The simplest explanation isn't always the correct or complete one 😵💫
The simplest explanation isn't always the correct or complete one 😵💫
Plus a charted review of the macro crosscurrents 🔀
📈 Stocks rallied to new all-time highs, with the S&P 500 setting a record intraday high of 5,375.08 on Friday and a record closing high of 5,354.03 on Wednesday. For the week, the S&P gained 1.3% to end at 5,346.99. The index is now up 12.1% year to date and up 49.5% from its October 12, 2022 closing low of 3,577.03. For more on the stock market, read: 12 charts to consider with the stock market near record highs 📈
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When it comes to understanding new developments in the economy or the markets, the obvious and simplest explanations aren’t always the correct or complete ones.
Consider the impact of higher interest rates. Higher rates are bad, right?
Two years ago, the Federal Reserve began hiking interest rates aggressively in its effort to cool inflation by slowing the economy. Sure, inflation rates have come way down and many economic metrics reflect decelerating growth. But the impact of higher rates has been far less severe than many expected, as reflected by upward revisions to 2023 and 2024 GDP growth forecasts. There were even economists warning of recessions that never came.
That’s because higher rates aren’t only bad. There’s also a brighter side of higher interest rates.
Households and businesses have been earning more interest income on their cash and new bond holdings. From The Wall Street Journal on Wednesday:
Washington has pumped out trillions of dollars in recent years for pandemic relief, clean-energy projects and more, selling Treasurys to finance soaring budget deficits. The snowballing debt, coupled with the highest rates in more than two decades, pushed government interest expenses to a seasonally adjusted annual rate of nearly $1.1 trillion, according to first-quarter figures from the Commerce Department.
That is income for cash-rich companies or Americans who park savings in money-market funds, where 5% annual returns can turn into a surprise five figures…
Andy Constan, chief executive of the investment consulting firm Damped Spring Advisors, said the higher government-bond payouts likely boosted Americans’ overall spending.
According to previous reporting by the WSJ’s Gunjan Banerji, “Investors parking cash in money-market funds [in 2023] reaped around $300 billion in interest income — more than in the prior decade combined.”
Of course, this financial tailwind mostly applies to those with a lot of cash and not too much debt.
In a research note published on Wednesday, JPMorgan’s Michael Feroli cautioned against jumping to the conclusion that higher rates are an obvious net benefit for economic activity: “[I]nterest income effects are only meaningful when the marginal propensity to consume of interest receivers is materially different from that of interest payers.“
Still, he concluded that “interest income flows may boost aggregate demand by a tenth or two of GDP.“
In other words, it’s possible higher interest rates have indeed been a tailwind — not a headwind — for the economy. Or as Yahoo Finance’s Myles Udland characterized it: a “backward problem” for the Fed.
A low saving rate isn’t necessarily a bad thing 💸
While we’re on the subject of household finances, we should talk about the personal saving rate (i.e., the percent of income left after spending money and paying taxes), which at 3.6% is down from its highs and is trending below prepandemic levels.
A low saving rate intuitively sounds less than great. It sounds like people aren’t earning enough to save, or maybe they’re spending increasingly irresponsibly.
Or maybe it’s neither of those explanations.
Keep in mind that the personal saving rate reflects a snapshot of monthly behavior. So its decline doesn’t tell us much about cumulative savings.
According to Federal Reserve data released Friday, households have over $4 trillion in checkable deposits sitting in bank accounts, which is about quadruple prepandemic levels.
And for households, it’s not just cash in the bank. Record high stock prices and higher home prices have helped fuel household net worth to record highs.
If you’re sitting on a ton of wealth, do you really need to be putting away more money?
“Elevated net worth supports a low saving rate,” Deutsche Bank’s Matthew Luzzetti wrote on Monday.
TKer subscribers first read about this relationship last September when Renaissance Macro’s Neil Dutta explored this phenomenon.
“When you are ‘loaded,’ you have less reason to save,” Dutta wrote. “If my stock portfolio is rising and home prices are climbing, I don't feel like I need to be saving as much.“
Zooming out 🔭
All of this speaks to TKer’s rule No. 1 of analyzing the economy: Don’t count on the signal of a single metric.
We’re lucky to have so many angles on the economy. Almost every day, we get periodic updates on things like jobs, manufacturing activity, housing, income, spending, sentiment, and so on. The confluence of these macro crosscurrents make for a rich mosaic on the economy.
Despite months and years of rising interest rates and falling saving rates, the bulk of the economic data has overwhelmingly confirmed consumer spending has been increasing, business investment has been rising, and aggregate wealth has been growing.
Keep this in mind as fear mongers and ill-informed commentators cherrypick data and mischaracterize it to suit their own interests.
For more on this topic, read: A 5-step guide to processing ambiguous news in the markets and the economy 📋
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Related from TKer:
There's more to the story than 'high interest rates are bad for stocks' 🤨
Still waiting for that recession people have been worried about 🕰️
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
👍 The labor market continues to add jobs. According to the BLS’s Employment Situation report, U.S. employers added 272,000 jobs in May. It was the 40th straight month of gains, reaffirming an economy with robust demand for labor.
Total payroll employment is at a record 158.54 million jobs, up 6.23 million from the prepandemic high.
The unemployment rate — that is, the number of workers who identify as unemployed as a percentage of the civilian labor force — rose to 4% during the month. While it’s above its cycle low of 3.4%, it continues to hover near 50-year lows.
For more on the labor market, read: Labor market: How cool will it get? 🥶
📈 Wage growth ticks up. Average hourly earnings rose by 0.4% month-over-month in May, up from the 0.2% pace in April. On a year-over-year basis, this metric is up 4.1%.
