The Sahm Rule

The Sahm Rule is designed to identify the start of a recession using changes in the total unemployment rate. It says that when the three-month moving average of the jobless rate rises by at least a half-percentage point from its low during the previous 12 months, then a recession has started. This rule has signaled every recession since 1970. With the U-3 rate having risen from 0.5 percent in July 2023 to 1.0 percent in June 2024, the Sahm Rule has been triggered.

Employment Composite Index based on 7 indicators is signaling for a recession.

(This is from Nov 2023, Look Where Their Composite Was Then. Source)

This index puts together information to picks up shifts in the labor market. These shifts are reduced demand for temporary help, increases in initial and continuing jobless claims, changes in the composition of the employed (for example, part-time “for economic reasons” because full-time work is unavailable), changes in the duration of unemployment, and declines in aggregate hours worked.

Multiple Full Time Jobs At Record Levels
Source( Multiple FT Jobs, Multiple Jobs)

On one hand, many individuals are struggling to secure employment, while on the other, some are working multiple full-time jobs just to cope with the inflationary price increases experienced in recent years. It shows how bifurcated our economy has become and how our middle class is being crushed.

Job Openings

Job openings have been falling off a cliff. Declines like this have only happened during 2000, 2008 and 2020 Recessions. Each decline has ended with sharp economic downturns.

Continuing claims

Continuing claims have risen to 1.85 million, up from 1.83 million, marking the ninth consecutive week of increases. This trend suggests that many unemployed individuals are finding it increasingly difficult to find new employment. As job openings continues to drop, this will continue to rise. This trend is lining up with unemployment rates rise as well.

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The US economy added far more jobs than expected in May as nonfarm payrolls expanded by 272,000 for the month, up from 165,000 in April and well ahead of the Dow Jones consensus. The unemployment rate rose to 4%, the first time it has reached this level since January 2022. This increase was due to a decrease in the number of people holding jobs by 408,000 as reported by the household survey used to calculate the unemployment rate. Additionally, the survey revealed a decline in full-time workers by 625,000, while part-time positions increased by 286,000. Revisions brought jobs added in March and April down by 15,000.

The Mainstream Narrative

• The strong jobs data and wage growth suggest a robust economy, which decreases the likelihood of the Federal Reserve cutting interest rates.

• Chances of rate cuts for the Fed’s mid-September meeting fell from 81% to 57%.

• Inflation has been slower to fall in 2024 because of our robust labor markets.

This raises a couple questions:

• How is our labor market this robust when full time employment is down?

• How are we getting positive jobs added reports every month?

• Why are all job gains foreign based workers?

• Why do we rely only on the establishment survey and not the household survey?

Full Time vs Part Time Employment

(Sources FT Emp, PT Emp)

Since June 2023 Full Time Employment is down over 1.5 million jobs. How is this job market robust if we are actively taking away full time jobs and replacing them with part time jobs? It is logical to assume that many of the price increases in inflation has not been due strictly to wages. So why does the Federal Reserve then tie themselves so directly to employment as a measure of who the economy is doing?

What is driving positive job reports

The BLS uses something called Birth/Death Assumptions, which account for the formation of new businesses. In May, the BLS assumed that 231,000 jobs were added due to these assumptions. Without Birth/Death assumptions, the number of jobs added for this year drops to -557,000, as Birth/Death assumptions account for +603,000. So the assumption is that so many new businesses are forming that our economy is adding jobs.

Foreign vs Native Born Employment

Source (Foreign vs Native)

When we look at this chart two thing are obvious. Native born workers have almost no job growth since 2018. Foreign born workers have consistently taken a larger share of the job market. In May, 663k native-born Americans lost their job while 414,000 immigrants (legal and illegal) gained a job.

So why would foreign born workers employment be rising?

Simple “In 2023, median usual weekly earnings of foreign-born full-time wage and salary workers ($987) were 86.6 percent of the earnings of their native-born counterparts ($1,140)”

(Source BLS)

The employment segment experiencing growth comprises individuals who can be paid below market rates. Undocumented workers are particularly vulnerable to exploitation by businesses. Additionally, legally present foreign workers face the risk of losing their visa status if they lose their job, and they often lack strong familial support networks already in the US.

Establishment vs Household Survey

The Household Survey counts the number of employed individuals, including the self-employed and those with multiple jobs, while the Establishment Survey measures the number of jobs in the economy, counting each job separately even if held by the same person. The Household Survey is the lesser-used measure, although the unemployment rate comes from this survey.

In May, the disparity between the headline jobs number from the establishment survey and the household survey reached 4.1 million, marking the largest difference in history. Over the past 6 months 1 million Americans have become unemployed. Additionally, the number of people working multiple jobs in the U.S. nearly hit a record high of 8.4 million in May 2024.

(Source)

Also worth noting:

The BLS is reducing the sample size of the Household Survey due to “budget constraints”. As a government, we run a 380 billion deficit monthly and somehow cannot afford to run this survey effectively? Highly Suspect. Seems these numbers are not favored, so lets slash the funding to fix the numbers. To silence opposing narrative.

Wrapping Up:

While the job numbers on the surface look strong, there's a lot more going on underneath. The rise in the unemployment rate and the loss of full-time jobs point to some real problems in the labor market, even as part-time work increases. The big gap between the establishment and household surveys also makes us question the accuracy of the job gains we're seeing. The segment of workers adding jobs are foreign-born workers taking jobs at lower wages. Plus, cutting the household survey's sample size due to "budget constraints" seems suspicious and makes it harder to trust these figures. As the Federal Reserve bases its decisions on these numbers, it's important to dig deeper to get the real picture of our economy.

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All we hear about these days is how AI is going to change everything—transform the world, revolutionize jobs. And guess what? That change is happening right now…

I mean these are just some of the headlines we are being inundated with:

• The Future of AI: How AI Is Changing the World

• Sam Altman believes AI will change the world (and everything else)

• How AI Is Changing The Future Of Work

Source.

Where exactly is this change happening ?

The main claims focus on white-collar jobs being automated. Companies are attributing layoffs to AI, or at least that's what the headlines suggest.

• Over 4,000 workers have lost their jobs to AI since May, outplacement firm estimates

But even with these claims, earnings calls and public statements made by companies indicate that these layoffs aren’t due to AI. For example, “A UPS spokesperson later said AI is not replacing workers, and that executives did not make an explicit connection between AI and the permanent layoffs on the company’s earnings call.” (Above Link)

So we have a huge wave of white collar layoffs happening and its all due to AI, yet its not due to AI.

I mean look at this graph. ChatGPT release date wasn’t even released until end of 2022. Yet software jobs had already peaked and returned to baseline. So ChatGPT / LLMs couldn’t have caused all of these layoffs? That also only leaves ~1year for companies to actually implement AI. Not many companies have the sophistication to do so.

We're in a situation similar to the dotcom bust of 2000. The internet is definitely transformative, but real change takes time—it doesn't happen overnight. The internet didn't really take off until smartphones became affordable and people could access it from anywhere. I mean pets.com reached $400 million valuation while selling products at about ~60% loss. The only reason pets.com reached this valuation was the internet trend stick that was slapped onto it. Exactly what we are seeing with the AI bumper sticker companies are slapping onto their company.

Look at the # companies saying AI in earning calls. Just following the herd and using buzzwords to generate stock interest. (Source)

Right now, most new AI advancements are just companies wrapping features that call upon large language models (LLMs), usually from OpenAI.

SideNote: Other forms of AI have already existed for years, so why weren’t predictive models laying off people before?

Current LLM Issues

Chevy's AI customer service messed up big time by selling a $76,000 item for just $1. (Source) This slip-up shows just how easy it is to trick our current AI systems. While this might seem like a harmless mistake, it actually points to a bigger issue: when these large language models (LLMs) have access to sensitive information, they can be easily fooled into giving it away.

Think of an LLM like a 4-year-old with a photographic memory of every piece of text ever written. This kid knows tons of words and can put them together in a way that sounds right. But they don't have the critical thinking skills to make good decisions. Even though they can talk the talk, they don't really understand the deeper meaning behind what they're saying.

I mean look at this Bloomberg Automation (AI) from 6/3/24. Yes, there was technically a drop in price due to a technical issue, but this is something a human writer would easily catch. The price dropped by over $600k but the AI has no reference of why that is crazy. It lacks the context and experience and the ability to connect with all of the data it has trained on. Source

Here is the NYSE technical issue that lead to many stocks literally dropping to worthless. $GOLD, $BMO, $BRK.A (Berkshire) all experienced drops of 99%.

NYSE Source

Unexpected GME Connection

That leads to another question. Why is it that when all of the glitches happen, GME (Gamestop) seems to be at the center of the discussion? Shouldn’t GME have 0 correlation with the broader stock market and how exchanges are operating??

It has long been a theory among "APEs" that when the stock market crashes, GameStop will shoot up in price. This theory is supported by GME's beta, which is around -0.3. A negative beta means that when the market goes up, the stock tends to go down, and vice versa. See the picture version below.

When we dig deeper into this situation, there's a lot of unusual swap activity involving GME that seems to be at play. A swap is a type of derivative contract. One example is a Portfolio Swap, where an investor pays someone to manage a basket of stocks or assets. The manager then passes any gains or losses along to the investor. So, while I don't own the stocks, I still get the profits or losses from them.

Firms that blew up during the 2021 GME rise, like Archegos, had massive swap positions that went the wrong way. Another problem with swaps is their ability to hide your position and leverage. Archegos could go to multiple banks and open these swap contracts, continually leveraging itself without the other banks knowing about the counterparty risk. This commented document on the SEC website does a pretty good job of detailing this issue. (Source)

Maybe this is just a technical issue, but it seems GME has a connection to these issue. These hidden swaps/derivative contracts could play a massive role in the market moving forward.

Note: This was meant to be an article just on AI and how overblown it has become.

