Year: 2023

Q4’22 GDP REVISIONS

Fourth-quarter real GDP growth was revised down by two tenths to +2.7%. Downward revisions to personal consumption (-0.7pp to +1.4%) more than offset upward revisions to business fixed investment (+2.1pp to -4.6%). Net foreign trade contributed -0.5pp to growth, compared to -0.6pp as previously reported.

Core PCE inflation was revised up 0.45pp from +3.90% to +4.35% annualized, and the year-on-year rate was revised up 0.11pp to +4.83%.

Jobless Claims Edged Lower Last Week Worker filings for unemployment benefits remain historically low in a strong labor market.

Initial jobless claims, a proxy for layoffs, decreased by 3,000 to a seasonally adjusted 192,000 last week, the Labor Department said Thursday. Weekly claims have remained below the 2019 prepandemic average of about 220,000 since the start of the year.

The four-week moving average of weekly claims, which smooths out volatility, rose slightly to 191,250. (…)

Continuing claims, a proxy for the total number of ongoing unemployment benefits payments, decreased by 37,000 to 1.65 million in the week ended Feb. 11. (…)

• Even JPMorgan Is Lashing Out At Ridiculous Seasonal Adjustments In Key US Data

It has become impossible to be an economist or data-watcher (and thus strategist, investor, pundit or analyst) in the US: the reason is that seasonal adjustments have made virtually every data set a load of garbage, with little relevance to the real world. (…)

Which brings us to today’s weekly initial jobless claims report, which once again surprised to the downside, and despite wave after wave of mass layoffs (and severance), it magically dropped to four-week lows, (…).

In a note from JPM’s Dan Silver, the bank’s economist points to the stubbornly, laughably low initial jobless claims, especially when considering directly tabulated reports of layoffs which in January just hit a multiyear high (according to Layoffs.fyi)…

… and politely says that “some alternative seasonal adjustments of the initial claims data show some less favorable changes in filings from recent weeks than the official figures.”

Here, JPM is merely echoing Goldman, which several weeks ago also found that initial claims are unrealistic, and that when looking at credible, state-level WARN mass layoff notices initial claims are far higher.

It’s not just JPM and Goldman, however: three weeks ago, UBS also joined the fray, and showed that yet another data series – Job Openings – is either intentionally or accidentally inflated, and that  when look at third party data, the real number of job openings is about a third of what the monthly JOLTS report indicates. (…)

But it’s not just the sellside: both the Philadelphia Fed and the BLS itself (!) recently found that the monthly NFP data is useless. (…)

Of course, if UBS knows this, and JPM knows this, and Goldman knows this, why not just call out the BS? Simple: the Biden admin has until February 2024 to come clean, which is when the official corrections to all the data errors will be revealed, as UBS concludes:

… Unfortunately, what we, the BLS, and the Philly Fed staff see as overstatement in 2022, will not be corrected until February 2024. (…)

Tech layoffs:

The Challenger Report, which tallies all job cuts announcements, says that

The Technology sector announced the most cuts with 41,829, 41% of all cuts announced in January. (…) Since November 2022, which saw the highest monthly total for the sector since Challenger began tracking in 1993 with 52,771, Technology companies have announced 110,793 job cuts. January’s total is the second-highest for the sector on record.

Here’s the chart on all job cuts:

Last month’s total is the highest January total since 2009, when 241,749 were announced in the first month of the year. It is the highest monthly total since September 2020 when 118,804 job cuts were reported. (…)

In January, employers announced plans to hire 32,764 workers, primarily in Entertainment/Leisure. This is down 58% from the 77,630 announced in January 2022 and down 37% from the 51,693 new jobs employers announced in December of last year. (…)

Retailers announced the second-most cuts in January with 13,000, up 3,225% from the 391 announced in the same month in 2022. Financial firms announced 10,603 cuts last month, up 1,423% from the 696 cuts announced in January 2022.

But the BLS’ Non-Farm Payroll report counted 30,100 new “seasonally adjusted” retail jobs in January and 6,000 in financial activities.

