Morning Briefings
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More On The Carry Trade, The Eurozone & Earnings
While carry traders likely have more yen-funded positions to unwind, we’re not worried about another bout of extreme market volatility as a result. We don’t see the conditions that sparked the great unwinding exacerbating, Eric explains. The Bank of Japan is unlikely to tighten dramatically with the yen’s recent strength helping to tame inflation there. The yen is unlikely to rise dramatically more, tethered by tamer inflation in Japan and strong economic growth in the US. … Also: Melissa reviews the Eurozone’s daunting economic challenges. … And: Joe gives us an overview of the strong Q3 earnings that analysts are forecasting for the S&P 500, the Magnificent-7, and the “S&P 493.”
On The Labor Market & Productivity
Yes, the unemployment rate has inched up over the past year. No, that doesn’t reflect a weakening of the economy at large. Permanent layoffs are muted; wages are rising; CEOs plan to hire. No unemployment spike heralding a recession is likely. Fed officials Waller and Williams agree, so we expect interest-rate cutting to be shallow and at a measured pace. … Revised Q2 economic output suggests an impressive rate of productivity growth last quarter, boding well for corporate profit margins and the no-recession scenario.
Another Growth Scare
The latest batch of labor market indicators has caused a temporary “growth scare,” in our opinion. Concerns that economic growth is slowing have convinced the markets that the Fed will open up the easing spigots and cut the federal funds rate by more than we expect. … Previous peaks in the yield-curve spread suggest that the bond yield is close to bottoming. … There were bright spots in the employment report too: The payroll and household surveys weren’t all that bad. … And: Dr. Ed reviews “Reagan” with one star for the movie but three stars for the man.
Retailers, Markets & AI
Why did the managements of Walmart and Dollar General paint vastly different pictures of low-income consumers in recent Q2 earnings calls? Jackie explores the differences in the two companies’ business models and operating landscapes that account for their divergent Q2 results and impressions of consumer spending behavior. … Also: a look at which S&P 500 industries and sectors shifted into and out of market leadership positions during the summer’s rebound. … And: Wall Street firms are implementing AI initiatives fast and furiously. The operating efficiencies that result could mean that recent finance grads with sights set on the Street need a Plan B.
GDP Vs GDI Debate; Mexico’s Failing Democracy
If you’ve heard that Gross Domestic Income is a better measure of economic activity than Gross Domestic Product, forget it. The two are sending divergent signals currently, with the former much weaker than the latter; but GDP is the one we trust the most currently. Eric explains why. … The US economy has become less interest-rate sensitive than it’s been in the past, so another thing to forget about are the “long and variable lags” before the economy reacts to the latest round of tightening. They’re not coming. … Also: Melissa updates us on the Mexico’s stock market and political developments, warning investors to tread carefully there.
Someday, There Will Be A Recession
Today, Dr. Ed puts the notion of a recession still to come into perspective. Since 1945, the US economy has been in recession 14% of the time. Most of the nine recessions stemmed from the credit-crunching effects of monetary tightening. The most recent tightening round won’t likely trigger a recession despite the “long and variable lag” often noted before the economy reacts to tightening. That’s because this tightening round is different in many respects, one being the “Immaculate Disinflation” it has achieved (moderating inflation without a recession). For multiple reasons, we think it’s wrong to expect a hard landing still to unfold from this tightening round. … Q3 is shaping up as another immaculate quarter. Also: Dr. Ed reviews “The Tourist” (+).
China, Nvidia & Humanoid Robots
The collapse of China’s real estate segment and the response of the Chinese government—stimulating not consumption but production—are keeping the country’s exports high and effectively exporting deflation along with goods. This has ramifications for the economies of its trading partners, as Jackie reports. China’s weak economy is hurting multinational companies doing business there and domestic corporations alike. … Also: A look at Nvidia’s fundamental and valuation stats in the wake of strong earnings that nonetheless failed to excite investors. … And in our Disruptive Technologies segment, more on humanoid robots: Optimus and Figure 2.0.
On Going Global, Volatile Oil & Earnings Revisions
While we recommend a “Stay Home” versus “Go Global” investment allocation approach, we note that the EU MSCI is trading at a big discount to the US MSCI. But challenges constraining economic growth do abound in Europe. Today, Eric surveys the investment fundamentals vis-à-vis valuations in both EU and EM stock markets, finding the latter more attractive. … Also: Melissa surveys the forces making for a volatile global oil market. … And Joe updates us on the latest batch of analysts’ net estimate revisions data for August—a month that saw net earnings estimates rise as net revenues estimates fell.
