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The Night Is Darkest Just Before The Dawn Thumbnail

The Night Is Darkest Just Before The Dawn

Market Musings

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


Unfortunately, in terms of economic stability, we are just now entering the night.  Recession appears to be on the horizon and like a rogue car in oncoming traffic, the average person doesn't see it coming - or do they?  The title of this week's musings is attributed to one of my favorite movies, "The Dark Knight," which ironically was released in 2008 - the last major recession in the U.S.  One reason I have always liked this movie is the unbelievable screenplay with so many numerous quotable lines.  In the movie, Harvey Dent utters the words in this week's title, yet it was Thomas Fuller, English theologian and historian, who originally penned the words in 1650.  The Dark Knight is appropriate for this week's musings as the American consumer is getting squeezed between higher inflation and negative real wage growth.  While Harvey Dent provided the ominous warning during the movie, the second part of his notable quote was, "And I promise you, the dawn in coming."  We may have to wait some time for the latter, but it will come eventually.  Here's what we're seeing so far this week...

Things Can Always Get Worse.  In the Dark Knight, Batman is contemplating how he will fight the Joker in light of Rachels Dawes' death.  Alfred, always the sage of wisdom says, "You spat the in the faces of Gotham's worst criminals.  Didn't you think there might be some casualties?  Things were always going to get worse before they got better."  This sentiment is what got us into this economic mess.  The massive government spending, denial of inflation, and too-little-too-late mentality has us dealing with runaway inflation and an exhausted consumer.  This morning's print of May inflation (Consumer Price Index) shows that the belief inflation had peaked was in error.  On a year-over-year basis, CPI increased by 8.6%.  That means that the gap between inflation growth and wage growth increased in May and we're seeing real data that it's having an effect on spending.  Consumers are now much more focused on purchasing essentials and far less focused on purchasing discretionary items.  Among some of the larger declines in discretionary spending items are hotels, airfare, and recreation.  I don't have to tell you that does not bode well for vacation season.  Why is this happening?  Because spending on gas, car insurance, personal care, and housing has increased due to inflation, and those are all essential items.  Further data shows that the Targets and Walmarts of the world now have too much inventory and not enough sales to justify further inventory build-up.  Target and Walmart have both recently warned of earnings decline due to poor inventory turn. 








The change in consumer behavior is bleeding over into the higher-end consumer as well.  As we noted earlier this week, vacation rentals in high-end areas, such as the Hamptons, are off from previous years.  Mortgage Applications were down 6.5% last week, which marks the 11th negative week in the last 13 weeks.  The Housing Affordability Index is down to the lowest level in in more than three decades and the University of Michigan's Buying Conditions for Houses sentiment has reached a three-decade low.  Speaking of the UofM's sentiment indices, the preliminary reading on June Consumer Sentiment was much lower than expected and hit a level not seen since the 1980s.

Become the Villain.  While at dinner with Bruce Wayne in The Dark Knight, Harvey Dent makes the case for the need for Batman and says, "You either die a hero or you live long enough to see yourself become the villain."  That's what we have in the Federal Reserve at this point.  While responsible for the smooth function of markets and managing inflation, they forgot to abide by those primary goals.  Treasury Secretary Yellen admitted just recently that they failed on recognizing the threat of higher inflation.  Next week, the Fed will announce a rate hike at the June 15th FOMC meeting and, at the same time, QT (Quantitative Tightening) has already begun as the Fed started to let $47.5bn of securities—$30bn Treasuries and $17.5bn mortgage-backed securities—roll off per month until September, when it will ramp up to a total of $95bn per month.  Fed Chairman Powell has estimated that a year's worth of QT is equivalent to a 25 basis point rate hike.  That, on top of the 75 basis point increase so far this year - 25 bps in March and 50 bps in May.  The market is pricing in a 92% probability of another 50 basis point rate hike next week and subsequent 50 bps hikes in July and September.  If you thought the consumer was already constrained, what would another 150 basis points in general interest rates do for consumer behavior?

The effects of inflation and interest rates are not the only challenges facing the consumer these days.  The average price of gas is about to hit $5.00 per gallon in the U.S., with California seeing an average price of $6.38 per gallon.  Despite the release of millions of gallons of oil from the Strategic Petroleum Reserves, oil is pushing higher.  There is an increase of oil supplies as consumption is shifting.  However, according to Goldman Sachs, there is still room for oil to go higher ($160/barrel) before consumer demand destruction begins to take hold.  The federal government wants to stick its proverbial head in the sand and pretend it's all something or someone else's fault.  However, the federal government controls/regulates the drilling, shipping, storing, refining, buying, trading, selling, and taxation of oil.  They don't get to state that they do not somewhat control the price of oil.  Other commodity prices continue rising and it's not just the result of inflation.  The world Wheat market is experiencing supply shortages due to the Ukraine crisis and declines in the planting of wheat globally.  In addition, Turkey tried to negotiate safe passage of Ukraine's grain harvest via the Black Sea, but that proposal was nixed by Ukraine.  Over the past two years, commodity prices in general have increased 164%, with no immediate relief in sight.  Even with the shift in purchases toward essentials and away from discretionary items, the consumer is going to continue feeling the pain from inflation and interest rates.