The Week Behind

Prompted by an article in the WSJ authored by Nick Timiraos, the Fed Whisperer, which implied a terminal rate above 5%, recession talk dominated last week’s tape. Talks centered on the variable and lagged effects of what would be 500+ basis points of tightening at a record pace as steep inversions across yield curves hint the worst has yet to come. Economic releases were mixed. PPI was hotter-than-expected, but the downward trend is still clearly intact. Ultimately, growth fears won the week with all major indices finishing in the red. The Dow lost 2.77%; the S&P 3.37%; and the NASDAQ ~4%. 

Highlights

• PPI came in at 7.4%, which was 0.2% above consensus but 0.7% below the previous reading. Broadly, the print suggests inflation is still coming down, but perhaps, not fast enough to satisfy the Fed.
• Initial jobless claims matched consensus, 230k, up 4k from the prior month. Continuing claims printed 1671k, above the 1600k consensus, reaching its highest level since March. Both suggest unemployment is rising.
• The final read on Services PMI for November confirmed contraction, printing 46.2. 

Bridging PPI to CPI

24 hours before the FOMC meeting concludes, CPI for November is released. It is the last piece of data the Fed will see before rendering its policy decision and formulating its message for the press conference. Consequently, CPI is undebatably the most highly anticipated report of the week. I think it will be the most important report of the month. 

Consensus for Headline CPI is 7.3%; the last print was 7.7%. For Core, consensus is 6.1%; last print was 6.3%. PPI, as a leading indicator, has predictive value for CPI. While PPI was hotter-than-consensus, Headline PPI declined 0.7%, and Core PPI declined 0.3%. Furthermore, gasoline futures are near 52W lows. Together, both mitigate the risk of a shockingly hot CPI. 

The Week Ahead  

It is a loaded week for the macro. These reports will make or break the Santa Claus rally. Christmas is in the balance. 

On Tuesday, November CPI hits the wire. Given its proximity to the FOMC meeting, I believe it will have a disproportionate effect on the outcome. While I do not foresee CPI giving the Fed a reason to do anything other than hike 50bps, it may influence updates to the dot plots – committee member projections for the Fed Funds Rate – as well as Powell’s posture at the podium. 

At ~3900, the S&P 500 closed the week trading ~19x earnings (TTM). Assuming eco-data fits the bull narrative and Powell doesn’t pull a Grinch at the conference, I think the S&P 500 can rally between 5-7.5%, reaching 4100-4200, by year-end. However, that implies a 20-21x earnings multiple. Holding the consensus economic outlook equal, I do not think that multiple is sustainable, which is why, if achieved, I will take the opportunity to raise cash. 

Given my perspective on CPI, I do not expect this week’s data to warrant a stock meltdown. That being said, throughout this market rally, the decline in treasury yields and the USD have acted as tailwinds. In recent sessions, these factors have stalled their declines, finding support at 3-6 month lows. Therefore, I do think it would be wise to count on these factors to generate additional tailwinds for equities. Incoming data could transform tailwinds to headwinds. Consequently, I am cautious, not fearful, going into this pivotal week. To reflect my sentiment, I have initiated some new positions to take advantage of the potential upside – no fear – but have limited their size to match my caution.

China’s Reopening: A Crosscurrent

As news continues to flow regarding China’s reopening, now is a good time to discuss its ramifications. 

On one hand, as one of the world’s largest producers and consumers, China’s reopening would help ease supply chain bottlenecks and growth concerns. With Chinese factories and logistics reliably operating, there is greater capacity for and less uncertainty surrounding production time of products across industries. With the Chinese people free to resume normal life, normal spending patterns can resume, bolstering the revenues of companies connected to the Chinese consumer. 

On the other hand, as one of the world’s largest producers and consumers, China’s reopening would generate a meaningful tailwind for commodity inflation. Under normal circumstances, China is the world’s largest consumer of copper, 2nd largest of oil, and 3rd largest of iron. If the Chinese economy comes back in a meaningful way, expect commodity prices to come back in a meaningful way too. This inflation could force the Fed to raise interest rates higher than, or keep rates higher longer than, currently anticipated. 

Luckily, barring revolution, I think their economy will reopen in stages. Open everything too quickly, it will appear as though the regime has capitulated to public pressure. Assuming a rolling-reopening, the inflationary effects would not be felt in a lump sum but in smaller, ideally more digestible, increments. China’s reopening is a matter of “if” not “when”. Therefore, you need to be ready for it and the opportunities it presents.