High-flying energy shares have hit turbulence in recent weeks but remain, by far, the leading performer for US equity sectors so far in 2022, as of yesterday’s close (June 27), based on a set of ETFs. But with global growth slowing, and recession risk rising, analysts are debating if it’s time to cut and run.

The broad-based correction in stocks has weighed on energy shares lately. Energy Sector SPDR (XLE) has fallen sharply after reaching a record high on June 8. Despite the slide, XLE remains the best-performing sector by a wide margin year to date via a near-36% gain in 2022.

By contrast, the overall US stock market is still in the red via SPDR S&P 500 (SPY), which is down nearly 18% year to date. The worst-performing US sector: Consumer Discretionary Sector SPDR (XLY), which is in the hole by almost 29% this year.

The case for, and against, seeing energy’s recent weakness as a buying opportunity can be filtered through two competing narratives. The bullish view is that the Ukraine war continues to disrupt energy exports from Russia, a major source of oil and gas. As a result, pinched supply will continue to exert upward pressure on prices in a world that struggles to quickly find replacements for lost energy sources. The question is whether growing headwinds from inflation, rising interest rates and other factors will take a toll on global economic growth to the point the energy demand tumbles, driving prices down.

The market seems to be entertaining both possibilities at the moment and is still processing the odds that one or the other scenario prevails, or not. Meanwhile, energy bulls predict that the pullback in oil and gas prices is only a temporary run of weakness in an ongoing bull market for energy.

Goldman Sachs, in particular, remains bullish on energy and advises that the potential for more prices gains in crude oil and other products “is tremendously high right now,” according to Jeffrey Currie, the bank’s global head of commodities research. “The bottom line is the situation across the energy space is incredibly bullish right now. The pullback in prices we would view as a buying opportunity,” he says. “At the core of our bullish view of energy is the underinvestment thesis. And that applies more today than it did two weeks, three weeks ago, because we’ve just seen exodus of money from the space… investment continues to run from the space at a time it should be coming to the space.”

Meanwhile, a bit of historical perspective on momentum for all the sector ETFs listed above reminds that the trend direction remains bearish overall. But contrarians take note: the downside bias is close to the lowest levels since the pandemic first took a hefty bite out of market action back in March 2020 (see chart below). This may or may not be a long-term buying opportunity, but the odds for a bounce, however, temporary, look relatively strong at the moment.

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

* China in focus at wrap-up for G-7 meeting
* Larry Summers’ inflation warning was right. Now he sees secular stagnation
* Lagarde says ECB is ready to “move faster” on rate hikes if needed
* Strong dollar is especially worrisome for emerging markets this time
* US durable goods rose more than forecast in May:

Robust durable goods orders in May suggest the US economy may be more resilient than recently assumed. “There’s some inflation behind the increase in orders, but, nevertheless, there are a lot of dollars flowing through the economy right now,” says Christopher Rupkey, chief economist at FWDBONDS in New York. “Businesses would not order new equipment if they thought consumers and other companies were looking to pull back their purchases.”

Did the stock market reach its bear-market low last week? Unclear, but several key metrics that are worth watching on this front offer some modestly encouraging news, according to LPL Research. “Overall we have not seen the levels of market capitulation or fear to believe that all potential sellers have been flushed out, so it’s entirely possible for there to be another wave of selling after this bounce, but we have seen more of the market signals that typically occur around, or after, market lows.”

Atlanta Fed’s GDPNow estimate of US economic activity in Q2 ticks up to +0.3%. That’s still points to a virtually flat economy.

A relief rally lifted most markets around the globe for the trading week through Friday, June 24, based on a set of ETF proxies. The question is whether the recovery is sustainable or just a bounce within an ongoing bear market for risk assets?

The strongest performer for the major asset classes last week: US real estate investment trusts (REITs). Vanguard Real Estate (VNQ) surged nearly 7%. Despite the stellar weekly gain, it’s not obvious that the fund’s correction is over. A key risk factor to watch: expectations for additional rate hikes by the Federal Reserve, which will make bond yields more competitive with payouts from REITs.

Fed funds futures are pricing in a 90%-plus probability that the central bank will lift its target rate another 75 basis points at next month’s FOMC policy meeting (July 27). If accurate, the outlook implies that interest-rate sensitive investments such as REITs will remain under pressure.

A big question that markets are grappling with: How far and how long will the Fed hike rates? Unclear, as Fed Chair Jerome Powell admitted last week.

“The disinflationary forces of the last quarter-century have been replaced, at least temporarily, by a whole different set of forces,” Powell said in testimony to Congress. “The real question is: How long will this new set of forces be sustained? We can’t know that. But in the meantime, our job is to find maximum employment and price stability in this new economy.”

