A version of this post first appeared on TKer.co
Stocks closed higher last week with the S&P 500 gaining 2.3%. The index is now up 15.9% year to date, up 24.4% from its October 12 closing low of 3,577.03, and down 7.2% from its January 3, 2022 record closing high of 4,796.56.
Economic data has been trending favorably. Last week, we got bullish updates on durable goods orders, business investment activity, new home sales, home prices, consumer confidence, and initial jobless claims. GDP is a bit more backward looking, but on Thursday we learned it grew in Q1 at a much faster pace than previously estimated.
The fresh data adds to reasons why many bearish economists have been dialing back their calls for a recession. It also confirms all the reasons for optimism coming into 2023.
But if you follow financial TV news, business newspapers, or social media, you’ll see there is no shortage of skeptics anchored in stale recession calls who’ll go to great lengths to spin good data into something less rosy.
“Wall Street has had recession on the brain since at least mid-2022,” Neil Dutta, head of economics at Renaissance Macro Research, wrote on Monday. “Analysts have a tendency of falling in love with their forecast, and it is clear some are having trouble letting go even as evidence piles up to the contrary.”
Earlier this year, I started to notice that regardless of whether a market or economic metric went up or down, there were bears coming out to explain why the development was bad regardless of the direction.
My friend Michael Antonelli, veteran market strategist at Baird Private Wealth Management, gave me a nudge and let me know this has always been the case for the bears.
“If you work in this industry long enough you’ll find out that things are bad both ways,” he tells me. “Why? Because pessimism sells.”
Michael and I have been flagging some of these “bad both ways” narratives as they arise. Here’s a summary:
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👎 Oil prices: When they’re rising, it’s bad because hit hurts consumer spending and it drives inflation higher. When they’re falling, it’s bad because they must be a sign of weakening demand, which means we could soon learn the economy went into recession. (Michael)
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👎 Home prices: When they’re up, it’s bad because it means fewer people can afford to buy. When they’re down, it’s bad because existing home owners are seeing their net worth shrink and some could go underwater on their mortgage. (Sam)
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👎 Walmart sales: When Walmart sales disappoint, it’s a bad sign since they are an economic bellwether as the world’s largest retailer. When Walmart sales boom, it’s a bad sign for the economy because it must reflect financially stretched consumers trading down from higher priced retail options. (Sam)
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👎 Lending activity. When businesses and consumers borrow more, it’s bad because the leverage they’re taking on puts them at greater risk of financial distress. When they borrow less, it’s bad because they aren’t taking advantage of leverage to amplify their returns on capital. (Sam)
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👎 Short-term interest rates: When they’re rising, it’s a bad because it reflects worries about higher inflation and tighter Fed monetary policy. When they’re falling, it’s bad because it suggests slowing economic activity. (Michael)
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👎 Long-term rates: When they’re rising, it’s bad because borrowing costs are increasing and the discount rate used to value assets is higher. When they’re falling, it’s bad because — similar to falling short-term rates — it suggests slowing economic activity. (Sam)
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👎 Market volatility. High volatility is bad because it reflects elevated uncertainty, and “markets hate uncertainty.” Low volatility is bad because it must reflect complacency in financial markets, leaving them vulnerable to a major selloff when bad news breaks. (Michael, Sam)
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👎 Consumer spending: When it’s falling, it’s bad because consumer spending is the dominant driver of GDP so it must mean recession risks are rising. When it’s rising, it’s bad because it’s inflationary and may lead to unfriendly actions from policymakers. (Michael)
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👎 Debt ceiling: Not raising it is bad because we’d get catastrophe in financial markets if it’s breached. Raising it is bad because it gives the green light for the Treasury to sell a ton of bonds, which could drain liquidity and in other asset classes. (Sam)
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👎 Mega cap growth stocks. The market must be sick when the biggest stocks are lagging the major market indexes. But it’s just as bad when the biggest stocks lead gains because they mask weakness in underperforming names. (Michael)
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👎 Student loan payments. When the payments are paused, it presents moral hazard for borrowers while also enabling inflationary spending activity. But when payments resume, it’s bad because now consumer spending will dry up causing recession. (Michael)
For a while, there was actually a period when “good news was bad news” in that favorable short-term moves in the economy were arguably exacerbating inflation and forcing the Federal Reserve to be increasingly hawkish with monetary policy.
But in recent months, inflation has been cooling and the Fed has been dialing back its hawkish tone. Indeed, we seem to be realizing the bullish goldilocks soft landing scenario where good news about the economy is good news as it is not fanning the flames of inflation.
Don’t the bulls also spin data their way?
Of course, the bulls can easily say the opposite of most of the things said above.
TKer and it’s founder have similarly been accused of tilting toward glass-half-full perspectives.
But there’s one big difference between the bulls and the bears: The bulls are usually right.
Just look at long-term charts of GDP, corporate earnings, or the stock market. All of them go up and to the right.
And I’d argue this isn’t a coincidence. Rather, it’s supported by the interests and motivations of everyone participating in the markets and the economy. As I wrote in “10 Truths About the Stock Market“:
There are way more people who want things to be better, not worse. And that demand incentivizes entrepreneurs and businesses to develop better goods and services. And the winners in this process get bigger as revenue grows. Some even get big enough to get listed in the stock market. As revenue grows, so do earnings. And earnings drive stock prices.