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Earnings Season

The narratives emerging from the business sector during this Earnings Season, coupled with macroeconomic data, suggest a potential recession. The fundamentals of the economy appear less robust than some narratives suggest, with insufficient incomes at the heart of the issue. As consumers run out of options, they will inevitably have to cut back on spending, which will have a ripple effect throughout the economy.

Apple

Apple stock jumped after announcing a $110 billion share buyback program and increased its dividend by 4% to 25 cents per share. The company's fiscal second-quarter revenue fell 4% to $90.75 billion, while net income slipped 2% to $23.64 billion. The company reported a nearly 10% drop in iPhone sales, indicating weak demand for the latest generation of smartphones.

Walmart

Walmart, the retail giant, delivered a substantial earnings beat for the first quarter of fiscal 2025. The company's Chief Financial Officer (CFO) noted that upper-income (100k+) households accounted for the majority of share gains in the quarter. Walmart has observed a continuation of "value-seeking behaviors" among its customers over the past year.

Kraft Heinz

Kraft Heinz experienced a drop in its shares after reporting first-quarter results that missed analysts' estimates. The company's revenue was $6.41 billion, a decrease of 1.2% from the previous year. Sales fell across all three of the company's regional segments, with North America experiencing a 1.2% decrease to $4.83 billion. The company attributed this decline to higher prices and the reduction of Supplemental Nutrition Assistance Program (SNAP) benefits in the United States.

General Mills

General Mills Inc., a leading breakfast and snack food manufacturer, reported a third-quarter adjusted income of $674 million which surpassed analyst estimates. However, the company experienced a 1% decrease in net sales from the third quarter of the previous year. The company has noted that sales have decreased over the last several quarters due to price increases implemented to combat inflation, which led some consumers to switch to cheaper brands. General Mills affirmed its lowered full year guidance projections from December.

Lowes

Lowes, has reported a better-than-expected performance in the first quarter, with sales and earnings surpassing analysts' expectations. The company has maintained its full-year financial forecasts with comparable sales predicted to fall by 2% to 3% from 2023. This cautious outlook is attributed to a continued weakness in consumer demand for big-ticket, discretionary projects.

Home Depot

Home Depot posted mixed first-quarter results, narrowly beating profit estimates & missing revenue estimates. The company attributed this to customers delaying larger projects and purchases, a trend that has been observed in previous quarters due to persistently high inflation and interest rates. A slowdown in home sales is hurting retailers as people tend to spend more on home improvement after buying or selling a home.

Etsy

Etsy experienced a significant drop in its shares following the release of its quarterly earnings, which fell short of expectations. Despite an increase in active buyers on the site, gross merchandise sales (GMS) across the marketplace decreased from the previous year. The company reported first-quarter income of $63 million a steep decline from the $74.54 million income reported in the same quarter of the previous year. The CEO of Etsy attributed this performance to a challenging environment where consumers are reducing their spending on discretionary products. The company also laid off about 11% of its employees in December.

Lululemon

Lululemon Athletica experienced a 15.8% drop in stock following the release of its report for the fourth quarter of fiscal 2023. Despite strong results for the quarter that surpassed Wall Street expectations, the company's guidance for the first quarter of fiscal 2024 spurred a stock sell-off. The Q1 guidance was notably lower than consensus estimates, especially for earnings.

Under Armour

Under Armour has projected a decrease in its fiscal 2025 revenue by a "low-double-digit percentage rate". This includes a significant 15%-17% decline in North America. Under Armour's board approved a stock buyback plan, allowing the company to repurchase $500 million of its own shares over the next three years.

Earnings Report Takeaways

• Companies are expecting less growth moving forward, indicating a potential deterioration in the economy. This is evidenced by their projections for lower revenues and earnings, as well as the challenges they face in the retail environment due to high inventories and consumer shifts towards cheaper brands.

• The common factors contributing to these challenges include a decrease in consumer spending, increased competition, and higher prices. These factors are expected to continue impacting the companies' performance moving forward, leading to a more challenging business environment.

• This trend is characterized by a focus on essential purchases and a shift away from discretionary spending, suggesting that many consumers are dealing with stretched wallets.

Building off the actual earnings reports, there are two metrics that are worth comparing too. These are the Late Earnings Report Index (LERI) & the Conference Board Measure of CEO Confidence.

The LERI tracks outlier earnings date changes among publicly traded companies with market capitalizations of $250 million and higher. A reading above 100 indicates companies are feeling uncertain about their current and short-term prospects.

The Measure of CEO Confidence surveys a sample of CEOs. A measure of 50 is the baseline, with close to 50 being considered cautious, above 50 optimistic outlook and below 50 pessimistic.

Late Earnings Report Index (LERI)

The current post-peak season LERI reading stands at 157. This is the highest its been since Q4 2019, right before the 2020 crash. This indicates that companies are less certain about economic conditions than they were at the beginning of the year. As of May 10, there were 107 late outliers. Link: LERI

Cautious optimism continues to prevail among CEOs

Link

The Measure of CEO Confidence™ rose to 54 in Q2 2024, up from 53 in the previous quarter. This marks the second consecutive quarter in which the Measure is above 50, indicating that CEOs are cautiously optimistic following two years of gloom.

Only 35% of CEOs surveyed in April anticipate a recession within the next 12 to 18 months, down from 72% in Q4 2023. Regarding expectations for their own industries, fewer CEOs expect conditions to worsen, while 46% think conditions will be the ‘same.’ 30% of CEOs expect economic conditions to improve over the next six months, down from 36% in Q1.

The LERI is signaling the opposite of the Measure of CEO Confidence survey. It is quite strange that CEOs in their earnings reports are so cautious about the future and project lower sales and profits and yet they anticipate the US missing a recession. Seems there is a massive mismatch between the survey and what earnings season is telling us. This could be due to only 136 CEOs participating in the survey and being in more resilient industries. As well, there is some mismatch between recession fears being lower according to these CEOs and short term economic outlook being worse.

We might be in a phase where companies are lowering short-term expectations while aiming for higher efficiency. The problem is in today's economy, growth is crucial. Lower growth can impact the entire economy, as the same cycles that boost growth can unwind & lead to its decline. Therefore, earnings reports may be a more accurate indicator of our economic future in this case.

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This is the prevailing narrative surrounding GameStop (GME). However, examining the week before reveals a significant 50% surge in stock price, climbing from approximately $10 to $20. Surprisingly, this substantial movement occurred without any corresponding news or announcements affecting the stock.

So what’s actually the underlying reason for this price increase? Why are meme stocks suddenly surging?

Keep in mind that this is a theory, not a confirmed fact, but consider the following.

The surge of forum called WallStreetBets in 2021 revealed a culture of individuals willing to risk it all to reach for better riches. After the meme stock surge in 2021, this community exploded including several others. One community even reached nearly 1 million members specifically focused on GME. Superstonk. This is by far the largest retail supported stock, dwarfing TSLAs reddit which only has 25,000 members.

So what did this reveal?

A couple things:

• An increasing rise of a 'YOLO' (You Only Live Once) mentality, characterized by high-risk, high-reward strategies. Mostly 0DTE and far out of the money options.

• A growing perception that the economy is excluding many individuals, leading to a belief that adopting such high-stakes behavior is the only path to financial success.

• An unearthing of systemic corruption that “allegedly” proves that the market has been rigged against retail investors.(Make sure to watch the information at the end, honestly go ahead and skip to the end of the first two bullet points don’t matter to you)

Now in a small sample size, this behavior would have little effect on the market. But is this community of thought growing?

Lets connect some other pieces here.

Birth Rates:

We have seen birth rates plummet to under replacement levels. This will create a contraction in the upcoming workforce available in the US. But when we look at what makes up birth rates, its really a question of house formation. Why are young people not reproducing?

One issue is the breakdown in incomes between male and females. Women generally will date at their perceived level or above. This can be seen from online dating. This excerpt from a study found by Paul Van Der Laken succinctly sums it up. link

As women's socioeconomic status has improved, they have become more selective in choosing their partners. Another chart showing here shows how income drives tinder engagement as well.

So better looking, higher earning men are what women are after. (Obvi)

So why is this different than the past?

Social media has significantly increased the competition in the dating landscape. Men are no longer competing to be the most desirable in their local community; they now find themselves contending with suitors from across the globe, or at least from a larger geographic radius. This shift has coincided with a noticeable decline in sex, a trend that has become more pronounced since the 2008 Global Financial Crisis. (Chart Below) Two major developments occurred after the GFC: the swift rise of social media and a scarcity of economic opportunities, which were insufficient to accommodate the increasing number of college graduates.

Returning to the YOLO strategy, consider the scenario where men find their potential suitors lacking. In response, they have a couple of options. They can enhance their physical appearance, which is somewhat feasible, or more commonly, they might seek to increase their earnings. If advancing significantly in their careers isn't viable, the alternative is to adjust their risk/reward balance by opting for investments with low odds of success but potentially massive returns. Thus, their investment approach often shifts towards 'moonshot' bets.

This appears to be an emerging trend likely to expand further. Much like the influence of passive investing on future market dynamics, high-risk investment strategies are also poised to leave a significant impact. This trend is particularly evident in the surge of investments in alternative cryptocurrency projects and coins, which has led to a notable increase in subsequent foreclosures.

When you put this information together, you can see a growing community of individuals that are reinforced by social media to treat investments in a more YOLO strategy and to take chances that prior generations would not have concerned themselves with.

Now the final reason for this entrenched meme stock mania investing is basically an f u from investors to large capital players that are capable of manipulating markets. This will require it owns future posts but here are some resources we implore you to explore.

Succinct wrap up of the gme saga. Link

The Great Taking, link. How our brokers have turned our assets like stocks into IOUs that we don’t actually own.

Literally tons of fines and articles about Wall Street committing crimes and paying Pennie’s here.