Last week, at least, offered a reprieve in terms of asset pricing with most of the major asset classes posting gains. The main exception: commodities. For a second straight week, WisdomTree Commodity Index (GCC) posted a sharp loss as investors fret over the potential fallout from demand destruction on the global economy’s appetite for raw materials amid forecasts of slowing economic growth and possibly recession in the near future.

Meanwhile, the Global Market Index (GMI.F) rebounded, posting a 4.5% weekly advance. The gain marks the first weekly increase following three straight weekly declines. This unmanaged benchmark, maintained by CapitalSpectator.com, holds all the major asset classes (except cash) in market-value weights via ETFs and represents a useful benchmark for portfolio strategies overall.

For the one-year trailing period, commodities remain the only winner. Despite recent losses, GCC is still posting a strong one-year return of 20%-plus – a gain that contrasts with losses for the rest of the major asset classes.

GMI.F is also deep in the red for the one-year period, posting a 13.3% loss.

Profiling the ETFs listed above via drawdown shows that nearly all the funds are posting peak-to-trough declines of -10% or deeper. The exception: a relatively mild -8.3% drawdown for iShares TIPS Bond (TIP). At the far end of the curve: emerging markets bonds (EMLC) with a near-30% drawdown.

GMI.F’s current drawdown: -17.7%.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

* G-7 leaders reaffirm their commitment to Ukraine and…
* Plan new sanctions on Russia including ban on Russian gold imports
* US economy will slow in 2022-23 but “narrowly avoid recession,” IMF predicts
* Russia defaults on its foreign debt for first time since 1918
* Central banks should act decisively to tame inflation, BIS advises
* Prominent crypto hedge fund at risk of default to repay $670 million
* Industrial metals prices set for the worst quarter since 2008 financial crisis
* Revised US consumer sentiment data confirms sharpe slide in June
* New US home sales rose in May — first monthly gain this year:

Will European Central Bank’s pivot to rate hikes to confront inflation shock create bond crisis for currency bloc? “The ECB is in great difficulty,” says Charles Goodhart, a former Bank of England policy maker. “They can’t normalize very rapidly — loading increases in interest rates up front — without dealing with the fragmentation issue.”

US may avoid a formal recession, “but underlying growth is likely to weaken significantly on the back of a jump in interest rates,” predicts ABN Amro analyst Bill Diviney, senior US economist at the bank. “This is likely to raise the unemployment rate by 1.5pp by the end of 2023, helping to cool inflation.”

● The Sinking Middle Class: A Political History of Debt, Misery, and the Drift to the Right
David Roediger
Summary via publisher (Haymarket Books)
The Sinking Middle Class challenges the “save the middle class” rhetoric that dominates our political imagination. The slogan misleads us regarding class, nation, and race. Talk of middle class salvation reinforces myths holding that the US is a providentially middle class nation. Implicitly white, the middle class becomes viewed as unheard amidst supposed concerns for racial justice and for the poor. Roediger shows how little the US has been a middle class nation. The term seldom appeared in US writing before 1900. Many white Americans were self-employed, but this social experience separated them from the contemporary middle class of today, overwhelmingly employed and surveilled. Today’s highly unequal US hardly qualifies as sustaining the middle class.

● Histories of the Future: Milestones in the Last 100 Years of Business Forecasting
Jonathon P. Karelse
Summary via publisher (Forbes Books)
Dating back to the ancient time of the venerated Oracle at Delphi, humans have been curious as to what the future has in store. The desire for foresight has been proven to be not only a subject of extreme curiosity but also one of considerable need. In Histories of the Future, author Jonathon Karelse walks us through the storied timeline of forecasting and its disparate origins in places like sugar beet farms, naval warfare, and computer labs. It begins with the period leading up to the calamitous 1929 stock market crash and brings us through the decades, showing how the blend of technological advancements and business progression have advanced us to where we are today. Histories of the Future opens the potential for new and unique ways of understanding this core business process and gives light to an entirely new way of viewing the future.

● How Minds Change: The Surprising Science of Belief, Opinion, and Persuasion
David McRaney
Review via Fast Company
If you’ve ever tried to change someone’s mind but found they were completely unwilling to budge in their thinking, it can help to understand how the brain works. Changing your mind—or someone else’s—is a complex process done through assimilation or accommodation, says David McRaney, author of How Minds Change: The Surprising Science of Belief, Opinion, and Persuasion and host of the science podcast You Are Not So Smart.
“When the brain is confronted with novel information that generates cognitive dissonance, we tend to assuage that conflict by either updating our interpretations information or updating the models of reality that we generated to make sense of it,” he says.

