Monthly Macro with Richard de Chazal—February 2024

A hard, soft, or no landing? Listen as macro analyst Richard de Chazal discusses the latest in macroeconomic news, including a more hawkish Jerome Powell, a red-hot S&P 500, fourth-quarter earnings, and a hotter-than-anticipated CPI report.

Podcast Transcript

Chris Thonis (00:07)
Hello, everybody. It's time for another episode of Monthly Macro featuring William Blair macro analyst Richard de Chazal. Hard to believe we're already into February, but here we are. Richard, as always, thank you for being here. The past few weeks since our last recording has given us quite an array of macroeconomic news to digest. We've got more regional bank pressure. We've got a more hawkish Powell, a red-hot S&P 500, fourth quarter earnings, and a hotter-than-anticipated CPI report. So, at least from my perspective, if we had to come up with a core thread at this point, it would seem as if we're not quite out of the woods yet as much as we would love to be. To kick things off, figure we can start with the ongoing debate about what kind of landing we're in store for now. And Richard, you recently wrote that you're, you think the narrative has shifted from between hard landing and soft landing to investors now debating between a soft landing and no landing. My question to you is, do you think there is still a possibility of a recession this year or is the market right to completely rule that out?

Richard de Chazal (01:26)
Thank you for having me again. Great to be back for another month. Yeah, I think we've definitely seen exactly that where the narrative has been shifting once again. If you remember at the start of 2023, everyone was really sort of in the negative hard landing camp and the boat was really sort of tipping to one side.

And then the data continued to surprise to the upside. So, we can see this in something like an economic surprises index, which measures the actual economic outcome versus what the forecasted outcome was by economists. And those or that index continued to push up through the first half of last year as that data continued to surprise to the upside and everyone was quite negative as it were.

And then I think, you know, probably towards the middle of last year, everyone sort of cottoned on to maybe things aren't so bad, maybe this is a bit of a soft landing. They kind of abandoned that hard landing camp. And then they started to adjust their expectations upwards. So, we started to see fewer of those economic surprises and that index started to head back down once again. And then, that left us at the end of the year where everyone had kind of flipped to the other side of the boat, the soft-landing camp. And then where we are today, or surprise, surprise is that the data, or at least the headline data has actually continued to surprise on the upside again. So that surprises index is once again, starting to move up and now people are starting to move from the soft-landing camp into the no landing camp, you know, where maybe they're thinking that the economy doesn't actually slow at all. And some are even talking about, you know, canceling expected rate cuts and maybe even starting to price in a rate increase. So I think that's quite a change in the last couple of couple of weeks. I guess I would say that that no landing camp is still a pretty optimistic one. I think if you actually scratch a little bit below the sort of headlines on some of that data, it doesn't actually seem to be quite as strong as it does on the surface. And maybe it's worth giving you a few examples of that. Clearly, the biggest kind of headline grabbing news each month is that monthly non-farm payroll data. And I think every month over the last year and a half, bar one or two, it's been surprising to the upside. And January's data was really no exception. There was another massive upside surprise with payrolls coming in at 335,000 compared to the expected 185,000. So, a pretty big surprise.

Particularly given where we think we are at this point in the economic cycle, i.e., somewhat late in the cycle, you have to ask where are all these workers actually coming from? But I think if we look a little bit closer at the data and maybe some of the other various bits of economic data, it's not quite giving us the same message. So, remember that the payroll survey is a survey of companies.

It's really just the Bureau of Labor Statistics (BLS) speaking with companies, looking or getting the data on who's actually on their payrolls, who they're paying. So if you have multiple jobs, you're technically counted twice. There's also this sort of birth -death adjustment that the Bureau of Labor Statistics makes to account for new companies entering the economy and companies dying or leaving the economy.

And historically that tends to kind of, or the BLS tends to overestimate new companies coming into the economy sort of later in the economic cycle and then underestimate them at the start of an economic recovery. But they also have this sort of second measure of the employment report. There's the establishment survey and then there's also the household survey of employment, which is a different survey. And that's where the BLS, kind of effectively knock-on household's doors and say, you are you working or are you not working? It doesn't really ask them about multiple job holdings.

Chris (06:05)
I did not realize that, that's interesting.

Richard
Yeah. And, you know, over time, Chris, the two of them should roughly be the same because, you know, either from the companies or knocking on people's doors. So they should roughly give the same message.

