Bottom Up!

During the 18th and 19th centuries, English Navy recruiters incentivized men to sign up by offering them a King’s shilling. If they accepted the shilling, it meant their recruitment was consensual. Some recruiters were less than above board – when drunkards turned their heads, they’d drop a shilling into their beer. The men wouldn’t notice the shilling or metallic taste in the beer until it was too late. Since they’d received the shilling, their names would be added to the draft list and having been overserved bad luck were dragged off to sea the following morning. Once bar owners grew wise to the deceitful ruse, they began serving suds in clear-based glasses. For added emphasis, they reminded grateful patrons to peer into their pints for shillings by barking, “Bottoms up!” before the boozers drank more than their problems away.

Dismal scientists delete one letter to attack economic analysis from a different angle. We go “Bottom up!” to get to the bottom of investors’ persistent source of angst: inflation. FactSet’s scraping of S&P 500 conference call transcripts showed 219 companies citing “inflation,” the lowest since tracking started in 2021’s second quarter when 218 said the same (yellow line). This year’s first quarter also marked the seventh sequential period of declining mentions. Even better, FactSet’s tally beautifully guides headline CPI (light blue line). The latest decline in 2024’s first quarter suggests a potential downside is brewing given the 2020 precedent. To that end, FactSet noted “there are still about 30 S&P 500 companies that have not reported earnings…the final number of companies citing ‘inflation’ will likely be higher than the current 219. However, the final number will not finish above the previous quarter’s number of 285.”

From a technical perspective, the downshift is locked in. Main Street begs to differ. Since 2005, Gallup has prompted U.S. households to name the top financial problem facing their family. For three years running inflation has topped the list. Moreover, mentions have grown from 32% in 2022 to 35% in 2023 to a new high of 41% in 2024. So pervasive is the problem, at 14%, the cost of owning/renting a home and too much debt/not enough money to pay debts, at 8%, were a distant second and third.

The easiest remedy to the misery of high inflation is a quality job to ensure families do more than “get by.” Unfortunately, perceived prospects of success on this front have deteriorated since peaking in late 2021. Gallup’s question is simple: “Thinking about the job situation in America today, would you say that it is now a good time or a bad time to find a quality job?” Respondents answering in the affirmative fell to 49% in April 2024 (purple line). Notably, this was the first reading under the 50% simple majority line in eight years. Additional wage disinflation also looks to be in train given the post-pandemic path for average hourly earnings has moved in lockstep with this gauge. Equally evident is that managers don’t share the same job quality concerns as the workers they supervise as their wage picture (lime line) is disconnected from the Gallup figure.

Labor demand is naturally a chief determinant of perceived job quality. The fewer job opportunities, the lower the capacity to grow compensation. We note an abrupt turn in the middle of this month on this count: Lightcast job postings requiring “minimal” education requirements took a nosedive to -17.6% below the benchmark month of January 2020 (inverted lilac line). Old-school economists might not blink an eye. Everyone knows those with the least formal training command the lowest wages and account for the smallest share of U.S. spending. Our Spidey senses say otherwise. This latest turn places job demand for the lowest income earners falling beneath that of the broad economy, flipping a warped post-pandemic dynamic on its head (Uncle Sam paying the least skilled the most on a relative basis dictated that they attained the most pricing power in the labor force…for a time.)

On a more fundamental basis, that little report tracked obsessively every Thursday morning might have something to say about the implications of rising ranks of displaced low-paid workers, namely because this same cohort has the highest propensity to immediately file a claim to collect unemployment insurance (aqua line). This separates them from their white-collar counterparts who’ve enjoyed 6-12 months of cushy severance as members of the Golden Parachute Club. Employers suddenly removing Help Wanted signs tilts our risk assessment to the upside for initial jobless claims in coming weeks.

Indeed’s job postings being in the doldrums corroborates. Through May 10th, Indeed’s total job postings index is -30.4% vis-à-vis its peak hit December 30, 2021. On a year-over-year basis, this metric has been running between -12% and -17% for 16 months in a row. Measured monthly, the last sequential increase was in 2021. Moreover, 40 of the 47 job categories have posted month-over-month declines thus far in May for an 85% hit rate (yellow bars).

Amid the job market gloom, it helps to have pricing power at your back (red line). Investors concur (blue line). As workers with experience in the insurance industry can attest, postings have bested all job groups, clocking three consecutive monthly gains at a 19% annualized pace in the three months ended May. Reach out to your buddy in the field. It’s their turn to pay the tab the next time the barkeep says, “Bottoms up!”

From Fort Circle Drive to the Beltway

As early as the 1880s, roadway engineers and planners floated the idea of a circle surrounding Washington, D.C. to improve travel within and around the city. The proposed “Fort Circle Drive” would have connected the Civil War-era circle forts that defended the Capital, but this concept was never realized. Several ring road proposals were contemplated in subsequent decades, including multiple concentric highways radiating from the city center. Absent execution of the multitude of plans, by the 1950s, Washington’s growing suburbs had overwhelmed the existing transportation network. After prolonged negotiations over everything from the route to the name, the final plan for the Washington Circumferential Highway was approved on September 28, 1955, as part of the Interstate Highway System backed by President Eisenhower. Over the years, the roadway was constructed in stages until its June 1960 completion. It was then that the highway was renamed the “Capital Beltway” by both Maryland and Virginia. On August 17, 1964, Maryland Governor J. Millard Tawes cut the ribbon to officially open the final stretch of Interstate 495.

Anyone who’s visited the nation’s capital in the summer can attest to the extreme heat emanating from one monument and museum to the next. As for the record, D.C.’s hottest was recorded on July 20, 1930, when 106 degrees was hit well before the Beltway opened. As for the runner-up, that was the 105 degrees logged on July 7, 2012. Rather than extreme heat, it’s the cooling in the labor cycle in D.C., Maryland, and Virginia that poses the greatest threat.