● Capitalism in the 21st Century: Through the Prism of Value
Michael Roberts and Guglielmo Carchedi
Summary via publisher (Pluto Press)
Contemporary capitalism is always evolving. From digital technologies to cryptocurrencies, current trends in political economy are much discussed, but often little understood. So where can we turn for clarity? As Michael Roberts and Guglielmo Carchedi argue, new trends don’t necessarily call for new theory. In Capitalism in the 21st Century, the authors show how Marx’s law of value explains numerous issues in our modern world. In both advanced economies and the periphery, value theory provides a piercing analytical framework through which we can approach topics as varied as labour, profitability, automation and AI, the environment, nature and ecology, the role of China, imperialism and the state.

● The Economics of the Stock Market
Andrew Smithers
Summary via publisher (Oxford U. Press)
The current consensus economic model, the neoclassical synthesis, depends on aprioristic assumptions that are shown to be invalid when tested against the data and fails to include finance. Economic policy based on this consensus has led to the financial crisis of 2008, the ‘Great Recession’ that followed, and the slow subsequent rate of growth. In The Economics of the Stock Market, Andrew Smithers proposes a model that is robust when tested, and by including the impact of the stock market on the economy, overcomes both these defects. The faults of the current consensus model are shown to result typically from an unscientific methodology in which assumptions are held to be valid despite their incompatibility with data evidence. Smithers demonstrates examples of these faults

● Tree-Based Methods for Statistical Learning in R: A Practical Introduction with Applications in R
Brandon M. Greenwell
Summary via publisher (Chapman and Hall/CRC)
Tree-based Methods for Statistical Learning in R provides a thorough introduction to both individual decision tree algorithms (Part I) and ensembles thereof (Part II). Part I of the book brings several different tree algorithms into focus, both conventional and contemporary. Building a strong foundation for how individual decision trees work will help readers better understand tree-based ensembles at a deeper level, which lie at the cutting edge of modern statistical and machine learning methodology. The book follows up most ideas and mathematical concepts with code-based examples in the R statistical language; with an emphasis on using as few external packages as possible.

Please note that the links to books above are affiliate links with Amazon.com and James Picerno (a.k.a. The Capital Spectator) earns money if you buy one of the titles listed. Also note that you will not pay extra for a book even though it generates revenue for The Capital Spectator. By purchasing books through this site, you provide support for The Capital Spectator’s free content. Thank you!

Headwinds for US growth continue to strengthen, but next month’s second-quarter report of GDP is still on track to post a gain, based on the median estimate from a set of nowcasts compiled by CapitaSpectator.com. The question is whether the data deteriorates further between now and the July 28 Q2 release from the Bureau of Economic Analysis? Recent releases suggest that’s strong, or at least rising possibility.

Let’s start with the median Q2 nowcast, which is 2.1% (seasonally adjusted annual rate). That’s down moderately from our previous estimate. More importantly, the new median nowcast reflects a solid rebound from Q1’s 1.5% loss. Unfortunately, the odds appear to be sliding that a roughly-2% increase will hold over the next month.

Notably, yesterday’s release of S&P Global Flash US Composite PMI for June indicates the US economy is slowing “sharply” in June. This survey-based proxy for GDP is still pointing to growth, but it’s fallen to a 5-month low and the current 51.2 print is close to the neutral mark that separates growth from contraction.

“The pace of US economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter,” says Chris Williamson, chief business economist at S&P Global Market Intelligence. “The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply.”

At this point, the global economy’s probability of recession in the near term is 40% for the next 12 months, estimates Mark Zandi, chief economist of Moody’s Analytics.    

“To avoid recession, the global economy needs a bit of luck and for the economic fallout from the coronavirus pandemic and Russian aggression to wind down quickly, along with some deft policymaking by the Fed and other central banks,” Zandi says.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

* EU leaders offer Ukraine and Moldova candidate member status
* Recession risks for US and Europe have picked up sharply, warn economists
* China and India become Russia’s financiers to evade sanctions
* Copper, an economic bellwether, falls to 16-month low
* KC Fed Mfg Index shows further growth slowdown in June
* A $100 million crypto hack reported by Horizon, a so-called blockchain bridge
* US Energy Secretary asks oil firms to combat high gasoline prices
* US economic growth slows sharply in June via PMI survey data:

Fed Chair Jerome Powell asks a critical inflation/disinflation question. It’s going to take time for the answer. “The disinflationary forces of the last quarter-century have been replaced, at least temporarily, by a whole different set of forces,” he says in yesterday’s House testimony. “The real question is: How long will this new set of forces be sustained? We can’t know that. But in the meantime, our job is to find maximum employment and price stability in this new economy.”

Russia’s slow squeeze on Europe’s gas supplies conitinues. “I don’t think they are going to cut the gas overnight, especially as we are going into the summer and during the summer the gas is not a strategic weapon. But the winter could be difficult and we have to be prepared in Europe,” says Josep Borrel, EU’s top diplomat. “I don’t think they are going to cut the gas overnight, especially as we are going into the summer and during the summer the gas is not a strategic weapon. But the winter could be difficult and we have to be prepared in Europe.”

