J.P.Morgan Insights (audio)

Eliud Kipchoge, the only man to ever run a marathon in under two hours, is in town for next week’s Boston Marathon. In the runup to the race, reporters will no doubt ask him about whether he is worried about any particular competitor. He will predictably reply that he is not - but that he has to focus on his own fitness and his own decisions in running the race. As with all individual sports, the keys to success or failure lie largely in the athlete’s own hands.

In three weeks, I will once again have the honor of running the Boston Marathon as a member of the gasping geezers division of the Dana-Farber Marathon Challenge team. A year ago, as I clambered up the Newton Hills, I resolved that, if I was ever fool enough to do this again, I’d lose a few pounds before attempting it. Admittedly, a few miles later, I made a sterner vow that I would never be fool enough to do this again, which made the first resolution seem irrelevant.

A good set of brakes is a very comforting thing.  A gentle tap of the foot should produce a quiet and gentle deceleration, as brake pads press up against disc rotors, in a smooth but firm action.  When I drive these days, I take this technology for granted.   However, the vehicles I drove as a young man offered far less assurance.  There were times when applying the brakes unleashed a cacophony of shrieking, squealing and grinding noises as worn-out pads battled with rusty rotors.  The braking action would be either be frighteningly nonexistent or of a sudden, whip-lash intensity.  Of course, in those vehicles, the acceleration wasn’t great either.  However, any temptation I might have had to drive more quickly was quickly squashed by doubts about my ability to slow the car back down again when I needed to.

One obstacle to assessing the direction of the American economy is the difficulty in getting a handle on how many people live in this country and how fast that number is growing.  It would seem to be a very elementary problem – surely the Census Bureau provides timely data on the size of the population, as well as births, deaths and net migration?  But it does not.  So far as I know, there is no official consistent measure of any of these numbers on a monthly, (or for that matter an annual basis), going back over the decades.  Moreover, the last time the Census provided a projection of the future path of these vital statistics was back in 2017.

Over the years, my standard approach to analyzing corporate profits has been to think of them as the last slice taken from a big national income pie.  The growth of the pie itself is important.  But so is the size of the other slices, such as labor costs, interest costs and corporate taxes.  Once every one else has had their slice, what’s left over is corporate profits.   It’s a useful model for analytical purposes.  However, it has one glaring flaw, namely that it assigns to corporations a purely passive role, meekly accepting the slice left after all the other factors of production have taken theirs’. In reality, American corporations are muscular and sharp-elbowed, growing profits by enhancing productivity but also by beating back the demands of labor, lobbying for a more favorable tax and regulatory environment and seducing customers into buying more goods and services than they really should, based on sober calculation.

It was 60 degrees in Acton yesterday, as our normally frigid Massachusetts winter continued to be a no-show.  Not that I have any problem with this, since running, rather than skiing, is my exercise of choice.  But this weirdly mild season is leaving nature very confused with streams gurgling, buds swelling and birds twittering loudly, presumably about their nest-building plans.

There is a slowdown lurking.  It is currently hiding so well, in the long grass of statistical anomaly, that many observers, including the Federal Reserve, don’t seem to notice it at all. However, investors need to recognize it and have a clear view on the outlook for economic growth, jobs, inflation and profits, how the Federal Reserve may react to a slowdown, and what this could mean for investment returns over the next few years.

In investing, as in life, it is important to learn from the past, appreciate the present and plan for the future.  This is particularly true at turning points. In the early weeks of the New Year, we do appear to be at an economic turning point.  Fourth-quarter GDP and consumption deflator data, due out this week, may give the impression of continued solid growth with still strong year-over-year inflation.  However, a more real-time assessment of the economy suggests a significant cooling in both, with monetary and fiscal tightening contributing to the slowdown.  That being said, it should be recognized that an environment of slow growth, low inflation, low interest rates and strong profit margins is likely to re-emerge in 2024, providing support for higher asset prices.  While there are too many short-term risks to justify a very aggressive strategy today, it still likely makes sense to prepare for this environment rather than trying to time market swings in what will likely be a very volatile 2023.

Last Friday afternoon, amidst the lengthening shadows of a winter sun, the Treasury Secretary delivered an ominous warning: By this Thursday, the U.S. federal debt will reach its legal limit, requiring her to take extraordinary measures just to keep paying the bills. Secretary Yellen’s warning was, perhaps, a little premature and she suggested that, with some adjustments, our real rendezvous with disaster might be postponed until June.  But even this date is considerably earlier than many assumed in the middle of last year, due, in large part to the budgetary effects of the Federal Reserve’s aggressive tightening.   

The word “resolution” has multiple meanings. The most obvious at this time of the year, is a decision to behave differently going forward. In many social sciences, “resolution” refers to a problem that is somehow mitigated or eliminated. Or, taken at its most literal, “resolution” could simply mean coming up with new answers to old questions – that is to say – “re-solving” them.