Finally, is it a coincidence that actual NFP numbers have significantly exceeded consensus forecasts in the last 12 months as Apollo Management shows? (h/t @SamRo)

A Turning Point in Wage Growth? (NY Fed)

(…) Our model decomposes wage growth in each sector of the economy into the sum of a persistent component common to all sectors, a persistent component specific to that sector, and some transitory shocks. Through this decomposition, we can assess whether the sharp increase in wage growth experienced by the U.S. economy over the past two years is broad-based or driven by specific sectors. This sectoral approach is motivated by the substantial reallocation of workers across different sectors of the economy triggered by the pandemic, which is likely to have affected aggregate wage growth. (…)

In this blog post, we break down aggregate changes in nominal wages into seven sectors of the economy. (…)

The chart below shows our estimated trend (solid blue line) together with the realized twelve-month wage growth defined as described above (dashed black line). The shaded area around the trend is a 68 percent confidence band that captures the uncertainty associated with the estimate. We highlight two main takeaways.

Wage Growth and Its Persistent Component

First, the trend remained stable between 3.2 percent and 3.7 percent between 2016 and 2020. Hence, most fluctuations in observed wage growth over that period, including those in the first part of the pandemic, can be ascribed to transitory shocks.

Starting in early 2021, the trend increased markedly, nearly doubling over the course of the year. As such, a large chunk of the wage growth we saw over the course of 2021 appears to be persistent. (…)

Second, the model suggests that the trend may have peaked in the early months of 2022, then started to decline. But, as shown by the shaded areas, there remains considerable uncertainty around the pace of this slowdown in the trend component of wage growth. (…)

Is the Persistence of Wage Growth Driven by Specific Sectors?

While sectors differ in terms of their contribution to the persistence of wage growth, the surge observed in 2021 is broad-based. Three industries moved first and contributed to more than half of the observed aggregate increase: education and health, finance and business services, and trade and transportation.

Sectoral Decomposition of Persistence in Wage Growth

Interestingly, leisure and hospitality had a relatively small contribution to the overall trend dynamics. While the estimated trend specific to that sector has gone up, this increase has been limited.

Since early 2022, most sectors have shown a deceleration, if not a fall, in the persistent component of wage growth. No specific sector, however, seems to be behind the recent decline in the overall trend component. In addition, the decline in persistence in some sectors, such as trade and transportation, recently stalled or even reverted.

All in all, this suggests that focusing on specific sectors of the economy is not particularly helpful in explaining the persistence of wage growth, but a more comprehensive approach is needed, as we expand on next.

While some sectors played a bigger role in the earlier increase and subsequent deceleration of the aggregate trend in wage growth, these changes appear widespread across the economy. In the chart below, we distinguish between changes in trend that are common across sectors and changes in trend that are specific to each sector. Like the sectoral breakdown shown above, the common and sector-specific wage growth trends are shown in deviation from their respective average over 2017-19.        

Persistence of Wage Growth: Common or Sector-Specific Trend?

The increase in trend wage growth witnessed in 2021 is clearly driven by the common component, which accounts for more than two-third of the increase. The deceleration in trend wage growth taking place over 2022 is also entirely driven by the same common component.

Looking ahead, it is unclear whether the common trend component of wage growth will keep decreasing, because the estimates for late 2022 suggest that the pace of this decline has slowed. Adding to this concern, the sum of the sector-specific trend components (the blue area in the chart above) has also plateaued in the last year and has not shown signs of reversal yet.

Despite the very obvious benefits of wage growth, the persistence of the recent increase in wage growth is potentially cause for concern because it may become incompatible with price stability. Wage growth is often thought to feed back into price hikes in labor-intensive sectors, and this pass-through may have increased during the pandemic.

In the chart below, we inspect how the trend in wage growth relates to the trend in price inflation in core services (excluding housing) recovered from PCE data. (…)

Persistence in Wage Growth and Services Inflation

Interestingly, our results not only suggest that the persistent component of core services inflation started to increase before trend wage growth did, but also show that it has come down faster, despite the fact that both trends peaked around the beginning of 2022. Persistent services inflation markedly slowed down between June and October, although it seems to have levelled off since. A further deceleration in trend wage growth may ease inflationary pressures, but considerable uncertainty about the speed of this decline remains.

