Control Panel: Short-term happy, long-term glum?

The Control Panel and METAR are snapshots, very short-term observations that don’t predict cyclic economic trends any more than a daily weather report would predict a change in seasons.

I post the Control Panel weekly to avoid day-to-day noise. Some METARs may be short-term traders or speculators while others may be long-term investors who rarely change allocations. Even long-term investors may be interested in the major trend changes to avoid medium to long-term market drawdowns like “Hurricane Covid” (my best forecast of all), a financial crisis, recession or broad change in interest rates.

Economists failed to predict the economic soft landing in 2023 after failing to predict the spike in inflation in 2022 (caused by massive fiscal and monetary stimulus in 2020-21). Perhaps they have gained a little humility. There’s no guarantee that the soft landing will stick. Inflation could recur due to large government deficits and/or the Fed cutting interest rates too rapidly. The economy could slide into recession as companies which borrowed at ultra-low interest rates default when attempting to roll over their debts at current higher yields.

Nation’s Top Economists Are Short-Term Happy, Long-Term Glum

At annual gathering, academic economists are surprised and relieved over soft landing, but worry about what comes next

By Gabriel T. Rubin, The Wall Street Journal, Jan. 7, 2024

The good news: the U.S. is headed for growth this year, not recession. The bad news: there is as yet little prospect growth will be any better than before the pandemic. That, for now, is the consensus of economists speaking at the annual meeting of the discipline’s largest association, the American Economic Association…

Economists were less optimistic about the long term than the prospects of a soft landing. In a presentation here, Eberly doubted recovering to prepandemic trends will boost long-term growth. That, she said, has to come from sustained boosts to productivity that counteract significant headwinds in the form of an aging population, increased global conflict, and more-fragmented international trade… [end quote]

The Institute for Supply Management (ISM) Purchasing Managers Index (PMI) was mixed.

Economic activity in the manufacturing sector contracted in December for the 14th consecutive month. Demand eased, with the (1) New Orders Index contracting at a faster rate, (2) New Export Orders Index essentially flat, and (3) Backlog of Orders Index climbing back above 40 percent but still in fairly strong contraction territory.

Economic activity in the services sector expanded in December for the 12th consecutive month. The services sector is much larger than the manufacturing sector as well as being more labor-intensive. An expanding services sector should support employment. However, employment fell into contraction whereas it had been growing for the past 2 years. This was a sharp change which could be noise or the start of an ominous trend.

The Labor Force Participation Rate - 25-54 Yrs. has recovered above the pre-Covid level and is near the all-time highs last seen in the 1990s. The unemployment rate (U-3) continues near a multi-decade low.

The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2023 was 2.5 percent on January 3. This is a nice, sustainable growth rate and certainly not a recession.

On a less-optimistic note, The Conference Board Leading Economic Index® (LEI) for the U.S. declined by 0.5 percent in November 2023. Stock prices made virtually the only positive contribution to the index in the month. The Conference Board forecasts a short and shallow recession in the first half of 2024.

METARs are interested in the impact on our investments.

Can Stocks Surpass 2022 Highs? Yes, but the Math Looks Scarier From There

Though the equity market faces a much improved outlook, high valuations imply lower long-term returns

By Jon Sindreu, The Wall Street Journal, Jan. 7, 2024

Nothing in the market looks cheap right now. Indeed, the richly valued technology stocks that led the way in 2023 have been at the forefront of a selloff in the first few days of 2024…

Yet tech isn’t the only expensive sector. With the exception of energy and real estate, price-to-earnings ratios are above the historical median since 1999 across all S&P 500 industry groups… Valuations are notoriously bad at telling investors when they should sell equities… [end quote]

John Hussman has decades of data showing that buying stocks at elevated valuations results in subpar long-term results.

Currently, the the Cyclically Adjusted P/E Ratio is still at a bubble high, close to double the historical average.

This doesn’t necessarily mean that the market will drop in the near future. Although both the stock and bond markets fell slightly in the past week, the drop was minor and could have been noise.

The risk panels were neutral, neither risk-on nor risk-off. The Fear & Greed Index fell from Extreme Greed to mere Greed although stocks still showed Extreme Greed.

The Treasury yield curve inched up a bit after falling dramatically for the past 2 months.

Caution is warranted since the markets are betting on the Federal Reserve cutting the fed funds rate more than the Fed has indicated it will. This has happened 3 times before and each time was followed by a sudden shock to the stock market as traders retrenched. The current fed funds target rate is 5.25% - 5.50%. Traders expect a quarter-point cut in March with a final fed funds rate of 3.75% - 4.25% in December. The Fed’s dot plot shows a median of 4.6%. That’s a big disconnect.

Not to mention that the Fed is targeting a neutral rate which neither stimulates nor slows the economy. It won’t go back to ZIRP in a garden-variety recession. (Barring a true crisis which isn’t on the horizon right now.) The historic level was 2.5% above the inflation rate. Today’s fed funds rate is actually lower than that.

Past Fed campaigns of raising the fed funds rate ended in a recession and a rapid retreat to very low rates. But this time may be different if the soft landing sticks. There’s no need for the fed to cut rates which may cause inflation to resume. Their reduction may be much more gradual than the markets expect.

The METAR for next week is cloudy. There’s a lot of uncertainty in the markets. Volatility may increase without extreme moves in the indexes.