The question of when inflation will peak consumes financial and commodity markets, and with good reason. When pricing pressure finally ebbs, the pressure on rate hikes and the headwinds for the economy will ease, if only on the margins. But every thousand-mile journey has to start somewhere.

“We’ve got to see a peak in inflation before the [stock] market will be substantially higher,” predicts Ed Yardeni, president of consultancy Yardeni Research.

Some economists are optimistic that a peak is near. The Fed’s increasingly aggressive rate hikes, combined with a sharp slowing in money-supply growth offer reasons for hope, a number of analysts say.

One way to keep tabs on hints of inflation’s peaking (or not) is to monitor the absolute change in the inflation indexes. On this front there are clues that a peak may be near, but some indexes suggest otherwise.

Let’s start with what I’m calling Inflation Bias Indexes. The methodology is taking the underlying index, calculating its one-year change, taking the monthly difference and then transforming the results into standard deviations around the mean.

In the first chart, headline and core estimates of the Consumer Price Index (CPI) through May suggest that a peaking process is already underway. Encouraging, although we’ve been here before only to find it was a false dawn. Is this time different? Only time will tell.

Zooming in on the data highlights that the reversal in pricing pressure appears to have legs.

As a reality check, let’s check how several alternative measures of inflation compare. A pair of so-called “stick price” estimates of CPI from the Atlanta Fed, along with the Cleveland Fed’s median CPI and 16% Trimmed-Mean CPI.

On these fronts, there’s still room for doubt about peaking inflation. Notably, the overall profile is mixed, suggesting that it’s premature to start celebrating inflation’s peak. Let’s see if the June CPI numbers change the outlook.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

* Powell tells Congress Fed is “strongly committed” to fighting inflation
* Powell returns to Capitol Hill today for testimony as rates stay in focus
* European leaders set to accept Ukraine as candidate to join EU
* Eurozone growth slows to 16-month low in June as demand weakens
* Germany lifts level of alarm over Russia gas disruption
* UK growth unchanged at 15-month low in June via PMI survey data
* US 10-year Treasury yield eases to 3.16%, lowest in nearly two weeks:

Economic data is becoming harder to decipher, says analyst. “There’s a lot of ambiguity right now in the economy and it’s hard to understand and parse what’s going on — never mind trying to understand what’s going to happen over the next few months,” advises Nick Bunker, economic research director at jobs website Indeed.com.

The Fed isn’t trying to trigger a recession as it combats inflation, but it’s a risk factor, says Fed Chairman Powell. “It’s not our intended outcome at all, but it’s certainly a possibility,” Mr. Powell said Wednesday during the first of two days of congressional hearings. “We are not trying to provoke and do not think we will need to provoke a recession, but we do think it’s absolutely essential” to bring down inflation, which is running at a 40-year high.

Cost of owning a home soars above price of renting, according to John Burns Real Estate Consulting. “High home prices and rapidly rising mortgage rates have created a rosy backdrop for the rental sector, with many prospective home buyers now priced out of homeownership or forced to purchase a smaller home in a less desirable area,” the firm advises in a report. “A little over a year ago, the monthly cost of owning (as we calculate it*) and renting were virtually identical. Now, owning a home costs $839 more per month than renting. This differential is almost $200 higher than at any time since the turn of the century.”

China’s housing slump shows no signs of slowing. “This is the worst property downturn on record,” says Lu Ting, chief China economist at Nomura Holdings.

* Tensions rising between Moscow and NATO over Russia’s Kaliningrad enclave
* Japan on high alert amid activity by Chinese and Russian warships near its coast
* IEA warns Europe to prepare for total shutdown of Russian gas exports
* Russia earns more oil revenue than before war due to China and India
* Biden expected to call for 3-month suspension of gas tax
* Fed expected to lift rates by 3/4 percentage point again in July
* UK inflation ticks up to new 40-year high: +9.1% annual pace in May
* Existing home sales in US fell for fourth straight month in May
* US growth slowed in May via Chicago Fed business-cycle index:

The rate of new US job posts has eased in recent weeks, according to Indeed.com, a career website. Companies “don’t want to talk about a hiring freeze, but what they are doing is adding an extra layer of scrutiny, like saying only the CEO can approve these jobs,” says David Vied at consulting firm Korn Ferry. “There is this stealth slowdown.”

Former NY Fed Governor Bill Dudley predicts a US recession is inescapable. “If you’re still holding out hope that the Federal Reserve will be able to engineer a soft landing in the US economy, abandon it. A recession is inevitable within the next 12 to 18 months,” he writes.

Markets-based forecasts aren’t flawless, but for some projects in finance these estimates are the baseline estimates that are often tough to beat. An example is monitoring the outlook for trends and changes in Fed monetary policy. On that front, you could do a lot worse than keeping a close eye on the 2-year Treasury yield.