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Big Whoop, Why Does This Matter?

The Yen Carry Trade.

The carry trade refers to a financial strategy where an investor borrows money at a low-interest rate in one currency (in this case, JPY) and invests it in another currency with higher interest rates (in this case, USD). This strategy is profitable as long as the exchange rate between the two currencies remains stable. The current yen interest rate is set at ~0%, where the U.S. dollar 10y is currently at 4.6%.

The carry trade strategy is influenced by the yield differentials between the two countries. The yield differential refers to the difference in interest rates between two countries. If Japan’s interest rates are at 0% and US interest rates are at 5%, an investor can borrow in JPY at 0% interest, exchange it for USD, and invest in a US bank, earning 5% interest on their savings. Analysts from Deutsche Bank estimate this market to be around $20 trillion as of November 2023. This massive size means that the feedback loop exists more strongly for dollar/yen than any other currency.

The Risks of the Carry Trade

An Example

If the USD depreciates against the JPY, the investor could lose despite the interest rate difference. This risk is particularly relevant in the current economic climate, where there are indications that the Federal Reserve may start cutting rates. As well, many central banks are in the process of cutting rates as of now. If this happens, the USD could fall, and the JPY could appreciate, eroding the yield on yen carry trades.

The BoJ is stuck

Intervene in JPY Spot Market

If the BoJ decides to intervene in the JPY spot market by purchasing JPY, they would need to fund this by selling sections of their substantial US Treasuries hoard. As Japan sells US Treasuries (USTs) to acquire the dollars necessary to buy back their own currency, this action pushes bond prices down, causing US yields to rise. As these yields rise, the carry trade becomes increasingly profitable, which in turn puts more downward pressure on the yen. This results in a vicious cycle where interventions in dollar terms have to get larger, causing yields to rise even more.

Raise Rates

The BoJ decides to raise rates. There a couple issues with this scenario. Japan has one of the highest levels of government debt relative to GDP in the world. Higher interest rates would increase the cost of servicing this debt and Japan would have to cut spending or increase taxes, which could also hurt the economy. A rate increase would lead to an appreciation of the yen which would make Japanese exports more expensive on the global market, potentially hurting export-driven sectors of the economy. Given Japan's reliance on exports, this could be a significant concern. As well, this would lead to a great unwind of carry trade, more later. A sudden or significant increase in rates could also lead to market volatility, affecting stocks, bonds, and other financial instruments, putting Japans financial stability at risk.

Alternatively, the Fed could cut rates to reduce the appeal of the carry trade, leading to lower rate of devaluation, but this is unlikely given recent inflation readings and the fact that domestic monetary policy doesn't typically revolve around events in other countries.

The Unwinding

When a trade opens, say borrow JPY to buy USD assets, this devalues JPY. An increases the value of USD assets (due to demand to purchase the asset). This then creates a loop that continually brings new investors as the trade becomes more lucrative.

Now what happens if the trade goes south. In 2008, many of these trade were put into subprime mortgages. When these mortgages failed, there was a rush to the door to sell these mortgages, buy JPY and pay back the loan. This scenario reverse the feedback loop above. Where now the JPY is appreciating, creating a scenario where all other carry trades become less profitable or negative and then those trades unwind. The USD or counterparty assets then lose value as well.

The problem is the amount of leverage in this trade. The feedback loop creates an environment where more and more borrowing keeps fueling the trade, making it bigger and bigger. As stated by the $20 trillion market estimate stated earlier. When a catalyst sets off these trades to be unwound, it will snowball quickly. When $20trillion in assets get unwound and sold into the market quickly it leads to a scenario akin to the 1987 crash.

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Article on GFC and USD/JPY carry trade influence. Link

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Government Debt

We have been predicting a US debt crisis since the 80s. The key question is whether we have reached the limit of what the markets will tolerate. One relationship that can offer insight is the US Treasury rates vs the German bond market.

Historically, US Treasury rates and German rates have often moved in tandem, almost as if they were a single market. The pattern of convergence and divergence between the US and German markets is not a recent phenomenon. It can be traced back to 2008 and 2009, with notable examples in 2010 to 2012. This pattern began to change around December 2022 with continued divergence in 2023. US Treasuries started to outperform their German counterparts, with yields lower in the US market relative to Germany.

In 2017 and 2018, the divergence between the German market and the U.S. was largely due to uncertainty about the Federal Reserve's actions. Once the Fed stopped hiking rates, the markets converged again, providing insight into current economic conditions.

In late 2022 and early 2023, a similar divergence occurred due to uncertainty about Fed rate hikes. The U.S. bank crisis hit regional banks hard, leading to increased uncertainty and potentially an end to rate hikes. This divergence could also be explained by difference of short term rates set by the European Central Bank (ECB and the Federal Reserve. The ECB paused in September and the Fed has had discussion about higher rates for longer.

Based on the above history, we should see US rates converge with the ECB. Even with talk of higher rates for longer in the US and Fed rate cuts reduced to 3 expected for the year, the US is not in a position to where rates could go further. It should also be noted when we zoom out US10y rates have been in range of 4% to 5%, with peak rates happening in 2023. We would expect rates to peak with inflation hit peak of 2022. The fact that rates dropped from 5% back down to 4% should further confirm we are trading in a range and that every increase upward in rates does not mean we are moving towards reinflation.

Asset Prices Restrict Interest Rates

Higher interest rates would really shake things up, destroying much of the wealth of the older generations. If it becomes more expensive to borrow money, fewer people can afford to purchase many assets (housing, cars, etc). This means prices would likely have to drop to attract buyers or we would face severely illiquid asset markets. We're already seeing hints of this, where housing markets are getting stuck because no one is buying at current rates. As well, we are seeing deflation in the car market as used card prices are freefalling due to interest rates being higher. As borrowing costs go up, fewer people can buy, which inevitably leads to falling prices. So, if interest rates keep climbing, we could see more of these trends, with big impacts on anyone trying to sell their assets.

Now one thing that could offset this is government intervention. If the government begins giving out stimulus checks or universal basic income then rates in theory could push higher. This is how things could play out long term, but probably not short term.

1970s Strikes Again - Reinflation

Source

This is quite a popular take on twitter, that the current interest rate environment is similar to the interest rate environment of the 70s (chart above). There are some key differences between this time period and the 70s. Demographically we are in contraction while in the 70s we were in expansion. Additionally, during the 1970s, the U.S. abandoned the gold standard due to pressures from an expanding dollar network, which the then-existing gold standard could not sustain.

This significant shift occurred when the U.S. decoupled the dollar from gold, leading to a surge in both gold prices and interest rates due to an oversupply of dollars. As well, if we were to see reinflation we would need to see the money supply increasing. If the money supply remains stagnant, any burst of inflation will eventually lead to disinflation or deflation. We would expect M2 to be increasing, not stagnating (as we see below).

Government Debt fueled Inflation

With the U.S. governments continued spending and the continued expansion of the Feds balance sheet, it is easy to make comparisons between economies that have experience hyperinflation/high interest rates like Argentina. There are a couple key distinctions of why US has not spiraled into hyperinflation.

One, the us treasury market is vital for the operation of the US dollar system and the Eurodollar market. Next, the Argentina Bond market does not have the depth and track record of the US bond market. There is a much higher confidence that the US will not default on their debts, aka go bust.

As well, demand for U.S. Treasuries is not just about investing or dollar liquidity, their is demand to own safe and liquid investments. As for those that tout how the demand for US treasuries is dwindling, take a look at the rehypothecation of US treasuries. This practice would not exist if demand for US treasuries were low. (Rehypothecation is the practice where banks, brokers, or individuals use collateral that they do not own) So banks will basically borrow these treasuries from another institution, instead of buying them outright.

While the US debt is not infinitely sustainable and history shows that countries with the reserve currency eventually lose it, the current environment does not have a viable competitor. There are systems proposed like a gold back currency or bitcoin, but these systems have not reached a network size to even compete with the US dollar. These stores of values must move into a space where they can be easily transacted on a day to day basis. Basically until it is possible to only use these assets to live day to day, the network is not yet strong enough to support a reserve currency.

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This is a complex topic. For a deeper understanding, we recommend checking out eurodollar.university (link). They offer extensive insights into this subject.

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Financial markets are now pricing in a September start to Fed rate cuts, with the U.S. rate futures market pricing in a 69% chance of a cut. Economists now predict only one or two rate cuts this year, down from the previously expected three, which is down from the previously expected six.

The CPI data has had a significant impact on global equities and Treasury yields. The bond market reacted to Wednesday's inflation report, with yields reaching their highest since November 2024. 2yr and 10yr yields posted their biggest daily gains since March 2023 and September 2022, respectively. As well a gauge of global equities slipped with the S&P 500 dropping almost 1% with roughly nine in every ten stocks losing ground.

Although CPI has been above expectation history shows that the core rate, like the headline rate, can go on multi-month runs that get everyone worked up about inflation pressures, only to disinflate all over again. As well, if inflation expectations were above 5% as many economists are predicting a second wave of inflation then we would expect the 10yr treasury yield to exceed this mark as well. With 10-year Treasury yield currently at 4.56%, it raises the question: Why would investors continue to hold this asset if they expected inflation to persist at 5% for the foreseeable future? Logically, one would expect long-term yields to exceed 5% if investors genuinely believed inflation would maintain this rate.

In contrast to the CPI data, U.S. Producer Price Index (PPI) data showed that producer prices rose moderately last month, with an increase in the cost of services being offset by falling goods prices. This softer than expected PPI report lessened the impact of the disappointing CPI report, indicating that progress on disinflation is stalling. The equity markets rebounded after the PPI data was reported.

Fed’s Outlook

Minutes from the Fed's March meeting revealed policymakers' disappointment with recent inflation readings before the latest report. A third straight month of hotter-than-expected prices likely sends officials back to an uneasy holding pattern where they wait several more months for either better inflation data or the type of evident economic weakness they were hoping to avoid.

