December 2023 Market & Economic Outlook Report
- InfraCap Management
- Dec 3, 2023
- 12 min read
Updated: Dec 3, 2023
New York - December 3, 2023 ~ The team at Infrastructure Capital Advisors has completed our new report providing key insights on current market conditions and economic outlook for this month and the coming months. See this month's full report below but be sure to JOIN our Monthly Market & Economic Outlook Webinar scheduled for Thursday, December 7th at 1:30 pm ET where Jay Hatfield, CEO/CIO and portfolio manager will provide even more recent updates and insights to this report and the changing market and economy. Not registered for the webinar already? Click here to register. Also, by registering, we will send you a webinar playback video link if you are unable to join live.
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Summary of Recent Research & Critical Insights Outlook:
We expect CPI/PPI to print cool in November and December (after a very cool print in October) as the over 15% plunge in gasoline prices since the beginning of October will impact headline and core inflation next month as well since only 5% of the 15% decline was reflected in October CPI. There is a 5% bleed-through of energy prices to core. The most obvious examples are airline fares and food prices as both have a 40% energy cost component.
Energy represents almost 9% of lower-income household expenses, which means a 15% drop in energy costs will boost consumer spending and help ensure that the US does not enter a recession.
We believe the Fed does not understand the energy bleed-through effect which is why it has developed a whole body of urban mythology about the inflation of the 70s when 90% of the problem was a catastrophic 1,200% (not a typo) increase in oil prices. The oil price explosion was exacerbated by draconian price caps on US production.
We are bullish on the bond market in 2024 as we expect the ECB to cut rates in the first half of 2024. The Eurozone is in a recession with last quarter’s GDP down .4% annualized and the Eurozone GDP Nowcast is currently tracking at a negative 2.4% annual rate for the 4th quarter, which implies Europe is in a deeper than average recession. The ECB has cured inflation by killing the patient:
Recent CPI data in the Eurozone has cooled to .5% for Nov. and year over year down to 2.4% vs. 2.9% last month.
We believe that the recent run-up in interest rates was caused by tight global monetary policy and not high US budget deficits. The Global Monetary Base shrunk by $566 billion (2.5%) over the last 6 months and over 90 central banks have raised rates by an average of almost 5% this year.
We remain bullish on the stock market with our 2023 target remaining at 4,500 which is 18.5x 2024 EPS of 245 and have established our new 2024 target of 5,000 which represents 18.5x 2025 S&P EPS of $270. The risk for both targets is weighted to the upside as the AI boom unfolds and large-cap tech continues to rally.
The Stock Market may be range bound in the 4.500-4,700 range for the rest of the year as the market is expensive in light of higher treasury yields in the 4.3% area. The theoretical market multiple at 4.30% is 17.5x vs. the current 2024 multiple of 18.7x.
The Fed meeting will be critical for the market with all the focus on the SEP (dot plot). The last dot plot had 1 rate cut implied whereas the Fed fund futures imply almost 5 rate cuts, setting up the potential for a disappointment given a Fed bias toward being hawkish given their focus on the discredited “expectations” theory of inflation.
We continue to project that the US economy will be resilient and will avoid recession this Fed tightening cycle as the housing sector continues to be strong with on ongoing shortage of homes for sale and strong housing starts continuing at approximately 1.4MM units.
8 out of the last 9 recessions were precipitated by a plunge in housing starts with the average trough at 900k of starts with a low during the GFC of 500k starts.
Bond Market Outlook:
We are bullish on bonds in 2024 and believe that the 10-year treasury is finding a bottom in the 4.50%-5.0% range as Europe has entered into a significant recession. The government bond market is a global market with US Treasuries over 80% correlated with other global benchmark bonds. The recent rise in rates has been global and the key driver of that decline is tight global monetary policy with the global monetary base dropping by $566 billion or 3.0% over the last 2 Quarters led by the ECB reducing the monetary base by an unprecedented $500 billion (US Money Supply up over 3.8% this year and .7% over the last 2 months).
The 15% decline in gasoline prices since the beginning of October is likely to drive a cool print in both headline and core inflation over the next two months as there is a 5% bleed through of energy prices to core. Reported core inflation still exceeds actual real time inflation by over 2% due to the delayed/flawed methodology of reporting shelter inflation.
Very strong Q3 GDP growth in the US is also an important driver of higher rates as it raises the fears of further Fed rate increases and causes the dollar to strengthen. The rising dollar causes foreign central banks to sell US treasuries to defend against currency depreciation.
We expect long-term interest rates to decline in the 4th Quarter due to the recession in Europe, a likely slowdown in US growth during Q4, and ongoing deceleration in inflation. Long-term interest rates may not decline dramatically until central banks start to ease policy in the first half of 2024.
Eurozone GDP printed at negative .4% for Q3 and only .1% growth year over year with Germany (-.8%), Austria (-1.2%) and Ireland (-4.7%) in a mild recession over the last year. At the ECB press conference President Lagarde acknowledged that the Eurozone economy was weakening and cited the October Eurozone composite PMI at 46.5 with any reading below 50 indicating a contraction in economic activity. She also implied that the ECB would lower its economic forecast when it provides an update in December.
