Brace For an Economic and Financial Hurricane?
Executives from Jamie Dimon and Elon Musk to Gary Friedman, the head of furniture retailer RH, all cautioned investors this week to be wary of an economic downturn. After months of strong consumer spending and supply-chain improvements, some of the country’s most outspoken corporate leaders have started intensifying alarms about decades-high inflation and impending interest rate hikes.
“We’ve got a long ways to go in raising interest rates to fight inflation,” Friedman said on RH’s earnings call Thursday. “And I think you just have to be prepared for anything right now.”
Musk reportedly told employees at Tesla Inc. this week that he has a “super bad feeling” about the economy and needs to cut 10% of jobs at the electric carmaker, according to Reuters.
The tone contrasts with Friday’s jobs report showing bigger-than-expected payroll gains. And economists still see the chance of recession as unlikely next year, even if the odds have crept up. A Bloomberg survey estimates a 30% chance of recession in the next 12 months, up from 15% in March.
Rick Rieder, global fixed income chief investment officer at BlackRock Inc., said on Bloomberg Television that the employment numbers for May are likely “the last solid report you’re going to get for a long time” as the pace of hiring slows.
Meanwhile, growth at US service providers moderated in May to the softest pace in over a year, reflecting a pullback in a measure of business activity that suggests supply constraints.
The sense of doom has been especially evident in the banking sector, where Dimon told investors this week that they should be preparing for an economic “hurricane.” Last month, he said “storm clouds” over the economy may dissipate.
“That hurricane is right out there down the road coming our way,” the JPMorgan Chase & Co. chief executive officer said Wednesday, citing rising interest rates and fallout from Russia’s invasion of Ukraine. “We don’t know if it’s a minor one or Superstorm Sandy. You better brace yourself.”
Goldman Sachs Group Inc. President John Waldron took up the theme the next day, calling the current economic climate one of the most complex he’s ever experienced. “The confluence of the number of shocks to the system to me is unprecedented,” Waldron said.
On Friday, Citigroup Inc. CEO Jane Fraser said a recession feels more likely in Europe than the US due to energy costs, though it won’t be easy for either to avoid. US consumers are healthy with a lot of money in their wallets, she said, even though interest rates, Russia and the threat of recession are dominating conversations right now.
BlackRock CEO Larry Fink said he expects inflation to remain elevated for several years. And PNC Financial Services Group Inc. CEO Bill Demchak said the only possible outcome is a recession.
Elsewhere, S&P Global Inc. suspended its annual guidance this week, citing deteriorating economic conditions and “extraordinarily weak” volumes of debt issuance.
Still, some bank executives are counting on the continuing strength of the US consumer. Holly O’Neill, Bank of America Corp.’s retail-banking president, said there’s no indication yet that that pillar of the economy is starting to crumble.
“We are not seeing any signs of cracks,” O’Neill said at an investor conference. “We obviously watch this every single day.”
Well, there are some indications that the mighty US consumer is buckling under the weight of inflation:
42% of consumers made late payment toward buy now, pay later debt in April, survey finds https://t.co/cg522K9iMF— Leo Kolivakis (@PensionPulse) June 3, 2022
36% of those earning over $250,000 now say they're living paycheck to paycheck after inflation surge https://t.co/ipYztMVrIU— CNBC (@CNBC) June 3, 2022
And there are those who think elevated inflation is here to stay.
BlackRock Chief Executive Officer Larry Fink said he expects inflation to remain elevated for several years primarily because of snarled global supply chains:
“It’s been aggravated by Covid and lockdowns in different parts of the world,” Fink, 69, said Thursday in a wide-ranging interview on “The Close” on Bloomberg Television. “It’s more supply driven.”
The world’s largest asset manager, which oversaw about $9.6 trillion as of March 31, is navigating a world beset by surging inflation, rising interest rates and geopolitical upheaval. Fink had previously said the war in Ukraine created profound changes to the global economy, forcing companies and governments to reconsider their reliance on foreign markets and spend more to boost their capabilities locally.
