Ladies and gentlemen, the weekend! In this space each week, Greg and I share some of our favorite articles, notes, and graphics from the past week along with our commentary. Please feel free to provide feedback and forward along to others if you enjoy. We appreciate you taking the time to read. 

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‘Simply staggering.’ FedEx hit with downgrades, price target cuts.

“A profit warning from FedEx was ringing alarm bells for Wall Street and beyond on Friday, with shares of the economic bellwether slumping as analysts piled on downgrades and price target cuts.

FedEx stock slid 20% to $165 in premarket hours after the company yanked guidance for the year, called for much lower quarterly profit and revenue and warned of a tough 2023. The shipper blamed ‘macroeconomic weakness’” in Asia and ‘service challenges’ in Europe for a $500 million revenue shortfall in these regions…

Putting the company’s gloomy forecasts further into perspective, Deutsche Bank analyst Amit Mehrotra said FedEx delivered ‘the weakest set of results relative to expectations in our 20 years of analyzing companies (30%+ below expectations).’

Mehrota was less willing to accept economic excuses from the global shipper, noting Express profits were down nearly $500 million annually even as revenue rose. ‘The company did say that revenue in this segment was $500 million short vs. its forecast; but the decremental margins associated with this should not be 100%.’”

FedEx had a brutal preliminary earnings announcement that cast some global recession warnings. FDX declined more than 20% on Friday after its earnings “reset” and potentially dragged down the performance of the entire market. It’s difficult to know how much to read into it. Analysts pointed out that some of the results might be company and competition specific, rather than a picture of the global economy. 

Predicting the Next Recession

“The Fed cannot ease pandemic related supply constraints (except by curbing demand), and the Fed cannot stop the war. So, there is a possibility that the Fed will tighten too much and that will lead to a "hard landing" (aka recession).

The key will be to watch housing. Housing is the main transmission mechanism for Fed policy.  One of my favorite models for business cycle forecasting uses new home sales (also housing starts and residential investment). I also look at the yield curve, but I've found new home sales is generally more useful…

Some observations:

1) When the YoY change in New Home Sales falls about 20%, usually a recession will follow. An exception for this data series was the mid '60s when the Vietnam buildup kept the economy out of recession. Another exception was in late 2021 - we saw a significant YoY decline in new home sales related to the pandemic and the surge in new home sales in the second half of 2020. I ignored that pandemic distortion.

2) It is also interesting to look at the '86/'87 and the mid '90s periods. New Home sales fell in both of these periods, although not quite 20%. As I noted in earlier posts, the mid '80s saw a surge in defense spending and MEW that more than offset the decline in New Home sales. In the mid '90s, nonresidential investment remained strong.”

This was a nice breakdown of housing as an indicator rather than the catalyst of economic health – which was the case with the Great Financial Crisis. Bill McBride has great breakdowns and data on the residential housing market in the U.S.

Peak Inflation Watch

Inflation has probably peaked. The problem is that the slide from the peak is proving to be slower than expected, dipping at a glacial pace, if any, depending on the metric. Inflation persistence, in other words, is increasingly the new new worry.

Yesterday’s August update on US consumer inflation certainly highlights the persistence risk. Economists were looking for a decline in the annual rate of headline CPI to 8.1%, based on Econoday.com’s consensus forecast. The actual decline was milder, dipping to 8.3% from July’s 8.5% increase. Better, but hardly inspiring for thinking that pricing pressure is fading in a meaningful degree. More worrisome: core CPI, generally a more reliable forecast of the trend, ticked up last month.

Fed funds futures are now pricing in a non-trivial possibility – an implied 38% probability as we write this morning — that the central bank will lift its target rate by 100-basis-points at the Sep. 21 FOMC meeting…

Overall, the numbers aren’t encouraging. High inflation is looking more entrenched, which in turn will likely spur the Federal Reserve to raise rates further for longer, and perhaps in bigger-than-recently expected increments. In turn, that lifts the odds that the economic growth will suffer, perhaps triggering a recession in the near term.

All of which reaffirms yesterday’s analysis that “Q4 is shaping up to be the acid test for the US economy’s resilience, or lack thereof.”

Tuesday’s consumer price index data was bleak with core CPI rising enough to offset falling gas prices. It caused the markets to almost immediately price in another 0.25% increase in the federal funds rate, and caused the work market day since the depths of the pandemic sell off. Wednesday’s producer price data was slightly better. Inflation’s persistence continues to drag equity returns lower.

Vanda’s VandaTrack tool monitors retail activity in more than 9,000 stocks and ETFs in the US market. There data shows an average portfolio drawdown of 32% in the first half of the year, which is the worst performance by retail investors since the firm started tracking data in 2014.

"History taught us that when facing losses of this magnitude retail would have given the first signs of capitulation, but sentiment appears to be (still) quite resilient," Vanda researchers Marco Iachini and Giacomo Pierantoni wrote in a note. 

Thanks for reading. Have a great weekend!