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Good morning and happy Monday! After taking a week off to celebrate Memorial Day, we have two weeks’ worth of data to go through, so this update will likely be a lengthy one. It’s also interesting to watch the stock market rally (in our opinion, foolishly) based on some of these numbers, which clearly are indicating that the economy is slowing down, even if there is some robustness (and disparity) in the labor statistics. I’ll address the current market sentiment head-on and demonstrate why we believe this is neither realistic nor sustainable. We believe as the summer continues, the numbers will begin to surprise, and then panic, Wall Street, and we will be needing to update more than once per week. Check out Jeremy’s (almost) daily economy journal that you can read and subscribe to at “Think Like A Rich Guy”):

• June 4 OPEC Announcement & a deep dive into Energy
• Jobs update
• Stocks are inflated in an unsustainable way
• Production slows but service holds on
• Inflationary pressures persist
• Mortgage and housing update
• Miscellaneous

June 4 OPEC Announcement (& a deep dive into Energy)

On June 4, the OPEC nations announced that the production cuts announced in April would continue through the rest of the year, and Saudi Arabia announced that they were voluntarily cutting another million barrels per day starting in July. This caused oil prices to spike in futures trading ahead of the market opening today.

Watching energy prices is a critical part of the work we do at nVest Advisors because energy prices generally direct the prices of so many other goods and services we rely on. With our central bank fighting inflation right now, even sending us into a recession to do so, having energy prices climb again will cause even more pressure on the Fed to continue to keep rates higher for longer than our investment markets have anticipated.

Oil production cuts won’t dramatically impact inflation only if demand drops faster than the supply, which a serious recession might do. At the moment, we are convinced a recession is coming in just a few months, how deep and painful the recession will be is still up for a lot of debate. We tend to believe it will be more significant than many in the market are expecting.

The problems energy is causing are two-fold:

1) We don’t have supply inventories where we need them, and haven’t since 2021. Current inventory of gasoline:

And although we currently show a surplus of energy, most of that was due to the draining of our strategic petroleum reserves since the middle of last year:

Current crude inventory in the U.S. is dropping rapidly:

And our operating capacity is growing while our refined output is declining. This means we have the ability to make more gasoline, diesel, and other distillates, but don’t have the supply.

A simple solution would be for us to drill and produce more of our own oil, but sadly this is not what the current political environment is permitting.  Oil and gas frac operations are dropping…

Just like our current crude oil rig counts:

2) The second major issue is the need to refill the petroleum reserves after draining them for over a year, in an effort to keep gasoline prices lower by about 15 cents per gallon. The U.S. will need to replenish its supplies at a higher price than they originally thought,  and cannot rely on more output from U.S. companies to do so, as the number of rigs and active wells is dropping. This need to refill the reserves will require the U.S. to compete in the open oil markets for prices, all of which are now climbing due to production cuts in the middle east.

What this means for you

This is a tenuous situation for energy prices, which will make energy companies’ stocks climb again, as well as start to raise the price of production and shipping for many other goods and services. We remain invested in energy companies and broad basket commodities, even though both have declined in recent months based on speculation of a recession, precisely because of the intermediate-term supply problems, the need for the U.S. government to refill its reserves, and the need for many nations to store up reserves for the coming autumn and winter. A recession will decrease the demand for oil because of production declines, but for the summer at least, we anticipate oil prices rising again.

Jobs update

The trend in jobs is largely unchanged from recent weeks, with the exception that May reports showed extremely strong hiring, but nearly all of that was in restaurant and hospitality jobs (seasonal jobs). Tech, manufacturing, and finance in particular saw significant layoff activity.  Initial jobless claims are very low compared to the previous decade, but following seasonal trends:

But this is the 14th week in a row where initial jobless claims climbed compared to the average of the last 3 “normal” job years, 2018, 2019, and 2022.

