A Note from Jeremy, CEO/CIO:
Happy Monday! We are watching the markets come down sharply this morning after last week’s Fed FOMC meeting, in which Chairman Powell stressed that the Fed wants to see more progress on inflation before any real talk of interest rate cuts will be considered, and Mr. Powell’s reiteration of that plan last night in a public interview on CBS’ “60 Minutes” news show. We’ve warned our clients and readers since 2022 of the very real likelihood of a recession based on the Fed’s actions, and have been warning about the stock market being preposterously and unjustifiably over-bought since November of last year, when investors fully priced in SEVEN rate cuts (out of a total of eight Fed meetings) in 2024. I have stressed repeatedly that the markets got far ahead of the actual economy and investors were piling in, quite literally, on what I can only describe as false hope. As I mentioned in our post last week:
“…the U.S. stock market has not followed the economic trends, with alarming implications for investors who are following market sentiment instead of the reality of the economic conditions upon which companies must build and grow their businesses. Sentiment simply means emotional response and collective intuition, and market participants tend to make decisions not based on reasoned research, but on where the herd is running. It is very easy to “run with the bulls” – we instinctively want to do so – even when the cliff’s edge is directly ahead…
“…As the CEO and CIO of nVest Advisors, I have been cautioning our clients for over a year about deteriorating economic conditions, and many of our clients have placed their funds in our protective defensive models as we anticipate a significant pullback in equity prices ahead of what looks more and more like an inevitable recession. “The market”, particularly in the last 3 months, has gone the other direction, to what I consider absurd and unsustainable highs.
“…Rallies based entirely on hype and hope and “hidden meaning in Fed comments” cannot be sustained.
“The market is currently “buying the rumor, and selling the news,” which is a terrible strategy for anything but casino-style day trading.”
The gravity of economic reality, combined with the dashed hopes of investors this morning for lots of rate cuts in 2024, is now weighing heavily on the equity markets. As we write this, the DOW Jones Industrial Average is down over 415 points to start the day.
I made a longer argument for why I expected to see significant market corrections last week in the blog. I encourage you to read it for more detail.
The market is also weighing the absolute meltdown overnight in the Chinese equity markets. For all of the economic concerns we have here in the U.S., the world’s second-biggest economy is in far worse shape. Chinese equities were down over 8% overnight until central authorities in China stepped in and started restricting stock sales for domestic institutional investors, but the index still closed down over 6%. (For comparison, an 8% single-day drop in the DOW JONES Industrial Average would be approximately 3,000 points down from its current levels.)
Since Chinese real estate companies started failing back in 2022, we have avoided long exposure to China in our own investment models, but investors should look carefully at the contagion in their own portfolios. The main reason China’s economy is failing is because the rest of the world is slowing down, and China depends nearly entirely on exports to support itself. When we stop buying, no one in China has anyone to sell to.
I’ve said many times that the recent stock market rally was a fallacy, anyway. In fact, it was only 7 tech stocks that had a great 2023, but those 7 companies were large enough to drag up the entire index. Nearly all of the rest of the economy had negative stock returns last year.
The following chart shows clearly that the “rally” of the last three months was not broad or widespread, and that except for only a few companies, profits are dropping rapidly for most of the companies in the U.S. Here, the “Magnificent 7” tech stock companies all revised their previous quarters’ earnings higher, but the remaining 493 companies that make up the S&P 500 (the gray line), revised their earnings per share DOWN by 15% on average.
This is NOT a sustainable rally. It’s not even a MARKET rally. This is a MAGNIFICENT 7 RALLY. And the major players in Wall Street know it.
One of the things you need to keep a watch on is where the “big guys” are in terms of sentiment. Are the institutions buying or selling? As of last week, institutional investors were dumping stocks at a very large clip (and have been all year):
(I should note that most of the “Corporate” stock buying in the graph above was stock buy-backs – companies buying their own stocks back to boost the price in the market.)
As we do our jobs for our clients each day, you need to know our rationale for the decisions we make. Right or wrong, there is tremendous effort put into assembling and interpreting the data, both in isolation and how they interconnect to tell us a bigger story. The markets will do what they do, but the economy is the foundation of the entire house and is the “lighthouse” by which we try to steer your assets away from the rocky shores of speculation and wild swings in market sentiment.
