Trade The Journey

Trade The Journey

Is the Economy edging toward a Recession?

Top of the Morning! This week was shortened due to the markets’ closure on Friday which is Good Friday. What made this past week unique was the release of the employment situation report on Friday while the market was closed. While some traders remained on the sidelines, I decided to trade this week and unfortunately, it didn’t end well. The trade review for this past week can be found here.

My initial thoughts on the market’s direction were that lower job openings, a contraction in manufacturing, and a fall in the number of the jobs added would bode well for stocks. However, the economy is contracting a bit more than expected, and that dampened market sentiment causing stocks to underperform. Some of the Fed members remarked that while the banking crisis seems to have abated, inflation is still running hot and higher rates may need to be sustained for longer.

Jamie Dimon also issued a statement concerning banks in his investment letter to investors, remarking that the recent bank failures and the repercussions of interest rates at higher levels will be felt for years to come. He also spoke about the current regulatory requirements and the stress testing based on the scenario devised by the Fed never incorporated interest rates at higher levels.

 Instead, the recent rapid rise of interest rates placed a heightened focus on the potential for rapid deterioration of the fair value of Held to Maturity (HTM) portfolios and, in this case, the lack of stickiness of certain uninsured deposits. Ironically, banks were incented to own very safe government securities because they were considered highly liquid by regulators and carried very low capital requirements.

Here are some goals he listed for the banking system to achieve:

  • Strengthen regional, midsized, and community banks which are essential to the American Economic System.
  • Large and complex banks should continue to play a critical role in the U.S. and global financial system.
  • A system in which a bank failure does not cause undue panic and financial harm.
  • Proper transparency and strong regulations.
  • Market markers should have the ability to effectively intermediate.
  • Banks need to be there for their clients in tough times.
  • Regulation, particularly stress testing, should be more thoughtful and forward-looking.
  • A decision on priori what should stay in the regulatory system and what shouldn’t.
  • Banks need to be attractive investments.

The resulting letter caused banking stocks to fall. Prolonged elevated rate levels are bound to cause some stress in the markets and economy, the only question now is the severity and the repercussions that are bound to arise.

Another development worth monitoring is the movement away from the dollar internationally by China, and a host of other countries joining the growing list of countries willing to trade non-dollar-denominated currencies. While the sanctions the United States levied on Russia due to the war may have spurred movement away from the dollar, the transition from the dollar’s dominance was already in motion. India, Brazil, Russia, and China all seem to be taking steps to move away from the dollar.

Also in the news was OPEC+ decision to cut oil production by over a million barrels which caused crude oil prices to rally. At first, this decision may be interpreted as inflationary but behind the cut may be a lack of demand from a looming global recession according to an article on oilprice.com. The IMF also issued a reduced growth rate for the world economy in the years ahead.

Clearly, a slowdown in the economy is occurring and a possible recession is on the way, so it’s best that traders and investors prepare for heightened volatility. Many are moving their capital to money market funds that are still earning at least 4%. $350 billion entered money market funds with a total of $5.25 trillion held in these assets to date.

Economy

The employment situation report showed that the labor market is still strong with non-farm payroll employment rising by 236,000 in March. The unemployment rate remained around the same level as the previous month, 3.5%. The labor force participation rate is 62.6%. Job growth continued to rise in leisure & hospitality, government, professional & business services, and health care. While the hiring decelerated somewhat in leisure & hospitality, growth was still found in food services & drinking places.

Average hourly earnings came in around forecast, growing 0.3%. The average workweek fell 0.1 hours to 34.4. The average workweek and overtime were unchanged for Manufacturing. While the number of jobs added remains high, it’s below the monthly average of 334,000 jobs added in each of the last six months.

Initial claims rose above the forecast of 203,000, coming in at 228,000 this past week. Continuing claims also rose this past week, up from the revised level of 1.817 million. The original measure of continuing claims was 1.689 million.

The Jolts or Job Openings and Labor Turnover Summary report for February surprised market participants, with openings falling farther than forecasted. The number of job openings fell to 9.9 million.  The largest fall in openings occurred in professional & business services, health care & social assistance, and transportation, warehousing, and utilities. Openings increased in construction and in arts, entertainment & recreation. The quit rate, which is an indicator of the confidence that workers have in finding another job edged up a bit.

The rate for layoffs, discharges, and separations changed little.

The ADP employment report showed that private employers added 145,000 jobs in March. Goods producing companies added 70,000 jobs with the only fall in the jobs added in Manufacturing. Service providing companies added 75,000 jobs with a fall in professional & business services, financial activities, and information. Growth in pay fell for job stayers and job changers. Most of the establishments added jobs from small to large establishments with the fall only occurring in medium establishments that employ 250-499 employees.

