Remember when it seemed everyone was predicting a recession?
That wasn’t so long ago.
First, it was going to be mid-2023…
Then late 2023…
Then by summer 2024…
Now Wall Street has pushed the idea of a recession out to… well… never.
Or, not anytime soon, anyway.
But how much can we rely on that? After all, they’ve revised their opinion three times already. Why should you trust them this time?
Let’s see what we can make of it. First…
The S&P 500 closed up 0.8% to end the day at 4,585.58… the Nasdaq added 1.4%, to close at 14,339.99.
In commodities, today’s prices and the gain or fall over yesterday, West Texas Intermediate crude oil trades at $69.66, up 29 cents…
Gold is $2,046.10 per troy ounce, up $2.50…
And bitcoin is $43,263 43,819, down $556 from yesterday.
And now, back to our story…
Same Turkey, Higher Cost
First of all, we should set the scene.
When it comes to inflation, most folks tend to focus on a price they see thrust in their face on the side of the road every day – gas prices.
But let’s look at something a little more seasonal, as further proof of how much prices have gone up…
How about a deli fully cooked turkey dinner from Florida grocery store chain, Publix?
We managed to find the Publix weekly brochure from December 5, 2019. Back then, a 10- to 12-pound turkey dinner would’ve set you back $49.99. It was at the time, as Publix kindly noted, a “surprisingly low price.”
It served 7 to 10 people and included everything you could possibly want on your table during the holidays… including a Marshmallow Delight (a dish – we confess – unfamiliar to your editor’s tastebuds).
Fast forward four years to December 2023, and the exact same product (although no doubt, not the same bird) now costs $69.99…
Despite being 40% more expensive, we are told, it is also a “surprisingly low price.”
We guess things are relative.
If this is your first turkey dinner, it may very well be a surprisingly low price… but for turkey dinner veterans, it’s not so low.
The point is, it’s hard to get excited about the inflation rate falling to 2–3% (where it is right now) when prices for many goods are up 20%, 30%, 40%, or more than they were four years ago.
So, it’s no wonder that:
U.S. personal credit card debt now stands above $1 trillion, around 18% higher than in 2019
U.S. auto loan debt is $1.6 trillion, up from $1.3 trillion at the end of 2019
Total U.S. household debt is $17.3 trillion, up from $14.2 trillion at the end of 2019
You can see why Wall Street is so keen to encourage the Federal Reserve to cut interest rates. Importantly, what, if anything, does this mean for the economy? And can we trust that Wall Street is right about a recession being off the cards?
Housing Costs Are a Big Factor
It’s well-known that consumer spending accounts for around two-thirds of U.S. economic activity. To be precise, according to U.S. Bank (USB), for the third quarter of 2023, consumer spending was 68% of the economy – a touch over two-thirds.
But if consumers have to shell out more on interest payments – whether that’s for credit cards, home loans, or auto loans – that means less money going towards actual goods and services.
Hence the recession fears, and the pressure to cut rates.
So how likely is that?
We asked our Director of Research here at Legacy Research, Jack Kasprzak. Jack has more than 20 years of Wall Street experience behind him.
His job here at Legacy Research is to scrutinize research before it goes out. Not necessarily to veto the research, but to question it… and make sure our analysts can justify the claims they make.
Of course, that doesn’t guarantee the success of an investment idea. But it does provide an extra level of due diligence that we feel is both necessary and important.
Here’s how Jack explained the story to us:
The Fed’s favorite inflation gauge, the PCE (personal consumption expenditures index), was last released on November 30. Notably, the six-month annualized core inflation rate fell to 2.5%. That’s not far from the Fed’s 2% target.
Based on that, you can expect inflation to fall below the Fed’s target in the coming months. Why? Simply because the largest component of inflation (CPI) is shelter. This is a calculation called ‘owners’ equivalent rent’, and it can be found in the breakdown of the CPI report released each month.
Owners’ equivalent rent has the longest lag time from when a change in interest rates impacts the price of shelter.
That means that when the Fed starts raising interest rates to slow the economy and the rate of inflation, rent prices are one of the last things to change.
This is because most people lock in their rent for a year, and it takes a long time to bring new supply onto the housing market.
Overall, Jack says, inflation looks set to go well below the Fed’s 2% target in coming months.
In fact, if you exclude the “shelter” component, we are already there. The latest data puts the inflation rate, excluding shelter, at about 1.5%. You can see this in the chart below:
It starts to make you wonder. Think back to 2019 and before. It was still a time when governments and central banks feared deflation, rather than inflation.
It was why interest rates had stayed so low since the market crash in 2008. Governments and central banks mostly worried that deflation would make it harder for businesses and consumers (and governments) to repay debt.
(The reason they worry about deflation is that if prices fall, profits fall and wages fall. That means less income to repay debt. Really, the only thing that doesn’t fall in this scenario is, of course, the value of the debt to be repaid.)
Now it has flipped.
Inflation and higher interest rates make it harder for folks to cover their obligations. If it’s a choice between eating (for instance, a turkey dinner!) or making the car payment, maybe the turkey dinner wins.
While that may be a relatively easy decision when it comes to a car loan, the choice between putting food on the table and paying rent or a mortgage isn’t so easy.
And as it happens, a big part of the inflation surge over the past few years has been an increase in housing costs.