On Another New Normal, Banks & Powell
With the growing economy set to benefit from interest-rate cuts and a weaker dollar, will inflation heat up again? We’re sanguine on the inflation outlook in the near term, but not as certain about the long run, which will depend on the outcome of November’s elections. In our opinion, the economy is normalizing from pandemic-induced distortions to a higher “norm,” meaning higher potential GDP, higher productivity growth, and a higher neutral interest rate. ... The economic backdrop should lift Financials stocks broadly, but large banks have more winds at their backs than small ones. … And: Why is Powell suddenly so dovish?
Powell’s Latest Pivot Won’t Be His Last
It was an unambiguously dovish Fed Chair Powell who described the Fed’s intentions for US monetary policy at the Jackson Hole gathering of global central bankers on Friday. In our opinion, he was too dovish for this point in the economic cycle. After all, successful execution of the Fed’s dual mandate basically has been achieved: Inflation is headed on autopilot down to the 2.0% target (thanks to solid productivity gains) and unemployment remains low. Why tamper with success? Powell’s pivot to dovishness assured the financial markets that they were right to expect more easing after the widely anticipated September rate cut. But if the labor market remains resilient or inflation reheats, Powell likely will have to pivot again. … And Dr. Ed favorably reviews “Young Woman And The Sea” (+++).
On AI, Payrolls & Global Economy
AI’s power to transform operations in nearly every industry is bound to feed the productivity growth boom we expect, the crux of our Roaring 2020s scenario. But the unbridled propagation of AI poses some challenges. Dr. Ed looks at the AI question from multiple angles, noting prudent precautions to using AI—like restricting its access to unvetted Internet content. … Eric warns that the financial markets may be overly confident that the Fed will cut rates after September despite the strong economic data we expect for August. … And Melissa shares an update on the global export landscape.
On The Carry Trade, Japan & Earnings
The recent carry-trade unwind triggered unnerving market declines that weren’t warranted by asset fundamentals. But Dr. Ed and Eric don’t think investors need to worry about a repeat performance. Carry trades continue, but positions are less extreme now. And if Friday’s statements by Fed Chair Powell and BOJ Governor Ueda are less dovish and more dovish, respectively, the yen would weaken against the dollar—also helping to avoid another carry-trade unwind. … Also: Melissa reports on Japan’s remarkable economic revival. … And: Joe’s data suggest a chance that 2024 could be a rare year of rising earnings, revenue, and profit margin estimates.
Global Growth Perspective: US Stands Out
Not only isn’t a recession headed down the pike, but the US economy is emerging from the pandemic tunnel with stronger potential GDP than it had prior to the pandemic. Today, Eric explains why he and Dr. Ed believe that potential GDP growth is 4.0% annually, more than twice FOMC members’ latest consensus forecast for long-run real GDP of 1.8%. Why is the economy resetting at a higher level? The growing labor force and the productivity growth boom we expect—our Roaring 2020s thesis—provide tailwinds. … The global economy is also gaining steam, even though China’s economy remains moribund.
Get Ready To Short Bonds?
Last week saw unfounded US recession fears and global financial market jitters go poof as quickly as they arrived. Dr. Ed examines what the markets were overreacting to when they beat a hasty retreat and the subsequent developments that set investors straight. … Weather was the reason for much of the weakness in July’s economic indicators, suggesting that August’s data may surprise on the upside and that Fed officials might push back against expectations of numerous rate cuts ahead. We expect just one 25bps cut in September and no more for the year, especially since a greater cut could trigger another carry-trade unwind. … As for the bond market, we see three possible scenarios and lean toward the mildly bearish one. ... And Dr. Ed favorably reviews “Widow Clicquot” (+).
On Consumers & More On AI
The US consumer’s spending hasn’t declined, but it has shifted—leaving retailers of out-of-favor items out of luck. Jackie recaps what company managements have revealed about what consumers do and don’t want to buy these days and pinpoints multiple reasons for the shifts. … And: AI seems to be advancing by the minute. Our weekly Disruptive Technologies segment looks at the strides two companies have made in producing avatars and robots that seem very human.
The ABCs Of Global Commodities
While the US federal budget deficit is on an unsustainable course, there’s good news about it: Income-tax receipts are up y/y—more evidence that no recession is on the horizon. And while spending also is up y/y, the net result is a lower deficit than at this time last year. For bonds, that means the 10-year Treasury yield won’t likely retest last fall’s highs near 5.00% anytime soon. … Australia, Brazil, and Canada are big exporters of commodities; Melissa surveys the export landscape for each by commodity and trading partner. … And Joe recaps the Q2 earnings, revenues, and profit margins to date for the S&P 500 and its 11 sectors.
On Geopolitical & Credit Crises
As geopolitical tensions in the Middle East mount and Ukraine’s war with Russia intensifies oil prices may be starting to spike. So we reiterate our commodity- and equity-based hedges for these risks. On a happier note, Ed reviews our Credit Crisis Cycle theory for how monetary policy induces a recession... and why we don't see one currently. Eric also reviews the latest consumer credit data, explaining why household balance sheets look better than before the pandemic despite alarms sounding on credit card delinquencies.
