January 2024 Market Update

The U.S. stock market continues to be buoyed by lagging and coincident economic data. Last week’s fourth quarter +3.3% GDP (gross domestic product) estimate combined with +2.9% PCE (personal consumption expenditures) continues to drive the narrative of a “goldilocks” economy and a “soft landing” while also providing hope the Federal Reserve will cut interest rates by the end of the first quarter.

On a month-to-month basis it appears that inflation is picking up. Although slightly, we suggested this was a possibility in our December Market Update when the “Powell Pivot” was delivered, https://www.macrovex.com/post/december-2023-market-update. “As nominal 10-year rates decline in response to the Fed pivot, mortgages rates have also declined. The slight inverse relationship between lower mortgage rates and increasing month-to-month CPi could pressure the Fed to walk back some of its dovish comments in January 2024, and once again shock markets by removing some of the now expected interest rate cuts the stock market is counting on to support its lofty valuation.”

This month-to-month inflation upturn is occurring at the same time rising geopolitical tensions between China, Taiwan and throughout the Middle East, disrupts global shipping routes in the Red Sea. These tensions leave the Federal Reserve in a precarious position regarding inflation data and the markets expected interest rate cuts by March.

The U.S. consumer continues to show signs of strength above the surface and signs of weakening below. The past month’s data shows a month-to-month increase in disposable income was offset by a month-to-month increase in personal consumption expenditures. The increase in personal consumption expenditures appears to have come from a large increase in consumer credit. The data suggests that Q4 consumption was mostly driven by credit card usage. While we expect unemployment to rise in the months ahead, these trends point to a consumer hangover on the horizon.

The S&P500 has had two bottoms in this bear market so far. October of 2022 and October of 2023. Neither bottom included significant increases in earnings. The price to earnings ratio has gone up and down twice with no material changes to earnings, just price. The Russell 2000 is still in a bear market and the Dow Jones Transportation Index has not yet risen to new highs to confirm Dow Theory and a new bull market. There has never been a time until now, when the S&P500 was at new highs and the Russell 2000 was still in a bear market.

The two bottoms in stocks in 2022 and 2023 both came with new expectations of interest rate cuts from the Federal Reserve. If the Federal Reserve cannot deliver on these cuts because inflation remains stubborn, then it is highly possible the market could quickly take back all its gains since the October 2022 bottom. Just as these interest rates cuts began to get priced in and the stock market recovered, interest rate cuts could begin to get priced out and the stock market could quickly deteriorate.

One way to visualize rate cut expectations is to view a chart of Bitcoin prices. Bitcoin rises with the idea that the Federal Reserve will move toward monetary accommodation and an increasing balance sheet, and declines with idea that the Federal Reserve will be restrictive, maintain or decrease the balance sheet. When interest rate cuts began to get priced in October of 2022, Bitcoin bottomed out and so did the S&P500. If The U.S. were to begin a return to sound money, away from budget deficits and toward surplus, Bitcoin would not be necessary, and neither would interest rate cuts to support the stock market. It has become obvious that Federal Reserve monetary policy has not been beneficial to the real economy.

Investors continue to believe deficit spending is creating a new bull market. If outright government spending is driving GDP and the rise in the deficit, why have tax receipts significantly declined?

The answer is the real driver of the deficit is due to a big decline in tax receipts. Economic weakness rather than strength.

When we compare the average hourly earnings (AHE) of all private employees adjusted for inflation (blue) to federal tax receipts as a percentage of gdp (red), it demonstrates that throughout U.S. economic history, the driver of lower tax receipts is simply wages being chewed up by inflation. As the rate of change slows, so does the economy (Real GDP).

Furthermore, the net national savings rate is now negative. Everyone’s eye is off the ball. This means that private savings are down, leading to a decrease in capital investment, which leads to a decline in productivity, leading to a declining standard of living and lower real GDP. This is only the third time in history negative net national saving has occurred, absent the Great Depression.

Fundamentally, it appears that the US economy has reached the point of the law of diminishing returns regarding using budget deficits and debt to finance real GDP growth. With negative net national savings, we don’t see how adding more debt increases real GDP. The system appears trapped here. As the real economic growth rate and American standard of living decline, there will be calls for more government spending. However, with negative net national savings, government spending programs will likely be self-defeating. If the government were to massively increase spending after individual and corporate growth rates decline, inflation would likely rise, causing individuals and corporations big problems getting access to credit in a low growth economic environment. This is in large part why a tax increase or a move away from deficits and toward surplus is inevitable.

As mentioned in our December market update, "stock investors are being given an incredible opportunity to lock in gains and reallocate capital toward assets which experience benefits during real economic weakness. We believe the Fed knows the economy is weakening and is preparing the market for a potential shock. The yield curve has now been inverted for 19 months. Which means something in the system could break at any time, causing economic calamity and forcing the Fed to cut interest rates."

MacroVex Capital believes that given the data from a variety of leading economic indicators, including warnings from the Federal Reserve and previous voting members of the FOMC, that in hindsight this could end up the most telegraphed recession in U.S. history. The inverted yield curve historically has 100% odds of predicting recession. The spread is closing in on un-inverting, which is historically when the economy recognizes it has entered recession.

Our recommendation since January of 2023 has been to position portfolios to endure a recession, in a defensive manor, risk off and in cash, T-bills, money market funds, fixed income duration extended in September 2023 from 0-5 year to 0-30-year U.S. Treasury bills and notes, 10-year minus 2-year yield curve re steepening and select low duration U.S. equities.

Getting paid to wait for growth assets to be priced at discounts, while being positioned to benefit from bond price appreciation as interest rates decline from downward economic pressure, continues to be a profitable and rewarding strategy.

We remain patient and focused on managing risk through 2024.

Disclosure: Investing involves risk, including the possible loss of principal and fluctuation of value. Past performance is no guarantee of future results.

This letter is not intended to be relied upon as forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date noted and may change as subsequent conditions vary. The information and opinions contained in this letter are derived from proprietary and nonproprietary sources deemed by Macrovex Capital, LLC to be reliable. The letter may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projection, and forecasts. There is no guarantee that any forecast made will materialize. Reliance upon the information in this letter is at the sole discretion of the reader. Please consult with a Macrovex Capital, LLC financial advisor to ensure that any contemplated transaction in any securities or investment strategy aligns with your overall investment goals, objectives, and tolerance for risk. Additional information about Macrovex Capital, LLC is available in its current disclosure documents, Form ADV and Form ADV Part 2A Brochure, which are accessible online via the SEC’s investment Adviser Public Disclosure (IAPD) database at www.adviserinfo.sec.gov, using CRD #300692. Macrovex Capital, LLC is neither an attorney nor an accountant, and no portion of this content should be interpreted as legal, accounting or tax advice