Winning The Life Lottery

Are we in a late-cycle backdrop? Or are we in the process of witnessing “immaculate disinflation” on the way to cycle extension and a new secular bull market?

It’s hard to say. GDP figures due out of the US later this week will show a brisk expansion fueled by robust consumption. And the labor market, lagging indicator though it is, still appears bulletproof.

The narrative for optimists centers around the idea that Jerome Powell can pull off a miracle. The glass half-full crowd is emboldened by recent Fed rhetoric which suggests the Committee is inclined to take “Yes” for answer. The disinflation process is unfolding, however gradually, and so far, it hasn’t come at the cost of jobs or growth. That can continue as long as the Fed doesn’t push the envelope much further. So, hold rates where they are absent conclusive evidence that inflation is re-accelerating and with a little (more) luck, perhaps assisted by an A.I. productivity boost, Powell the non-economist will achieve what few PhDs can claim: A soft landing on the way to a prolonged expansion.

If that seems far-fetched to you, that’s because it is. But just because a best-case scenario is unlikely doesn’t mean a worst-case scenario is a foregone conclusion, which is where the bears have repeatedly gone wrong. But, the longer we go without a recession, the closer we are to one. Recessions are never a matter of “if,” just a matter of “when.” I’m not sure that’s especially useful when it comes to trading (“What’s with the umbrella? It’s sunny and cloudless.” “Well, eventually, at some point, it’s gonna rain again.”), but a couple of big names are betting on a downturn, and the sell-side’s most famous bear is sticking with his late-cycle call.

Bill Gross on Monday said he’s buying SOFR futures. The US economy is “slowing significantly,” he wrote, on social media. “Recession in Q4.” That, as the other Bill (Ackman) likewise said the economy isn’t holding up as well as many believe on the way to announcing that Pershing covered its bond short. Growth is “slowing faster than recent data suggests,” Ackman remarked. That’s a low bar. The recent data suggests the economy is speeding up. (Ba dum tss.)

Equities’ fate is a bit indeterminate in all of this. In the very near-term, stocks need a reprieve from the inexorable rise in yields. In the here and now, it doesn’t so much matter where that reprieve comes from. Bad economic news could be good to the extent the long-end rallies. From a medium-term perspective, though, bad news for the economy would likely just be bad news for equities given the read-through for earnings. On the flip side, a strong economy and a resilient labor market bodes well for profits, but it could prop up yields and if sustained over the medium-term, could force the Fed into another rate hike or at least push out the first cut, all to the detriment of valuations.

If you ask Morgan Stanley’s Mike Wilson, we’re late-cycle. I realize this is ad nauseam and has a kind of Phil Connors alarm clock feel to it (“Nice going boys. You’re playing last week’s tape”), but I swear I’m not quoting old notes. Wilson on Monday cited “notable weakness” in market breadth which he said some market participants might be inclined to view as “a bullish signal” and indicative of “oversold conditions.”

Spoiler alert: Wilson doesn’t think the dynamic on display in the top two charts is a bullish signal. “We believe it is a reflection of our long standing view that we remain in a late-cycle backdrop where earnings fundamentals remain at risk,” he cautioned, adding that “further support for that view can be seen in earnings revision breadth which is now definitively breaking lower into negative territory… as well as the fact that, broadly speaking, stocks are trading poorly post Q3 results.”

Assuming he’s right, it’s problematic and made more so by the Fed’s perceived inability to quickly pivot should the various harbingers and canaries bears see manifest in an actual downturn. Wilson underscored that point in the same Monday missive.

“Even though the Fed has tightened monetary policy at the fastest rate in 40 years, they are confronted with sticky labor and inflation data that has not allowed them to signal a definitive end to the tightening cycle or when/if they will begin to ease policy,” he wrote. “In our view, the strength in the headline labor data masks the headwinds faced by the average company and household that the Fed likely can’t respond to proactively.”

It sounds like Wilson, Ackman and Gross are on the same page, at least when it comes to the notion that the incoming data has instilled a false sense of confidence in the economy’s capacity to weather the fiercest rates storm in a generation.

Or something. I have to close with a melodramatic flourish. And it’s always contrived. This is all bulls–t if I’m being totally honest with you. Nobody knows anything. Not me, not you, not Mike and not the Bills, either. As I told one reader last week, this is all just entertainment. Take it seriously at your own risk. And don’t forget to count your blessings. If your biggest concerns this week are bond yields, equity market breadth and macro data releases, you won the life lottery.