Dimon Says the US Economy Is Facing Some ‘Scary Stuff’ Ahead

(…) “The US economy right now is doing quite well — consumers have a lot of money, they’re spending it, jobs are plentiful,” the JPMorgan Chase & Co. chief executive officer said on CNBC Thursday. “Out in front of us there’s some scary stuff.”

Dimon said the level of uncertainty about where the economy is headed is worse than usual, citing a list of obstacles that included the Federal Reserve’s quantitative tightening as well as “Russia, Ukraine, oil, gas, war, migration, trade, China.”

The longtime CEO echoed comments he’s made in recent months on the Fed’s ongoing effort to fight inflation. He predicted that policymakers will have to pause rate hikes, but they might ultimately have to resume them to rein in inflation.

Dimon said last month that there’s a 50% chance that the Fed will boost its benchmark rate to about 5%, and a 50% chance it will have to go to 6%.

• Summers Sees Signals of a Sharp Drop-Off in Economic Activity

(…) “We’ve got an extremely difficult economy to read,” Summers said on Bloomberg Television’s “Wall Street Week” with David Westin. “People may be reading a bit too much into the moment in terms of economic strength — relative to the way things could look very differently in a quarter or two.” (…)

Coincident indicators “look very strong,” said Summers, a Harvard University professor and paid contributor to Bloomberg Television. But “there are a variety of leading indicators that are more troubling,” he said. Among the signs of concern:

• Inventories “look to be building up relative to sales.”
• Companies are “reporting concerns about their order books.”
• The business sector appears to have a high payroll head-count relative to “the level of output they’re producing.”
• “Consumer savings are being depleted, with a low savings rate.”

“There is stuff when you look down the road a bit that has to be substantially concerning about the Wile E. Coyote kind of moment,” Summers said, reiterating his reference to the cartoon character that falls off a cliff.

Federal Reserve policymakers will need to “stay nimble and flexible” given the uncertainty, Summers said. The central bank should “resist the pressure to be giving strong signals about what it’s going to do next,” he said. (…)

Moody’s: Global Oil is Oversupplied

(…) First, demand was and continues to be weak in most advanced economies. U.S. oil demand is approximately 10% below its level a year ago in the face of high prices.

Second, coordinated releases of oil from global strategic petroleum reserves put additional supply on the market. And third, strong EU purchases of crude oil ahead of the
December implementation of a bloc-wide ban on Russian oil imports created a “sell the news” situation, as oil demand was no stronger when the ban went into effect. (…)

If the sanctions are fully implemented as envisioned, EU imports of Russian oil could fall another 1.2 million bpd by spring, and the infrastructure simply does not exist to move that volume of crude oil to Asia via pipeline. Because of a lack of infrastructure that could take years to build, Russia has nearly exhausted its ability to ramp up oil sales to other countries. In response, its oil ministry announced that 500,000 bpd of production would be shut in as of March.

The Moody’s Analytics forecast expects another 500,000 bpd of Russian crude oil production to be lost throughout the course of the year. Sanctions evasions will continue, but Russia will not be able to replace Europe customer for customer and will run out of places to store its oil.

The long-term implications are equally damaging. It is unlikely that Europe will resume buying Russian oil once it has secured new, more reliable sources of supply. This
would reduce Russia’s market share of the global oil trade for at least a decade.

The oil market is oversupplied, as supply increases have outpaced growth in demand in the year since Russia invaded. Not only has Russia been able to reroute exports to this point, but U.S. oil production has climbed by 1 million bpd as higher prices created a strong incentive to produce. A second source of new oil supplies has been OPEC. Saudi Arabia and the United Arab Emirates have headlined a 700,000-bpd increase in crude oil production since the start of last year. And global SPRs have been a third source of new supplies. At the peak, allied countries were releasing up to 1 million bpd of oil from reserves to tamp down consumer price increases. Combined, these new sources of supply amount to 2.2 million bpd.

At the same time, demand growth has been exceptionally weak because of broad-based monetary tightening by the world’s major central banks. China’s zero-COVID policy was also a major factor weighing on oil demand. Weak demand, coupled with strong supply growth, allowed private sector OECD inventories to increase over the past year. (…)

Oil prices are expected to move sideways, averaging $90 per barrel in 2023 and $87 by the end of the year. Investors have already priced in the multiple reasons we expect the oil market to move from surplus to deficit throughout the year. Most importantly, China’s economy is expected to surge as it emerges from COVID-19 lockdowns. Developing countries are the main sources of global oil demand growth, and China is the biggest.

