by Franklin J. Parker, CFA
The Summary
- The Federal Reserve was the big news last week, posting a 0.50% hike in the federal funds rate. More importantly, they announced a plan to begin shrinking their ~$9 trillion balance sheet by allowing $47.5 billion per month of bonds mature. In short, this “destroys” about $47.5 billion worth of dollars every month. In September, the plan is to increase that to $95 billion/month. Markets reacted positively to Powell’s dismissal of a 0.75% rate hike, but this does mark the beginning of a tightening cycle and history shows us that we get 18 to 24 months of tightening before the next recession hits.
- This week we get inflation data (fingers crossed!) and consumer sentiment. Both figures could be market-moving, and consumer sentiment will be key. To date, consumers have continued to spend—any sign of that faltering would likely be a prelude to a recession.
- Earnings continue to be pretty good. It appears the S&P 500 will post 10% earnings growth. Of course, that is not distributed evenly. Energy is seeing enormous growth, while consumer discretionary is seeing a 30% contraction in earnings. Technology has seen 13% growth, but has suffered at the shift in Fed policy. Many of the valuations that were supported by low interest rates and ongoing money-printing have come back to earth (though are still high by historical standards).
The Details
My investment philosophy centers around two things: first, an understanding of individual goals—what is it that you need doing? Second, I spend a lot of time and energy trying to understand where we are in the business cycle, and allocating investments accordingly. Of course, that adds some risk to a portfolio (the risk that we get it wrong), but it is a philosophy that has served us well so far.
As I look at the fundamentals of this economy, there are several indicators that are showing we are likely in the final phase of this very short business cycle. If I had to put a timeline on it, I’d say we have 12 to 16 months before a recession (at least, that is based on today’s data).
This is, of course, a difficult economic environment. There appears to be ample demand in the economy—people and companies want to buy things—but there is an ongoing shortage of supply. This supply bottleneck has been exacerbated by supply-chain problems (backed-up ports, shipping costs and shortages, even warehouse space for containers), and also a dramatic shortage in labor.
Last week, job openings hit an all-time high of 11.5 million. Unable to get goods and labor, many businesses are simply constrained on their output. This applies often to service business, especially, which are some two-thirds of the US economy. The “raw material” of a service business is, ultimately, labor.
The economic indicators, then, are somewhat mixed. On the one hand, demand is strong, so a focus on those indicators would seem to indicate a roaring economy. On the other hand, supplies and labor are short, so a focus on actual transactions done would seem to indicate a faltering economy. In a sense, this is good news—if supply and labor problems are resolved, the increased supply would likely be met with instant demand and the economy would lurch forward.
Inflation, of course, could begin destroying that demand, in which case a recession wouldn’t be far behind.
In any event, close attention to ongoing developments in the data is absolutely key for investors wishing to adjust allocations with the business cycle. And, as I have repeated numerous times, flexibility is key.
Chart of the Week
Last week, the job openings level posted a record 11.5 million job openings, and the quit rate also hit a record. Adjusting for the size of the total population shows just how dramatic the current situation is, although it is the culmination of a post-2020 trend, with enough job openings to employ 3.5% of the US population.
This is another indication of the constraints facing the current economy. Without labor—especially in higher-skilled fields—many US businesses simply cannot meet demand and that limits economic activity.
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