Outline -- week 3.pdf

Market Update – September 9, 2024 SLIDE 150 I. Last Week A. Stocks 1. DJIA -2.93%; S&P 500 -4.25%; Russell 2000 -5.69%; Nasdaq -5.77% SLIDE 151 a. Worst weekly performance for S&P 500 since March 2023...

Market Update – September 9, 2024 SLIDE 150 I. Last Week A. Stocks 1. DJIA -2.93%; S&P 500 -4.25%; Russell 2000 -5.69%; Nasdaq -5.77% SLIDE 151 a. Worst weekly performance for S&P 500 since March 2023 b. Worst week for Nasdaq since Jan. 2022 i. Big tech below 100-day moving average (XLK and Nasdaq) SLIDE 152 ii. NVDA -13.86%; Broadcom (AVGO) -15.86%; SOX -12.22% SLIDE 153 2. What happened? a. The market became concerned about growth (as opposed to inflation) i. Fear that a recession could result in earnings dropping 10% and the multiple dropping closer to 16 (S&P 500 at 3800) (WSJ) ii. Other concerns remain: negative seasonality (Sep. and Oct.), ongoing AI scrutiny, tech valuations, weaker consumer (especially low-income consumer), Chinese growth concerns, continued unwinding of yen carry trade, election uncertainty (very close election) b. Two big economic releases (discussed later) i. JOLTS report on Wednesday ii. Employment report (jobs report) on Friday 3. Bullish narrative: imminent Fed rate cuts, unemployment rate lower, a soft landing is still possible a. The problem is that the Fed had to raise rates to slow the economy (to lower inflation) and we’re now at the point where we’re seeing some signs of slowing and we don’t know if this will end with a soft landing or a hard landing 4. Big issue over next 10 days: will the Fed cut 25 bps or 50 bps on Sep. 18th? a. Market is pricing in 100% chance of 25 bp cut and 34% of another 25 bps. SLIDE 154 i. Total for four to five cuts by end of year (4.16%) b. Nine of the 12 districts reported flat of declining activity in the Beige Book SLIDE 155 c. NY Fed Pres. Williams said that it’s appropriate to lower the Fed funds rate due to a weaker job market and slowing global growth but also said that the Fed can move to neutral over time. d. Chicago Fed Pres. Goolsbee – multiple cuts over several meetings; one particular meeting doesn’t matter e. Fed Governor Waller said labor market softening but not deteriorating f. Average hourly earnings reaccelerated to.4% (.3% expected). SLIDE 156 i. Hurts 50-bp cut hopes. 5. This week: core CPI expected to hold at.2% MoM and 3.2% YoY B. Atlanta Fed Pres. Bostic – 3 Signs We’re Headed to 2% Inflation (Atlanta Fed) 1. The breadth of price increases is narrowing to a range that accords with price stability. For the three months through July, 27% of prices (weighted by expenditures) rose by more than 5% YoY in the PCE price index. This is the lowest share since mid-2021. The figure for July alone was 18% (near the long-term average of 17%). 2. Core PCE for the three months through July came in at an annualized rate of 1.7%. SLIDE 157 3. We’ve finally started to see signs of the long-anticipated slowdown in shelter prices. SLIDE 158 13 C. Two New Important Themes 1. We’ve entered a new market paradigm with a focus on (concern about) economic growth rather than inflation a. When the market focused on inflation, good news on the economy was generally bad news for stocks because it meant upward pressure on prices and higher interest rates from the Fed. i. Now, good news on the economy is good for stocks, because it relieves concern about growth, and rate cuts are expected anyway. And bad news on the economy is now bad news for stocks. 2. Previously unloved stocks have beaten the market’s stars SLIDE 159 a. Falling yields are part of the reason for the recovery in unloved stocks – value beating growth. (WSJ) II. The Soft-Landing Narrative (Torsten Slok, Apollo) 1. The overall economy is doing well. a. The Fed’s weekly GDP model suggests Q3 GDP will be 2.4 and the Atlanta Fed’s GDPNow says it will be 2.1%. SLIDE 160, 161 b. Default rates and weekly bankruptcy filings are trending down. SLIDE 162 c. Fed lowering rates will help the economy. SLIDE 163 2. Labor market is still doing well. a. Unemployment rate declined in August. i. Neither the HH survey or establishment survey show signs of a slowdown in job creation. SLIDE 164 b. Wage growth accelerated to 3.8% and it remains sticky above pre-pandemic levels. SLIDE 165 c. Layoffs are low. SLIDE 166 d. Jobless claims have declined for several weeks. e. Continuing claims have declined for several weeks. f. Supply of labor is increasing. SLIDE 167 3. Consumer spending is still strong. a. Daily data for debit card transactions show that consumer spending has been accelerating in recent weeks, driven by spending on clothing, food services and drinking places, sporting goods, and motor vehicle and parts dealers. b. Weekly data for retail sales went up last week and remains solid. SLIDE 168 4. Market data is promising. a. Weekly data for S&P 500 forward profit margins shows that profit margins are near an