Transcript:
Tom Vaughan:
I always like to start off the show with a summary of what I’ve seen happen in the stock market this week. And of course, this has been an unbelievable week altogether with what’s happened. The markets been very volatile, lots of things going on with inflation, the Federal Reserve and what have you. So I want to break down kind of what I saw happen, some of the reports that have come out, and just give you some opinion on, you know, what the market I think is looking at right now, and what we need to focus on coming forward. So we’ll start off with just kind of a chart like I normally do, here’s the S&P 500, so far this year, down about 22%, unfortunately, in this particular timeframe, but you can see what’s happened since our last show, just last Friday, we’ve had kind of this cascading down motion, a little bit of stability here, you know, recently up a little bit today, for example. And so, you know, I’m gonna break down kind of why I see this happening, but then also kind of show you some of the things that are, that are coming up now that I think are important to pay attention to. So first of all, this is the leading economic index, this blue line, the gray line is actually the concurrent economic index, which just means it’s kind of the current economy. Pay attention to that blue line, because it’s really important, this report was just released today, for May. And so if you look back all the way to the early 2000s, there, you can see that when that blue line peeks out, oftentimes within you know, a fairly short period of time, 8,10, 12 months, we start to see a gray bar coming up, which signifies a recession. And it’s very important in this type of market to understand that, you know, if you combine a downturn with a recession, the downturn could be much, much higher, as like we saw in 2000, like we saw in 2008.
So even though we’re down so far, right, now, maybe we come back around if we don’t have recession, well, if you look at the most current end of this blue line right above me there, you can see that it’s showing a little bit of weakness, right. And so it came down point 4%. In May, they readjusted April in March, so the peak is now in February, and the drop from the peak is point 9%. So it’s starting to get into a range starting to signal the possibility of recession. As far as that goes. So important to keep track of that, respond to that and understand what that means, in my opinion. Now, I do follow a couple of other recession indicators. And I’ll show you those just really quickly, I’ve covered these before. This is the clear bridge indicator, they actually break out the 12 pieces that they use, the leading economic indicator uses 10 pieces, they put a green arrow or a yellow circle or a red X, depending on where are they see it in terms of recession indication, this is the last three months. And so you can see, you know, we’ve had this red X under wage growth all the way through, but the number of yellow dots there is starting to grow, again showing some weakness, but the overall indicator is still green, you can see that little arrow right at the bottom. And we probably have a ways to go before this is going to start flashing future recession on the horizon. We do get this again every month. So we’ll find out what happened in June, really, in early July, they actually update this quite quickly, which is nice. The other big one that I follow is the spread between the 10 year treasury bond and the three year treasury bill. So theoretically, you should always be making less on a three month bill than you would get on a 10 year bond. Right. So like a CD, if you went to the bank and said You invest for three months, you’re gonna get a lower return most of the times and you’d get on a 10 year.
Now, once in a while that inverts and very high probability when it inverts. In other words, the three months pays more than the 10 year. And especially if that stays down for about three months and stays inverted for about three months, that you would end up with a recession in roughly the next 12 months. And so you can see right now, and this is as of yesterday, we’re at about 1.7% differential in yield between the three month and the 10 year. That’s pretty good. That’s pretty good spread, but I would be a little cautious because the direction you can see it peaked out back here in May. And we’ve been kind of slowly but surely starting to compress, that spread so something to watch for. But of the three big indicators, the leading economic indicators showing a little bit of weakness that ClearBridge is showing some weakness but still pretty strong. This is showing you know the yield spread showing some weakness but still pretty strong. So but these are things to keep track of and make sure you understand because if we’re heading into recession, you might want to do some things differently with your portfolio than you might normally do and be be at least more cautious, just because you can roughly double the downturn that you might have with a recession versus a downturn in the stock market without a recession, if that makes sense. And the recovery time can be quite a bit longer also. So definitely something to pay attention to. Now, just getting back to kind of what is happening right now and why we’ve had this, you know, kind of big cascading drop here started last Thursday. And then on Friday, we got the Consumer Price Index report, we talked about this on the last show on Friday. Well, if you look at that, we kind of peaked out in March, and everybody thought, okay, April was down, the big hope was that may would be down also, and may was up and actually was up higher than March.
And so the market really responded to this. It wasn’t supposed to be down a lot, if you look at the consensus estimates, but still supposed to be down some or at least flat and that didn’t happen. And so the market looked at that as a negative, because that is the big piece that the Federal Reserve is looking at as a whole. And really, you know, worried that the Federal Reserve is going to have to do a lot more rate increases, which the market looks as as a possible negative if they’re not careful. So here’s why I think some of the things have happened since the Federal Reserve announced their increase. So they increase the rates by three quarters of a point on Wednesday, the expectation prior to this week was that it would be half a percent. Once this report came out, we started to hear about three quarter percent, which is pretty rare. The last time that happened was 1994. So it’s a big increase. It’s not something to do very often. And one of the things that I think was very interesting in watching the conference that Chairman Powell had in the question and answer was that he kept focusing on this, this is the kind of the top line inflation includes everything. Well, that also includes energy and food, which the Fed constantly says they don’t have as much control over. So the Fed often looks at what’s called core inflation.
And if you look at core inflation, so this is the same basket, just taking out food and energy, core inflation is down. Okay, so think about that for a minute. The thing that the Fed talks about all the time that they have control over is actually down, peaked out in march down April down even lower in May. And they increase the rate from point 5% expectation to three quarter. So what are they responding to, and I think that’s what the markets reacting to. And the markets also reacting. And I’ll talk about what I think is happening here in a minute. But the market was also responding to the fact that the Federal Reserve kept talking about how strong the economy is. And they’re right to a large degree, but didn’t really acknowledge all of the different things that are starting to show softness. And so, you know, if we look here, the Producer Price Index, another kind of inflationary measure peaked out right earlier. Here’s the PCE the the pursuit, sorry, personal consumption expenditure. This is the favorite index for inflation for the Federal Reserve. They talked about this all the time. This is not up to date through me, this is just through April, so it dropped in April. So we’ll see what happens with may. But again, no conversations about these preferred or core type inflationary things, just talking about top line inflation, and trying to really reduce that.
Jobs openings was the hot subject for the Fed meeting last month, they wanted to reduce job openings, there’s almost two people were looking, you know, two jobs open for every one person looking. And that’s creates problems on an inflationary basis. So they wanted to bring that down. Well, it did come down. So not a lot, right. But came down no acknowledgement of that. We actually saw Unemployment Claims first time, unemployment claims come up. So it’s not a lot. But you can see there’s a bottom there and April is starting to come back up. Again, those are things that are showing softness, we need softness, we need to slow down the economy, because the inflation is too hot. And it looks like things are starting to happen and starting to work. Yet they increase the rates by the most that they’ve done since 1994. Kind of interesting. Here is retail sales, just reported really the same day that they raised the rate. And that was down a little bit not a lot, you know, but down which is kind of interesting, because we’ve seen retail sales, as you can tell been pretty healthy here. But consumers are possibly starting to respond to these higher prices, or to respond to the fact that the stock market’s down, respond to the fact that they can’t refinance their house, you know, at a low rate anymore, as far as that goes.