Recent CPI data in the Euro Zone has cooled to .5% for Nov. and year over year down to 2.4% vs. 2.9% last month.
the Eurozone GDP Now is currently tracking at a negative 2.4% annual rate for the 4th quarter, which implies Europe is in a deeper-than-average recession.
The ECB raised rates twice during the third quarter and most long-term bonds in the Eurozone increased in yield by over 60bp. Since the Eurozone has 45% floating rate mortgage debt, the impacts of the intra-quarter rate increases are likely to deepen the Eurozone recession during the fourth quarter.
We are forecasting the Eurozone declines 2% over the next 3 quarters which is in line with an average recession.
Recent data continues to be negative with the October Eurozone Manufacturing PMI at 43, indicating a recession is under way. In addition, German unemployment grew by 30,000 vs. expectations of 14k.
We expect US growth to decelerate dramatically in Q4 into the 1-2% growth range as interest sensitive sectors slow (but don’t crash) such as autos and housing.
The US Manufacturing PMI came in at 46.7 vs. expectations of 49, which resulted in the Atlanta GDP Now to decline to only 1.2% for the 4th Quarter.
Tesla warning on the impact of rates on buyers of autos indicates that rate increases are starting to impact the auto sector.
Both wholesale and retail gasoline prices have dropped over 10% in October, which makes a cool CPI/PCE/PPI print likely for the month as there is a 5% bleed through of energy prices to core.
We expect global interest rates to peak out this year and decline next year as the ECB is likely to be forced to cut rates in the first half of 2024. We forecast that the US 10-year bond yield is likely to fall into the 3.5-4.0% range in 2024 as global growth drops and the Global Monetary Base increases. The US economy is likely to stay out of a recession, however, as investment in housing, infrastructure and technology prove resilient even in the face of very high interest rates.
US Treasuries have performed in line with other benchmark bonds during the most recent sell off so US centric explanations are misguided, although strong US growth does have global implications. We expect, however, that the US external deficit of 95% of GDP with a deficit of 6% of GDP is manageable as the post WWII nominal average GDP growth is over 6%, implying that the ratio of debt to GDP will be relatively stable over time.
Fed open market operations (unwinding reverse repo) have kept the US monetary base growing this year despite QT.
CLICK HERE to go to the most recent adjusted real-time CPI index report from Infrastructure Capital Advisors.
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Stock Market Outlook:
We continue to have a year end 2023 target for the S&P of 4,500 (our original 2023 target) based on 18.5x estimated S&P 2024 EPS of 245. The risk is to the upside with enthusiasm for AI possibly going to drive over valuation of the stock market as a whole.
We are bullish on the market for 2024 and have established our target on the S&P of 5,000 based on 18.5x the 2025 EPS estimate of $270. We believe that central banks will ease in 2024, led by the ECB as Europe has already entered a recession. We project that lower long term interest rates, a resilient US economy, and the ongoing AI boom will drive the S&P to our target by year end 2024.
We are focused on investing in preferred stocks and large cap dividend stocks as yield stocks are well below fair value due to rising rates and a volatile stock market.
Many preferred stocks are benefiting from conversion to floating-rate and will have yields of 9-12% with modest default risk.
The S&P 500 High Dividend Index is trading at only 10.8X 2024 Earnings and yields over 5%.
The economy continues to be resilient and earnings estimates have only declined slightly.
Earnings estimates for 2023 and 2024 have been stable this year despite pundits predicting a dramatic decline.
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Fed and ECB Outlook:
We do not expect the Fed will raise rates again this cycle as we forecast that data over the next two months will show a softening labor market and continuing declines in reported inflation. Also, the recent rise in long-term rates could cause the housing sector to decline significantly, triggering a slow. In addition, it should become obvious to the Fed that the Eurozone is headed into a significant recession. We expect the ECB to cut rates during the first half of 2024 and the Fed to cut rates in the second half of 2024 as this Fed is always 12-18 months behind the curve.
The Fed statement and press conference commentary indicated that the Fed recognizes that the recent dramatic increase in long-term rates is contractionary and argues for a pause at the December meeting.
The Bank of England has launched an inquiry led by Ben Bernanke to determine what went wrong with the central bank’s policy framework that led it to miss the surge in inflation.
The Fed should launch a similar inquiry and revise their policy framework as it raised rates 3 months after the BOE so was even more incompetent than the BOE.
The Fed should change its policy framework by targeting a 2-4% range of inflation and look at a variety of measures of inflation including both headline and core for PPI, CPI, PCE and CPI-R and be more attentive to leading indicators of inflation such as the money supply, housing prices, auto prices and energy/commodity prices.
The Fed’s hardline adherence to the 2% target has made the Fed the primary culprit during this century in the decline of the middle class as the Fed attempts to depress nominal wages to hit their unreasonably low target.
There is consensus that the Fed should raise its inflation target, with a number of research papers supporting an increase and most recently a WSJ opinion piece from Jason Furman advocating for a 2-3% target.
