Picking up on our theme that there are many economic and financial market questions right now, we turn to Ed Yardeni and his look at uncertainty.
Nine Known Unknowns is how the President of Yardeni Research is framing it, to borrow from the late U.S. Secretary of Defence, Donald Rumsfeld.
We’ve culled a few salient excerpts from Yardeni’s report to give you some flavour on what the respected market watcher is thinking about.
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by Ed Yardeni, President, Yardeni Research
The stock market has been having a volatile year so far because there isn’t a consensus on the economic and geopolitical outlooks.
In other words, there is lots of uncertainty.
Let’s review some of the more important sources of uncertainty:
(1) Uncertainty about a recession.
There’s widespread puzzlement over the yield-curve spread.
That’s because the spread between the 10-year and 2-year Treasury notes has turned slightly negative, presumably signalling a recession within the next few months.
However, the official spread is the one between the 10-year yield and the federal funds rate.
It has continued to widen from around zero just after the end of the lockdown recession in 2020 to about 250 basis points now.
We don’t see any evidence of an impending credit crunch in the credit-quality yield spread between the corporate high-yield composite and the 10-year Treasury.
(2) Uncertainty about the consumer.
Another more troubling component of leading economic indicators is the average of the expectations components of the Consumer Confidence Index and the Consumer Sentiment Index.
Rising inflation has weighed on consumer expectations, which have fallen to the lowest reading since January 2013.
Given that this series is an leading economic indicator (LEI) component, it is concerning to see it drop last month in much the same way as it has in the past prior to and during recessions.
On the other hand, the labor market is red hot.
The unemployment rate fell to 3.6% during March, the lowest since its 3.5% pre-pandemic rate, which was the lowest since the end of 1969.
(3) Uncertainty about housing.
Another component of the LEI is building permits.
It fell 1.9% during February but remains on a solid uptrend.
The significant increase in home prices over the past two years and the recent jump in mortgage rates may soon slow demand for new homes.
However, rapidly rising rents should boost construction of multi-family units.
(4) Uncertainty about capital spending.
Another component of the LEI is inflation-adjusted non-defence capital goods orders excluding aircraft.
This series has been flatlining over the past 11 months through February.
The inflation-adjusted measure has been a good indicator of private nonresidential investment on equipment in the real GDP accounts.
We continue to expect that businesses will respond to chronic labor shortages by boosting their capital spending, particularly on equipment and technologies.
(5) Uncertainty about higher-for-longer inflation.
We are forecasting that headline and core inflation rates will peak between 6.0%-7.0% by the middle of this year before declining to 4.0%-5.0% by the second half of 2022 and 3.0%-4.0% next year.
Our key assumption is that inflation will moderate significantly for consumer durable goods.
On the other hand, we expect that the 33.4% increase in the median existing home price over the past 24 months through February will lead to higher rent inflation, which is at the highest pace since November 2007.
(6) Uncertainty about the Fed.
The Fed’s talking heads will keep talking until the next “blackout period” from April 23-May 5.
They are likely to reinforce widespread expectations of a 50 basis point bps rate hike.
We believe that the Fed will raise the federal funds rate by another 200 basis points by April 2023.
For now, stock investors are betting on a soft economic landing.
For now, we agree with them.
(7) Uncertainty about the world order.
Russia’s war with Ukraine does not appear to be close to a ceasefire, let alone any sort of peace agreement.
It appears that Russian President Vladimir Putin is scaling back his ambitions from a quick overthrow of the Ukrainian government to annexing territory in eastern Ukraine.
However, it is unlikely that Ukrainian President Volodymyr Zelensky will acquiesce or that Putin will be overthrown.
So a protracted war now seems likely.
(8) Uncertainty about earnings.
The prospect of slower economic growth with more inflation makes forecasting S&P 500 earnings trickier than usual.
Weaker growth is likely to be more than offset by higher inflation, which is why we raised our outlook for both revenues and earnings.
Industry analysts seem to agree, since they continue to raise their 2022 and 2023 estimates for both.
(9) Uncertainty about valuation.
Among the biggest uncertainties is the valuation multiple.
It is a tug-of-war between the Fed’s hawkishness and all the liquidity accumulated over the past two years as a result of the Fed’s dovishness.
It is also a tug-of-war between the MegaCap-8 and the remaining S&P 492.
Most of the market’s overvaluation is in the former eight stocks.
But maybe they deserve to be highly valued given their size, market power, growth rates, and uniqueness.
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