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Market Volatility to Continue – It’s the Economy (Stupid)!

Financial market volatility continued this past week (ending March 3). The equity indexes were up about 2% for the week (the Nasdaq slightly more) after shedding nearly -3% the prior week. They don’t seem to be able to make up their minds as to their direction. It’s a similar story for the fixed-income markets. The 10-Yr. T-Note ended last year at a 3.88% yield, which fell to 3.40% by the end of January. Then it pierced the 4% level (4.07%) on March 1, falling slightly to close the week (March 3) at 3.96%. Such volatility is not a wonder considering the mixed data signals from the economy. On the one hand, the latest headline data (GDP, Payrolls, Retail Sales) indicates that economic growth is positive. That, in turn, has kept the Fed in tightening mode. The market hesitancy, however, comes from an analysis of the underlying data, i.e., the headline data appear to be misleading.

Take the Payroll data, for example. The January number was +517K. That is a Seasonally Adjusted number. The raw data (Not Seasonally Adjusted) was -2.505 million. (yes – million!) Because seasonal adjustment factors are based on many years of history, any significant change in current behavior is not picked up by the seasonal adjustment process for several years. Throughout 2022, businesses had a very hard time finding employees. As the economy has started to slow, businesses have been hesitant to lay people off. Instead, they have gone to a reduction in hours worked (we’ve seen a contraction in the workweek), and to part-time employment. There is a sister survey to the headline-grabbing Payroll Survey– it is called the Household Survey. This survey showed +84K, not +517K like its sister. The Household Survey distinguishes between part-time and full-time employment. According to that survey, there has been no increase in full-time jobs since May. All the job growth in 2022’s second half was in part-time jobs! The data underneath (the shrinking workweek and the move to part-time jobs) tell a different story.

Back to the seasonal adjustment process – it takes several years for the seasonal factors to recognize that kind of sea change in behavior. So, it’s clear that the +517K was an overstatement. As a backup, ADP, the country’s leading payroll processor (so they know how many payrolls they process), said that they counted a total of +106K payrolls with small businesses (1-49 employees) actually chopping heads (-75K).

The story is similar for Retail Sales. November and December sales disappointed. As a result, more merchandise than “normal” went on “sale” in January, likely causing the unexpected “rise” in January’s Retail Sales (+3%). In their recent quarterly reports, Macy’s and Best Buy reported that they expect sales to fall in 2023. Costco saw a slowdown in the purchases of big-ticket items. All the retailers discuss the consumer’s move to lower-cost store brands and toward necessities vs. discretionary items. Hence, we also view January’s Retail Sales numbers as an outlier.

Economic Activity Indicators

The incoming data continue to indicate a slowing economy. The Conference Board’s Leading Economic Indicators (LEI) (left-hand chart) have fallen for ten months in a row and in 11 of the last 12. And the Census Bureau’s Index of Economic Activity also signals an economic slowdown, as seen on the right-hand side of the chart below. Such chart patterns never occur outside of a Recession.

Existing Home Sales

Existing Home Sales are tanking, and as they fall, prices follow. The Case-Shiller Home Price Index has fallen for six months in a row and is down at a -9% annual rate from its June peak. Economists sometimes refer to a phenomenon called the “wealth effect.” When people feel like they have a significant nest egg, they are likely to spend more freely. But if they see that nest egg shrinking, they become more frugal. In the U.S. and around the world, home prices have risen significantly during the pandemic era. But they have now started to contract. As this continues, the ”wealth effect” will become more pronounced, i.e., more consumer frugality.

The chart below shows the rapid falloff in mortgage applications, both for purchase (dark line) and for refinance (the light line). The refinance applications are essential because the borrowers are tapping into their appreciated equity values, generally for the purchase of a big-ticket item, like an expensive vacation, to purchase a car or truck, or to do a significant home improvement project (swimming pool, new kitchen, upgraded windows …). Note the slight uptick in the dark line in January (extreme right-hand side of the chart). That happened because, much to the chagrin of the Fed, markets were loosening financial conditions in January, and as we noted above, the 10-Yr. Treasury Note yield fell in January. Mortgage rates are tied to the 10-Yr. As a result, many households took advantage and pulled the trigger on a purchase or refi. Since then, as noted above, the fixed-income markets have moved to higher yields, thus raising mortgage rates to even higher levels. As can be seen, mortgage applications tanked further in February.

