New York - September 10, 2023 ~ The team at Infrastructure Capital Advisors has completed our new report providing key insights on current market conditions and economic outlook for this month and the coming months. See this month's full report below but be sure to JOIN our Monthly Market & Economic Outlook Webinar scheduled for Thursday, September 14th at 1:30 pm ET where Jay Hatfield, CEO/CIO and portfolio manager will provide even more recent updates and insights to this report and the changing market and economy. Not registered for the webinar already? Click here to register. Also, by registering, we will send you a webinar playback video link if you are unable to join live.
Due to key influencers in the market and economy changing, The September Market & Economic Outlook report has been reorganized and is a much longer report than normal including several NEW sections to the report. Click any key area below to skip straight down to that section further down in the report.
Fed and ECB Outlook NEW for SEPTEMBER
Inflation and Market Outlook NEW for SEPTEMBER
Oil Market Outlook NEW for SEPTEMBER
Bond Market Outlook:
We believe that the 10-year treasury is finding a bottom in the 4.00-4.25% range as we are forecasting Europe will enter into a significant recession over the next 6-9 months. Germany has already entered into a recession. The government bond market is a global market with US Treasuries over 80% correlated with other global benchmark bonds. The recent rise in rates has been global and the key driver of that decline is tight global monetary policy with the global monetary base dropping by $726 billion or 2.9% over the last 2 months led by the ECB reducing the monetary base by an unprecedented $500 billion (US Money Supply up over 3.8% this year and .7% over the last 2 months).
German Factory orders were down 11.7% for July and German Manufacturing PMI came in at 38.8
German retail sales for July were negative .8% and down 2.4% Y/Y.
German GDP growth for the 2nd quarter was flat and down .6% over the last year.
Eurozone PMI came in at 47 vs. expectations of 48.5, which indicates the European economy is in contraction.
European mortgage rates are 45% floating rate, vs. less than 10% in the US, which puts tremendous pressure on Eurozone consumers.
The ECB is a single mandate central bank and inflation has not decelerated significantly in the Eurozone with y/y inflation still at 5.5%, indicating that the ECB is likely to continue to increase rates.
US Treasuries have performed in line with other benchmark bonds during the most recent sell-off so US-centric explanations are misguided, although strong US growth does have global implications. We do not believe the Fitch downgrade materially contributed to the global sell-off.
We believe that the Fitch downgrade was appropriate as the Federal government budget process is broken as there is no balanced budget requirement and very limited restraint on profligate spending by both parties.
We expect, however, that the US external deficit of 95% of GDP with a deficit of 5% of GDP is manageable as the post-WWII nominal average GDP growth is over 6%, implying that the ratio of debt to GDP will be relatively stable over time.
Fears about treasury issuance post-debt ceiling agreement were largely unfounded as the Fed offset the issuance by reducing reverse repo to offset the increase in Treasury cash.
We expect the bond market to rally later in the year as global growth continues to decline. Eurozone growth over the last 9 months is near zero and the Eurozone economy is likely to go into recession later this year as the ECB continues to raise rates and executes an unprecedented QT program. The recession will eventually cause the ECB to halt rate increases and stabilize the European monetary base.
CLICK HERE to go to the most recent adjusted real-time CPI index report from Infrastructure Capital Advisors.
Fed and ECB Outlook:
We do not expect the Fed to raise rates again as we expect that data over the next two months will show a softening labor market and continuing declines in reported inflation. We expect this fundamentally flawed Fed will be forced to consider abandoning its “persistent/entrenched” theory of inflation and to acknowledge that inflation is declining rapidly, just as lagging data in late 2022 forced the Fed to abandon its disastrous “transitory” theory of inflation.
The labor market has decelerated dramatically over the last 3 months with private payrolls growth averaging only 140k vs. 222k over the prior 3 months. Sixty percent of that growth came from the health sector which has been growing on a secular vs. cyclical basis due to the aging population and Pandemic effects. The most recent jobs report also showed the unemployment rate rising to 3.8% from 3.5% and wage growth slowing to .2% from .3%.