Over very short-term periods of time, things might be just as likely to go wrong as they are likely to go right. But over time, things tend to go right.
When you’re bullish, you’re essentially in line with what’s happened in the past and what the majority hope and expect for the future.
When you’re bearish, it’s certainly possible that you’re proven right over short periods of time. History is riddled with instances where the bears nailed their calls.
However, the longer you stay bearish, the more you’ll find yourself on the wrong side of reality. And you’ll strain as you struggle to explain why good news is bad.
It’s certainly possible that tomorrow, things will start to go down in the markets and the economy. But for now, the data is very clearly saying things are going up.
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🎈 Inflation is cooling. The personal consumption expenditures (PCE) price index in May was up 3.8% from a year ago, down from the 4.4% increase in April. The core PCE price index — the Federal Reserve’s preferred measure of inflation — was up 4.6% during the month after coming in at 4.7% higher in the prior month.
On a month over month basis, the core PCE price index was up 0.3%. If you annualized the rolling three-month and six-month figures, the core PCE price index was up 4.1% and 4.6%, respectively.
The bottom line is that while inflation rates have been trending lower, they continue to be above the Federal Reserve’s target rate of 2%.
🛠️ Big ticket spending, business investment heat up. Durable goods orders (via Notes) jumped 1.7% to $288 billion in May. Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — rose 0.7% to $74 billion during the month.
The backlog of unfilled core capex orders was at $273 billion during the month.
🛍️ Consumer spending ticked higher. According to BEA data (via Notes), personal consumption expenditures increased 0.1% month over month in May to a record annual rate of $18.3 trillion.
“It’s slowing, but not plunging,” said Gregory Daco, chief economist at EY Parthenon.
💳 Card spending growth is positive. From JPMorgan Chase: “As of 24 Jun 2023, our Chase Consumer Card spending data (unadjusted) was 0.3% below the same day last year. Based on the Chase Consumer Card data through 24 Jun 2023, our estimate of the U.S. Census June control measure of retail sales m/m is 0.30%.”
👀 A bleaker estimate for excess savings. According to Federal Reserve researchers, household excess savings in the U.S. may be depleted. From the report: “…we note that the United States’ path differs slightly from other countries, as its stock of excess savings increased more rapidly, peaking in 2021Q3, and then decreased more quickly.
As a result, its excess savings stock, at least computed according to our method, is currently completely depleted, which contrasts with other advanced economies where households still hold a buffer of excess savings of about 3 to 5 percent of GDP. Given the more rapid drawdown of excess savings, aggregate demand in the United States is likely to have been supported more than in other countries over the past year.”
This is in contrast to a recent San Francisco Fed study that estimated U.S. households still had about $500 billion in excess savings. Apollo Global’s Torsten Slok, by contrast, estimated households were sitting on closer to $1.2 trillion in excess savings.
👍 Consumer confidence is up. From The Conference Board’s June Consumer Confidence report (via Notes): “Consumer confidence improved in June to its highest level since January 2022, reflecting improved current conditions and a pop in expectations… Assessments of the present situation rose in June on sunnier views of both business and employment conditions. Indeed, the spread between consumers saying jobs are ‘plentiful’ versus ‘not so plentiful’ widened, indicating upbeat feelings about a labor market that continues to outperform. Likewise, expectations for the next six months improved materially, reflecting greater confidence about future business conditions and job availability.”
🏘️ New home sales jump. Sales of newly built homes (via Notes) jumped 12.2% in May to an annualized rate of 763,000 units.
🏠 Home prices rise. According to the S&P CoreLogic Case-Shiller index (via Notes), home prices rose 1.3% month-over-month in April. From SPDJI’s Craig Lazzara: “If I were trying to make a case that the decline in home prices that began in June 2022 had definitively ended in January 2023, April’s data would bolster my argument. Whether we see further support for that view in coming months will depend on the how well the market navigates the challenges posed by current mortgage rates and the continuing possibility of economic weakness.”
💼 Unemployment claims tick up. Initial claims for unemployment benefits (via Notes) fell to 239,000 during the week ending June 24, down from 265,000 the week prior. While this is up from the September low of 182,000, it continues to trend at levels associated with economic growth.
👍 The economy was better than we thought. GDP growth in Q1 (via Notes) was revised up to an annualized rate of 2.0% from a previous estimate of 1.3%. Personal consumption growth during the period was revised up to 4.2% from 3.8%.
📈 Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.2% rate in Q2. While the model’s estimate is off its high, it’s nevertheless very positive and up from its initial estimate of 1.7% growth as of April 28.
Putting it all together 🤔
We continue to get evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.” On May 3, the Fed signaled that the end of interest rate hikes may be here. And at its June 14 policy meeting, it kept rates unchanged, ending a streak of 10 consecutive rate hikes.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations) to linger.
All of this means monetary policy will be unfriendly to markets for the time being, and the risk the economy sinks into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms, meaning that prices will have bottomed before the Fed signals a major pivot in monetary policy.
Also, it’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.