The bigger story for us is the number of continuing jobless claims. It’s one thing to be laid off, but if it becomes increasingly difficult to replace that job, and you have to stay on unemployment for longer, this is where we can finally get a sign of how the economy is actually working. Continuing claims continue to be low, but the trend is concerning. We started 2023 with the lowest continuing claims, by far, and have now climbed past 2018, 2019, and 2022 in terms of the number of people needing to stay on unemployment benefits week-to-week. 28.2% of unemployment claims continue week to week now, which is the highest percent – by far- since the end of the Great Recession of 2008-2011 (chart 2):

Also, the reason for the job cuts must be taken into consideration. The number of job cuts being reported to state unemployment offices because the business is closing is again significant and is now higher than during the absolute peak of the Covid-19 pandemic.

Will employment get better or worse? One way to know is to look at Job Cut announcements because there is a lag effect between a company making a layoff announcement and the worker filing for unemployment. Most companies give a 60-day notice for a mass layoff situation, and many offer severance packages to affected workers, so there may be a 3 to 6-month lag between a job loss announcement and the filing for unemployment. Current job cut announcements are climbing, but still below both Covid and the great financial crisis, for now:

What this means to you

The job market remains strong but most of the jobs being filled now are low-skill, low-wage jobs. Many of the jobs being touted by our political leaders are actually part-time second- and third jobs for many people, as well as self-employment “gig” work like being a part-time Uber or Lyft driver. As the economy worsens, we strongly believe job losses will accelerate, with the layoffs already announced showing up in the unemployment numbers by late summer.

Stocks are inflated in an unsustainable way

One of the marvels we’ve watched this year is the sentiment of stock market investors as the economic data comes in. Bad news, it seems for many traders, was actually seen as a reason to invest, because many on Wall Street believe the Federal Reserve will “pivot” from their current process of raising interest rates and reducing the money supply in their fight against inflation. If the markets are wrong (and we firmly believe they are), all of these gains can be wiped out in a matter of days or even hours.

I’ve also been amazed (and frankly, disgusted) by Wall Street’s pushing of the “shiny new object”, artificial intelligence. Just like cryptocurrencies, SPAC investments, nonfungible tokens, green energy, and others before it, Wall Street loves to fixate on what it perceives to be the new and disruptive thing, zealously over-investing in anything that looks like it might be the newest trend to try to get ahead. This is where asset bubbles come from, and sadly, since the start of 2023, it’s happened again with “AI”.

First, let’s remember that all sectors of our economy are still trading lower than their highs in November 2021:

But the recent craze related to “A.I.” has caused massive inflows of investment money into companies simply because they announced they were going to begin experimenting with A.I., or even just because their company leaders mentioned “A.I.” in their earnings conference calls last quarter. This massive flow of money into tech stocks has never been seen before, even during the run-up to the 1999 tech bubble burst that caused a significant recession from 2000 to 2002:

I want to make it clear to our clients and readers that this investment frenzy is speculative at best, wild “FOMO” (fear of missing out) gambling at worst, and it cannot sustain itself. Look at the performance of the S&P 500 compared to the index that tracks companies that make semiconductors (needed for AI neural nets):

Another way to see it, is how retail investors are following the craze and buying up AI company stocks in preposterous numbers:

This is causing a phenomenon where just a few companies are pulling up the entire index all by itself. All of the major indexes you’re familiar with (the Dow Jones, the S&P, Nasdaq, etc.) are lists of companies but each company is weighted to impact the index price more or less depending on its market share, company size, etc. This can cause just a few companies to move the index, giving you a false impression that ALL of the companies in the index are doing well.

This is patently false.

If you equally weighted all 100 companies in the NASDAQ 100 (pink line), instead of using the weighted matrix they actually use (blue line), you can see how much just a few companies are outperforming all of the others in the index, dragging up the entire index:

The S&P 500 is even worse. Only 10 companies in the S&P 500 are actually up for the year. The other 490 company stocks are down since the middle of last year. If you were weigh each of the 500 companies equally, you’d have the performance of the pink like for the S&P, but because the big 10 companies’ stocks have rallied so hard on A.I. promises, the index is positive for the year.

10 companies outperforming is only 2% of the companies that make up the S&P. That means 98% of the companies are flat or down based on their earnings. This is not a healthy market to be invested in, as these 10 companies are now grossly over-bought and will correct.

