This Dispatch updates our US recession and earnings outlook. Forward-looking macro indicators like the LEI point to further slowing. June Quarter ex-energy earnings declined YoY, and Wall Street is finally starting to cut estimates. Yet, the dominant narrative we hear is that that earnings are growing, and valuations are now attractive. As we’ve previously written (see Have Stock Bottomed), the current valuations do not support further slowing of economic activity and corresponding earnings declines.
We continue stress test our views by seeking data to refute the above thesis. “Testing Our Biases” section provides several data points on why our thesis may be incorrect. It should come as no surprise that if the US economy avoids recession, then stocks are reasonably valued.
Dispatch #18 contains the following lineup:
- Recession indicators
- Earnings are declining & estimates cuts underway
- Testing our biases
- Tornado Cash activity chart
US Recession watch
The Leading Economic Indicators (LEI for finance nerds like the Dispatch) composite index published by the Conference Board has recorded 5 negative months in a row. The last time the LEI posted such results was during the Global Financial Crisis of 2007/08.
Chat 1: LEIs point to high recession probability
Furthermore, the 6-month growth rate of the LEI is at levels that have presaged a recession in the past. The August LEI will be out on September 18th, and we’ll be watching that closely.
Chart 2: LEI has predicted past recessions
The LEI index breakdown:
The Fed has raised the short term funds rate from zero percent to ~3.1% in seven months. This tightening, we believe, will feed through into softer LEIs and corporate earnings weakness, as we discuss next.
Earnings are weak and energy sector the sole support
S&P earnings growth is being supported by the, low-valuation, energy sector. Without energy, June Q earnings growth would have been negative, which is not widely discussed presently.
Chart 3: S&P earnings ex-energy declined 3.7% YoY in 2Q22
The 2Q sectoral earnings growth gap is shockingly large, which is how earnings growth from a low index weight sector offset the earnings declines of the much larger sectors.
Chart 4: Energy sector main drive of current S&P 500 growth
Since June 30th, earnings revisions have been supported entirely by the energy sector, as shown below. This momentum should decelerate into 3Q and beyond as WTI crude oil has fallen ~ 30% from the June peak.
Chart 5: S&P 500 earnings upgrades supported by energy sector
Earnings downgrades are finally underway
Chart 6: Wall Street is finally catching up with estimate cuts
Third quarter earnings pre-announcements over the past week by Fedex, Ford, Gap and Compass have been weak. Fedex’s downgrade and withdrawal of full year finance guidance was most notable. This Freight Waves post provides more nuanced color on the problems at Fedex.
Ocean contain volumes are slowing
The volumes softness at Fedex is further supported by the 11.7% YoY August import container volume decline reported by the ports of Los Angeles and Long Beach.
Chart 7: US Container Import Volumes up YTD
It remains to be seen if the losses by West Coast ports have been made up elsewhere. Total US Import volumes YT July were positive YoY, with East Coast ports gaining volumes from West Coast ports. While the volumes of containers arriving in US ports don’t offer a conclusive softer trend, container volumes leaving China are slowing according to Freight Waves’ Craig Fuller.
Fuller’s tweet thread insights and data on the slowdown. There’s a several-week lag between Freight Waves’ China loading data and US port import data. This is a single cherry-picked tweet from his thread.A longer-term chart of the Shanghai to LA container shipping freight rate is shown below. While absolute rates are well above pre-Covid levels, the negative marginal change is a more powerful consideration for RockDen’s economic activity calculations.
Chart 8: Container Freight Rates weaken
As we have pointed out previously, most recessions are caused by inventory adjustments and less about a collapse in end demand. We see signs of inventory adjustment in the slowing import volumes.
Testing our biases
We continue to seek out data that refutes our currently held cautious view (see Dispatch #16). Consumer sentiment improved in September, but remains at depressed levels. It’s also worth noting that consumer sentiment has a relatively high correlation to gasoline prices as noted by Mercatus research. We’ll be watching how this data evolves and, equally importantly, watching gasoline futures.
Current stock market declines are in-line with prior non-recessionary bear markets. If the economy does not weaken materially from here, the June low could very well be the cycle low.
Chart 9: S&P 500 non-Recessionary Bear Markets
Could we repeat the 1940s and markets move sideways?
As Fidelity’s Jurrien Timmer posits, we could well move sideways as nominal earnings, helped by inflation, remain stable and valuation multiples derate over time. As we showed above, trends don’t support a robust earnings outlook. Additionally, 3Q earnings pre-announcements have been mostly negative.
Institutional investors position is extremely cautious
The BofA chart below shows current extremes.
Chart 10: Institutional investor equity position is already bearish
This positioning likely means that markets grind lower if activity/earnings slow rather than adjust rapidly. BofA’s wealth management client equity positioning (chart in Dispatch #16) and other retail surveys show high equity allocations, which may offset the institutional positioning.
Chart 11: Individual investors less bearish
The AAII Bull-Bear indicator, which captures retail sentiment, is far from fearful, as shown below.
Tornado Cash activity breakdown
In Dispatch 17, we asserted that a majority of activity by value on Tornado Cash was illicit. That was incorrect as this chart below of Chainalysis data via Bankless shows.
Tornado Cash activity by source since 2019 launch
The table below from crypto security firm Nansen put the figure at ~ 35%, with a list of the exploits routed through Tornado listed.
Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
Important Disclosures
| This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results. At the time of publication, RockDen and/or its affiliates may hold positions in the instruments mentioned in this newsletter and may stand to realize gains in the event that the prices of the instruments change in the direction of RockDen’s positions. The newsletter expresses the opinions of RockDen. Unless otherwise indicated, RockDen has no business relationship with any instrument mentioned in the newsletter. Following publication, RockDen may transact in any instrument, and may be long, short or neutral at any time. RockDen has obtained all information contained herein from sources believed to be accurate and reliable. RockDen makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice, and RockDen does not undertake to update or supplement its newsletter or any of the information contained therein. |