Fed Governor Waller, who is normally very hawkish, recently made dovish comments acknowledging recent data supports pausing at least in September.
We expect that the ECB will raise rates one more time as inflation remains high in the Euro Zone and the ECB is a single mandate central bank. We project that the ECB will then pause as we believe that Germany has already entered a deep recession.
The Bank of England has launched an inquiry led by Ben Bernanke to determine what went wrong with the central bank’s policy framework that led it to miss the surge in inflation.
The Fed should launch a similar inquiry and revise its policy framework as it raised rates 3 months after the BOE so was even more incompetent than the BOE.
The Fed should change its policy framework by targeting a 2-4% range of inflation and look at a variety of measures of inflation including both headline and core for PPI, CPI, PCE, and CPI-R, and be more attentive to leading indicators of inflation such as the money supply, housing prices, and energy/commodity prices.
The Fed’s hardline adherence to the 2% target has made the Fed the primary culprit during this century in the decline of the middle class as the Fed attempts to depress nominal wages to hit their unreasonably low target
There is consensus that the Fed should raise its inflation target, with a number of research papers supporting an increase and most recently a WSJ opinion piece from Jason Furman advocating for a 2-3% target.
The Fed continues to make major policy errors as it relies on lagging indicators such as CPI and the labor market to predict inflation vs. leading indicators such as the money supply, housing prices, and energy/commodity prices. If the Fed followed the Infrastructure Capital Real-Time CPI Index (CPI-R), it would have started tightening policy in late 2020 as annualized inflation exceeded 10% instead of waiting until late 2021 and would have halted interest rate increases two months ago as the index turned negative.
The Fed ignores the fact that lower energy, commodity and shelter costs raise real wages and reduce the need for employers to raise nominal wages.
The Fed continues to assert that it is a greater risk for the Fed to pause early than tighten too much and risk a recession.
The expectations theory of inflation, dating from the 1970s, is antiquated as union membership fell from over 25% in the 70s to less than 10% in 2022. Services are only 26% of CPI and a large component is transportation services which are primarily driven by energy prices, not wages.
The Fed will eventually have to capitulate on its “Entrenched” theory of inflation just as it did with its “Transitory“ theory.
Persistent inflation during the 70s was primarily caused by two massive oil price shocks, not the “wage-price spiral” that the Fed focuses on.
The Fed’s 2% target has been an unmitigated disaster for the middle class since it was adopted almost 20 years ago. If the Fed sticks doggedly to its 2% target and is not patient, ongoing and rapid rate increases well above 5% could cause a recession in 2023.
Congress should reform the Fed by mandating the adoption of an unemployment target of less than 5%, nominal wage growth of at least 5%, and raising the inflation target from 2% to a range of 2-4%
The Fed’s 2% target was arbitrarily adopted without any empirical analysis or support. The 2% inflation target adopted almost 20 years ago has been terrible for the middle class as nominal wage growth has plummeted with average annual nominal wage growth declining from over 7% from 1980-2009 to under 3% from 2010-2022. In addition, the Fed’s adoption of the target led to 17 rate increases in a row prior to the Financial Crisis, causing or at least exacerbating the Great Recession.
Since the balance sheet started to shrink the Fed has offset a significant amount of the roll-off through open market operations, lessening the impact of QT.
The monetary base shrank by almost $1.0 Trillion or 16.2% so far since January 1, 2022, and the Fed’s short-term lending of treasuries and mortgages increased to $2.5 trillion over the last year (reverse repo). This is the most rapid decline in the Monetary Base since the great depression and drove the dollar up more than 15% and pressured the prices of both stocks and bonds.
We estimate that future net quantitative tightening will be modest as bank reserves are now in line with pre-pandemic levels. Most of the impact of Fed balance sheet reduction will be offset by a reduction in the Fed’s $2.5 trillion dollars of borrowing from banks (reverse repo)Stock Market Outlook:
Inflation and Market Outlook:
Inflation is now contained even though the Fed does not recognize it:
CPI came in at 3.3% y/y down from a high of 9.1%.