all-time high. SLIDE 169 b. The stock price of staffing firms is rebounding (meaning we could see a rebound in job openings). SLIDE 170 14 III. The Recession Narrative (restrictive policy is finally slowing the economy) A. The Labor Market is Weakening 1. JOLTS (Job Openings and Labor Turnover Survey) a. Job-openings (7.7MM) for July was below expectations (8.1MM). SLIDE 171 i. Lowest level since Jan. 2021 (but also below pre-pandemic) ii. Now just 1.1 openings per unemployed person. Was 1.3 before pandemic and reached 2.0 during pandemic. SLIDE 172 b. Quits rate stayed at.5 (was almost double that in 2022). Fewer workers are quitting than in 2019. SLIDE 173 c. The rate of layoffs rose slightly to 1.1%, but it’s not far from the all-time low of.9% (spring of 2022). (MarketWatch) (FT) 2. Employment report a. Payroll: Added 142K jobs (165K expected). Prior two months revised down by 85K. S 174 b. Household: unemployment dropped from 4.26% to 4.22% SLIDE 175 3. Gap between high labor demand (employed plus job openings) and low labor supply (employed plus unemployed) has narrowed from more than 5MM in early 2023 to under 1.5MM in June. (Atlanta Fed) SLIDE 176 B. Fears About Consumer Spending 1. Weakness of lower-income households is starting to scare us a. Consumer loan delinquency rates have risen to levels last seen in 2010 (when the unemployment rate was double what it is today). 2. A softening labor market will undermine consumer spending. The personal savings rate stood at 2.9% in July, less than half of what it was in 2019. C. Weak Manufacturing 1. ISM manufacturing PMI was a little weaker than expected (47.2). SLIDE 177 a. The new orders component of the ISM manufacturing index fell in August to the lowest level (44.6) since May 2023. SLIDE 178 b. The production component fell to 44.8%, the lowest since the economy shut down in May 2020. 2. Employment report: lost 24K manufacturing jobs SLIDE 179 (continued on next page) 15 D. A Weak Real Estate Market 1. Home-construction market a. Homebuilder confidence dropped in August to the lowest level so far this year. b. Home sales are weak. Housing starts (on track to be down 16% YoY) and permits have rolled over. The number of housing units under construction has declined by more than 8% since the start of this year. c. Bank lending for home construction has dropped 10% YoY to $92B. SLIDE 180 i. Weak demand for loans? Slow housing market? Unwilling to lend? 2. Commercial real estate a. Commercial real estate remains under duress. Office vacancy rates are at an all-time high. Default rates are climbing in the office, apartment, retail and hotel segments. i. Regional banks will experience more losses. b. In July, the annual pace of multifamily-building starts was down 22% from the same month a year earlier and down 41% from an April 2022 peak. i. Reasons: lower property values, higher interest rates, flat rents E. Signals from Financial Markets 1. Continued rotation into defensive stocks a. But financial firms, which are also cyclically sensitive, fell less than the broader market (XLF is best performing sector over past month) 2. The market is expecting the FOMC to cut the Fed funds rate by more than 2% over the next 12 months. 3. Treasuries rallied (flight to safety and lower Fed funds rate) SLIDE 181 a. Lowest yields since early-to-mid 2023 4. The dis-inversion of the yield curve (first time since July 2022) SLIDE 182 a. Happens close to recession or soft-landing! Doesn’t tell us anything. b. Bets on Fed rate cuts are growing i. Pricing in more rate cuts than we did at the start of any other easing cycle since 1990 SLIDE 183 c. 2-year UST yield minus Fed funds rate is most inverted since financial crisis SLIDE 184 5. Five-year breakeven inflation rate is below 2% -- the lowest since 2020 SLIDE 185 F. Weak Commodity Prices SLIDE 186 1. Oil dropped 8% last week and has lost all of its 2024 gains, despite heightened geopolitical risks. a. Weaker global growth i. China grew 4.7% in Q2; China’s manufacturing activity fell to six-month low in August; more Chinese drivers switching to EVs ii. Manufacturing ISM rose to 47.2% -- but in contractionary territory b. OPEC+ rethinking plan to raise production in October. For more than a year, OPEC+ has suspended more than 5MM barrels of production per day. They had planned to bring back 180K barrels in October. i. Libya bringing production back online 2. Copper has been falling – near $9K a ton a. Slower growth b. Green transition taking longer to materialized (WSJ) (FT) (Bloomberg) (FT) (MarketWatch) (Barron’s) (FT) 16 IV. The “Beveridge Threshold” 1. The Beveridge curve describes the relationship between the unemployment rate and job vacancies. SLIDE 187 a. When the unemployment rate drops, job vacancies (openings) can increase greatly. b. Rather than rates, we can also think of this in number of people and jobs 2. The Phillips curve describes the relationship between the unemployment rate and inflation. SLIDE 188 a. When the unemployment rate drops, inflation can increase. 