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Saturday, May 25, 2024

Capital markets perspective: Strike one

Capital markets perspective: Strike one

09.18.2023

Strike one.

If you want to watch October baseball in Colorado, you’ll have to find someone else to root for, because the only place you’ll find our Rockies competing next month will be on the golf course. But that’s okay: Everyone knew this would be a rebuilding year, so those who follow the team are willing to look beyond this year’s record and hope for better things in the future.

Not so for those of you in New York: Whether you wear Yankees pinstripes or bleed Mets’ orange and blue, you’ve been disappointed. Sorely. Back in the spring, both teams were legitimate contenders to win their respective leagues. Today, both teams have about the same chances of even making the playoffs as the Courtland Sutton had of making a game-tying catch with Washington’s Benjamin St. Juste draped (illegally, to my eye) all over him at the end of yesterday’s Broncos-Commanders game.

But I digress. Here’s the thing: As I sat down to write this week’s Perspective, Colorado fans’ relatively blasé response to our Rockies basement-dwelling record vis-à-vis the far less tolerant reaction of Mets’ and Yankees’ fans got me thinking about the role that advance expectations play in our response to disappointment. The Colorado Rockies’ record is an awful 56-93 through yesterday, but they still manage to put 32,000 butts in the seats per game[1]. By contrast, google “how mad are New York baseball fans?” and you’ll be treated to a YouTube video titled “Angry Fans Throw Baseballs at Players.” Yikes.

Last week’s reaction to two disappointing inflation releases felt a lot more like Rockies’ fan’s take-everything-in-stride response than the Yankees’ and Met’s get-out-the-pitchforks-and-storm-the-outfield reaction, largely because everybody knew (or at least suspected) that inflation was going to be ugly. It was: Prices at the consumer level rose 0.6% in August, faster than at any point in more than a year[2]. At the producer level, things were even worse: PPI rose 0.7%, also the biggest increase since last summer[3].

But that’s okay: Markets took both reports very much in stride, largely because a big (but entirely expected) increase in gasoline prices – which was obvious more than a month ago even to economists, at least those who still drive their own cars to work – was largely responsible. Add to that a persistent but equally well-known climb in shelter costs and investors mostly understood well ahead of time that August’s inflation numbers were always going to be bad. So when they were, nobody started lobbing baseballs at anybody.

Perhaps a little more perplexing was the market’s similar lack of reaction to Thursday’s retail sales figure, which frankly was a bit of a surprise[4]. U.S. consumers continued to binge, spending 0.6% more in August than they did in July even as headwinds continued to build. That figure was well ahead of expectations, even considering the impact of a 5.2% increase in spending at gas stations that itself was related to that same surge in at-the-pump prices.

Collectively, the hottest inflation numbers in a year and an unexpectedly robust increase in consumer spending kept the prospect of further increases in rates by the Federal Reserve very much in play. All else equal, that probably should’ve sparked a bigger reaction among both equities and rates than it did. But as we’ve argued here before, it seems as if investors are finally resigned to an aggressive Fed and are therefore mostly hardened against anything but the most shocking of surprises. That certainly seemed the case last week, when markets were mostly quiet despite the clearly inflationary data.

So again, we Colorado Rockies fans can relate to the market’s ambivalence because we expected it. But one area where higher gasoline prices did seem to produce a Yankee-and-Mets-like reaction was in consumer sentiment: According to the University of Michigan’s mid-month read on consumer attitudes, a big drop in the current conditions component caused the UofM’s index to hook noticeably lower[5]. That’s not altogether unexpected: The upside-down relationship between gasoline prices and consumer confidence is well-known, especially, it seems, when gas prices move from moderate to expensive. That makes higher gas prices feel very much like "strike one" against the likelihood that consumers will be able to continue their hitting streak. And in my view the next two pitches thrown to consumers are likely to be strikes as well: First, the pending resumption of student loan payments next month and the potential softening of the jobs market at some imagined point in the future.

Speaking of which, let’s close with a recap of the now really-for-real strike of the UAW against Detroit’s Big Three. (You knew this was coming when you saw me lead with the word “strike” on page one, didn’t you?) On Friday, roughly 13,000 members of the United Auto Workers union walked off the job across three states as their contract expired with no agreement yet in place. That was far fewer than the 100,000-plus that were (and still are) authorized to strike, a measured approach that represents a clever tactic: By selectively shutting down only plants that produce relatively high-margin vehicles (one for each manufacturer, Ford, GM and Stellantis), the union is applying pressure to all three automakers while also preserving its own funds in case the strike becomes long and drawn out.