PPI is now .7% down from 11.7% y/y.
CPI-R (CPI using real-time shelter index) is now .9% down from 12.0%.
PCE-R is down to 2.6% from a high of 7.6%
The above indicators are real-time or coincident indicators of inflation with core CPI and PCE being deeply lagged due to slow bleed-through of energy prices and highly flawed estimates of shelter cost. PCE Core will only be down to 4.2% from 5.0% a year ago.
The PCE Index has a much higher weighting in medical services at almost 21% vs. 5% in CPI. This makes the PCE measure less desirable as Fed policy has minimal, if any, impact on medical services which is more driven by demographic trends.
The Fed’s focus on Super Core services is misguided as the high Super Core number is caused almost entirely by an increase in auto-related services due to a reduction in new car production directly due to a chip shortage. The Fed should not tighten monetary policy to attack supply shocks.
The leading indicators of inflation are energy prices, money supply growth, housing prices, and auto prices. We forecast that inflation will continue to be contained as we believe that energy prices will stabilize and housing prices are unlikely to rise significantly with 30-year mortgage rates at a 20-year high of 7.55%
During the 70s, energy prices increased an unimaginable $1200% ($3 to $39), which caused 80% of the core inflation during the decade and housing prices rose an average of 10% per year. These two categories accounted for almost all of the inflation during the decade. Real wages declined by 6% detracting from inflation, which proves the labor market did not contribute to inflation
Shelter and the auto sector represent 58% of core inflation. Goods prices drive wages, not vice versa, particularly in the US which is less than 6% unionized.
Inflation in the goods portion of autos is down with used car prices down 5.6% over the last year and new car prices now only up 3.5% while motor vehicle maintenance is still up 12.7% y/y and automobile insurance is up 17.8% y/y.
We expect oil to have a seasonal pullback when we enter the Fall as demand for refined products declines after the summer travel season ends. A decline would be positive for inflation as there is a 5% bleed-through of energy prices to the core.
Housing prices are down almost 1.2% year over year.
Chair Volker made a huge policy error by pursuing an ultra-aggressive monetary tightening to fight an energy price shock in the late 70’s.
We do not expect the Fed to cut rates until at least June of 2024 as this Fed is almost always a year behind in making the appropriate policy actions. Since the Fed should have cut rates after the banking crisis started in March of this year they will take at least a full year to discern that they should cut.
This Fed is fundamentally flawed as it focuses almost exclusively on the discredited Phillips Curve policy framework which focuses on employment and wages driving “inflationary expectations”, “wage-price spirals“, “entrenched inflation” and “Inflation that is more dangerous than a recession”. These conclusions are based on learning all the wrong lessons from the 70’s oil price shock and are Urban Myths, often repeated but inaccurate.
This Fed completely ignores changes in the money supply which is a huge mistake when the money supply is extremely volatile, which it has been since Powell became Chair in 2018.
The money supply is 60% correlated to inflation since 2018.
The Fed’s assertion that persistent inflation is a bigger risk than a recession, is not supported by any research. Moderate inflation in the 2-4% is ideal for growth and nominal wages, and recessions are terrible for almost everyone. Very high inflation of 5-10% is a problem but that is not currently a risk for the US economy, This type of inflation is usually caused by energy shocks, which are terrible for both inflation and economic growth.
We are currently in a rapid disinflation. The Infrastructure Capital Real-Time CPI Index (CPI-R) hit 1% in June, signaling that inflation has ended and will Y/Y CPI will continue to decline rapidly over the next 6-12 months. Housing prices started declining in July of 2022 and will eventually be reflected in the lagging BLS CPI index. The CPI shelter estimate has enormous lags due to outdated survey methodology and is currently reflected in CPI at an annual rate of 7.2%. There is a 70% correlation between housing prices and shelter increases 12 months later, so housing prices are a better reflection of inflation than the reported shelter numbers in CPI.
