Juggling Dynamite

The latest rebound in equity prices has pulled the S&P 500 and Canada’s TSX back to levels seen two years ago in June/July 2021. In the process, bullish sentiment among professional and retail participants is back to the highest readings since November 2021, and the spike in Google searches for “bull market” (below, since 2018, courtesy of The Daily Shot) speaks volumes.

At the same time, in the real economy, Canada’s Producer Price Index (PPI) for May contracted 6.3% year-over-year and the sharpest decline since 2008 (below courtesy of The Daily Shot). Similar downtrends are evident in other major economies.
This is relevant because the PPI has led Consumer Price Inflation (CPI) at a lag of about three months (below, since 2009) and suggests that CPI should drop sharply in the second half of 2023. Falling demand on credit contraction is a well-established disinflationary force. But how long will central banks leave policy rates at 16-year highs to fight last year’s inflation problem?

As shown below, via Bespoke, US monthly real retail sales have been negative year-over-year for four months, which hasn’t happened since the 2008 recession. Going back to the 1950s, a contraction in US Real Retail Sales led to a recession in all cases except 1967. Central banks were starting to ease credit conditions at this point in past economic downturns. Today they say they do not plan to do so for the foreseeable future. Tough talk is due to be tested. EPB’s Eric Bamajian lays out timelines in Three Sequential Signals of Recession. We’re well and duly warned:

The recession is virtually assured, but most investors and the Fed still can’t see it or refuse to believe it.

Only when Signal #3 comes does the Fed panic and investors give up as the waves of job losses create defaults and deflationary pressure.

With the Leading Index deeply negative and the Coincident Indexes below 2%, we have a sustained Signal #2.

This signal was triggered five months ago, and the average recession starts six months after getting a Signal #2.

Policy should be easing already as a result of this, but the Federal Reserve is still raising interest rates targeting lagging economic indicators.

Monetary policy has never been this opposed to the business cycle signals in the last 50 years.

There’s a timeless adage that when money is cheap and easy, many people do dumb things with it. When money was free and easy (2010 through 2022), dumb things were all the rage.

In 2021, $346 billion was handed out to startups by US venture capital firms alone, averaging more than $86 billion a quarter. In the three quarters through Q1 2023, that funding rate averaged less than $42 billion (chart on the left).

With central banks fixated on tighter for longer, capital continues to sober up. See More Startups Throw in the Towel, Unable to Raise Money for Their Ideas:

The pace of startup shutdowns, fire sales and sharp business-strategy changes is picking up. Fresh capital from venture investors and bank loans is scarce and expensive. Going public is nearly impossible. Some business models that worked when cash was cheap are unsustainable now. That means venture-backed startups are running out of money and facing hard choices.

Helpful overview and charts from Nick in this segment.

Jerome Powell and the Federal Reserve just pivoted and are no longer increasing interest rates. With the Fed FOMC deciding to skip a rate hike at their June 2023 meeting.

This was the first meeting in 15 months where the Fed didn’t hike. The reason the Fed did this is that inflation is now going down, with the BLS reporting 4.0% YoY CPI growth in May 2023. Lower inflation levels give the Fed an excuse to pause rate hikes. Here is a direct video link.