We’ll never be perfect at it – no one in this business is – but we will continue the process of study, learning from our mistakes and correcting the course a little bit at a time, for your benefit.
Have a wonderful week.
- Jobs Update
- Real Estate Update
- Housing Update
- Inflation Update
The Bureau of Labor Statistics (BLS) released their monthly Establishment Jobs report last week. It was a positive blow-out. The government claimed that more than 350,000 jobs were created in January, and also upgraded their estimates for several previous months, as well.
This report took nearly every economist by surprise, and for good reason: nearly every other measure of employment is showing the exact opposite.
I have two major issues with the current BLS data. First, it is politically manipulatable, and we are in an election year. The BLS is part of the government’s Executive Branch, and therefore, may have inherent bias to make things look as optimistic as possible going into a year in which the incumbent President, their boss, is up for reelection. The BLS data used to run very closely to the other metrics, until 2021 (that graph is below), when it completely decoupled from the data and always presents a very positive view of the job market. I therefore look for correlation with all the other measures of job gains and losses, and discard the outliers. At this point, the BLS data is the outlier.
The second reason is that the BLS data is not based on actual headcounts or survey data (as most of the other jobs reports are), but is instead created using computer modeling.
Let’s look at these other job measures in a little more detail. First, here’s a composite graph of other jobs estimates for January, nearly all of them are based on actual counts of jobs and changes to payrolls. All of them placed January far below the BLS:
The primary challenger to the BLS Establishment data has always been the Household Survey, which as the name suggests, polls actual families and asks what their employment situation is for the prior month. The Household survey (purple) shows substantial deviations from the Establishment Survey, specifically since mid-2021. While the BLS showed robust hiring in December and January, for instance, the Household survey in December showed the biggest number of job losses since Covid, and a net negative for jobs in January:
Here is another look at the difference between the Establishment Survey and the Household Survey. Note when they disconnected from each other. You can see that while the official BLS computer model shows slow, steady growth, households are reporting a totally different experience. There is now a discrepancy of more than 9 MILLION jobs between what the government claims are out there versus what actual families are sharing with surveyors:
We also learned from the BLS survey that nearly all of the jobs created in 2023 were government jobs. In fact, private sector jobs DECLINED significantly throughout the second half of the year.
And when we ask the workers themselves how things are going at their companies:
Now let’s look at actual unemployment claims being filed in the States. Initial claims jumped unexpectedly in January:
…. but as I’ve written about repeatedly over the last two years, the CONTINUING claims is what you need to watch closely. It says one thing about the economy when people lose their jobs, but it says another thing entirely if they can’t quickly find another one. Continuing claims, while still on the low end of the spectrum historically, jumped also, quickly crossing 2019 and 2020 in headcount of people who could not find a new job quickly, and had to remain on unemployment benefits for an extended period.
It is also starkly against the seasonal trends – hiring tends to improve at the start of each year, but this year, it’s going against the trend of the entire previous decade:
We can also track new job postings on websites like Indeed.com. In this case, we can see that the number of jobs being listed declined all of last year, at a rate worse than right before the Covid pandemic. In all categories, job listings are down from 15% to 50%:
We also have a tracking of companies as they announce layoffs. In January, 82.300 jobs were cut (thousands more have been cut since this report was issued). In all of 2023, there were only 224,000 layoffs; there have already been 37% of that number, in a single month of 2024:
And finally, here is confirmation of the decline in employment from the Manufacturer’s Survey, where the actual companies are asked if they are currently hiring or letting workers go. Again, this completely refutes the BLS labor estimates for January:
Another measure we can watch is the number of job openings employers say they can’t fill because they can’t find a qualified worker (meaning, hiring is really strong and there just aren’t enough workers to go around). That’s the blue line in the graph below. The red line is the national unemployment rate. There is an INVERSE relationship between these two numbers, meaning whenever employers start saying that they ARE able to find workers with relative ease, the unemployment rate is about to jump up.
Right before recessions, both lines quickly reverse course. (In fact, since 1975, this occurrence has always predicted that a recession has either already started or was imminent, without fail. If history is any guide, unfortunately, layoffs should start rising rapidly in the coming weeks.)