That could work to the union’s advantage because it may force (or encourage) the automakers to idle other plants as well. If so, workers at those plants would officially be classified as laid off and therefore qualify for unemployment benefits (striking workers generally do not qualify for government benefits and are instead paid strike pay from the union’s own coffers). That’s led some observers to speculate that the Union is digging in for a long work stoppage that could have profound impacts.

Whatever your view on organized labor, markets are likely to pay attention to a few things. First, if the strike does become a lengthy war of attrition, it will almost certainly detract from economic growth. While its difficult to estimate exactly how big a bite out of growth an extended strike might take, its safe to assume that the impacts will reach far beyond the autoworkers themselves and will also hit suppliers and businesses surrounding the plants, most of whom have no beef with either the union or the automakers themselves.

And then there’s the potential impact on inflation, which most of us had hoped was on its way to fully and finally being licked. Used car prices were one of the most visibly impacted line-items in the BLS’ inflation data during the post-COVID climb-out, and if the strike expands or drags on long enough for car dealers to exhaust existing inventories of new cars, it’s not unreasonable to assume that auto prices – new and used – might respond as well. The extent to which that becomes upward pressure on prices more generally will depend on lots of things – many of which are completely out of the Fed’s control.

What to watch this week

Economic Events, September 18–23              

Monday: NAHB Housing/builder sentiment

Tuesday: Housing starts/permits, FOMC meeting begins

Wednesday: Fed rate decision

Thursday: Philly Fed, existing home sales, weekly jobless claims, LEI

Friday: Flash PMIs

It’s Fed week. The rate-setting body of the Federal Reserve will convene on Tuesday and issue its decision at mid-day on Wednesday, with the FOMC’s announcement followed, as always, by a press conference and Q&A session featuring Fed Chairman Jerome Powell. Trading is likely to be quiet in the run-up to the announcement and the post-decision press conference as few speculators will be willing to take much of a stance before the Fed makes its decision public and Powell has a chance to expound. Expectations overwhelmingly favor a pause in September, but as many as one-in-three rates traders see a resumption of rate increases as possible in November, based on futures prices[6]. That once again places a whole lot of pressure on Powell to say the right things during Wednesday’s post-decision press conference.

That’s even more true given that markets are still placing the odds of at least one cut in rates in the next 12 months at more than 80%. That view comes despite Powell’s insistence that rates will be “higher for longer” to avoid reigniting inflation and therefore repeating past Fed mistakes. Of particular interest therefore will be the “staff economic projections” that will be released alongside Wednesday’s rate decision. The most notable page within those so-called quarterly “SEPs” will be the infamous “dot plot," which shows where each participating member of the FOMC sees rates evolving over the next two years (and beyond). I still think markets have moved beyond the Fed as their sole source of fear and greed, but if the Fed still has the ability to shock markets, it might be the dot plot that does it.

Beyond the Fed, we’ll also get a few reads on the health of the housing market including the National Association of Homebuilder’s housing market sentiment index on Monday, housing starts and permits on Tuesday and existing home sales on Thursday.  The housing market is almost always the first to react to Fed tightening, and this cycle has only been different insofar as the inventory of available housing has been so limited. That makes any data surrounding inventory potentially interesting. Starts/permits and the NAHB’s sentiment index both qualify.

In terms of the real economy, we’ll get two separate PMI-type releases, starting with the Philly Fed on Thursday and the mid-month (or “flash”) PMIs from S&P global on Friday. Economists will watch Philly to see whether it follows the trend in last week’s Empire State Manufacturing release, which was better than expected (and even hinted at a very mild expansion). Ditto for the flash PMIs – there the question will be whether services has legitimately begun to weaken alongside manufacturing

Finally, Thursday’s Index of Leading Economic Indicators from the Conference Board might be worth a glance – not so much for the data itself, but more so because the Conference Board economists continue to see signs of a recession before year-end. That stance (one that I at least partially sympathize with, for what it’s worth) has left the Conference Board staffers feeling more and more lonely as investment banks and asset managers have begun to walk back their earlier predictions of economic gloom. So while the LEI itself may not spark much debate, the commentary surrounding it – always thoughtful and precise – actually might.

 


[1] https://lastwordonsports.com/baseball

[2] https://www.bls.gov/news.release/pdf/cpi.pdf

[3] https://www.bls.gov/news.release/pdf/cpi.pdf

[4] https://www.census.gov/retail/marts/www/marts_current.pdf

[5] http://www.sca.isr.umich.edu/

[6] Cme.com

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Tom Nun, CFA

Contributor

Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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