What’s Your Budget?

FIVE THINGS YOU SHOULD KNOW

1. Equity Markets – were lower this week with U.S. stocks (S&P 500) down -1.11% while international stocks (EAFE) fell -1.06%.
   
   
2. Fixed Income Markets – were lower with investment grade bonds (AGG) down -1.07% while high yield bonds (JNK) fell -1.49%.
   
   
3. 100 Days – Russia’s war on Ukraine surpasses 100 days of a grueling global campaign that is not slowing any time soon. Roughly 6.9 million people have fled Ukraine and an estimated 22,000 residents have been killed. The war has reached a critical point with Russian troops controlling 20% of the country and have “seized much of the industrial heartlands of Ukraine’s east and vast tracts of its fertile agricultural land”. Ukraine’s future now hangs in the balance, relying mostly on Western aid which is needed at $5 billion every moth to keep the economy and government from collapsing.
   
   
4. OPEC Ups Supply – OPEC+ announced this week a modest boost to supply (0.4% of global demand) for the summer months in hopes of easing currently tight oil markets. While the supply boost is lower than some had wanted, it does strike a positive note for U.S./OPEC relations going forward as the oil producers continue to navigate global pressures amidst the Russia/Ukraine conflict.
   
5. Key Insight – [VIDEO] This week we discuss the importance a defining “your budget” to find financial success. However, your budget is NOT just about spending, it’s just as much about the risk you can afford and the emotional/personal burden you can bear. [ARTICLE] We share some interesting info and graphics on the economy to help assess its health, as well as a great piece from Lord Abbett on those continuing recessionary fears.
   

NSIGHTS for INVESTORS

The stock market has predicted nine of the last five recessions. – Old quote/joke from famous Keynesian economist Paul Samuelson.

Intro

As we shared last week (click here) in a detailed look at the realities of recessions, while they are inevitable, they are not something investors need live in perpetual fear of. Two big reasons investors can take to heart are, 1) recessions are infrequent and usually short, and 2) with the right portfolio design they can be safely navigated.

We share the information below not to make a prediction around the next recession ourselves, which like trying to predict markets, has been shown to be a foolish endeavor, but rather to at least present another side to the overwhelmingly negative sentiment you’ve likely been bombarded with.

It is also noteworthy (take a close look at the last chart), that even if a recession were to be on the horizon the damage to markets may already have occurred in advance and thus there isn’t much to “trade” around that news.

Good News from the Economy

As we’ve explained in the past, when evaluating the market and economy it is more often about relative rates of change (which in many cases are not currently positive) as opposed to just absolute levels (which aren’t all that bad today). However, that truth must ALSO be applied while noting the context of market expectations which today are incredibly bearish/recessionary.

The numbers below are not as good as we’ve seen in the past few years which would normally be a problem, however in an environment with such negative expectations they are the reason the market appears to be finding a floor and they could be the catalyst to push higher in the months ahead. The fact that such a move would shock most market participants only adds to my “suspicions” that this may be the path forward.

From a commentator I respect, Lawrence Fuller came out with the following key developments to keep in mind regarding recent PMI data (a key metric to watch). He noted, “The latest survey of purchasing managers in the manufacturing and service sectors from S&P Global confirms that the slowdown is underway but still not falling below trend. The mid-month FLASH survey resulted in a decline in the index from a very strong 56.0 in April to 53.8 in May, which was a four-month low. Readings above 50.0 indicate expansion, and this one was still indicative of a healthy level of growth”. Chris Williamson, the Chief Business Economist at S&P Global, said that survey results, “…remain indicative of the economy growing at an annualized rate of 2%, which is also supporting stronger payroll growth” (see chart below).

Brian Wesbury commented on this week’s latest manufacturing data by saying, “The manufacturing sector continued to expand in May, and at a slightly faster pace, with fifteen of eighteen industries reporting growth. The best news in today's report was that the two most forward-looking indices, new orders and production, posted gains after two months in a row of declines. Moreover, both indices are above 50, signaling growth.”

1. As illustrated by the Flash PMIs, growth remained resilient in May, as lackluster manufacturing prints were offset by a strong service’s showing. The U.S. headline composite index came in at 53.8 (vs. 56.0 in April), the Eurozone at 54.9 (vs. 55.8), the U.K. at 51.8 (vs. 58.2) and Japan at 51.4 (vs. 51.1). Compared to April, the headline prints did cool a bit, but nonetheless remained expansionary.

In short, you can always cherry pick a data point to prove a point and the bears are finding some doozies these days to focus on, but a more honest look at the overall health is broad data points such as those above which suggest that while wounded, the economy is once again proving resilient and might even be beginning to show signs of renewed life.

Good News from Corporate America

While you may not know it from listening to many of their public pronouncements or earnings calls, where they are somewhat dour likely in an effort to set a low bar to clear from future earnings reports, their actions when it comes to their own portfolios suggest they are much more optimistic about the future than they are telling you.

