Business activity is declining as stock prices are on the verge of breaking through a key resistance level, and and consumer spending is down as well. The Fed takes these declines as good news and may slow its interest rate hikes. We are at the start of an important week.
The Week That Was
As expected, economic reports show business activity has been steadily declining for the past three months. Although the fourth quarter numbers point to a 2.9 percent annual growth rate, this refers to the August to November timeframe.
Monthly data for consumer spending, incomes, and prices tell a different story. Changes in real consumer spending for October, November, and December were 0.4 percent, -0.2 percent and -0.3 percent, respectively. Current-dollar personal income increases were 0.8 percent, 0.3 percent, and 0.2 percent, respectively.
The trend in core inflation was moderated at 0.3 percent, 0.2 percent, and 0.3 percent, espectively. December’s core inflation amounts to a 3.6 percent annual rate.
Two points are relevant. First, the slowdown in spending and inflation came soon after the Fed began its restraint. This probably is due to the Fed telegraphing its moves and allowing businesses to adjust to the anticipated changes. Second, since the Fed is set to continue its
restraint into February, March, and even May, normal lags point to the downturn in business activity continuing into the fall.
In other reports, S&P’s survey of business activity in mid-January was in the mid-40s, close to its year-end level. The report shows January business activity declining at about the same rate as in December.
There is still very little indication of any trouble in the job market. Weekly initial unemployment claims declined to slightly below 200,000, the lowest level since May. In contrast, insured unemployment payments are up by almost 300,000 since October.
Things to Come
The important reports due this week are likely to be mixed.
On Wednesday through Friday, January business surveys from S&P and ISM should continue to show the economy and new orders declining, with readings in the mid-40s. Fifty is break-even.
In contrast, weekly unemployment surveys and business surveys point to jobs increasing. January gains in payroll jobs are expected to be in the vicinity of 150,000.
Market Forces
Stock prices are off to a good start this year, with the S&P500 up 6 percent in January. Financial markets continue to behave as if the Fed will be successful in containing inflation.
Economic data on Friday were very positive. They show a significant slowing in spending and a likely near-term downturn in business activity. These numbers raise the odds the Fed will succeed.
My assumption had been interest rates would have to go much higher for the Fed to accomplish its objective. Financial markets are convinced it will only take another 50 basis points to do the trick.
The downturn we have been forecasting appears to be underway. We expect a decline of roughly 2 percent in real GDP from the fourth quarter to the second or third quarters. Ideally, a recovery can occur by the end of the year, or early 2024.
The key to longer-term interest rates is inflation. Given the volatility of food and energy prices, the Fed will focus more on core inflation rates. Core inflation has remained in the 3 percent to 4 percent vicinity, both in December and in the last three months.
From a technical perspective the market is beginning to look better, but it is still facing some strong resistance. The Dow already passed a key point of resistance, with its 50-day average above its 200-day average. The S&P500, IJR, and IWM indexes are on the verge of this important technical breakthrough. With longer-term interest rates remaining well below our expectations, and with various indexes on the verge of major breakthroughs, prospects for equities are looking good.
With the expected downturn in the economy, odds have increased that longer-term interest rates will remain low. If stocks can break through current resistance, it will be another good sign for the market.
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Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 24 percent
Monetary Policy: restrictive
