• Employment figures for August came in with a less than vigorous new jobs figure: up 142,000, but with unemployment moving down slightly to 4.2%. We have long expected unemployment to gradually move upwards, to over 4%, and that has now occurred. The Fed considers numbers in the low 4.x% region to still be “healthy”. Our view is that moves over 4.5% will be seen as “unhealthy”.
• Annual CPI inflation thru August was announced on September 12, with the actual reported value as 2.5%, which was 0.4% below that of July. Additionally, the core CPI that leaves out volatile food and energy prices was 3.2%, slightly higher than expectations, and “Sticky” price inflation less food and energy continued high in August at 4.10%, which is a bit less than double of where the Fed wants to see it in the long term. Oil prices have gradually declined over the past few weeks, and have moved from just under $80/bbl earlier in the year, to below and then returning to $70/bbl. Motor fuel prices are less likely to be adding to the CPI headline inflation numbers in the months ahead.
• The Federal Reserve FOMC has just begun the back-side of their rate hike program on September 18 – they last increased the Fed Funds rate back in mid-2023. This key interest rate is now adjusted downward by 50-basis points to 4.75-5.00%. The FOMC held its meeting scheduled on September 17-18, with Chairman Powell stating that along with this first rate cut, their new expectations are that they are beginning a return to “normalcy” as far as rates, money supply, and employment are concerned, via an as yet indeterminant path for reducing interest rates. (9/18/24)
• The S&P500 index remained deep into “bubble territory”, closing August at 5648, up 126 points for the month. Equities continued their pushes to fresh new highs right up through mid-August, deepening equity risk levels further into “Extreme Risk Warning” territory, near all-time highs. We saw an imminent correction as having begun around our July publication date (7/25/24), and it was downhill for equities from then through the first full week of August. At this point in time however, equities have digested that brief sharp correction, now having recovered most losses and “closing the gap” from the downdraft. By mid-September, they have returned close to the record highs set in recent months. Their first response to the interest rate decline was to move vigorously upwards.
• Our indicator system continues our recession risk level at ~70%, due to still declining Leading Economic Indicators, Federal Reserve monetary policy reversal actions, and ongoing red AP indicators. One AP indicator shows yellow, and the other five remain red.

NOTE:

Remember that in dealing with ANY economic statistics, the TRENDS are more important than any single reading. Up and down “noisy” movements in these statistics must be monitored and filtered to identify the underlying trends. Also, when we assign a probability for recession, it is like a weather forecast for precipitation. Conditions warrant an assignment of probability, and under such conditions, there is an X% chance that the forecast event will occur, be it rain or recession.

Current underlying economic details:

Last month, we said this: “General expectations out just ahead of this August’s CPI announcement were for 3.0% year over year inflation, and it came in at 2.9%, with the Core CPI less food and energy at 3.2%. If the September CPI also comes in below 3%, the Fed might recognize this as an acceptable trend confirmation, allowing them to begin lowering rates. We are not positive about this, as they may want to see at least three months in a row of a CPI below 3% and trending downward before beginning to lower rates.” Now, as the CPI has dropped to 2.5% with unemployment now trending back upwards, the FOMC clearly determined that it was time to begin reducing interest rates. This was not a “token cut” of 25 basis points, but a significant cut of double that amount.

Bureau of Labor Statistics reports: Unemployment declined a bit, to 4.2%, with a new job gains figure for August, adding a tepid 142,000, well below the 168,000 that was expected. Here is the latest BLS summary table:

The currently healthy employment situation still allows the Fed to be as free as they deem necessary in their interest rate policy decisions, and in their plans for unwinding their balance sheet to slowly decrease the money supply.  They previously indicated that their rate increases have come to an end, but with three months of inflation that is actually declining over the previous month, and headline CPI at 2.5%, the probability that they will have to raise rates again in this business cycle dropped to just about nil.

If unemployment remains below about 4.5%, the Fed can remain focused on their stable price mandate (inflation), and adjust rates slowly downward in a measured fashion. We expect politicians and economists to start making unpleasant noises if unemployment moves to, or thru, 4.5%, despite the Fed’s stating that that is still a “healthy” employment figure. If unemployment heads north of 4.5%, they will have to divide their attention to address both problems, and that’s where it gets tricky for them. Unemployment trending up and over 4.5% begins to get the attention of the media, politicians, and the working population, at which time all become much more vocal on the topic of employment.