Widely followed as the most-sensitive spot on the yield curve for policy expectations, the 2-year rate has again proved itself worthy in anticipating the current shift to a rate-hiking bias. Midway in 2021’s fourth quarter, the 2-year rate was effectively signaling that the central bank was set to begin a new round of tightening. And so it did, several months later, announcing the first increase in the Fed funds target rate on March 16.

What’s useful for anticipating new tightening phases is no less valuable for estimating when Fed policy has peaked and rate cuts are on the horizon. History suggests that the 2-year rate offers an early and often accurate estimate for these events too.

One way to monitor the signal is via a spread: 2-year rate less effective Fed funds. Tracking this spread through time provides a rough estimate of how the market is pricing in expectations for Fed policy. Not surprisingly, the market is currently telling us that the Fed is far behind the curve and still needs to play catch-up. In theory, a spread close to zero suggests that the market is saying that Fed funds policy is approximately right, neither too hot or too cold.

Note, however, that last week’s 75-basis-points hike delivered a substantial round of catch-up action, based on the market’s estimate. The spread is still well above recent levels, but the sharp decline to 1.56 percentage points marks the lowest spread level since early March.

With another 75-basis-points hike expected for the July 27 FOMC announcement, the Treasury market seems to be considering the possibility that the rate-hiking regime is maturing, if not necessarily ending. A complicating factor is the economy, which is slowing. A growing number of economists are forecasting heightened recession risk. In other words, there’s a possibility that the Fed will end or even reverse its rate hikes at some point in the near term, depending on how business-cycle risk evolves.

The Treasury market is having a tough time pricing in the conflicting pressures of high inflation and slowing economic growth, as suggested by the increase in volatility for the 2-year/Fed funds spread recently. Nonetheless, market sentiment will eventually find the signal in the noise. Exactly when is unclear.

At some point the market will be price in a peak in the current rate-hiking regime. The first question: Has that peaking process already started? No, according to the consensus view of most economists and macro observers. Let’s see if the Treasury market agrees, or not, in the days and weeks ahead.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

* European Central Bank plans two rate hikes this summer
* Goldman Sachs raises US recession-risk probability to 30% for 2023
* China’s economy continues to face downside risks
* Fed’s rate hikes are starting to slow borrowing and spending
* Israel’s gov’t collapses, new elections set
* New US ban on imports from the China’s Xinjiang region has started
* German 10-year yield rebounds to highest since 2014:

St. Louis Fed President James Bullard expects US economy to continue growing in near term. “On GDP growth, I think that the indicators are that there will be continued expansion in the quarters ahead,” he says. Although he acknowledged various risks, “right now, there will continued expansion through 2022,” he predicts.

US housing market is correcting, not crashing, says Matt O’Hara, head of portfolio management and research at Unison Investment Management. “The best way to describe the housing market is that it is coming back to Earth. This is not a crash landing. We are returning to a more manageable supply-and-demand situation. During the pandemic, the market reached a fever pitch because more and more people wanted to move – whether it was to have more space, to work remotely, to pay less than they previously were, or any other factors. Now, as the world opens up, we’re starting to see those factors settle in.”

Markets suffered a clean sweep of losses last week. It’s a rare event, but it happens, as the trading week through Friday, June 17 reminds in the wake of all the major slices of global markets posting simultaneous declines, based on a set of ETFs.

US bonds were the “best” performer by way of a relatively mild decline. Vanguard Total US Bond Market (BND) fell 0.8% last week. Despite outperforming the rest of the major asset classes, BND’s outlook still looks bearish, based on the fund’s weak technical profile, driven by expectations that the Federal Reserve will continue to raise interest rates (which move inversely with bond prices). Fed funds futures are currently pricing in a 99% probability that a second rate hike of 75 basis points is on tap for July 27 FOMC meeting.

Tightening monetary policy at a time of slowing economic growth is raising fears that a US recession is lurking. But in the short term, at least, forecasts that that the Fed will continue to lift interest rates will probably keep bonds on the defensive. At some point investors will be looking for a pivot in market sentiment from pricing in higher interest rates (i.e., lower bond prices) to heightened anxiety over recession fallout. In the latter case, demand for safe havens, such as bonds, may rebound as concern for macro fallout overtakes worries related to higher interest rates.

In the meantime, macro risk is an equal-opportunity offender. “Our worst fears around the Fed have been confirmed: they fell way behind the curve and are now playing a dangerous game of catch up,” advise analysts at Bank of America said in a research note.

Elsewhere in markets, there was no place to hide. The deepest loss for the major asset classes last week: US shares via Vanguard Total US Stock Market Index Fund (VTI), which closed down for a third straight week, settling near its lowest close since November 2020.

The Global Market Index (GMI.F) continued to slide, too, losing 4.6%. This unmanaged benchmark, maintained by CapitalSpectator.com, holds all the major asset classes (except cash) in market-value weights via ETFs and represents a useful benchmark for portfolio strategies overall.