Labor demand in DC/MD/VA has already pierced a cyclical peak. At 451,000 last July, regional job openings fell sharply last summer, well under December 2022’s top of 604,000. To contextualize, as of the latest available month, March 2024, job openings were -21.5% below that high point (teal line). To wit, nonfarm payroll employment growth in the area has downshifted to a 1.1% year-over-year (YoY) rate through April, below that of the nation’s 1.8%. For completeness, weakness in trend job creation in D.C. and Maryland, both of which posted 0.2% YoY gains in April, drove the compression, while that of Virginia’s 1.8% is in line with the nation as a whole.

The sustained decline in demand for warm bodies transitioned to an upcycle in unemployment. Unrounded, the combined DC/MD/VA unemployment rate troughed in June 2023 at 2.39%. Since then, the three-month average has risen steadily and breached the McKelvey rule – a 0.3 percentage point rise in the three-month moving average off its prior twelve-month low – in October 2023 (lilac line).

Regardless of the outcome of this November’s Presidential election, the Biden Administration is seeking only modest increases to the Federal workforce in fiscal year (FY) 2025. According to, most major agencies are poised to grow their ranks less aggressively than envisioned in previous proposals aligning with spending caps Biden has signed into law. The overall civilian Federal workforce would grow by just 1% with the Department of Homeland Security and Treasury leading the way. Some agencies that have long been in hiring mode, like the Department of Defense and Veterans Affairs, will now see their headcount contract.

The Biden FY2025 proposal is fundamental in nature. In the five quarters ended 2023’s final three months, real government receipts have sequentially contracted on a YoY basis (fuchsia line). Historically, a five-quarter downdraft has been associated with recession as was the case in 1948-49, 1953-54, 1969-70, 1973-75, 1981-82, 2001, and 2007-09.

What distinguishes the current episode is the spread between government net dissaving and private (household plus business) net saving, which has inverted. At the end of last year, this gauge plumbed to -$70.8 billion on a four-quarter moving average basis, a massive departure from the +$400 billion average in the four quarters which capped off 2022. The current figure stands in stark contrast to postwar history, wherein private saving outpaced government dissaving (or borrowing). Critically, this role reversal has only been on display once, during the Great Recession.

For capital deepening to occur in an economy, and thereby raise productivity, requires an increase in net saving. The inversion that’s manifest illustrates this process is at risk flagging cyclical vulnerability to the capital spending outlook. Moreover, the prolonged decline in the volume of government receipts risks an amplified need for borrowing over the course of this year.

Revenue challenges aren’t contained to the Federal sector. In FactSet’s latest Earnings Insight, John Butters’ compilation of first and second-quarter S&P 500 revenue growth draws the starting line; profiling both quarters and taking the difference between the two of them marks the end point.

What jumps out is the deceleration in S&P 500 sectors exposed to cyclicality and interest-rate sensitivity. Real Estate, Consumer Discretionary and Industrials are visibly suffering a top-line deceleration in 2024’s first half. The same can be said of noncyclical Consumer Staples and Communication Services. The weakest of the lot is Financials, which represents the ‘rate sellers’ who disseminate the credit impulse, or lack thereof, to the broader U.S. economy.

A quick glance at the table’s S&P 500 line waves the ‘All Clear’ to the casual observer. But a Higher for Longer Fed constrains private credit creation, impairing private demand. While a young nation called “The United States” no longer requires circle forts around its Capital for protection, the same cannot be said of an equivalent economic moat for its private households and businesses.

An Impossibly Short Four Years

“The days are long, but the years are short.” Upon recently hearing these words for the first time, I remain numb at their cruel veracity. I navigate my days in uncharted territory, mourning the imminent high school graduation of my middle son. These four years have been impossibly short. The tears spill unconsciously with every “last.” Desperate to impart wisdom, I borrow first from Beverly Sills’ 1981 commencement speech at Barnard College: “If you wonder when you’ll get time to rest, well, you can sleep in your old age if you live that long. You may be disappointed if you fail, but you are doomed if you don’t try.” My favorite is from Ralph McGill, editor of the Atlanta Constitution at the University of Miami in 1949: “It has sometimes been my idea that instead of a speaker offering sage advice, it would be a far better idea to place before a graduating audience a fine symphony…or a magnificent ballet, and when this had been completed, to say; ‘Ladies and gentlemen, life can be very lovely or very sad. It probably will be a mixture of both…Goodbye, and God go with you.”

Perhaps it’s because we sent him away as a freshman to a sealed campus as Culver struggled to administer a global student body amidst a global pandemic. There’s a special guilt reserved for parents who discharge their 14-year-old charge to boarding school thousands of miles from home during Covid. If nothing else, he’s not a Class of 2024 college graduate. A weekend Financial Times interview featured a finance undergraduate grappling with gaslighting. To protect his shot at landing a job, he asked his name not be revealed. “On one hand I’m going into a great workforce and on the other hand there are not a lot of jobs,” he said. “I do not know what to believe…it is a little worrisome.” His experience is not unique. According to the National Association of Colleges and Employers. U.S. employers will cut hiring of fresh graduates by 5.8% year-over-year, the steepest decline since the series’ 2015 inception. As for college grads aged 20-24, their unemployment rate rose to 5% from 4.2% in the last year.

Adherents to the Sahm Rule, triggered when the 3-month moving average unemployment rate is 0.5% off its prior 12-month low point, recognize that college graduates are experiencing recession. As for the broad economy, the Sahm Rule is flashing red in 37% of states (fuchsia line). This suggests the U.S. economy is roughly five months into recession based on this critical mass having been hit in April 2008. The month recession began, December 2007, saw 20% of states with the Sahm Rule activated. As for the McKelvey Rule, which has a track record that’s equally perfect though its bogey is only a 0.3% increase on the same basis, it’s been sparked in 65% of states, the highest since June 2008, seven months into the Great Recession (teal line). This aligns with our call that recession should be backdated to October 2023 as revised data out of the Bureau of Labor Statistics shows 192,000 jobs were shed in last year’s third quarter.