No Recession In Earnings Or In Disinverting Yield Curve
Corporate earnings have never been higher, suggesting that employment should continue to grow as profitable companies expand their payrolls. Today, Ed and Eric put the prospect of a recession into perspective with their “Credit Crisis Cycle.” Ed notes that S&P 500 companies’ record-high forward earnings is a bullish indicator for the stock price index. The S&P 500 forward profit margin is near its record high and expected to hit new highs in the productivity growth boom we project, our Roaring 2020s scenario. … Eric explains why this time, a disinverting yield curve is not signaling an imminent recession as it has in the past. Other relied upon recession indicators are flashing false signals as well. … Dr. Ed favorably reviews “Pachinko” (+ + +).
Semis, Rails & Robots
Not all semiconductor manufacturers are faring as well as the stats of the S&P 500 Semiconductors industry suggest, Jackie tells us. Many are experiencing a punishing inventory correction, particularly those that sell semis used in cars, PCs, cell phones, and industrial products. The good news is that inventories should be back to normal in a few more quarters, and share prices soon should reflect that. … Also: After a tough 2023, the railroad industry should return to growth this year; several growth engines are expected to help CSX gather steam. … In our Disruptive Technologies segment, a look at China’s robotic ambitions and the concern they’re raising on Capitol Hill.
Giving Private Credit Some Credit
Those who’ve long insisted that the US economy is headed into a recession have been citing the opinions of bank loan officers surveyed by the Fed. The latest such survey, however, suggests banks don’t expect a recession. Eric recaps the just released survey’s takeaways and points out that banks aren’t the go-to source of capital for businesses that they once were anyway. … Instead, reports Melissa, companies increasingly are turning to the booming private capital market. She explains what makes it tick. … Also: Joe gives us an update on Q2 reporting season. Results so far have been mixed—underwhelming for the Magnificent-7, better for the “S&P 493.”
The Almost Everything Global Panic Selloff
We’ve been making the case against a hard landing of the economy, as recessions invariably result from financial system crises and the credit crunches they cause. Could the unwind of the yen carry trade and the subsequent global rout in financial markets precipitate such a crisis? We don’t think so, but are closely monitoring credit conditions on both sides of the Pacific. How will the Fed respond? We’re sticking with our one-and-done rate-cut forecast for this year. How much longer will the stock-market pain continue? The bleeding could stop this week.
Rolling Into A Recession?
A weak July employment report does not a recession make. The financial markets reacted on Friday as though it does, but we believe that report was a weather-impacted anomaly and not representative of the strength of the US labor market. Eric & Ed make that case today, explaining what was going on behind the scenes to make Friday’s stock market unusually volatile, why we expect employment data to snap back in August, and why we don’t expect a hard landing of the economy. … Furthermore, the latest productivity data are consistent with our Roaring 2020s outlook. ... Also: Dr. Ed reviews “Presumed Innocent” (-).
China, Tech & Solar Panels
Collateral damage from China’s ailing real estate sector has hit its consumer sector. US companies with exposure to China’s consumers have felt the blow of depressed consumer sentiment and spending. Jackie shares her takeaways from some of the victims’ June-quarter earnings reports. … Is the MegaCap-8 stocks’ recent selloff a canary in a coal mine, warning that AI won’t live up to its hype? Nope, suggests a look at their valuations together with their earnings growth prospects. … Also: Our Disruptive Technologies segment focuses on prospects for solar panel manufacturers and some innovations they’re developing.
US Resilience, Eurozone Weakness& More On Earnings
Why hasn’t the Fed’s tightening of monetary policy slammed the brakes on the US economy? Eric explains the structural economic shifts that have led to increased rate insensitivity as well as the implications for setting the federal funds rate going forward. … The Eurozone economy seems to have long Covid: Melissa reports that it been struggling to regain its pre-pandemic pace of growth. The European Central bank is tasked with a balancing act, both stoking growth and dampening inflation. … Germany’s leadership is floundering, and its economic indicators are pointing south. … Also: Joe reports that the investment-style rotation away from large caps has healthy earnings support.
YRI’s Earnings Tweaks & Dudley’s About-Face
We’re updating our S&P 500 price targets for this year and the rest of the decade. Near term, we see the index continuing to churn below its July 16 record high through election time; it seems to have support around 5450, its 50-day moving average, which we don’t think will be breached given companies’ earnings strength. A strong rally at year-end might sweep the index to a new record high around our (newly raised) 5800 target. Dr. Ed shows the math that yields this and our subsequent years’ price targets. … Also: Eric counters NY Fed President Dudley’s recent op-ed argument for easing sooner than September.