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Navigating the Markets: August 21-25

Happy Sunday, friends! Can you believe it's been about a year since that storied 8-minute fire and brimstone Jackson Hole speech, where Chair Powell promised pain and the market collapsed by about 4%?

Pouting Powell: "Mission not accomplished"

Since then, stocks have recovered, financial conditions have loosened, and the market began to discount the Fed's credibility rather aggressively.

Until recently.

Something has changed, a theme we've been discussing here on Navigating the Markets and our Midweek Update for the last several weeks.

There's quite a bit more to catch up on this week, so let's dive in!

The Big Picture

We've heard a lot of opinions about the health of the American consumer. The picture is indeed mixed, largely divided across lines that divide people by income and wealth. With lower tiers seeing a larger impact on their overall cost of living and need to borrow as a result.

For some time excess savings, largely pushed higher from enormous and historic fiscal stimulus, had supported household spending. That stock of excess savings is projected to run out over the summer.

Liquid assets are also eroding, though remain well above the inflation-adjusted historical trend.

As a result of rising prices and an increasing cost of capital, consumer borrowing on credit cards hit a record level, $1 trillion, recently. That staggering figure only tells part of the story here, however, as we're also seeing delinquency rates rise past COVID crash levels, with younger generations leading.

Citigroup's Economic Surprise Index has slowed considerably, after numerous upside surprises over the summer.

Source: Edward Jones

This likely suggests that interest rates on the 10-year are about right here, given the correlation between movements in the Surprise Index and 10-year yield.

When we look at the 10-year yield as a voting mechanism regarding economic and inflationary risk, this also would make sense as we see concerns about inflation on the rise as the economy as largely remained more resilient than many expected.

That concern about inflation is being driven in no small part higher by crude prices remaining buoyant.

We're also seeing the 2s-to-10s yield spread flattening out after a rather deep inversion. It's worth watching carefully as if we do steepen into positivity that would suggest that we could have a downturn in the economy coming imminently.

Real wages are on the rise, which is a breath of fresh air for consumers, but retail stocks aren't responding of yet, though the latest retail sales data showed a big monthly increase in the demand for discretionary products. The question becomes how long will real wages rise and will it be enough to offset the impacts of inflation, which has slowed, but prices nevertheless remain quite elevated in many areas.

China's reopening has become a bit of a tired joke for many macro commentators, and instead we're turning our attention to the concern that something not so pleasant may be brewing over there.

We've seen Country Garden default, Evergrande seek chapter 15 bankruptcy protection, increasing local government funding vehicle stress, exports and imports plunge, PPI show deflation, and a record high youth unemployment rate.

That's a lot to take in. On top of that, now, we see China's 10-year yields hovering near record lows, suggesting that concerns are mounting about the economy.

During Q2 earnings season 32% of S&P 500 companies mentioned AI during their conference calls, but what we didn't hear much about was AI having an immediate positive impact on productivity or margins for most companies. The only company that I am aware of which mentioned that directly was Meta.

Source: Goldman Sachs

Until we see AI driving meaningful productivity and profit margin gains, I think it needs to be treated with some degree of skepticism from the perspective of pulling forward years of future returns into the present with this multiple expansion-driven rally. It remains a "show me" story from that context.

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