Welcome to the Upside Down Market
The Fed Has an Employment Problem and a Data Problem where the good is bad and the bad is good.
Cartoons of the Week:
What is the Upside Down?
The Upside Down is a fictional reality in the hit TV series Stranger Things.
The name “The Upside Down” is a name given to an alternate dimension that mirrors our world — or at least our world if it was a toxic hellscape overrun with creepy, moving vines, filled with murderous creatures linked together in a hive mind system, and is constantly experiencing electrical storms.
In the current upside-down world we live in in the markets, it seems the market is hoping and praying for bad data and selling everything on any sign of positive data.
Let’s take a look into this weird upside-down market we are currently in….
Economic Data Not Painting a Pretty Picture
On Tuesday, the monthly reading for consumer confidence came out, declining for the second month in a row.
This measures how you as a US consumer feel.
As you can see below in the blue line, we have seen a steady decline since 2018 ex-COVID.
Looking at a similar indicator released at the same time called the Sentiment Index, we get even an uglier picture. This indicator measures how consumers feel about the economy, their personal finances, business, and buying conditions.
Clearly, we, the US consumer, are not feeling good about the economy at the moment (the blue line has only been this low - meaning you as a consumer are not happy - only a handful of times - usually in a recession or dramatic downturn).
This reading is to be expected, especially when you see the data on Pending Home Sales, which came out the following day.
Pending Homes Sales declined year-over-year the most on record, down 37%!!!
Homes are the average person’s biggest asset, so when they see sales plummeting, that can have a negative effect on their spending habits.
(Pending Home Sales YOY Worst Since Records Started in 2000)
It seems the sentiment in real estate is turning negative very quickly. Historically, real estate is the first sector to feel the pain of rising rates. This data does not bode well for everything else over the next 12-18 months.
Talking to a closing title agent last week, she has never seen her business this slow. She said she is scared; really scared about her business going into 2023.
Yesterday the ISM Manufacturing data was released. This is the biggest measurement of manufacturing data around the country.
This index contracted for the first time in 2.5 years, falling to a reading of 49. Measured on a scale of 0-100, with anything above 50 measured as growth and anything below 50 as contraction, we are currently seeing a contraction in manufacturing around the country.
The Market is Different Than the Economy
These three data points paint a clear picture of what is happening at the moment. We are seeing a significant slowdown around the world and the average consumer is scared.
On the back of all this negative information, the market did what you expected it to do.
It RALLIED!!!
Wait….What…Why?????
Common sense would tell you that if we get negative news on the economy, then the market should go down on that news.
But we are not in a normal market. We are in a market where negative news is positive and positive news is negative.
Why?
The Market is Trading on Hopes of a Fed Pause
As we have talked about all year HERE and HERE, the Fed’s primary goal is to try and make you feel poorer. If you feel poorer, you spend less. If you spend less, demand for goods goes down, companies cut back, and we get inflation lower.
Inflation lower means fewer rate hikes, less Fed tightening, and more opportunity for the Fed to start cutting rates. If the Fed cuts rates, the market sees liquidity increase and the markets will rise. That is the game at the moment…(Sadly, right now, the Fed is the only game in town. It is very sad. The market is like a drug addict looking for the next fix. This is the reality of the markets after 10-plus years of emergency stimulus.)
I discussed at the beginning of October HERE and the middle of October HERE, I think we probably have seen the top of inflation and as a result, the market will rally on the prospects of lower inflation (which means maybe fewer rate hikes).
Well right on cue, the markets rallied nicely in October, up over 8% on the S&P 500.
And as we close out November, we again saw a fantastic month, with the S&P 500 up over 5.50% in the month.
Both of these months have seen higher returns because of a stream of negative data releases combined with lower inflation data.
.This morning we got some positive news. The jobs report showed an unexpected rise in new jobs, keeping unemployment at 3.7% and seeing hourly earnings double expectations.
As Michael Feroli of JP Morgan said this morning:
“The job market keeps humming along, adding a larger-than-expected 263,000 jobs in November, which was little changed from the prior three months’ 282,000 average monthly gain. Perhaps more alarming from the Fed’s perspective was the 0.6% gain in average hourly earnings and the 5.8% annualized gain in earnings over the last three months (after upward revisions).
While today’s report clearly has hawkish implications, it still seems as though 50bp is locked in for the December FOMC meeting; the bigger question is what follows. We had assumed they’d step down again to a 25bp tempo at the Jan/Feb meeting, but with only one more jobs report between now and then they may not have the justification for that until March.”
The market did not like this positive news. As you can see in the weekly S&P 500 chart below, the market sold off hard on this release (big red bar lower on the right-hand side).
Normally higher wages are a good thing. It means you are making more money than the year before. But in today’s upside-down market, seeing the hourly earnings move higher is a negative for the stock and bond market. It gives the Fed more ammunition to continue to raise rates.
Welcome the upside-down market.
So What Is Next
So here we are. Clearly seeing a slowdown in the economy but at the same time a very robust and hard-to-break employment market.
I am afraid that the Fed will focus mainly on the employment data as we enter 2023 at the expense of other data. As we talked about HERE, since the Fed is the ultimate leading indicator and they are using the biggest lagging indicator as their judge on rate levels, it is to be expected by the time we see a slowdown in unemployment, the economy will be worse off.
I am focused on seeing the market reverse this trend of bad news being good news and good news being bad news.
I suspect as we enter next year, inflation will come in at a more moderate level, changing the market’s focus on inflation and the Fed and switching its attention to the consumer and earnings (as I talked about HERE), both of which need to stay positive for us to get a real push higher.
Next week we will do a recap of what happened in 2022.
The following week I will publish a 2023 outlook and give you some observations on what may happen in the markets next year.
Then the week before Christmas I will make my last write-up of the year where I will publish part 2 of my series on US Energy Policy. I published part 1 last week. You can find it here titled, “Why High Gas Prices are Here to Stay”.
I hope you all have a wonderful weekend!!!
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