There is at least a 5% bleed-through of energy price shocks to Core PCE. We expect inflation to continue to decline in 2023 as we anniversary the energy price shock that occurred in the 1st quarter of 2022
Oil prices have been flat since February, having just recovered to pre-banking crisis levels.
Natural Gas prices are now down 25% from the beginning of 2022 and down 70% from the 2022 highs, which is highly deflationary as gas and electricity equate to half of the energy component of CPI and bleed through to core CPI.
Certain sectors are more impacted with most crops having a 40% energy component and airline fares 30%.
Fertilizer prices are off more than 70% from the highs reached in March of 2022.
Despite the lag in the BLS measuring shelter costs, we are forecasting that core year-over-year PCE will drop to less than 3% by December as shelter is only 16% of PCE vs. 33% of CPI.
Inflation in the 70’s was caused by consistent and excessive money supply growth that averaged over 8% for annum over the entire decade and two massive oil price shocks where prices rose 150% and 200%. The improvement in inflation is likely to accelerate in the 3rd Quarter and 4th quarter of 2023 as we anniversary the oil price shock of 2022 where oil went from $75/bbl to over $120/bbl. In the 1973 oil price shock Core PCE rose from 3.8% to over 9% within a year of the 150% oil price increase and during the 1979 200% oil price shock the Core PCE rose from 6% to over 9%.
Stock Market Outlook:
We are currently neutral on the stock market as global interest rates have risen and we are in the weak Fall season. We expect the S&P to be range bound in the 4,300-4,600 range during this difficult season, although this view is conditioned on the bond market stabilizing in the 4.25% area. Every 40bp move in the 10-year treasury affects the theoretical market multiple by one point.
We remain bullish on the market in the 4th quarter of the year and have raised our target on the S&P to a range of 4,500-5,000 based on an 18.5x 2024 EPS estimate of $245 on the low side of the target and under 21x at the high end. As the AI boom unfolds and many AI stocks move from being undervalued to becoming fully or over-valued the market may trade to the high end of our range.
The Dow is currently only trading at 17x 2024 earnings and only 16x non-tech EPS, which is in line with our estimate of a fair value multiple of 15X at a 4.25% treasury, indicating that the broad market ex-tech is fairly valued, with tech companies vulnerable to a pullback during the Fall.
The economy continues to be resilient and earnings estimates have only declined slightly.
Earnings estimates for 2023 and 2024 have been stable this year despite pundits predicting a dramatic decline.
Stock Picks:
2023 is likely to continue to be volatile with Fed tapering reducing liquidity, inflation continuing and growth slowing so we are focused on large capitalization defensive dividend stocks and preferred stocks that have lower volatility and benefit from inflation
Covered call writing strategies are likely to outperform during the remainder of 2023 due to high volatility.
REITs that benefit from declining interest rates and a Pandemic recovery such as hotels, office, retail or entertainment.
Other large-cap dividend stocks such as pipelines, large-cap energy companies, super-regional banks, and utilities
Overvaluation of companies in promising industries is a very efficient characteristic of the US capital market as it attracts capital to those industries and speeds the development of breakthrough technologies. Speed to market is more important for new technologies vs. efficiency. This overvaluation normally lasts until there is an overwhelming surge in the supply of new IPOs that drives down valuations.
The AI boom will likely stabilize the office market for tech and lab space as most AI start-ups require hardware and are likely to be closer to “live from the office” than “work from home”.
Economic Outlook:
We expect the US economy to avoid a recession and execute a soft landing with economic growth to be 1-2% as credit tightens due to Fed policy and the ongoing bank crisis offset by post-pandemic tailwinds and the enormous decline in energy prices. The housing sector, which usually is the leading cause of recessions, continues to be resilient with an ongoing shortage of total homes for sale.
There are currently 7.9 million construction workers employed which is an all-time high and has been steadily rising during the Fed tightening. We expect this to continue as the housing shortage and spending on infrastructure supporting the sector. Construction spending totals $1.8 trillion representing over 8% of GDP and is the most volatile of all sectors.
