By: Stash Graham
Financial asset prices started the month of January on a strong foot as investors were eager to forget about the prior year’s woes. All asset prices showed strength from the tech-heavy NASDAQ to the 10-year United States Treasury. Optimists’ momentum grew throughout the month as the financial media often repeated the idea of a soft landing in the United States. Even traditional haven investments like gold had a strong month. Considering our strong outperformance last year, the best action is to exercise caution and have the economy show us that it is not ill. We are monitoring several opportunities in sectors that offer great value.
We are a little more than two weeks into earnings seasons, and results have been mixed at best. Perhaps, the most enlightening is the opaque guidance looking out into 2023. Semiconductor giant Texas Instruments mentioned in their call, “as expected, our results reflect weaker demand in all end markets, except for automotive. A component of the weaker demand was customers working to reduce their inventories. In the first quarter, we expect a weaker than seasonal decline with the exception of automotive as we believe customers will continue to reduce inventory levels.” Tech leader Microsoft had their CFO warn of a negative trend coming into 2023. “We are seeing customers exercise caution in this environment, and we saw results weaken through December.” Most discouraging was guidance from MMM, “The slower than expected growth was due to rapid declines in consumer-facing markets such as consumer electronics and retail. A dynamic that accelerated in December as consumers sharply cut discretionary spending and retailers adjusted inventory levels.. we anticipate those trends to continue at least through the first half of 2023.” What is essential about 3M is that they have a wide range of products for various sectors. You need help finding a more comprehensive look into businesses and homes than 3M. In summary, executives from leading companies in different industries are concerned about the future.
The Federal Reserve provided its Beige Book in the middle of the month. The noticeable trend from this recent survey compared to past reports was the amount of regional Federal Reserve banks reporting, at best, slowing or contracting monetary activity (getting loans, making investments). From the Cleveland Fed, “Bankers noted a moderate slowing in commercial lending, and some contacts reported weaker loan pipelines. On the household side, lenders said that residential and auto loan volumes continued to decline as higher interest rates and selling prices dampened activity.” The Richmond Fed illustrated further weakness, “Loan demand continued to be weak across all commercial and consumer loan types. This weakness was being attributed mainly to increasing rates and borrower apprehension about the overall economy.” Perhaps most alarming was the Dallas Fed, “Loan volumes declined for the third reporting period in a row, and loan demand fell further. Business activity experienced a significant decline, and expectations for the next six months are for loan demand and business activity to decline further and loan nonperformance to increase.” When you think about states that should have benefited the most from the last couple of years, Texas should have a strong tailwind and produce positive loan growth. Finally, the New York Fed reported how higher lending standards are impairing loan generation, “small to medium-sized banks in the District reported widespread declines in loan demand across all segments — especially residential mortgages. Credit standards continued to tighten, and loan spreads were little changed except on business loans, where they widened”. These statements do not bode well for the intermediate future.
Conference Board’s index of leading economic indicators (LEIs) declined -1.0% in December after a downwardly revised -1.1% print in November. Why would someone put capital to work at a time when leading indicators continue to deteriorate? The best answer is that coincident and lagging metrics show positive momentum. These increases could provide a simple example of why people are not concerned with the domestic economy. Most of the economic data presented in the news continue to indicate that everything is well. The divergence between the economic indicators has reached extremes we have not seen since the Great Financial Crisis. It is consistent with levels in the early stages of an economic contraction that is coming to its inflection point. We have written about how various LEI models (Conference Board, Variant Perception, ECRI) have been flashing warning signs for the last several months. Indeed there are times when leading indicators, which are more volatile than their counterparts, will flash weakness, and a recession does not occur. Unfortunately, we are at a point where Conference Board’s leading indicators have deteriorated for so long and so deeply that these levels indicate imminent recession. Per Rosenberg Research, “ten consecutive months of declines in the LEI at over a -7% annual rate has been a recession harbinger 100% of the time since the data series began in 1959.”
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