One thing that has historically happened before mass layoffs is that workers will find their hours cut. This is because employers don’t want to have to lay people off until business conditions force them to. So as the new orders for their products and services start slowing down in the early days of a recession, we often just see a decline in the number of hours people are working each week. It is only during the first third of most previous recessions that we see the actual layoffs spike up dramatically.
So while the BLS claims that hiring was robust in January, their own reports show that the hours people are working have declined rapidly in recent weeks. This gives us yet another very important bit of evidence that an economic slowdown is underway (source: BLS):
This is in part explained by the BLS survey. Over the last year, we’ve lost 97,000 full time jobs (career, benefits, etc.) but created 870,000 part-time / gig – type jobs:
In fact, in just the last rolling three months, full-time employment has dropped by nearly 1.4 million. That hasn’t happened in history except for a few instances during major recessions (shaded red areas):
So as an investment manager and economist, I am faced with either believing the government hiring computer model (one that is constantly being revised downward months later), or the numerous other data points on employment (most of which are based on actual counts and not estimates). At the moment, they tell an entirely different picture of the job market. Either the BLS data is wrong, or all of the other measures – collectively – are wrong. Until we see congruence again, we have to discard the outlier and work with the preponderance of the evidence we have.
What this means for you
We continue to watch employment for a number of reasons. First, and most obviously, employment tends to give you an inside look at the overall financial health of a company, industry, and economy. But also, when unemployment spikes (and it does indeed spike it doesn’t usually just creep up, as the chart above demonstrates), it can happen very quickly. That loss of income will immediately impact spending and credit payments, which is where the recessionary pain really comes from.
Employment is a lagging indicator. It is not logical to watch for unemployment to change before you alter your investment risk profile ahead of economic challenges. We believe we have already positioned our clients properly for what Wall Street will always claim is a “surprise” or “unexpected” spike in unemployment, because we have no reason to believe this business cycle will be substantially different than prior ones.
Real Estate Update
We hit the real estate markets very regularly in this space, so this week I will only point out that, while following seasonal trends following the Christmas and New Years holidays, mortgage applications climbed slightly in January. We are still at the lowest point for mortgages since approximately 1995, and certainly, as the graph below shows, the lowest in the previous decade:
But part of the economic optimism of late has been the idea that interest rates would soon be dropping, and with them, the rates for mortgages. This gave a lot of hope to mortgage brokers, homebuilders, realtors, and even consumers desperate to refinance current high-rate mortgages or buy their new home.
The challenge is, that interest rates are not likely to drop anytime soon, and the market is starting to figure that out. In fact, mortgage rates have climbed back up to nearly 7% nationally in the past week. Here in our home state of Colorado, a 30-year mortgage on a $350k home with a 720 credit rating is currently at 7.512% and climbing.
What this means for you
We believe there will be continued pain in the mortgage and real estate sectors, particularly in commercial real estate investments where office space is a high percentage of the assets. A large number of people who bought homes in 2021, 2022 and 2023 did so in the hope of a quick refinance to a lower rate as soon as the Fed pivoted. However, with inflation running well above the target, and inflationary pressures resuming, this may not happen very quickly. Additionally, a large number of investors in homes for short-term rentals (think AirBnB) are starting to struggle with fewer and fewer bookings, and cities and counties starting to restrict or even ban these kinds of uses of residential property. We believe a large number of the homes currently listed on AirBnB may, in fact, return to the market as they prove to be harder and harder to achieve profits.
If you are in the market to buy a home, we urge patience – we believe that both house prices and interest rates will decline in the coming months.
Most of the recent market rally has been based on the notion that inflation has truly been beaten and the Federal Reserve will now begin to lower interest rates. It’s a rally based, again for the fifth time, on a narrative that so far has not been true, and ultimately reverses.
So is inflation finished this time? We don’t believe it is. Inflation tends to run in waves over successive years, each wave slightly higher than the one before (because after each wave, you’re still slightly above where you started). We therefore have said for months now that the Federal Reserve will likely have to hold interest rates high, or even raise them slightly from here, in order to make sure inflation is truly crushed.
Even Fed Chairman Jerome Powell tried to warn the markets last week that inflation was likely not finished, a warning that market participants, hell-bent on a “Santa Claus” rally to end the year, ignored. We not only heed his warning; we’ve been saying the same thing for months.
