Recession Narrative Dealt a Blow

Stocks opened sharply higher this morning. The Dow is currently up 680 points and the S&P 500 is up 1.9%. There are other signs of a risk-on bent to today’s session. The VIX fell 4%, gold is down over 1%, safe-haven Treasury bonds are sagging but junk bonds are in rally mode.

The US economy returned to positive growth in the third quarter. Gross Domestic Product grew an annualized 2.6% from the prior quarter, driven by continued healthy spending by consumers, businesses, and the government. Elevated inflation and Fed’s effort to quell it will higher interest rates are clearly slowing the economy, but not as quickly or deeply as most economists and investors expected. The report did confirm weakness in the housing sector, which will drag on growth for the foreseeable future. Much of the financial news media are either ignoring this report, or else spinning it negatively. For example, Bloomberg Economics reporters wrote, “A return to economic growth in the third quarter obscures continued signs of a slowdown in components that provide a cleaner signal of momentum.”

US consumer income & spending remained healthy in September, according to the Bureau of Economic Analysis. Incomes rose 5.5% from year-ago levels, and spending grew 1.9%. Both figures came in higher than expected, and August numbers were revised higher as well. Here again, that data are obscuring the widely accepted recession narrative. I concede that growth is slowing, but clearly not as fast as expected. So we’re seeing the word “resilient” in print quite a lot now, a word used to casually brush aside the core underlying strength in the economy.

Of course, this underlying strength has a dark side as it keeps inflation from falling rapidly. And we all know the Fed intends to continue raising interest rates until it sees concrete evidence of a sustained drop in prices. Bloomberg News just published results of a survey suggesting 75% of economists think the Fed will go too far and trigger a global recession. This is why we sometimes say good news is bad news.

New home sales fell to an annualized rate of 603,000 in September, the lowest rate since the spring of 2020. Exceedingly low affordability along with high mortgage rates—the average 30-year fixed rate is over 7%– dragged down demand. Mortgage applications are down 42% from a year ago. And we’re finally seeing an increase in for-sale inventory of new homes (the highest since 2008). It seems clear that homebuilding and mortgage origination is now in recession as a direct result of the Fed’s rate hikes. Stocks are already down 20-30%, bonds are down 15-20%, but home prices are just now beginning to crack.

Apple (AAPL) reported better than expected third quarter results and the stock is up 7%. Sales and profits are resetting toward more normal levels after 2021’s explosive post-Covid growth. Last year’s 29% revenue growth was clearly unsustainable. Last quarter’s revenue & earnings growth slowed to +8% and +4%, respectively. I think the stock’s surge this morning, which Wall Street analysts are grumbling about, reflects credit to the management team for consistently and effectively navigating a very difficult business environment since early 2020. Last quarter, Mac computer sales rebounded sharply with sales up 25% from a year ago. iPhone sales grew nearly 10%, which I think is good enough. Services (music, apps, iCloud, etc.) rose 5%, and this is where Wall Street is really disappointed. The stock’s direction over the next couple of days will show how much that matters.

Amazon (AMZN) is down 10% after reporting quarterly results. It’s not that the numbers were weak. Revenue growth accelerated to 15% from the year-ago quarter and earnings per share were far better than expected. The trouble began when management gave its fourth quarter outlook. Sales are expected to slow to a range of 2-8% as consumers reduce spending. That’s what the CFO said, but what investors heard was that economic uncertainty and increasing caution is about to kill the upcoming holiday shopping season. And of course that news is dragging down the entire retail group today. The CFO also said, “We’re taking actions to tighten our belt,” a process started earlier this year.