Top Three Videos – July 19 2023

Quick Summary Bullets:

Factors Influencing a Potential Hard Landing

• “Housing is always at the beginning of every single economic upturn, and if housing is not improving, nothing is.”
• According to the speaker, employment is driven by profits, which in turn are driven by orders and the cycles of easing and selling housing.
• Investors should not rely on one data point or signal, but instead build a breadth of evidence to make informed decisions during recessions.
• A recession is not an event, but a process that occurs at different points in the business cycle and market.
• The speaker suggests that if there is enough erosion in employment in the next couple of months, it could potentially be a “lights out” moment for the markets and the economy.
• “Credit spreads is something what I’m watching closely right now to corroborate the claims data and ultimately that’s why when claims turn up we will get really bearish because it creates a credit problem and the worst thing for equities is a credit problem.”
• The speaker presents charts to support the argument that the landing will be hard, emphasizing the data-driven nature of their analysis.
• A soft landing in the economy is determined by three factors: a downturn preceded by higher rates and oil prices, a Fed tightening cycle, and the absence of an inflation problem and tightened lending standards by banks.
• The aggressive tightening cycle and the potential drag on the economy caused by factors such as inflation, energy prices, and banks tightening lending standards are concerning for a potential hard landing.
• The compounding effect of tightening cycles and rising interest rates can have a cascading impact on middle income and higher income individuals who rely on credit for investment or loans.

The H.O.P.E. Framework and Economic Progression

• Michael Kantrowitz’s “Hope framework” is crucial in understanding the progression of the economy into a recession and the importance of the jobs market in preventing a hard landing.
• The H.O.P.E. framework helps to overcome our human nature of doubting the effectiveness of actions by providing a way to deconstruct the process between cause and effect, enabling us to identify and analyze the outcomes more effectively.
• “As we build more and more evidence, we feel more and more convicted to continue to position in the direction where we think that the ultimate end game is.”
• “I like using sequences and repeatable patterns which is you know what our hope framework is.”
• “All about positioning trying to beat the market trying to understand where our investor funds flowing to as we see more and more evidence convincing people that a hard Landing may be coming.” – The focus is on strategic positioning and understanding investor flow as evidence mounts for a possible hard landing.

Data Analysis and Visualization

• The heat map used in the analysis is not just a pretty picture, but an actual mathematical representation of correlations and time variations in data.
• Charts are a powerful tool for conveying information and can often speak better than words.
• Building a mosaic of information, rather than relying solely on simple charts, is crucial for gaining a comprehensive understanding of the economic situation.

Information Distillation and Trusted Sources

• In today’s information overload era, it is crucial to distill the noise and find trusted sources to rely on for accurate signals in both the economy and the markets.

Transcript Summary:

The speaker predicts a potential hard landing in the economy and advises investors to be cautious and prepare for a potential recession.