For more on why the Fed wants wage growth to cool, read: A key chart to watch as the Fed tightens monetary policy 📊
📈 Job switchers still get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in May for people who changed jobs was up 7.8% from a year ago. For those who stayed at their job, pay growth was 5%.
💼 Job openings decline. According to the BLS’s Job Openings and Labor Turnover Survey, employers had 8.06 million job openings in April, down from 8.35 million in March. While this remains elevated above prepandemic levels, it’s down from the March 2022 high of 12.18 million.
During the period, there were 6.49 million unemployed people — meaning there were 1.24 job openings per unemployed person. This continues to be one of the most obvious signs of excess demand for labor.
For more on job openings, read: Were there really twice as many job openings as unemployed people? 🤨
👍 Layoffs remain depressed, hiring remains firm. Employers laid off 1.51 million people in April. While challenging for all those affected, this figure represents just 1.0% of total employment. This metric continues to trend below pre-pandemic levels.
Hiring activity continues to be much higher than layoff activity. During the month, employers hired 5.64 million people.
For more on why this metric matters, read: Watch hiring activity 👀
🤔 People are quitting less. In April, 3.51 million workers quit their jobs. This represents 2.2% of the workforce, which matches the lowest level since September 2020 and below the prepandemic trend.
A low quits rate could mean a number of things: more people are satisfied with their job; workers have fewer outside job opportunities; cooling wage growth; productivity will improve as fewer people are entering new unfamiliar roles.
For more, read: Promising signs for productivity ⚙️
💼 Unemployment claims tick higher. Initial claims for unemployment benefits rose to 229,000 during the week ending June 1, up from 221,000 the week prior. While this is above the September 2022 low of 187,000, it continues to trend at levels historically associated with economic growth.
For more, read: Labor market: How cool will it get? 🥶
🛫 People are traveling. From Apollo Global’s Torsten Slok: “The TSA has daily data for the number of people scanning their boarding pass with a TSA agent, and it continues to show no signs of the economy slowing down…”
💳 Card spending is holding up. From JPMorgan: “As of 30 May 2024, our Chase Consumer Card spending data (unadjusted) was 0.7% below the same day last year. Based on the Chase Consumer Card data through 30 May 2024, our estimate of the U.S. Census May control measure of retail sales m/m is 0.47%.“
From Bank of America: “Total card spending per HH was down 0.4% y/y in the week ending Jun 1, according to BAC aggregated credit & debit card data. Retail ex auto spending per HH came in at -1.9% y/y in the week ending Jun 1. Y/y spending growth in many categories was likely impacted by the shift in Memorial Day observance (5/27/24 vs. 5/29/23).”
For more on consumer finances, read: Unsettling stats about consumer health are missing the bigger picture 💵
🚗 Used car prices are cooling. From Manheim: “Wholesale used-vehicle prices (on a mix, mileage, and seasonally adjusted basis) were down in May compared to April. The Manheim Used Vehicle Value Index fell to 197.3, a decline of 12.1% from a year ago.“
Falling used car prices reflect the improved supply chains. For more, read: We can stop calling it a supply chain crisis ⛓
⛽️ Gas prices fall. From AAA: “Gasoline prices took another trip south this week, falling eight cents since last Thursday to $3.48. It marks the largest weekly drop of the year. … According to new data from the Energy Information Administration (EIA), gas demand dipped from 9.14 b/d to 8.94 last week. Meanwhile, total domestic gasoline stocks jumped from 228.8 to 230.9 million bbl. Tepid gasoline demand, increasing supply, and falling oil costs will likely lead to falling pump prices.”
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
🏠 Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.99% from 7.03% the week prior. From Freddie Mac: “Mortgage rates retreated this week given incoming data showing slower growth. Rates are just shy of seven percent, and we expect them to modestly decline over the remainder of 2024. If a potential buyer is looking to buy a home this year, waiting for lower rates may result in small savings, but shopping around for the best rate remains tremendously beneficial.”
There are 146 million housing units in the U.S., of which 86 million are owner-occupied. 39% are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
👍 Services surveys signal growth is heating up. From S&P Global’s May U.S. Services PMI: “A return to growth of new business following April's blip supported a marked strengthening of growth in the US service sector in May. … It was not all positive in May, however, with services employment down for the second month running as firms wait to see whether the renewed rise in new business will be sustained before committing to new hires.“
The ISM’s May Services PMI also signaled growth in the sector.
🏭 Manufacturing surveys mixed. S&P Global’s May U.S. Manufacturing PMI improved from the prior month. From the report: “It was pleasing to see new orders return to growth in May following a blip in April. Although modest, the expansion in new work bodes well for production in the coming months. In fact, manufacturers cited confidence in the future as a factor contributing to increases in employment, purchasing activity and finished goods stocks."
The ISM’s May Manufacturing PMI, meanwhile, signaled contraction in the industry.
It’s worth remembering that soft data like the PMI surveys don’t necessarily reflect what’s actually going on in the economy.
For more on this, read: What businesses do > what businesses say 🙊
🔨 Construction spending ticks lower. Construction spending declined 0.1% to an annual rate of $2.099 trillion in April.
📈 Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.1% rate in Q2.
For more on economic growth, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
Putting it all together 🤔
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
Proof that 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 334 large-cap equity funds were in the top half of performance in 2021. Of those funds, 58.7% came in the top half again in 2022. But just 6.9% were able to extend that streak through 2023. If you set the bar even higher and consider those in the top quartile of performance, just 20.1% of 164 large-cap funds remained in the top quartile in 2022. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2023.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
