An earnings recession is brewing, one expert says. Hunker Down in cash.

If there’s one person who wasn’t surprised by the massive failures in big-box retail results last week, it’s our long-time (but not-so-long-term) friend Stephanie Pomboy, who heads MacroMavens’ institutional economic advisor. Even though she has been dealing with a (thankfully) mild case of covid-19, she remains as sharp and biting as ever in assessing the current situation.

In order not to lose the short attention span types, here are some of Steph’s insights:

We are now experiencing withdrawal pains after the massive injection of fiscal and monetary stimulus of the past two years, which actually boosted asset values ​​more than real economic activity. With manna no longer flowing from Washington, consumers are turning to credit cards to pay for the rising costs of incidental items such as food, energy and rent. Companies are also being squeezed. Producer prices are well ahead of consumer prices by the highest margin recorded,

There is also good news. In the midst of scarcity of everything, the supply of one thing, labor, could improve. Some people made rich by high asset prices, be it stocks, houses or cryptocurrencies, joined the leisure class for a while. As asset prices begin to deflate, some of these nouveau riche face the bleak prospect of having to go back to work.

Pomboy says that both Wall Street and the Federal Reserve have woefully underestimated the role of stimulus policies in the current recovery. After Uncle Sam pumped roughly $10 trillion in fiscal and monetary largesse into the US economy, nominal gross domestic product rose by about $2.3 trillion, a pathetic reversal. However, household net worth soared by $34 trillion, compared to $24 trillion for the US economy. In effect, American consumers received approximately two full years of income, through the increase in the value of their homes and their 401(k) accounts and other securities holdings.

Now the movie is on rewind. The notion of consumers sitting on an ample cushion of savings is incorrect, Pomboy says, with personal savings back at the December 2019 level. Credit card balances, which shrank after the US received the stimulus fix of the government, are increasing at a record annual rate of 16%. It’s hard to imagine consumers shouldering double-digit interest charges on plastic if they weren’t forced to pay mounting bills at the checkout counter, gas pump and rental office, he adds.

The stress that dominates the daily lives of most Americans shocked Wall Street through retailers’ first-quarter earnings reports last week, highlighted by the 28.7% swoon in two days by

Goal

(ticker: TGT) on Wednesdays and Thursdays. Rising spending on food, energy and housing are crowding out discretionary spending, Pomboy says. Retailers catering to the mob are unable to pass along their rising costs, resulting in a massive margin squeeze that decimates their stock.

The effect of the now deflating asset bubble remains to be seen. He passed a JOLTS (Job Vacancy and Turnover Survey) graph overlaid with the


Wilshire 5000

index, which measures the broad US stock market in dollars. Through the most recent reading for March, the JOLTS-indicated labor market tightening moved roughly in lockstep with Wilshire.

At some point, however, the opposite could happen. According to Wilshire Associates, the US stock market has lost some $10.1 trillion in value, or 19.9%, this year through Thursday. The losses are relatively recent, with $7.1 trillion of that falling since the current quarter began, including $2.6 trillion in May, $1.7 trillion of which went up in flames in Wednesday’s loss alone.

That doesn’t take into account the roughly trillions of dollars in cryptocurrency wealth that has evaporated globally this year, according to the Goldman Sachs economics team, led by Jan Hatzius. Declines in household wealth point to a significant drag on spending, not so much from cryptocurrencies as from conventional assets. Stocks accounted for about 33% of household wealth at the end of 2021, compared to just 0.3% for cryptocurrencies, they write in a client note.

Labor force participation among younger men, cryptocurrency’s main fan base, has almost fully recovered, Goldman economists say. Previous academic studies have found that the wealth effect primarily affects labor force participation among those approaching retirement age, who might be more likely to take their money and run.

At first glance, the jobs numbers seem to show that labor demand is still ahead of supply. But looking below the surface, Pomboy sees confusing data. While the April establishment survey found a solid 428,000 increase in nonfarm payrolls, the separate household survey showed a 353,000 decline in employment. While the household series (from which the headline unemployment rate is derived) tends to be more volatile from month to month, he has never seen such a wide split, suggesting there is something wrong with the numbers.

And recently, some big tech companies, including

Metaplatforms

(FULL BOARD),

amazon.com

(AMZN), and

Uber Technologies

(UBER), have announced more restricted hiring policies. Initial jobless insurance claims have been rising, to 218,000 in the week ending May 14. That’s a historically modest level, but it’s still above the 53-year low of 166,000 hit in March. As profit margins shrink, labor costs are sure to come under scrutiny.

At the same time, Pomboy adds, Fed Chairman Jerome Powell wants to present himself as “Volcker 2.0,” a reference to the Fed chief who beat inflation four decades ago with 20% interest rates and back-to-back recessions. And equity analysts have yet to seriously lower their earnings forecasts, with those of consumer discretionary still pointing to 30% gains by 2022, he observes.

Pomboy’s conclusion: We are in the early innings of an earnings recession in the making. The Fed would likely welcome wage gains if the labor market weakens. In the meantime, he advises investors to resist any temptation to buy dips. Instead, he advises, duck into cash; the lows are still far away.

write to Randall W. Forsyth at randall.forsyth@barrons.com

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