by Edward Harrison, Credit Writedowns
I want to go back to my theme of just over a week ago about the resiliency of the US economy. That’s because, regardless of one-day — or even multi-day — stock market gyrations, the real economy is the defining issue for markets.
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Uncertainty reigns
But, over the near-term, I am more attuned to volatility than a directional call on any specific asset class. That’s because there’s a high degree of uncertainty about the path of the global and US economy, about the Fed’s reaction function, and about political interference from US President Donald Trump.
So, the 1,000 point rise in the Dow Jones Industrial Average today isn’t necessarily shocking in that context. Nothing in the macro data screams recession. So there really isn’t a real-economy catalyst for a longer-duration down move. There’s just a lot of uncertainty.
My view has always been that it will be hard for the market to sustain a longer-duration bear market without a real-economy catalyst. And the causality goes from real economy to markets or from the credit cycle to the real economy to financial markets, not from the financial economy to the real economy. I simply don’t see a stock market fall driving what happens in the economy. That’s the tail wagging the dog.
My view on the real economy
In terms of the real economy, what I was saying last week was this:
I believe the US and global economies are slowing, with recession an unlikely outcome for at least the next six months. But, I believe that slowing will mean more volatility in asset markets, with policy responses by central banks acting as the deciding factor over the medium-term.
So, markets are simply trying to gauge where we are headed next. Up until now, it was full steam ahead. But, now the economy is faltering somewhat – more globally than in the US. And markets are doubly unsure because they don’t know where the trajectory is headed and how central banks will act in response.
The Atlanta Fed’s GDPNow gauge for Q4 stands at 2.7%, with the next update due on 3 January. But, I’ve been saying I think Q4 will end up being a good quarter. And everything I have heard recently points to buoyant holiday sales. For example, there was this just yesterday:
Shoppers delivered the strongest holiday sales increase for U.S. retailers in six years, according to early data.
Total U.S. retail sales, excluding automobiles, rose 5.1% between Nov. 1 and Dec. 24 from a year earlier, according to Mastercard SpendingPulse, which tracks both online and in-store spending with all forms of payment. Overall, U.S. consumers spent over $850 billion this holiday season, according to Mastercard.
The figures suggest a stock-market swoon and partial government shutdown haven’t curbed consumer confidence and spending.
The causality is real economy to markets, not the reverse.
The Fed’s reaction function
When the data come in for Q4, they are going to show growth closer to 3% than 2%. And consumer spending will have been robust in the holiday season. If the Fed took a deterministic auto-pilot view of the data, that would put them on course to raise the Fed Funds target rate once again in March. But I think December’s policy statement was a sign they are not on auto-pilot. And March is looking less likely unless financial conditions improve. A 5% up day goes a long way toward helping. But it is just one day.
The volatility will continue though. Until we know for sure what the Q4 numbers look like and the Q1 outlook is plus how the Fed will react, markets will be on edge. But volatility doesn’t imply sustained bear market. And today was the first sign that we may not be headed in that direction just yet.
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