November 2023 saw a massive rise in risky assets and a sharp drop in Treasury yields.
This increase in risky assets and treasury bonds can be traced return to two sets of macro notifications. In early November, there was a weak ADP jobs report, which was followed by higher-than-expected jobless claims, weaker-than-expected nonfarm payrolls and a higher-than-expected unemployment rate. as expected. November 14 brought benign inflation figureswith core CPI and ex-food and energy all coming in lower than expected.
As of mid-November, Fed funds futures projects that the Fed will begin cutting interest rates in mid-2024, which is several months earlier than forecast before the CPI numbers came out. The market’s bullish reaction to weaker jobs and better inflation data is based on a dual thesis: Fed policy will orchestrate lower rates and slower growth while avoiding a moderate to severe recession. It’s a fine line for the Fed to walk, but the macro tea leaves are properly lined up.
It is notable that the better US inflation figures are in line with the better inflation figures globally. After peaking in 2022, year-over-year CPI inflation is trending lower seemingly everywhere, not just in the US. Any idiosyncrasies of the US inflation data – and there are certainly many – cannot account for the global decline in inflation, with China entering deflationary territory.
Commodity prices, another major contributor to rising inflation in 2022, have moderated. The S&P Goldman Sachs commodity index is well off its 2022 levels, and despite concerns about the Israel-Hamas war, a wider conflict in the Middle East – which is likely to boost oil prices – has not materialized. Of course, this remains a risk, but at the moment commodity prices are not contributing to inflationary pressures.
Inflation hawks, while conceding these points, nevertheless argue that economic growth remains robust and inflationary pressures will inevitably rise again, pulling rates up and driving down the prices of risky assets. However, an objective look at macroeconomic data does not support this argument.
Consumers, housing and growth
University of Michigan Consumer Survey is one of the most important gauges of US economic sentiment. After experiencing a sharp decline in 2020 during the onset of the Covid pandemic, consumer sentiment attempted to rebound several times, only to experience subsequent declines, the most recent of which began in September 2023. Surprisingly, consumer sentiment is now near its lowest levels. The last 50 years.
One of the notable features of the latest Michigan consumer survey is the large percentage of participants who cite tight home loan conditions as an important determinant of their economic outlook. In accordance with this message, housing affordability index published by the National Association of Realtors is showing the lowest level of home affordability since the survey began in the mid-1980s. Apparently, mortgage rates in the 8% range are actually having a contractionary effect on the US economy.
Year-over-year growth in industrial production — which, unlike quarterly GDP data, is available every month — is also slowing. The most recent two prints showed negative year-over-year growth. While nowhere near the levels of the global financial crisis of 2008-2009 or the even sharper downturn around the start of the Covid pandemic in 2020, the current negative year-on-year growth in industrial production is indicative of slowing economic growth, which is likely to brought about tight credit conditions as a result of Fed tightening.
Industrial production in Germany and France has turned in the same negative way. Industrial production in Italy is still weaker. Only in Great Britain are there signs of increased economic growth. Beyond this single point, however, the story of weakening US growth is mirrored by the experiences of major European countries.
Following their extreme spike during the Covid-19 economic shutdown in 2020, ongoing US jobless claims have fallen, reaching a nadir in 2022. Since then, ongoing claims have increased, with growth accelerating from September 2023 Along with the US unemployment rate rising recently, this increase in jobless claims is indicative of a weak labor market.
The story is similar when we look at international unemployment data. While in general the unemployment rate in the eurozone is at cyclical lows, unemployment rates in the UK, Germany and France are starting to rise. Admittedly, these increases are only points from a low base, but if the trend continues in the coming quarters, the employment situation in Europe will deteriorate significantly.
The Covid stimulus and the American consumer
Ratings suggest that the US government spent nearly $5 trillion to provide stimulus to the US economy during the height of the Covid crisis. Close to 2 trillion dollars of the stimulus came in the form of checks and unemployment benefits for American families. Despite this, as the Covid shock worked its way through the economy, consumers cut back on spending and engaged in precautionary savings to protect against potential future economic and geopolitical disruptions.
The next chart shows the monthly personal savings (in billions of dollars) of all American households. The dashed line is the personal savings trend estimated using data from January 2014 to February 2020. From 2020 to just before 2022, savings came in well above trend as American consumers, in aggregate, held back on spending. However, starting in 2022, pent-up consumer demand for things like dining out and travel returned, and American households began spending the excess savings accumulated over the previous two years. One of the contributors to the increase in inflation in 2022 was this suppressed consumer demand.
Next, consider excess savings—the cumulative amount of savings’ deviation from trend—over the past decade. Based on QuantStreet’s savings trend estimate, cumulative excess savings peaked by the end of 2021 at $2.35 trillion. Since then, excess savings have roughly halved as consumers began spending their hoards of cash. By the end of 2023, excess savings had fallen to $1.16 trillion. This is still a large amount of above-trend savings, but the current trend is showing a depletion of excess savings, which will have major economic consequences.
Projecting this trend another year or two will leave the American consumer in a much weaker place than it is now. This will lead to lower spending and weaker economic growth, as well as more people entering the workforce and thus lower wage pressures. A different trend calibration from the San Francisco Fed gives an even level lower rating of current excess savings. In this case, lower spending, weaker growth and re-entry into the workforce could materialize even sooner.
Acquisition of shares
Inflation is slowing in the US and internationally. At the same time, there is ample evidence of a slowdown in global growth, as seen in employment and industrial production data. In the US, consumer sentiment is weak and home affordability is at historic lows. Furthermore, the large excess savings generated by the US consumer in the wake of the Covid-19 crisis are slowly being spent, which will leave consumers with a smaller financial cushion if macroeconomic issues arise in the future.
While a slowdown in growth is certainly underway, most measures of economic activity (outside of housing affordability and consumer sentiment) are NO at historically extreme levels. Slowing inflation with moderately slower economic growth suits the stock market well, as the discount rate effect from lower rates is likely to dominate the weaker earnings effect of a mild recession. So stocks may be poised to do well in the next 6-12 months. I have shown in the past that stocks tend to do well in the two-year period before and after the start of the easing cycle. If the Fed begins to ease in mid-2024, as the Fed funds futures market predicts, stocks are currently in the sweet spot of the cycle.
While a reasonable base case, this benign forecast could be disrupted by either a rise in inflation or a sharper-than-expected economic slowdown, accompanied by much weaker corporate earnings. Despite my view that risk assets are set for growth in 2024, the risks are many. Investors should tailor portfolios to their risk tolerance and liquidity needs.