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What Recession?

Dzmitry Dzemidovich/iStock via Getty ImagesLast week I discussed the balancing act between slowing the rate of economic growth with tighter financial conditions to bring down the rate of inflation and maintaining just enough growth to avert a recession. It is a fine line we must walk to stay on track for a soft landing, but that remains my base case. Investors panicked midweek when the headline inflation number for June hit a new high of 9.1%, increasing the probability of a full-percentage-point rate increase by the Fed at the end of the month to an almost certainty. That sent risk asset prices reeling. Yet the markets staged a huge rebound on Friday, due to a better-then-expected retail sales report for June, as well as forward-looking indicators on the inflation front that tempered expectations of tighter monetary policy. Edward Jones A more pessimistic view of the retail sales report would conclude that the entire gain of 1% in June was a function of higher prices, but the important thing is that consumers were still spending, despite the higher prices. They may be saying they are miserable, but they are drowning their sorrows in bars and restaurants with both discretionary spending categories the largest contributors to June’s gain. This is in no way indicative of a recession, which increases the likelihood that we are still on the path for a soft landing. Bloomberg The underlying strength of the retail sales report was coupled with a decline in longer-term inflation expectations in the University of Michigan’s consumer sentiment survey. Consumers now see prices increasing at a 2.8% annual rate over the next five to 10 years, which is down from June’s 3.1% and at a one-year low. They see prices increasing at a 5.2% rate over the next year, which is down from 5.3% last month. As I have said many times before, markets respond to rates of change, and these rates are moving in favorable directions. More good news came from the assessment of current conditions, which rose to 57.1, due largely to the decline in gasoline prices. Overall, the consumer sentiment index nudged modestly higher in July to 51.1, which is just above the June low. I have discussed many of the commodities falling in price in recent weeks, which should feed into lower prices of goods and services during the second half of this year. The most important of these is oil, which is now resulting in lower prices at the pump. In another development, the supply-chain bottlenecks that led to shortages of just about everything over the past year have now eased in each of the last three months, which should help to further reduce inflationary pressures. Bloomberg Another way to monitor the health of the global supply chain is to track the number of times the word “shortage” is mentioned in the monthly Beige Book survey conducted by the Fed. Here too we are seeing a gradual healing in the form of fewer references to shortages of materials, workers, and other inputs. Bloomberg The most ardent of bears on Wall Street are now turning to second quarter earnings reports for new reasons to sell stocks with expectations for deteriorating margins, due to rising costs and weakening demand. Yet rising costs and expectations for weakening demand are the reasons why stocks had their worst six-month performance to start a year since 1970! The market discounted this news already, and the stock market indexes will start to rebound well in advance of any improvements in costs or demand. I think that is already happening with June marking the low for this cycle. If stocks don’t look back, the inevitably conversion of Wall Street bears to bulls will provide additional demand for risk assets down the road. Bloomberg The performance of bank stocks on Friday is a perfect example. After mixed reviews for some of the sectors largest banks, namely JPMorgan and Morgan Stanley, the sector soared at the end of the week to lead the market higher. Valuations are already reflecting a deceleration in business activity, but the stock prices should start to look forward to a second half and 2023 recovery. Finviz After purging the markets of speculative investment activity over the past year, investment dollars should continue to rotate between asset classes and sectors of the market in search of growth at a reasonable price. I still think the market climbs a wall of worry during the second half of the year, as the consensus shifts its concerns from higher prices to fears of slowing growth. Economic Data Housing market data for the month of June is the focus this week, and it show a softening under limited supply and rising borrowing costs. I will be very interested in the mid-month surveys of manufacturing and service sector managers for signs of economic strength and weakness in July. MarketWatch Technical Picture We look poised to challenge the 50-day moving averages for all the major market indexes this week, especially with a strong start to trading in the futures markets this morning. That would be the first positive development on the technical front in a long time. Stockcharts Continue reading

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Clues On ‘Peak Inflation’

After another set of stunning CPI and PPI reports, not to mention hot jobs growth data earlier in the month, traders are left wondering if inflation has finally reached its climax. As early as March and April this year, many market pundits jumped the gun on the “peak inflation” narrative. Alas, more sizzling data points hit the tape through Q2. Is it different this time? I say probably yes. Just take a look at one-month returns on key commodities. Important agricultural soft products like cotton and wheat are off by more than 20% in the last month while we all know about the steep drawdowns seen in the energy arena – though natural gas has perked back up, crude oil and RBOB gasoline futures are way off their June zeniths. Moreover, the cost to ship goods around the world is in steep decline while “Dr. Copper” has been severely hurt. M/M Commodity Performances Point To A Peak In Inflation Koyfin Charts Perhaps the biggest market “tell” right now is indeed what’s happening with copper futures – a key industrial metal. Earlier this year, the United States Copper Index Fund (NYSEARCA:CPER) rallied impressively, though it did not break out. According to VettaFi, the exchange-traded product seeks to replicate an index that is comprised of a basket of exchange-traded futures contracts. The underlying index is designed to reflect the performance of a portfolio of copper futures contracts, diversified across multiple maturities, fully collateralized with 3-month U.S. Treasury Bills. CPER illustrates the turn from inflation fear to a global economic growth scare. The ETP rallied off its early 2020 lows but then traded sideways for much of 2021 through the first five months of this year. Whenever a chart consolidates as shown below, the key question technicians ask themselves is: Is that pattern indicative of a bullish consolidation or bearish distribution? The answer is seen starkly in price action over the last six weeks. CPER is down nearly 30% from its late-May high. Interestingly, CPER nears support today. CPER ETF Rallied, Then Stalled Before A Recent Collapse Stockcharts.com The move in copper echoes what happened during the middle of 2008, immediately before the onslaught of the Great Financial Crisis. While I was just a college kid trading haphazardly and just getting started investing, the broad market shifted from inflation worries to serious global recession realities at that time. A similar story is bearing out now. So, while some inflation top-callers might sound optimistic, I’m less sanguine considering the alternative could be an ugly economic contraction. DBC Commodities ETF Surged in 1H08, Then Fell As the GFC Ensued Stockcharts.com Something else to watch is what happens with labor costs. The upshot right now is that the employment situation is far better than what was seen in early and mid-2008. After June’s positive NFP surprise, +372k jobs, it’s clear that U.S. consumers still have a few weapons in their arsenal to whether stubbornly elevated retail prices. Moreover, last Friday’s upbeat retail sales data further bolstered a positive demand thesis. While all that sounds good on the surface, it’s inflationary. The Fed no doubt wants to see demand ease and wage pressures soften. June’s Advance Retail Sales Above Consensus Investing.com Finally, the housing market must chill out. While some high-frequency data points to falling prices, the S&P/Case Shiller Home Price Index still shows stout monthly advances. Moreover, rents are at nosebleed levels. Due to a controversial tracking methodology the CPI uses, those high prices (which climbed rapidly over the last two years) will only slowly find their way into the index’s calculation, keeping CPI prints high through the end of 2022. I will be watching more indicative figures like what Zillow and Redfin post. Rents and Owning Costs Keep Rising Bianco Research The Bottom Line Commodities, particularly copper, point to solid disinflationary risks, but wages and the housing market still have work to do to buttress the narrative that a long-lasting decline in the CPI growth rate is imminent. There’s no doubt that we’re near peak inflation though – forward breakeven markets point to a massive drop in the rate of consumer price increases. Breakeven Inflation Markets Show Dampening Inflation Risks St. Louis Federal Reserve Continue reading

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