Drilling down, the economy’s cyclicality is on full display. In the ten states in which manufacturing contributes the most to Gross State Product, the Quits rate has been falling since May 2022 (red line). No coincidence, that timing coincides with the beginning of the decline in Industrial Production outside the auto sector. As for Leisure & Hospitality, job insecurity began to grow in October 2022 (blue line). QI’s Dr. Gates observes, “Cooling Quits trends in cyclical sectors point to fewer opportunities to earn more money, which is, by definition, disinflationary. Most notably, the 20 states that illustrate this are exclusive of each other.”

Leisure & Hospitality waning gels with the latest data out of Redfin on demand for that summer ocean or lake house. Per the data provider, “U.S. homebuyers took out 90,772 mortgages for second homes in 2023, down 40% from a year earlier and down 65% from the height of the pandemic housing boom in 2021.” Last year, the usual suspects of Austin and San Francisco saw the biggest declines in demand for second homes. Redfin continued with, “An early look at this year’s data shows that demand for vacation homes hasn’t picked up in 2024; interest in second-home mortgages has been sitting near an eight-year low all year.”

As for primary homes, the refusal of Federal Reserve Chair Jerome Powell to bend on Higher for Longer has sent Buyer Traffic back down as per the National Association of Home Builders (purple line). After dueling flirtations with recovery, data via the Mortgage Bankers Association (MBA) concur. The Purchase Index for mortgages remains mired in negative territory YoY (lime line) while Average Loan Size has fallen back into the red, presaging the temporary nature of recent home price gains (orange line). What’s to come? After a four-month reprieve of positivity, Redfin’s Pending Home Sales index fell back into YoY contraction in May (yellow line). At the same time, at 40 days, Median Days on the Market is at the highest since September 2020 (lilac line) while Active Listings are up by 14.2% YoY, a fourth month in the black after nine months of YoY declines (light aqua line). To the list of things high school grads will avoid this summer, we can add a slow-moving housing correction.

The Class of 1949

Do you remember the first week back after winter break of your senior year in high school? For the Culver Military Academy Class of 1949, the first few days of January could have been characterized as happenstance on steroids. From the 2nd to the 5th, three states to the west, the Blizzard of 1949, the worst to ever hit the northern Plains, ripped through at 90 mph, dumping up to 40 inches. In its wake, at least 40 perished, half in Nebraska, as rescue workers were thwarted by blocked roads and railways. Fifteen days later, a man from Missouri, two states west, was sworn in as the nation’s 33rd president, an event that took many by surprise. The world beyond U.S. borders was healing. In February, the rationing of clothes ended in Britain. Londoners would also see the light that April as restrictions on electric lighting were fully lifted for the first time in a decade. That May, halfway around the world, the Tokyo Stock Exchange resumed operations after being closed for four years.

This weekend, members of the Class of 1949 have gathered in Culver for their 75th Reunion. Will they speak of that blizzard that stopped short? Or Truman’s unlikely victory? Or will they simply marvel at living to tell into their 90s and of having been too young to have served in the war? With luck, five years from now, also with luck, my middle will mark his first 5-year reunion with his friends. Will they marvel at their luck of entering college into the teeth of a slowdown that stymied the efforts of their older siblings entering the workforce?

The shift in the winds is increasingly difficult for fans of headline data to ignore. As expected, Thursday’s release of initial jobless claims perfectly unwound that aberrant 10,000-worker pop from the prior week as New York bus drivers and other public school employees returned to work. The remaining 222,000 initial claimants nonetheless marked the highest weekly tally since last November. I asked QI’s Dr. Gates if he’d also sensed that a baton handoff had occurred, that momentum had shifted from continuing to initial claims. Rather than words, he replied graphically, illustrating that last September, initial claims were declining by 20% on a 13-week annualized basis; that’s since flipped to +5.0% (lilac line). Continuing claims, on the same basis, were rising by a pace north of 16% in February 2023 and have since flatlined (teal line).

Of course, stock jocks will tell you they won’t blink an eye until initial claims are above the 300,000 mark. If they prefer unequivocal, they can relish in the Philadelphia Federal Reserve’s May read on manufacturing. The grandaddy of all factory surveys flashed double outliers — the more than -20-point swings in May’s New Orders and Shipments gauges boast a scant eight comparables since the survey’s 1968 inception. The ties that bind the precedents are scares of the recessionary, financial, pandemic, or geopolitical variety.

Don’t you know? You can marry the first two regional Fed manufacturing surveys out of the gate each month — Empire and Philly – to proxy the ISM (blue line). To scale these reports to the national figure, the five components of New Orders, Shipments, Employment, Inventories and Delivery Times are weighted accordingly (yellow line). Echoing a relatively more stressed household sector in the region, Northeast factories are underperforming the broader U.S. For what it’s worth, divergences of the current magnitude occurred during the Great Recession and the 2015 global industrial recession.

With recessionary parallels multiplying, investors are existential, trying to gameplan Fed Chair Jerome Powell’s thinking. Is it the pre-May-FOMC Powell, who’s focused primarily on inflation? Or is this the post-May, dual mandate Powell, the guy who has rediscovered the importance of the labor market?

Luckily, the Philly Fed opens prisms to both versions of Powell. Manufacturers’ resource utilization gauges inflationary pressures. Rising capacity utilization tends to be accompanied by adding extra shifts to satisfy marginal demand. The opposite dynamic is at work, with the U.S. factory operating rate in a persistent downturn (purple line). Capitulation manifests at the worker level, which is on full display in the Philly Fed, which is flashing red as its Current Employment and Current Workweek indexes are in deep contraction (orange and lime lines, respectively). You can see the future of inflation, the sole phenomenon that lags lagging labor.