 

You can see it here, clearly: the earnings for the top 10 companies in the S&P are far outpacing the other 490 companies in the index, but their run-up in investor speculation has pulled the entire index higher. This is not sustainable, realistic, or frankly, believable. It’s certainly not a reason to go running back into a stock market on the knife’s edge of a recession:

Let’s go even one step further, to prove my point. Below is a chart showing the stock price of Nvidia (NVDA) which is a major part of the Nasdaq index.  NVDA reported fairly strong earnings at its recent conference call, but most importantly, it announced an intention to become involved in artificial intelligence. The stock price rocketed in a vertical line afterward. This is not a normal or sustainable stock movement based purely on what NVDA MIGHT do in the future, or what success it MIGHT have. But because investors were itching for the newest, “shiny object”, money flowed into the stock in unsustainable momentum. And because NVDA is such a large part of the Nasdaq index, the index rose significantly just on this one company’s stock price jump.

And all of it is based on the speculation of A.I. and the future use of it at NVDA. Nothing real has happened yet. This is not sustainable.

What this means for you

Our investment models remain VERY skeptical of the current stock market valuations. We believe the recent rally is speculative, overly optimistic, and as we’ve proven, has only been because of a very small percentage of the underlying companies outperforming in their stock prices (and all of it because they are touting a commitment to artificial intelligence). This is not a healthy equity market, and our Macro model remains defensively and minimally exposed to only four sectors (tech is not one of them).

Let’s be clear: the markets are being run up not based on improved profits or better economic conditions. They are being pulled up by wild speculation in just a few companies that are promising to venture into artificial intelligence. Here are the actual sale and profit performance results for the different sectors of the economy, and all of them are trending down:

Corporate bankruptcies this year are the highest since Covid and the trend is worsening:

And finally, much of the rally has not been new money coming back into these companies’ stocks. Investment flows are actually very weak right now. The difference is largely the use of highly speculative stock options contracts and day trading, neither of which is “real” or sustainable:

Production slows but service hangs on

We got a number of reports from different parts of the country, all of which show that our manufacturing sector remains in a worsening recession. Our service industry is showing some resiliency, but still far off from the highs of the previous couple of years. Let’s start with Chicago, which if you can see from this first graph, is very tightly correlated with the national average:

 

Chicago’s manufacturing index came in far below expectations, landing very solidly in the recessionary territory:

Next, we have the Dallas region’s manufacturing report, massively below expectations and also deeply in recession:

Followed up by the Richmond, Virginia report, almost twice as bad as expectations, and deeply in recession:

When we composite all of the regions together, we can see that the United States manufacturing sector is now in recession:

This is true also for all U.S. companies, even with operations overseas:

Additionally, orders for manufactured goods have slowed way down. Companies no longer have a backlog of orders to work through (the lowest since the Great Recession):

And new orders, which will give factories work for the  next few months, are also deeply in recessionary territory:

And here is where Wall Street will often get it wrong. If you look at Capital Goods Orders (the black line), you might see a really strong environment, but this is ignoring the effect of inflation on the sales being reported. The blue line shows what is called the REAL (adjusted for inflation) total. Although some companies may be reporting higher sales than last year, they are actually making fewer and fewer products – they’re just selling them for much more than they did a year or two ago. But the actual number of items being made and distributed out of U.S. factories is definitely in decline.

What this means to you

The U.S. Manufacturing sector is in recession. Services are not far behind, even though in the past couple of months, service industries have shown a little bit stronger resiliency. With recessions come layoffs and business closures, which we’ve demonstrated is starting to occur in the Jobs research above. We remain uninvested in most of the U.S. economy at the moment, focusing our client’s money on sectors of the economy most able to withstand a protracted downturn (in small amounts). We believe this will get much worse before we find a bottom.

Inflationary pressures persist

The U.S. Personal Consumption Expenditures (PCE) was released last week, as well. Frustratingly, but not surprisingly for readers of our economic reports, this key measure of inflation came in higher than expected. Core PCE (meaning those things we tend to purchase regularly, like gasoline and groceries) is one of the Federal Reserve’s preferred inflation measures, and this report shows that inflation is “sticky” and risks becoming entrenched into the economy unless the Fed continues to tighten the money supply.

This is a major concern, as inflation is now holding up much higher than the Fed’s own forecasts.

