Market Update - April 2024 | |
- Stocks rose again in March as investors salivated over the prospect of future Federal Reserve interest rate cuts and the potential of artifical intelligence to change the world.
- Bonds rose slightly in March, but are overall down for the year. Bond investors do not seem worried about inflation.
- Once again, the leading indicators show a recession is imminent, yet GDP growth and corporate profits continue to muddle along.
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Table 1: Market performance estimate as of 3/28/2024 (LIMW) | |
Inflation indicators continue to edge down | |
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Inflation indicators continue to edge down, but are not below the Fed's 2% target. There is tremendous strain on the economy as the private sector retrenches, pushing down inflation, while the government sector spends like crazy, pushing up inflation.
One of the reasons we follow this data closely is that the Fed will base policy on the reported inflation in the economy. The Fed chairman forecasted rate cuts several times in the past few meetings, but economic strength and persistent mild inflation hold their hands back. Rising oil prices and strong home sales prices aren't helping the Fed's desire to cut rates.
Figure 1: Inflation, 10-year Treasury yields and Federal Funds rate 2015-2024 (LIWM)
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The markets tend to hear what they want to hear from Fed officials. Cutting rates is bullish for stocks because it encourages growth and lending. Historically, markets rise dramatically after the Fed starts cutting rates. What the analysts are not telling you is that the reason markets rise after Fed rate cuts is because they typically fell dramatically prior to a rate cut cycle. The market isn't always rational, but it helps to understand its foibles.
Quietly, the Fed has said that rates will be higher for longer. After the 1970s inflation, the Fed kept rates higher than inflation for almost 12 years. I don't hear anyone calling for the Fed to keep rates higher for more than a few months, but in the past we can see that the Fed has imposed higher-interest-rate medicine on the economy for a long, long time.
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Figure 2: Inflation, 10-year Treasury yields and Federal Funds rate 1980-1999 (LIWM) | |
The labor market continues to gradually weaken | |
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There are two employment data points closely followed by investors. One is the monthly change to corporate payrolls. This data has been stable indicating no recession. The other is the unemployment rate, which has been weakening for several months now.
Why are these surveys different? Both the payrolls employment data and the unemployment data collect the same information about number of employed persons, but from different sources. The payrolls data comes from corporations and is frequently revised. The unemployment data comes from a household telephone survey of workers and is rarely revised.
How can we reconcile this dichotomy?
- Perhaps corporations are replacing workers with immigrants who do not respond to telephone surveys.
- Perhaps the elimination of land line telephones is lowering the accuracy of the household employment surve.
- Perhaps the payrolls data will be revised to the reflect the household data. There is evidence payrolls data is frequently revised downward in recessions.
- Perhaps failed companies who laid off workers are not reporting because they are no longer in business.
The key takeaway is that the lagging employment data is beginning to weaken, with the household employment data falling prominently.
Figure 3: Household employment versus Institutional Payrolls 2005-2024 (LIWM)
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Inverted yield curves typically foreshadow problems | |
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Yield curve inversions describe a situation where short-term interest rates are above long-term interest rates. They are one of the most reliable precursors to recession and stock market volatility. Today, we can compare 3-month T-bills of 5.3% yield with 10-year Treasuries of 4.3% yield to see that the yield curve is inverted by about 1% (5.3% - 4.3% = 1% inversion).
Usually, higher volatility readings are associated with lower stock market prices; similarly, low volatility is typically associated with higher stock prices. We've been living with low volatility for a couple of years now. One of the deliberate Federal Reserve policies of the 2010's was yield curve suppression and volatility suppression. That is not the case today.
If we look at long-term volatility trends and compare it to the yield curve shape 18 months prior, we can see that we are due for a significant rise in volatility. The traders of options may be aware of this, but it does not prevent them from very popular strategies that "sell" volatility.
In particular, the structured notes space is full of investments where the investor is selling volatility to collect a small bit of premium. It is likely these investments will do poorly if we have an ordinary recession in 2024 or 2025 and volatility rises.
Figure 4: Yield curve inversion versus volatility lagged by 18 months (LIWM)
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Hubris is on full display | |
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Magazine publishers can't help themselves. They must write about what people want to hear. This has led to an interesting behavioral finance phenomena where magazine covers provide precisely the wrong advice at a particular points in time, especially market extremes.
The classic example was the Business Week magazine cover of 1981 declaring "Stocks are dead!" Of course, in hindsight, that was a great time to buy.
Today, we see the opposite of despair; we see hubris. There is widespread belief that the markets can't go down and that anyone not involved and fully invested is a fool. Time will tell who is right.
Here are the illuminating covers of three recent magazines.
Figure 5: Recent magazine covers (The Economist and Barron's)
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Real estate continues to deteriorate | |
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The news in the commercial real estate space continues to get worse. Big city office buildings are getting sold at steep losses and there is fear that the banks will be hurt by commercial mortgage defaults. While some analysts say that the large banks are in good shape, all banks have exposure to one degree or another. The similarities to the Financial Crisis of 2008 are sobering.
While the inner city office space market has garnered the headlines, other real estate markets are starting to crack. This chart on multi-family mortgage defaults was interesting because the default rate has already exceeded that of the Financial Crisis. A defining feature of the 2008 crisis was the contagion effect, where issues in one sector spread to others.
Figure 6: Default rate on multi-family housing (Trahan Macro)
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We sound like a broken record: the leading indicators still warn of trouble; the lagging indicators like employment are starting to weaken. So far this year, the markets are focused on the economic strength, Federal stimulus spending and expected Fed rate cuts. Stock investors are drawing positive conclusions; bond investors are expecting a slowdown of some type.
It is our view that we are moving into a typical recession with a rising risk of a banking crisis due to defaults in the commercial property sector. The question we constantly ask ourselves is this: if the government policy is to bailout failed banks, does it even matter what the Fed does with interest rates? Is there any limit to the stimulus that will be created if times get difficult?
The answer to these questions cannot be answered right now, but will determine the trajectory of our nation's inflation, debt, growth and prosperity.
If you'd like to discuss any of our research, please feel free to reach out to us.
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Rob 281-402-8284
Chris 281-547-7542
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Christopher Lloyd, CFP ®
Vice President and Senior Wealth Planner
Lloyds Intrepid Wealth Management
1330 Lake Robbins Dr., Suite 560
The Woodlands, TX 77380
281-547-7542
Chris.Lloyd@lloydsintrepid.com
www.lloydsintrepid.com
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