Also high up on the list of post-pandemic lags is the auto sector. We waited forever for those darn semiconductors to arrive from overseas to finish out fields of Ford F-150s. Long since satisfied, we now dread the pendulum has swung too far as oversupply sets in amidst consumers who will be increasingly challenged to access financing for big-ticket items.

In the meantime, ex-auto manufacturing has been contracting since late 2022 (red line). As Gates notes, “Not cranking out more products at the production level means not shipping them downstream at the distribution level. We see this underperformance in rail carloads relative to output (light blue line).” As detailed in depth in this week’s Quill, the state of U.S. household balance sheets is flagging exhaustion on the demand and supply sides, from maxed-out credit card lines to lenders poised to sustain such heavy losses, standards will remain tight. If only we could be 18 again, with our sole worry being that of deciding which classes to register for come fall.

What Lies Between France and Italy

The 320-mile-long France-Italy border runs from the Alps in the north down to the Mediterranean coast in the south. There are three national parks along the border – Vanoise and Mercantour on the French side and Gran Paradiso in Italy – as well as Mont Blanc, the highest mountain in Western Europe. Under the mountain is an engineering feat whose idea dates back to the 19th century. The idea percolated until 1907, when Francesco Farinet, a Member of Parliament of the Aosta Valley, advocated for construction. The agreement between France and Italy on building the Mont Blanc Tunnel was signed in 1949, drilling began in 1959, completion followed in 1962 and it was opened to traffic in 1965. At more than seven miles in length, it was the world’s longest road tunnel until 1978. Interestingly, it passes almost exactly under the summit of the Aiguille du Midi. At this spot, it lies 8,140 feet beneath the surface, making it the world’s second-deepest operational tunnel. Small wonder it took 330 tons of iron to support the vault and 66,000 tons of cement to form the marvel.

U.S. Retail Sales would seem to be the farthest thing from the Mont Blanc Tunnel, but they share a commonality — both lie between the economies of France and Italy. At $705 billion in April, U.S. retail sales are smaller than France’s nominal gross domestic product (GDP) of $780 billion and larger than Italy’s $568 billion.

While the consumer price index (CPI) was the source of investors’ obsession Wednesday, it’s easily arguable that the level shift lower in the U.S. Treasury curve had more to do with Retail Sales. It’s true that core CPI eased for the first time in four months, but this fell in line with the consensus. Disappointing April Retail Sales were driven by the core ‘control group’ and not limited to the first month of the second quarter as both February and March sales data were revised lower. The weaker impulse for consumer demand generated a sizable downward adjustment by our favorite GDP trackers at S&P Global, whose first-quarter figure now stands at 0.9% vis-à-vis the 1.6% advance estimate. Before the data hit, the team led by Ben Herzon, a.k.a. the Godfather of GDP modeling, had already lowered their estimate to 1.4%; the 0.5% trim was unusually large for their standards.

It’s too early to pass judgment on second-quarter growth projections, but we can observe where the retail momentum is and is not. In nominal terms, gasoline’s 22.4% quarter-over-quarter (QoQ) annualized jump bested all categories (green bars). Miscellaneous goods (7.9%), building materials (6.6%), food & beverages (4.7%) and general merchandise (2.7%) rounded out the top five. The negative side was led by furniture & home furnishings (-10.5%) followed by pullbacks for recreation goods (-6.1%), health & personal care items (-2.1%), auto parts (-1.0%) and sales at auto dealers (-0.8%).

It’s clear that the interest rate-sensitive auto and housing sectors continue to be penalized. Categories with inelastic demand are equally ‘beneficiaries’ though we doubt households would characterize it that way. Staples, like food and energy, are not only driving Retail Sales, but they’re also exerting extraordinary price pressure and explain why nondiscretionary inflation, at 4.7% year-over-year (YoY) in April, remains well north of its long-term average of 3.2% long-run average. The upshot is decimated pricing power for purveyors of discretionary goods and services, the inflation for which is 0.3% YoY, a fraction of its 1.1% long-run average.

Inflation-adjusting Retail Sales reveals a material downshift into 2024’s second three months to a 1.5% two-quarter annualized rate from 1.9% in the first quarter and 3.7% in 2023’s fourth quarter. Moreover, growth in real retail inventories has run above sales for four quarters. Supply outrunning demand implies a deepening in goods deflation and an inventory correction in the making. Notably, as foreseen in Wednesday’s commentary, core goods CPI inflation fell further into negative territory to -1.3% YoY, almost double March’s -0.7% YoY rate.

Yesterday’s New York Fed’s Empire Manufacturing survey piled onto the cooling narrative as its Future Capital Spending (capex) index slid to 2.0 in May from April’s 6.7, which itself was half January’s 2024 high of 13.7. Smoothing the series to a quarterly frequency and normalizing with a z-score painted a capex outlook rivaling past recessions (red line). As a hard-data check, the deterioration in the core capex spread, the difference between Nondefense Capital Goods Ex-Aircraft Orders and Shipments, looks to be worsening (blue line). Of course, capex investment and labor co-move over business cycles, a factor that will amplify other stressors pushing up the unemployment rate (yellow bars).

The mid-month update of state-level WARN notices concurs. Zeroing in on the top 15 states, 28,291 workers in April (dashed aqua line) were swept up in mass layoffs, which is consistent with Great Recession readings. The 2024-to-date average (far right fuchsia line) is the highest annual count since 2008 and 2009. Notably, California accounted for nearly half of the WARN notices; its tally of 12,684 was the highest since 2020. Across cycles, the ratcheting up of WARN notices has been accompanied by an increase in Google Trends search interest for “severance pay” (purple line). When severance runs dry, workers no longer get counted on payrolls. The bulges at the right of figure four clearly tilt toward upside risk for joblessness this year. Convergence of the high inflation-low unemployment narrative lies ahead.