The Federal Reserve doesn’t have the tools on its own to fix supply problems across the economy, Fink said in the interview, predicting market volatility to continue. Inflation also is likely to remain elevated as the economy transitions to greener sources of energy, he said.
Larry Fink said he expects inflation to remain elevated for several years primarily because of snarled global supply chains. This presents a real problem for a Fed that can’t fix supply-driven issues, and will lead to prolonged bouts of volatility. https://t.co/xqxjnHel5A— Lisa Abramowicz (@lisaabramowicz1) June 2, 2022
Fink is right, the Federal Reserve cannot fix supply problems, it can only raise short rates and slow down its purchases of Treasuries and mortgage-backed securities (quantitative tightening).
As far as inflation, some strategists are warning investors may be in for a rude wakening as it might keep rising and take years before it comes back down:
Inflation — running at 8.3% as of April, near a four-decade high — has stayed stubbornly persistent for a full year to the surprise of virtually everyone who tracks it. Now there’s a risk that price gains could take much longer than expected to fall back down, even when the Federal Reserve is aggressively hiking interest rates.
That risk was highlighted on Thursday by BofA Securities strategists Vadim Iaralov, Howard Du and others, who point to the period between 1974 and 1988 as the most comparable time in which the annual headline U.S. consumer-price index was rising at a pace similar to the U.S.’s pandemic era of 2019-2022.
In 1980, with the Fed’s main policy rate target already above 10% for most of that year, the annual headline CPI, also in double digits, still did not fall back below 3% after 36 months “even on the back of unprecedented rate hikes enacted by Fed Chairman Paul Volcker,” they said.
This was also the case during the pre-Volcker years, when the Fed was led by Arthur Burns and G. William Miller. In July 1973, when the annual CPI rate was hovering near 6% but poised to keep climbing, a Burns-led Fed pushed the fed-funds rate above 10%, FactSet data shows. Policy makers brought interest rates down to 9% for six months, then pushed them back up again to 10% or higher through mid-1974. But the CPI rate didn’t fall back below 6% until the second half of 1976.
Under Miller’s short term from 1978 to 1979, inflation came roaring back until it was in the double digits again. Policy makers returned to pushing rates above 10% again, even before Volcker took the helm.
No one is suggesting the Fed is about to resort to double-digit interest rates right now, particularly when the fed-funds rate target is only between 0.75% and 1% with two more 50-basis-point hikes on the way for June and July. But if a similar stubborn-inflation dynamic plays out this time around, it would likely come as a rude surprise for financial markets, putting equity valuations further at risk.
Investors may be in for this rude surprise: History shows inflation can take years to return to normal even when Fed hikes above 10% https://t.co/2hhT6VLXVT— Leo Kolivakis (@PensionPulse) June 3, 2022
Economists like those at BofA Securities are expecting the year-over-year CPI rate to fall to 3.3% by year-end. Traders have also been projecting the rate will fall into early next year, to around 5% or lower. And the Fed’s vice chair, Lael Brainard, told CNBC on Thursday that bringing inflation down is the Fed’s No. 1 challenge; she’s looking for a string of lower readings to feel more confident the central bank can get back to its 2% target.
“There are aspects of the historical pattern that are very relevant: Namely, that inflation took a number of years to develop, kept growing, receded, then came back and was hard to get rid of,” said Mace McCain, chief investment officer at San Antonio-based Frost Investment Advisors, which manages $4.7 billion.
“That is also probably true today, we just have to be a little careful about drawing direct comparisons,” McCain said via phone. In the past, the U.S. labor market had stronger labor unions, which he says contributed to the wage-price spiral of the 1970s and 1980s.
For now, his base-case expectation is that annual headline CPI readings will fall toward 4% or 5% by year-end from April’s level of 8.3%, an environment which will still be “very damaging to people’s real earnings.” The next CPI print for May is due on June 10.
