February 24th, 2023
It was a dreary week for markets as investors were no longer able to ignore the growing evidence of inflationary pressures reemerging within the economy. Significant economic releases were back-end loaded, but trading throughout the week’s holiday-shortened sessions managed to foretell what those reports would show. Jobless claims, consumer spending, new home sales, services PMI, and consumer sentiment all showed an inflection towards strength. Normally, this would be good news but for the fact that it was capped with a personal consumption expenditures (PCE) report – the Fed’s preferred gauge of inflation – that showed inflation trending higher on the back of that strength. The core PCE metric rose 0.60% in January (4.7% YOY). This follows last week’s hotter than expected core consumer (CPI) and producer prices (PPI) reports which were up 0.40% and 0.60%, respectively. For much of the year, the market has lived with the belief that the Fed’s work on inflation was nearly done. Two weeks of data to the contrary has chilled that narrative and forced investors to now reevaluate their probabilities for a “soft landing”. With this week’s performance, the S&P 500 has given back nearly two-thirds of its January rally, declining -2.67% this week alone.
Dollars Continue to Burn Holes in Consumers’ Pockets
January is historically a tough month for retailers with shoppers usually tapped out after a holiday spending splurge. This year has proven different, however, as consumers were eager to open their wallets to kick off 2023. Personal spending rose 1.80% in January and spending on goods specifically rose 2.80% month-to-month. That figure comes on the heels of last week’s retail sales report which showed a broad-based resurgence in consumption, where overall sales grew 3.00%. Spending on services also managed to pick up in January, increasing by 1.30%. The higher consumption figures were supported by a 0.60% increase in monthly personal income, up from the prior month’s 0.30% rise. The overall personal savings rate also increased to 4.70% in January from 4.50% in December, but this is likely to simply be a function of consumers having taken out more debt to do so, with total outstanding credit card balances at all-time highs. Consumers’ willingness to add to their debt shows they are clearly feeling confident in the jobs market and are willing to leverage themselves to enjoy spending in the meantime. The University of Michigan’s consumer sentiment index for February mirrors the spending data, rising to 67 from 64.9 the previous month. That was the index’s third consecutive monthly increase. What was particularly notable within the sentiment index was the 12% improvement in consumer’s short-run economic outlook which was the sole reason for the broader index’s increase. All other components remained relatively unchanged. Absent a sharp slowdown in the labor, consumer instinct continues to be to spend.
Cooling Existing Home Market is Week’s Sole Win
The Federal Reserve managed to claim one victory this week – a cooling housing market. Existing home sales fell for the 12th straight month in January. This is the longest losing streak since the National Association of Realtors began tracking sales in 1999. Sales fell -0.70% to a seasonally adjusted annual rate of 4 million. Despite the slide, the median price for an existing home still rose 1.30% yoy to $359K in January, supported by strong sales growth in the South and Midwest. Housing inventory climbed by 2.10% to stand at 988,000 units at the end of January. Supply, however, remains extremely tight at just 2.9 months’ worth of inventory. By comparison, six to seven months is considered a healthy balance between supply and demand. Although the central bank has been able to cool the housing market with higher interest rates, there remains a lot of pent-up demand as we head into the historically strong spring and summer buying season.
The selloff we’ve seen over the last several weeks has been long overdue. Throughout January, investors became so consumed with missing out on the easy money to be earned once the Fed pivots that in many cases they failed to digest the totality of the broader data, choosing instead to focus only on those points supportive of the soft-landing case. This week’s releases, and the PCE in particular, were simply too numerous and too explicit to continue brushing under the carpet. After skidding through the end of Q4, the economy appears reinvigorated in 2023. Our assessment is that the Fed is not the wild card the market has made it out to be. Despite all the Fed hikes, interest rates seem to barely be touching levels that would dissuade spending and investment (existing home sales the notable exception). The job market is still too strong to create uncertainty or to prevent speculation. Most importantly, having misread inflation on the front-end, the Fed has just too much at stake to risk credibility on the backend by pausing or reversing course prematurely. We expect conditions and inflation will moderate as we progress through the year, and the risk remains what it has always been – which is the Fed remains too hawkish for too long – resulting in a recession. For long term investors, the technicality of whether the Fed engineers a soft-landing, or we have a recession is entirely irrelevant other than the opportunities that it presents in the near term. Bond markets, in particular, were quick to dismiss inflation risk once the Fed pivot narrative took hold, and yields fell sharply in January (meaning bonds rallied). Even with the selloff in February, equites have yet to fall to levels we’d consider materially undervalued. Fixed income, on the other hand, is starting to look attractive with intermediate and long-term treasuries now yielding north of 4% and investment grade corporates yielding roughly 5.25%. It all comes down to timeframe. We think the Fed will ultimately get inflation under control in a reasonable amount of time, and while a recession may be the consequence, it lays the groundwork for the next cycle, and it will provide opportunities in the meantime.
The Week Ahead
The state of the global economy will be top of mind for investors as the U.S. and China release PMI reports.
Scientists Use Earthquakes to Answer Long Debated Questions
The recent earthquakes in Turkey and Syria have brought to light scientific research around what is happening at the center of the Earth and how seismic waves from earthquakes help scientists answer important questions. For decades, scientists have been studying the Earth’s inner core, a solid iron ball that spans about 1,500 miles wide. It is estimated to be nearly 70% of the size of the moon, and it is believed to reach temperatures of 9,000 to 13,000 degrees Fahrenheit. It cannot be accessed to take samples or to measure, however, researchers have been using seismic waves from earthquakes to learn about it.
When an earthquake occurs, it sends shockwaves of released energy that shake or jiggle the Earth. These movements are called seismic waves. Landslides, volcanic eruptions, explosions, avalanches, and even rushing rivers can also cause seismic waves. Seismologists record the amount of time it takes these waves to travel through different layers of the Earth and can deduce the type of material the waves are travelling through from one point on the globe to another.
This technique was used in 1936 to help scientists discover the existence of the inner core. In 1996, researchers realized that the amount of time it took for seismic waves to travel through the Earth’s center had changed over time. That signaled to them that there were shifts occurring in the Earth’s innermost layer. Some scientists theorized that the core was spinning slightly faster than the rest of the Earth.
In a new study released earlier this month, researchers examined seismic records from the 1960s to 2021. The data suggests that around 2009, the inner core had slowed its spinning to roughly the same speed as Earth’s surface and since then, it has been moving slightly slower. This isn’t cause for alarm, and scientists have proposed that the change is normal part of a 70-year cycle where the inner core switches between spinning just a little faster and a little slower than the surface, matching the speed of the surface roughly every 35 years.
Paul Richards, a seismologist at Columbia University who was not part of the recent study explained that most scientists assumed that the inner core rotated at a steady rate that was slightly different than the Earth, and the new research shows that the evidence for faster rotation is strong before about 2009 and then dies off in subsequent years.
A second study also released this month theorizes that our planet has a distinct ball of iron within its core — a hidden layer or “innermost inner core” within. The research was published in Nature Communications and argues that the Earth has five major layers instead of four as previously thought, including the crust, the mantle, the outer core, the inner core, and now an innermost inner core. This study also used the analysis of quake activity and seismic waves to reach its conclusion. You can read more about this study here and more about the research into the rotation of the Earth’s core here and here.
Understanding the Earth’s core is important because it may influence fluctuations in the Earth’s magnetic field and the length of a day. Geoscientists have more to learn about the innermost layer of our planet, and many are optimistic that science is on the verge of solving some of the core’s secrets.