So, we asked Jack for his take there:
That’s the last piece of the puzzle. Real-time data that tracks the list prices for rents shows these increases are coming off the boil as well. Importantly, this shift is not yet reflected in the shelter component of CPI as the chart below shows.
As new leases are executed with much smaller rent increases, the shelter component of CPI should slow meaningfully.
Meanwhile, there is a flood of new supply hitting the housing market. As the chart below shows, there have never been more housing units under construction in the U.S. This comes after a period of severely depressed housing construction, so it took a while for the industry to catch up.
Over the next six months, this new supply will hit the housing market. More supply should eventually weigh on housing prices and drive down shelter inflation and along with it the CPI.
This all looks like good news on the inflation front…
Could Deflation Make a Comeback?
Yet, prices are still significantly higher than they were four years ago. If that changes, how long will it take to change? And will the cost of shelter actually fall, or will it just grow at a slower rate?
Remember, when they talk about inflation falling, they don’t necessarily mean that prices are falling. It’s often just that the rate of increase is slower than before.
Anyway, if Jack’s interpretation of the data is right, it could be that the Fed successfully executes a “soft landing” – a term meaning the economy slows without it causing a recession.
But as we pointed out at the top, Wall Street has been wrong about recession or no-recession forecasts consistently over the past year.
Furthermore, we know that markets tend not to move to one extreme and then settle calmly back at “fair value.” A violent move one way tends to result in a violent move the other way.
The inflation from 2021 to early 2023 was arguably a direct result of more than a decade of money-printing and low interest rates.
Could we see an equally violent move the other way? With inflation falling so quickly that governments and central banks become scared of deflation again?
If so, what will that mean? A return to 0% interest rates?
It’s almost too much to think about. And it certainly feels weird to consider deflation when prices have increased so quickly in such a short period.
We’ve said it more times than you probably care to remember… whatever the market does in 2024, even if there isn’t a recession, it still doesn’t yet feel as though a bull market is guaranteed.
Recession or Not, This Trend Sticks
Recession or not, the biggest investment trend this year has been AI – artificial intelligence.
No doubt, it’s a trend that’s set to stay. Look out for content over the next few days from colleague Nomi Prins.
Nomi’s beat is looking at big macro and geopolitical themes, how Washington D.C. reacts to those themes, and how investors can profit from it.
And Nomi says that AI fits perfectly into that mold. In fact, the recent executive order on AI looks set to create multiple billion-dollar opportunities in the sector.
AI itself isn’t new. Technologists have been developing it since the 1950s. But only recently have we seen that research begin to impact the economy and peoples’ lives… and give them the chance to invest directly in it.
Nomi is hosting a special event on the subject next Tuesday at 8 p.m. ET. In that event, she’ll show investors exactly what is on her radar for the sector and how you can access it.
To join her, just go here.
Our main task at the Daily Cut is to try to “connect the dots.” That is, we help you figure out what events are about, what makes them important, what their consequences are, and what it all means for you.
But sometimes, we see the individual “dots,” but can’t yet figure out how they connect to anything. Maybe they never will connect to anything.
Regardless, if those unconnected dots feel as though they could be important, we’ll mention them here. And we’ll let you draw your own conclusions.
Today’s unconnected dots…
At the top of this letter, we mentioned the market had gotten the recession story wrong at least three times.
It’s not the only thing it has gotten wrong. According to this story from Bloomberg, markets failed six times to pick the point where the Fed would stop raising interest rates:
There have been several false dawns in financial markets over the past two years, when investors accustomed to the long era of easy money predicted the Fed was poised to change course, only to be caught flat-footed when it didn’t. Deutsche Bank AG has counted six of them. But across Wall Street, there’s growing confidence that this latest one is the real thing.
Despite that track record, the same report says the market “sees a visible path for rate cuts in 2024.” We’re sure they thought it was visible in 2022 and 2023 too.
It turned out to be a lot less clear than expected. Maybe the market will be right this time. We’re not convinced.
The more we think about it, the more it looks to us that 2024 will be a flat year… until November 5… depending on the result (in other words, if the “bad orange man” wins), that could be the catalyst for the next bull market.
Coincidentally, that election day also happens to be Guy Fawkes Night in the U.K. It’s the celebration of a failed Catholic plot to blow up Parliament in 1605.
Today’s top gaining ETFs…
ProShares Ultra QQQ (QLD) +2.8%
iShares Semiconductor ETF (SOXX) +2.7%
SPDR S&P Semiconductor ETF (XSD) +2.6%
First Trust Nasdaq Semiconductor ETF (FTXL) +2.4%
VanEck Semiconductor ETF (SMH) +1.4%
Today’s biggest-losing ETFs…
Franklin International Low Volatility High Dividend Index ETF (LVHI) -2.4%
Xtrackers MSCI Japan Hedged Equity ETF (DBJP) -1.8%
iShares Currency Hedged MSCI Japan ETF (HEWJ) -1.8%
WisdomTree Japan Hedged SmallCap Equity Fund (DXJS) -1.7%
WisdomTree Japan Hedged Equity Fund (DXJ) -1.7%
If you have any questions or comments for our experts here at Legacy Research, we’d love to hear from you.
Write to us at [email protected] and just type “Daily Cut mailbag” in the subject line.
Editor, The Daily Cut