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Volume 11, Edition 24 | August 15 -August 19, 2022

Half Full or Half Empty?

Doug Walters, CFA
Two alternative narratives are being pushed by economists: inevitable recession and soft landing. Investors should not get bogged down in predicting which alternative truth will play out.

Contributed by Doug Walters, Max Berkovich, David Lemire, Eh Ka Paw

There appear to be two alternative realities taking shape. This phenomenon has nothing to do with the multiverse or even the metaverse. Instead, it is the diverging economic narratives being shopped around by two camps of economy experts these days.

In one reality, we are in a fight against inflation that will inevitably end in a significant recession. The Fed’s battle with inflation does not have a happy ending within this universe of thought. Rising interest rates lead to a slowdown in the housing market. That is happening, and we already see a dearth of mortgage applications. From there, earnings fall, unemployment claims rise, and a recession ensues. With any luck, inflation is in its tracks, but there will be economic pain to bear in the process.

In a more rosy alternative reality, the fight against inflation proves to be easier than anticipated. Inflation historically is a sticky phenomenon, yet big improvements appear to be afoot. If you have been to the gas pump lately, you will likely have noticed that $5 gas is now closer to $4. Used car prices (a poster child of pandemic inflation) are falling. Commodity prices, like steel and lumber, are down (lumber prices have been down over 60% since March). Optimists are also watching supply chain indices. After all, supply chain constraints were a contributor to the pandemic-era inflation. Here we see notable improvements. The RSM US Supply Chain Index moved into positive territory this month for the first time since the pandemic began (positive is good). The NY Fed’s Global Supply Chain Pressure Index is still elevated (indicating pressure) but falling fast and at the lowest level in a year and a half. All of this might suggest that the Fed’s fight against inflation might be short-lived.

So which of these two scenarios will play out? Only time will tell, and investors need to be ready for either. Even if you guess correctly the economic outcome, you could easily get the stock/bond market call wrong. The stock market and economic market are not the same things. In this very uncertain environment, diversification is paramount. Within a diversified portfolio, opportunities will present themselves over time. Rather than try to predict the future, investors are better placed to take advantage of regular market moves through opportunistic rebalancing and then institute tactical positioning in assets where the evidence points to an overreaction.

In this environment, our go-to evidence-based mantras appear more relevant than ever… do not predict, prepare… embrace science, not speculation.

Index Value: 0.29

The RSM US Supply Chain Index, which measures the health of US supply chains, rose above zero for the first time since the pandemic took hold. A reading above zero indicates an adequate level of supply chain efficiency. Supply chain constraints have been a significant contributor to inflationary pressures.

Headline of the Week

It should have been a week for Fed commentary to dominate with the release of the Fed Open Market Committee (FOMC) July meeting notes (i.e., the “beige book”). But the commentary provided no new nuggets, giving crypto and meme stocks room to grab some airtime.

  • The FOMC minutes reiterated the previously delivered message that data will determine the pace of future rate decisions, leaving the potential for another 75bps hike or smaller if the data so justifies.

More interesting, albeit soap opera-esque, headlines came from our shiny object friends in the crypto and meme stock space.

  • Meme stock Bed, Bath & Beyond (BBBY) was in the headlines again after news sources reported a student investor raking in $110M after the embattled retailer’s shares spiked as the online meme chatter ratcheted up. His timing was impeccable but equally impressive, and less frequently discussed was the fact that he entered the trade with $27M from friends and family.
  • The other side of that story is meme patriarch Ryan Cohen, who was significantly underwater on his BBBY position and used his clout with retail/Reddit investors to push BBBY shares up massively. He then sold out, leaving his fellow meme investors holding the bag and sending the shares down over 50% in two days.
  • Meanwhile, bellwether Bitcoin struggles to find footing following recent declines and the stablecoin shakeup in the world of cryptocurrencies. Bitcoin has fallen over 12% in the past week. The narrative that cryptocurrencies are an inflation hedge or a source of stability has failed this year.

Meme stocks and cryptocurrencies make for good headlines but are not suitable investments. There will always be the potential for fantastic headlines coming out of these markets, but for every $110M made on BBBY, many more have lost their shirts picking up these shiny objects.

The Week Ahead

The back end of the summer and a leisurely trip to Wyoming will be on investors’ minds. While most will not physically travel there, investor attention will, as the annual Jackson Hole symposium is next week.

Hole Lot of Talking

The Jackson Hole symposium is a gathering hosted by the Federal Reserve Bank of Kansas City that brings together central bankers, finance ministers, academics, and financial market participants to discuss economic issues, implications, and policies that impact the topic.

  • This year’s topic is “Reassessing Constraints on the Economy and Policy.”
  • With Chairman Powell’s speech on the docket, everyone will be looking for a hint at “50 or 75” in September.
  • Any indications may be premature with another inflation and jobs report between the symposium and the actual rate decision.
  • Commentary around the $9 trillion balance sheet the central bank wields could be significant.

Looking East

Chinese central bank has a rate decision to make early next week.

  • There is an issue with liquidity in China, and the consensus is that China will cut lending rates. However, there is doubt that the People’s Bank will support the economy more than shoring up liquidity.
  • New loans in China have plummeted, so lower lending rates are necessary to boost demand for loans – the fuel for growth.

Eyes Wide Open

The Personal Consumption Expenditures Index (PCE) release on Friday should fuel debate in Wyoming.

  • The July numbers, if they show decelerating inflation, should help reinforce what another inflation indicator, Consumer Price Index (CPI), told us earlier in the month: Inflation is moderating.
  • Also, Home Sales and Durable Goods Orders are released next week along with another look at second quarter Gross Domestic Product.

Euro Trip

Flash Purchasing Manager Index (PMI) across the pond will also be noteworthy as this survey is considered a good gauge of economic health.

  • The previous month’s Eurozone survey was at a 17-month low and just below the 50-mark, which indicates contraction.
  • Lastly, Wednesday will mark the 6-month mark since Russia invaded Ukraine, or “the special military operation” that the Kremlin calls it.
  • For the record, Oil, Wheat, and Corn prices have come down to pre-invasion levels, but natural gas is still rising.

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