A second insight from Lawrence Fuller called this out highlighting that, “…corporate insiders, who know a thing or two about the economy and their businesses, are scooping up shares of their own stocks like there is a fire sale. The data in the chart below comes from The Washington Service, and it shows insiders have not been this aggressive since the pandemic lows of 2020 and December of 2018” See accompanying chart below.

As the adage goes, watch what people do, not what they say.

To paraphrase It’s a Wonderful Life again, “Potter (corporate CEOs and insiders) isn’t selling, he’s (they’re) buying…”

Good News from History

Recency bias is one of the hardest things to overcome as an investor. When the market is dropping, it is natural to feel like it will never end, and with that type of a belief, of course people often conclude that they should bail out.

The reality, counterintuitive as it may seem, is that markets bottom on bad news, not the start of good news. A drop of 20% in markets, as the chart below, does not increase the odds of another 20% decline but rather decrease it.

As you can see below, after a 20% decline the more common path forward is higher, not lower. And while each timeframe is positive, it’s the one-year average that is really staggering with an average return of 24%.

Will such history play out again? Of course, no one knows for sure. But addressing perhaps the greatest obstacle to such a turnaround (a recession), Goldman Sachs stated that, “Even if (a recession) were to occur, we would expect it to be technical in nature, not cyclical. Financial imbalances, a key driver of recent recessions, are broadly absent today. The private sector—the banking system, businesses, and consumers—is well-positioned to absorb a more challenging growth and inflation mix given sustained balance sheet strength and excess liquidity, lessening potential effects in a downturn. Consequently, any drag on growth would likely be modest.”

I’ve included another great article on the topic of a pending recession below that is worth a read as well.

Have a great weekend,



Tim and the team at TEN Capital
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Recession Risk: A Reality Check for Investors

Souring sentiment among investors and consumers suggests growing pessimism about the U.S. economy. But that perception appears to be at odds with current fundamentals.

By Timonty Paulson, Investment Strategist Lord Abbett Funds

Gloom seems to be the order of the day. U.S. consumer sentiment surveys have fallen to levels not seen in a decade, while market uncertainty and investor bearishness continue to grow amid renewed volatility. The primary culprit is inflation, which has accelerated to the highest levels in four decades. To some degree, this negative outlook makes sense; inflation is an historically destabilizing market and societal force, and emergence from the COVID-19 pandemic is riddled with uncertainty.
The U.S. Federal Reserve (Fed), historically viewed as supportive of markets during past selloffs via the so-called “Fed put,”¹ will not be bringing out the monetary punch bowl this time around. To counter inflation, the Fed is hiking rates at its fastest pace in decades and appears to be far less likely to stabilize market stress than in years past. All the while, a steady drumbeat of negative headlines from around the world can keep even the most optimistic observers on edge. But does the extent of the negative sentiment match the facts on the ground?

Right now, measures of the mood among U.S. consumers and investors are near the lowest levels since the global financial crisis (GFC) of 2008–09—levels seen only rarely in prior decades. The University of Michigan Consumer Sentiment Index, which aggregates a range of consumer views on finances, outlook, and general business conditions, dropped below a level of 60 this spring for only the fourth time since its inception in 1978. (See Figure 1.) The other episodes corresponded with the Iran hostage crisis and late-stage stagflation of 1979-80, the global financial crisis in 2008, and a sharp but brief drop in 2011 when S&P downgraded U.S. Treasury debt.

Does extremely negative sentiment tell us anything useful in terms of predicting market or economic activity? Prior episodes would suggest not, and that negative sentiment is primarily a function of short-term consumer experience. Among other factors, declining consumer sentiment is highly correlated with rising gas prices, as Figure 1 indicates. While it may affect consumption patterns (negative sentiment may make consumers less likely to spend money in the short term), this downshift in sentiment does not necessarily portend any meaningful behavioral changes.

Figure 1. Souring Consumer Sentiment and Soaring Gas Prices Go Hand-in-Hand
University of Michigan consumer sentiment index and average U.S. price for unleaded gasoline, January 2000-May 2022 (through May 19)

Similarly, negative market sentiment does not typically predict market declines; indeed, it is often best seen as a contrary indicator, because it typically means that investors have already adopted bearish positioning and may have already priced in the bulk of anticipated negative developments. Figure 2 shows that investor sentiment, like the mood of the consumer, has turned quite dour; only twice since the Reagan era have investors been this bearish.

Figure 2. U.S. Investor Sentiment Has Turned Markedly Bearish
American Association of Individual Investors bull/bear sentiment ratio, July 24, 1987–May 19, 2022

Source: American Association of Individual Investors and Bloomberg. Data as of 05/19/2022. For illustrative purposes only.