Lost in Translation

Out of the blue, as promised, of a New York

Puzzle-rental shop the puzzle comes –

A superior one, containing a thousand hand-sawn,

Sandal-scented pieces. Many take

Shapes known already – the craftsman’s repertoire

Nice in its limitation – from other puzzles:

Witch on broomstick, ostrich, hourglass,

Even (surely not just in retrospect)

An inchling, innocently branching palm.

These can be put aside, made stories of

While Mademoiselle spreads out the rest face-up,

Herself excited as a child; or questioned

Like incoherent faces in a crowd,

Each with its scrap of highly colored

Evidence the Law must piece together.

Sky-blue ostrich? Likely story.

Mauve of the witch’s cloak white, severed fingers

Pluck? Detain her. The plot thickens

As all at once two pieces interlock.

Pulitzer Prize-winning James Merrill’s poem “Lost in Translation” graced the pages of his seventh book of poetry, Divine Comedies. Merrill is reminiscing about his summer of 1937, waiting for and then working on a jigsaw puzzle with his governess, Zelly. That last name should ring a bell for anyone with Wall Street roots. Born in New York City, Merrill was the only son of Hellen Ingram Merrill and Charles E. Merrill, founding partner of Merrill Lynch.

While many of us mourn the passing of Mother Merrill, we still enjoy her vestiges such BofA’s (Bank of America) Global Fund Manager Survey (FMS). Michael Hartnett’s baby gets reported each month on Bloomberg like it was any other top-tier economic release. Since reclaiming the top tail risk spot in February, investors’ conviction in “Higher Inflation” topping their worry wall has grown markedly; the spread over the second biggest concern, “Geopolitics,” widened to 23 points in May from 3 points three months prior.

Inflation has been top of mind for U.S. small businesses. In fact, the commentary section of the April National Federation of Independent Business (NFIB) small business survey included ten references to inflation by Chief Economist and QI mentor Bill ‘Dunk’ Dunkelberg. Dunk noted that inflation progress has hit a wall at the 3% mark “as firms on Main Street continue to report raising selling prices and labor compensation at historically high levels. An analysis of the factors driving inflation in the small business sector identified compensation gains as the major driver of price increases….”

To that end, the percentage of small businesses raising worker compensation has picked up at the start of the second quarter (1.6 z-score in April, light blue line) off lows from the prior three-month interval. Moreover, the share of Main Street proprietors citing labor costs as their biggest problem moved higher and remains well above normal (2.8 z-score in April, teal line). Market participants will be looking for progress on supercore (services excluding energy and rent) disinflation in today’s consumer price index (CPI) report after acceleration in the first quarter (fuchsia line). On balance, the NFIB wage backdrop leans in the direction of less ‘dis-’ and more ‘-inflation.’

Staying on the service side, both rent measures in the CPI — Primary Rent and Owners’ Equivalent Rent (OER) are not far off last year’s peak rates (orange and purple lines). The best news is there’s more downside to come given what we’re witnessing in the producer price index (PPI). Introducing the QI Residential Real Estate Service proxy, which fuses four PPI gauges into one by combining real estate agents, appraisers, attorneys with mini warehouse & self-storage facilities. Lagged four quarters, the proxy projects through 2025’s second quarter. Granted, it’s a higher beta measure vis-à-vis Primary Rent and OER, but it maps the contours well over time – and points to a return 2% within 12 months (lime line).

Shifting to core goods, Inventory Sentiment is an appropriate way to track good price trends as it communicates whether stocks are too high or low relative to demand. Z-scoring NFIB’s Inventory Sentiment gauge reveals overstocked conditions remain (lilac line), which flags further deflation in the core goods CPI (aqua line). Moreover, at a z-score of -1.3 NFIB firms reporting Higher Sales remain well below normal at the outset of 2024’s second quarter, the fourth straight quarter at or below -1 (not illustrated). Excess supply punctuated by below-trend sales will compound deflationary pressures.

The persistence of inflation as owners’ biggest problem as reported in the NFIB only compares with readings from the 1970s and early 1980s (green line). Elements of stagnation are also visible in extremely weak expectations for improvement in the economy. April’s z-score is worse than almost all past cycles since the survey’s 1973 inception (blue line). Hammering home the risk of stagflation is an uplift in the ‘Poor Sales’ figure, which signals labor losses and higher unemployment. Since 1986, the series has a robust .83 correlation to the unemployment rate (not illustrated).

As for those collecting jobless benefits coon, MacroEdge has tallied 60,000 job cuts announced thus far in May. At this pace, the current month will surpass April’s total of nearly 115,000. Granted, this month has been amplified by big headlines out of Rue21 and Red Lobster as well as the seemingly never-ending bloodletting at Tesla. Still, with a hat tip to QI’s friend across the pond, Patrick Perrett-Green, we can count on two hands (nine) the number of times in the last decade PPI has been revised down by a magnitude of as much as -0.3%, as was the case in March. There are clearly shifting winds on both the unemployment and inflation fronts.

I’m Your Density

Marty McFly: Just tell her destiny has brought you to her and you think she’s the most beautiful girl you’ve ever seen. Girls like to hear that – what are you doing, George?

George McFly: I’m writing it down. This is good stuff.

Marty McFly: There she is. Just go and ask her.

George McFly: Uh, Lorraine… My density has brought me to you.

Lorraine Baines: I beg your pardon?

George McFly: Oh – what I mean to say is…

Lorraine Baines: Haven’t I seen you somewhere?

George McFly: Yes! I’m George. George McFly. I’m your density. I mean, your destiny.

Despite George McFly’s petrified awkwardness in 1985’s Back to the Future, screenplay writers knew there was something endearing about him, like a lost dog. Not only did Biff’s untimely soda shop entrance thwart George’s moment to captivate his future bride, but Marty’s distraction by way of altercation shifted Lorraine’s attention back to him. Re-channeling Cupid, Marty was back to contriving to get his folks back on path to their first kiss at the Enchantment Under the Sea dance.