Total construction spending for February edged down by 0.1%. Private construction spending was unchanged and public construction spending edged down by 0.2%. Residential construction spending for both private and public construction decreased. Single-family home’s private construction is down over 20% from a year ago. Multifamily private construction spending edged up a bit this past month and is up over 20% from a year ago.

The factory orders report showed that new orders for manufactured goods fell 0.7% in February. New orders are down 3 out of the last four months with a surprise increase in December. Shipments fell 0.5% and unfilled orders fell 0.1%. Inventories fell 0.1%, falling 0.2% for durable goods and 0.5% for non-durable goods.

New orders for durable goods fell 1% and new orders for nondurable goods fell 0.4%. Shipment for durable and nondurable goods fell this past month. New orders and shipments both rose heavily for mining, oil field and gas field machinery. Capital goods new orders, shipments, and unfilled orders fell in February. Total inventories for capital goods rose slightly. Inventory based on stage of fabrication, fell for materials and supplies, was unchanged for work in process and rose slightly for finished goods.

The ISM manufacturing report for March showed a third consecutive month of contraction, with the manufacturing PMI coming in at 46.3%.  Manufacturing PMI is now at its lowest level in the past year as it continued its decline from the 50 level in October.  The PMI reached a low in March far below the 50.9% average of the last twelve months. Some of the remarks from respondents include a lead-time improvement, slower sales, supply chain improvement, a somewhat strong business environment, and some softening in new orders.

New orders softened with the percentage of respondents reporting a lower percentage of new orders rising. The leading reason is uncertainty regarding future demand.

Production fell by 0.5%, with transportation equipment, machinery, and food, beverage & tobacco products being the only industries that expanded. The employment index fell with respondents reporting an increase in the lower percentage of industries hiring. The report also remarked that companies are attempting to maintain their current workforce level for a more active second half of the year. Supplier deliveries, which are measured differently than the indexes with a level below 50 indicating faster deliveries, fell 0.4% with most respondents reporting the speed of deliveries as about the same.

Inventories fell slightly, with machinery and computer & electronic products industries increasing manufacturing inventories. Companies are still attempting to decrease the inventory accumulated from the pandemic boom. Prices index fell 2.1 points to 49.2% with prices rising for foundational purchased materials which include steel, copper, and aluminum. These industries reported paying increased prices for raw materials: Machinery; Plastics & Rubber Products; Transportation Equipment; Fabricated Metal Products. The backlog of orders rose by 1.2% to 43.9%.

The average commitment lead time for capital expenditures increased by two days to 178 days. The average lead time for production materials decreased by one day to 87 days. The average lead time for Maintenance, repair, and operating supplies increased by three days to 46 days.

Below is a chart showing the level of contraction and growth and the speed at which this is occurring.

The ISM nonmanufacturing index expanded, coming in at 51.2%. Business activity fell by 0.9% to 55.4%. New orders were 10.4%, to 62.6%. Supplier deliveries times improved by 1.8 points to 45.8%, the fastest delivery performance since April 2009. Prices fell by 6.1 points to 59.5%. Inventory sentiment improved, expanding for the fourth straight month. Respondents remarks were mixed with restaurant sales comparable to pre-pandemic trends, uncertainty of future demand, falling diesel and gas prices, and supply chains stabilizing in other industries.

Although the Service PMI has fallen from its high in April 2022, it’s still expansionary territory although the PMI is 1.9 points higher than its 12-month low. Although new orders contracted, some comments from respondents include increased guest traffic over the last month and placing orders for the second half of the year. Hiring remains a challenge in the service sector. Respondents indicated that inventory levels are high for business activity levels.

Moving to housing, mortgage applications fell 4.1% from the week prior. The refinance index fell 5% and the purchase index fell 4% from the week prior. The average rate for a 30-year fixed-conforming loan fell by 0.05% to 6.45%. The average rate for a 30-year fixed jumbo loan rose by 0.09% to 6.36%. Tighter credit conditions are beginning to influence mortgage lending.

* I added an indicator to the bottom of the VIX chart for trend identification purposes.

This past week’s cash flow in review:

This week, I was a little more restrained in purchasing decisions although I did make some ill-advised purchases. I’m confident that this next week will show some improvement.

I would like to dedicate this insight to my Mentor’s son, who passed away from cancer.

Grade: D+

Reason: Little improvement from the previous week

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