US hedge funds have taken out the biggest bet on so-called cyclical stocks (autos, banks, and so forth) versus so-called growth stocks (tech) in years, according to brokerage-house notes to clients this week. But there’s nowhere to hide in this market.
The worst performers in the Jan. 19 market were Ford Motor Co. and General Motors – down 8% and 3.5% on the day, respectively. The next-worst performers were banks, supposedly a refuge when interest rates rise.
There’s no place to hide because inflation leads to recession. The Federal Reserve has signaled a 1.5% rise in its overnight rate during the next year and a “taper” of its securities purchases. Bond yields are rising in response.
The US may not be due for a recession, but a succession of disappointing data indicate that inflation has throttled a significant amount of economic activity. Retail sales fell in December. So did industrial production. The economy added just 199,000 new jobs, a fraction of what economists expected.
Maybe it’s the Omicron epidemic, and maybe it’s the impact of surging costs on business and consumers.
The first of the regional Federal Reserve manufacturing surveys to report in January was New York, and it showed the first negative reading since the peak of the pandemic in 2020 – once again, sandbagging the consensus forecast.
Meanwhile, the diffusion index for prices paid by manufacturers remained at its highest level on record. A diffusion index measures change, not levels, and it means that costs are still rising – no surprise with oil at the highest level in seven years.
Manufacturing, to be sure, is just 12% of the US economy; services represent 78%. And prices paid by service providers as of December were rising at the fastest rate since the Institute for Supply Management’s records bean in 1997.
That’s mainly due to wages. Hourly earnings are rising at 4.7% a year, less than the inflation rate of 7%, which means that workers are losing 2.3% a year in real terms (and much more if they have the misfortune to shop for a car or a home). Rents are up 14% year-on-year as of December 31 according to the website Zillow, while home prices are up nearly 20%.
A lot of workers, especially older workers with some retirement savings, don’t see the point of working for pay that’s effectively been cut so it’s hard to find workers.
The December retail data also suggest that at some point consumers will balk at higher prices.
Auto prices have risen to an unprecedented extent, with used-car prices at double the level of April 2020. For a while the major auto manufacturers made hay out of the shortage, hoarding scarce computer chips for higher-end vehicles bought by affluent consumers with less price sensitivity. Investors evidently think that this fiddle has played itself out.
It’s a market shibboleth that a little inflation is good for stocks: Large companies are better positioned to maintain pricing power than anyone else. But a lot of inflation, and especially a lot of inflation for a long time, is bad for all risk assets.
Either the Federal Reserve will restrict spending by tightening monetary policy, or businesses and households will restrict spending because they want to and need to.
For the moment there’s no sign of relief from inflation. Commodity prices and especially the price of oil are rising, wages are rising, transportation costs are soaring, rent and home prices continue their vertical climb, and most of the surveys show that prices paid by business are still rising at historically fast rates.
If people refuse to pay the higher prices, inflation will stop, but at the cost of a severe slowdown or even a recession. If they keep paying up, inflation will continue, until people stop paying up.
That’s why cyclicals (except oil) continue to languish along with the bubbly tech sector.