Things often seem better at the time than they do in the rearview mirror. I'll bet Fed Chairman Powell is thinking that right about now.
It reminds me of the famous Beatles song, "Yesterday." While the Beatles' songs were primarily written by Paul McCartney and John Lennon together, by 1965, their songs were written by one or the other. McCartney wrote the music to the song "Yesterday" after waking up from a dream. He immediately played the song so he wouldn't forget it. Then, while on a five-hour car trip from Lisbon, Portugal to Albufeira, he penned the lyrics. Trivia - his original working title for the song was "Scrambled Eggs." I'm not sure the song would have been as big of a hit under that working title, but it might have worked just as easily for this week's Market Musings. The song, after finally being released in 1965, was a massive hit across a mass swath of the adult market. The song was #1 on multiple international charts, including the US Billboard charts. However, the band thought the song was so different from their other works that they decided not to release the song as a single in the U.K.
"Yesterday, all my troubles seemed so far away
Now it looks as though they're here to stay
Oh, I believe in yesterday
Suddenly, I'm not half the man I used to be
There's a shadow hanging over me
Oh, yesterday came suddenly
Why she had to go
I don't know, she wouldn't say
I said something wrong
Now I long for yesterday"
Here's what we're seeing so far this week...
Yesterday, All My Troubles Seemed So Far Away. Last week, Fed Chairman Powell was singing a hawkish tone on any kind of Fed Pivot. Thursday's Consumer Price Index
report for October might have him considering changing his tune. For the month, CPI rose only 0.4% in October, which was lower than the expected +0.6%. More importantly, the year-over-year number for CPI came in at 7.7%, which is a 0.5% decline from +8.2% in September and it's the 4th consecutive month of declines. In fact, October's year-over-year decline is the largest since July and Inflation is now the lowest since January. From the peak in June of this year, the year-over-year CPI has dropped 1.4%.
Since 1948, when the CPI has dropped by that much or more, the year-over-year number was lower 6 months later by 1.3% on average. I think we can now safely say Inflation has peaked and will be headed lower. Two Fed Presidents - Harker (Philadelphia) and Logan (Dallas) - both provided a dovish response to the CPI print on Thursday morning. Both indicated a "slowing" to the pace of rate increases. To their point, the implied futures for December's Fed Rate hike plummeted from 43% probability of 75 bps to only a 19% probability, and the probability of a 50 bps hike jumped from 57% to 81%. So, Mr. Powell may find it difficult getting the troops in-line with a more aggressive stance toward future rate hikes. This has helped drive equity prices higher since the CPI surprise.
Is the worst of inflation over? That's a little more up in the air. While it's clear that Goods, Food, & Energy have declined on a year-over-year basis, the fourth component to CPI - Services - has not followed suit. This is the one element that is of concern going forward.
While CPI components Food & Energy have declined over the past few months, Services has increased for the past 14 consecutive months. Conversely, Food has declined for 2 consecutive months and Energy has declined for 4 consecutive months. If you have been out at a restaurant or hired someone to do work on your plumbing, you've noticed costs for those services are higher. Many businesses that have had to re-staff or recover losses from COVID are now doing so by using the rise in inflation over the past two years as a reason to recoup costs. From their standpoint you can't blame them. However, just like COVID was an excuse for not getting services or products in a timely manner last year, now inflation has become an excuse this year for costs remaining higher for longer. We will have to wait and see how that element of inflation persists.
There's A Shadow Hanging Over Me. While we've come through an economic slowdown earlier this year and emerged on the other side, there's still plenty of uncertainty looming overhead. As we move into the holiday season, the consumer is now the most important contributor to economic growth that we need to watch.
According to Deloitte, holiday sales are expected to increase between 4% and 6% this year. If we compare that to 2021, total holiday sales increased 16.1%, year-over-year (the largest increase in 20 years). If we look at the 2022 projection, the holiday sales growth looks paltry. However, if we take into account the rise in inflation and the "technical recession" we experienced the 1st half of this year, 4-6% growth would be solid. For some perspective, U.S. holiday sales last year totaled $1.22 trillion. If we were to get 4-6% growth on that number, we're talking about a a considerable driver of U.S. GDP (as a reminder, the consumer comprises 2/3 of GDP). Currently, the Atlanta Fed is projecting 4th quarter GDP to come in at +4.0%. In that forecast, personal consumption was revised higher for Q4 from 4.0% to 4.2%.
All that being said, we did see a drop in Consumer Credit in October. From one standpoint, that's good news as it may mean that people are not using credit to finance higher inflation costs.
Yet, from another standpoint, it may mean consumers are too stretched and have begun pinching pennies. It will be interesting to see how the holiday sales numbers come in to determine if consumers are slowing down or holding their own. Next week, we'll get the October report on Retail Sales, which is expected to show 0.8% growth versus a flat 0.0% number in September.
However, this won't provide us with much information to determine how the consumer is spending for the holidays. We will be watching the Redbook year-over-year numbers, which come out weekly, to see if we can identify a trend. For example, last year's gaudy holiday sales were reflected in December's Redbook numbers. Prior to 2021, December Redbook Sales averaged +6.4%, compared to +17.3% in 2021. November Redbook Sales averaged +4.6% prior to 2021, compared to last year's number of +16.9%. So far, and it's early, November Redbook Sales this year are averaging +8.6%, which is above trend compared to the same time period in 2018-2020. We'll see what the rest of the quarter holds for the consumer.
Now I Long For Yesterday. As we've pointed out the last two weeks, historically, markets have fared well after Mid-term Elections. Markets are off to a good start so far. (pic) While the uncertainty of the outcome of the election was hanging over markets on Wednesday, Thursday's return was all about the prospect of a Fed Pivot and the falling inflation number. Since Tuesday's close (Election Day), the S&P 500 Index is up 3.5%.
The other index we've been focused on recently, SKEW, was down 3% on Thursday and is still trading near 3.5yr lows. This indicates that outsized returns toward the downside may be less likely here in the short-term.
The S&P is now only 126 points (3.2%) away from crossing the 200-day Moving Average - a mark the index has not seen since March. The next level of the index to watch after that is the August 16th high of 4,325. If that is surpassed, equities might have some room to run. As we stand today, there are a few scenarios that could play out, but I'll just highlight two main outcomes. If we assume a bullish scenario, it would likely mean that the Fed has pivoted/paused/slowed rate increases, the consumer remains strong or stable, and companies have not had to announce considerable layoffs. If we assume a bearish scenario, it would likely mean the Fed has maintained a hawkish stance and continues raising rates into March of next year, the consumer falters due to higher interest rates and job losses, and companies are stretched too thin on costs and have to cut labor. These are the key areas to watch as we head into year-end.
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