• 00:00 Kantrowitz emphasizes the importance of the Hope framework in understanding the economy, highlighting the impact of housing, orders, profits, and employment in preventing a hard landing and predicting economic upturns.
  • He discusses the importance of the Hope framework in understanding the progression of the economy and the critical role of the jobs market in preventing a hard landing.
  • The global economy and financial markets are currently uncertain and volatile, and it is important to have a framework to understand history and contextualize the current cycle, with equities being seen as a poor risk reward at these levels due to the impact of tightening cycles from central banks and inflation problems.
  • Kantrowitz discusses the Hope framework, which is a logical and deconstructive approach to understanding complex systems like the markets and macro economy.
  • He discusses the three indices (leading, coincident, and lagging) and how they can be simplified into housing orders, profits, and employment, which spell out “hope,” emphasizing the importance of distilling information and finding reliable sources in today’s information overload.
  • Housing is a key indicator for economic upturns, and in order for things to improve, a soft or hard landing in the housing market needs to occur, followed by improvements in orders, profits, and employment.
  • The progression of the H.O.P.E. framework starts with housing reacting to changes in interest rates, which impacts the wealth effect and consumer spending, leading to changes in orders and eventually company earnings, which in turn affects employment.
• 11:03 Kantrowitz discusses the correlation between data points and interest rates, highlighting the impact on home builders sentiment and building permits, while also discussing the lag between changes in interest rates and their impact on the economy, and the current state of the housing market.
  • He discusses a heat map chart that shows the correlations of different data points and explains how certain data points react to changes in interest rates, specifically focusing on home builders sentiment and building permits.
  • The transcript discusses various macro data series, such as new orders, consumer confidence, manufacturing sales, capital goods demand, industrial production, employment data, and core inflation, and explains their order of importance in analyzing the economy.
  • The chart shows a highly correlated relationship between mortgage rates and housing sentiment, with a lag of about six months, as evidenced by the decline in existing home sales and the nhp index in the last year and a half.
  • The lag between changes in the Fed’s interest rate and their impact on the economy is on average about 18 months, and despite recent weakness in the economy, it is unlikely that higher rates are the main cause as the majority of the effect of the Fed’s tightening cycle is still ahead.
  • The speaker explains that the ISM New Orders Index is a survey that indicates whether things are getting better or worse in the economy, but it does not determine if GDP is down a specific percentage, and while historically low levels of the index have been correlated with previous recessions, there is no specific number that indicates a recession.
  • The housing market is entering a correction as prices have peaked and the K-Shiller index is starting to decline.
• 22:29 Housing data decline suggests a potential hard landing later this year, as earnings expectations and employment are impacted, with claims turning up in April historically indicating a change in trajectory.
  • Kantrowitz presents four charts that demonstrate the relationship between interest rates, earnings growth, and employment, showing a decline in earnings expectations and the impact on employment.
  • Housing data has been declining, which historically leads to a rise in unemployment claims, indicating a potential hard landing later this year.
  • Housing data, including home prices, peaked in November 2020 and are a lagging indicator, making them unreliable for predicting a recession.
  • Profit expectations peaked in June 2022, and a hard landing occurs when unemployment claims increase, leading to a bear market and potential economic downturn.
  • When earnings start deteriorating, it signals the start of a new bear market, and the change in trajectory of employment or unemployment is what sets things off.
  • Claims turning up in the month of April is data that indicates a change in trajectory historically.
• 31:12 Kantrowitz emphasizes the importance of using multiple data sources to determine recession and highlights the correlation between unemployment claims and small business hiring plans, suggesting that investors should approach the market with a spectrum of risk and adjust their positions based on evidence.
  • He discusses the complexity of determining recession and the relative nature of oil prices, emphasizing that the real price of energy has not significantly increased over the last several decades due to rising incomes and economic growth.
  • Recessions typically start around the first negative non-farm payrolls print, but it is important to not rely on one data point and instead gather a breadth of evidence, such as looking at unemployment claims and earnings, to make informed investment decisions.
  • Kantrowitz emphasizes the importance of using multiple data sources, such as the nfib data, to corroborate claims and highlights the strong correlation between unemployment claims and small business hiring plans.
  • He discusses the correlation between hiring plans and economic indicators, emphasizing that a recession is a process that occurs at different points in the business cycle and market, and there is no specific threshold to determine when to sell everything.
  • Investors should approach the market with a spectrum of risk and adjust their positions based on evidence, as there is a potential disconnect between the market and the data.
  • Kantrowitz discusses the progression of data points and questions how much more deterioration is needed before the last light switches from green to red.
