Will Spring Awaken The Bear?
I know I have written a lot about seasons to start my monthly market outlooks in the past.
But the "seasonal" changes we generally refer to as weather can also be connected to the more philosophical personal, economic, or financial life experiences.
To me, and many others, new seasons represent
change, growth, and learning.
We've all been there.
In fact, the economic and investment season we collectively find ourselves in is just that.
A season of difficulty, growth, and learning.
That is why I love what I do so much.
There is never a definitive answer which means there is always something to learn.
In that regard, the first quarter of 2023 did not disappoint.
Whether geopolitical tension, banking turmoil, high mortgage rates, tighter financial conditions, or the strong yield curve inversion, the headwinds for capital markets were, and still are, abundant.
Despite that, the markets have held up relatively well.
Much of this optimism is in anticipation that the Fed will actually cut rates sometime in the 3rd or 4th quarter. Mainly due to the aforementioned headwinds and slowing inflationary growth forcing the Fed's insistence on tighter policy to shift dramatically.
Nevertheless, indications of stress for both the consumer and businesses may be a more severe catalyst for market strength to deteriorate.
Consumer Stress
Costco, Walmart, Target, and many others across the retail spectrum, have highlighted stress in consumer spending as durable goods sales have declined. Stating that discretionary spending has been eaten up by higher-cost grocery products.
Costco's finance chief, Richard Galanti, described weakness in big-ticket discretionary items, particularly major appliances, home furnishings, small electronics, jewelry, and hardware.
In anticipation of a further decline in consumer spending businesses have scaled back on their planned capital expenditures.
Businesses Capex
Earning calls have also highlighted scaling back of capital expenditures. For instance, FedEx has stated that they have cut their capital spending budget by roughly 6% citing slowing demand for shipments. Many others are following suit including Micron and Taiwan Semiconductor (TSMC) citing weaker consumer demand for personal computers and electronics.
In fact, the manufacturing sector is experiencing the steepest decline. The chart below, taken directly from FRED, the Federal Reserve's Economic Data system, shows The Philly Fed future capital expenditures index decreased to -3.8 in March 2023 from 7.5 in the previous month, the index’s first negative reading since September 2009.
The Space Between
Considering consumer spending accounts for roughly 70% of US economic activity, and consumer spending and business revenues are directly correlated these are both areas of concern.
When consumer spending slows, or in this case, is needed on non-durable items such as groceries, business earnings decline. In turn, this causes them to cut back on investments such as capital expenditures and hiring.
In my opinion, this could be the key to a labor market, currently considered strong, starting to weaken.
When consumers believe jobs are at risk they tend to spend less. Creating a snowball full circle self-fulfilling prophecy of sorts.
Of course, it is too early to tell if this is a blip or the start of something more significant, but these are both areas of strength that have kept the NBER at bay in officially calling a recession.
Although she is still singing, we should see any consumer weakness as a canary in the coal mine indicator.
Conclusion
The Fed does expect a "mild" recession in 2023 according to the recent Fed minutes. We can only hope that "mild recession" is not similar to the "transitory inflation" scenario the Fed touted in 2021.
But investor optimism is apparent as longer-term treasury yields declined from their October 2022 peaks coinciding with a fair increase in broad index equity prices.
In my opinion, based on all the data we have right now, barring some type of "event" or unforeseen impact of stress we may see higher prices. At least for the next few months.
Data takes time to fully show as it is mostly a look in the rearview mirror. If the Fed does cut rates, especially an emergency rate cut, It will be more of an eminent recessionary signal, assuming one is not called before that comes.
Perhaps this should be seen as a "sell the news" moment versus an "up and to the right" moment.
Currently, I continue to add exposure to certain areas of value I see in the capital markets, but cautiously.
As spring has finally brought good weather here in the West, I hope you enjoy some well-needed time with your families outdoors!
I look forward to connecting with you all soon!
“Many people want the government to protect the consumer. A much more urgent problem is to protect the consumer from the government.” ― Milton Friedman
Thank you for reading,
James Anadon