The evidence of inflationary pressure resuming is easily seen in this composite graph of other indexes. In each instance, the lower inflation trend of late has reversed and is headed up again.
Of note: oil prices have continued to climb in recent weeks, and as we say here often: where the price of energy goes, so goes the price of everything else:
This was partly explained by the surprise, dramatic revision in the actual supply of oil in the United States last week:
The Middle East conflict grew in intensity last week, as the U.S. started attacking terrorist encampments in Iraq, Yemen, Jordan, Syria and other locations. This was in response to missle and drone attacks on our bases and on military and commercial shipping in the region. As a result of this hotbed of active combat, most shipping companies are steering clear of the Suez Canal and the Red Sea as shipping lanes between Asia and Europe and northern Africa. They are opting to traverse the entire way around Africa, which has dramatically slowed shipping and more than tripled its cost. This will add further increases to inflationary pressure in the short- to mid-term. Here is the traffic through the Suez Canal, which normally accounts for 12-15% of all global trade:
Inflation might improve a company’s short-term profits but it will wreck its long-term success. Paying more for fewer and fewer products and services is not economic growth. The black line below shows the purchase of actual items – manufactured things – at current prices, but if you remove the recent price hikes due to inflation (the blue line), you can see very clearly that we are buying less and less with the money we do have.
Let me address a few more economic data points that weigh on our investing decisions that don’t neatly fit into some of the other categories. This week I want to look at other indications of financial difficulties in the country, that have in all periods of the recent past, resulted in a recession we firmly believe is imminent, and investors should take caution to prepare for.
First is an indicator that measures the economic activity in each of the 50 United States. The graph shows a count of the states with a current economic slowdown underway. We currently have 30 states – 60% of the country – in recession already. If you look back across the graph, anytime we had a measure above 50% of the states showing economic slowdown, we had a recession:
Another sign that things are hard for families is the amount of theft taking place in retail stores. This is partially internal theft by employees but is mostly the result of shoplifting, not ringing everything up at self-checkout lanes, etc. Some people steal because they have the opportunity, but most people resort to stealing when they have no other option:
Why would theft now be something consumers are increasingly resorting to? One major reason is, our expenses are so high from inflation, we’ve run out of savings:
People are putting more and more on credit to maintain their current standard of living, and even that is now coming with a price. As interest rates have climbed, inflation continues (albeit at a slower pace than the previous two years), we can see the rate of default on debts climbing, as well:
And yet, the market rallied hard in the face of a decaying economic outlook. This also has historical precedent, particularly when the largest companies rally strongly against the rest of the market. What we have never had in history has been such a disconnect between the economy at large, and a few favorite brand names getting all of the market attention. This simply MUST correct:
What this means for you
We do not believe there will be any way out of the current economic conditions without a recession, and we believe the groundwork has been laid for this recession to be harsher and longer than many economists currently believe. In fact, there is a minority but growing consensus that there will not even be a recession, which we categorically reject. The data, as we try to show our clients and readers every week in this space, tells us anything but a recession can be avoided.
We hate to “doom and gloom” in this space, because we’re ultimately optimists about the future. But we must be realistic and willing to confront data that tells us that, at least in the short term, things will get worse for our economy before they get better.
Wall Street is starting to figure out what we’ve been telling our clients for more than a year: the economy is headed for rocky shores. Today’s stock market is the first leg down in what we predict will be many more as reality sets in. We are patiently on the sidelines for most of our clients’ assets for now, ready to take the opportunity to reinvest once the market has come down to realistic price levels.
Download our brand-new E-Book “7 Hacks To Recession-Proof Your Financial Life” today.
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. No one knows exactly when a recession will be declared, but we 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 movements that run 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 of Wall Street. We do believe, however, that the recent rally has fully run its course, and the shift from stocks into safer investment options such as gold, cash, and government bonds will continue. 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.
Almost a year ago, 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:
Our Economic nSight articles are typically 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. It is copyrighted and may not be republished in whole or in part without written permission.
At nVest Advisors, we believe that successful investing depends on an understanding of, and correct response to, changes in the world economy as they happen. We incorporate real-world economic conditions into almost all of our investment models and strategies at nVest Advisors, which we believe provides significant benefit to our clients’ overall investment returns by reducing various short-term market risks and enhancing portfolio performance over time.
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