Powell's crash landing
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Wall Street, we have a margin problem. Shares of Target (TGT) fell by 25% on Wednesday the 18th as their margins shrank by the same amount. TGT margins collapsed due to higher input costs, overstocking and overstaffing. So much for the mantra that stocks are a great hedge against inflation. In reality, inflation is destroying American corporations, the economy and the middle class.
Walmart (WMT) is America's and the world's largest private employer. It's earnings report on Tuesday the 17th had a lot to say about the US economy. The company missed earnings primarily because of inflation and margin pressure. One of the primary drivers for the margin compression was that WMT has TOO MANY EMPLOYEES. The reason is clear: after the COVID stimulus checks expired, these furloughed workers found themselves out of savings and in need of money. Hence, they returned to work enmasse. The key point here is that the world's largest employer is no longer hiring, but instead will be letting workers go. There are over 2.7 million people employed by WMT and TGT.
A weakening labor market would normally get the Fed to turn dovish. However, Mr. Powell and the Fed cannot turn dovish imminently. Nevertheless, Wall Street is still hoping that the Fed put is nigh. But record high inflation is the primary problem facing consumers and corporations. Chair Powell finally understands this. Therefore, the Fed is being forced to adopt the most aggressive tightening monetary policy since 1980. This is precisely because an economy cannot function properly while inflation is extremely high.
In spite of this, the Fed, along with its lackeys in MSFM, are busy trying to convince investors why this current tightening cycle won't end in recession and a stock market meltdown like nearly every other time in history. They hasten to liken this tightening cycle to the one that ended in a soft landing in 1994. The Fed took interest rates from 3% at the start of 1994, up to 5.5% by the end of the year. That total of 250 bps of rate hikes did not cause a recession and is viewed as proof that the Fed's ability to engineer a soft landing is readily achievable this time around. Indeed, GDP growth for all of 1994 came in at a solid 4%. So, will 2022 turn out like 1994, as the perma-bulls would have you believe?
The chances of a soft landing in the economy are near zero--this rate hiking cycle will be nothing like 1994.
Fed Chair Alan Greenspan started hiking rates by 25bps to 3.25% in February of that year. CPI averaged 2.6% during 1994, with a high print of 3%. Three percent inflation is not even close to the 8.3% inflation we suffer today. Also, the 10-2 Treasury yield curve spread was a healthy 150 bps in ’94, which is indicative of a healthy economy. In sharp contrast, the Fed started hiking rates this time around when that yield spread was flat to inverted. In addition, GDP growth was 3.9% in Q1 of 1994. Q1 GDP growth for 2022 actually started out with negative 1.4% annualized growth. Hence, the situation today is one where inflation is much higher and the starting point of GDP is significantly lower than it was during that extremely rare soft landing enjoyed 28 years ago.
Most importantly, the Fed was only raising the Fed Funds rate in 1994 in order to bring down inflation. However, this rate hiking cycle is being paired with a Quantitative Tightening (QT) program that is nearly 2x greater than the previous failed attempt to reduce the Fed's balance sheet back in 2018. Also, the asset bubbles and debt levels seen today dwarf what was in place several decades ago. As Guggenheim’s Scott Minerd points out, the fed has never reduced inflation by more than 2 percentage points without engendering a recession. Mr. Powell is now tasked with reducing inflation by over 6 percentage points. Soft landing, no. Crash landing, yes.
A few recent and important data points need to highlighted. Nonfarm productivity, a measure of output per unit hour of work, declined 7.5% during Q1. That means worker productivity fell to start 2022 at the fastest pace in nearly 75 years. At the same time, unit labor costs soared 11.6%, bringing the increase over the past year to 7.2%, the biggest gain in labor costs since Q3 of 1982. Productivity is how you grow a healthy economy, not by inflation. Mr. Powell, we have an inflation problem.
Hence, the Fed must continue with its very hawkish monetary policy stance until one or more of the following three things occur: back-to-back negative Non-farm Payroll reports; the credit markets freeze (no high yield, commercial paper, CLO etc. issuance) or inflation drops back below 4% on a y/y basis and the m/m increase drops below 0.3%. The latter is your only hope for a significant and sustainable market rally. If the job or credit markets falter first, the market will go into freefall before Powell has time to react. So, the bulls have to hope for inflation rates to drop precipitously within the next few months.
However, the May 11th release of April CPI data dampened the idea that inflation is going to significantly cool off anytime soon. In contrast, the m/m inflation rate is actually increasing. So, the markets and economy are in a race against the Fed. Inflation has to subside imminently--before the 50 bps rate hikes of June & July occur and the $95 billion per month QT program ramps up in September. The economy and markets are already sputtering; and this is before the Fed Funds Rate is above 1% and before QT begins on June 1st. Save the bottom fishing talk for the main stream financial media.
This still nascent bear market will eventually set investors up for a great buying opportunity; but only after inflation becomes fully tractable. That great buying opportunity is reserved only for those who had the foresight to preserve their capital during this bear market (which includes raising extraordinary amounts of cash in the short-term).
For most of Wall Street, who have bought and held the whole way down, there is only a painful crash landing in stocks and the economy with no chance of deploying a substantial hoard of cash once the bottom is in. Whereas investors with their capital intact, will have a better chance to profit once this liquidity crisis is over.
Wall Street’s Inflation/Deflation, Boom/Bust cycles continue unabated. Progressively greater doses of helicopter money and debt monetization should ensure these cycles will continue to grow more dangerous with each iteration. That is really bad news for most investors. But for those who know how to trade these dynamics, it may just provide more opportunities to shine.