3. If you think of these ideas (the Beveridge and Phillips curves) together, lower unemployment can result in job openings and inflation. 4. The idea of the “Beveridge threshold” is that there is a point at which the number of unemployed people and job openings are roughly equal. If we move beyond this point, we have a labor shortage. Below this point, we have looseness in the labor market (excess workers). a. In a tight labor market, the vacancy rate can shoot up. In addition, it only takes a small increase in economic activity to produce a burst in inflation (the Philips curve steepens). b. In a loose labor market, it takes a big decline in employment to bring inflation down just a little. Inflation should already be low. 5. The academics behind this idea believe that the unemployment rate currently associated with their Beveridge threshold is 4.4%. When the rate is higher than that, the labor market stops being tight. 6. This helps to explain two issues: a. Why inflation has fallen rapidly without a significant rise in unemployment b. The argument that we now need to worry more about the labor market than inflation (NYT) V. Political/Economic Issues A. Losing Faith in College 1. US colleges are facing declining enrollment due to a falling birth rate, high tuition / a student debt crisis, a changing job market, and political battles over race and diversity initiatives. 2. Only 22% of US adults said it’s worth getting a four-year degree if one has to take out a loan to do it. 3. 50% of Republicans say it’s not too, or not at all important to have a four-year degree to get a well-paid job; 30% of Democrats say the same. 4. The share of high school graduates going on to post-secondary college nationwide has decreased from 70% in 2016 to 62% in 2022. (FT) 17 B. Goldman Sachs: How the Election Would Impact GDP 1. GS estimates that if Trump wins in a sweep or with divided government, the hit to growth from tariffs and tighter immigration policy would outweigh the positive fiscal impulse from maintaining most tax cuts. 2. If Harris wins and Democrats sweep, new spending and expanded middle-income tax credits would slightly more than offset lower investment due to higher corporate tax rates. (Bloomberg) C. Capital gains tax 1. Most countries have capital gains tax rates that are lower than ordinary income tax, partly to compensate individuals for putting their own capital at risk and to promote investment. 2. Unintended consequences of raising CGT: a. Raise them too high and nations risk an outflow of investors to lower tax locations. b. Higher CGT can punish genuine risk takers (e.g., business owners). c. Higher CGT can raise the incentive to hold on to assets, which prevents capital from being redeployed for more productive uses. (FT) D. Immigration Remade the Work Force 1. Since the end of 2020, more than 9MM people have migrated to the US (net). That’s nearly as many as came in the previous decade. 2. Immigration has lifted US population growth to almost 1.2% per year, the highest since the early 1990s. Without it, the US population would be growing.2% per year. 3. Less than 30% (or 2.6MM) are what the CBO counts as “lawful permanent residents,” which includes green-card holders and other immigrants who came through legal channels (such as family or employment-based visas). 4. Of recent immigrants aged 16 or older, 68% are participating in the labor force (vs. 62% of US- born Americans). This amounts to more than 5MM people, equal to ~3% of the labor force. a. This could rise. It takes ~six months to receive a work permit. b. Labor force participation for those who arrived from 2004 – 2019 is 73% (census data). 5. While 5% of working-age Americans are unable to work (chronic illness, disability, drug addiction, taking care of family members), less than 1% of post-2020 immigrants report being unable to work. 6. Immigrants are twice as likely to not have a high school diploma. They are also more likely to have a college degree. SLIDE 189 7. Around half say they speak English very well or exclusively. (WSJ) E. In Defense of Revisions of Economic Data (particularly the recent 818K jobs revision)SLIDE 190 1. Rather than saying that the BLS is “cooking the books,” realize that revisions are a normal part of obtaining an accurate picture of the nearly $30T US economy with a labor force of ~170MM people. If the US wants timely statistics, revisions are a necessary byproduct. 2. Employer response rates to the payroll survey are 60% for the first estimate (three weeks) and 88% by the third month. 3. Revisions reflect a commitment to high-quality statistics. In this case, they are using tax records from state unemployment insurance agencies rather than just surveys. a. ADP data was helpful in forecasting the revisions. (Bloomberg) 18