• 37:48 Despite the S&P 500 reaching all-time highs, market indicators suggest underlying issues, such as slowing earnings growth, a rotation into quality stocks, and concerns about recessions and commercial real estate, indicating potential evidence of a hard landing.
  • He emphasizes the importance of the market not yet reflecting certain data and uses a scene from the movie Wall Street to illustrate this point.
  • Market indicators such as housing stocks, consumer stocks, high beta stocks, and credit spreads suggest that there may be underlying issues despite the S&P 500 reaching all-time highs, indicating the need to look beyond surface-level data.
  • Earnings growth has slowed and the market is starting to discount the downturn, with smaller banks at a low and larger cap stocks seeing a rotation into quality.
  • The market is discounting evidence of a hard landing, with the S&P being the last to fall as people crowd into larger, high-quality assets, while cyclical sectors like Industrials and materials have peaked and real estate is at a one-year low, indicating potential concerns about recessions and commercial real estate.
  • Financials in the market have been performing well, but a healthy market should have cyclical sectors outperforming growth sectors, and the business cycle generally explains market trends.
  • Kantrowitz discusses a risk on risk off model that tracks the relative performance of stocks and indicates that despite the rebound in the S&P 500, the level of risk on leadership is still significantly lower than it was in early February.
• 45:42 Kantrowitz predicts a potential hard landing in the market due to deteriorating employment, widening credit spreads, and declining earnings, which could result in a market downturn lower than the previous year.
  • Kantrowitz explains that the economy and market work in a progressive manner, and although there is currently a deterioration in employment, it is not yet at a level that would significantly impact the markets.
  • He emphasizes the importance of using sequences and repeatable patterns rather than averages to determine how much the market will fall during a bear market, as data without context may not always be helpful.
  • Unemployment deterioration, rising continuing claims, and widening credit spreads indicate a weakening employment backdrop and declining earnings, leading to a bear market.
  • Default risk and credit spreads increasing indicate a potential recession, and if that happens, it is likely to be a hard landing with a market downturn that could go lower than the previous year.
  • Investors with different time horizons are debating whether there will be a hard landing, but the focus now is on positioning and understanding where investor funds are flowing.
  • Most recessions are determined by the NBER after they’re over, but the speaker believes that a hard landing will occur when claims rise, credit spreads widen, and earnings decrease, and although the market has not experienced this yet, the speaker predicts that the markets will go below 34.91 and that when claims start to rise, it will create credit problems and ultimately bring the market down.
• 54:08 Kantrowitz believes a hard landing is likely due to historical data showing that housing data often bounces before a recession, and factors such as inflation, banks tightening lending standards, and the Federal Reserve raising interest rates can negatively impact the economy, leading to a recession, rise in unemployment, and a bear market.
  • He explains why they believe the landing will be hard, using charts to differentiate between a soft landing and a hard landing.
  • Housing data often bounces before a recession, leading to false optimism about a soft landing, but history has shown that a hard landing is likely to follow.
  • A sustainable bottom in the economy, determining the difference between a soft and hard landing, is determined by three factors: the presence of an inflation problem during the Fed tightening cycle, whether banks tighten lending standards during or after the cycle, and the overall employment and market conditions.
  • Inflation, banks tightening lending standards, and the Federal Reserve raising interest rates can all have negative effects on the economy, and the current aggressive tightening cycle is of greater magnitude than previous cycles.
  • The Fed is raising rates aggressively due to an inflation problem, particularly in food and energy, which is causing a compounding effect on tightening cycles and impacting lower income individuals as well as middle and higher income individuals who rely on credit.
  • When the Federal Reserve raises rates aggressively, coupled with high food and energy inflation and tighter lending standards, it historically leads to a recession, rise in unemployment, and a bear market due to weaker earnings and wider credit spreads.
• 01:02:32 Investors should be cautious and prepare for a potential recession, as indicators suggest economic instability, high levels of debt, and the need for tough political decisions, while seeking guidance from financial advisors.
  • Kantrowitz discusses the preconditions and indicators that suggest a high probability of a recession, emphasizing the importance of understanding the magnitude and duration of the downturn and the need to navigate the market accordingly.
  • Investors should be cautious and prepare for rougher times ahead in the markets as there are indicators suggesting a potential recession, low probability of a sharp turnaround, and concerns about the extent of debt in the system.
  • Countries with high levels of debt, such as Japan, are at risk of economic instability and will need to make tough political decisions to avoid a debt crisis, especially as the debt ceiling debate approaches.
  • Kantrowitz advises investors to be patient and cautious, preferring treasuries over equities and recommending monitoring employment data while waiting for a more sustainable opportunity in the economy.
  • He anticipates a future bull market but acknowledges the need to get through the current recession and volatility before that can happen.
  • Michael Kantrowitz discusses the possibility of a recession and market correction later this year, emphasizing the importance of considering these factors in investment plans and seeking guidance from a professional financial advisor.