Wisdom in the Whipsaw

Where were you when the world ended and began all in the same day? We were right here, preparing for the next leg of the journey.

We’re picking ourselves back up after a major whipsaw when the S&P 500 experienced both its worst and best single-day performances of the year.

Now with the recent CPI numbers released (lower than expected), we’re looking at how this may give the Fed the ammunition it needs to cut rates.

We’re also tracking what some are referring to as a “main event” in the credit space and how the real cost of life on Main Street is more of an indicator of rough seas on the horizon.?

Let’s get into it.

Meanwhile on Mainstreet

The latest CPI numbers show cooler inflation continues on its run, and a rate cut in September seems pretty likely.?

Although CPI came in below expectations at 2.9%, the high cost of basic necessities paints an entirely different picture. Despite the news, prices keep rising and Americans are struggling.

Car insurance inflation sits at a whopping 18.6% and rent inflation is over 5%. Transportation, healthcare, and utilities continue to rise in cost. In the logistics world, global container rates are over double what they were back in 2019, driving up the cost of shipping.?

Inflation continues to hurt small businesses, with loan availability at its lowest level in 11 years. This trend looks a lot like what we saw in 2007 just before the financial crisis.?

Sure, some might be celebrating the latest cooling inflation numbers, but there’s nothing cool about it. Unless you’re the Fed.?

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Extra Credit

A few short weeks ago, US high yield credit spreads were near their tightest levels since 2007. Spreads increased to their widest levels since last November during the recent 10% S&P 500 correction.

Some may say this is a sign that bond investors are starting to price in a recession, but we’re not quite there (yet).?

During our country’s last three recessions, credit spreads moved over 1,000 bps at times, far more than what we’re seeing right now. However, that doesn’t mean it shouldn’t stay on your radar.

According to Michael A. Gayed’s “main event” thesis, the risk is no longer Japan. It’s credit.

We all thought the world was ending after the carry trade incident, but then we experienced a rebound.?

To quote Gayed, “in a chaotic system, a butterfly flapping its wings creates a hurricane.” The precursor to every main event in the markets is overconfidence, which leads to leverage.?

Japan has been the enabler of that leverage since the carry trade. Japan wasn’t the event, it was the spark.?

Gayed also points to small caps relative to junk debt. If small caps are underperforming substantially, then junk debt shouldn’t be doing well, either.?

But when you look at junk debt spreads, they keep narrowing. Small caps have largely gone nowhere out of concern of default risk. However, there’s no concern about default on the junk side and that’s the disconnect.

Many of these companies won’t make it unless the Fed gets things just right in terms of lowering just as the refinancing wall hits. How that plays out is yet to be seen.

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