Foreboding macroeconomic signals keep on popping up, and it would be wise to pay attention.
In case you can’t tell, this is exactly like late 2006 with key (worse) differences:
- The macroeconomy has peaked: Jobless claims are barely below last year’s, meaning that growth has peaked. GDP is low and inflation is about to pick up. Wages aren’t really growing much whereas expenses like healthcare are surging. US trade has fallen to 2014 levels and a global industrial recession is worsening.
- The market is flashing peak valuations: For example, the Shiller P/E has hit cyclical highs and absolute levels not seen since… 2007/2008. That’s especially scary given that revenue growth is not expected.
- Credit market turmoil is coming: On the one hand, subprime auto loans are defaulting at their worst level in 20 years. If you believe that all problems start at the margins and work their way in, then that’s a big fat red signal. Another is Tuesday’s announcement by Synchrony Financial (NYSE: SYF) – formerly a General Electric (NYSE: GE) business unit and a provider of private label credit cards to companies like Walmart (NYSE: WMT). SYF had to both write-off delinquent loans AND build capital to cover the debt. It’s not like the last cycle when the credit markets were excessively exposed to defaults, but it is a confirming signal that growth is getting so hard to come by that lenders are giving loans to people who shouldn’t get it. That was the essence of 2006 when subprime loans started to implode. On top of that pain, we have a Fed rate hike that will hit the market negatively. Plus, somewhere further on the horizon is a likely China Lehman event.
The Next Inflection Point
Following this macro peak, I believe that we will see a downshift in consumer spending in late 3Q for several reasons.
Between now and then, companies are navigating narrow revenue growth. Peak consumption has been reached and excess supply and capacity remain as big headwinds.
For the macro picture, I see the following rhythm in the supply chain:
- 4Q 2015: Drop in revenue growth driving deep inventory drawdowns.
- 1Q 2016: No inventory bounce-back. The continued lack of demand growth delays inventory builds and slows hiring.
- 2Q 2016: Confirmation of sluggish growth (especially China) for 2016. Slight re-stocking after two quarters of delays. China 1Q stimulus triggers some false starts. Macro will deteriorate starting with June reports (i.e. May data released starting June).
- 3Q 2016: Service sector gets hit as consumer spending growth slows further (real wage growth hit by rising costs, particularly healthcare).
On the Cusp of a Vicious Cycle
A slowdown in consumer spending is the Achilles Heel.
Businesses are walking a tightrope to maintain margins in the face of slow topline growth. Companies have the pricing power to pass along inflating costs.
While conditions are not quite stagflationary, consumers are facing slowing income growth at a time of rising costs. Sentiment will turn down and bring down with it retail spending.
Interview Zatlin: Vice Index Pointing Toward Consumer Pullback
Faced with further topline deterioration, companies will respond with headcount cuts and smaller salary raises.
The timing is likely the Fall.
For consumers, September and November are big pain points (back-to-school spending followed by Thanksgiving and holiday spending).
For companies, October earnings season is a trigger for big layoffs. On the one hand, they will have to respond to a falloff in consumer demand and on the other they can’t fire people after Thanksgiving (that’s a big no-no). Faced with a short window in which to move, companies will begin preliminary staffing rationalization assessments in September.
How to Play It
At the end of May, I cashed out my 401K and went into money market funds.
I’m also up nearly 75% in cumulative returns through my Moneyball Trader weekly advisory. You can find out how to participate in this sort of profit-taking by clicking here.
There’s extremely low volume. There is no breadth here. I could be wrong and the S&P will finally break through the resistance. Or it could double-top and fade fast like it did in November.
As the saying goes: I’d rather be a few months early than a day late.