The (mistaken) belief that inflation was beaten and that the Fed would soon be able to change course (or “pivot”, as you’ll hear a lot in financial news) is what caused the stock market to rally since January. But inflation isn’t coming down – it’s remaining stubbornly high, as we’ve been concerned about for months now. This is why our investment models did not jump back into a majority of stock investments – we don’t believe this rally is sustainable because it was based on assumptions that haven’t come true.

The other inflation index (CPI – Consumer Price Index) is also showing a slight drop in overall inflation, but CORE CPI is also remaining very sticky. The black line shows Core / Structural inflation and the gold line shows inflation that is cyclical (what’s affected by the business cycle). Almost all of our price drops so far have come from cyclical factors; core inflation remains very persistent.

One of the primary reasons that core inflation remains so difficult to dismantle is labor costs for companies. Ever since Covid, you can see that the cost to make a product or provide a service in the United States has jumped 11%. Companies simply had to increase their prices, because labor costs climbed so much faster than the traditional line. Killing this upward spike in labor costs is what the Federal Reserve is now trying to do, but the only way to do it is to eliminate the demand for more workers (recession).

Is there good news on this front? Kind of. Expectations for prices in the supply chain for the next six months (dark blue line) are predicting a sharp drop in prices as the U.S. and much of the world drops into recession late this year. That remains to be seen, but it would indicate that price increases will finally halt by the end of the year (in a recession). But so far, we are at the light blue line, not the dark one. We’ll have to see if the expectations hold up.

But for now, the cumulative effect of inflation remaining high – and climbing – is what we’re facing:

 

What this means to you

We do believe there is hope in the fight against inflation, but it will require more work and for much longer than anyone is currently pricing in. In this way, we are a contrarian compared to much of Wall Street, for reasons I hope our readers can appreciate. Whether we are right will only be a matter of time, but all of the data, taken together, give us strong reasons to remain defensive and to avoid much of the chaotic feeding frenzy we’re seeing currently in the equity markets. Inflation is stubbornly high, and it is impacting company profits and families’ budgets in ways that can only harm long-term economic growth. The solution – quantitative tightening and higher interest rates – inevitably ends in recession. Despite so much “greed is good” happening again on Wall Street right now, we remain absolutely convinced that the worst is ahead of us, and our clients have invested accordingly.

Mortgage and housing update

Most mortgage information is released weekly, so this section is well-known to most of our readers.  Once again, we see that despite better new home sales in April, the mortgage and real estate markets are some of the most impacted so far in this recessionary cycle. First, a look at the current 30-year mortgage interest rates, climbing up close to 7%, and near all-time highs for well over a decade:

Government backed loans are seeing the same rising rates:

And as expected, rate locks (mortgage applications that are pre-approved and anticipating a home sale within 30 or so days) are dropping again (black line). Mortgages and home sales had a couple of months of (slight) momentum while interest rates were closer to 6%, but now that they are back up nearly 7%, this is cooling off completely.

When mortgage rates dipped a little back toward 6% a few months ago, we got a spurt of quick mortgage applications and home closings, but higher rates price most people out of the housing market, so we expect to see mortgage purchases and home sales drop further in the weeks ahead. Keep in mind that the real estate market peaks each year in June, and hits bottom in December.

Mortgage purchases are at decade lows, trending down over the last few weeks. This is kind of in line with seasonal trends, though VERY soft overall:

Pending home sales notched past 2020 (an extreme outlier due to Covid lockdowns), but are well, well below the average of the last decade.

And finally, we are very concerned with commercial real estate and believe the biggest part of the coming real estate problems will revolve around it. These are the current vacancy rates in the major business districts of our major cities (and it’s getting worse):

These vacancies are caused by multiple factors: higher taxes in the major cities, rising crime rates, inflation raising rent costs, and the ability and desire of many workers to work from home since Covid, but also the faltering economy is causing this. This will get much worse before things stabilize, leaving many downtown areas feeling deserted.