This raises two different possibilities:

1. One is that the Fed's expectation that inflation continues to move lower but in an uneven and bumpy fashion is still intact, but with bigger bumps. In such a scenario, a delayed and slower pace of rate cuts is still possible this year.

2. A second possibility is that inflation, rather than on a bumpy path to 2%, is getting stuck at a level closer to 3%. Without evidence that the economy is slowing more notably, that could scrap the case for cuts altogether.

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Influences On CRE

Interest Rates

Interest rates are a key factor influencing this sector. When interest rates are low, borrowing costs are reduced, making it more attractive for businesses and individuals to invest. When interest rates rise, the cost of borrowing increases and profit margins get squeezed which reduces investment in this sector. The Federal Reserve's decision to hike interest rates in response to inflation in 2021 has also had a significant impact on the commercial real estate sector. This move put trillions of dollars' worth of commercial real estate underwater.

Bank Lending Requirements

The lending practices of banks have seen a significant shift. A few years ago, it was common to see a loan-to-value (LTV) ratio of around 75%, but now, these ratios have dropped to around 50%. This means that banks are lending less and requiring borrowers to come up with more equity.

Consumer Behavior Changes

The rise of e-commerce has led to increased demand for warehouse and distribution centers while reducing demand for traditional retail spaces. Similarly, changes in work patterns, such as the increase in remote working has led to reduced demand for office spaces.

Inflation

During periods of high inflation, the value of real estate often increases as it is seen as a tangible asset that can retain its value. However, if inflation is accompanied by economic instability or uncertainty, this could negatively impact the commercial real estate sector.

Causes For Concern

Potential Bank Crisis

The current situation in the commercial real estate sector could potentially mimic and even surpass last year's bank crisis, which was triggered by falling bond prices. That crisis was only halted when the Treasury Secretary and Federal Reserve Chairman effectively bailed out every bank in America with loans based on fictitious asset values, along with unlimited taxpayer guarantees through the Federal Deposit Insurance Corporation (FDIC). The FDIC is currently guaranteeing more than $20 trillion in deposits with just over $100 billion, meaning it has only half a penny on the dollar.

The problem is that nothing was actually fixed during the last crisis, and the situation is getting worse. As the months roll by, more and more debt is coming due. There is currently $929 billion of commercial real estate debt due this year, a figure that is up 28% from last year according to MBA estimates. Trepp estimates that $3.3 trillion will be due by 2028.

The commercial real estate sector is already showing signs of distress, with delinquency rates jumping to 6.5%, a 30% increase in just a few months. The rate of distress in office loans has hit 11%. A recent study from the National Bureau of Economic Research estimated that up to 385 American banks could fail due to commercial real estate loans alone. These would predominantly be small regional banks, which typically hold a third of their assets in commercial real estate loans.

Another study conducted by consulting firm Klaros Group analyzed U.S. banks and found that 282 institutions have both high levels of commercial real estate exposure and large unrealized losses. This combination could potentially force these lenders to raise fresh capital or engage in mergers.

Negative Feedback Loops

There is currently negative feedback loops being driven by the shift to remote work. This is leading to office vacancy losses, loss in property value that then impacts city budgets. City governments, due to balanced budget requirements, are then forced to either raise taxes or cut services. This could potentially lead to more people leaving the city, further perpetuating the loop.

A new study predicts that nearly half of downtown Pittsburgh office space could be vacant in four years. This is a trend that is being seen across the country, with many businesses unable to get all their workers back into the office. The hybrid model of working, which combines in-person and remote work, is becoming increasingly popular. However, it appears that remote work is winning out, leading to a potential 30% reduction in the footprint of office space once leases are renewed.

Office property prices have declined significantly in recent quarters, with an index of office property prices more than 30% below its pre-pandemic level as of September 2023. The U.S. office vacancy rate has risen from 11% in late 2019 to 18% today, higher than at any point during the 2008 global financial crisis.

CRE CLOs

CRE CLOs are a type of security backed by a pool of commercial real estate loans. These bundle debt that would usually be seen as too speculative for conventional mortgage-backed securities into bonds of varying risk and return. They can provide insights into potential liquidity and credit defaults in the commercial real estate space.

The CRE CLO market is experiencing significant stress, with delinquency rates for the hardest hit reaching double digits. To keep CLOs afloat, managers are implementing unprecedented strategies, particularly the buying of delinquent loans through the use of cash reserves. This allows them to avoid tripping asset-coverage tests which would turn off cash-flow streams to certain investors - a mechanism designed to protect those who purchase less risky portions of the structures. Firms have bought back a record 1.3 billion of delinquent loans last year, indicating increased stress in the market. This has forced managers to take unprecedented steps to protect the integrity of their Commercial Real Estate Collateralized Loan Obligations (CRE CLO) structures.

For context, issuance of CRE CLOs jumped from $19 billion in 2019 to $45 billion in 2021, this has significantly dropped to under $10 billion in 2023. As much as 72% of the collateral inside CRE CLOs is backed by multifamily property, with another 13% tied to offices.

Market watchers have noted that the share of loans in CRE CLOs with payments more than 30 days overdue fell to 7.4% last month, down from a peak of more than 8.5% in January. This decrease is attributed to the CLO managers using their reserves to buy back more bad loans from the overall CLO pool.

AI Price Setting

Another significant development in the rental market is the use of Artificial Intelligence (AI) to set rent prices. AI can push property managers to raise rents in ways they might not have considered manually. This technology analyzes a wealth of data, including what nearby competitors charge, to recommend rent prices. This system discourages bargaining with renters and can even recommend accepting a lower occupancy rate to raise rents and increase revenue. This scenario can lead to increased volatility, as the determination of prices by a limited number of rentals may result in more significant price fluctuations. There's also the potential for a scenario where vacancy rates surge, driven by a misalignment between prices and the broader economic landscape.

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Passive Investing

Conceptually, passive investing is when an investor buys a portfolio that mirrors a market index, such as the S&P 500, and holds it over the long term. It is an algorithmic model that uses very simple rules to purchase. It involves buying equities or bonds in proportion to their market cap anytime money is available. This approach has grown in popularity due to its lower costs and simplicity compared to active investing, where fund managers actively buy and sell stocks in an attempt to outperform the market. This type of investing can cause markets to veer off of fundamentals dramatically. According to a JP Morgan analysis in 2017, less than 10% of trading had a fundamental component to it, a significant decrease from the 60-70% prior to the global financial crisis.

Passive investing now accounts for approximately 44% of the US equity market, a significant increase from just a few years ago. One of the main concerns is the influence of passive flows on the markets. Passive flows refer to the money invested into passive funds, which then invest in the stocks that make up their benchmark index. As more money flows into these funds, they have to buy more of these stocks regardless of price, which then drives prices up further. This can lead to underperformance by active managers, who may have to sell their stocks, which could further drive up the prices of the index stocks as that money cycles back into passive funds.

There is also potential risk as more and more investors migrate to passive investing. If a majority of participants in the market are passive, it could lead to more severe implications if people try to make withdrawals under certain conditions. Passive investors are not looking to exit at a good price, but looking to sell to fund their lifestyles. When investor put their money into an index fund, the fund operates off of the world's simplest algorithm: if you give me cash, then buy; if you ask for cash, then sell. This can lead to buying at whatever price they can get, which is not an effective negotiation technique. The imbalance in the market could lead to a violent reversal or market crash, especially as baby boomers start retiring and the net flows threaten to turn negative.

As well, there could be implications for corporate governance. As more money flows into passive investments, there are concerns about the potential lack of oversight on company management. This could potentially lead to situations where management can act without sufficient checks and balances.

Another key issue is the distortion caused by market cap weighted indices. These indices assign a weight to each stock in the index based on its market capitalization due to larger companies having a greater influence on the index's performance than smaller ones. This will push more buying power towards a smaller set of stocks.

Market Cap Weighted Indices

An issue with passive flows going into weighted indexes is the disproportionate amount of automatic buying that will happen for certain stocks in the index. This is a major reason why the market is showing similarities to the 2000 period, where a few extremely profitable companies led the charge. The current market situation feels like a narrower version of this, with people increasingly investing in technology, abandoning traditional investments in energy, metals, and old economy stocks.

Passive investing amplifies the select companies to continually have their price drive up as passive investors like Vanguard and BlackRock do not have the discretion to sell when prices are high. They can only buy, and can continue to buy no matter the price. This can create positive feedback loops that cause prices to rise, similar to the dynamics of 2000.

The growth of Nvidia is particularly noteworthy. The company has become one of the fastest-growing companies in history and is expected to continue this trajectory. However, this growth has been accompanied by staggering statistics. For instance, Nvidia did not increase its spending on sales, general administration, or other areas despite a $10 billion sales jump.

Jobs Report

The BLS has reported a gain of 275,000 jobs in February 2024. However, its important to note that previous job gains have continually been revised downward. Over the past year, the BLS has been issuing positive numbers in its initial payroll reports, only to revise them lower in subsequent months. This pattern appears to be repeating itself. For instance, in December, the initial payroll report was revised from 333,000 to 290,000 indicating a loss of 43,000 jobs. Similarly, January's initial payroll report of 353,000 was later revised down to 229,000. This means that in just two months, there was a cumulative downward revision of 167,000. Considering the recent trend of downward revisions, it remains unlikely to stay at the 275,000 mark.

As well, the recent household survey has signaled a potential recession, primarily indicated by the continuous decline in full-time jobs. In February alone full time jobs fell by 184,000. The six-month average of the household survey is now negative, a strong recession signal. Since the late 1960s, there have only been 14 instances where the household survey level of employment was negative. Most of these instances were during outright recessions or periods leading up to recessions. This trend suggests that businesses are taking measures to cut costs in response to perceived weakness in the general economy.

