Some indicators have triggered for a potential recession in the future. The conditions for a recession take some time to materialize, but are we living on borrowed time? That's the theme for this week's market musings.
This week's musings is inspired by the 1986 hit song, "Livin' On A Prayer" by Bon Jovi. Here's some trivia about the song:
This song was the follow-up hit to "You Give Love A Bad Name" from the "Slippery When Wet" album. The song reached #1 in the U.S., Canada, New Zealand, & Norway. It sold more than 15 million copies worldwide.
While Jon Bond Jovi and Richie Sambora were the primary songwriters in the band, the studio brought in Desmond Child to help the duo on this song. The inspiration for the song was Desmond and his girlfriend, Maria, who went by the name "Gina." Desmond was a taxi driver in New York in the '70s and Gina was a singing waitress.
The song resonated with working-class fans in New York and New Jersey, where there are plenty of docks - "Tommy used to work on the docks" - and plenty of diners - "Gina works the diner all day."
In a 2023 interview, Desmond said about the song, "The message is, you work hard, you build your life, and you achieve the American Dream."
After recording the song, Jon Bon Jovi wanted to leave it off "Slippery When Wet" because he thought the song wasn't good enough. According to Jon, a meeting with some teenagers changed his mind and he added it to the album...the rest is history.
"Tommy used to work on the docks, union's been on strike
He's down on his luck, it's tough, so tough
Gina works the diner all day, working for her man
She brings home her pay, for love, mmm, for love
She says, 'We've gotta hold on to what we've got
It doesn't make a difference if we make it or not
We've got each other and that's a lot for love
We'll give it a shot'
Whoa, we're half way there
Whoa oh, livin' on a prayer
Take my hand, we'll make it, I swear
Whoa oh, livin' on a prayer"
Here's what we've seen so far this week..
Does It Make A Difference If It's 25 or 50 Bps? At this point, I feel like the Fed is playing so many games that Chairman Powell is akin to Gina when she says, "It doesn't make a difference if we make it or not." Fed speakers have been all over the place this week regarding comments about the first rate cut for the Fed.
After a poor jobs report this morning, New York Fed president Williams stated, "Cooling in job market retreat from overheated conditions." I guess we're just going to ignore the revision to jobs we discussed a couple of weeks ago. And yet, San Francisco Fed President Daly said yesterday on the labor market, "I am watching it extremely carefully because any additional slowing would be unwelcomed." Additional slowing in the labor market is exactly what is happening.
Today's job report showed 142,000 jobs added in August, which was less than the 164,000 expected. However, for the past four months, the headline jobs number was revised lower by a total of 116,000 jobs. On top of that, the JOLTs Job Openings report showed that openings have dropped by more than 1.2 million this year alone. Meanwhile, job cuts, as reported by Challenger, increased by more than 50,000 in August, the largest monthly increase in over a year.
The probability of a 25 basis point rate cut or a 50 basis point rate cut has shifted slightly since this morning's labor report. Just a week ago, there was only a 30% probability of a 50 basis point cut. Today, that has moved higher to a 37% probability. So, the question now is, which amount would have the largest impact on the economy?
According to Redfin, 62% of mortgages in the U.S. have a current interest rate of 4% or lower. That means that if the Fed were to cut 50 basis points, the current 30-year mortgage rate of 6.35% would drop to approximately 5.85%. Is that enough to force homebuyers off the sidelines? I'm not sure that it is, so from a housing market perspective, a 50 basis point rate cut probably wouldn't move the needle very much. Oh, and by the way, Construction job openings fell by 50,000 last month, matching the level of jobs available in that sector in 2007.
We'll Make It, I Swear. Despite the fact that the Fed is likely behind the curve on cutting rates, there is probably going to be some time before things get real.
A few weeks ago, I wrote about the steepening of the yield curve (10yr Yield minus 2yr Yield). At that point, the margin was at 17 basis points. Today, the 10yr Treasury Yield is trading at 3.65% and the 2-year Treasury Yield is at 3.63%. If they close at those values, it will be the official normalization of the yield curve since 2022. This is a typical sign that a recession is on the way. However, the lag time between when the curve steepens to normalization and the beginning of a recession is 6 to 8 months.
Another problematic sign is the euphoria among retail investors. Since the beginning of this year, the meter that measures euphoria among investors has increased substantially. Some of this has been evident in the buying mania around AI-related stocks. The good news is that most of the AI-related names are solid companies - Apple, Microsoft, Amazon, Google - that have been around for multiple decades and have sound balance sheets. This differs from the mania surrounding Dot.com-related names that flamed out in 2000 and 2001.
Also problematic is the seasonality of markets. We have entered September, which is historically one of the worst months for equities, with the added bonus of being a little over two months from the election. Most of the monthly returns for the S&P 500 in September, going back to 1950, have been negative. However, like Gina & Tommy, we can hold on to what we've got. Defensive sectors like Utilities, Consumer Staples, and Financials are positive more than 7% on average since the middle of July. Meanwhile, Semiconductors, Consumer Discretionary, Technology are down more than 8% over the same time period. The point is, there are places to still find value among equities.
We'll make it, I swear...
Disclosures
The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.
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