Second, we expect the EU to implement the overwhelming majority of its Russian oil sanctions. Pipeline exports to Slovakia, the Czech Republic and Hungary will continue, but seaborne Russian oil imports will cease. This will force Russia to shut down roughly 1 million bpd in oil production. Third, we expect OECD SPR releases to wind down. The U.S. Department of Energy is already detailing plans to refill the SPR at prices of $72 per barrel. Fourth, we expect U.S. oil production to grow by 250,000 barrels between now and the end of the year. The pace of growth will be much slower than last year because prices have fallen, but they remain above the levels necessary to profitably drill new wells.

Last, we expect the global economy to avoid recession. The European economic outlook has brightened, and the U.S. labor market remains red-hot. While interest rate increases will continue to slow global growth, central banks are expected to achieve price stability without a hard landing that would undermine global oil demand.

Risks to the forecast are balanced. On the downside, our key assumptions are that the global economy avoids recession, Russia will continually be forced to shut in production, and the Chinese economy’s reopening will fuel blockbuster growth in global oil demand. If these do not happen, the oil market will not shift from oversupply to deficit and prices will underperform our forecast.

On the upside, we could be underestimating the rebound in global oil demand growth. Unexpected supply outages in Africa or the Middle East could also push oil prices above their forecast levels.

Peacetime Would Be a Black Swan Event For Energy Even if an end to the war in Ukraine isn’t imminent, energy producers need to consider the possibility before they invest in long-term projects

(…) Europe will probably never let itself become as reliant on one source as it was before the war, when Moscow supplied 40% of the bloc’s natural gas imports. However, Brussels still needs Russian gas and increased LNG imports from its foe by 11% in 2022, according to data from Rystad Energy. (…)

It could be tough for U.S. LNG to remain competitive in peacetime. Russian pipeline supplies tend to be cheaper than seaborne imports once liquefaction, freight and re-gasification costs are factored in. And most of the infrastructure linking Europe and Russia is still intact. Even excluding the NordStream undersea pipelines that were sabotaged last year, there is 100 billion cubic meters of available capacity, according to the OIES.

For LNG producers, the risk of being outcompeted by a return of cheap Russian pipeline gas to Europe is highest between now and 2026. Significant new global gas supply won’t arrive until then, so Europe may find it harder to refuse more Russian flows. In one of five scenarios for Russian gas modeled by the Columbia Center on Global Energy Policy, Europe would import 56.5 billion cubic meters of pipeline gas from Russia in the event of a truce. This is less than half of levels seen before the war but roughly double what it is receiving today, so it would reduce the region’s need for LNG. (…)

Europe hopes it won’t need gas in such big quantities for much longer, the war having only hardened its determination to shift to renewable sources of energy. Before the conflict, Rystad Energy estimated that the EU would have 688 gigawatts of wind and solar capacity by 2030, a 75% increase from 2022 levels. Additional measures announced since Russia’s invasion mean capacity is now expected to be 858 GW by the end of this decade. (…)

Speaking of NordStream, David Hay offers this:

One of the strangest geopolitical episodes of the past year was surely the partial destruction of the Nord Stream pipelines. The act itself wasn’t strange (there is of course ample precedent for structural sabotage during wartime). What was strange was the Western media’s contorted (yet nearly unanimous) attempt to pin the attack on… Russia? As in Putin’s Russia, yes. Despite obvious strategic dividends for NATO and the United States — to say nothing for their destructive capacity to pull it off — somehow, Russia became the agreed upon culprit, with any evidence or arguments to the contrary angrily shouted down as the mouth noises of (God help us) Putin apologists and/or puppets.

One of those who suggested in the immediate aftermath that, indeed, the West itself might have been responsible for the attack was Jeffrey Sachs, who recently appeared with Freddie Sayers on the latter’s show UnHerd to take something of a victory lap. Said lap is owed to recent reporting by Seymour Hersh confirming much of what Sachs himself suspected from the outset. But we’ll let him tell you:

FYI:

Fed Minutes Show Most Officials Favored Quarter-Point Rate Rise Stronger economic conditions have boosted investors’ expectations for higher rates this year

(…) a few officials favored or would have also agreed to support a half-point increase.