In the case of inflation expectations, density is the destiny, according to the New York Fed’s Survey of Consumer Expectations (SCE). The headline number is a median one-year ahead expected inflation rate, measured using density forecasts, where respondents are asked for the percent chance that the rate of inflation will fall within specific ranges. Think 12% or higher, between 8% and 12%, between 4% and 8%, between 2% and 4% and between 0 and 2%.

In April’s SCE, median one-year inflation expectations rose to a five-month high of 3.26% (purple line). After being rangebound between 3.00% and 3.04% from December to March, the uptick in short-run inflation expectations was echoed by the SCE’s long-run (five-year) measure, which skipped up to 2.82% from 2.62%. The medium run (three-year) gauge, however, fell to 2.76% from 2.90%.

Median one year ahead inflation expectations reflect current consumer price (CPI) inflation rather than the outcome 12 months hence. Since the pandemic hit in 2020, the correlation between the two is a stout .95. April’s bounce in one-year inflation expectations seems to jibe with the consensus U.S. CPI view for a 3.4% year-over-year rate (YoY, orange line) due to be reported tomorrow.

Today’s April small business survey from the National Federation of Independent Business (NFIB) adds to the inflation discussion. March’s NFIB small business selling price plans metric (net 33%, green line), was in line with the New York Fed’s one-year figure. Based on this convergence of household inflation expectations and small business price plans, the last mile from 3-handles to 2-handles appears to be the longest.

Expediting the journey are two SCE series showing mounting weakness in the labor market, especially in the peak-earnings-years 40-60-age cohort. The mean probability they foresaw of finding a job in the next three months, if they were to be virtually pink slipped today, fell to 49.7% (teal line), a first foray south of the 50% breakeven mark and a three-year low. A second series showed one year forward expected wage inflation declining for a third straight month to a 2.0% annual rate (lilac line). Eight short months ago, this metric was a full point higher at 3.0%. The pandemic aside, the eight-tenth compression in the three months was the steepest in history.

Home sellers are acting as if they’re immune to growing layoffs. The University of Michigan’s (UMich) consumer survey portrayed a net 40% of optimism for home selling conditions related to prices (red line), a right-tail reading that exceeds the highs of the expansions of the 1990s, 2000s and 2010s. Buyers aren’t buying it. May’s UMich was as bad as it gets for home buying conditions as the index fell to a record low 26; the 21-point plummet was the seventh worst on record placing it in the 1stpercentile (yellow line). Of the other six occurrences, three led or happened in recession, two were catalyzed by the COVID-19 shock, and the other one followed the 1987 stock market crash.

Such is the extreme disconnect, a buyers’ strike could indirectly manifest as a relief for sticky home rents. A weakening in buying conditions running in tandem with rising credit concerns would add credence to household balance sheet risks. Debt delinquency expectations, measured as the inability to make a minimum debt payment over the next three months, continued its march higher in April. The normalized z-score for the SCE aggregate rose to 0.50 from 0.49 in March (fuchsia line), the worst pre-pandemic performance in six years.

Not curiously, the Northeast is at the forefront of household credit distress. The region where services contribute the greatest percentage to Gross State Product saw its debt delinquency z-score spike to a record high 3.2 (light blue bars). For completeness, the three other regions – Midwest -1.0, South 0.2 and West 0.2 (not illustrated) – didn’t flash anything near as red a signal. April’s dual declines in service employment indices from ISM and S&P Global corroborate soaring Northeast delinquency expectations. New York was also notoriously identified as the state in which jobs to satisfy growing social services offered more than offset net private sector job losses. At last check, it’s still expensive to live there making essentials inflation sting even as job losses continue to deplete income generation capacity. If only Marty McFly could hatch a rescue plan in enough time to save the future.


Hunting Hotspots

It takes a lot for me to power down my MacBook. The risk of not being able to reopen both browsers’ open windows is unquantifiable. Such was my level of frustration Saturday morning the nuclear option was deployed. An hour in the car should have afforded me the opportunity to get a leg up on writing. Who knew that the sun had different plans in store? According to the National Oceanic and Atmospheric Administration (NOAA), a large and “magnetically complex” sunspot that’s 16 times the Earth’s diameter — known as NOAA Region 3664 – generated the mother of all geomagnetic storms. Like hurricanes, these storms are ranked on a ‘G’ scale from 1-5. Friday night’s G5 was extreme and the strongest since 2003 making for a lovely Northern Lights display. While predicted to affect shortwave radio transmissions used by ships and aircraft, emergency management agencies, the military and ham radio operators, what it did Saturday morning was knock out my iPhone’s hotspot. It could have been worse. As NOAA warned, “Some grid systems may experience complete collapse or blackouts. Transformers may experience damage.” Lucky for laptop users on the move, the storm passes tomorrow.

As for investors, they’re hoping they’re not in the track of an inflation storm come Wednesday morning. April’s headline consumer price index (CPI) is expected to tick down by a tenth of a percentage point to 3.4% year-over-year (YoY) while the core rate, which excludes food and energy, is forecast to fall to 3.6% from 3.8%. But anxiety is sky high that there could be unexpected upside. Friday’s preliminary release of consumer sentiment from the University of Michigan (UMich) was a toxic combination. Households’ perceptions of inflation, the job market, their paychecks, and borrowing costs deteriorated.

Survey Director Joanne Hsu noted that, “This 10 index-point decline is statistically significant and brings sentiment to its lowest reading in about six months. This month’s trend in sentiment is characterized by a broad consensus across consumers, with decreases across age, income, and education groups. Consumers in western states exhibited a particularly steep drop.” Little wonder, of the 5.3 million unemployed Americans seeking full-time work, a fifth reside in California. The Golden State has the highest unemployment rate in the nation as its technology and manufacturing sectors contract. And job openings in software and technology are 40% lower than they were prior to the pandemic.