My first job out of graduate school, in the early 1990s, was as the consumer economist for the economic consulting firm of DRI/McGraw-Hill, in Lexington, Massachusetts.  One weekend each month, we would run a U.S. macroeconomic forecast.  (It always had to be over the weekend, as this was the only time when we could get our own clients off our mainframe computer.)  Anyway, on Saturday afternoon, having produced some preliminary numbers, we would gather around a huge conference-room table and discuss how the forecast was shaping up.    My colleagues were smart and seasoned economists and very patient with someone clearly just waking up to how forecasts are constructed in the real world.   However, I believe they did somewhat resent my position as “the consumer guy”.  Because then, as now, consumer spending accounted for roughly two-thirds of GDP and they would spend much of the weekend vainly trying to offset what they saw as my undue optimism by hacking away at their forecasts for investment, trade and govern

At his press conference on November 2nd, Fed Chairman, Jay Powell opined that the window for a soft landing had narrowed.  This was very much in line with his messaging for many months which has emphasized that the Fed regards inflation as being much too high and is willing to put the economy in recession, if necessary, to return it to its 2% target.  However, it also underscores the economic problem caused by “supply-shock” inflation: it simultaneously boosts inflation expectations, inducing a more restrictive monetary policy, and drags on economic growth.

At 8:30AM, on the first Friday of every month, the Labor Department releases the monthly jobs report.  By 8:35AM, the network scriptwriters deliver a verdict to the teleprompters – jobs either “sky rocketed” or “plunged”.  The job market is either “red hot” or “stalling out” and, either way, investors need to be worried.  No middle ground will keep an audience.

For many people, I suspect, 2022 will be a year to forget.  However, for millions of home-builders, home-sellers and home-buyers, it will be remembered for the speed with which a housing boom turned into a housing bust.  The reason, of course, has been a surge in mortgage rates.  These rates look likely to stay high, at least over the next year, contributing to sharp declines in housing starts and home sales and a negative impact on GDP.  Eventually, this could motivate the Federal Reserve to reverse course and cut rates.  However, mortgage rates are unlikely to fall to anything like the levels they maintained for the 14 years prior to 2022, while limited housing supply will probably prevent a collapse in prices.  Given this, it appears we are now entering an era when the decision to buy a house should be focused more on the finding the right home in which to live than the right asset in which to invest.

Markets bounced higher last week in a justifiable show of enthusiasm as the latest CPI data confirmed that inflation is indeed receding.  However, even as investors worry less about inflation they may well worry more about recession.  The risk of a near-term recession is climbing.  However, such a recession would be more like sliding into an economic swamp than falling off an economic cliff.  While a “swamp” recession wouldn’t be very deep, the economy would likely struggle to get out of it.  The good news for investors is that a prolonged period of economic swampiness should snuff out inflation and force the Federal Reserve to reverse a significant part of their 2022 tightening.

Among the many challenges of parenthood is trying to get your kids to eat healthy food.  As the children get older, the school lunchroom becomes one of battlefields, with some kind of weekly menu posted online or sent home with the kids.  Many of these menus appear to imply that the three essential food groups are sodium, fat and sugar.  However, some schools employ a little more imagination both in providing healthy choices and evoking some interest in the fare to come.  This week the lunchrooms in our own local schools will feature “Rocking Roll Ups” on Monday, “Healthy Half Days” on Wednesday and “National Sandwich Day” on Thursday, with vegetarian options available daily.  I’m not quite sure what all of that means but it does sound interesting.      

At the peak of the railroad boom of the late 19th century, the Framingham and Lowell line was incorporated to transport goods and passengers up and down the western outskirts of Boston.  Over the years, the traffic dwindled, the line was sold and resold and eventually abandoned.  However, for more than three decades now, some enterprising local citizens have pursued the construction of a bike trail along the old abandoned line, which is now, finally, mostly complete.

On many occasions in my adult life, I have made New Year’s resolutions to become fitter.  As the days of the old year gradually dwindled and my girth gradually expanded, I would commit myself to exercise more and eat less.  However, experience has taught me that both of these noble aspirations must be approached with moderation.  Any attempt to starve myself while running more miles leads inevitably to physical slowdown or breakdown.  Moreover, if I simply refuse to eat more, the exercise comes to a screeching halt.  

The Federal Reserve maintains strict rules prohibiting FOMC members from commenting on the economic outlook or monetary policy in the 10 days preceding an FOMC meeting or on the following day.  Thereafter they are free to speak and over the last two weeks many have opined on both subjects.  Their opinions show remarkable unanimity.  They are focused on bringing inflation back down to their 2% target.  They acknowledge the uncertainty in the economic outlook, and, as a consequence, they profess themselves to be “data dependent” and frequently quote, with furrowed brows, the year-over-year increases in CPI and consumption deflator measures of inflation.

A famous Sherlock Holmes story concerns the abduction of a race horse and a guard dog that didn’t bark.  For those who haven’t read the story, I’ll skip over the reason for the dog’s silence.  The point is he didn’t bark – no alarm was raised – no actions were taken - and the horse disappeared. Entering the fourth quarter of 2022, the U.S. economy is teetering on the edge of recession.  However, it is a recession that has been delayed and potentially softened by an excess demand for labor, the lack of over-building in the most cyclical sectors of the economy and healthy bank balance sheets.