Wanted Ice Cream Scoopers – $23/hr – Yes, The Service Economy Is Booming

Imagine my surprise upon seeing this sign outside my local J.P.Licks ice cream store in the Boston area. While this is certainly anecdotal, it still appears to be a manifestation of the problem the Fed now faces in getting inflation back to 2%. The service economy is booming, the labor market is tight, and core inflation measures have started creeping up again. in my january 3^third column (The Monkees Were a Big Hit in 1966-67. So Was Inflation (Forbes.com)) My bottom line was that the recession was not obvious, and that’s why you should cover your equity hedges. It was a good idea then. Should we be expecting a recession soon? Let’s explore the macro-outlook.

In the preview, it is difficult to see a hard landing recession in the next 6-9 months. More recently, the 2-year note yield moved back above the fed funds level. It is ‘inverted’. This is not unprecedented but it likely means that the economy is stronger than expected. And there are plenty of signs like private sector labor earnings up 8% (3-month annualized) and up. So, we end up with $23/hr ice cream scoopers. And we ice cream eaters are content to pay because domestic cash on the balance sheet is still nearly $8 trillion, more than double what it did in 2019. Elsewhere, China is rising again, and the Bank of Japan is still printing trillions of yen to support their yield curve control. you get the picture; Nominal growth is still strong.

The Feds get the picture too. The Cleveland Fed median and trimmed average inflation reports showed a re-acceleration of core inflation in January. We know that Chair Powell watches both of these measures closely. Meanwhile, 2019 may have 3-6M fewer employees than you anticipate. They are not yet eager to enter the job market. Businesses cannot wait and hence service labor costs are increasing and with them the prices will also increase. Keep your eye on Fed dot-plot projections coming into the March meeting. If the plots show unemployment levels at 4.5-5%, Fed members are clearly saying they need a recession to drive down prices. Forget pausing or pivoting, the Fed is still chasing labor-led inflation.

Our governing monetary bodies eventually get what they want, and you shouldn’t fight them. So, in the 9-18 month time frame, I think the Fed engineers a bearish start to reduce inflation. There are plenty of indicators pointing in that direction during that time frame. The 3-month T-Bill yield reverses (rates higher) against the 10-year government yield in October, and often 12-18 months later we see a recession. Major economic indicators (Conference Board and OECD) are pointing down and have a good track record. Also, consumer sentiment expectations of the future have been consistently worse than current conditions, reflecting public anger and have historically been a good indicator of an impending recession.

During these next 6 months, if the economy remains strong, there could be a path to higher bond yields and yes, potentially higher equity prices. We can also challenge the August 2022 high of 4300. There isn’t much oxygen above that level because of valuations and high interest rates. And just when everyone declares no landing and is bullish, the Fed can hit the bearish hammer.

Is Recession Worth It? not even close. Earnings can easily drop by 25-30% in a recession. Credit spreads will become very high and with them the financial situation will become very tight. It’s not a pretty picture to soothe the existing investor. But from my vantage point, if you can bear the cost and the calories, keep eating ice cream in the summer.

All data quoted from Bloomberg LP and Ned Davis Research.