During the housing crisis of 2008 2.7MM construction workers were laid off, representing a 30% decline, and 2.0MM related manufacturing and transportation workers were also laid off, representing 2/3rds of the job losses during the Great Recession. Every post-WWII recession has had large construction layoffs that on average caused a 14% loss of construction workers.
We project that the impact of the infrastructure bill, IRA, Chips Act, and ARPA will add approximately $200 billion per year to construction spending, which should offset the slowing in the construction of office buildings and other commercial real estate.
Hawkish Fed and ECB Policy are likely to cause a global recession in 2023 but the US is likely to stay out of a recession.
We do not expect a recession in the US in 2023 due to:
a very resilient housing sector with an ongoing shortage of housing and
tailwinds from the enormous 70% energy cost advantage relative to the rest of the world.
We expect 2022 economic growth to slow dramatically into the 0-1% range due to erratic and very hawkish monetary policy and the banking crisis.
The Institute for International Economics forecasts that the Euro Zone will contract by 2% next year.
The additional possible 25bp of Fed tightening is unlikely to have a large impact as long rates already reflect that level of increase and 75% of US consumer debt is fixed. Recessions usually are precipitated by a housing and auto crash causing mass layoffs of construction and auto workers. Housing is the key cyclical sector that has crashed in 11 out of the 11 post-WWII recessions. There is currently a shortage of homes and autos in the US so mass layoffs are unlikely in 2023. Consequently, we are projecting that the US economy will avoid a significant recession in 2023.
The total inventory of existing houses for sale is near an all-time low of 1.6MM units vs 4.5MM total homes for sale at the peak of the financial crisis. The national vacancy rate is close to an all-time low of 5.0% vs. the peak of 11.1% during the financial crisis in 2009. Monetary policy acts with a lag and there has already been a tightening of financial conditions with the 30-year mortgage rate rising from an all-time low of 2.80% to over 6% now.
Auto inventories are down by approximately 90% at 130,000 autos vs. normal levels of 1,000,000.
There has been a 33% decline in gasoline prices over the last 6 months and a 70% decline in natural gas and wholesale electricity prices over the last two months, which increases consumer purchasing power significantly.
The US consumer is strong with over 65% of US households owning their own home so are insulated from rent inflation and have benefited from price appreciation. Lower-income consumers have benefited from the recent 30% decline in gasoline prices.
The rest of the world is suffering from the ultra-strong dollar which makes their prices rise substantially and forces other central banks to follow the Fed and adopt an ultra-hawkish monetary policy that their weaker economies are unlikely to be able to weather.
Oil Market Outlook:
We expect oil to trade in the $75-95 range while the Ukrainian war continues
Recent weakness in oil prices, driving prices below our range, were caused by:
Tepid demand in China,
Fears of fallout from the banking crisis, and a
Slight increase in US production.
The ongoing European energy crisis is likely to offset weak global demand for oil.
The end of the China zero Covid crisis will result in a slow recovery of oil demand.
OPEC+ continues to support oil prices through production cuts.
The key global energy/climate opportunity is to rapidly develop the US natural gas transmission and export capacity of the US.
There is a 70% discount on US natural gas prices relative to European prices.
Expanding natural gas consumption reduces the consumption of coal, and coal represents over 44% of global carbon emissions.
High European natural gas prices are driving fuel oil/distillate prices through the roof as distillate can be used as a substitute for natural gas and is easy to ship.
It is not possible for the US to stop using hydrocarbons as wind and solar only represent less than 6% of US energy production and are extremely difficult to expand rapidly as siting/NIMBY issues are huge barriers to expansion. The fastest way to reduce carbon emissions is to drill for more natural gas which will displace coal.
Energy Prices and refining cracks have plummeted over the last year:
Oil prices are down 15% y/y
Natural gas prices are off more than 75% of the highs
Jet fuel is down 50%
Wholesale gasoline prices are down 60% from recent highs
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