What this means to you

Housing is going to be more affordable for home buyers, especially as we see the unfortunate effects of home foreclosures that always spike with recessions. Sellers should either sell right now, or wait for the housing market to stabilize. Homeowners should expect to see a decline in property values of up to 30%, depending on where they live, which will slowly rebound after the recession is over. Buyers – this is your time to shine. You’ll soon get the opportunity to buy a property at a much lower cost (though your initial loan interest rate will be uncomfortably high – you can always refinance this later). Our investment models are right now completely divested from the real estate and mortgage industries.

Miscellaneous

Consumer sentiment came down from the month before (chart 1). Expectations for the future dropped, also (chart 2).

It’s very important to watch consumer sentiment because about 70% of our country’s GDP (economic output) comes from you and I spending our paychecks. If we feel confident about the future, we’ll spend more and take on more debt, but if we are fearful, we pull back on unnecessary purchases. Whenever consumer confidence drops to certain levels, recessions have ALWAYS followed. You can see that we are well below the threshold where recessions have typically happened (shaded gray areas):

And finally, what happens to jobs and GDP during a recession? It depends on how hard the landing is. Most economists believe we are headed for a “soft landing”, though we believe it will be much more likely that we experience a “somewhat of a hard landing”. A “crash landing” is the worst kind of recession, and I don’t see that happening yet.

Let’s look at what normally happens during typical recessions:

A soft landing (right side of the chart) will see unemployment climb by as much as 3% and GDP basically flat to down less than 1%.

Hard landings have typically created negative GDP of around -2% and unemployment climbing to around 4.5%.

Crash landings have caused GDP to plummet by as much as 10%, and unemployment spiking by the same amount.

What this means to you

So it’s not the “end of the world” that we are predicting and investing our clients around. But it is a harder landing than the industry is currently expecting (and therefore, hasn’t priced in yet). Our experience after almost 20 years is that Wall Street works in extremes nearly all the time – extreme greed, or extreme fear. I hope we’ve made the case earlier in this post, and in many economic posts in recent weeks, that we believe extreme greed is currently running the investment markets. That can switch in an instant, however, as it typically does, and Wall Street will tell you it was a “surprise” or “unexpected” data point that moves the markets wildly from euphoria to panic.  Our job is to stay focused on your long-term goals and to be as realistic as we can possibly be about the condition of the world around us.

It’s also important that you know that we are not just focused on the U.S., though that’s what our economic updates are primarily focused on. Economies around the world are interconnected now, so we will begin to give you perhaps monthly updates as to the conditions faced by other nations that will have an indirect impact on us here in the U.S.

Bottom Line:

We remain convinced that a recession is imminent, even as the market fights back hard against it. Do not let the current market rally fool you – there is no sustainable way to grow profits (and therefore a supportable stock price) in an economy that is rapidly losing steam. Corporate profit reports are backward-looking and economic projections are forward-looking. Do not be lulled into complacency just because the stock market allows itself to.

We’ve been alerting our clients for nearly two years now that inflation was going to cause significant problems and our central banks would have to take progressively stronger actions to combat it. That appears to be a correct call.

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 predicted the beginning of a turn in the current market rally last week, and we reiterate that sentiment now. There will always be market movement that runs counter to the economic data because markets are much more short-term focused, and let’s face it: until fear takes hold, greed is the prevailing emotional state of most market participants. We do believe, however, that the recent rally has fully run its course, and there will soon be a strong shift from stocks into safer investment options such as corporate and government bonds. With interest rates this high, getting a 5% or better yield, risk-free is becoming a more and more attractive option for investors concerned about the coming economic uncertainty. Once there is consensus that either the economy is 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.

Just this past month, I published an ebook to help you get your finances ready for the recession directly ahead. It’s yours totally free. Just click on the book image to access and download it.

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:

• Jobs Report
• Service Sector Update
• Commodities

The views and opinions expressed in this economic outlook are for information purposes only and are not intended to be financial advice. nVest Advisors, LLC does not provide specific investment or financial planning advice to a client without an executed client service agreement. nVest Advisors, LLC does not trade directly in commodities or cryptocurrencies. Economic data changes rapidly; no warranty is expressed or implied about the reliability of this data once published. Although the information provided here is derived from authoritative sources, we cannot guarantee the accuracy of this information. Please see our general disclosure page for additional details.