Resurgence or Reversion
Inflation surprised to the upside in early February, pushing back rate cut expectations. January CPI and Core CPI rose 3.1% year-over-year and 3.9% respectively, surpassing economists' forecasts of 2.9% and 3.8%. This sparked debate on the potential for inflation persistence not being priced into markets. However, the shape of the SOFR (Secured Overnight Financing Rate) curve can be interpreted as pricing in an ~15% chance of inflation resurgence. Recession is about twice as likely as a resurgence, but a reversion in inflation to normalcy remains most likely given the continued strength of the US economy, which is denoted by strong corporate earnings and GDP growth flying in the face of elevated real rates. Extinguishing the heat, yesterday Core PCE (the Fed’s preferred inflation gauge) came in as expected at 2.4%, down from 4.7% a year ago and 5.2% in January 2022 (see exhibit below). Equity markets shook off the hawkish warnings from the upside surprise in early February and pushed higher after the in-line PCE report, with the S&P 500 reaching above 5,000 for the first time in its history.
Unrealized Unemployment
In most tightening cycles the narrative is most positive before the recession hits, which is what makes recessions almost impossible to predict. Recessions appear, on average, 18 months after the beginning of hawkish campaigns, and we are now in month 24 of the current cycle. Therefore, it’s worth taking a look under-the-hood of the economy to see if a recession is clandestinely brewing. The tell-tale sign of recession is unemployment, and so far, the reported unemployment rate is consistent with the soft-landing narrative (see exhibit below).
Despite a mostly flat unemployment rate, there are some concerning signals that individuals may not be reporting their unemployment, and this is likely driven by two factors. First, in many US states, unemployment benefits have not kept pace with inflation, and thus declaring unemployment has become less beneficial. Second, without full-time employment, many are electing to take up part-time positions or pursue vocations in gig-economy roles, such as driving for Uber. Those who don’t make jobless claims or participate in non-full-time roles simply aren’t accounted for in traditional unemployment rates. Although Uber obviously cannot pick up the slack for the entire country, it has boasted significant increases in driver supply in recent earnings reports. More broadly, mentions of “Job Cuts” in earnings calls reached pandemic highs in Q4, and these cuts will trickle into Q1 data (see exhibit below).
Amid subtle signals of rising unemployment, another notable recession indicator is a downturn in consumer expenditure. Coca-Cola and PepsiCo's latest earnings portray nuanced spending reticence, especially among budget-conscious lower and middle-income demographics. Despite witnessing a slight dip in sales volume—Coca-Cola by 1% and PepsiCo by 6%—both entities managed compensatory price escalations of 8% and 9% respectively. These findings hint at underlying economic frailties yet affirm the enduring narrative of a stable, 'goldilocks' economy, and market performance shows the same conclusion (see 2024 heatmap below). Next Friday’s jobs report will be at center stage as analysts hunt clues on US economic health.
Foreign Indicators
Since unemployment seems to be skewed in the current cycle, it can be useful to look at other countries with relatively weaker economies to see how they are responding to the tighter financial conditions imposed by increased interest rates, as such economies could be leading indicators for potential future recessionary conditions in the US. For example, while unemployment remains low, Canada has had tepid GDP growth coming out of COVID-19 compared to the US (see exhibit below). Compounding the underperformance, Canadian population has grown by more than twice that of the US since 2021 on a relative basis, increasing 2.5% while US population increased only 1.2%. These factors make the first signs of a monetary policy fueled recession more likely to appear in Canada than the US.
Although Canada is likely to feel the possible recession first, Canadian central bankers have remained hawkish and seem focused on matching the moves of the US Federal Open Market Committee more than acting on sovereign data. This is because lowering policy rates before the US is likely to devalue the Canadian Dollar against USD, as the returns for holding Canadian cash would be relatively lower (see monthly CADUSD chart below). Conversely, keeping interest rates higher longer is hard on Canadian business, and there is more variable rate debt per capita in Canada than the US. Many believe that the Bank of Canada should ignore the US and act in the best interest of its domestic economy instead of relative purchasing power, but it’s still unclear which path will be taken. Juxtaposed to the follow-the-leader central banking policy, US allocators are looking North to see what could be on the horizon for the US economy.