Over the past six months, full-time jobs have decreased by 1.8 million, resulting in a six-month average of -220,000. This is the second recession signal from the household survey. A six-month average in full-time employment often aligns with officially declared recessions, with only a few minor exceptions.

Another signal is an increase in part-time jobs. During many recession periods, part-time jobs increase significantly as businesses cut back on hours, converting full-time workers to part-time to reduce costs. Over the past ten months part-time jobs have increased by approximately 1.7 million.

Connecting Jobs Data & Passive Investing

Despite the optimistic headlines touting a thriving economy and remarkable job growth, a closer look reveals a concerning trend: full-time employment has significantly declined over the past year. This downturn is particularly troubling because full-time jobs are a cornerstone of passive investing strategies. As employees contribute to their 401(k)s, often benefiting from employer-matched contributions, the erosion of full-time employment directly impacts the volume of these passive investments.

The persistent decline in full-time job opportunities, juxtaposed with a growing dependency on 401(k)s for retirement, is forging a precarious scenario for passive investment strategies. This dynamic, characterized by dwindling contributions from the workforce and increasing withdrawals by retirees, threatens to significantly diminish the volume of passive investment flows. In essence, as individuals exit the workforce—either through job loss or stepping into retirement—the once steady stream of capital into passive funds is at risk of not just stagnating, but reversing.

As well as passive investment strategies gain popularity, there's a noticeable drain of cash from the market. Consequently, when stock prices decline, there's insufficient cash on hand to "buy the dip," exacerbating the liquidity crisis. This scarcity of liquidity can trigger rapid market declines, often more swiftly than anticipated. If passive investment flows cannot maintain their levels to support stock prices or passive flows actually reverse, the market becomes primed for aggressive downturns similar to the crash of 1987.

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A special note for the work Michael Green has done on passive investing and passive flows. He can be found on twitter here: @profplum99 and substack here. Highly recommend reading his material and listening to his podcasts about the topic of passive investing.

Boeing, a prominent player in the aviation industry, has recently been under scrutiny due to a series of airplane malfunctions. Quality lapses at Boeing have been exposed following an accident on an Alaska Airlines flight on January 5th where the door plug was ejected from the airplane. The impact of this incident and many other reported quality issues has led to FAA audits, a DOJ investigation and temporary groundings of several Boeing 737 planes.

Boeing's current challenges are not unprecedented but part of an ongoing issue spanning several years. Boeing needs a significant shift in culture, prioritizing engineering over profits. Boeing's recent problems have not only affected its delivery schedules but also its reputation in the industry.

The shortage of single-aisle jets are also impacting the passengers. The shortage primarily affects planes that are used for short to midrange distances, like the Boeing 737 and Airbus A320-family, and constitute the majority of the global fleet. Domestic and regional flights are more affected and have lead to fewer flight options and higher prices.

This year, Boeing stock was at $249 a share before the door plug failure in January. As of now, it stands at $181, off 27% in 2024, making it the second worst-performing stock in the S&P 500 this year.

Boeings Mechanical Issues

Boeing's production standards have been under scrutiny for some time. Allegations have been made about the rush to build planes as quickly as possible to maximize profits leading to unsafe practices, including the deliberate fitting of substandard parts to planes on the production line.

Five years ago, Boeing faced one of the biggest scandals in its history when two brand new 737 Max planes were lost in almost identical accidents that cost 346 lives. Both crashes were caused by a relatively unknown piece of software, the Maneuvering Characteristics Augmentation System (MCAS). Leaked documents and congressional hearings revealed that Boeing’s leadership knew that MCAS could cause crashes by forcing a plane into a nosedive, overriding pilot control.

In 2024, the Federal Aviation Administration (FAA) conducted a six-week audit of Boeing's 737 MAX manufacturing processes and found multiple instances of quality control issues. The audit was initiated after a door plug flew off a 737 MAX 9 at 16,000 feet. Boeing failed 33 out of 89 product audits, with a total of 97 counts of alleged noncompliance. Further evidence of production problems emerged when the FAA warned that improperly installed wiring bundles on 737 Max planes could become damaged, leading to controls on the wings deploying unexpectedly and causing the aircraft to roll. If not addressed, this could result in loss of control of the airplane. Hundreds of planes already in service will have to be checked as a result.

The FAA announced a temporary grounding of certain Boeing 737 Max 9 aircraft operated by U.S. airlines due to various malfunctioning incidents. This includes incidents such as emergency landings due to parts of the fuselage ripping off, cockpit windows cracking, possible oxygen leaks, engine failures, and even a wheel loss during an attempted takeoff. As well, Boeing's challenges have also led to a criminal investigation by the US Justice Department into the January accident.

Airlines Affected

The ongoing crisis at Boeing is now causing problems for airlines. US carrier Southwest plans to cut its capacity this year because it can't get hold of the planes it needs. Southwest Airlines does not anticipate receiving any of its long-awaited 737 Max 7 aircraft this year. Instead, deliveries of other Boeing models will total only 46 units, a significant decrease from the previously expected 79. This has led Southwest to revise its fleet plan, which was already adjusted last year due to earlier delivery delays. The airline also plans to reduce capacity by at least one percentage point in 2024 compared to 2023 due to the fluid aircraft delivery schedule.

In Europe, Ryanair recently revised its annual passenger forecast downwards due to receiving only 40 Boeing planes instead of the originally anticipated 57. This will result in a slimmer summer schedule and 5 million fewer passengers this year. The carrier plans to raise prices by around 10% and cut back on services from Dublin, Milan, and Warsaw. An Irish discount carrier

Alaska Airlines, which experienced an accident with a Boeing 737 Max 9 in January, has also expressed uncertainty about its capacity outlook due to unpredictable aircraft deliveries. The incident in January, which led to a temporary grounding of all Max 9s, resulted in a $150 million reduction in Alaska Air's profits.

Some carriers may try to obtain Airbus models to replace the lost Boeings, but a wholesale transfer of orders from the American manufacturer to the European is simply impractical due to full order books.

In response to these issues, top executives across the airline industry have urged Boeing to address its problems urgently. However, with only two main players in the industry - Boeing and its rival Airbus - finding a quick solution to the aircraft shortage is proving difficult. Airbus's order book is already stretched well into the next decade, making it hard for airlines to fill the gaps left by Boeing's delivery delays.

Whistle Blower

The death of John “Mitch” Barnett, a former Boeing employee and whistleblower, has raised questions about the company's practices. Barnett was in the middle of a deposition against Boeing at the time of his death, alleging harassment and forced early retirement due to his concerns about the safety of Boeing’s 787 Dreamliner commercial aircraft. His lawyers and family friends have questioned the ruling of his death as a suicide.

Barnett had previously spoken out about Boeing's dangerous and negligent practices after leaving the company in 2017. He described how Boeing compromised quality control in a manner that was "catastrophic" for passengers on Boeing planes. He also exposed the role of Boeing’s military connections, inherited from its merger with McDonnell Douglas in 1997.

Boeings Significance

Boeing plays a significant role in the American economy and the US military-industrial complex. It is one of the country’s largest manufacturers and exporters, and is a key supplier of the vast sums of war material purchased by the US government. Despite the controversies and safety concerns, Boeing remains in business, protected by federal regulators and politicians who design laws allowing the production of complex aircraft with essentially no oversight.

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Powell has indicated that the central bank expects to reduce interest rates later this year, noting that inflation has eased significantly since reaching 40-year highs in 2022. Even with hotter-than-expected inflation and hiring data in January, the central bank is still on track to cut interest rates this year.

Powell has chosen to overlook a significant aspect of inflation: the surge in asset prices. As tech stocks reach record highs, indicators of U.S. financial conditions have reverted to more supportive levels. observed before the Federal Reserve initiated its rate hikes. According to a Bloomberg measure, U.S. financial conditions have already attained the accommodating state seen prior to the Fed's adjustments. Meanwhile, a Goldman Sachs metric indicates that the cumulative easing across assets over the past four months is one of the biggest since at least 1982.

Chart Source

Powell has dismissed expectations that officials might consider cutting rates at their next meeting. Recent economic data that the Fed uses to gauge the economy supports this. The Labor Department reported that the economy added twice as many jobs as forecasters had anticipated in January and inflation, using the Fed's preferred gauge, posted the largest monthly increase in a year.

In December, most Fed officials thought they could cut rates around three times this year provided that inflation was moving closer to that target by year-end. Currently, investors in interest-rate futures markets currently expect the Fed to cut rates three or four times this year, beginning at their meeting in June. The Fed will be slower to cut if inflation remains sticky and faster to cut if the labor market weakened or there was very persuasive lower inflation.

U.S. Manufacturing

U.S. manufacturing is struggling to regain momentum as it tries to recover from a prolonged but shallow downturn. Lower interest rates, which could potentially help the sector, have been delayed due to continuing inflation in the service sector. This has limited diesel consumption, postponed the anticipated depletion of fuel inventories, and caused refining margins to soften.

The manufacturing downturn has been the most prolonged since the slowdown of 2000-2002 and before that 1981-1983. Both of those downturns were cycle-ending recessions rather than mid-cycle slowdowns, characterized by a far more severe contraction in activity. The worst of the current downturn was over by the second and third quarters of 2023, but manufacturers have since struggled to regain momentum.

PMI Measures

The Services PMI has been above 50% for the 14th consecutive month, indicating sustained growth in the sector. However, the rate of growth in February was slightly slower due to faster supplier deliveries and a contraction in the Employment Index. Despite this slowdown, 14 industries reported growth in February, suggesting a robustness in the services sector. The Services PMI is a significant indicator of the overall economic health of the U.S., as the services industry accounts for more than two-thirds of the economy.