Commodities remain the only slice of the major asset classes posting a gain for the trailing one-year period. WisdomTree Commodities (GCC) is up nearly 30% for the past 12 months, far ahead of the rest of the field.

By contrast, the biggest one-year loser in the field: foreign corporate bonds (PICB), which has shed more than 20%.

GMI.F is off nearly 16% for the past year.

Profiling the ETFs listed above via drawdown shows that all the funds are now posting relatively steep peak-to-trough declines, or worse. The softest drawdown as of Friday’s close: -8.9% for iShares TIPS Bond (TIP). At the far end of the curve: emerging markets bonds (EMLC), which are nursing a near-30% drawdown.

GMI.F’s current drawdown: -22.2%.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

* Ukraine war could last years, says NATO’s secretary-general
* France’s newly-elected President Macron loses absolute majority in parliament
* EPA’s power over greenhouse gases at stake in upcoming Supreme Court ruling
* Emerging markets face rising pressure from higher interest rates and inflation
* Apple workers in Maryland vote to unionize
* Bitcoin rebounds after a sharp slide below $18,000 over the weekend
* US Treasury real yields rebound to positive terrain but still below 2018 peak:

Small businesses in the US are having a tough time weathering higher inflation. “Companies with under 50 workers lost head count in three of the past four months, data show, reflecting difficulties in keeping pace on wages and benefits,” reports The Wall Street Journal.

When will stock market correction end? “Stocks Historically Don’t Bottom Out Until the Fed Eases.”

US inflation won’t slide to Fed’s 2% target for two years, says Cleveland Federal Reserve Bank President Loretta Mester. “It isn’t going to be immediate that we see 2% inflation. It will take a couple of years, but it will be moving down,” she predicts.

● Money, Magic, and How to Dismantle a Financial Bomb: Quantum Economics for the Real World
David Orrell
Review via Irish Tech News
David Orrell argues that the emerging discipline of quantum economics, of which he is at the forefront, is the key to shattering the illusions that prevent us from understanding money’s true nature. In this colourful tour of the history, philosophy and mathematics of money, Orrell demonstrates how everything makes much more sense when we replace our classical economic models with ones based on quantum probability – and reveals the explosive reality of what is left once the illusions are stripped away.

● The End of the World Is Just the Beginning: Mapping the Collapse of Globalization
Peter Zeihan
Summary via publisher (Harper Business)
In The End of the World is Just the Beginning, author and geopolitical strategist Peter Zeihan maps out the next world: a world where countries or regions will have no choice but to make their own goods, grow their own food, secure their own energy, fight their own battles, and do it all with populations that are both shrinking and aging. The list of countries that make it all work is smaller than you think. Which means everything about our interconnected world – from how we manufacture products, to how we grow food, to how we keep the lights on, to how we shuttle stuff about, to how we pay for it all – is about to change.

● The Meddlers: Sovereignty, Empire, and the Birth of Global Economic Governance
Jamie Martin
Summary via publisher (Harvard U. Press)
A pioneering history traces the origins of global economic governance—and the political conflicts it generates—to the aftermath of World War I. International economic institutions like the International Monetary Fund and World Bank exert incredible influence over the domestic policies of many states. These institutions date from the end of World War II and amassed power during the neoliberal era of the late twentieth century. But as Jamie Martin shows, if we want to understand their deeper origins and the ideas and dynamics that shaped their controversial powers, we must turn back to the explosive political struggles that attended the birth of global economic governance in the early twentieth century.

● Two and Twenty: How the Masters of Private Equity Always Win
Sachin Khajuria
Summary via publisher (Currency/Penguin Random House)
Private equity was once an investment niche. Today, the wealth controlled by its leading firms surpasses the GDP of some nations. Private equity has overtaken investment banking—and well-known names like Goldman Sachs and Morgan Stanley—as the premier destination for ambitious financial talent, as well as the investment dollars of some of the world’s largest pension funds, sovereign wealth funds, and endowments. At the industry’s pinnacle are the firms’ partners, happy to earn “two and twenty”—that is, a flat yearly fee of 2 percent of a fund’s capital, on top of 20 percent of the investment spoils.

● Warp Speed: Inside the Operation That Beat COVID, the Critics, and the Odds
Paul Mango and Tom Cotton
Review via Fierce Pharma
Political zealotry aside, it’s hard to deny that Operation Warp Speed—the Trump administration project to develop and deliver vaccines to Americans to counter COVID-19—was anything less than a success.
But if there’s one aspect of Warp Speed that came up short, it was in the initial production of vaccines. After setting a highly ambitious goal of producing 300 million doses in 2020, the effort produced barely 100 million.
In his book, Warp Speed: Inside the Operation that Beat COVID, the Critics, and the Odds, Paul Mango discusses—with some interesting revelations—the manufacturing constraints that the operation faced and why the pledge proved unrealistic. Mango, the former deputy chief of staff at HHS, followed the agency’s chief Alex Azar when he took a major role with Warp Speed.