New Homes

The left-hand side of the chart below shows the recent fall-off in single-family housing starts. Single-family housing has powerful knock-on multiplier impacts on the economy (the purchases

of appliances, furniture, carpeting, landscaping, and the ongoing expenditures for utilities and home maintenance…). Single-family starts fell -4.3% for the month in January and are now down more than -27% over the past year. Worse, new permit applications are falling faster. The gap between the two (starts and permits) is worsening. This implies that future starts will be even lower. The last time this happened was in mid-2007. Six months later, starts were down -28%, and they were down -43% over the following year.


If the economy is so strong and jobs are that easy to find, why are consumers defaulting on their car payments? The chart below shows the rapid rise in the percentage of borrowers at least 60 days late on their car payments. Note the fall in such delinquencies in 2021 due, no doubt, to the monetary gifts from Uncle Sam. Those days are gone, and we see a spike back up to delinquency levels even higher than during the Great Recession. The chart for credit card delinquencies looks similar.

According to Bloomberg, on Friday, February 24, American Car Centers (40 dealerships across ten states) suddenly closed its headquarters in Memphis and terminated its 288 employees. If the economy is so strong, one must ask why we see such events! In addition, we are now seeing cracks in the commercial real estate sector. As reported in our last blog, we have now seen foreclosures on large office properties in L.A. and NYC. It looks like this is just the beginning.

Business Surveys

Some of the Regional Federal Reserve Banks do monthly surveys of business conditions in their territories. These have all been downbeat of late. For example, the Dallas Fed’s Services index was -9.3 in February. It has fallen in each of the last nine months.

The Chicago Fed has a National Activity Index. It is shown in the chart below. Note the dotted line, which traces the current survey level back in time; each time we have been at the current level, we were in the midst of a recession!

The Chicago Fed also has a Purchasing Managers’ Index. It was 43.6 in  February, down from 44.3 in January (50 is the demarcation line between expansion and contraction). Its production and employment indexes were 38.4 and 37.3, respectively.

The Richmond Fed manufacturing Index was -16 in February (-11 in January). The following were the sub-indexes: Shipments: -15; Orders: -25; Employment: -7; Workweek: -1; Capital Spending: -3; Capacity Utilization: -17.

The ISM Manufacturing Index for February was 47.7 (50, here is the cut-off between growth and contraction). It has been below 50 for four months running. 22% of the companies surveyed showed growth compared to 89% a year ago! Compare this 22% number to what occurred in 2008, when that Recession was already three months old. Back then, 39% of those surveyed showed positive growth!

Job Openings

Part of the Fed’s excuse for raising rates is that they continue to see a strong jobs market. We dealt with the Payroll numbers at the top of this blog and why the last data set is unreliable. The Fed has also trotted out the JOLTS (Job Openings and Labor Turnover Survey) to prove the jobs market is strong, thus justifying more rate hikes. The chart below shows trends from four different surveys, including JOLTS. Note that the peak in these job opening surveys occurred in mid-2022 and has been on a downtrend ever since. As noted in past blogs, Challenger, Gray, and Christmas say layoffs are now up more than 400% from a year earlier.

The Consumer

Consumption is about 70% of the U.S. GDP. So, a healthy consumer is essential to a growing economy. In this blog, we’ve discussed rising delinquencies, and in past blogs, we’ve noted that credit card debt has skyrocketed as consumers have attempted to maintain their living standards in the face of rising prices. The following chart is eye-opening regarding growth, or lack thereof, in real (inflation-adjusted) terms. Note that on a year-over-year basis, actual sales to the private sector barely grew over the year. A healthy consumer is a requirement for a healthy economy.

Final Thoughts

Powell testifies before Congress the week of March 6th. We suspect he will be somewhat hawkish, especially since he is armed with the questionable January jobs and Retail Sales data and hotter-than-expected inflation gauges for January. We think it is even possible that when the Fed meets in mid-March, such data might be an excuse to raise rates 50 basis points instead of the 25 that is currently in the market prices.

Given the underlying data, we have now questioned the Fed’s intentions. Since monetary policy impacts the economy with long and variable lags, one would think that the Fed would pause to allow its past actions (which have been very intense from a historical perspective) to have their impact and then assess what to do next. This Fed seems consumed with the lagging indicators, like year-over-year inflation data, instead of looking at the reliable leading indicators like the Conference Board’s Leading Indicator Index or the historical record of the inverted yield curve and the occurrences of Recessions. As a result, we have begun to question their actual motivation. Some pundits have speculated that one of their goals is to convince the financial markets that the “Fed Put” is dead. (The “Fed Put” is market slang for the Fed’s move toward ease whenever the equity markets cratered in the post-Greenspan Fed era.) The Fed didn’t flinch during last year’s market melt, and if the equity market were to tank in the near future, we don’t think the Fed would lift a finger to stem the tide.

Robert Barone, Ph.D.

(Joshua Barone contributed to this blog)


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