Nationwide, 40% of households expect the unemployment rate to rise in the next year (blue line). The eight-point monthly increase was double the norm and suggests the increase in initial jobless claims will be sustained (lilac line). Not illustrated, income expectations collapsed to the lowest since May 2020, when the unemployment rate was 13.2%. It stands to reason that average buying conditions for autos, homes, and major appliances fell to the lowest since January 2023 (aqua line). The irony is recession probabilities are at a two-year low (orange bars).

The proverbial insult to injury is households’ expectations for year-ahead inflation have risen to 3.5% in April from 3.2% the prior month. Fortunately, the increases in prices at the pump have been arrested, which should cool near-term inflation expectations. S&P Global energy analysts have also noted that global supply constraints have eased, propelled by what they see as peak demand for the year as evidenced by declining diesel sales reflecting the slowdown in the U.S. economy.

While the media is busily talking up the most persistent source of inflationary pressures – shelter – two sources of anecdata indicate we could be at the precipice of seeing a turn on this front. John Wake is an independent housing analyst with a wide following. Over the weekend, he posted data showing that existing home inventory in Phoenix had surpassed 2019 levels. While “the number of homes for sale is at the low end of the ‘normal’ range, seeing inventory increase this time of year is very abnormal and suggests inventory will continue increasing abnormally for a while.”

Separately, a longtime QI contact emailed that the costs of rental ownership in Florida are going through the roof. A client of his in Miami who paid $11,000 to insure a seven-unit property in 2016 had seen his premium double in 2022 and redouble to $44,000 this year. His conclusion: “More supply is coming online.”

Persistent deflation at the producer level in China demonstrates how anemic demand is in the world’s second-largest economy (lime line). As noted by Bloomberg of Friday’s release of China’s producer price index (PPI), “Prices of consumer goods in the PPI basket extended declines.

That suggests downward pressure on the headline CPI from consumer goods won’t let up in the foreseeable future.”

Despite the historical relationship that flags downside in U.S. CPI (purple line), 16% of U.S. households queried by UMich project inflation will be north of 10% in 5-10 years, the highest since the mid-1990s and double the percentage with sky-high expectations in March (orange line).

We think we know the cause and we doubt it’s perfect prescience as to what price pressures are going to be in 2034. For one thing, note how erratic long-term expectations are, both to the upside and downside (red line). More importantly, we see zero coincidence in how radically different inflation expectations were in the last administration nor that they are a mirror image with the greatest political divide in the postwar era (teal line). We’ll let you decide which “war” we reference.


Air Rage Baptism by Fire

Consider me baptized by fire…on the tarmac at La Guardia. I’ve officially been on the receiving end of air rage, defined as “violent anger directed mainly at inflight airline personnel and arising from the frustrations and stresses of air travel.” No, I have not started moonlighting as a flight attendant, but yes, I was the target of a British thug. Asked to stow my laptop after the airplane door closed, I quickly closed it but did not immediately move to place it under the seat in front of me. While no violence ensued, he got this close to my face and barked at me to stop breaking the law. My laptop could inflict grave harm upon his body! After jumping back into my skin and steadily disengaging my weapon, he raised the volume one more notch and screamed at me for texting and disregarding yet another law! What is it about rage that becalms? Keeping an even tone to my voice, I explained that I was already legally logged onto the plane’s WiFi system on which I maintain a monthly subscription for two devices. Words fail to describe the disappointment on his face.

The same could be said of most investors at 8:30 am ET Thursday morning when news hit that initial jobless claims in the week ended May 4th jumped to 231,000 from 209,000, the highest since August 2023. The mad rush by the media to apologize for the print constituted high entertainment. Boil it down to not seasonally adjusted (NSA) data and the 22,000 gain was only 20,000. Even better, half of that was tied to New York school workers who can claim unemployment insurance when school is in its one-week recess. Economists tripped all over each other vowing an imminent reversal.

From our perspective, the NSA data were inconclusive. (We don’t track the seasonally adjusted series given the constancy of modeling changes at the Department of Labor). There was a decline in the number of states with rising initial claims to 22 from 28 at the end of April which was offset by a flip in the overall direction of claims. After three straight months of falling on a year-over-year (YoY) basis, claims nationwide are once again on the rise.

More notably, several states have raised true red flags that have zilch to do with spring break benefits. With the exception of March 2023, initial claims in Indiana have been in a relatively deep YoY decline vis-à-vis the nation as a whole. In May, they flipped from being -26.4% YoY to +34.1% YoY and ranked third in terms of the number of new claimants. We care because Indiana is the most factory-intensive of any state; its manufacturing as a percentage of Gross State Product is the highest in the country. We equally note that California and Texas, respectively the first and second absolute largest manufacturing output states, were numbers two and five on the list of states with the biggest rises in NSA initial claims.

Missing in that Top 5 is Illinois, the state with the fourth highest number of initial claimants. While not the stalwart Indiana has been for the past 12 months, Lincoln’s home state did boast declining YoY initial claims in five of the last six months, a nice run. We can tell you with near certainty that the good times are over. In April, Illinois WARN notices jumped significantly off trend (light blue bars). This micro-to-macro tell suggests the May uptick in initial claims in one of the largest U.S. states might be more than just coincidence (red line).

Given the pace of MacroEdge layoffs has picked up appreciably – nine days into May, announced cuts have topped 42,000 vis-à-vis 115,000 for all of April – we venture WARN notices in other states are busying the bureaucrats. Continued job losses highlight the growing divide between the haves and have-nots of consumption, as in gas & grub vs fun. Bank of America’s proprietary data mined from its customers’ credit and debit cards aptly illustrate the tightening vise on household budgets. Last March, spending on Airlines, Lodging & Entertainment was +9.0% YoY; it’s since fallen by 15 percentage points to -6.0% YoY (purple line). Conversely, spending on Gasoline & Groceries was -3% YoY a year ago and is now +1.0% YoY (orange line).