My own base-case expectation is inflation will likely fall to 4% by year-end and if we see a truce in Ukraine and a big decline in energy prices, it could really ease inflation pressures considerably.
Having said this, inflation will remain elevated by historical standards and we aren't headed back to 2% any time soon unless we see a major global recession and that isn't around the corner, at least not yet.
In the United States, there are already emerging signs of a housing downturn and it will have ripple effects in other sectors of the economy and likely lead to a recession:
The housing market is starting to show signs of a slowdown. If the trend persists, the U.S could see an impact in other sectors of the economy — starting with big-ticket items that go into furnishing a new home.
"The housing market is very much a leading indicator of the economy because of the knock on effects through the various sectors, like consumption of durable goods," Eric Basmajian, founder of EPB Macro Research, told Yahoo Finance.
He predicts durable goods such as large appliances that go into a home could cool off as fewer homes are sold.
“We’re going to see a cooling of new orders, and then we're going to see a pullback in industrial production or the manufacturing sector more broadly," said the researcher.
New orders for durable goods in March were up .4%, a slowdown from .6% in the prior month. Retail foot traffic compiled by SafeGraph and analyzed by Bloomberg for the 3rd week of May showed the sector with the biggest decline was home improvement and home furnishings, down 24.6% year over year.
The housing industry has already seen a substantial decline in number of sales and loan applications as 30-year mortgage rates shot up from around 3% at the end of last year, to current levels north of 5.25%.
“If we see several more months of declines in housing data, including building permits and housing starts, that would be a very clear sign that the housing market is undergoing a slow down in volumes and that risks employment in the construction sector,” said Basmajian.
“I'd very much be on the lookout for employment in the construction sector, which would be a clear warning sign that a recession is right around the corner,” he added.
As for the argument of not enough homes for buyers — Basmajian’s viewpoint differs.
“Most of the supply arguments are focused on single family homes, and that's sort of fighting the last battle. In 2005 and 2006, we had a significant overbuilding in single family homes. This economic cycle, we didn't overbuild single family homes, but we made a substantial new high in terms of the construction of multi-family, five-plus units,” he said.
“People that are arguing tight supply are generally focused on single family homes. But when you look at total housing units, which would include, multifamily apartments and single family homes, the inventory numbers are actually quite high,” he added.
How much the housing market could contract will depend "largely on how long and how forcefully the Federal Reserve tightens" monetary policy, says Basmajian.
This year the Federal Reserve began hiking interest rates and telegraphing quantitative tightening in an effort to combat red hot inflation.
“If the Federal Reserve pivots in the next three months, we could maybe have a softer decline in the housing market. But if the Federal Reserve continues to tighten policy through the end of the year and into the middle of 2023 persistently contracting real money supply, then the probability of a severe decline in the housing market is likely.” he added.
Francois Trahan of Trahan Macro Research has also sounded the alarm on housing and he often cites a paper from Edward Leamer, "Housing Is The Business Cycle," to make his case that a recession lies ahead.
If you look at the decline in lumber prices, it also tells you a slowdown in housing and economic activity lies ahead:
Lumber is back in major decline mode … recent leg lower brings max drawdown to -64.5%— Liz Ann Sonders (@LizAnnSonders) June 3, 2022
[Past performance is no guarantee of future results] pic.twitter.com/SypVgefXhf
Will it be a hard or soft landing? That all depends on the Fed but with inflation still running at 40-year highs, it's hard to envision a soft landing scenario.
Maybe that's the reason why JPMorgan CEO Jamie Dimon is warning of an economic hurricane is coming our way:
Jamie Dimon warned of an economic “hurricane” that is “coming our way.”— Lisa Abramowicz (@lisaabramowicz1) June 1, 2022
“We don’t know if it’s a minor one or Superstorm Sandy. You better brace yourself.” https://t.co/hHLY2rzhYG
Other Black Swan investors are warning that "the greatest credit bubble in human history" might pop and wreak havoc on the financial system and economy:
Mark Spitznagel is paid to be prepared for when the market’s weakest links are exposed in a big way.
