During years of Federal Reserve suppression of the REAL fed funds and longer-term rates to negative, investors bought riskier assets (stocks, junk bonds, cryptocurrencies, etc.) because There Was No Alternative (TINA).
Real fed funds and longer-term Treasury yields are still negative, but the Fed has slightly removed its heavy hand from the bond market and yields have risen to the point that there is an alternative to overpriced, risky assets. As a result of Fed actions (and more to come, due to continued high inflation), investors have moved a lot of money away from stocks (especially “high-growth” profitless companies). All METARs know that 2022 saw a nasty bear market in stocks, especially the NASDAQ tech stocks.
However, the stock market hit a low in June 2022. Though still well below its New Year maximum, stock indices have climbed for the past month and a half. Should we shift to Fear Of Missing Out (FOMO) and back up the truck to buy stocks? Have we seen the last of the bear market? Should we jump on the bandwagon before it passes us by?
Economists are puzzled about the economy because employment is rising even though GDP dropped for two quarters.
1Q & 2Q2022 had negative GDP growth. But this is REAL GDP. Real values are inflation-adjusted estimates — that is, estimates that exclude the effects of price changes. Because inflation is so high, I looked up the tables showing the inflation adjustment. The table showed an inflation adjustment for energy prices but not for consumer goods. So I’m puzzled. Did the economy really contract? Or is this an artifact of the way inflation is calculated (differently by the BLS and BEA) and applied to raw GDP numbers? The slight drop in 2Q2022 (-0.9%) could easily be revised away later.
Let’s look at the unemployment rate. The unemployment rate represents the number of unemployed as a percentage of the labor force, 16 years of age and older, who have actively sought work in the previous month. U-1 is the total rate of everyone who looked for a job but didn’t find even an hour of paid work. U-6 Total Unemployed, Plus All Persons Marginally Attached to the Labor Force, Plus Total Employed Part Time for Economic Reasons, as a Percent of the Civilian Labor Force Plus All Persons Marginally Attached to the Labor Force. These are people who would like to work full-time but can’t find a full-time job. We also need to look at the prime working-age adults, 25-54. Also at the Civilian Participation Rate, which includes people who aren’t looking for work, such as stay-at-home caregivers, retired people, just plain bums, etc.
The unemployment rate of prime working-age people is 3.1%, the lowest since 2000. These are people who are actively seeking work. The prime working-age participation rate for men is 88.4% which hasn’t quite recovered to the pre-pandemic level. This has been dropping almost continuously since 1960. The overall Labor Force Participation Rate is 62.1%, well below the pre-pandemic level. This includes retirees, women who can’t find child care, etc.
Disposable income rose but real disposable income declined due to inflation.
The Fed has said that inflation is its priority. With such a strong labor market, they will raise the fed funds rate until inflation declines. Many economists see the Fed raising rates into a slowing economy and expect a recession.
**Investors Brace for More Market Volatility as Earnings Estimates Slump**
**Stock market again at risk of appearing expensive, even after this year’s tumble**
**By Hannah Miao, The Wall Street Journal, Aug. 7, 2022**
**Corporate-earnings expectations are falling. That means the stock market is again at risk of appearing expensive, even after this year’s tumble....Now that Wall Street analysts are cutting profit estimates at a faster pace than usual, some investors are bracing for another stretch of volatility in the stock market....**
**Although second-quarter earnings are on pace for their slimmest increase since the end of 2020, profit margins are set to top the five-year average, suggesting companies have found success passing on higher costs to their customers. ...Earnings figures aren’t adjusted for inflation. When costs rise, companies also tend to boost prices, which pushes earnings on a dollar basis higher even if real growth slows....** [end quote]
The S&P 500 P/E ratio has dropped but it’s still well above the historical average. The CAPE shows this even more clearly. The market is still way overvalued.
The Control Panel shows that FOMO has taken hold. Stocks are rising and market internals are positive. The trade is risk-on as stocks and junk bonds are rising faster than Treasury prices. The Fear & Greed Index has risen to Neutral. The USD is gently declining. Gold and copper are gently rising together. Oil and natgas have stopped rising.
However, all is not clear sailing. The Treasury yield curve is partially inverted. If the Fed raises the fed funds rate in August and September, as expected, the short end will be above the long bonds and the yield curve will be fully inverted.
The 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity spread is strongly negative, a clear pre-recession signal. The 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity spread is only 0.25% and will go negative within the next month or two if the Fed raises the fed funds rate as expected. These are leading indicators which usually precede a recession by a few months.
The Conference Board Leading Economic Index® (LEI) for the U.S. decreased by 0.8 percent in June 2022 to 117.1 (2016=100), after declining by 0.6 percent in May. The LEI was down by 1.8 percent over the first half of 2022, a reversal from its 3.3 percent growth over the second half of 2021.
The Federal Reserve Bank of Atlanta’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2022 is 1.4 percent on August 4, 2022.
I think that FOMO may be reasonable for short-term traders. I think this mini-run has some legs.
However, I don’t think the economy is out of the woods yet. Inflation, while perhaps subsiding a fraction due to lower energy prices, has a lot of built-in pressure from rising wages, rents and labor and supply restrictions. Sticky price inflation is high and rising.
The METAR for next week is sunny. But the Fed will be forced to raise rates. The longer term forecast is for a volatile autumn with setbacks in the stock and bond markets.