Thank god we’re crashing down…but slowly. The latest flurry of data this week is rather telling. Inflation for Oct23 stood at 3.2%, lower than estimates and the 3.7% of Sep23. Production prices continue to drop, while energy price is sagging on weaker demand. Initial and continuing jobless claims both came in above estimates, pointing to a softer job market. Shall we worry?
First, the good news. The glass looks more half full than it looks.
- China-US relationship: defrosting
- Auto-workers strikes: solved
- US budget conundrum: pushed back
- Oil supply-demand: not affected by geopolitics for now
- Economy: cooling down
- Inflation: dis-inflating
- Financial conditions: easing
Analysts start placing bets on when Fed policy rates will start to go down, and those vary wildly. Yields go down in anticipation. Market rallies across equities and bonds.
As already commented here, rate-sensitive sectors are bound to rally the most, namely real estate, small caps, and utilities. Beyond the momentum buzz, fundamentals should find a bottom as/if rates start to go down. But, are they?
Sorry to state the obvious, rates haven’t gone down yet and are still high relative to the previous 15 to 20 years, for both corporates and consumers. The 10-year yield was last this high in Sept 2007, while 3-year mortgage rates at 7.75% were not seen since Sept 2000. I guide any financial analyst, myself included, to look through the window of their ivory tower to note that the economy is feeling the pinch of higher rates.
If google.trends is any judge, it looks like concerns on inflation, and recession are still front of mind, even though they may have peaked. Rest assured that these concerns are way behind those for Bengals Quarter Back Joe Burrow’s sprained wrist.
In and on itself, this new normal could be totally fine. As long as economic growth remains sustainably higher, there is a good argument for higher rates. And a sound one too. No, the problem is not the linear trend, it is the brutal transition. An athlete doesn’t tear up its ACL running in a straight line, but in a knee-jerk move.
I don’t want to sound like a Cassandra, but the day of reckoning is near for business models relying on cheap money, or households & students who were making both ends meet only thanks to a pause on their debt payments.
The good news is that free-cash-flow positive businesses should not mind, and the Magnificent 7 are a case in point. For debt-heavy businesses, there will be meaningful exceptions too. Take uranium miners, or Infrastructure industrials involved in the energy transition. Overall, guilted few will successfully tap new sources of growth in EVs, AI, industrial real estate, microchips, high-end consumer goods…or any combination of those.
The new normal is great, but some will look more normal than others.
Stay safe out there !
360 Advisory LLC is a Boston-based RIA managing investments