By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group
This week's inspiration for musings is pretty obvious in the title. The Byrds first recorded the song "Turn! Turn! Turn!" in 1965, but they were not the first to record it. The song was originally a "folk" song written by Pete Seeger in 1961. Seeger's publisher asked him to write a song that wasn't so "angry." Pete said he didn't write songs like that, but sat down and wrote it out on a sheet of paper in 15 minutes. It was recorded by a few artists, but The Byrds turned it into a hit by re-arranging the song and recording it over 50 times before they got the sound (steel guitars) right. The song peaked at #16 in the U.K. and #1 in the U.S. The song's lyrics are apropos to the current state of the markets - what goes up, must come down.
"A time to be born, a time to die
A time to plant, a time to reap
A time to kill, a time to heal
A time to laugh, a time to weep
To everything - turn, turn, turn
There is a season - turn, turn, turn
And a time to every purpose under heaven
A time to build up, a time to break down
A time to dance, a time to mourn
A time to cast away stones
A time to gather stones together"
Here's what we're seeing so far this week...
A Time To Case Away Stones. Consumers are responding to higher inflation, higher gas prices, and higher interest rates with shifts in behavior. A recent survey by Provident Bank showed that 83% of respondents slashed personal spending due to soaring prices of food and gasoline. In the same survey, more than 10% said they eliminated all "non-essential purchases" and 70% said they had made some changes to travel habits. Among some of the consumer behaviors that were changed: switching to generic brands, preparing food items at home, and taking on "odd jobs" for extra income were listed. Travel changes included: avoiding travel in expensive areas, delaying trips due to gasoline prices, and even video conferencing family instead of in-person trips.
A different survey conducted by the Census Bureau showed that more than 8 million Americans are behind on their rent and nearly 3.5 million households were likely to leave their rented spaces in the next 2 months due to an eviction. Approximately 6.7 million households said their rent increased $250/mth, on average, over the last year. There is plenty of information that the lowest income households are maxing out credit cards as savings have dwindled.
There Is A Season - Turn, Turn, Turn. Second quarter earnings season will soon be upon us. It's looking more and more like the 2nd quarter will be a disappointment in terms of earnings. According to FactSet, analysts have decreased S&P 500 companies' Q2 bottom-up earnings by 1.3% from $56.06/share to $55.36/share. When consumers shift their spending habits at the beginning of a recession, companies naturally make less money - especially companies that create discretionary goods/services. In fact, Goldman Sachs recently adjusted their earnings model moving forward. Their median Earning Before Interest and Taxes (EBIT) is modeled for a considerable drop over the coming quarters - all while consensus forecasts are calling for a rebound. Looking back in history at previous recessions, the actual margin growth compared to Goldman's modeled margin growth typically shows a difference in favor of actual earnings. The actual results are usually worse than the modeled results.
A Time To Reap, A Time To Weep. The Fed is reaping the results of policy failure over the past 18 months. Yesterday, at the ECB Forum on Central Banking, Fed Chairman Powell actually uttered the words, "The U.S. economy is actually in pretty strong shape." Well, the Fed's own data would say otherwise. The Dallas Fed Manufacturing Survey released on Monday revealed concerns across all industries. One respondent stated, "You can’t ignore the economic fundamentals leading to a likely recession." Other comments included:
- "Inflation on raw materials, especially steel and gasoline and diesel fuel, continues to damage gross margin."
- "We are seeing a contraction in business activity."
- "As you can see, we are already into a bit of stagflation."
- "Orders are trending down, and with the Federal Reserve continuing to tighten, we think the six-month outlook for a recession is strong."
Does that sound like business owners are seeing the economy as in "pretty good shape?" In fact, the results of the survey are used to create the Dallas Fed Manufacturing Index, which plummeted for June to -17.7 - the lowest reading since the pandemic. Similarly, the Richmond Fed Manufacturing Survey released on Tuesday reveled similar results. The Index created by that survey also plummeted to -19, also the lowest reading since the pandemic. The survey showed a drop in Shipments to -29 vs +17 in April. New Orders dropped to -38 vs +6 just two months ago. Prices Paid for goods was up 12% in June versus April. That doesn't indicate any slowdown in inflation. In fact, if we look at the majority of indices tracked by the different Fed Regional Banks - Philadelphia, New York, Richmond, Kansas City, & Dallas - they reveal a disturbing trend. All of those indices are down since early-to-mid 2021. Does that seem to match with the Chairman's comments that the economy is in "pretty good shape?" Is there some data point that the Fed has not yet revealed that would dramatically effect the view that the economy is actually in decline? Well, the Fed's own view of 2nd quarter GDP - Atlanta Fed's GDPNow - is showing an expected growth rate of 0.3% for the 2nd quarter. Does that indicate and economy in "pretty good shape?" What about inflation? Current futures on July's Fed Rate Hike continue to point to a 75 basis point rate hike and recent comments by multiple Fed presidents seem to verify that outcome.
Is there is a lack of confidence in the Fed brewing among investors? At what point does that lack of confidence become apparent and collide with consumer downshifting in spending? Thursday morning, Personal Spending in May came in lower than expected (+0.2% vs +0.4%, expected). Adjusted for inflation, Personal Spending actually declined 0.4% month-over-month. In addition, the jobless claims appear to be shifting in a different trajectory. Initial Weekly Claims disappointed for the 4th consecutive week and were revised higher for the 5th consecutive week. Continued Claims disappointed for the 3rd week in the last 4 weeks. The trends seems to suggest a move higher in Initial Claims and a plateau in Continued Claims. If the layoff situation picks up steam along with consumer spending declining - all while the Fed is raising rates - the recipe for a recession will be in place.
A Time To Build Up, A Time To Break Down. Quick update on the Reverse Repo situation we have been analyzing over the past few weeks. Yesterday, a record 108 counterparties took an all-time high $2.33 trillion in Reverse Repos from the Fed. There was zero activity in the regular Repo market. The Fed technically ended "excess reserves" in March of 2020 when the Fed reduced reserve requirement ratios to zero. The amount of Reverse Repos, combined with the amount of Reserves held by the banks at the Fed, the amount of interest payments to counterparties/banks amounts to $242 million daily! The Fed has essentially created a "riskless" profit center for banks and, thus, created an alternative liquid market that has skewed markets into a false sense of security.