Remarks:
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Charts and charts from the past week that tell an interesting story about markets and investing…
1) Climb the wall of worry
Inflation. Fed tightening. Profits down. Economic weakness. War.
Investors have not failed to worry in recent months.
And they care, as evidenced by the longest streak of negativity we’ve ever seen in the AAII sentiment survey (36+ weeks).
The stock market scaled that wall, rallying 17% from October lows. As a result, the S&P 500 is back above its 200-day moving average for the first time since April.
Will this rally have a different ending to the previous four, which were all followed by lows?
The majority does not seem to believe it, as evidenced by this recent poll…
2) Imminent Weakness
Foremost among investors’ concerns are signs of impending weakness in the US economy.
The Chicago PMI (a measure of manufacturing activity) has not been as low as it has in the past during recessions (the last in 2020, before that of 2008-09).
And the yield curve continues to slide deeper into inverted territory, with the yield on 3-month Treasury bills now 0.83% higher than that on 10-year Treasury bonds.
Over the past 60 years, the only periods with an equal or greater inversion:
-2000 (recession in 2001)
-1979-82 (recessions in 1980, 1981-82)
-1974 (recession in 1973-75)
3) Moderate the pace
How does the yield curve inversion deepen?
Yields on short-term (3-month) Treasury bills continue their upward trend while yields on longer-term (10-year, 30-year) Treasury bills have fallen over the past month.
And why is this happening?
a) Markets are anticipating continued Fed hikes that will drive up short-term yields.
b) Long-term Treasuries get a bid (yields fall) on the expectation of slower economic growth and lower inflation.
In a speech this week, Fed Chairman Powell said “the time to moderate the pace of rate hikes may come as soon as the December meeting.”
Translation: a small increase of 50 basis points at the December 14 meeting. This will be the 7th consecutive rate hike and will take the fed funds rate to a new range of 4.25% to 4.50%. The last time it was this high? December 2007.
This is great news for savers, as returns from FDIC-insured savings accounts continue to rise. You can now earn 3.90% and with the next rate hike we will soon see returns above 4%.
4) The case of short hikes
Why would the Fed hike 50 basis points this month instead of an additional 75 basis points?
They see progress on the inflation front and a number of indicators pointing to a lower inflation rate ahead.
-The PCE price index fell to 6%, its lowest level since last December. The peak was 7% in June.
-The prices paid component of the ISM manufacturing index hit a 30-month low in November. During the inflation peaks of the 1970s/80s, a fall in prices paid was a leading indicator of falling inflation rates to come (which was also associated with US recessions during these two periods).
-Rents in the United States fell 1% in November, the third consecutive monthly decline. The year-over-year percentage increase has now declined for 12 consecutive months after peaking at 18.1% last November. At 4.6%, it was the lowest year-on-year increase since April 2021.
-Global container freight rates fell to their lowest levels since November 2020 this week, 77% below 2021 peak prices.
-Fertilizer prices peaked in late March and have been down 43% since, now at their lowest levels since August 2021.
-Gasoline prices in the United States fell to $3.41/gallon (national average), 32% below their record high in mid-June and their lowest levels since early February.
5) The case of continuous hikes
In this context, many wonder why additional hikes are necessary.
This is the main reason: November was the 20th consecutive month in which the rate of inflation exceeded the growth in hourly wages, a drop in prosperity for the American worker.
When that happens, something has to give, and so far that translates to increase in credit card balances and lower savings rates.
The US savings rate fell to 2.3%, the 2nd lowest level on record with data dating back to 1959 (lowest was 2.1% in July 2005).
The Fed now recognizes that this is a serious problem and does not want it to become a permanent feature of the economy. As such, they appear to be erring on the side of caution and risk tightening too much if it means a higher degree of certainty that the inflationary spiral will break.
Continued strength in the labor market gives the Fed more leeway to maintain a tightening bias. Jobs rose by 263,000 in November, the 23rd consecutive monthly gain.
The US unemployment rate remained at 3.7%, just 0.2% higher than September’s reading (3.5%) which was tied with the lowest rate we’ve seen since 1969.
6) A little money supply help
Rate hikes aren’t the only tool in the shed when it comes to fighting inflation.
One of the main factors driving up prices has been the unprecedented increase in the money supply (+40% in 2020-21), which is now moving in the opposite direction.
US money supply (M2) has fallen by 1.5% in the past 7 months, the largest decline ever recorded over a 7 month period (note: M2 data dates back to 1959).
Since 1959, the US money supply (M2) has increased every year, with the 0.3% increase in 1994 being the smallest and the 25% increase in 2020 the largest.
2022 is on track to be the first calendar year in which the money supply has fallen in the past 60+ years, down 0.3% year-to-date.
7) Tesla’s reversal is complete
Rising interest rates, rising output and shrinking money supply put an end to one of the weirdest things we’ve ever seen in the markets: car rollovers.
You read correctly. Demand for cars, especially hot EVs like Tesla, has outstripped supply so much that people have literally been able to flip their new/used cars for a profit.
It was a reversal of the age-old principle that a car was said to lose a certain % of its value the minute you drive it off a dealership’s lot.
We now seem to be returning to the old normal, and at a rapid pace.
The average price of a used Tesla is down nearly 15% over the past 90 days, down $11,500 from July’s peak.
8) An interesting divergence
Energy was by far the best performing sector in 2022, driven by rising revenues and profits.
Generally, there is a strong correlation between the direction of energy stocks and that of crude oil. But over the past two months, we’ve seen an interesting divergence, with energy stocks advancing while crude oil traded sideways.
9) Oscillating volatility
The Volatility Index ($VIX) closed below 20 this week for the first time since August. It was a year of oscillation for the $VIX with brief periods of calm followed by a return to higher volatility with an average level of 25.9 (the historical average is 19.7).
With data starting in 1990, the only years with an average VIX $ higher than this year: 2008, 2009, 2020 and 2002.
10) The housing downturn continues
Home prices in the United States fell in September for the third consecutive month. The 3-month decline of -2.2% is the largest 3-month decline since 2009.
When the last housing bubble peaked in February 2007, prices fell 26% nationally.
The same drop today would only bring home prices back to September 2020 levels. only two years.
The rate of home price appreciation in the United States continues to slow, up 10.6% year-over-year nationally according to the Case Shiller Index. This is the smallest year-on-year increase since December 2020, but only from September, missing the last 2 months.
Real-time data shows that year-on-year appreciation has fallen to 2% and is likely to turn negative at some point over the next few months.
Every city in the 20-city Case-Shiller index saw house prices decline in August and September. The last time the 20 cities fell two months in a row was in December 2008/January 2009. San Francisco posted the biggest drop in house prices to date, -10.5% from its May peak.
Why are the prices falling?
The number one factor is the lack of affordability.
The median U.S. household is expected to spend more than 46% of its income to pay for a home at the median U.S. price, the highest percentage on record with data dating back to 2006.
And that’s it for this week.
Have a great week everyone!
-Charlie
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