Our economic updates are written once weekly by nVest Advisors CEO Jeremy Torgerson for the general education of the public, and as a way to provide transparency for our clients and sponsored-plan participants as to how we create and modify our investment models.
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Good morning and happy Monday! This market reacted to a huge mixed bag of economic data last week, with a big mid-week rally followed by significant declines on Friday. Today’s market appears to be opening lower, also, as investors digest not only the new data received last week, but the logical course of that data through the economy.
There is increasing talk of a “soft landing” or even an outright avoidance of a recession this year by many analysts. We wholeheartedly disagree and believe this has much to do with recency bias (the cognitive bias that makes us think the most recent number in isolation is somehow more important or impactful than the previous numbers, or the entire group of numbers taken in total). The economy is a massive collection of individual actions and reactions and events already in motion. It cannot turn on a dime, so often when we see new numbers that fall far outside of the previous trend, we cannot assume there’s been a change in direction unless we can see that number verified with follow-up readings. Many times, numbers showing up far outside the trendline, good or bad, are the result of one-off events, or outright human error that is later corrected.
At-a-Glance:
- U.S. Labor Market in January was impossibly strong.
- The Fed raises rates and Wall Street parses every word of Chairman Powell
- US Housing and Auto Sales picked up slightly as interest rates cooled briefly
- Is the Market wrong about the economy?
U.S. Labor Market numbers came in (impossibly) strong.
Perhaps the biggest surprise of the week, and one that frankly doesn’t seem accurate (and is definitely not going to repeat or sustain) is that the U.S. reported a whopping 517,000 jobs in January, outpacing the long-term trend by more than 300% month-over-month.
There is much to question, (and even to be skeptical) about this number. Hiring trends are actually trending down in nearly every other measurement, like the manufacturing and services indexes released a week earlier:
… and layoff announcements are continuing to grow.
It is highly likely that this number will be revised downward in the coming months, just like what happened a few weeks ago to jobs figures from the summer of 2022. In that case, jobs were over-reported by over 1,000,000 in just three months. What looked initially like strong hiring during the summer of 2022 turned out to in fact, be flat to slightly down.
Assuming this figure is correct, however, what does it tell us about the economy? It appears that a huge number of people might have picked up a second, part-time job immediately after the holidays. In any event, this report gives further fuel for the Federal Reserve to do more to combat inflation, as it at least appears that the jobs market remains wildly robust.
What this means to you:
We frankly don’t believe this most recent jobs number. It is so far out of line with the longstanding trend that we believe it will be found to need significant revision in coming months. In any event, Wall Street is responding two ways: one, by acknowledging that a super-strong jobs report will likely allow the Federal Reserve to hold interest rates higher for longer than the market thought was likely (a negative event), but also that the economy seems to be handling the Fed’s actions remarkably well so far (a positive event). The jury is definitely out on how much credence to give this recent jobs number. We’re largely ignoring it in light of other jobs data that shows the trend in employment is decidedly lower.
The Fed raises rates and Wall Street parses every word of Chairman Powell.
The Federal Reserve, as expected, raised the nation’s base rate (called the Fed Funds Rate) by 0.25% (25 basis points) last Wednesday. This was a largely anticipated move, and Wall Street was not taken by surprise.
The current rate is now considered by many to finally be sufficiently restrictive on economic growth to begin to bring inflation under control. The new target Fed Funds rate is 4.5%-4.75%, which finally crept slightly above the current core inflation rate:
There is no direct correlation between interest rates and inflation (meaning, having a Fed Funds rate higher than inflation doesn’t automatically mean that inflation will be tamed), but Wall Street seems pleased with the trending direction of both implying better control over inflationary pressures. Time will tell. However, we do not believe there is sufficient evidence to prove that inflation will just continue downward unabated; with the recent re-opening of China and talk by OPEC of further reducing oil production, we think this is a premature assumption.
Chairman Powell stressed this concern himself in his comments last week, in which he indicated that they were pleased with the current trends in inflation and that employment seems to remain strong, he warned that the Fed still has much work to do, and that pausing rate hikes, or lowering them too soon, could see inflation roar back with a vengeance like it did repeatedly during the 1970s and early 1980s. Powell stressed that they anticipate further rate hikes (plural) and that rates would stay high for as long as it took to fully contain inflationary pressures.
But Wall Street, eager to find any possible hint of good news to spur a rally, focused much more on the “progress is good so far” comments of the Fed Chairman while largely ignoring the “more work to do” comments, of which there were far more. We believe this caused a couple of days when investors added to the unsustainable market rally we saw in January, only to have the market reverse on Friday.
What this means to you:
Economic downturns don’t travel in a straight line toward a predictable bottom. There are always market and economic forces fighting back against a recession. No one wants a business to struggle or for a family to lose a source of income in a layoff, so we instinctively look for any reasonable hint of optimism, and respond disproportionately to that. We do not believe the current market rally is sustainable in the face of a deteriorating economy, and that these recent market movements, particularly in the technology and real estate sectors, are the slightest bit sustainable.
U.S. housing and auto sales enjoyed a brief respite as interest rates cooled temporarily.
Part of the market’s sudden surge in optimism came because mortgage interest rates dropped slightly in January (a seasonal norm):
source: tradingeconomics.com
And it resulted in a slight uptick in house sales and refinances. Also, auto sales climbed slightly as the prices on new and used cars continue to decline from historical highs in 2021 and 2022.
