Jerome Powell’s War
The most recent economic data and information points to a delicate situation for the markets. Despite assurances that the Fed would watch the data and adjust accordingly, it would appear we are headed to another rate hike next week.
The inspiration for this weeks' musings is the 2007 film, "Charlie Wilson's War." The film depicts the true story of a Texas congressman who helped the Afhgan army fight the invading Russians during the conflict in 1980s. The film did poorly in the U.S. on a $75 million budget, only grossing $66 million. The film garnered $53 million overseas to help it get into the black. While the film only implies such, it's evident that the arming and training of the Afhgans to fight the Russians would come to haunt the U.S. years later as it likely led to fanatics taking root in that country and, ultimately, the events of 9/11. Will this be the legacy of Fed Chairman Powell - the willingness to crush inflation at the cost of sparking a recession?
Here's what we've seen so far this week...
Saying One Thing, But Doing Nothing. As we pointed out last week, the Fed appears ready to raise rates once again next week and we can't understand why.
During the film, "Charlie Wilson's War," Charlie's benefactor, Joanne Herring, asks Charlie, "Why is Congress saying one thing and doing nothing?" Charlie answers, "Well, tradition mostly." First, that is a glaring truth. Second, the fact that our society jokes about such a truth is sad.
Third, it's indicative of the Fed. In this case, the Fed is busy saying inflation hasn't progressed and the banking crisis is not a concern, when reality tells us different. We've already stressed the decline in inflation over the past 9 consecutive months, but this week also showed that flows into money markets (considered a safe haven) increased and the use of the Fed's Discount Window and BFTP increased, as well.
This indicates that the banking crisis may not yet be fully over. Renewed concerns about First Republic also added to the stress this week. It's in this environment that the Fed wants to hike rates next week after 9 consecutive hikes already?! The Fed has stressed that inflation has only "moderated" and that "further sustained improvement" is needed. The Fed's own favorite inflation indicator, the PCE Price Index, showed only 0.1% increase this morning, lower than both expectations and last month's increase of 0.3%. In fact, the PCE Index has declined year-over-year in 7 of the last 10 months. Given the improvement in inflation and the fragility of the current banking situation, failing to act on new data and pause further rate hikes is at best ignorance - at worst willful stubbornness.
Recession or Expansion - We'll See. Near the end of the film, Charlie and his CIA workhorse, Gust Avrakatos, go out on the veranda at a party celebrating the Russians withdrawal from Afghanistan. They begin to contemplate the victory they have helped achieve. It's at this point that Gust warns Charlie that the victory may have come at a cost. Gust tells the following story:
"There's a little boy and on his 14th birthday he gets a horse... and everybody in the village says, "how wonderful. The boy got a horse" And the Zen master says, "we'll see." Two years later, the boy falls off the horse, breaks his leg, and everyone in the village says, "How terrible." And the Zen master says, "We'll see." Then, a war breaks out and all the young men have to go off and fight... except the boy can't cause his leg's all messed up. and everybody in the village says, "How wonderful."
The point is that thoughts and actions often have unintended consequences - sometimes they work out for the good and sometimes not. First quarter GDP came in much lower than expected. In fact, the Atlanta Fed adjusted their GDPNow estimate just hours before the official number was released. GDP grew in the 1st quarter +1.1%, which is lower than the previous week's estimate of +2.5%.
The good news, despite the lower-than-expected number is that personal consumption rose in the 1st quarter +3.7% compared to +1% in the 4th quarter. The primary reason for the lower GDP number was a decline in inventories as businesses reduce inventory bloat, probably the result of supply chain disorders from the previous year and lower-than-expected consumer spending coming out of the last bit of COVID restrictions last year.
Personal Savings increased last month to 5.1%, which is the highest in 15 months. This is likely the result of the banking crisis, causing consumers to be more careful and the slow decline in excess savings from COVID "free" money policies. This actually could be a good thing that consumers are being careful with their spending instead of loading up on debt. There is still an excess of savings in the U.S. economy that is likely to help fuel more expansion (if the Fed can get out of the way). The Chicago PMI reflected what we saw in the Global PMI last week - an increase in new orders. In fact, Chicago PMI came in higher than expected, the largest increase in the last 4 months, and close to a reading of 50, which equates to economic expansion.
Sell In May? There's an old moniker in the investing world that states, "Sell in May and go away." It means that summer months tend to be either lackluster or disappointing as investors go on holiday and aren't very engaged. The adage has led to some investors selling out of key positions to go to cash and staying uninvested for a few months until markets become interesting again. Considering my tenure and experience, I've had to dissuade investors from this kind thinking for the better part of two decades. The reality? Since 1985, the month of May has turned out to be positive 76% of the time, with a median return of +1.22%. The Nasdaq, typically a more volatile index, has provided positive results in May 68% of the time and has a median return north of 3%.
In truth, making investment decisions based on an Old Wives Tale or some investing guru's outdated moniker is not the best course of advice. Investors should work with a financial professional and develop a financial plan to be used as a backstop against knee-jerk reactions and poor investment decisions.
There are enough green shoots to go against the common narrative that a recession is imminent. As long as consumers have money in their pockets, jobs are available and prevalent, and inflation is on the decline, economic growth will result. It might not be robust growth, but growth nonetheless. Is the economy headed for recession - we'll see. Does this lowly analyst know what he's talking about - we'll see.
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