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The title of this note is inspired by former Intel CEO Andy Grove 👇
"Success breeds complacency, complacency breeds failure, only the paranoid survive"
It's also inspired by the complacency I'm seeing almost everywhere I look. A quick disclaimer first 👇
I'm not saying that we're on the verge of crisis and everyone should panic, buy gold and live in bunkers to wait it all out. Just that there seems to be a lot of (wilful?) ignorance of risks and those famous monetary policy lags. Almost like we've got bored of waiting for a recession that never comes...
Being perfectly honest, I think that's exactly what's happened. At the start of 2023, everyone was already talking about the most anticipated recession of all time.
Almost five months later and we're still looking for the recession like...
Not only that, but the flash PMI numbers show a global economy that's picking up speed again!
Today's UK PMI composite jumped to 53.9 from 52.2 👇
Number go up = good, right?
The Eurozone reading leapt to 54.4 from 53.7 in March...
However, the manufacturing sector is still below 50 and contracting while the service sector continues to roar. This snippet sums the mood up well...
How long can a two speed economy continue for?
Especially when "the survey has not previously recorded such a strong service sector expansion at a time of manufacturing decline".
Can the service sector hold the economy (and the stock market) up?
Sure, maybe for a while...
The Elephant In The Room
From the US Composite PMI (which also pushed up from 52.3 to 53.5) 👇
“However, the upturn in demand has also been accompanied by a rekindling of price pressures. Average prices charged for goods and services rose in April at the sharpest rate since September of last year, the rate of inflation having now accelerated for three successive months.
This increase helps explain why core inflation has proven stubbornly elevated at 5.6% and points to a possible upturn – or at least some stickiness – in consumer price inflation.”
2023 rate cuts...?
OK. Not gone. Even though the economy's clearly slowing, it's not slowing fast enough (hurry up and slow faster 🤨) to really raise hopes of rate cuts.
Heading into recessions, manufacturing usually leads the way...
"With virtually no exceptions, all recessions start in the construction and manufacturing sectors, so these two sectors deserve special attention"
We'll come back to construction in a second. The framework above is from Eric Basmajian.
Three signals. An increasingly higher probability of recession as each triggers and he says...
Signal #2 was triggered five months ago and the average recession starts six months after getting a Signal #2.
On average, there is an eight-month lag between a Signal #2 reading, which is a reliable recession flag, and Signal #3, the undeniable confirmation of a recession.
This eight-month gap is the most dangerous period for the Federal Reserve and for investors. The recession is virtually assured, but most investors and the Fed still can’t see it or refuse to believe it.
I'm not a big fan of averages, mainly because people frequently misuse them, or forget what an average actually is.
See, you can look at that and say we should be in recession next month, based on the average, but we're not, and we won't be.
However, the idea that a recession is nailed on and most investors and the Fed still can’t see it or refuse to believe it is definitely an idea I can get on board with.
We've covered manufacturing, let's look at construction.
Still pretty active, but slowing...
While big US Homebuilders trade near all-time highs...
Demand has remained robust, and new home sales have 'outperformed' the usual mortgage correlation so far...
ING don't think that trend will continue.
All About Credit
The combination of higher borrowing costs, reduced access to credit, and the threat of rising unemployment means a greater chance of a hard landing for the US residential property market and the economy more broadly.
Rising unemployment has historically been associated with rising default rates and therefore the rising supply of homes for sale, which will hurt the outlook for residential construction considerably.
Falling property prices at a time when construction costs and labour remain elevated (price rises have at least slowed back to more normal rates of increase) also means squeezed profit margins, which is another disincentive for construction.
The Hot Labour Market™ isn't as hot as it was...
Credit is definitely tightening & defaults are ticking higher in the subprime auto sector...
Meanwhile, this sentiment (although he's referring to Australia, it's all the same 'trade') is becoming prevalent 👇
Returning to Andy's quote...
Success breeds complacency, complacency breeds failure, only the paranoid survive
I think we're in the complacency phase now. And failure is closer than we'd like to believe.
That's not to say we're going to roll over immediately. It's a process. But when you look around, the risks just don't seem to match the rewards.
"Risk is what's left when you think you've thought of everything"
And risk is inevitable. The aim of the game is to be sufficiently rewarded for taking those risks.
As we enter the next market phase...
Complacency is unlikely to be rewarded. Only the paranoid survive.