• A Memorial Day message about the cost of war
• Krugman (Nobel laureate) “fanatically confused” about the next direction for interest rates
• Deciphering the good news is bad news effect
• Inflations expectations, inflation and political affiliations
• Focus Point Sector Rotation Update: Market pressure shakes off weak trends

A Memorial Day message about the cost of war

• There are a lot of ways to measure the cost of war. The most personal way is in lives. As we reflect on Memorial Day and remember the lives of the people lost defending our country, it’s helpful to provide some context of the volume of lives it has cost defending the United States (dead and wounded):
  • American Revolution: 75,000
  • Civil War: 1,129,000
  • World War I 320,000
  • World War II 1,076,000
  • Korea 140,000
  • Vietnam 212,000
  • Afghanistan 22,000
  • Iraq 37,000
• These numbers are both staggering, heartbreaking and a constant reminder of the cost of war.
• For the first time in decades Europe is engaged in struggles for sovereignty manifesting in drawn out war. According to the latest data published Ukraine and Russia have each lost as many as 500,000 soldiers, with tens of thousands of civilian Ukrainian casualties.

Krugman: (Nobel laureate) “fanatically confused” about the next direction for interest rates

• An interesting interview caught our attention last week by Bloomberg Television’s Wall Street Week, when David Westin interviewed Nobel laureate Paul Krugman. In the interview Krugman said he was “fanatically confused” about the next direction of interest Krugman identified what many on Wall Street and Main Street feel, splitting views into two camps:
  • Interest rates are going higher for longer, with the neutral rates potentially moving higher
  • Interest rates will settle back down to pre-pandemic and long-term trends

• There is evidence that the Fed is beginning to buy into the higher for longer and a higher neutral rate camp, demonstrated by the most recent Fed’s last Summary of Economic Projections, where the inched long-term interest rate expectations higher. It was only a marginal notch up from 5% to 2.6%, but it’s momentum in the upward direction. There was further evidence of discussion on the topic from the Fed minutes released last week.

• Potential drivers of higher for longer identified include:
  • Permanently impaired global supply chains
  • Changes in consumption and work patterns in the post-pandemic world
  • Demographic shifts in major economies
  • Increased borrowing needs of the US government
• Others in the camp expecting rates to settle back down bring up an important point: The economy always looks fine right before it sails off a cliff, and when it does, rates fall.

https://www.bloomberg.com/news/newsletters/2024-05-21/bloomberg-evening-briefing-even-krugman-is-fanatically-confused-about-rates

Deciphering the good news is bad news effect

• The Market Perception Matrix provides a simplified way of understanding the market schizophrenic reactions to economic data
• Last week was a good example of Good News Is Bad News when the S&P Global PMIs came in better than expected. On the same day, Initial Unemployment Claims came in lighter than expected, which also contributed to the perception that the economy has too much momentum for the Fed to ease soon and rates may remain higher for longer.
• One of the central problems with the Market Perception Matrix is that it is reactionary, focusing on just the most recent data release without context, and without looking at the larger picture and incorporating that into a forecast.
• In the larger picture, the labor market is showing signs of weakness and excess government sponsored pandemic savings have been extinguished, putting the markets at a potential inflection point for demand.

Labor market and savings normalized, setting the state for inflection point in demand

Inflation expectations, inflation and political affiliations

• In a recently published paper titled “Partisan Expectations and COVID-Era Inflation”, authors Binder, Kamdar and Ryngaert conclude that political affiliations had a strong relationship with perceptions of inflation since the pandemic, showing the Democrats have had inflation expectations relatively anchored, while Republicans and Independents expectations have become unhinged.
  • Republicans
    • Short-Run Inflation Expectations 4% to 7%
    • Long-Run Inflation Expectations 3% to 4%
  • Democrats
    • Short-Run Inflation Expectations 3% to 4%
    • Long-Run Inflation Expectations 25% to 2.75%

https://conference.nber.org/conf_papers/f192768.pdf

• We compared this analysis to the most recent data available from the Bureau of Labor Statistics and Bureau of Economic Analysis, analyzed by the states where Biden won the states were Trump won in 2020 as well as battleground states. Our analysis indicates the opposite of expectations.
  • Republican States
    • Average CPI (April) 2%
    • Average Unemployment (April) 3%
    • Average GDP Q42023 5%
  • Democrat States
    • Average CPI (April) 5%
    • Average Unemployment (April) 7%
    • Average GDP Q42023 2%

Source: Bureau of Labor Statistics, note – state day often represented by regions in BLS data and converted to states by Focus Point, Bureau of Economic Analysis, National Archives

Research highlights how people from different political parties perceive inflation

Source: “Partisan Expectations and COVID-Era Inflation”, authors Binder, Kamdar and Ryngaert, University of Michigan Survey of Consumers

Focus Point research indicates the opposite of perceptions is true

Sector Rotation Update: Market pressure shakes off weak trends

• The Focus Point Sector Rotation Model is a combined trend following and mean reversion model that utilizes seven factors to analyze daily price data on sectors to determine the strength of upward trends.
• The selloff last week shook loose the weak trends, with the model moving from 9 sectors with up trends to 4 sectors with up trends.
• Weakness deepened, with 2 sectors entering negative These are the 2 sectors we have been highlighting may be encountering fundamental areas of weakness.
  • Real Estate: Fundamental weakness due to rising inventory, lower closing transactions and falling listing prices.
  • Consumer Discretionary. Fundamental weakness due to slumping Retail Sales that may be associated with a softening the labor markets and exhaustion of government sponsored pandemic savings.

Putting it all together

• In last week’s commentary, for the first time this year we used the word “complacency”. The VIX Index had an 11 handle two days last week for the first time since 2019.

• Three recent surveys supporting the onset of complacency in investor attitudes:
  • Bloomberg poll that indicated that only 23% of market participants are worried about a recession
  • Bloomberg survey of economists indicating that they view the odds of a recession at 30%
  • Conference Board Measure of CEO Confidence indicating that CEOs are the most confident they have been since 2019
• This reminds me of an old saying – when everyone is thinking the same thing, someone isn’t thinking.

• The New York Fed’s Global Supply Chain Pressure Index normalized to pre-pandemics trends in the middle of 2023, indicating that the supply pressures that had plagued the markets since the pandemic had largely been That was a key turning point, when the baton for the economy was handed from supply to demand.

• We’ll now see how far demand can take the baton after pandemic savings have run out and the labor market is showing signs of tarnishing.
• Based on coincident indicators, the economy is still performing very well, and risk assets will likely stand to benefit, but investors need to be vigilant for signs to not overstay their welcome in risk assets if the current begin to shift.

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