Interest rates on mortgages did decline slightly in January, but that trend has already reversed this week, rising today to just below 7% here in our home state of Colorado:
Even with the recent rate drop, mortgage rates are still more than double what they were a year ago, so we see no change in our forecast of a serious and prolonged decline in the housing sector (and those sectors that support it, such as financials, lumber, trade labor, etc.).
What this means for you:
We believe interest rates on major household purchases (home and autos) will continue to weigh on the prices of both over the coming months. This makes it a bad time to sell a home but a very good opportunity to buy one in the coming 12-24 months. Auto prices should continue to decline over the next months, as well.
Is the market wrong about the economy?
One of the biggest challenges in our business is reading what are often backward-looking economic results, and then projecting the consequences of those numbers forward. It’s one of the reasons you’ve seen your 401k slam up and down since last year: investors and analysts simply don’t know what is coming with any degree of certainty, and so are responding to each economic report in real-time.
Interestingly, because Wall Street doesn’t like the Federal Reserve turning off the “easy money” faucet by raising rates and reducing the money supply (absolutely crucial things they must do to control the crushing price inflation so many families are struggling with right now), it seems that any economic news that looks like the economy is slowing is actually making Wall Street respond positively and sends stocks soaring, and anything that shows the economy is weathering the storm okay is sending the stock market down.
So right now, for most of Wall Street, bad news is actually “good news”, and good news is being treated as “bad news”. In my cynical view, and because nVest Advisors exists to support regular people on Main Street and not rich guys on Wall Street, this seems like Wall Street is actually betting against you and your family, and wants to see more economic pain quicker, only because they want the Federal Reserve to turn their cheap money supplies back on sooner.
As a result, Wall Street seems to be looking for literally any opportunity to second-guess the Federal Reserve’s resolve to restore inflation to its 2% target rate, and is celebrating anytime they see signs that things are bad for your family. Surely, they theorize, seeing pain on Main Street will make the Federal Reserve lose its nerve and “pivot” from its current restrictive policies sooner than later.
We think that is a patently stupid approach to investment strategy for our clients. Your life savings is not a game, and so we’re not going to gamble with the rest of the day traders and CNBC gurus (most of whom have always been profoundly and repeatedly wrong in their guesses). We’re going to let the economy, the ultimate force of gravity in the investment world, dictate our strategy. Thankfully, the economy has no ego, no political agenda, and no reason to lie to us. Economic numbers just are.
Also, there is a longstanding problem of excessive optimism every time a country goes into recession. Analysts have routinely overestimated the economic strength of the country whenever hardship strikes.
This is largely a problem of confirmation bias: we sincerely want to believe things are better than they are, and so we tend to assume the best in most situations. This is obviously more healthy long-term than going through life expecting the worst all the time, but it creates blind spots that people who manage the money of other people cannot afford to go unchallenged.
For example, Wall Street people are in a fairly protective bubble of their peers most of the time, so while the advisors in the room might be feeling more optimistic, the survey of consumers themselves (that’s your family and mine) says things are not going well, right now, or our expectations for the next year.
And since our spending accounts for more than 70% of America’s total economy, if we don’t feel okay spending money, we will bring about the very recession we are worried about. Wall Street believes that the economy can “walk between the raindrops” when economic reality has caught our money experts off-guard over and over (and over)again.
We’re not alone in this opinion. In fact, a handful of financial and media sources are trying to sound the same alarm bells we are.
Ultimately, at the end of the day, all we can control are the investment choices we make for our clients’ models, and let the rest of the industry chatter, posture, strut around proudly for a few days at a time, and then alternately take their frequent Walks of Shame.
To us, your investment success is a long-term endeavor, and reducing your losses is the first thing we are focused on as our economy grinds down into a recession.
Bottom Line:
We firmly believe the United States and much of the rest of the developed world will endure a recession in 2023 and we reaffirm that this week. No one knows exactly when a recession will be declared, but we firmly believe most of the larger economies of the world are right at the door of one now. Recessions can take years to recover from, which is why we believe it is vitally important to get your family and business finances ready to weather through such a storm.
We do believe this week is consequential to the stock and bond markets. We believe the recent rally has fully run its course, and there will soon be a strong shift from stocks and into safer investment options such as corporate and government bonds. With interest rates this high, getting a 5% or better yield, risk-free, is no longer impossible. Once there is consensus that either the economy is now earnestly deteriorating, or the Fed announces the end of rate hikes, the move from stocks to bonds will accelerate.
Whether you are our client or not, you need to consider the broader economy (and much less so the daily market fluctuations) when making investment decisions. The economy is telling us clearly what is coming, and you need to have your investment accounts prepared before that happens.
Use these economic reports, and those of others working in this space, to prepare. You can not only avoid much of the pain that is coming, but you might actually profit from it, if your investments are properly positioned, and you’ve done what you can to shore up your business’ and family’s financial situation. If you need help with this, nVest Advisors has amazingly affordable personal financial planning and fiduciary investment management services to help you.
This is what we do for a living, and we’re very happy to partner with you on that endeavor.
Reach out to us for a totally free financial and portfolio checkup today if you’re concerned about where your finances sit for the coming few years, particularly if you are at or approaching retirement age. We’re delighted to offer you our thoughts. You can schedule that time with us below:
Watching This Week:
- Thursday, we will get updated news on the current inflation rate in the U.S.
- Friday, we will learn the new consumer sentiment numbers from the University of Michigan.
