Juggling Dynamite

Rising unemployment has overtaken inflation as the dominant fear, and today is expected to bring the Fed’s first rate cut of a new easing cycle.

Like Pavlovian dogs, stocks typically rally in anticipation of Fed easing. However, unemployment continued to surge in the eight recessions since 1969, and stock markets eventually fell an average of 24% in the 195 days after the first Fed cut.

In the three rare incidents where stocks entered cutting cycles at extreme valuation highs, similar to now (1973, 2000 and 2007), the S&P 500 lost 35 to 56%. The masses holding little cash and bonds with record equity allocations are set up to suffer.

Anna Wong, Chief U.S. Economist of Bloomberg Economics, discusses the health of the U.S. labor market, the chance of a recession “steepening”, and the election’s impact on economic growth. Here is a direct video link.

In his webcast titled “1984” in remembrance of George Orwell’s dystopian novel, DoubleLine Founder and CEO Jeffrey Gundlach on Sept. 10, 2024, dives “into the subject of the Fed and some of the variables that will likely underpin their logic and their thinking” at the Sept. 18 meeting of the rate-setting Federal Open Market Committee (FOMC). In his analysis, Mr. Gundlach finds both components of the Fed’s dual mandate, employment and prices, support a rate-cutting cycle. If energy prices remain near present levels, he expects sub-2% Consumer Price Index (CPI) reports in a few months, and he cites new signals of an imminent recession. Here is a direct video link.

Despite the latest University of Michigan’s consumer confidence index nearing 2008 recession lows (blue line below since 1990), the share of savings allocated to equities remains aggressively above 40% (green line). This gap has traditionally closed with equity allocations following consumer confidence down as stock prices tumble and the quest for cash accelerates.
From the highest 12-month S&P 500 forward price-to-earnings ratio (22x) since 2021 and 2000 (shown below since 1978), the scope for price-to-earnings contraction is truly epic.

And although mortgage rates are more than 100bps off their peak last October, still-high property prices mean that US home affordability remains near its worst level since the previous housing bubble peak in 2006. The downside in real estate–the most widely held and highly leveraged asset market–looms large.

Once real estate bubbles bust, prices typically fall for years, and paying down debt becomes the priority. In the process, slashing interest rates does not entice the hoped-for revival of borrowing, and it takes years to rebuild balance sheets. This is now underway in the world’s second-largest economy. Et tu, Canada?

Richard Koo, senior adviser at CSIS, chief economist at Nomura Research Institute, and pioneer of the “balance sheet recession” phenomenon, explains why he thinks China’s balance sheet recession has already begun. Here is a direct video link.

China’s M1 money supply contracted by 7.3% in August, hat tip China Beige Book.

M1 money supply (in black below since 1999) leads producer prices (PPI in red) by about six months, and suggests the trend in falling prices has further to run.

Chinese prices (GDP deflator below since 1997), contracted for the fifth consecutive quarter in the first half of 2024, in the longest period of deflation since 1999 (see blue bars below).