Historically, as illustrated in the above chart from Advisor Perspectives, recessions have come pretty quickly after unemployment levels begin to trend upward, and they end coincidently with fresh employment gains. This time, however, it seems as if the Fed has finally learned from many past lessons, that using a solid data-driven approach to deal with inflation has paid off, with the gap between the unemployment trough and the current time being a full year, without triggering a recession. We credit this with the Fed’s recognition of the lags between their policy moves and their intended effects, and not adjusting policy too quickly when data trends first change.

Energy

Without some new major geopolitical disruption that is perceived to be significant, such as expansions of the instabilities in the Middle East and around the Straits of Hormuz, we don’t see crude prices now moving much higher than the ~$85 per barrel peak experienced earlier this year. Any fresh or forecasted demand weakness could just as easily drive prices down again. WTI is currently trading around $70/bbl, and has bounced around that value for about a month. The EIA continues to project a general seasonal decline in motor fuel prices for the next two years, but not before the effects of temporary OPEC production cuts add a bit to the price of gasoline again in the last quarter of this year. WTI has recently traded as low as $67/bbl.

The EIA also expects Henry Hub prices to remain below $3/mcf for all of 2024 and 2025, after those prices bottomed out below $2 just a few months ago. Underground storage reserves are already at the high end of their five-year average range, and Henry Hub prices remain well below $3/mcf, so it continues to be a good time to look at locking in a lower price for home heating gas. We at the end of “reload season” with underground stored gas levels having been replenished for the upcoming winter. With last winter being the warmest on record, there was a surplus remaining in storage, and additions to storage have been running below normal, due to the existing surplus. Those lower replenishment rates have contributed to lower and more stable prices, at the expense of profits at 36 energy exploration companies. We have the expectation for gas to be cheap and plentiful throughout the winter, aside from regional price spikes.

Interest Rates & Fed Analytics

The Fed’s previous “dot plot” projection, released with June’s FOMC report, showed slightly declining rates in 2024 and more so in 2025, but the “consensus” amongst the voting members appeared to evaporate for 2025 and 2026, with a very wide spread amongst the expectations of the members. That dot plot embodied those widely varying expectations, and we continued to have greater faith in the opinions for higher rates for longer than expected. The December ’23 plot was widely misinterpreted by pundits who simply used the “majority view” to draw an erroneous conclusion, neglecting to recognize the fact that the “majority view” has been dead wrong, i.e. too optimistic, throughout ten quarterly issuances of dot plots since December 2021. We were waiting for their 9/2024 and 12/2024 Dot Plots, as we looked for further alignment with our own more realistic outlook for rates.

Above is courtesy of Yahoo Finance, showing the FOMC’s June and September dot plots in comparison, as well as our own projections shown in red. The Fed’s dot plot issued with this September’s FOMC meeting appears to resume an overly optimistic view for the speed of their return to “normalization” of interest rates. Also missing from their longer term projections, which we include in red, is a slight overcorrection to the downside, with longer run rates moving a bit higher again, as a natural consequence of the more rapid descent in rates.

AP-FD | Federal Reserve

The Fed’s own algorithm, shown in the graphic above, predicts recession probability based on the yield curve inversion we watch, and that rapidly increased in 2022 and early 2023. In November 2022, its initial movement over 40% was a historically accurate red flag for a recession centered about one year after reaching the 40% mark. Our enhanced AP-FD indicator has been red ever since that indicator moved solidly above 40%. We show that trigger level in this most recent chart from the Cleveland Federal Reserve. The 10-year yield had recently moved from around 4.6% back down to 4.36% in the last couple of weeks, as traders again adjust prices to reflect a bit more hope for declining rates, and a bit more pessimism for the economy. After the rate cut by the Fed, the 10-year yield plunged to well below 4%.

AP-YC | Yield Curve

With the Fed Funds rate now down to 4.75-5.00%, our AP-YC Yield Curve indicator’s negative spread magnitude continues to remain wide, and it is expected to remain red for many months ahead. This spread maxed out at nearly -1.9% at the end of May 2023, just weeks before the Fed pause. It ended this May at -1.00%, but moved back to -1.32% at the end of August, and is now around -1.00+0.05% during late September.