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Inflation Outlook:
Inflation is now contained even though the Fed does not recognize it:
PCE-R (PCE Core adjusted for market shelter prices) is currently 2.3% Y/Y and last 3-month PCE Core annualized is at 2.1%.
CPI came in at 3.6% y/y down from a high of 9.1%.
PPI is now 1.6% down from 11.7% y/y.
CPI-R (CPI using real-time shelter index) is now 1.5% down from 12.0%.
Housing prices are flat y/y but CPI is estimating that shelter costs are up 7.7% due to a flawed, heavily lagged survey methodology (only 1/6th of the index is updated every month and an outdated survey methodology is utilized).
Wholesale gasoline prices are down over 10% in October and are now flat for the year.
The above indicators are real-time or coincident indicators of inflation with core CPI and PCE being deeply lagged due to slow bleed-through of energy prices and highly flawed estimates of shelter cost. PCE Core will only be down to 4.2% from 5.0% a year ago.
The PCE Index has much higher weightings in medical services at almost 21% vs. 5% in CPI. This makes the PCE measure less desirable as Fed policy has minimal, if any, impact on medical services which is more driven by demographic trends.
The Fed’s focus on Super Core services is misguided as the high Super Core number is caused almost entirely by an increase in auto-related services that has been caused by the reduction in new car production resulting from a chip shortage. The Fed should not tighten monetary policy to attack supply shocks.
The leading indicators of inflation are energy prices, money supply growth, housing prices, and auto prices. We forecast that inflation will continue to be contained as we believe that energy prices will stabilize, housing prices are unlikely to rise significantly with 30-year mortgage rates at a 20 year high of 7.55% and auto prices and services are likely to moderate as auto production continues to recover.
During the 70s energy prices increased an unimaginable 1200% ($3 to $39), which caused 80% of the core inflation during the decade and housing prices rose an average of 10% per year. These two categories accounted for almost all of the inflation during the decade. Real wages declined by 6% detracting from inflation, which proves the labor market did not contribute to inflation.
Shelter and the auto sector represent 58% of core inflation. Goods prices drive wages, not vice versa, particularly in the US which is less than 6% unionized.
Inflation in the goods portion of autos is down with used car prices down 5.6% over the last year and new car prices now only up 3.5% while motor vehicle maintenance is still up 12.7% y/y and automobile insurance is up 17.8% y/y.
We expect oil to have a seasonal pullback when we enter the Fall as demand for refined products declines after the summer travel season ends. A decline would be positive for inflation as there is a 5% bleed-through of energy prices to the core.
Housing prices are down almost 1.2% year over year.
Chair Volker made a huge policy error by pursuing an ultra-aggressive monetary tightening to fight an energy price shock in the late 70’s.
We do not expect the Fed to cut rates until at least June of 2024 as this Fed is almost always a year behind in making the appropriate policy actions. Since the Fed should have cut rates after the banking crisis started in March of this year they will take at least a full year to discern that they should cut
This Fed is fundamentally flawed as it focuses almost exclusively on the discredited Phillips Curve policy framework which focuses on employment and wages driving “inflationary expectations”, “wage-price spirals“, “entrenched inflation” and “Inflation that is more dangerous than a recession”. These conclusions are based on learning all the wrong lessons from the 70’s oil price shock and are Urban Myths, often repeated but inaccurate.
This Fed completely ignores changes in the money supply which is a huge mistake when the money supply is extremely volatile, which it has been since Powell became Chair in 2018.
The money supply is 60% correlated to inflation since 2018.
The Fed’s assertion that persistent inflation is a bigger risk than a recession, is not supported by any research. Moderate inflation in the 2-4% is ideal for growth and nominal wages, and recessions are terrible for almost everyone. Very high inflation of 5-10% is a problem but that is not currently a risk for the US economy, and this type of inflation is usually caused by energy shocks, which are terrible for both inflation and economic growth.
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Commodity Outlook:
China’s Economy is Way More Resilient Than Perceived which Benefits Commodities:
China is the only major global economy that is loosening monetary policy. China increased its monetary base to over $140 billion in September representing a 2.9% increase vs. a $300 billion drop in the Global Monetary Base.
China is projected to grow by 5% this year.
China saves 45% of GDP vs. less than 20% in the US, which results in much higher long-term growth as the critical driver of economic growth is savings and investment.
The China recovery story is bullish for global commodities and growth.
We are bullish on oil with a 2024 target of $ 95 based on steady demand growth in China and continued production restraint from OPEC+.
The utopian vision of an all-electric economy has now completely imploded as average consumers have limited interest in all-electric autos, and renewables development falters due to nimby opposition to offshore wind and massive cost over-run. Europe's failed energy transition is likely to exacerbate a recession and lead to regime change in many countries.
The failed attempt to push an all-electric vision has hurt the environment as there was less focus on hybrid electric cars and using natural gas to supplant coal.
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QUICK TIP:
The key to national economic growth is competitive corporate tax rates as corporations are the key driver of economic growth and earnings growth is fueled by after-tax corporate earnings. High corporate tax rates encourage corporations to relocate operations to lower-tax countries and reduce after-tax corporate earnings.
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