In honor of Aaron Judge hitting his 61st home run of the season this week, I thought I'd play on the baseball theme for this week's musings. Markets are down, but not exactly functioning as expected. The current economic environment, while not great, is showing some signs of improvement.
The larger shadow hanging over the market is the Fed. The Fed updated their projections last week, which stands in stark contrast to the Dot-Plot for future rate hikes. Investors seem to be at a fever pitch for some logic and reasoning from the Fed. Speaking of, the baseball movie "Fever Pitch" was released in 2005 after the Boston Red Sox had won the World Series the previous year (don't think the irony of celebrating a Yankees player's defining moment with a movie about the Red Sox has escaped me). The movie was a product of the Farrelly Brothers (of "Dumb and Dumber" & "There's Something About Mary" fame) and was moderately successful at the box office. The budget for the movie was $30 million and it grossed just over $50 million. The movie tracks the ups-and-downs of a young couple's romance with the historic season of the Red Sox in the background. So many one-liners and comedic truths about the game of baseball make this one of my favorite comedies.
Here's what we're seeing so far this week...
You Know What's Really Great About Baseball? You Can't Fake It. As the two main characters of "Fever Pitch" are getting to know one another, Ben tells Lindsey why he loves baseball so much. "You can either hit a curveball your you can't. That's the way it works," says Ben. (Note: given the "Steroid Era" of the late '90s, apparently you can fake it.) You can either manage inflation or you can't.
Don't tell that to Jerome Powell, current Fed Chairman. The Fed missed managing inflation as it was skyrocketing in 2021. They are not about to let it get out of control now, even to the point of worsening the recession. However, inflation appears to have potentially peaked as gas prices have come considerably since early June. In September alone, the average price of gas declined another 2%, which is likely to have an effect on September's CPI report.
In fact, every time the PPI (Producer Price Index) peaks and subsequently falls below the CPI (Consumer Price Index), overall inflation drops. On average, since 1951, it has taken 5.6 months for PPI to drop below CPI once PPI has peaked. If September's PPI report is lower on a year-over-year basis, and has indeed dropped below CPI, we will be right on track with the historical average.
Only 3 times (highlighted in red in the table to the right) has CPI not been lower 6 months later and only 4 times has CPI not been lower 12 months later. If CPI & PPI have peaked, the question remains, why would the Fed need to continue raising the Fed Funds Rate to combat inflation? In fact, the Fed just last week adjusted their growth projections for 2022 lower. If growth is expected to drop, why the need to continue battling inflation? As a reminder, inflation = growth; deflation = lack of growth. And yet, even the average consumer expects inflation to decline over the next year. Has the Fed gone too far in trying to overcompensate for its failures in 2021?
This Is Not Your Grandmother's Recession. A funny point in the movie "Fever Pitch" happens when Ben is willing to sell his primo Red Sox tickets (for a lot of money) so that he can prove to Lindsey that he cares about her. She refuses to let him do this and has to run onto the field during a playoff game to stop Ben from selling his tickets.
As she reaches him and the Cops are about to arrest her, he stops and says, "You gotta tell me, wait: the outfield - the grass, is it spongy." She has to chide him as she says, "Ben, focus!" Sometimes we need to hear that - as we look around at all the shiny data points and fail to see the bigger picture. The recession has been slight so far. While GDP was -1.6% for Q2 and -0.6% for Q2, the latest estimates for Q3 show positive 0.3% (inflation-adjusted). That could mark one of the slightest recessions in history (if the Fed can manage to adjust their hawkish stance). So the question remains, why has the recession (to this point) been so slight?
The U.S. consumer for one reason. In the recently revised GDP number this week, Real Consumer Spending (adjusted for inflation) came in revised upward. While Personal Income was flat for August, Personal Spending increased 0.4% after declining in July. So far, inflation and interest rates have not caused spending to drop off a cliff. Another reason has been the job market. COVID destroyed so many jobs that several key industries have not had to layoff people, but yet, are still looking for employees. In the lasted JOLTs Job Openings Report earlier this month, transportation, warehousing, entertainment, and recreation continue to post more job openings. In addition, more people have begun to take on a 2nd job to deal with the effects of inflation. And, unlike in most recessions, layoffs have not been systemic as both Weekly Jobless Claims and Continuing Claims have reversed Summer trends have have dropped significantly over the past two months.
Where Do We Go From Here? Many of you could be wondering when should we adjust our portfolios? A funny scene from "Fever Pitch" involves the first time Lindsey's friends get to meet Ben.
We've all been there when the friends want to meet the person you're dating. As soon as Ben walks into the party he says, "Ok, let's start the interrogation." So, let's get into why markets have behaved strangely and what can we expect for the 4th quarter. First, though markets are down, there have not been massive equity outflows like we have seen in previous Bear Markets. In fact, the outflows from U.S. equities hasn't even been on the same magnitude as the Taper Tantrum of 2013 or the Summer of 2015.
Second, the Wealth Protection Signal, while a little elevated at times, has not exploded higher as in previous Bear Markets (see last week's Blog post for more on that). From a technical standpoint, the S&P 500 Index has had the opportunity to close below the June 17th low of 3,636 for the past 5 trading days. The Index has flirted with that number today, so we'll see how markets close out the quarter. It's certainly possible we could head lower from here, but until the Index closes below the June 17th low, markets could still remain range-bound in relation to the March 29th high. Finally, many will speak about October potentially being a "disaster" month. October is the month commonly associated with "Black Monday" and "The Great Depression." However, September is actually the worst month of the year for the S&P 500. Since 1928, The S&P 500 Index has averaged -1% for the month. The median return for the other months of the year is positive - including October. In fact, statistically speaking, October's return would be significantly higher if we were to remove Black Monday and the start of the Great Depression. It could be argued that Mid-term Elections could play havoc on the markets. That is certainly possible. However, the market doesn't like uncertainty. Since the numbers do not point to any uncertain expectations for the Congressional makeup for 2023, unless things change dramatically, Mid-terms may not have the same dampening effect on markets that they typically have. All of this is to say, investors should keep risk tolerance in perspective and not make any hasty or drastic decisions.
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