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The outlook is turning grim for the US economy, or so a range of soft data and forecasts advise. But while expectations are deteriorating at the moment, the hard data continues to reflect a growth bias. Short of an epic, sudden (and at this point unexpected) collapse in business activity and/or consumer spending, the US economy will continue to expand for the near term. What happens beyond the next several months is unclear, which is par for the course. The crowd, however, is becoming increasingly pessimistic, which raises the question: Will the next recession become a self-fulfilling prophecy?

Sentiment is a factor in economics and on that front there are increasing signs of mood swing to the downside. A poll of investors from early June, for instance, finds strong expectations for a US recession at some point in 2023.

The Conference Board reports similar results. A new survey from the consultancy advises that more than 60% of business executives anticipate a recession over the next 12 to 18 months.

Even darker forecasts are circulating by various individual pundits. “The economy is going to collapse,” predicts Michael Novogratz, CEO of investment management firm Galaxy Digital. “We are going to go into a really fast recession, and you can see that in lots of ways.”

The stock market appears to be forecasting trouble ahead. The S&P 500 Index has fallen more than 20% from its peak, which is widely viewed as a bear market. Expectations for rising recession risk are thought to be the main driver.

The catalysts for the macro gloom include the usual suspects this year: surging inflation, rising interest rates and blowback on various fronts from the ongoing Ukraine war. Given the accumulating run of bad news, it’s easy to assume the worst and on some level it’s prudent to do so.

There’s also a case for a separate track of business-cycle analysis: estimating in real time, based on the data in hand, when the US slips over to the dark side, or doesn’t. On this front, it’s clear that the economy is still expanding and the odds remain low that an NBER-defined downturn is imminent. The details, based on analysis of several public and proprietary business-cycle indexes, are updated weekly in the US Business Cycle Risk Report. The newsletter’s main takeaway in the latest issue, echoing results in recent months: US economic activity is slowing, but gradually. Our current estimate for the earliest start date for contraction, assuming current conditions persist, is sometime in this year’s fourth quarter.

Meantime, a pair of business-cycle indexes published by two regional Federal Reserve banks show that the economy continues to grow at a moderate pace. The Philly Fed’s ADS Index, a multi-factor indicator, still reflects above-average business conditions through June 11.

The New York Fed’s Weekly Economic Index (WEI) paints a similar macro profile through June 11. Note, however, that WEI highlights an ongoing slowdown in growth, although the odds remain low that a new recession is imminent.

A lot can go wrong for the economy in the months ahead, but it’s premature to rule out positive surprises. All the more so for trying to divine business conditions in the summer of 2023. For perspective, think back 12 months. What were you expecting in terms of major threats and/or conditions that would boost the economy? How have those expectations fared vs. current conditions today?

There’s a strong case for expecting that the current expansion will survive through the summer. Beyond that, the outlook becomes increasingly fuzzy, as it always does beyond a few months. That doesn’t mean you should ignore the business-cycle risks lurking, but just don’t confuse the dark forecasts for recession in late-2022 and beyond as high-confidence estimates. Indeed, the economy’s revised outlook still evolves one data release at a time.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

* Putin continues to wield Russia’s energy weapon with a deft hand
* China launches its third, most advanced aircraft carrier
* More than 60% of executives see recession in next 12 to 18 months
* European leaders lay out path to European Union membership for Ukraine
* World Trade Organization changes global trading rules for first time in years
* Cosmetics maker Revlon files for bankruptcy, citing supply-chain disruption
* Philly Fed Mfg Index turns negative in June
* US jobless claims tick lower, but still reflect strong labor market
* US housing starts fall in May to lowest level in more than a year:

Food, energy and shelter are driving inflation, representing more than half of the surge in overall prices. “Those are the basics,” says Tom Porcelli, chief US economist at RBC Capital Markets. “That’s what you have to spend money on. You have to spend money on shelter, you have to spend money on food, and most of us have to spend money on energy. [Inflation] represents a meaningful challenge for consumer spending.”

US Southwest continues to suffer from megadrought conditions. “We’re definitely looking at a hotter future,” says Katrina Bennett, hydrologist with the federal government’s Los Alamos National Laboratory in New Mexico. “There will be more of that wet to dry sort of scenarios we’re seeing, but regardless, we’re going to see more minimum streamflow, increase in drier soils and lower snowpacks, which all together will lead to likelihood of drought increasing across the board especially in the upper areas where we really haven’t seen that intense drought stress yet.”

The Federal Reserve’s 75-basis-point hike for its target rate on Thursday — the biggest increase since 1994 — signals that the central bank is increasingly committed to fighting inflation.