“If this credit bubble ever pops, it’s going to be the most catastrophic market failure that anyone has ever read about -- but let’s hope that doesn’t happen,” Spitznagel, Miami-based Universa’s chief investment officer, said Thursday in a telephone interview. “We’ve gotten ourselves into a tough spot.”
Spitznagel, 51, insists he’s not a “doom and gloomer.” He’s long been critical of central banks keeping interest rates near-zero or even negative, which he says has propped up asset values and encouraged excessive borrowing. Officials around the world are now tightening monetary policy to combat elevated inflation.
Maybe Spitznagel isn't a doom & gloomer but he sure doesn't sound too uplifting (he's in the business of selling protection).
What does all this mean for markets?
Well, today stocks are selling off as investors weigh rising rates and the strong jobs report but the Big Bounce I covered last week remains largely intact:
The first chart shows you the daily chart of the Nasdaq going back a year and price action remains above 20-day exponential moving average and the second chart shows you the 5-year weekly chart on the Nasdaq and price action remains above the 200-week exponential moving average.
Everyone thinks this is just another bear market rally, and they're probably right, but when everyone expects a correction, the market turns out to prove everyone wrong.
The big focus next week will be on the release of the May US CPI figures next Friday morning.
If they come in better than expected, that bodes well for long bond yields and tech shares.
If not, then the market will reassess the odds of another 50 basis points rate hike in September.
Again, with the economy slowing and base effects starting to kick in, I doubt inflation pressures will persist but you just never know.
I would encourage institutional investors to see the replay of Martin Roberge's (Canaccord Genuity) June webinar from earlier this week to really get into all this.
Next week, June 8th at 10:30 am, Francois Trahan of Trahan Macro Research will hold a conference call on whether equities have fully discounted a slowdown,
This week, Francois wrote a great guide to macro for interns but all investors should read it.
Lastly, in his latest installment of Real-Time with Jordi Visser, Jordi takes us through the current market focus and ways he thinks the picture is changing into the second half of the year. While market moves year to date have been centered around 1) uncertainty over the Federal Reserve rate hikes, 2) inflation pressures, 3) geopolitics in Eastern Europe, and 4) China’s Covid lockdowns, Jordi believes these are now priced in and the second half will be focused on peak inflation, slowing growth, no recession, and China reopening. He believes these will lead to a sustained rally in the second half of the year. This would likely be a change that many investors are not yet positioned for.
Below, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon warned of a "hurricane" as the economy struggles against fiscally induced growth, quantitative tightening and Russia's invasion of Ukraine. He spoke at conference sponsored by AllianceBernstein Holdings Wednesday.
And responding to Jamie Dimon's comments that investors should brace themselves, and that JPMorgan is going to be very conservative with it's balance sheet. With CNBC's Scott Wapner and the 'Halftime Report' investment committee, Steve Weiss, Liz Young, Joe Terranova and Jon Najarian.
Third, BlackRock CEO Larry Fink warns that inflation is not transitory and the Federal Reserve does not have the tools to deal with it right now. Speaking with David Westin on "Bloomberg Markets: The Close," Fink also discusses sustainability investing and his concerns about immigration.
Fourth, Jan Hatzius, Goldman Sachs chief economist, joins 'Squawk on the Street' to discuss his take on Friday's jobs report, if today's jobs report gives the Federal Reserve confidence they may not need to tighten as much and more. He thinks a pause in rate hikes is very unlikely (I disagree, with midterms elections ahead, a pause is very likely).
Fifth, Charlie Bobrinskoy, Ariel Investments, and Joe Amato, Neuberger Berman, join 'Closing Bell' to discuss rate hikes, whether Amato sees opportunities after a choppy start to the market and more.
Lastly, a great discussion on CNBC's ETF Edge featuring Nicholas Colas of Datatrek which you should all watch.
Have a great weekend!