One Thing Leads To Another

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group

The buildup in pandemic relief, the mismanagement of inflation, and the bad policy decisions during the pandemic - all chickens are now coming home to roost.  The Fixx was an English new wave band in the 1980s that was largely unremarkable.  However, their biggest hit, "One Thing Leads To Another" came along in 1983 as MTV was picking up steam.  The video to the song was played non-stop on the network which helped the song reach #2 on the U.S. charts and #1 on the Canadian charts.  As a child of the '80s, the song is fixed (pun intended) in my brain as a staple request of the DJ at the roller skating rink (did I just date myself?).  According to Fixx frontman, Cy Curnin, the song was written about malleable politicians who make false promises and lie in order to get elected.  The words of the song remind me of the current economic predicament we are living through:

"Why don't they
Do what they say
Say what you mean
Oh baby, one thing leads to another
You told me something wrong
I know I listen too long
But then one thing leads to another"

It has become clear that actions have consequences and, unfortunately, the American consumer is going to feel the pain of those consequences in short order.  Let's look at what we've seen so far this week...

Say What You Mean.  This week, Secretary of the Treasury, Janet Yellen, admitted that she was wrong about inflation over a year ago.  One year ago, Yellen said that inflation was "a small risk," was "manageable," and was "not a problem."  While this certainly noble of the Secretary to admit she was wrong, her follow-up statement is more questionable.  She told CNN's Wolf Blitzer, "There have been unanticipated and large shocks to the economy that have boosted energy and food prices.  And supply bottlenecks that affected our economy badly that I didn't, at the time, fully understand."  While one person may not understand something, it's doubtful that the 400 Ph.D. economists employed by the Federal Reserve and the hundreds of other staff economists employed by the U.S. Treasury didn't understand how to read the data coming from multiple economic inputs.  If a lowly analyst in Memphis could figure it out over a year ago, so could the federal government. 

As we have pointed out multiple times over the last several months, the build-up of stimulus during the pandemic created a phenomenon where demand among consumers remained high (savings plus handouts) while the supply chain was plunged into chaos due to bad COVID policy decisions.  This outcome should have been easily foreseeable by the economists at the Fed.  If they didn't see it or understand it, then that's a bigger problem in-and-of-itself.  Now that savings have eroded and consumers are partially dealing with inflation by utilizing too much credit card debt, the economy is on a cliff.  The Fed's own Beige Book released this week showed a slowdown in economic activity.  The Beige Book is an amalgamation of data received from the 12 Federal Reserve banks located in various regions of the country.  April's report showed "moderate" economic activity.  This month's report showed "slight to modest" activity.  Why the change?  If you look deeper at the report, the retail inputs showed consumers were balking at higher prices due to inflation.  The housing market inputs showed weakness due to higher prices and higher mortgage rates.  Finally, the report collected data from companies and their primary concerns moving forward.  Companies stated their primary concern was the difficulty finding workers and their second biggest concern was supply chain disruptions.  What's the point?  The Fed collects this kind of data continuously and prepares this report to the public.  Are we really to believe that our current economic predicament wasn't at least partially foreseeable?

Do What They Say.  Could we be in a recession already?  There is some evidence that we could be in the initial stages of a recession.  Multiple high profile CEOs are warning of recession and layoffs are beginning to be announced.  Tesla CEO Elon Musk recently warned of worry about a recession and announced a "pause all hiring worldwide."  J.P. Morgan CEO Jamie Dimon has signaled an "imminent hurricane" of economic disaster and Goldman Sachs CEO John Waldron has stated, "The confluence of the number of shocks to the system to me is unprecedented."  The number of layoffs or hiring freezes that have been announced over the past 6 weeks is considerable.  Among the more notable layoffs/freezes is Peloton, Wells Fargo, Meta, Twitter, & Netflix.  On average, the number of layoffs amounts to 500 among the list shown here.  This morning's Jobs Report for the month of May showed slightly a higher Unemployment Rate month-over-month (3.6% vs 3.5%).  Though the number of jobs created in May was higher-than-expected (+333,000), it was lower than April's number (+405,000).  But, of greater concern was the decline in Average Hourly Earnings.  May's report showed +0.3% increase, which was lower-than-expected and and still behind the pace of inflation.   

One Thing Leads To Another.  It's hard to see the beginning of a recession when we are living in the moment.  However, the Fed has another tool that their disposal that is regularly published in the National Financial Conditions Index (NFCI).  

The movement in that index recently has been similar to the movement just prior to the 2008 recession.  The level of the index released yesterday showed -0.17, which is dangerously close to a neutral level of zero.  At the beginning of the year, the index had a healthy reading of -0.60, which is well below the historical average.  At this point in August of 2007, the index had made a similar move over a shorter time period.  On top of that, the Fed seems determined to hike rates at least 50 basis points over the next 3 FOMC meetings.  That is the measure of their resolve to correct the situation they partially created.  If the U.S. consumer is already constrained, the Fed is behind the curve, and the cracks in the economy are already beginning to show (even in the Fed's data), then the time for concern is upon us.

Financial Planning Note of the Week:  It's a good time to adjust portfolio's for tough economic times ahead.  What does that mean?  Common sense dictates that sectors involved in basic consumer needs would perform better during a recession.  Consider Utilities (people still need to turn on the lights), Consumer Staples (people still need to eat), and Healthcare (people still need their medicine and their doctor).  These sectors allow for less downside capture during a bear market.