Mixed Economic Data Provide Little Clarity

Stock market indexes opened mixed this morning as traders tried to digest a raft of conflicting economic data. The Dow and S&P 500 are off 250 points and .4%, respectively. Despite a modestly stronger dollar, commodities are trading broadly higher (gold +.2%; copper +2.4%; oil +2.5%). Bonds are down in price today, allowing yields to drift upward. I should note that Fed Chair Powell is scheduled to speak later today, so we can expect some market volatility.

The US economy (as measure by Gross Domestic Product) grew a better than expected 2.9% (annualized) during the third quarter, effectively reversing contraction during the first half of the year. Consumer & business spending helped drive the upward revision to growth. Even excluding international trade & inventory components of the GDP formula, domestic economic activity accelerated to .9%. As expected, residential fixed investment shrank during the quarter. The report is of course backward looking, but didn’t offer any hint of oncoming recession. However, it also didn’t show any evidence of falling inflation. To the contrary, the GDP Price Index was a bit higher than expected at 4.3%.

But while the GDP report was fairly rosy, other data confirm the economy is clearly slowing. The number of open job positions shrank in October to 10.3 million from 10.7 million in the prior month. Given recent corporate announcements we believe that figure will fall further in coming months. Pending home sales tanked again last month and are down nearly 37% from a year ago. We learned today that business activity in the Chicago area hasn’t been this weak since the summer of 2020 when portions of the economy were shut down.

And yet, some professional investors are turning more optimistic on stocks. Why? They’re guessing that economic weakness will soon begin to pull down inflation and that we’re fairly close to peak interest rates. Invesco’s Brian Levitt says the Fed’s desire to keep raising rates into economic weakness “suggests recession is likely in the offing.” If that scenario begins to play out, the Fed will be forced to lower rates. While that doesn’t sound very optimistic, Mr. Levitt reminds us that investors are looking forward well into next year and are seeing some light at the end of the tunnel.

Economist Ed Yardeni acknowledges other signs of recession, such as the inverted yield curve. But despite extreme distress in speculative assets—crypto, meme stocks, SPACs—he hasn’t “yet seen an economy-wide credit crunch,” or financial meltdown. The economy is showing itself to be resilient, meaning that recession is not a foregone conclusion. And at the same time, inflation is falling. He believes durable goods will be in a deflationary environment next year. So it is very possible that we’ve already seen the peak of interest rates. If that’s the case, the stock market has already bottomed.

Bank of America’s outlook sort of splits the difference between the two views expressed above. The bank’s investment strategy team believes the Fed will “pivot,” or pause interest rate hikes in 2023. In fact, they are now predicting a peak Fed-funds rate of 5.25% next March, followed by rate cuts during the second half of the year in reaction to slower inflation & growth accompanied by higher unemployment.