The Weekly Random Walk – September 4, 2023 From Stephen Colavito
An Aggregation of Various Economic, Market Research, and Data
Hammer and Nail
Most of you already know the hammer analogy. It’s the law of the instrument or, in this case, the hammer. This analogy was highlighted in a paper by Abraham Maslow, who described this law as a cognitive bias involving over-reliance on a familiar tool. Maslow wrote in 1966, “If the only tool you have is a hammer, it is tempting to treat everything as if it were a nail.”
Since Fed Funds and the Fed’s ability to (somewhat) control monetary policy is often referred to as “a blunt monetary instrument,” this week, we are going to continue to look at data that may indicate that the economy (and consumers) is starting to look like a nail. But with a confusing mix of data, can they stop hammering?
“If I had a hammer, I would hammer in the morning…”
The move higher in long-term interest rates that began in late July has brought financial conditions close to their 2023 highs. This was cited by some regional Fed Presidents at Jackson Hole last week as a factor that could counter some of the recent better-than-expected consumer spending data. Since those comments, rates have rallied, and conditions have eased slightly.
“I would hammer in the evening, all over this land!”
Multi-decade highs in mortgage rates and “trapped” borrowers who have low-interest coupons (and don’t have the additional cash flow) have put pressure on active home listings. According to Redfin (source of the chart below), active listings fell 3.9% month-over-month (MOM) in July to the lowest level on record. Even with season adjustments, home listings are down almost 20% from a year earlier. However, home prices have remained high despite sluggish demand because of a lack of inventory. The middle class (who by percentage is the grassroot buyers of homes in the US) is having to compete with a small pool of properties, the ultra-wealthy, and corporations (who are buying homes for rental).
Nails can cause cracks if you hammer too hard.
A year ago, Chairman Powell said, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate cost of reducing inflation. But a failure to restore price stability would mean far greater pain.” August 26, 2022.
A year later, several retailers have reported weaker-than-expected second-quarter earnings. What caught our eye this week was the quarter from Dollar General. The discount retailer faces its first annual decline and lowered its profit forecast for the second quarter in a row amid “softer sales trends.” This points to cracks in low/mid-tier consumers who rely on these types of retailers (Walmart is another example). As with many retailers, softer sales and expected inventory shrink (theft) are forcing many companies in the retail space to revise their 2023 outlook.
With Covid cash evaporated, inflation taking away discretionary spending, personal savings drained, record highs in credit card debt (leverage), and the lack of safety nets for lower and middle America. Even Vice President Harris admitted in a discussion on reproductive rights, “Most Americans are a $400 unexpected expense away from bankruptcy.”
WWE
We are unsure if Chairman Powell made his best impression of Randy “Macho Man” Savage when he predicted, “Here comes the pain!” However, looking at the data above, it’s easy to believe he has been proven right in his prediction, as lower and middle-class consumers feel the pinch of higher rates.
The Fed's general thesis has always been that higher rates' pain is better than inflation's longer-term pain. However, Fed officials will likely keep a firm grip on their hammer after their favorite indicator jumped higher in July (as we predicted several weeks ago). The Core PCE deflator rose 4.2% year-over-year (YOY), and the Headline PCE jumped 3.3% YOY, the most significant jump in YOY prints since June 2022.
These numbers on top of the Services Inflation Indicator (ex-shelter) show that inflation continues to be sticky and much higher than the Fed’s target of two percent.
The Fed has difficulty pinning inflation to the mat like a WWE wrestler.
WWE – Part 2, 3 and 4
This is where things get tricky. Here are three data points that make the Fed's job (and my job in trying to read their direction) hard.
Apartment List national rent report recently came out, and (unlike active housing listing), there is some (bad news is) good news here. Vacancy rates are increasing, helping the national average on rents, which has started to decline. As of August, rents decreased by 1.2% for the month, the first time since the pandemic that rents have fallen. One month does not make a trend, but it may mean the rental market is starting to soften.
So, score one data point for potentially lower inflation.
