'Your Uber driver gave you a kiss goodbye!'

So asked my advisor host as he welcomed me to our luncheon restaurant and waved to my husband/chauffeur in warm and sunny Naples. And so began another “I can’t believe they pay me for this” enjoyable week on the road. Next off to balmy Ohio, with stops in Akron, Columbus and Dayton. My drive to see LeBron’s 2-square-blocks compound in an Akron neighborhood sent off good vibes as he set an all-time scoring record for the NBA that evening. Columbus, home of The Ohio State University, my beloved son’s alma mater, is growing like a weed! Locally dubbed “Silicon Heartland,” it’s welcoming new Intel and Honda chip plants, adding to Google and Amazon facilities already there. The best meetings are ladies’ events and I was privileged to speak to groups in all three locales. Perhaps you didn’t know that women historically make better investors than men (now you do!). That’s good news, since the numbers living well into their 100s are ever growing. Lots of questions about what to make of this market. The high-beta rally to start the year (last week’s Nasdaq trading volumes were eight times those of the NYSE, a level seen only at the very peak of the meme-stock mania in early ’21) gave way to a sell-off this week. The rally in bonds also reversed. Frenzied options trading is a big driver of activity—more than 40 million call-option contracts changed hands in a single day last week, a record high, CBOE Global Markets reports. With little clarity on rates, inflation or the broad economy (how could everyone have gotten Friday’s nonfarm payrolls so wrong?), “the tape is abnormal,’’ Evercore ISI says. Most people can’t say with conviction whether this is a bull or bear. What it is, is a stock picker’s and trader’s market.

One thing seems certain. A very tight labor market (4-week claims hovering at record lows), $1+ trillion of excess Covid savings still in consumer pockets, rising incomes and fiscal juice from massive bills passed in Biden’s first two years  hardly are indicative of an economy ready to stop on a dime. The Atlanta Fed says Q1 GDP is tracking at 2.2%, up from 0.7% at the start of the month. While off its highs, inflation is hardly rolling over. Used-car prices (an early indicator of inflation’s initial surge) are soaring again (more below). Gasoline and oil prices, too (more below). Wage growth remains elevated (more below). Sounds like higher for longer to me. Indeed, global short rates are surging—some interest-rate options traders (there they are again!) are pricing a 6% terminal rate. Recession worries that were heavy going into 2023 may be right, just wrong about the year, ISI says. Coming off zero, the Fed hikes last year didn’t start becoming material until late summer/early fall. That puts 2024 into play. There’s a growing “soft landing” consensus for 2023, and some economists surveyed by Bloomberg are even talking “no landing.” The problem is stocks already have discounted a soft landing—S&P 500 valuations have shot to 18.5x forward earnings on the risk rally. This outcome seems out of sync with a deepening yield-curve inversion, outright M2 contraction and inflation that could plateau well above the Fed’s 2% target. Jefferies sees the disinflationary base effects on CPI dissipating in the back half of the year, just as the worst of the Fed-tightening impacts hit. Hmm.

The fiscal case against disinflation is strong, too. The U.S. budget deficit, which has a solid historical (and lagging) correlation with inflation, soared 68% ($600 billion) the last six months. Just how much the fiscal situation has deteriorated should become clearer next week, when the Congressional Budget Office releases new baselines for taxes and spending. The current budget assumes a fed funds rate below 1%, sharply underestimating interest expenses ($260 billion by some estimates) even as year-over-year (y/y) tax revenues have begun to decline. Strategas Research estimates the combination of higher interest costs with lower tax revenues has pushed U.S. government debt servicing costs to a 23-year high, with interest expenses on track to represent 14% of revenue, a level that in the past has seen financial markets force austerity on policymakers. At the least, this should provide fodder for a debt-ceiling debate that’s just warming up. In his State of the Union address, Biden proposed trillions in new spending and taxes. No way Republicans, with their slim House majority, go along with that. Against this backdrop, where does the market go? The two largest S&P advances with an inverted curve, in 1979 and mid-2006 to mid-2007, ran about 25%, suggesting a top range of 4,350-4,000 for this market. What then? In the prior two cases, the bottom fell out. Hmm, hmm, hmm.