The FOMC statement was certainly clear on intent: “With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.”

The challenge is that intent remains well behind current pricing conditions. Consumer inflation, running at an annual 8.6% in June, is far above the revised Fed funds rate, which is now at a 1-1/2-to-1-3/4% range. That implies a series of aggressive hikes in the months ahead. Not surprisingly, Fed funds futures are projecting another 3/4 percentage-point hike for the July FOMC meeting.

Note, however, that the 10-year Treasury yield eased yesterday (June 15) for the first time in more than a week, settling at 3.33%. One day could be noise, but the market may be starting to consider the implications of ongoing rate hikes in terms of the effect on the economy.

The Fed is now “telling you: ‘We will do whatever it takes to bring inflation to 2%,’”, says Simona Mocuta, chief economist at State Street Global Advisors. She adds that the risk of a recession is now 50-50. “It’s not like there’s no way you can avoid it,” she said. “But it’s going to be hard to avoid it.”

Fed Chair Jerome Powell says “We’re not trying to induce a recession now, let’s be clear about that.” Nonetheless, policy mistakes by the central bank are hardly rare and so the market will be increasingly mindful that tightening could go too far for too long.

That risk appears low when looking at inflation, which is far above the Fed’s policy rate – a gap that implies that many rate hikes are still needed for the foreseeable future. But the 10-year rate may be increasingly focused on economic conditions overall, which may suffer from higher rates. In that case, weaker growth and recession will likely boost demand for safe assets, such as Treasuries. In turn, yields may soon peak.

That possibility is implied in today’s revised estimate of ‘fair value’ for the 10-year Treasury yield, which is based on averaging three models (see details here). Today’s update puts the fair value for the 10-year rate at 2.54% for May, or nearly 40 basis points below last month’s monthly average market rate of 2.90%. The gap marks the second month of a market yield above the average fair-value estimate, a sharp change from the previous trend.

The question is whether the market will prioritize pricing the outlook for ongoing rate hikes over the risk of slower growth and/or recession? Unclear, but Mr. Market will at some point be forced to choose.  

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

* Chinese leader restates support for Russia on “sovereignty and security” matters
* Three European leaders visit Ukraine as US pledges $1 billion in new security aid
* Federal Reserve hikes interest rates 3/4 percentage point
* Business inflation expectations are relatively steady in June
* NY Fed Mfg Index reports second month of contraction in June
* US homebuilder sentiment falls to two-year low in June
* US retail sales fall in May, posting first monthly loss this year:

Federal Reserve’s 3/4-percentage-point rate hike is largest increase since 1994. “We’re not trying to induce a recession right now, let’s be clear about that,” Fed Chair Jerome Powell says. Kathy Bostjancic, chief US economist at Oxford Economics, explains: “What Powell and the rest of the FOMC are saying is that restoring price stability is the primary focus — if they risk a mild recession, or a bumpy soft landing, that would still be successful. The focus is greatly on inflation right now.”

The bull market for US stocks ended this week after just 21 months. That’s the short bull run on record since the end of World War II, reports LPL Research. It was also the quickest doubling:

Will the Fed’s ongoing rate hikes lead to recession? History isn’t encouraging, based on aggressive tightening cycles, which usually lead to economic downturns.

The trend has turned ugly, at least for the usual suspects in the land of asset classes. The question is when will it be comparatively safe to start raising risk exposures? Unclear, but when the tide begins to turn we’ll likely see early clues in price trends via several ETF pairs.

Portfolio Strategy
As a starting point, the risk-on/risk-off profile for portfolio strategy remains in a holding pattern, based on the ratio trend for an aggressive portfolio mix (AOA), the other a conservatively run allocation (AOK). It’s a bit surprising that this ratio hasn’t decisively tumbled… yet. Is that a sign that the current market correction is more light than heat? Or is this the calm before the storm?

US Stocks-US Bonds
A similar holding pattern applies to the US stock/bond ratio via SPY and BND. The explanation here is that both slices of this mix are suffering at the same time. Which side will blink first?

Inflation/Reflation
Meanwhile, the red-hot reflation/inflation trend continues to show no signs of slowing, much less reversing, via TIP/IEF.

US Treasuries
Ditto for the risk-off trend for US Treasuries, which has accelerated since CapitalSpectator.com’s previous update on this front.

Equity Risk-On/Risk-Off
One measure of US equity risk appetite confirms what’s already obvious: relative safe havens are in high demand.

Renewable Energy Stocks
Meanwhile, the risk-off bias for renewable energy stocks persists.

Copper/Gold Ratio
Finally, the ratio for copper/gold prices – considered a leading indicator for the 10-year Treasury yield – suggests the recent run-up in rates is due to pause. That’s a contrarian view at the moment. Let’s see if this ratio continues to suggest otherwise in the weeks ahead.

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