Equities

AP-SI | Stock Indices

August’s closing value for the S&P500 was 5648, up 126 points for the month, which is keeping our AP-SI indicator deep in red bubble territory. The more tepid August 142k new jobs figure, along with renewed expectations for a September rate cut, ignited some increased volatility, and a downdraft in late July. After the August inflation figures came out, the focus returned to the likelihood of a September rate cut. We saw that as at least a 50-50 chance of happening in our last month’s report, which also included the potential for a 0.50% cut if jobs and inflation numbers were moving in the directions the Fed needed to see.

Clearly, there is still plenty of cash available to continue driving upward moves in equities. Corporations are doing at least $380B in buybacks in 2024, which we still claim is a huge flood of (poorly spent) corporate capital. Margin borrowing increased significantly in May, up 4.4%, but June was flat with no significant change. July’s reading was up a mere 0.2%, and August actually showed a decline of 1.7%, even as equity prices returned to their highs. A continuation of the divergence in the direction of equity prices and margin debt may indicate unstable topping behavior in equity pricing.

AP Equity EKG:

For March thru July of this year, our equity EKG (above) indicated very high risks due to the extreme overconfidence levels shown over that time, just as new index highs were being set. We warned of an imminent correction on July 25, using the chart above. Below, this month’s Equity EKG shows the spike in volatility and sharp price decline which then ensued, along with a surprisingly rapid recovery by the end of August:

In the long term historical chart shown below, courtesy of Advisor Perspectives, we continue to point out how risky the US equities markets are at this time. The chart shows where the investment risks in the S&P500 went during the past 125 years. The base zone around -50% risk level is where equity valuations have bottomed historically, as recently as 1980. This version of the chart is updated through the end of July, and in August, risk declined slightly to 129%. We expect that September’s new highs in equity will push risks back up, and will continue to be accompanied by our own continuing warning of EXTREME equity overvaluation/risk status, with October’s chart version in our next report.

Moving above 130% risk means another historically risky bubble will likely be ready to burst. Risk right now is forming its second highest peak in 125 years, and is clearly in 3-sigma danger territory. This risk level should return to well below 50% before it even begins to look “statistically safe” to be heavily invested in equities again for the long term (i.e. for those who prefer to “buy low” and hold for decades). The market’s activity just after the most recent inflation report certainly reflected more knee-jerk optimism, but whether that is sustainable (and why it should be) continues to be the ongoing question.

Hussman Strategic Advisors is very clear about how risky markets are, from their own historical perspective, and how safer investing in long-term treasuries has paid off better when markets established historic bubble tops. In our own opinion, we are in such a region again, and we recommend reading John Hussman’s somewhat lengthy article:

https://www.advisorperspectives.com/commentaries/2024/06/24/ring-my-bell-john-hussman

AP-LI | Leading Economic Indicators

Our AP-LI indicator: This month’s Leading Economic Indicator baskets are again coming out on the negative side. The set that is OECD-sourced and published by the Federal Reserve showed a miniscule decline, and the basket sourced by The Conference Board showed a small decline yet again. We incorporate both the TCB and OECD baskets, and that results in our AP-LI indicator continuing red for September.

Here’s the commentary from TCB in their recently released September LEI report. Note that their current LEI has fallen back to 2016 levels:

The Conference Board Leading Economic Index® (LEI) for the U.S. declined by 0.2% in August 2024 to 100.2 (2016=100), following an unrevised 0.6% decline in July. Over the six-month period between February and August 2024, the LEI fell by 2.3%, a smaller rate of decline than the 2.7% drop over the six-month period between August 2023 and February 2024.

“In August, the US LEI remained on a downward trajectory and posted its sixth consecutive monthly decline,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “The erosion continued to be driven by new orders, which recorded its lowest value since May 2023. A negative interest rate spread, persistently gloomy consumer expectations of future business conditions, and lower stock prices after the early-August financial market tumult also weighed on the Index. Overall, the LEI continued to signal headwinds to economic growth ahead. The Conference Board expects US real GDP growth to lose momentum in the second half of this year as higher prices, elevated interest rates, and mounting debt erode domestic demand. However, in the Fed’s September 2024 Summary of Economic Projections, policymakers suggested 100 basis points of interest rate cuts are likely by the end of this year, which should lower borrowing costs and support stronger economic activity in 2025.”