The Manufacturing PMI registered 47.8% in February, indicating a contraction for the 16th consecutive month. This is a decrease of 1.3 percentage points compared to January’s reading of 49.1%. Four out of five sub indexes that directly factor into the Manufacturing PMI are in contraction territory.

The New Orders Index contracted for the 18th time in 20 months, registering 49.2%, a decrease of 3.3 percentage points compared to January’s reading of 52.5%. The Production Index also moved back into contraction territory in February, registering 48.4%, 2 percentage points lower than the January reading of 50.4%.

In the manufacturing sector, employment saw a slight decrease in February 2024, with the index falling to 45.9 from 47.1 in January 2024. This indicates a contraction in employment in the manufacturing sector. Many companies are continuing to reduce head counts using layoffs, attrition, and hiring freezes.

Both the services and manufacturing sectors are experiencing challenges in the current economic climate. While the services sector shows signs of resilience the manufacturing sector continues to contract. Both sectors are grappling with labor shortages and inflation pressures.

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The Household Pulse Survey from census.gov gives some key insights into the rental market. When we examine the situation of renters who are behind on their rent, we observe an increasingly troubling trend. Over the past couple of years, the amount of overdue rent has grown, reaching an average of approximately 3 months of backrent for these tenants.

Upon further examining the likelihood of eviction among the same group of renters, we encounter an even more concerning trend. The percentage of tenants deemed very likely to face eviction has escalated from 16% to an alarming 23%.

It's important to highlight that there has been a gradual increase in the overall percentage of rentals paid on time, as illustrated below. The proportion of timely rental payments has risen from approximately 80% to 82.5%.

However, it's crucial to understand that this improvement is attributed to survivorship bias. The total number of rentals included in the study is decreasing, leaving only those tenants who are able to pay their rent. As indicated in the data below, the number of rentals surveyed has declined from approximately 62 million to 58 million, representing a decrease of 6.5%. (Unfortunately this study only goes back to 2020).

The insights from the Household Pulse Survey highlight a critical trend: as renters increasingly fall behind on rent and face higher eviction risks, and with a noticeable decline in the total number of rentals, there's potential for a significant shift in housing supply. This situation could lead landlords to convert rental properties into sales to mitigate losses from high vacancy rates and unpaid rent. This change in the supply dynamics can have a substantial impact on the housing market, affecting everything from affordability for potential homebuyers to investment strategies and overall market stability.

Additionally, there is corroborating data that supports the observations mentioned above. Rental prices are declining across the United States, with many areas experiencing negative growth rates. Specifically, year-over-year data for November 2023 indicates a decrease of over 2% in rental prices nationwide, with the trend showing a significant downward trajectory. Source

Case Shiller Home Price Index

The Case Shiller Home Price Index, which tracks changes in the value of residential real estate across several markets, shows a pattern that mirrors the stages of a typical asset bubble. There has been a major increase in housing prices, while prices have more or less stayed high. This sustained high level of prices has created a pervasive illusion among many that housing prices are immune to decline.

However, in the lifecycle of any bubble, there inevitably arrives a moment when prices begin to fall, ushering in phases of denial, fear, and ultimately capitulation. Homeowners rush to sell in an attempt to preserve their home equity before it dissipates. During this phase, the market often faces a scarcity of buyers, as the previously high prices have excluded many potential purchasers who are now hesitant to invest in a declining market, wary of "catching a falling knife." We are currently in this stage as evidenced by the sharp decline in existing home sales, as seen below.

Right now, the housing market's at a crossroads with two main ways it could go. On one hand, people's paychecks could start catching up to those steep home prices, making things balance out. On the other hand, and what seems more likely with how things are going, home prices might have to come down a notch to match what folks are actually earning. For housing prices to stay elevated, we'd need to see our incomes go up without our other bills piling up even higher.

Here's some data to give us a clear picture of where the average American stands in terms of affording a home purchase or even just keeping up with their current mortgage payments.

Mortgage Payments: (Source)

% Of Disposable Income Spent On Food. (Source.)

Credit card delinquency rates have surged beyond the levels seen during the COVID-19 pandemic, a time when many were compelled to stop working. (Source)

Almost ~70% of Americans Cannot save money after their paychecks. 30% cannot even cover current expenses. (Forbes) Other Sources (Barrons, CNBC)

This collective evidence suggests that American housing prices are unsustainable given the current economic conditions. The rising expenses driven by inflation are not being adequately counterbalanced by wage increases, and mortgage payments are becoming increasingly burdensome amidst these escalating costs. Additionally, the growth of shadow inventory signals the potential formation of another housing bubble.

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The AI Bubble

Nvidia, known as one of the "Magnificent 7" set of global tech stocks, forecasted a roughly 233% surge in quarterly revenue. This forecast sent its shares up by approximately 10% in pre-open Wall Street trading. However, it's worth noting that Nvidia's shares initially dropped before reversing after the earnings report was released. This forecast exceeded expectations and could potentially add more than $200 billion to the company's market capitalization. The positive performance of Nvidia also had a ripple effect on other companies seen as beneficiaries of the AI boost, including its rival Advanced Micro Devices (AMD) and server component supplier Super Micro Computer (SMCI).

Market Feedback Loop

Wall Street analysts also play a crucial role in shaping the market trends. When prices on stocks rapidly rise, industry analysts tend to raise their estimates for the revenues, earnings, and profit margins of their companies. This, in turn, leads to a justification of these estimate increases by convincing themselves and clients that fundamentals have vastly improved. This cycle can fuel a rapid rise in stock prices, also known as a market meltup, which is typically followed by meltdowns.

The president of Yardeni Research and his team have been analyzing data showing industry analysts' consensus expected long-term earnings growth (LTEG) for S&P 500 companies. This reflects analysts' annualized expected earnings growth over the next three to five years. The data suggests that industry analysts tend to be overly bullish on the long-term earnings prospects of the companies they follow.

The MegaCap 8 stocks - Alphabet, Amazon, Apple, Meta, Microsoft, Netflix, Nvidia, and Tesla - which make up 32.2% of the S&P 500's market capitalization, have seen their LTEG increase significantly. This carries weight in the index overall and could potentially influence market trends.

Leading Economic Index

the Conference Board's Leading Economic Index (LEI) is a key tool for assessing the overall health of the economy. The LEI is a composite index of ten economic indicators that typically lead overall GDP growth. It can provide early signals of turning points in the economy such as peaks and troughs.

The Leading Economic Index (LEI), a key indicator of economic health, fell by 0.4% in January 2024, marking its 22nd consecutive month of decline. Despite this, six of the ten index components have shown positive results over the past six months. This is the first time this has happened in two years, suggesting that the economy may not be heading towards a recession. Source

When the LEI is broken down into its component parts, each major component is still negative. Additionally, the positive components exhibit only a slight increase compared to the negative ones, which may indicate a potential shift towards improvement or merely a return to the average within an overall downtrend.

FOMC Minutes

The minutes from the Federal Reserve's last meeting highlight the uncertainty associated with how long a restrictive monetary policy stance would need to be maintained to return inflation to the Fed's 2% target. Most participants noted the risks of moving too quickly to ease the stance of policy, while a few pointed to downside risks to the economy associated with maintaining an overly restrictive stance for too long. Policymakers agreed they needed "greater confidence" in falling inflation before considering cutting rates.

Markets have significantly dialed back expectations for early and rapid rate cuts as a result, with traders in the federal funds futures market now betting the Fed will first lower rates in June. Investors also expect three to four cuts in 2024, a pace more in line with policymakers' median projection in December.

Some noteworthy notes from the minutes:

• The system's financial vulnerabilities were described as notable, with asset valuation pressures considered significant. Valuations in various markets were deemed high relative to fundamental values.

• House prices were at the higher end of their historical spectrum when compared to rents and Treasury yields, despite restrictive underwriting standards.

• Commercial real estate (CRE) prices, particularly in multifamily and office sectors, were on the decline, reflecting weaker fundamentals, especially evident in the office sector due to low transaction levels.

• Leverage within the financial sector, especially in banking, was noted as significant. Banks showed robust regulatory risk-based capital ratios, indicating strong loss-bearing capacity. Insurers were increasing their investments in higher-risk corporate debt.

As well, in the Fed’s eye the U.S. Labor market has continued to expand at a brisk pace, adding 353,000 nonfarm payroll positions in January. This, along with a GDP growth at a 3.5% annualized pace in 2023 and Gross Domestic Income (GDI) growth of 1.5%, has encouraged FOMC members that the succession of 11 interest rate hikes implemented in 2022 and 2023 have not substantially hampered growth.

Members also brought up the bond holdings on the Fed's balance sheet. The Fed has allowed $1.3 trillion in Treasurys and mortgage-backed securities to roll off rather than reinvesting proceeds as usual, aka quantitative tightening. The central bank's balance sheet, which at one point reached almost $9 trillion, has been a topic of discussion among financial experts. The balance sheet has shrunk by $3 trillion since the Quantitative Tightening (QT) started in June 2022.

Fed officials consider current policy to be restrictive, so the big question going forward will be how much it will need to be relaxed both to support growth and control inflation.

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A closer examination of the inflation data reveals some puzzling number. While the overall inflation rate for all items was reported at 3.1%, many individual categories showed much higher increases. (More Below) While the ongoing trend of deflation in core goods continued, inflation in services remained strong.

It's important to note that a lower inflation rate does not mean that prices are falling. It indicates that prices are rising at a slower pace. Consumers are still feeling the impact of higher prices for the items they purchase most frequently. As well its important to know that data from the past 10 to 12 months can be revised, which means that our understanding of inflation during this period may change.

Shelter/Housing

Much of the hotter-than-expected report comes down to sticky housing costs. Shelter costs, which include rents, rose by 0.6% on the month, contributing more than two-thirds of the headline increase. On a 12-month basis, shelter costs rose by 6%.

