While Jay Powell and crew are the center of attention this week, for obvious reasons, what was most striking were the comments from a former senior Fed official: Jim Bullard, former President of the St. Louis Fed (he is now dean of the business school at Purdue and was on the FOMC for 15 years). He recently said at a National Association of Business Economists conference in Washington just a few weeks back, “I think they should get going. It’s probably wiser to go sooner and slower.” That is a direct quote — and he added this little ditty: “Policy should be close to the neutral rate by the time inflation is within 50 basis points of 2% to account for the difficulty of measuring inflation accurately.”
That is a big comment from someone who was a policy hawk, but someone who was early on the 2020 recession call and early again on the 2022 inflation call, his track record is actually unparalleled at the Fed, and he still has an influence on Powell to this day. So, something to consider if, after the press statement and dot-plot, rate cuts come out of the front end of the curve or Fed funds futures get whacked initially. Getting close to neutral means getting the funds rate down to 3.0% by the time inflation is down to +2.5%, and the inflation rate right now is +3.2% (it was +6.0% a year ago), and even with the bump over the past two months, at the rate it’s going, we’ll be there by September.
Meanwhile, if we can strip out the shelter components, which we know have nothing to do with the prices anybody is paying for anything, inflation already is running at +1.8% YoY, compared with +5.0% a year ago; and the core ex-shelter is at +2.2% from +3.7%. For all the hand-wringing over the PPI last week, the headline is running at the oh-so-scary year-over-year rate of +1.6% from +4.7% this time last year, and the core is right at +2.0% on the nose and less than half the +4.6% pace this time last year.
So, we can all pull our hair out because of the latest month or two (of what looks to me to be early-year statistical noise), or shift away from the month-to-month gyrations in the data and focus on the big picture because the fundamental downtrend in inflation and core inflation have hardly been violated despite the incredibly long slate of economists out there crying in their soup.
Nothing moves in a straight line, I get that. But the disinflation trend is fully intact. And then we have to consider that inflation is inherently a lagging economic indicator, but it is, in the end, very sensitive to shifts in aggregate demand.
And what do we see on this score? We have this situation on our hands where, with one month to go in the first quarter, real retail sales are running at a -5.6% annual rate, and industrial production is down at a -2.0% pace. Looking at the historical record, both are contracting at the same time in any given month just 17.5% of the time. It happens 52% of the time when we are in recession and only 12% of the time when we are not in recession. So, just as everyone has thrown in the towel on the recession call, we have a proxy for industrial activity and a proxy for consumer demand contracting in tandem, which actually tells you that the recession risk is more than four times the chance of seeing no recession. I mean, what a perfect setup here, since practically everyone now considers a recession to simply be out of the question. But it is creeping into the data.
The downward revisions we have been seeing in payrolls, production, and retail sales have been huge! January’s industrial production was revised to -0.5% from -0.1%, retail sales for January were taken down to -1.1% from -0.8%, and what about those -167k downward revisions in the last payroll report? I mean — what?? Do you know that in the past year, the revisions have been equivalent to nearly 25% of the initially reported number… why? Because the initial survey response rate is down to 40% from what was normally 60% or more pre-COVID-19. And the markets buy into this number even though we know that the Household Survey showed an employment decline of -184k in February and that followed a -31k decline in January, and this supposedly robust labor market has not created one net new full-time job over the past twelve months.
I mean, I feel like I’m Christopher Columbus in 1492 pleading to Isabella and Ferdinand that the world isn’t flat. But everyone and their mother somehow believe that the stock market and the economy are one and the same, but they’re clearly not, and all anyone needs to recognize is that the S&P 500 hit its then-record high in October 2007 as the recession was just getting going almost simultaneously. Back then, only two Wall Street economists, me and Dick Berner over at Morgan Stanley, stuck with our guns. Then look at what happened.
Nobody is paying attention to these downward revisions, which tend to always happen at turning points in the cycle, and which is not just a testament to how poor the data quality is on the initial release but also how this soft-landing view is predicated on statistics that clearly are spurious. No recession except for the fact that real GDI was flat over the past year, production is down -0.2% YoY, real retail sales are off -1.6%, and growth in full-time employment swung negative year-over-year last month for the first time since March 2021. We run our own in-house Nowcast model, with 190 macro inputs, and it is currently flashing a -1.4% real GDP pullback in Q1 (at an annual rate). Let’s see what the Atlanta Fed measure does next — it was already trimmed to +2.3% from +3.2% last week, but something tells me it has a lot further to go. The St. Louis Fed comparable is already down to +1.2% from +2.2% a month back, and over this time, the New York Fed has pulled back its estimate to +1.8% from +3.3%.
When you look at what the aggregate supply curve is doing (the sum of labor force expansion and productivity growth), it is expanding at a +3.3% annual rate, so even if you buy into the Atlanta Fed number, aggregate demand is running well below aggregate supply. So, yes indeed, we hit a bump in the CPI and PPI data these past two months, but there is not a construct in theory or practice when supply growth is front-running demand growth by this much that is inflationary. And what it means is to ignore the inherent volatility in the price data and respect the fact that the pressures on inflation are indeed still in the process of subsiding and, while there is a whole lot of “new era” thinking going on today on Wall Street, the one thing that has not been repealed (and never will be) are the laws of supply and demand.
Every market-clearing price balances supply and demand, an interaction that has been with us for thousands of years. Adam Smith’s three laws of economics were (i) the law of self-interest, (ii) the law of competition and (iii) the law of supply and demand. It’s amazing to me how folks in medieval times are more aware of this incontrovertible fact than most of today’s market and macro pundits who populate Wall Street research houses. That’s all we really need to know.
For stocks, this is purely and solely a momentum driven market — and as such, is not really providing any information on where the economy is heading. The stock market is not the economy, especially today. This is a highly speculative backdrop, and a market that’s driven exclusively by price momentum is not one that may care if a recession commences… this may be the first time where the S&P 500 just keeps hitting new highs even as the economy turns down.
To show just how much is priced into the S&P 500, we estimate, based on normalizing the forward P/E multiple benchmarked against the risk-free rate, that the market is effectively pricing in +45% EPS growth for this year. That is a 1-in-30 event. We have now gone through 269 trading days without a -2% drawdown in the S&P 500 — we have to go all the way back to February 21st, 2023. The S&P 500 has also managed to notch gains in November, December, January, and February, and even with the positive seasonal influences, this has just happened 16 times since 1928 — call it a 1-in-7 event. Another milestone recently reached was 17 record closings so far in 2024, the most for any start of the year since the onset of the last tech bubble in 1998. Then tack on the fact that the highest-momentum stocks in the index have seen their share of the market cap soar to more than +30% over the past year — a development that occurred in 1929, 1973, and 2000.
Call it a case of Wile E. Coyote never looking down!! It is indeed a Wile E. Coyote market. That’s what I’m labeling it.
David Rosenberg is founder of Rosenberg Research, and author of the daily economic report, Breakfast with Dave.
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David Rosenberg