Positives

• Signs of life in housing Home mortgage purchase applications rose 3.1%, their third increase in four weeks, as affordability continued to improve. The Mortgage Bankers Association said the average 30-year rate ticked down to 6.18%, a percentage point below its October peak, and Case-Shiller prices have fallen 2.5% from their 2022 high. Building and permit activity is still down 25-30%, but construction employment grew in January to an all-time high.
• Consumers feeling better Preliminary February Michigan sentiment hit a 13-month high, up 6% from a year ago and beating consensus. Online polling firm Civiqs put consumer attitudes about the economy at their highest level since last March. Jobs are a big reason—on top of January’s 517K, 2022 revisions put December’s gain at even larger 813K. One reason for the strength: the ratio of worker compensation to corporate revenue is at a record low as Covid stimulus still has corporate revenues running $1.6 trillion above their pre-crisis trend, vs. compensation at $700 billion above its pre-Covid trend. But this is about to change.
• Investors feeling better The Investors Business Daily/TechnoMetrica economic optimism index rose to a 10-month high this month, led by the personal finances subcomponent that moved into positive territory. The 6-month outlook improved, though a majority of respondents still felt the U.S. was in recession. Overseas, the Sentix gauge of eurozone investor morale rose a fourth straight month to its highest level since last March.

Negatives

• This doesn’t look like disinflation The Atlanta Fed wage tracker, which tends to be more informative about underlying wage trends than average hourly earnings, suggests the deceleration of wages in late 2022 came to a halt in January. On an unweighted basis, it shows wages rising 6.2% y/y in January, up from 5.5% in December but still below November’s 6.5% pace. A smoothed version of the unweighted measure, the 3-month moving average, held at 6.1% y/y. The Fed closely watches this gauge.
• This doesn’t look like disinflation Manheim used-car prices rose a second straight month in January by 2.5%, the most since November 2021. AAA gasoline prices jumped 4.4% during the month, before their typical late-winter run-up when refiners start overhauling capacity to prepare for the summer travel crush. Crude oil futures breached $80 this morning on news Russia was cutting production. And German CPI accelerated 0.8% in January, almost wiping out December’s 0.9% decline.
• Banks more cautious The Fed’s Senior Loan Officer Survey found a more pervasive tightening of bank credit standards for all categories of business and household loans in Q4 ’22, as well as a similarly broad decline in demand. Supply and demand for commercial/industrial and commercial real estate loans in particular were contracting as quickly as they have before past recessions. Residential loan tightening was as bad, though demand fell a second straight quarter. New data (see above) suggest a reversal.

What else

Kidding ourselves? The S&P operating margin has fallen more than 150 basis points off last year’s peak, coinciding with the magnitude of declines that occur during recessions. It could get worse if there actually is a recession. Downturns in ’08-’09 and ’20 saw margins shrink a respective 500 and 200 basis points. So far, sales estimates for this year have remained relatively stable at 2% growth, indicating the market in the aggregate still expects margin expansion.

You can’t believe everything you read Pomona College economics professor discovered that ChatGPT—the AI tool sweeping the world (more than a billion cumulative web visits since its November launch)—gets questions about current events or nonsensical queries wrong but sounds authoritative when doing so. To wit: asked which is faster, a spoon or a turtle, it said, “Generally speaking, a spoon is faster than a turtle. A spoon can move quickly and cover large distances in a short period of time, while a turtle has a much lower rate of speed.”

And we’re off! Looks as if the Biden administration is settling on “Finish the job” for its reelection rallying cry. Not quite Reagan’s 1984 “Morning Again in America,’’ Cowen & Co. says, though it notes Reagan’s approval at the same point in his first term was nearly 5 points below Biden’s. The president, VP Harris and his Cabinet were holding 30 events in 20+ states over two days to “sell” the message.

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