CEOs are all on board with canceling fun. At -3.7% YoY in the week ended April 27th, occupancy at hotels that are large enough to host corporate boondoggles is at the lowest since February 2021, when the economy was re-opening (lilac line). It’s clear workers are concerned that it’s more than just travel and expense budgets being axed. If you can see through the noise in the University of Michigan’s gauge of households’ Mean Probability of Income Gains in the coming year, tomorrow’s preliminary take on May should reveal further deterioration from last month’s six-month low (teal line).

As for corporate chieftains’ plans beyond the travel budget, QI’s Dr. Gates made the following observation: “When you think ‘CEO Confidence,’ stock market performance comes to mind. And the trends are there to prove it. So why today’s disconnect (lower right chart)? Why have equities continued to fly high while CEOs are assigning their own industries failing grades if there’s not something fundamental at work?” We only wish we jested in worrying about a hypothetical future scourge akin to Air Rage called Fired Rage.

The Chain

In 1977, Fleetwood Mac packed in more talent per capita than most bands can dream of: Stevie Nicks, Lindsey Buckingham, Christine McVie, John McVie, and Mick Fleetwood. Of all their great compilations, only one song is credited to all members of this lineup — “The Chain.” Each musician made a unique contribution, and the song came to represent the resilience of Fleetwood Mac and the strength of their bond as they pressed on as a group for many years despite personal and professional clashes. The thing is what began as a Christine McVie song called “Butter Cookie (Keep Me There)” didn’t begin so well. But the band loved Mick Fleetwood and John McVie’s ending. To back into a better beginning, they counted back from the baseline and used the kick-drum as a metronome. Nicks then delivered the lyrics for the verses and Buckingham and Christine McVie wrote the music and the chorus lyrics. Finally, Buckingham added the guitar over the ending. “The Chain” as we know it was born and, with good reason, was often the first track on the set list in concert.

Logistics managers live and breathe a different sort of chain — the supply chain. These professionals live and breathe how resources are acquired, stored, and transported to their final destinations. That’s what makes the Logistics Managers’ Index (LMI) a go-to for dismal scientists. The monthly snapshot of inventory, warehousing, and transportation metrics keeps us together to assess cycles.

Hat tip to long-time QI friend Peter Boockvar for bringing to our attention the money quote from the April LMI, which saw the headline fall to 52.9 from 58.3, March’s 18-month:

“While this still indicates growth in the logistics industry, this breaks what had been four consecutive months of increasing rates of expansion and is the slowest rate of growth observed so far in 2024. The slowed pace of growth is driven by a significant decrease in the expansion of inventory level. This has cascading effects across the supply chain, as lower levels of inventory led to a loosening of both warehousing and transportation capacity, slower expansion for warehousing utilization, and most importantly, transportation prices moving back into contraction…”

Clarity isn’t always the order of the day – or should we say, month – with the LMI. It has many moving parts and is surveyed over early and late parts of the month, describes upstream and downstream performance and tallies perspectives from large and small firms alike. That’s why the report’s description of two transportation metrics was decidedly decisive (bolding ours): “Transportation Capacity is now 17.3-points higher than Transportation Prices indicating that we are still firmly in a state of freight recession.

When the supply chain was broken in 2021, the LMI for transportation prices posted persistent readings in the 90s (purple line). For a series with a 50 breakeven and a maximum level of 100, this was extraordinary. As capacity began to recover in 2022 (orange line crossing above 50), pricing started to normalize. The widening gap between higher capacity and declining prices defined the freight recession narrative. Hope sprung in 2024’s first quarter, when prices expanded again amid a continued decline in capacity. April’s reversal suggests the Cass Freight Rate index will remain in contraction after seven straight quarter-over-quarter declines starting in 2022’s second-quarter (green bars).

Declarations of freight recession should be manifest in transportation & warehousing employment. To that end, openings, hires, and quits peaked in 2021’s fourth quarter (green line, upper right), 2022’s third quarter (yellow line, upper right) and 2022’s fourth quarter (blue line, upper right), respectively, while the ranks of unemployed bottomed in 2023’s second quarter (green line, upper right). The most convincing takeaway was the unemployed exceeding (lagged) openings in the first quarter and advancing further through the first month of the second quarter.

The wholesale industry’s tentacles reach deeply into the supply chain. Sizable downside surprises in demand from this “middleman” sector raise the warning flag higher. Real Wholesale Sales sit on the NBER’s scorecard of recession indicators and registered a -2.8% annualized drop in the six months ended March, making it the weakest performer behind industrial production (-1.2% six-month annualized).

Deteriorating revenues have translated into a bottom in wholesale unemployment over the last year (red line, lower left) and notably coincided with 2023’s second quarter trough in joblessness in transportation & warehousing. When combined with wholesale’s prior peaks in job openings (2021’s fourth quarter, green line, lower left), hires (2022’s second quarter, yellow line, lower left) and quits (2021’s third quarter, blue line, lower left), conviction grows that a turn in the supply chain’s labor cycle has arrived.

Another way to illustrate this is by examining one of the hottest sectors in the logistics’ space: industrial warehouses. As the post-pandemic transition toward e-commerce accelerated, investment and construction in warehouses took off. This darling of CRE portfolio managers was seen as Teflon. The abrupt collapse in the warehouse building cycle (lilac line) in 2023’s second half speaks volumes about the direction of risk for nonresidential building construction payrolls that have defied gravity (teal line). The move from warehouse boom to bust in 2023 implies the 2024 outlook for inventory accumulation has turned pessimistic. Moreover, the turning points in the labor cycle in these key cyclical sectors suggest that the flare-up in the freight recession narrative captured in the April LMI report is not likely to be a one-month wonder.