Interestingly, the real estate industry is puzzled by government data showing housing costs increasing. This is a mystery since apartment rents are no longer rising and single-family rent growth is at low single digits. Private sector data shows cooling costs that have yet to be reflected in the official data.

Food

Food prices rose by 0.4% month over month, the largest gain since January 2023. The year over year prices rose by 2.6% overall. Individual items such as juice saw a staggering 29% increase, with beef and baby formula also seeing significant hikes of 10.7% and 8.7% respectively. Similarly, food away from home saw an increase of 5.1%, but vending machines and limited service meals and snacks saw increases of 10.6% and 5.8%.

Inflation By Category

Source

Report Accuracy

The narrative being pushed is that the economy is strong and consumers have no reason to complain. This conclusion is based on a 3.1% increase in overall incomes compared to inflation. However, this 3.1% seems incorrect. Even excluding certain items, most components of the consumer price index are over 5%, far above the reported 3.1%. When housing is included, which has seen a 6% increase, the real inflation figure seems like it should be much higher. Just look at the graphic above.

U. Mich Consumer Survey

Despite the inflation report diverging from the deflationary trend, consumer confidence has shown a notable increase. This optimism may stem from a common tendency to conflate stock market performance with overall economic health, particularly highlighted by the significant uplift in sentiment coinciding with the bull market's onset in 2023.

Market Impact

The S&P 500 Index has been on a relentless rally, surpassing a series of troubling markers and reaching 5,000. Over-exuberance is evident in the market, with the S&P 500's 15-week rally pushing the gauge 13% above its 200-day moving average, a phenomenon that has only occurred on 5% of trading days this century.

With the release of the January CPI, the S&P 500 dropped 1%, and the small-cap Russell 2000 dropped 4%. Futures tied to the Dow Jones Industrial Average were off by more than 250 points, and Treasury yields surged higher. 10-year Treasury yields rallied. The increase could send mortgage rates higher ahead of the typically busy spring home buying season.

As well oil prices have remained relatively stable, while gold and Bitcoin have both fallen. This is counter to what would be expected as they are considered inflation hedges. The dollar has risen, increasing the perceived risk in the banking system due to the increased difficulty of servicing dollar-denominated debt outside the United States. In the long run, an environment where bond yields decrease while the dollar increases could indicate a risk-off environment and could signal that a crisis is imminent.

The Fed

The Federal Reserve entered 2024 within reach of its 2% inflation goal. However, the risk that inflation could remain stuck above their 2% target is guiding Fed officials' preference to keep interest rates where they are for now. This is further justified by the January inflation report which surpassed expectations.

As well, January's increase could pose a challenge for the central bank as it seeks to ease its monetary policy. Following the release of this data, the likelihood of a rate cut in May implied by futures markets fell from 50% to 30%, while the chances of a cut in March were almost fully eliminated. Futures markets now price in fewer than four 25bp interest rate cuts in 2024, down from five a week ago.

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Despite these positive payroll numbers, other data from the Current Employment Statistics (CES), paints a different picture. The hours worked index fell by 0.3% in January. This suggests that the labor market is struggling, with employers working their workers much less per worker than they had been previously. Average weekly hours worked decreased to 34.1 in January, which is worse than April 2020's 34.2 and only slightly better than March 2020's 34.0. The decrease in work hours implies weak earnings, as reduced work hours mean less pay, regardless of hourly rates.

This decrease in hours worked over the last four months aligns with what we've seen in the household survey, particularly with full-time jobs. It appears that employers are reacting to weakness in the economy, not strength. If they were responding to strength, we would expect to see an increase in hours worked, not a decrease.

The CES is often considered the gold standard for policymakers and economists. However, recent benchmark revisions have shown a noticeable slowdown in the labor market starting around January and February of 2023. This suggests a change in trend, deviating from the previous steady upward trajectory. The Bureau of Labor Statistics (BLS), however, is reluctant to acknowledge short-term variations and instead aims to smooth out these fluctuations to maintain the perceived trend in the labor market. The BLS looks to follow the long term trend, adjusting jobs according to this trend. This is why we have been getting revisions downward for most of 2023 as they continuously overestimate the jobs being added.

The Current Population Survey (CPS), another source of employment data suggests a substantial decrease in employment over a four-month period. Full-time jobs saw a significant decline in December and a further decrease in January. This data, combined with the CES figures, paints a picture of a weakening economy, contradicting the optimistic narrative presented by the headline payroll report.

Hiring has slowed to its lowest pace since 2014, according to Bureau of Labor Statistics (BLS) data and the U6 rate or underemployment rate increased to 7.2%. As well, Labor market surveys from both the ISM manufacturing and services sector are indicating job shedding, a sign of contraction. The household survey showed a decline of 31,000 jobs in January, contrasting sharply with the establishment survey's reported growth. Furthermore, there has been a significant shift towards part-time work, indicating underlying economic weaknesses rather than strengths. Over the past year, many of the jobs added have been part-time positions. This shift towards part-time work suggests that the employment landscape might not be as robust as many believe.

Market Impact

This surge in jobs according to the CES has bolstered the case for the Federal Reserve to defer cutting interest rates until at least the second quarter, leading to a surge in Treasury yields. Short-dated Treasuries, which are more sensitive to monetary policy shifts, led the move, with 2, 5 & 10-year yields rising 20 basis points.

Despite this, there hasn't been a disinversion; the delta between the 2-year treasury and the 10-year treasury has remained the same, still inverted by approximately 35 basis points. If the economy was truly strong and running on all cylinders, and if these job reports were a reflection of the overall economy, then the 10-year treasury yield would not be under the 2-year. This is a basic principle of lending: the longer you borrow money, the higher the interest rate should be.

The bond market still expects rate cuts to begin later this year, with the December swap contract pricing in about 120 basis points of rate cuts this year, about 25 basis points fewer than before the jobs data. However, whether the Fed goes in March or May, the pivot has happened and monetary policy will be wind at the sails of fixed-income investors in this strong economic environment.

The tech-laden Nasdaq and benchmark S&P 500 also saw increases of 0.32% and 0.60% respectively, as investors reacted positively to robust quarterly results from major tech companies.

The U.S. dollar has also strengthened on the back of the jobs report, jumping the most in two weeks and pushing the currency back near levels last seen before the Federal Reserve's December pivot. The dollar gained against all the Group-of-10 currencies. (About: G10)

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The Houthi rebels, backed by Iran (suspected), have been launching attacks on ships traveling through the Red Sea and Gulf of Aden since the end of November. The Red Sea is a critical global shipping route and these attacks have forced tankers and cargo ships to reroute. It is important to note that these disruptions have not yet interrupted the flow of crude oil from the Middle East. These attacks were reportedly a response to Israel's war against Hamas in Gaza. The Houthis have stated that their campaign will continue until Israel halts the fighting in Gaza and humanitarian aid is allowed in.

The United States has accused Iran of supplying the Houthis with weapons, funding, and other support. In response to these attacks, the U.S. has launched several limited strikes aimed at weakening the Houthi group and securing ships passing through these critical waterways. Despite these efforts, the Houthis have continued their attacks on commercial ships, with over 30 incidents reported. The U.S. is attempting to manage this situation without escalating tensions in an already volatile region. However, defense officials have noted that strikes alone are unlikely to deter the Houthis, who have survived a decade of war and have gained an elevated status in a region angered by Israel's war in Gaza.

In addition to the Houthi ship attacks, there has been an escalation in hostilities between Iran and the U.S. An attack on a U.S. outpost in Jordan near the Syria border was reportedly carried out by Iranian-backed militants in Syria and Iraq. This attack result in three American soldiers being killed in a drone attack in Jordan and presents a significant challenge for the Biden administration, which has sought to avoid widening the conflict in the Middle East.

The administration is now faced with the decision of how to take stronger military and potentially much tougher economic action without sparking a major conflict with Tehran. The response to this attack is likely to be a significant factor in the upcoming political campaign, with some demanding a forceful strike back against Iran and its backed militias.

Crude Oil Impacts

The ongoing conflicts and the potential for further escalation pose a significant risk to the stability of the oil market. Any disruption in oil production or shipping routes could lead to a spike in oil prices, impacting economies worldwide. History suggests that escalating violence involving Iran can significantly impact oil prices. In 2019, attacks by Iran's Islamic Revolutionary Guard Corps and Houthi militants on assets in and around the Persian Gulf led to a 10% spike in oil prices in a single day.

Despite this, oil prices remained relatively stable, with traders adopting a wait-and-see approach. Prior to these conflict, futures on Brent crude oil had largely remained in the $70s and currently sits at ~$82.

.On the flip side the International Energy Agency (IEA) recently forecasted that the world would generate a substantial surplus of oil in 2024 due to slowing demand growth and increased production from non-OPEC countries, including the US, Brazil, and Guyana. This prediction underscores the challenges facing OPEC and its allies, who have lost market share by cutting production but have failed to trigger a significant rally in crude prices.

The lack of a rally in oil prices, despite recent events and OPEC+ production cuts, indicates a weakening demand. This has led experts, including Jeff Gundlach, to predict that oil could fall to $40 per barrel in 2024 due to deflationary pressures. While lower energy prices could benefit consumers, a significant drop in oil prices could indicate a decrease in demand, potentially leading to higher unemployment rates and a recession.

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The Grayscale Bitcoin Trust (GBTC), which converted into an ETF on January 11, has seen an outflow of approximately $8 billion, according to Bloomberg Intelligence data. In contrast, nine newly launched spot-bitcoin ETFs have attracted about $4 billion in inflows within their first six trading days. Funds from BlackRock and Fidelity Investments have each drawn more than $1 billion in inflows.