Here's some slight statistical differences, so they're not exactly the same. But what we have been seeing in that household survey has been actual declines in three of the last four months. And then the BLS also does an adjusted household survey where it tries to take that household survey data and make it more comparable to the non-farm payroll data. And that data in December actually fell by 450,000 jobs. And in January, it was even worse. There was a decline of 753,000. It's quite a big difference. I mean, what explains it? Maybe it's a bit of that birth/death adjustment.

It could be that companies are putting workers on severance pay. So as far as a company concerned, they're still employed, they're still on their books. But if you go and knock on their door and ask that person in the house, are you employed? They might say, well, no, I was laid off two weeks ago, but I'm on severance pay. So, there could be a bit of that. It's hard to know. It's hard to track actual severance pay. But I think, even if we're not seeing major layoff data yet, we're definitely seeing fewer job openings, so there's big hiring freezes going on, and we've also seen falling hours worked. So I think to a certain extent, companies are still hoarding labor because it was so difficult to get in the last few years. So that's probably a structural feature.

They don't want to risk losing them, particularly if it actually does turn into a soft landing or actually a no landing. But what they are doing is they're starting to give their employees fewer working hours and hoping they're going to stick around until things improve. So I think that's one area where the employment data, maybe not so strong. Then if you look at the corporate sector itself, small business sentiment.

I mean, that's still at levels that you would normally associate with recessions. If you look at future capex plans, you know, in surveys by the Fed, of the regional Fed surveys, those are still pretty weak. And maybe the last thing you could point out is that if we look at personal income growth after inflation, you know, clearly a big driver of consumer spending, again, maybe not so strong under the surface as the headline data is showing. So, for example, I think a lot of the growth in incomes that we've seen has been sort of segregated to leisure and hospitality workers, whereas a lot of other industries are still seeing negative real income growth, say from the start of the pandemic, where those workers haven't felt so much of a recovery at all. Across the world, if we look in Europe, big parts of there are still in recession. The U.K. is just sort of officially dipped into a technical recession. So, I don't want to sound too negative...

Chris (09:45)
Right.

Richard
...But I think there are still a lot of good things out there. I mean, think faster productivity is definitely one of them, which is super important. But I guess I think my point is that maybe the data is just not quite as strong as it seems on the surface. And I think maybe the debate should still be sort of soft landing versus hard landing, as opposed to sort of soft landing versus no landing whatsoever and moving on to fed, maybe wiping out the cuts or even maybe tightening.

Chris (10:16)
Got it. So I have two questions that correlate with this. So first, you know, we're through a big portion of fourth quarter earnings. How do you feel this is being reflected? And then the second question would be if the economy maybe isn't as strong or as a little softer than it seems on the surface, why is it the stock market has been so hot?

Richard
Great question. I think probably the same message here, certainly on earnings, you know, again, strong on the surface, maybe not quite as robust underneath. You know, earnings are currently beating expectations on the headline by a fraction more than they normally do. It's always a bit of a beat, but is the beat greater than the expected beat?

So yeah, that's been good, a little bit better than expected. Corporate guidance has been a little bit more mixed, a little bit more conservative, not quite as upbeat as maybe it normally is. We've also been seeing some layoff announcements coming through. So, if we look at announced layoff data, that's actually been pretty high. And I also think [that] companies also starting to be a little bit more worried about rising interest costs as debt starts to mature and they start to get closer to those maturity walls. Also starting to be a little bit more worried about what happens if they start losing some of that stronger pricing power. So, you know, we're already hearing some companies telling us about consumers, or seeing more consumers trading down, which means that consumers are actually pushing back against those higher prices, particularly lower income consumers. And then once again, surface versus underneath is this whole disruption that's being caused by the Magnificent 6 or the Magnificent 7 versus the rest of the market. So, you know, median earnings for those six growth stocks have been up something like 15%, 16%. But for the rest of the market, so those 494 remaining stocks, earnings growth seems to have been basically flat. So, I think that's on the earnings side. On, the stock market, again, same sort of answer.

Richard (12:47)
The easy one would be to say again, look at the aggregate market. So, over the last 12 months, it's been up 23% on the S&P 500. Magnificent 7 has been up 60.6% on a weighted average basis. And then the remaining stocks, the ex-Mag 7 have been up just 12%. Or if you look at the equally weighted S &P 500 on the, you know, over the last year, it's only up six, roughly 6%. That's quite a difference even from the weighted to the unweighted. So 23% versus 6%. So, I think again, that could be one explanation for the market versus the data. Maybe another one could be that, you know, the market is still in this kind of bad news is good news type mentality. So, the market could actually be looking at all of the data. It is more efficient than maybe we give it credit for. So, it's seeing falling job openings. It's seeing some rising layoff announcements, seeing weaker corporate sentiment and is thinking, well, actually that's kind of good news because it means, you know, the Fed’s tightening is working. Inflation is going to be coming down.