As predicted, oil prices continue to climb, and now WTI is $85.48. One of the reasons the Core PCE deflator increased in July was a bump in oil prices (which affects transportation costs across various sectors). Despite the administration's claims of victory at the gas pump, consumers' prices have increased 23% year-to-date (up over 80% since President Biden took office).
Cuts from OPEC+ led by Saudi Arabia on oil production and lack of domestic drilling are the most significant components of gas prices in the US. Also, lower-than-usual inventories and refinery outages (partly due to regulatory blocks by the administration) have put upward pressure on prices.
We admit we have been critical of the administration and the Energy Secretary for their policies since they have come into office. So, it was nice to see that this week, the administration started refilling the SPR (at a glacial pace, but at least it’s something) at prices that will cost the taxpayer much more money.
This creates inflationary pressure, so the score is tied 1 – 1.
Lastly, we are sure Fed officials gave high-fives on Friday when the US economy added 187,000 jobs in August. This makes the third consecutive month that job gains have fallen below the 200,000 threshold, indicating a gradual easing in the labor market. Sectors that gained jobs were healthcare (+71,000) and leisure and hospitality (+40,000). The two areas that lost a lot of jobs were trucking (-34,000 with the bankruptcy of Yellow Freight) and motion pictures (-15,000) due to the job strike by writers and actors.
The U3 rate (unemployment rate) went to 3.80%, up from 3.50% last month. This is bad news is good news, or “we are flying off the top rope and coming in with an elbow to workers to get wage inflation to go down” (my words, not the Feds).
Inflation lower adds one to that data point; now it’s 2 to 1.
As younger people generally text…WTH? What do we do with these mixed data points?
Construction Zone – Hard Hats Required
This is a no-pulling punches bullet point(s) this week.
The BRICS bloc met for its annual leaders summit in Johannesburg, South Africa, last week, in which new members included Egypt, Ethiopia, Iran, Saudi Arabia, United Arab Emirates, and Argentina. There are over 80+ nations in or applying for membership in this economic group. Although the amount of currency through their system is only about 4% of the world exchange, they continue to gain momentum. We believe a multipolar reality is less than ten years away. This will dramatically affect our currency and economy; those who ignore this group will leave the US and the West weaker for their arrogance.
After a brief rest a few weeks ago, money markets added 14.4 billion dollars to reach a record high of 5.5 trillion dollars last week. Retail funds saw inflows for the 19th straight month (3.5 billion), and institutional funds returned to inflows (10.9 billion). The victim of the flows was bank deposits, which continue to struggle to keep money in their doors. So, with money going out of banks, the Fed’s emergency funding facility continues to climb as banks are using the collateral to get additional dollars.
Another day, another retailer closes shop in San Francisco. This time, Nordstrom is closing their doors at the Westfield location. The retailer blamed the closure on decreased sales revenue and “changing dynamics” in the area. However, employees interviewed by ABC7 News blamed it directly on the rampant crime in the area.
Over the last few months, more mothers have been participating in the workforce than since 1948, when the Labor Department began tracking the data (good news). In July, 75% of mothers participated in the workforce, only slightly higher than the 74% rate at the start of 2020. Once the pandemic began, that number dropped to 70.5%. Still, now that personal savings rates are down and inflation is up, it is becoming harder for couples with a median wage to make ends meet, forcing participation (bad news).
As the West continues to move away from fossil-based fuels, a recent report by S&P shows that China continues to tighten its grip in the critical minerals space and now has the majority of lithium mines in the world. Even though more restrictive foreign investment has blocked China from acquiring more lithium (e.g., Australia), countries in other areas are doing joint partnerships and helping the Chinese continue acquiring this precious resource.
· Lastly, nothing has changed as far as our market expectations over the month of September. We would love to see the S&P move across the 4600 level (current resistance) but don’t see the catalysts to propel that move higher. We believe a trading range is more likely as we continue to get (conflicting) data. We could see a breakout in November because we believe if the Fed raises rates, that would most likely be the last time.
Monday is Labor Day. I hope everyone enjoys the last few days of summer.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
stephen.colavito@sanblas-advisory.com
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