For years, the Grayscale Bitcoin Trust was one of the few options for individual investors to gain exposure to bitcoin without purchasing the cryptocurrency directly. However, it was not an ETF, and investors could not easily redeem shares for the underlying bitcoin. The fund's shares would trade at a discount to the underlying value of the bitcoin it held. Since early 2021, the fund had traded at an increasingly steep discount to the underlying bitcoin it held, peaking at nearly 50% in December 2022.

The transformation of the Grayscale Bitcoin Trust into an ETF has narrowed its discount to near zero. However, this change has also led to investors taking profits on the price gain and moving to lower-fee competitors, contributing to a downturn in crypto markets. Despite hopes that the new bitcoin ETFs would boost the price of bitcoin by attracting individual investors, the price of bitcoin has fallen over 10% since the SEC approval.

The conversion of Grayscale's 10-year-old bitcoin trust into an ETF has allowed some of its investors to exit their holdings altogether. The fund's overall size has fallen from $28 billion earlier this month to $22 billion. Analysts believe much of the money in the 10 new funds is likely to have come from investors exiting Grayscale, which charges much higher fees than its competitors. This could also explain the 10% price drop in bitcoin as well. The approval of spot Bitcoin ETFs was a long-awaited “catalyst” in the crypto market. However, it has proven to be a "buy the rumor, sell the news" trend among investors, despite the long-term bull case.

How does this influence bitcoins price?

So how could GBTC even affect the price of bitcoin
This answer lies in how GBTC and many other ETFs are structured.

Here is an excerpt from investopedia for how GBTC is structured.

When an authorized partner wishes to invest, Grayscale buys bitcoins on the cryptocurrency market and issues an equivalent number of GBTC shares in exchange for capital. Those shares can then be sold on the stock market to retail investors. The trust holds a significant amount of actual bitcoins, and the price of its shares is meant to reflect the value of bitcoin held per share.

So Grayscale will change the number of bitcoins they own based upon the buying/selling of their GBTC shares. So an outflow of GBTC shares would mean an outflow of bitcoins in their cryptocurrency wallets, meaning they are being sold in the market. With many investors taking profits, this created a surge in supply, lowering the price of bitcoin.

Possible Consequences for Crypto Exchanges

The approval of Bitcoin ETFs could alter perceptions of cryptocurrencies by making them more accessible to retail investors and offering lower fees than direct crypto purchases. These ETFs could also become competitors to crypto exchanges rather than avenues for them to acquire new customers.

Coinbase, a leading cryptocurrency exchange, reported a quarterly trading volume of $177 billion in 2021. However, in its most recent quarter, this figure dropped to $11 billion. This substantial decrease in trading volume is largely due to the inherent price volatility of the cryptocurrency market, coupled with the collapse of numerous cryptocurrency projects. As Exchange-Traded Funds (ETFs) start to offer access to a variety of cryptocurrencies, and the number cryptocurrencies begins to consolidate, Coinbase could further see their market share drop in terms of trading volume. Coinbase's stock is trading almost 30% below its level in late December, when speculation about likely SEC approval began.

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The U.S. labor market added 216,000 jobs in December. The Bureau of Labor Statistics noted that the October payroll gain was revised down by 45,000, from the initial estimate of 150,000 to 105,000. Similarly, November's jobs growth was revised down by 26,000, from 199,000 to 173,000. Markets initially sold off on this news, contributing to one of the worst starts to the year in a decade for global stocks and bonds.

The household survey measure of employment experienced a significant decline in December, with a drop of 700,000. Over the last four months, the employment situation according to the household survey has been incredibly weak, with full-time positions crashing by 1.6 million. This type of behavior is typically only seen during a recession. However, the unemployment rate remained at 3.7% for the second straight month due to those who lost their jobs and were not looking for a replacement simply falling out of the labor force.

The establishment survey suggests that 5.8 million jobs have been created since April 2022, while the household survey indicates a figure of only 3.0 million.

Unemployment Rate

The unemployment rate remained steady at 3.7%, due to a significant decline in the labor force participation rate. However, the underemployment rate (the percentage of employed people working part-time but would prefer full-time) rose to 7.1%, up from 6.6% in April 2023. The long-term unemployment rate (those unemployed for at least 27 weeks) also increased to 19.7%, up from 17.5% in February 2023.

Full, Part & Temp Jobs

The BLS also reported that temporary help services, typically seen as a leading indicator for overall payrolls, has been cutting jobs for 11 consecutive months. This is a trend that has never been observed outside of a recession. Another alarming trend is the surge in multiple jobholders, which reached a record high of 8.57 million in December. This suggests that more workers are having to take on more than one job to make ends meet. Furthermore, the number of full-time workers fell significantly, with the only gains seen in part-time employment.

Job Growth By Industry

A significant portion of the job growth came from government jobs - 52,000 to be precise. This raises questions about the sustainability and quality of these jobs. The report also showed that average hourly earnings rose by 0.4% on the month and were up 4.1% from a year ago, both higher than respective estimates. The jobs report also showed a loss of jobs in the transportation and warehousing sector. This is puzzling considering that a healthy economy with high employment would typically see an increase in the transportation of goods across the country.

Participation

Data on participation in the job market showed signs of slight weakening with a decrease to 63.5% in December. The number of out-of-work individuals who weren't actively looking for work during the four weeks preceding the survey or were unavailable to take a job currently stood at 1.7 million in December and was up by 514,000 overall in 2023.

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Current Status of US Labor Market

The job openings report just dropped and showed that total job postings declined more than 15% from a year earlier. Despite this decline, job postings are still up by more than a quarter from their pre-pandemic levels. Much of the strength in hiring in 2023 was for in-person positions, such as in nursing, child care, food service, and bars.

However, the solid labor-market data is hiding the pain of those stung by recent layoffs. The current low unemployment rate is allowing state legislators to keep payouts for unemployment insurance low. Five states have weekly payment maximums below $300, despite inflation that's increased the price of an average basket of goods and services by almost 20% since 2020. In comparison unemployment benefits were at $600 per week on top of regular benefits after COVID. However, if the nation falls into recession, which many economists still expect, this approach could lead to a reckoning.

The unemployment benefits situation is further complicated by the fact that it is taking longer for people to find work, as evidenced by the number of people applying for recurring unemployment benefits hitting a two-year peak in mid-November. As well there has been a noticeable decrease in the number of new hires. The number of hires has dropped significantly, with the figures falling below the low points observed in the years preceding the pandemic. This is attributed to fewer people quitting their jobs and fewer layoffs, resulting in fewer vacant positions to fill.

This has resulted in a less frenzied labor market. Job growth became more concentrated in a handful of industries: healthcare and social assistance, leisure and hospitality, as well as state and local government. Outside these sectors, hiring slowed sharply and in some areas contracted.

The less dynamic labor market has helped put a brake on rapid wage growth, a key consideration for the Federal Reserve. Average hourly earnings across the private sector rose at an almost 6% annual pace early in 2022 but cooled to 4% near the end of 2023.

Another warning sign for the labor market is the downward slope of temporary hiring for more than a year. Temporary workers are often considered a bellwether for the labor market as they are often the first hired when businesses start staffing up and the first dismissed when the economy sours. Another warning sign is the ongoing transformation driven by AI. Almost every role is expected to be redefined in the context of AI, from engineers to salespeople, marketers, finance professionals, and lawyers.

Looking back, the 2023 labor market added an average of 312,000 jobs a month in the first quarter, but that number fell to an average of 175,000 in the fourth quarter. The government will revise its unemployment data for the past five years. Normally these changes are tiny, but if the revisions are unusually large, it could force economists to revisit prior assumptions about the labor market.

December FOMC Minutes

The Federal Open Market Committee (FOMC) has indicated an increased optimism about the path of inflation, noting clear progress. This optimism is reflected in the committee's willingness to cut the benchmark lending rate in 2024, should the current trend continue. However, the timing of such a move remains uncertain. The minutes from the FOMC meeting reveal that almost all participants, reflecting improvements in their inflation outlooks, implied that a lower target range for the federal funds rate would be appropriate by the end of 2024.

Expectations for the federal funds rate at the end of 2024 varied widely among officials. The Fed's 'dot plot' showed eight officials saw two quarter-point cuts or less, while 11 officials expected three or more. The post-meeting statement highlighted this shift in tone. Futures markets have been anticipating the Fed will cut rates six times this year, beginning with a likely quarter-point reduction in March. According to the CME FedWatch tool, there is a 72% probability of a quarter-point reduction in March. However, several Fed officials have cautioned against expectations of an imminent policy move. Officials slowed the rate of increases last year after a series of rapid hikes in 2022.

Markets 2024

Turning to Wall Street, there is a sense of optimism about the stock market as we enter 2024. Stocks rose through much of 2023, powered by an economy that stayed stronger than nearly all of Wall Street had anticipated. The recession that investors had largely agreed was imminent never came. Behind the dramatic turn in attitude is a growing belief among investors that the Federal Reserve's campaign to fight inflation is winding down, ending the interest-rate hikes that buffeted markets in recent years. This shift in market dynamics seemed unlikely just months ago, but now it appears to be a reality.

The market's recent gains, particularly those in 2023, have helped to alleviate some of the gloom. The past year saw a robust rally across nearly all asset classes, including stocks, bonds, gold, and cryptocurrencies. The S&P 500 returned 24% in total.

Investor sentiment remains positive, with a December survey by BofA Securities revealing that fund managers were more optimistic than in any month since January 2022. More than 90% of participants, who collectively manage $691 billion of assets, predicted that the Fed is done raising interest rates. More than 60% expect lower bond yields in a year, a record high for the survey.

There is some skepticism towards the 'Magnificent Seven' group of big technology companies that dominated the market in 2023. Nearly half of survey respondents identified owning shares of these seven firms as the most crowded trade on Wall Street, indicating limited future upside. Uncertainty stemming from the upcoming presidential election and potential shifts in fiscal policy also pose potential risks for markets. Historically, the S&P 500 has risen in 82.9% of presidential election years since 1929.

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