no problem being a contrarian, but you don’t run against the tide just to be edgy. You need data and reasoned analysis to take that kind of stand, but if the data informs you that the herd is wrong, stand your ground.
Scotiabank asked a bunch of portfolio managers what they think the Fed will do in the coming meetings. To my great surprise, and contrary to what this same group of guys was saying three months ago, the majority believe there is at least 1 to 2 more rate hikes coming before the Fed pauses. Thankfully, only a small handful of idiots believe lots of rate cuts are on the way. These are the advisors who actually agree much with me – that a significant economic downturn is likely and that the Fed will have to drop rates quickly after something “breaks” in the economy.
How bad will the recession be? The majority are still optimistic that we’ll have a soft landing, though a much stronger percent – roughly 40% of us now believe it will be a much harder landing than the markets have priced in.
Most advisors predict a two-quarter-only recession late this year, and then we somehow snap back out of it as if nothing happened in 2024.
I strongly disagree. The run-up to this recession, largely fueled by fake low-interest rates and LOTS of government stimulus spending – over 15 years – created massive asset bubbles in real estate, financials, tech stocks, and cryptocurrency, among others. Those bubbles must now pop in a meaningful way. Some of that happened already – crypto is less than half what it was in November 2021, but tech stocks and even real estate in particular, have had large run-ups so far this year, erasing much of the progress in 2022 of deflating them back to sane valuations.
We have much further to drop still.
Tuesday, April 25, 2024
Here was the first number that greeted me this morning – the yield curve inversion is extreme. It has been for a while, but as you can see in this historical chart, we’re back to the very painful recession of 1980-1982 now to find another time when the treasury yields were this wild.
I don’t want to get into a long explanation here of the Yield Curve and why an inversion matters, but here is a great resource to help you understand in more detail. Basically, a yield curve shows how much interest bonds pay out based (plus or minus the price you paid for it), over different periods of time. The theory is, the longer someone borrows your money, the more interest they should pay you. So in healthy conditions, a normal Yield Curve for bonds should look like this:
The less time your money is being borrowed, the less interest you receive, and the more time your money is borrowed, the more interest you should get. When things get screwy, however, this curve can go all out of proportion. Last year, the Federal Reserve started rapidly raising the shortest-term interest rate, called the Fed Funds Rate, from with all other interest rates are based. But the rest of the curve didn’t keep up because the increases to the Fed Funds rate happened so quickly. Here’s the Yield Curve as of this morning:
This means that you can get a LOT more interest lending your money for a short period of time than you will for a decade or more, which isn’t normal. When these rates get high enough, it makes sense that investors will flock over from risky stocks to essentially “safe” treasury bonds for 6 months to a few years, which will eventually flatten the curve back down, but will also bleed money out of the stock market.
This kind of curve also means big problems for companies that have to borrow short-term funds to make ends meet. For example, if you get paid by large government contracts or other infrequent forms of payment, you may have a short-term credit facility to meet your monthly bills while you wait for that contracted work to finally pay you. The huge spike in short-term interest rates means your once cheap 30-day loan from the bank just doubled or more in cost.
And finally, this type of curve deformation means there is more long-term bonds being bought at the moment than short-term bonds (the longer-term bonds are being bought at higher and higher prices, further collapsing their yield. Remember that YIELD is the INTEREST RATE plus or minus the PRICE you pay for the bond. Higher Prices mean lower overall yields. This tells you that investors believe that their money is better placed in a 5-20 year bond than it is in stocks; it’s a way investors vote with their wallets on a coming recession. In fact, an inverted yield curve is such a good predictor of recessions, it’s the only “clue” that has a near 100% success rate. I always say this is because it becomes a self-fulfilling prophesy – investors believe a recession is coming, so they buy long-ish term bonds to protect their assets, draining money from stocks, and down we go.
Well I didn’t want to give a long explanation about yield curves, but here we are. Let’s look at the rest of today’s data:
First, do you remember the discussion about the S&P manufacturing stats from yesterday (the top of this post)? I said all of the other indicators from different parts of the country showed a decline, not an increase? Dallas area manufacturing info arrived this morning and, as I expected, it’s not pretty. In fact, its downright awful compared to those expert analysts (who like to give us the “soft landing” narratives we also talked about above). The Dallas Area manufacturing came in almost TWICE as bad as the experts expected:
When you don’t have busy factories, you don’t need the workers. But firing and then rehiring is costly and hard on people, so employers try hard to avoid layoffs, at least at first. We can now see the average workweek for an employee in these companies is seeing his or her hours cut:
And manufacturers believe they will be able to now offer lower wage and benefits packages when they do hire again (because they need fewer people in a slower factory). This is the information the Fed is wanting to see because when there isn’t such a strong demand for labor, wages don’t rocket up as companies compete for the same few job applicants. And when company costs are lower, the pressure to raise prices on their products and services is lower. Thus, we cap and finally turn the corner on inflation. The Fed needs to see a LOT more of this before they can confidently stop raising rates:
We also got some data on bank deposits and credit card usage. Watching bank balances is interesting because banks can see what is coming into your account from a payroll, and where your spending is going. Current average bank account balances are down, but interestingly, mostly in the accounts of more affluent customers. This means executive pay is dropping faster than lower-income-bracket workers, and the cost impacts on the wealthy are kicking in, particularly now that tax season has just finished (and we know taxes went up for most incomes this year).
As savings deplete, people will (foolishly) shift their spending to credit cards before they finally cut expenses entirely. Thankfully we are not seeing massive increases in credit card usage, at least at Bank of America:
But we ARE seeing a HUGE increase in credit card payment delinquencies. This tells me that people aren’t adding to their cards because many of us are already “tapped out”. We heard similar stats on auto loan delinquencies in March that I will be sure to cover when they report in April:
A couple of other data points for today. First, a look at Core PCE inflation. This looks like we can expect the regular day-to-day spending stuff to finally start to drop in price. This can reverse quickly (look at the jagged sawtooth of that graph), but at the moment, we do see the mountain that core inflation climbed in 2021 and 2022 to finally be abetting. This may mean a prolonged drop in commodity prices is coming.
Small, private business bankruptcies are skyrocketing, and public companies have also trended up some. Take from that what you will about whether a “soft landing” or something much worse is coming.
And interestingly, a look at how stock markets reacted after the last central bank rate hike in an economic cycle. There is a HUGE difference in how stocks performed after a central bank pauses or pivots, based on whether or not the Yield Curve was inverted or not at the time of the pause. Remember that an inverted curve nearly 100% of the time predicts a recession.
See you tomorrow!