Lies, Damned Lies, and Lying About Statistics
“’Me, I always tell the truth, even when I lie”???
???????????????????????? ???-Al Pacino, Scarface?
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Actions have consequences.?
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Key takeaways:?
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Noteworthy:??
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A Man of Letters Dept: Jamie Dimon’s shareholder letter left me a bit uneasy, because he wrote that he is more concerned about geopolitics, cyberthreats, and a repeat of the UK gilt market debacle stemming from dysfunctional markets than he is about inflation or interest rates. When he turned to inflation and interest rates, he predicted a reemerging bond bear market from the double supply pressures of central bank balance sheet reductions dovetailing with increasingly large sovereign bond auctions.??
One chart illustrated that 2022 was the first year out of the last 15 that JP Morgan’s consumer deposits experienced a year-over-year decline. Of course, 2023 is on track for an even deeper contraction.?
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Fed Fibbin’?
Two Fed economists published a study that examined the forecasts in the December Statement of Economic Projections (SEP) and found a major discrepancy between forecasting a drop in core inflation to 2.1% with an unemployment rate of 4.6%. The researchers used the very same factors listed by Chairman Powell during his December 2022 press conference to describe the drivers of core PCE inflation (housing, non-housing related core services, and core goods) and they arrived at a much higher 2025 inflation rate of 2.8%. Their conclusion was that inflation would persist higher for longer than the stated FOMC consensus, and that “a deep recession would be necessary to achieve the SEP’s projected inflation path.”??
They found that a reasonable unemployment rate to drive inflation down to 2.1% was 7.4%. Let that sink in: That is more than double our current rate of unemployment.?
Paul Singer agrees, as he has lamented that “money printing, prices, and the growth of debt are in an upward spiral that the monetary authorities realize cannot be broken except at the cost of a deep recession and credit collapse” (my emphasis).?
Two conclusions can be drawn from their analysis:?
First, if we do not enter a deep recession, inflation will persist above the Fed target, falling only to 2.8% in two and a half years.?
Second, if the Fed’s own economists are presented their data internally, is Powell unconscious or untruthful??
I do not believe we are uncovering Fed fraud, and I can understand why the Fed governors are not rolling out 7.4% unemployment forecasts, but should Fed officials maintain that they can produce a soft landing with at worst a mild recession and 2.1% inflation? They employ these economists to produce forecasts, and upon reviewing their back tested results, I concluded that their method is robust and accurate, lending credibility to the 2.8% inflation forecast. After the study was released, the Fed did not change its outlook on inflation and unemployment in the March SEP.??
To delve into the numbers, using the SEP’s unemployment path results in an expected inflation level of 2.8% with a standard deviation of .4%. Therefore, according to the research, the Fed’s SEP forecast of 2.1% only has a 4% chance of being hit.??
The Fed is clearly trying to manage inflation expectations. The University of Michigan’s 5-to-10-year inflation expectations are at 2.9%, and the Fed hopes to keep that contained. Considering the Fed advocates transparency and forward guidance, I do not accept that a “believe it and it will manifest” mantra will achieve the Fed’s dual mandate of steady growth and low inflation.?
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As Above, So Below?
Keeping in mind that the Fed has been a little loose with its economic numbers, who is to blame companies for being a bit creative with theirs? There has been evidence of the worst financial manipulation since the 1980s recession based on a set of balance sheet ratios that flag a company with improving top line growth but has deteriorating gross margins with rising operating expenses and leverage. That can be taken on an individual level as showing a company is manipulating its earnings but can be used as a macro indicator as well. A recent study looked at this measure across 2,000 firms and found that it has long term predictive ability for recessions?
This matters because material effects of such misreporting exist because it affects corporate and consumer investment and spending decisions. Misrepresenting financial data can contribute to consumers and firms misallocating resources and overextending themselves. They both pull back on investing and spending dramatically, causing a more sever pullback once it becomes clear that the economy cannot avoid a recession.??
Therefore, if corporate well-being is built on fiction—and it is the same case with an unrealistic Fed forecast of 2% inflation--when reality hits, there is potential for an economic reckoning.??
Fraudulent reporting creates an illusion of prosperity that can delay the average firm from cutting production and investment and keeps consumers hopeful when they should be cutting spending. And once they are forced to react, they do so aggressively.??
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Regarding the markets, the Bear Stearns analog continues to chug along, and the expected pullback began to play out with the S&P 500 topping at the open on Tuesday. The market could continue lower, and then reverse to new highs using the analogy as our map. The analogy is unfolding not only in price action, but in investor sentiment, encouraged by the absence of bank runs. The latest Fed data are supportive of that view:?
The Federal balance sheet report shows that $2.4 billion was borrowed from the Bank Term Funding Program upon its opening during the week of March 13, and borrowings rose to $32 billion and $28 billion over the next two weeks, respectively, to close out March. For the week ending April 6, activity pulled back dramatically with only $5.5 billion borrowed, reflecting that the deposit run from small banks is abating. Deposit growth has continued to fall for its 10th consecutive week, but recently the larger institutions are again seeing most of the outflows.??
We had mentioned that a break below 3980 in the S&P 500 index would be a warning sign of a bigger selloff, but due to two cautionary signals described below, we will become incrementally more defensive below 4070, 4040, and 4020. The long-term picture is still bullish above 3800, but that is far below current levels.?
The two areas we are very worried about are regional banks in the financial sector and semiconductors in the technology sector.??
Primarily, we are concerned about the financial sector's continued underperformance, particularly regional banks.??
The chart below shows the relative performance of KRE, a regional bank ETF versus the S&P 500 moved below the prior all-time lows from 2020 this week.?
Kirt Corregan has pointed out that regional bank insiders have been decidedly bullish since the SVB crisis, with buyers overwhelming sellers eight to one, the most lopsided situation since March 2000. Insiders can be early but are rarely wrong. The absence of a viable bid for Signature Bank’s $60 billion loan portfolio is presently helping depress industry sentiment. We are focusing on KRE/SPY because we would have more confidence in the 4300 S&P forecast when we see regional banks begin to outperform.??
Our second concern is that the semiconductor ETF SMH has an extremely negative price setup. To consider the 4300 S&P forecast intact, SMH must rally above its March 31 264 year-to-date high. Friday’s close was 252, and if a break below 250 occurs next week, then it could lead the general indices lower. The NASDAQ 100 Index has rallied 25% since October 2022 with interim highs in November, February and March. At each subsequent peak, fewer stocks have been above their respective 50-day moving averages, a sign of decreasing breadth that suggests an impending reversal. Key on the tech sector--and particularly the semiconductor industry--for directional clues.??
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Bond Note??
Ten-year yields closed near 3.30% support, and a break below that level would target strong support at 3.10%. Our monthly bond model flipped to a buy as of the end of March. The fact that the 3-month Treasury Bill moved to the steepest inversion relative to the 10-year is notable, but the 2-year/10-year curve is 50 bp flatter than its pre-SVB lows, although it remains inverted.?
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Dollar Note?
The dollar index continued its post-SVB downtrend, holding above 102. It will need to clear 102.5 to give the first sign of a recovery to new highs. Any break of 100 would be clearly negative.?
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Peter Corey?
PavePro Team?
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