(…) “A number of participants observed that a policy stance that proved to be insufficiently restrictive could halt recent progress in moderating inflationary pressures,” said the minutes of the Jan. 31-Feb. 1 meeting, released Wednesday. (…)

But the minutes suggest a high bar for the Fed to resume half-point rate rises, analysts said Wednesday. (…)

• Via Bloomberg:

(…) “Participants observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2%, which was likely to take some time,” according to the minutes of the Jan. 31-Feb. 1 gathering released in Washington on Wednesday. (…)

“Participants generally noted that upside risks to the inflation outlook remained a key factor shaping the policy outlook, and that maintaining a restrictive policy stance until inflation is clearly on a path toward 2% is appropriate from a risk-management perspective,” the minutes said. (…)

Following the release of the minutes, swaps traders kept steady their conviction that the Fed will keep pushing rates higher, with the market indicating that 25 basis-point hikes are likely coming at the March, May and June meetings. Investors lifted expectations for where rates will peak to around 5.36%. (…)

But the FOMC met before employment, CPI, PPI and retail sales data changed the picture.

• January data may overstate the strengths, but the Fed is far from done

The big repricing in financial markets started with a very strong US employment report for January, which sent interest rate expectations towards the sky. Most US data releases for January have been strong, even suggesting that instead of heading towards a recession, US growth might actually be accelerating.

We would refrain from making overly strong conclusions based on only one month of data. For example, the payrolls report is very volatile from month to month, and we know January was an exceptionally warm month. More data are thus needed to draw firmer conclusions. That said, the message we do take from the US January data releases is that despite the weak state of many leading indicators, the US economy is not on the verge of another recession at this point, underlying inflation is not quickly coming down to be in line with the Fed’s target and the case for the Fed to continue to hike rates remains strong.

Financial conditions simply remain too easy compared to the Fed’s attempts to cool the labour market and constrain inflation pressures. Instead of tightening, the higher equity prices, the fall in long rates from their highs last year and the narrower credit spreads mean that financial conditions have eased from their peaks last year, not tightened further.

Given the resilience of the economy to higher rates, we now think short rates will have to rise rather to around 6% than around 5%. Though the risk of 50bp hikes has risen, we think the Fed will prefer to stay on the course of 25bp rate hikes and continue on that path until the September meeting when the target for the fed funds rate will hit 5.75% to 6%.

Our new rate forecast is clearly above current market pricing, and we do not expect the market to quickly price in our rate path. It is quite normal for market pricing to lag in a rate hiking cycle (and in a cutting cycle as well), and the priced-in peak in rates usually moves higher gradually as the central bank hikes rates. This has certainly been the case in this cycle, but it has also been seen many times in previous rate hiking cycles.

January in the US was exceptionally warm, which may have boosted US data releases …

… but financial conditions remain much too easy to rein in inflation (…)

But estimates of financial conditions vary considerably:

NY Fed’s John Williams yesterday:

“At the end of the day our job is clear,” Williams said Wednesday at a conference held at the New York Fed. “Our job is to make sure that we restore price stability which is truly the foundation of a strong economy.” (…)

Williams said strong demand in the US economy continues to exceed supply, pointing to persistent price pressures in the services sector, excluding food, energy and shelter. He also said continued demand for goods, as well as ongoing supply-chain issues in the global economy, may keep prices from falling as quickly as some have expected. (Bloomberg)

The Fed’s staff yesterday released a paper linking the recent jump in inflation to the sharp increase in goods consumption after the government flooded Americans with Covid dollars.