And that means we're going to get more rate cuts coming through in the pipeline. So soft landing, maybe even a mild recession, maybe not such a bad thing. But I think the risk is that at some point, maybe you go a little bit too far. Bad news really becomes bad news. That would happen if we really started to see corporate profitability being adversely impacted by that bad news or perhaps conversely if people are starting to get a little bit more worried which maybe they kind of are now about a no landing camp and high and sticky inflation where good news really becomes bad news maybe again it means that the tightening cycle is not over, and the Fed might not start raising rates again so I'm not really in that camp, but what I do think is worth pointing out and what's interesting is that this bad news is good news narrative really kind of only started since the pandemic. And I think what brought that on has been this sort of shift in the inflation regime.

And I think that's super important. And I think that's why the market is clearly still so obsessed with the inflation data and this past week's CPI numbers. In the 20 years or so pre-COVID, I think we were strongly in a disinflationary regime where all of the key sort of inflationary drivers were all funneling in one direction and that was lower inflation and the main risk to the economy was deflation. Bernanke was sort of writing about making sure it doesn't happen here. So anytime we got any good news on the economy, that was great.

And really the more the better because inflation was completely under control. And it also pushed us further away from that sort of deflation threat. And of course, that also meant that bad news really was bad news. But then I think what that also meant from an asset allocation perspective was, the 60/40 portfolio was really worked.

But I think what's potentially changed today is if that threat is now inflation, and I suspect that the risks are a little bit more evenly balanced now, while inflation is still probably going to come down to the 2-2.5 % by year end, I think what has changed is that not all of those sort of secular, structural, inflationary drivers, are all kind of heading in the same direction as they were pre-COVID. Things are a little bit more mixed at the moment. And maybe that's something for another podcast. But I think what it does mean is from the perspective of this sort of 60/40 allocation strategy is that it might still work for a bit, but we might also get sort of a little bit more volatility. And that could include periods where it's less successful. And I think from that perspective, certainly portfolio managers and investors are going to have to be a little bit more nimble in their asset allocation. Maybe being a little bit more, you know, leading towards the active side of investment as opposed to previously just heavily waiting towards passive.

Chris (18:07)
Fascinating. So let's shift the conversation a bit to the January FOMC meeting where Powell was more hawkish than expected and clearly took a March rate cut off the table. So given the recent CPI data, this seems like it may have been a reasonable decision. And based on that CPI report, the meeting and then some of these other recent economic indicators, what do you think the market is expecting today?

Richard
Yeah, so I think that's exactly right. I think in December Powell came out as surprisingly dovish. We were expecting to walk that back shortly after the meeting. He didn't really, but then he did in January and he came out much more hawkish. He and basically all of the other members of the FOMC really put the message out that March is not going to happen for rate cuts. Looking today at the probabilities for a March rate cut, that's just 8.5 % at the moment. A month ago, that was 63%. So, that's clearly quite a big change in sentiment. On the CPI, definitely stronger than had been expected.

I'm not particularly stressed out about that. I always thought that getting to 2%-ish was going to be a bit of a bumpy ride, bumpier than perhaps the market was thinking. I still think the direction of travel is still that 2-2.5 % by year end. And it's interesting, you know, much of that strength in the CPI came from the shelter component. And I think what we already know is that shelter component really lags reality by about eight to sort of 14 months. And looking at other measures on rent of what's sort of going on the ground, we know there's a lot more disinflation in the pipeline to come for that shelter component of the CPI. And then I think also how the Fed's going to look at this. Well, again, their preferred measure of inflation is the PCE price index. The December reading on a six-month annualized basis, that was already 1.9%. The three-month annualized rate was 1.5%. The shelter component has a much smaller weighting in the PCE. So, I think from the Fed's perspective, it'll really stand pat. It'll say that it's happy with its projected 75 basis points of cuts this year. I don't think there's any reason to cause them to re-assess that at the moment, but what is changing is definitely the market is kind of scaling back on its expectations for sort of 150 basis points of cuts this year, and it's already scaled them back to what's probably a more realistic 100 basis points this year.

Chris (21:07)
All right, well Richard, appreciate your time as always. Anything else you want to touch on before we go?

Richard
I think that's probably enough for now.

Chris
Okay. All right. Well, again, love these chats. Let's do it again next month.

Richard
Okay.