FIVE THINGS YOU SHOULD KNOW
INSIGHTS for INVESTORS
The big news this week was the release of first quarter GDP data, which came in at 1.1%. The market has used this data point, along with some recent comments by various Fed governors, to fuel a rally based on the belief that a pivot in Fed policy will occur sooner rather than later.
I think the real issue at this point has less to do with whether there will be a policy shift, and is more about how quickly the economy is slowing and whether such a shift will be “too little too late.” As Daryl Jones of Hedgeye noted this week, “looking at the numbers we had a major deceleration in GDP. Now this is the QoQ SAAR but it was 2.6% in 4Q to 1.1% in 1Q. That's a pretty significant slowdown. The other thing that's interesting is the Atlanta Fed cut their GDP Nowcast meaningfully.”
This recent drop in GDP, coupled with data like this week’s US Consumer Confidence report falling to 101.3 from 104.0 month over month would seem to suggest the Fed may have gone too far already. The team at Bespoke highlighted that “the FOMC appears almost certain to hike rates another 25 basis points (bps) next week, even as risks of a recession increase, the spread between short and long-term US Treasuries yields continues to widen. As of yesterday’s close, the 10-year vs. 3-month yield curve, the Federal Reserve’s preferred measure of the yield curve as an indicator of a recession, was inverted by 164 bps, which is the most extreme reading since the early 1980s. Every other time in the last 60 years that it inverted by as much or more, the economy was either right on the cusp of or already in a recession.”
And while some feel compelled to “make a call” on all of the above, we don’t—especially when there are currently plenty of solid options that can both help protect against volatility while providing generous cash flows in the meantime.
Predictions are not a plan, but neither is panicking.
Take that time and energy and know your path through whatever may lie ahead. As Brian Wesbury
, discussed below there will be a time before long to get “greedy” but it’s likely not now.
For those of you here at TEN, we began preparations months ago, so get out and enjoy your sunny weekend! If you’re not yet a client, we are here to chat anytime.
Have a wonderful weekend,
Tim and the team at TEN Capital
Closer to a Turning Point
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
In spite of weakness in some economic data, problems in the banking sector, and much higher interest rates, real GDP in the first quarter will almost certainly show moderate growth. Meanwhile, the S&P 500 is 15% higher than its low point in October 2022. And, now, many are starting to believe that a recession isn’t going to happen.
But we still think a recession is coming. Ultimately, recessions are about mistakes. In particular, there’s too much investment broadly throughout the economy or in some important segment of the economy, like technology back in 2001 or housing several years later. Once businesses realize they made a mistake – that the return on their investment will be too low – they ratchet back economic activity to bring the capital stock back into line with economic fundamentals.
Almost always, it is government policy mistakes that cause this over-investment (or “malinvestment”). Then, when imbalances become too great, and policymakers change course after realizing their prior mistakes, the economy contracts and a recession becomes nearly inevitable.
Sound familiar? We think so. The Fed opened the monetary spigot in 2020-21 while Congress and two different presidents passed out enormous checks to try to smooth over the damage done to the economy by COVID Lockdowns. Inflation has been the result. Now both fiscal and monetary policy have turned tighter. The unprecedented nature of policies during the COVID Era makes the timing of a contraction in activity difficult to predict, but, in our opinion, this contraction is almost certain.
If anything, the notion among some businesses and investors that recession risk is declining may, by itself, contribute to greater risk, as it’s also consistent with less of a pullback in investment. It means businesses are not as widely coming to terms with past mistakes, which, in turn, means more problems ahead.
This is why we think no one should get excited about a positive first quarter GDP report. As always, it tells us where the economy has been recently, not where it is going. The economy grew 2.9% in 2000; we had a recession in 2001. And, real GDP grew 2.4% in the year ending in mid-1990, right before a recession.
Most importantly, recent data show some early signs of weakness. Jobless claims have risen. Manufacturing production in March was lower than a year ago. Real (inflation-adjusted) retail sales are down from a year ago.
In addition, keep in mind that the Fed used policy measures (like insuring more deposits) in the wake of the banking problems in March in order to prevent any widespread crisis in the financial system. In turn, that makes the likely path for short-term interest rates, for at least the next several months, higher than most investors anticipate.
We think the futures market is correct in anticipating another 25 basis point hike in May, just like we had in February and March. But the markets are not as prepared for another rate hike in June, which we think is more likely than not. Inflation remains a problem and the April inflation print, arriving May 10, should confirm that problem. The federal funds futures market expects the Fed to end the year with short-term rates lower than they are today; we think they end up higher than today at year-end, instead.
Where does that leave equity investors? We understand the desire for optimism, but our model still says equities are overvalued. There will come a time to get bullish, but that’ll be after the recession starts, not before.
DATA, JUST THE DATA
Data points this week included: