Week of May 15th, 2023

Key Points for the Week

• Stocks continued to hang tough last week in the face of economic and banking worries.
• April CPI inflation data came in as expected, but we may now see a clear path to lower inflation.
• Energy, food, and used car prices have pulled inflation down from 9% in June 2022 to 4.9% in April 2023.
• Core inflation remains elevated, mainly due to above-average housing inflation.
• The good news is housing inflation appears to be at an inflection point and could help drive core inflation lower in the second half of 2023.

Economic Update

The Consumer Sentiment Index fell to a six-month low in May, dropping 9.1 percent month-to-month. Participants in the University of Michigan survey were:

• Less concerned about current economic conditions (down 5.4 percent, month-to-month), and
• More concerned about future economic conditions (down 11.7 percent, month-to-month).

They were wary about the outcome of debt ceiling discussions, concerned that policymakers will cause the United States to default on its debt, and apprehensive about how that could impact the economy, according to Director of Surveys Joanne Hsu.

What is the debt ceiling?

The debt ceiling is the amount of money the United States government is allowed to borrow to pay debts it has already incurred. These payments include interest on Treasuries, military salaries, Social Security and Medicare benefits, tax refunds, and other financial obligations. The debt ceiling has been lifted 78 times since 1960. Part of the reason that we have a debt ceiling is that both parties use it as leverage for their political agendas. Some points to consider:

• The debt ceiling is political and not economic
• Both parties play a game of chicken hoping to increase their political leverage
• The demand for US Government Debt remains high
• A default is a red line that we believe neither side wants to cross

What happens if policymakers don’t raise the debt ceiling?

No one knows for certain, although many economists, analysts, and the financial press are concerned. Here is what some have said:

…the U.S. federal government would face various unpalatable options, ranging from delaying payments to contractors, Social Security recipients, Medicare providers or agencies; to defaults on payments on US government debt.

Chris Giles and Colby Smith, Financial Times

A technical failure by the U.S. to meet its obligations would impact those Treasuries coming due most immediately. Bill markets are pricing in some risk of default in early June…A default threatens to spur big moves around the globe, with the prospect of a major economic downturn and a reassessment of Fed monetary policy potentially igniting a perverse bid for Treasury bonds on haven demand. Conversely, a resolution could shift the focus back to the outlook for inflation and the credit cycle for traders betting on whether the era of aggressive Fed interest-rate hikes has peaked.

Benjamin Purvis, Michael Mackenzie, and Ye Xie, Bloomberg

Potential repercussions of reaching the ceiling include a downgrade by credit rating agencies, increased borrowing costs for businesses and homeowners alike, and a drop off in consumer confidence that could shock the U.S. financial market and tip the economy into recession.

Noah Berman, Council on Foreign Relations

Many observers believe a deal will be reached before the June 1 deadline.

If you’re a long-term investor, there’s a strong case to do nothing. If history is a guide, a deal to avoid a default will be struck.

Lauren Foster, Barron’s

Last week, major U.S. stock indices finished the week with mixed performance, reported Barron’s. The Dow Jones Industrial Average and the Standard & Poor’s 500 Index lost value, while the Nasdaq Composite gained. The yield on the one-month Treasury bill finished the week 28 basis points higher than where it started.

This Week in the Markets

Stocks fell for the second consecutive week. In the face of banking and economic concerns, stocks are holding the line. Stocks tend to lead the economy, so just because the economic headlines are poor now doesn’t mean they will be in the future.

Stocks just turned positive on a year-over-year basis as of the end of April. This matters as the S&P 500 had a negative year-over-year return for 12 months in a row before finally turning positive last month. We reviewed previous examples of the stock market going at least 12 months with negative year-over-year returns, and sure enough the future returns could be positive.

Inflation

April’s CPI inflation data came in at expectations. Headline inflation rose 0.4% and is now up 4.9% over the past year. That is well below the peak rate of 9.1% last June. The big picture is inflation has already pulled back in a big way. That is primarily because of lower energy prices and a welcome decrease in food prices. Used car prices rose in April but have been on a downtrend since last summer, contributing to the pullback in inflation. New car price inflation appears to be easing now, too.

Excluding food and energy, core inflation is now running higher than headline inflation, at 5.5% over the past year. That’s not far below last summer’s peak of 6.6%, and so the pullback in headline inflation hasn’t quite translated to the core measure. Core inflation is also what the Federal Reserve typically focuses on, and from that perspective, inflation remains well above the Fed’s target 2% rate.

The main reason behind elevated core CPI inflation is housing inflation, which makes up 41% of the basket. Housing inflation, which is basically derived from rents (as opposed to home prices), has been running hot, around 8-9% over the past year.

This is in sharp contrast to market-based rental price measures, which have shown a sharp deceleration in rents over the past year. Apartment List’s national rental index peaked at 18% about 18 months ago, but that has decelerated to a 1.7% pace as of April. The official shelter index clearly has a significant lag to this market-based index. But here’s the good news: The official data looks to be at a turning point.

On a month-over-month basis, rents had been increasing at an average rate of more than 0.7% between June 2022 and February 2023. But that has decelerated to an average rate of about 0.5% over the last two months, which is a very positive sign. However, as the chart below shows, that’s still higher than 2018-2019 when monthly increases averaged about 0.3%.

In short, the official housing inflation data is decelerating, but there’s still some ways to go. We’re likely to get closer to the pre-pandemic pace as we move into the second half of 2023, and that will also pull core inflation lower. That would be more than welcome, especially since it should ease the Fed’s concerns about inflation running above target.

It's a Grill Rush!

Since its post-pandemic re-opening, the Chinese economy has been recovering more slowly than many companies and investors anticipated, but there’s one industry that’s red hot: food tourism. Domestic tourists have been flocking to a small industrial city that has become the epicenter of a national obsession with grilling.

Thousands of tourists have been traveling to the central province of Shandong to experience grilled kebabs and taking pictures of the experience for social media. The skewers are cooked, flattened and dipped in garlic chili paste before being coated in sesame seeds and peanuts. According to The Economist, crowds have been so large that arenas are being remade into temporary dining halls, and banks are issuing low-interest loans to support companies in grilling-related industries.

The great grilling frenzy highlights a social media trend that’s currently popular among young people in China: Special-Forces tourism. The mission of these tourists is the experience – find and eat tasty food while forgoing sleep and spending as little time and money as possible. Some travel to more than 10 locations in a single day. Kebabs and a local beer hit the sweet spot for special-forces tourists. Altogether, the meal and drink cost hungry travelers about $0.40 in US dollars.

Did you Know? This Week in History

May 16, 1929: First Academy Awards Ceremony

On May 16, 1929, the Academy of Motion Picture Arts and Sciences handed out its first awards, at a dinner party for around 250 people held in the Blossom Room of the Roosevelt Hotel in Hollywood, California.

Created by Louis B. Mayer, head of the powerful MGM film studio, the Academy was organized in May 1927 as a non-profit organization dedicated to the advancement and improvement of the film industry. Its first president and the host of the May 1929 ceremony was the actor Douglas Fairbanks, Sr. Unlike today, the winners of the first Oscars—as the coveted gold-plated statuettes later became known—were announced before the awards ceremony itself.

The Academy officially began using the nickname Oscar for its awards in 1939; a popular but unconfirmed story about the source of the name holds that Academy executive director Margaret Herrick remarked that the statuette looked like her Uncle Oscar. Since 1942, the results of the secret ballot voting have been announced during the live-broadcast Academy Awards ceremony using the sealed-envelope system. The suspense—not to mention the red-carpet arrival of nominees and other stars wearing their most beautiful or outrageous evening wear—continues to draw international attention to the film industry’s biggest night of the year.

Weekly Focus

Don’t count the days. Make the days count.

Muhammad Ali, Boxer

It ain’t no sin to be glad you’re alive.

Bruce Springsteen, Singer