Speaking of low rates, here’s the 30 year mortgage rate over the last year, you can see it’s just really accelerating to the upside. And what we’re having here is where it was nearly, you know, 3% or less on average 30 year mortgage, that’s almost double that now. And what’s what that most likely means is some slowdown in the construction industry, and the new home sales industry, which is a really big chunk of the economy. And you can see that here, here’s the number of permits that have been asked for, for new buildings. And of course, that peaked out back, you know, at the beginning of the year, and has come down quite drastically. So the market is saying, hey, you know, things are already starting to go in the direction that the Federal Reserve wants, probably not at the pace that the Federal Reserve wants because they want to hit inflation faster and harder. But we got lots of evidence of core inflation coming down lots of evidence of some of the different pre indicators of economic slowing, like new building permits coming down, and no acknowledgement whatsoever about those in in a meeting. And so what’s what the markets afraid of is they’re going to make a policy mistake, they’re going to keep pushing and pushing and pushing on the interest rates, and all of a sudden, kick us into recession. And of course, recessions are really, really rough for the for the stock market. So that’s why we’re seeing so much volatility come down. Here’s the other piece. And I mentioned this on Wednesday. And we’ve seen a lot of articles about this sense, like gas prices. So for the first time I’ve ever seen, the Federal Reserve started talking about consumers expectations for future inflation. This was done through a survey at the University of Michigan. And all of a sudden, consumers have decided that inflation might be a lot higher over the next next 12 months, then was previously and Chairman Powell talked about that and said probably because gas prices are coming up. Seems fair enough.
But he says he wants to get that number back down. And they’re paying a lot of attention to what consumers think inflation might be going forward. But at the same time, many, many times during the same conference, he talked about not being able to control the gas prices. So here’s the fear is that the Federal Reserve is going to push on overall inflation, to try to create a scenario where gas prices go down. And that is going to be very, very difficult to do without getting into a recession, right. And so this is going to be what you want to watch here. And because there is another actor in this, and that’s Russia. So Russia can basically weaponize their energy by holding back deliveries. And there’s already been news, where they’re talking about reducing the amount of shipments of natural gas to Europe, right. And Europe is trying to get off of Russian natural gas, oil and coal. But they don’t have great places to go. And you have a very tight energy market already. Because the economy is opening up faster than you know, the production of oil and refineries of gas and those types of things could do. And so we’ve got this scenario where Russia could start to try to push on this cut back on their oil deliveries, even if it hurts them, it creates a possibility of kicking a bunch of Western economies into recession. So it’s one of the things I definitely would be watching and really watching the price of gas. There is one other component, obviously, of gas. This is a refinement of oil. So it takes refineries to do this. And a lot of refineries were closed down during the pandemic and have not completely reopened yet. That is happening. There was some news about refinery opening up in Kuwait, for example, and those types of things. But it does take time.
And so there’s this kind of lag right now, where the markets looking at this and saying, wait a minute, the Federal Reserve is going to be aggressive trying to reduce gas prices, which they really don’t have as much control as they probably wish they did. And we’ve got this other scenario where gas prices have a high likelihood of going up. And we’ve got a seasonality situation with the summer and all those types of things. So really, really interesting what’s going on right now very different. And I think that the market is very worried about what the Federal Reserve is talking about right now. They’re being extremely aggressive in their thoughts and talking about fighting inflation, which is fine, but then they started to go off into some areas of trying to fight things that they don’t have that much control over that I think worries the market. So, you know, these are things we’re gonna have to see how they play out. But I do see enough pieces here between kind of what happened to the price of the S&P 500. What happened with the leading indicators and the recent pre recession indicators that I’m watching to say that we should be more conservative here in this environment. You know, if you’re younger, and you want to go out and buy some small stocks and you got it Want to your time I go for it, probably a great time to do so honestly. But you know, if you’re like most of my clients, who are, you know, near or in retirement, you know, looking for income production or living off of those assets, I would think you want to be a little bit more cautious here, just as far as that goes. So, this is something you know, we’ll continue to work on within our portfolios, just to try to kind of dial back some of the possible volatility, just in anticipation of what might happen. I would love to see what’s going to happen with gas prices here. That’s one of the things that’s I think really driving this at this point in time. So great timeframe to be paying attention to the market, because boy, you can really learn a lot here about investing from what’s happening now, and how things are related and how they connect together. So thank you very much for watching my summary this week and look forward to again talking to you next week.