The COVID-19 pandemic has led to a large, abrupt, and unprecedented increase in the demand for goods relative to services in the United States, interrupting a secular decline in the share of spending on goods. A popular narrative is that this sudden reallocation of demand has strained supply chains, leading to bottlenecks and labor shortages in a number of key sectors, thus contributing to a buildup of inflationary forces. (…)

The share of consumption expenditures on goods rose from 31 percent in the last quarter of 2019 to more than 35 percent by the middle of 2021, and has remained high thereafter. Personal Consumption Expenditures inflation reached almost six percent by the end of 2021, primarily driven by a surge in goods inflation, while services inflation has been more muted. Finally, employment collapsed and rebounded, remaining significantly below the pre-pandemic trend by the end of the sample, driven by a decline in labor market participation. (…)

We find that the demand reallocation shock is able to explain a large portion—3.5 percentage points—of the increase in U.S. inflation post-pandemic. (…)

We then examine the two supply shocks. The first, sectoral productivity shocks, is motivated by the increase in the dispersion of sector-level variables shown in Figure 2. Additionally, some sectors, such as the metals or oil industry, have experienced both significant declines in production and increases in prices, which cannot be explained by demand reallocation alone.

To account for this, we measure the evolution of total factor productivity at the industry level between 2019:Q4 and 2021:Q4, and feed the estimated shocks into our multi-sector model. We find that sectoral productivity shocks dramatically improve the model’s cross-sectional fit, but dampen aggregate inflation, as aggregate productivity rose above trend over this period.

The second shock we consider is a reduction in aggregate labor supply, motivated by the prolonged decline in employment shown in Figure 1. We estimate the magnitude of this shock and find that it explains approximately two-thirds of the post-pandemic decline in employment. However, its effect on inflation is relatively limited: on its own, it would only increase inflation by around 1.5 percentage points, which is less than half the impact of the demand reallocation shock.

When we consider the effect of all three shocks simultaneously, the estimated model can explain the majority of the rise in U.S. inflation between the end of 2019 and the end of 2021, largely driven by the demand reallocation shock. The model also explains a large proportion of the cross-sectional dynamics of prices and quantities: both the demand reallocation shock and the sectoral productivity shocks are important for this finding. The labor supply shock is important for explaining the persistent decline in aggregate employment, but plays a smaller role in explaining aggregate inflation and no role in accounting for the model’s cross-sectional fit. (…)

Tuesday, I posted this chart showing how profit margins, which were “normalizing” after their post GFC spike, jumped along with prices in 2021-22:

Simply stated, the U.S. government’s wide open money spigot during Covid induced a “sudden reallocation of demand”, responsible for 3.5% inflation, at the same time that Covid suddenly reduced the supply of labor, responsible for 1.5% inflation. Higher productivity has contributed to “dampen aggregate inflation” but, in reality, it mainly boosted corporate margins by 50%. Sustainable?

(Societe Generale)

Somebody could build a case for higher corporate income taxes…

While on goods demand:

You may recall the news last week of a blockbuster 3% surge in January’s retail sales, which rippled across global markets. But that report actually showed retailers had $121 billion less in January sales than they did in December — a 16% drop.

The difference is a result of the seasonal adjustment process that is applied to most major data — and right now, it may be sending misleading signals about how the economy is doing at the start of 2023.

A series of hot reads on growth and inflation have sent markets reeling this month. But at least part of that heat appears to come from shifts in seasonal patterns, making this winter’s numbers look gaudier than they are.

There’s little doubt that the economy has gained momentum so far this year, but it’s less clear how much of that is real.

If 2020-21’s pandemic supply shortages caused people to start their holiday shopping earlier than usual, the seasonal adjustment would exaggerate the strength of October’s retail sales number and depress November and December.

It would also make January’s figures look much stronger than the reality, because the falloff in spending from December to January would be less pronounced than seasonal models predict.

That looks to be exactly what happened in last week’s retail data, which after seasonal adjustments was negative in November and December, and then sharply positive in January.

Weather can compound seasonal distortions. In a normal January, frigid temperatures and snowstorms disrupt economic activity in large parts of the country. Seasonal adjustments account for that.

But this has been an uncommonly warm winter, which means seasonal adjustments increase reported activity above and beyond the true underlying trend.

A San Francisco Fed model that adjusts reported jobs numbers for weather effects found the nation would have added around 390,000 jobs in January — not the 517,000 the Labor Department reported — had it not been a warm winter.

