'How long can this keep going on?'

(That was the refrain of the 1975 hit, “How long” by the British group Ace. The lyrics will get stuck in your head.) How long? Do you know? There ain’t any use in pretending…. To wit: the second- and third-largest bank failures in history failed to stop the Fed from raising rates (!) or a Q1 equity rally led by last year’s big losers (!), growth stocks. Bookended by big runs in January when peak-rate talk proliferated and in March when banking jitters sent yields plunging the most since the pandemic began, the Nasdaq 100 was up 20% at this writing (a new bull!). In fixed income, the two best-performing asset classes were 30-year Treasuries and CCC-rated high-yield bonds, polar opposites on the risk spectrum! While volatility remained restrained in equities save a blip when banking crisis fears were their highest, it soared in fixed income. The 2-year Treasury yield fell 108 basis points in just three trading days in March, and the MOVE index jumped to its highest level since late 2008, the apex of the global financial crisis! Since 1928, April has been the second-best month for stocks. Michael Burry, of “Big Short” fame, this week tweeted, “I was wrong to say sell” in January. And Fundstrat shares that bear markets are extremely rare whenever the S&P posts two consecutive quarters of gains, as it just did. Although, Gavekal Research notes that this month S&P 500 relative performance against gold broke below its 7-year moving average, which historically has happened on the cusp of a structural bear market. Do you know how long? I ain’t quite as dumb as I seem….

The consumer reigns supreme. Outside of younger families (see below), the consumer may not be concerned about a possible credit crunch. Household cash balances surged the last three years—Empirical Research estimates balance sheet liquidity relative to income is at a 60-year high, fed on pandemic relief, surging wages, and strong jobs and income growth. Home equity has benefitted from the run up in home prices to record highs (though they’ve since started to decline, more below) and the rush into mortgages at generationally low rates. Corporations acted in much the same way, locking in longer-term debt at cheap market levels. Until the labor market cracks—little evidence of such yet (see below)—these forces could keep the consumers and corporations stronger for longer. Smaller banks that issue the bulk of real estate loans could back off amid an exodus of deposits—$610 billion the past 12 months, with money market funds a big recipient ($570 billion). But that outflow slowed to trickle in the past week, Fed data show. And with home inventories tight (who wants to give up a low-rate mortgage?) and buyers eager to bid on what is available (more below), residential mortgage loan risk doesn’t seem all that great. Nor do commercial real estate (CRE) worries. Exposure on $4 trillion of CRE assets to banks in the $50 billion+ range is $440 billion—material but hardly cataclysmic.

Perhaps the best recession predictor is the persistent strength of underlying inflation. Data this week (more below) showed it is hanging tough. Since jumping from a sub-2% annual rate to above 5% in 2021, the Cleveland Fed’s median and trimmed mean measures have been bouncing around that level ever since. Fundstrat believes markets are underestimating Chair Powell’s resolve to fight inflation. This would indicate forward profit expectations may be too high, though Empirical thinks the underlying strength of the economy may be underappreciated and that earnings could surprise to the upside (!). What’s an investor to do? Patience suggests selectivity and picking spots while the market traverses the range trade that’s been dominating until the clouds clear over which way the Fed and economy (with a debt-ceiling drama thrown in) break. Bank of America’s global fund manager surveys saw recession worries and pessimism soar on the banking stress. And yet here we are at 4,100 on the S&P. The bottom of the range may require a sharp weakening in the hard data. How long can this keep going on? Could be a while.

Positives

• The consumer reigns supreme Pending home sales rose a third straight month in February, and mortgage purchase applications climbed a fourth consecutive week, their longest up streak in four years. Extremely tight inventories, declining home prices (down in 15 of 20 cities in the Case-Shiller gauge that has fallen six consecutive months) and lower mortgage rates have buyers snapping up homes quickly—46% were off market within two weeks of going on, vs. 2019’s average of 31%.
• The consumer reigns supreme Real consumer spending advanced at an estimated 4.6% clip in Q1, and March Conference Board confidence unexpectedly rose (the survey was taken 10 days after Silicon Valley Bank’s collapse), with consumers citing improving outlooks for jobs and incomes and relatively tame energy prices. The Atlanta Fed’s GDPNow shows Q1 real GDP tracking at a 2.5% pace, just a tenth of a point below the final take on Q4 ’22.
• Still buying the dip Bank of America clients bought U.S. equities for a fourth straight week—the biggest inflows since October. Tech and Health Care sectors were the largest beneficiaries, while last year’s star, Energy, saw outflows.

Negatives

• Inflation is sticky Core prices remain high and are accelerating in some developed markets—up 4.8% year-over-year in Europe through February vs. 4.1% in December. This morning’s read on February core PCE in the U.S. slightly surprised at a tick below consensus at 4.6% y/y. Tight labor markets are keeping costs elevated everywhere. Respective Conference Board jobs “hard to get” and “jobs plentiful” measures remain historically low and high, and jobless claims continue to linger under 200K. Anecdotally, 100s of Walgreens stores are cutting hours due to staffing shortages.
• Student debt was not forgiven Citigroup credit card data shows spending rapidly decelerating, with March on pace to be the weakest month in a year. Delinquency rates on card debt owed by those under 40 have risen to 2019 levels, a concern as younger households last year used credit card and auto debt to fund a third of their spending growth. With monthly student loan payments averaging $400 set to resume in August if not sooner, depending on the courts, this cohort is confronting another potential drag later this year.
• Recession is out there somewhere Surveys by Fed regional banks showed composite activity (manufacturing and services) solidly negative this month. Elsewhere, U.S. bankruptcy filings by private corporations have surpassed Covid levels; for 12 of the past 13 months, Conference Board expectations have been below 80, a level historically associated with a recession within a year; and the final March tally of Michigan sentiment was revised lower, the first decline in four months, on rising recession expectations.

What else

Did you know? Bank of America shares that more money is spent on bottled water ($270 billion) than the required investment to provide safe drinking water for all ($114 billion).

Unfathomable For every word spoken in human existence, there are more than 100,000 stars in the universe! Approximately 100 billion people have ever lived on the planet, each speaking more than 300 billion words in their lifetime. By comparison, the number of stars in the universe are roughly estimated at 10 to the 24^th power.

If you don’t believe in God, then …  how do you explain chocolate? Over 70% of people will reveal their passwords for chocolate.

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