Flying Forecasts
Recession and inflation carrying some probabilistic weight, the narrative remains centered around the most likely outcome—a soft landing. Many institutions are revising their forecasts for the S&P 500 even higher for 2024 after the index soared past 5,000 (see daily chart exhibit below). Barclays has raised its year-end target to 5,300, buoyed by strong Big Tech earnings and the US economy's performance, and commenting that a bull case scenario driven by continued tech sector outperformance and an economic re-acceleration could see the index reaching 6,050. Similar bullish forecasts have been made by Capital Economics and Yardeni Research, with projections extending up to 6,500 by 2025, underpinned by a growing productivity and technological advancements.
AI Supercycle
We stand at the threshold of an AI supercycle, with NVIDIA at the forefront, equipping the industry with essential tools akin to the "picks and shovels" of a gold rush. This pivotal role is significantly uplifting market morale, and therefore money managers were heavily anticipating the companies earnings call last week. The chipmaker did not disappoint. NVIDIA announced record-breaking results for the fourth quarter and fiscal year 2024. Quarterly revenue reached $22.1 billion, up 265% from the previous year, while full-year revenue was $60.9 billion, up 126%. NVIDIA's performance underscores its pivotal role in providing foundational technology for the AI revolution, and the stock price reflects it (see daily chart exhibit below). The company's significant growth in its Data Center segment reflects surging global demand for AI, and exhibits the companies position as a key supplier in this transformative era. Past supercyles have lasted much longer and than market participants anticipated and usually contain downturns characterized by broad disillusionment, but this type of sentiment is almost unimaginable in the current environment.
Bitcoin is Back
One innovative asset class that has undeniably recovered from its phase of disillusionment is cryptocurrency. With yesterday’s PCE, the only thing “hotter than expectations” is crypto summer. Winter came and went, and now the laser-eyes of bulls are directed at new all-time highs. Even holders of FTX token who suffered massive losses from the money-creation Ponzi scheme à la Sam Bankman-Fried have rebounded amicably. Bitcoin broke above 60,000 USD earlier this week in an almost completely vertical move—up ~50% since last month’s mention (see daily chart exhibit below).
Explanations range from ETF inflows to the halving cycle, and pundits are now even speculating that major governments are buying the decentralized token unannounced. Regardless of the rumors, the digital currency is the only asset outperforming the Magnificent Seven and it’s doing it in style. It’s hard to tell if we’re at the “we’re back” moment or the “we’re so back” moment on the Bitcoin weekly chart (see exhibit below). Investors need to avoid FOMO in these situations and remain vigilant with their pre-determined plans.
Uranium Bombs
In the opposite binary direction, the Sprott Physical Uranium Trust (U.UN) experienced a sizeable pullback this month but looks to be finding support at its 100-day moving average (see daily chart exhibit below). Reversions to the mean after a large move tend to be normal to bubble-type market cycles of this nature, but catching a falling knife is a dangerous game. The market remains structurally bullish from both a fundamental and technical perspective. Traders can express their views on the uranium markets both through the aforementioned security or through the stock of companies in the industry like Cameco (CCJ).
Reddit IPO
Reddit has officially filed for an IPO to be listed on the NYSE under the ticker "RDDT." The last major social media platform to go public was Pinterest in 2019 (see weekly chart exhibit below). Reddit is planning to launch its IPO in March, aiming to sell about 10% of its shares, with its valuation to be revealed around the listing time. The company was valued at $10 billion after its 2021 funding round. Reddit gained widespread attention in the finance community during the GameStop trading frenzy, propelled by its WallStreetBets subreddit, which showcased the platform's influence in markets. Reddit owns a plethora of unique data that could be used to train generative AI and has confirmed that it has already been licensing this data to interested parties. The IPO is planned to take place later this month, however, the exact timeline could change.
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