Nick Hodge,
Publisher
Sept. 29, 2022
Publisher’s Note: What follows is an excerpt from the September premium monthly issue of Foundational Profits. It covers the S&P, housing, employment, and Europe. Paid up members, of course, got the full issue on September 9th, in which we locked in further profits ahead of the most recent leg down in broader equities. We’ve sold 13 positions this year for a closed portfolio that stands at 39.28%. That is an exceedingly good performance in an environment where the S&P 500 is down 21% year-to-date. To learn more about Foundational Profits, click here.
Nick
The first sentence of last month’s issue was: Still bearish.
That came amid many market watchers calling for the bottom to be in after we saw a ~16% rise in the S&P that started in June. Funny how those calling for a bottom failed to warn you the top was in, but I digress.
Your editor maintained it was a bear market rally and said last month that:
Given their propensity to do the wrong thing at the wrong time, eg., hiking into a recession, I’m not convinced a pivot is at hand quite yet, which is why I remain in “defensive capital” mode.
We also happened to ponder, back in April, if oil’s top was in for the year amid slowing economic growth. We talked about “recession coming” and an inverted yield curve that same month. The five months that have elapsed since feel like an eternity as what I outlined has played out.
Having the conviction to remain bearish and defensive has now proven correct.
Mr. Powell told us at the late-August meeting in Jackson Hole that we should brace for “some pain” as he expects the central bank to continue raising rates.
I have been telling you there was more pain ahead for both the economy and stocks.
That pain quickly radiated to markets with the S&P giving up more than 60% of the gains it had mustered since the June rally.
It was especially acute for those who were expecting a pivot and for those who were crowing that “the bottom was in.” They must now taste that crow.
With the dust settling, earnings growth for the S&P for Q2 came in at 6% — the lowest since Q4 of 2020. It’s important to note the number was buoyed mostly by the energy sector because oil prices were above $100 in the quarter. They won’t have that liferaft for Q3.
As it stands, the S&P remains in negative territory as we head into Q4, down ~18% for the year. The NASDAQ has fared even worse, having lost a quarter of its value year-to-date.
And the economic headwinds continue to mount as the business cycle proves inescapable despite prolonged expansion fueled by unprecedented loose policy and Fed asset purchases.
On the housing front, with 30-year rates on the cusp of 6%, mortgage demand is now at its lowest level since 2000. Over five million houses are not current on their mortgage payments. And new home sales are down ~50% in two years, from a seasonally adjusted annual rate over one million in 2020 to 511,000 at last report.
Not only is the supply of new homes in the US currently the highest since 2009, but the median home price is down 6% in two months.
Having your million-dollar house now worth $940,000 contributes to the negative wealth effect that’s already been mounting since the heady handout days of Paycheck Protection Plans and stimulus checks. With the money printer no longer going “brrrrrr,” the consumer is starting to chill.
As for the labor market, unemployment has risen slightly off its post-COVID lows while more people are coming back into the workforce to pay for goods that now cost significantly more.
Over 40% of households are reporting they’re having difficulty paying for usual household expenses. That’s higher than at any point during the pandemic. As a result, the amount of people who report working multiple jobs is also at a post-pandemic high. And while more people are looking for more jobs, the amount of job openings has been shrinking, and layoffs are on the rise. As Charles Schwab bank noted after the August jobs report came out:
Job openings have rolled over from their peak. In July, the Bureau of Labor Statistics (BLS) reported 11.24 million open positions, down from the all-time high of 11.86 million in March. It's clear that they are well off the hot streak during the initial recovery phase of the pandemic.
Confirming the move lower in job openings has been an increase in job cut announcements over the past few months. Companies' announcements of layoffs picked up by 30% in August. While that is down from the prior month's 36% increase, it's the third consecutive month in which layoff announcements were up year-over-year.
As I wrote to you last month: “Hike, and it’s more layoffs and higher unemployment. Pivot and it’s high inflation for longer.” Your unelected financial overlords are going with the former.
The demand destruction that comes with people not being able to pay their bills will send orders/purchases, commodities, and earnings lower.
The yield curve remaining inverted is saying that recession is still here.
The one saving grace, and the reason cash has been my largest single holding, is the strength in the dollar — now at 20-year highs and looking like it could break out further.
That is not the case, however, with many other currencies, including the Canadian Dollar, Australian Dollar, Yuan, and Yen all losing value relative to the greenback.
Indeed, the economic pain is global.
Energy prices in Europe are setting up to make it an extremely frigid winter in terms of economic activity and sentiment.
The S&P Global Eurozone Composite Purchasing Managers Index is now at an 18-month low. And the associated commentary from S&P Chief Business Economist Chris Wiliamson offered little encouragement that things would improve anytime in the next few months:
A second month of deteriorating business conditions in the euro area adds to the likelihood of GDP contracting in the third quarter. August saw output fall at an increased rate, with companies and households scaling back their expenditures amid the recent surge in inflation and growing uncertainty about the economic outlook. The deterioration is also becoming more broad-based, with services now joining manufacturing in reporting falling output.
Looking ahead, an increased rate of loss of orders in August suggest that the downturn in business activity could gather pace in September, and firms are already cutting back on their hiring in the face of weaker than expected sales, surging costs and concerns about future growth prospects.
The answer, at least in Germany, is to print more money. The government there is planning a $65 billion package to help households struggling with inflated energy costs. With Russia cutting off gas supplies via Nord Stream 1 until economic sanctions are lifted, Germany is also backpedaling on its environmental policies as it warms up to using coal and nuclear to keep the lights on.
While there are many global storylines and data to watch, one thing is a near constant across cultures right now: the trend for equity markets is down and not in danger of breaking out. That goes for the Nikkei, the Shanghai Composite, the CAC 40, the S&P 500, the KOSPI, the DAX, and the NASDAQ.