“Right now, it’s difficult to ascertain whether COVID-induced consumer behavior changes and business practices are altering seasonal data adjustments, or if the real underlying economic activity is as strong as some recent economic indicators suggest,” said Doug Duncan, chief economist at Fannie Mae. (Axios)

INTO THIN AIR

U.S. Stock Market Climbs to Risky Heights (Morgan Stanley’s Mike Wilson)

Jon Krakauer’s book “Into Thin Air” chronicles one of the deadliest years on Mount Everest, when 12 mountaineers died trying to reach the summit without proper regard for the risks. Everest’s peak is 3,000 feet above the start of the “death zone,” the altitude at which oxygen pressure is insufficient to sustain human life for an extended period. Many fatalities in high-altitude mountaineering occur in the death zone, either directly through loss of vital functions, or indirectly from bad decisions made under stress.

This is a good analogy for where equity investors find themselves today, and where they’ve been many times over the past decade. Either by choice or out of necessity, investors have followed stock prices to dizzying heights as liquidity (the market equivalent of bottled oxygen) allows them to keep climbing. But the oxygen eventually runs out and those who ignore the risks get hurt. Developments over the last few months show how the market got here, and what could be coming next.

This most recent ascent began in October from a much safer place of lower valuations: a price/earnings ratio of 15x, compared to today’s 18.6x, and an equity risk premium of 270 basis points above U.S. Treasuries, compared to today’s 155. The ascent was based on a reasonable narrative that China’s long-awaited reopening was finally about to begin and could provide an offset to the slowing U.S. economy. As a result, this rally was led by more economically sensitive stocks like global industrials, financials and China equities, and it made sense to go along for that stage of the climb.

By December, however, the air started to get thin again with the P/E back to 18x and the equity risk premium down to 225 basis points—indicating that it was time to head back to base camp, by positioning portfolios more defensively.

With the turn of the new year, many investors decided to make another summit attempt, taking an even more dangerous route with the most speculative stocks leading the way. This time, the narrative was that the Fed was finally going to pause its rate hikes at its early February meeting, and even begin cutting rates by the second half of the year as inflation continued to decline.

It was like a shot of oxygen. Investors began to move more quickly and energetically, talking more confidently about a soft landing for the U.S. economy. As stock prices have reached even higher levels, there is now talk of a “no landing” scenario, in which the U.S. economy never slows down. These are the tricks that the death zone plays — we have now reached a P/E ratio and equity risk premium that put us in the thinnest air of the entire liquidity-driven secular bull market that began back in 2009.

Meanwhile, interest rates are likely to keep increasing, with inflation turning back up and a Fed pause now off the table. In fact, additional rate hikes have been priced into market expectations, with the terminal rate expected to reach 5.25%.

Bottom line: The bear market rally that began in October from reasonable prices and low expectations has gone too far, based on an anticipated Fed pause and pivot that aren’t coming anytime soon. Moreover, despite the economic improvements indicated by a strong labor market and resilient consumer spending, the earnings recession has a long way to go.

As the Fed is tightening, financial conditions are continuing to loosen thanks to the liquidity provided by other central banks, China’s reopening and a weaker U.S. dollar. Since October, the global money supply has increased by a staggering $6 trillion, providing the supplemental oxygen investors need to survive in the death zone, and tricking them into thinking they are safer than they really are.

As famous mountaineer Ed Viesturs once said, “getting to the summit is optional, getting down is mandatory.”

Crypto Still Draws Investors Hoping to Strike It Rich

And now the AI craze as ADG relates:

Meanwhile, the recent frenzy surrounding artificial intelligence has duly made its way to the cryptocurrency realm. CoinDesk reports today that “nefarious market participants are attempting to cash in on the ongoing ChatGPT craze in tech circles by issuing fake tokens branded after the AI chatbot despite having no official association with the tool.”  Nearly 200 such freshly issued coins are circulating on decentralized exchanges such as Uniswap, digital data firm DEXTools finds.

To wit: one ducat issued on the Ethereum network, which sports some 300 unique holders and $185,000 in trading volumes over the past 24 hours, has rallied some 300% since Sunday to push its market value north of $300 million. “Trading volumes on such fake tokens – and scams in some cases – are a glimpse of the crypto punting dream being alive and well,” CoinDesk concludes.