So consumers are extremely negative, and markets have once-in-a-decade bearish positioning. Is all of this justified? As is often the case, perception doesn’t always match reality. For example, leisure travel, often seen as the most discretionary of expenditures, is flourishing. Recent data from the U.S. consumer price index report have shown a marked increase in airfares and hotel room rates, and although there is some grumbling from travelers, rooms are scarce, and planes are packed. U.S. retail spending data released May 17 showed a fourth straight month of increases in outpacing inflation, with notable gains in other discretionary spending categories such as restaurants and bars, and furniture and clothing, even as households cut spending on gasoline. That is, although consumers are unhappy with rising prices, they are continuing to spend, as Figure 3 shows.


Figure 3. Despite Weak Sentiment Measures, U.S. Consumer Spending Powers Ahead
Retail trade and food services component of U.S. retail sales data, January 2007–March 2022

Source: U.S. Federal Reserve Bank of St. Louis FRED database. Data (monthly) as of March 31, 2022 (latest quarterly). For illustrative purposes only.

Moreover, one of the major influences on U.S. households’ perception of their financial strength, and a key pillar of consumer confidence, is the health of the labor market. When jobs are plentiful, consumers tend to continue to spend, and generally feel better about the world. Yet despite the dismal confidence and market positioning data, jobs are not only plentiful, but they have also never been more available, with nearly two job openings for every job seeker. (See Figure 4.) We believe there is ample room for labor markets to soften, yet remain at historically tight levels, with very favorable conditions for job seekers.

Figure 4. Help Really Wanted: Ratio of Job Openings to Seekers Near All-Time High
Data for the period January 1975–February 2022

Source: U.S. Bureau of Labor Statistics. Data as of February 28, 2022 (monthly; latest available). For illustrative purposes only.

As we noted before, inflation is a fundamentally destabilizing phenomenon, one that most people in the U.S. have not really experienced. Add other sentiment-sapping factors such as an uncertain COVID-19 recovery, geopolitical conflict, low confidence in political leaders and institutions, and the widely hyped headwind of Fed hikes, and it is easy to see why investors and consumers are demoralized. More generally, the future seems unusually murky, and no crystal ball can tell us what shape the economy will take in several years. How long might inflationary pressures remain? What impact might Fed hikes have on imbalanced parts of the U.S. economy—a “soft landing” or a recessionary jolt? Questions are numerous, and answers are elusive. During periods of uncertainty and negative sentiment, markets tend to price in the worst-case scenario.

But does the current data argue the case for the “worst”? Not really. Robust consumer spending, broad strength in corporate earnings (despite the attention given to a handful or high-profile misses, earnings are still historically strong, with 77% of companies beating estimates in the most recent batch of earnings reports), and the tightest labor market in history do not support the extraordinarily bearish tilt seen in market surveys and price action. Meanwhile, negative sentiment and bearish positioning generally mean there is substantial room to improve. The Fed’s attempt to slow economic activity has commenced during a period of strength, suggesting a decent cushion for the economy as policy moves take hold. As uncertain as everything feels, we know that at some point, the gap between perception and reality will close; investors may find that the worst-case scenario was just that—a scenario—and that the solid fundamentals we mentioned earlier will provide support for the economy and the markets going forward.

DATA, JUST THE DATA

Data points this week included:

• U.S. Jobless Claims – declined by 11K to a claimant count of 200K for the week ending May 28^th. This was slightly below market forecasts of 20K. The four-week moving average has decreased 500 for the week, down to 206.5K.
  
  
• U.S. Jobs Added – the United States economy added 390K jobs for the month of May – the least since April of last year, but more than the forecasted report of 325K. Job gains could be seen in the leisure and hospitality market with 84K, professional and business services at 75K, and transportation and warehousing with 47K. The economy is left 822K, or 0.5% jobs below pre-pandemic levels and the unemployment rate remains at 3.6%.
  
  
• U.S. Consumer Sentiment – the Univ. of Michigan consumer sentiment reading fell to 58.4 in May, marking the lowest since Summer 2011. Buying conditions of homes, durables, and the overall outlook for the economy moving forward (due to inflation) has sentiment at decade low. Personal finance and future business condition sentiment stands at a better level at 63.3.
  
  
• U.S. ISM Manufacturing Index – slightly rose for May 2022, to 56.1 – this was above market predictions of a decline to 54.5. new orders, production and inventories are climbed to 55.1, 54.2, and 55.9, respectively. Both prices and employment contracted to 82,2 and 49.6, respectively.
  
  
• U.K. PMI Manufacturing – fell to 54.6 in May after a reading of 55.8 the month previous. This marks the slowest factory activity since January 2021. Weaker domestic demand, lower exports, and ongoing supply chain disruptions were all factors to the decline of manufacturing. The war in Ukraine, China lockdowns and fluctuating exchange rates also drove up purchasing costs and selling prices rose near record highs.
  
  
• Eurozone Retail Sales – decreased (1.3%) MoM in April, which is the first contraction in 2022 and in contrast to a forecasted 0.3% increase. Food, drink, and tobacco sales fell (2.6%), but auto fuel spending increased 1.9%. Amongst the bloc, Germany’s sales fell (5.4%), but YoY sales are up 3.9% in the Zone.