A couple of other factors are noted here, which we feel are worthy of attention, beyond the small on-trend changes in LEIs:

• The Chicago Purchasing Managers Index had PLUMMETED in December ‘23, dropping from 55.8 in November, to 46.9 in just one month, well below the expected decline to 51. It dropped again in January to 46.0, which is lower than at the start of 5 of the last 7 recessions. It fell further from March thru May, all the way down to 4 . This June it rebounded to 47.40 but in July fell back to 45.3. Back up a bit to 46.1 at the end of August, this index remains within contraction territory, now for a ninth consecutive month.

• The NFIB Small Business Optimism Index moved down again in August to 91.2, erasing all of July’s gains. This is the 32nd consecutive month below the 50-year average of 98. Their frequency of reports of positive profit trends was a net negative 37% (seasonally adjusted), seven points worse than in July and the lowest since March 2010.

AP-MS | Money Supply

The AP-MS money supply indicator has been red and will likely remain there for many more months. The Fed has generally been engaged in the process of unwinding their balance sheet, in a painfully slow fashion, but which has the effect of contracting the money supply. The value at the end of 2022 was $21.37T, down 2.6% from the April ’22 peak.  The recent Fed numbers from December and January said the M2 ended December at $20.92T, but it then declined by $170B during January. First quarter levels hovered around $20.8T, down 5.2% from its recent peak. A final 2Q reading through June of this year shows a modest increase to $20.95T. Third quarter estimates should be in our October report, and we forecast a level well above $21T by year’s end.

AP-PM | Precious Metals

Gold prices ended August up to $2503, having recently moved solidly over $2500 and now above $2600, solidly into all-time high territory. Silver moved down in the month, to $27.90, but has recovered nicely since then, now above $30.50. Rhodium was also up a bit at $4525/oz and is a little higher now. Platinum ended the month down slightly to $925/oz. August’s month-end prices for gold and rhodium keep our AP-PM indicator at yellow at this time. This indicator is unlikely to change state for the time being, until either rhodium deteriorates significantly, or gold prices continue exploding upwards.

We remain in a “classic” business-cycle period, during which our standard six indicators should reliably indicate an incipient recession. In addition to the indicators, we are able to generally infer in real time what the implications are for recent Fed policy moves, as well as make some informed predictions of what they will do next. We emphasize here that they won’t respond to any equity market tantrums, as long as there is no accompanying corporate debt crisis. It is advisable to respect the Fed’s commitment to resetting inflation back to 2%, which is clearly a multi-year process which they have just declared as a job not yet finished.

Our recession potential stays at ~70% this month, with expectations of further trend validations over the next months ahead. The Federal Reserve had responded to declining inflation numbers with a year-long rate-hike pause, which has now officially ended with their 0.50% rate cut this month. More recent jobs and inflation DATA now suggests to them that there will be one or two more cuts likely by the end of the year, as confirmed by the Fed’s latest dot plot. The Fed now sees rates continuing above “normal” through 2025, and normalized by mid-2026. We believe they have gone back to being overly optimistic in these expectations.

We continue to maintain that this is an extremely risky equity market environment from a valuation standpoint, with the potential for significant and protracted drops, as well as short-term rallies based on unwarranted optimism from a few misunderstood inflation and Fed rate policy readings taken out of context from the broader economic picture. The continuing high levels of valuation indicators shown in our charts over the past year are what determine the levels of risk in equities.

These are solid reasons for our continuing caution regarding equity speculation, and we must use our knowledge and instincts at this point, as well as our reliable metrics and indicators, as sensible guides. Where can we expect the S&P500 to go?  Euphoria continues to “overwrite” sensible market behavior, but the continuation of extreme equity index overvaluations must crack at some point. Those cracks often require a significant external event to catalyze a protracted breakdown of equity overpricing.

This is still a good time to ignore any of the optimistic “happy talk” pumping of equities that still prevails, dismissing it as self-serving stimulation of churn in the accounts of less astute buyers. Only those with the highest tolerances for risk, and a long-horizon time-tolerance for protracted returns to break-even, should even think about speculating heavily in the equities markets at this point. These moves into “new highs” territory simply mean deeper into the bubble we have been talking about and illustrating since 2021. The last time the S&P500 was rationally priced, with risk levels still elevated at around 70%, was back in mid-2015 to mid-2016!