The market rally has brought back the bulls as sentiment ALWAYS follows price. Yesterday Investors Intelligence said Bulls rose 46.5 from 41.4 and that is the most since December 2021. Bears fell to 29.6 from 32.9. In today’s AAII, Bulls rose 7 pts to 31, the most since mid November 2022. Bears fell by almost 7 pts to 33.1, the least since early November 2022 and just .2 pts from the lowest since March 2022. The CNN Fear/Greed gauge is at 57, a touch in the ‘Greed’ camp.
Bottom line, I get the excitement in the markets that inflation is rolling over and the Fed is almost done hiking rates. But, to repeat something I’ve said before, bear markets have 3 stages. The first is one, which we are now past it seems, is that we take out a lot of the froth from the bull market. The second phase has only just begun however and that is digesting the economic impact from aggressive Fed rate hikes and what that also means for earnings. With yesterday’s selloff in response to the soft economic data, we might have now just begun part two. The 3rd phase by the way is when everyone throws in the towel and many never want to own a stock again. That’s the bottom.
Months ago I gave an example of a real estate project/deal that was struck a few years ago and whose loan was coming due and needed to be refinanced in order to highlight the acute impact the sharp rise in rates will have on commercial real estate players who took on too much debt and/or have loans coming due this year. If you didn’t see the article in yesterday’s WSJ titled “Commercial Landlords Grapple with Big Surge in Hedge Costs”, please read it, //www.wsj.com/articles/rising-interest-rates-hit-landlords-who-cant-afford-hedging-costs-11673900169?mod=itp_wsj&ru=yahoo.
As of 2019, the MBA said about 1/3 of commercial property debt was floating rate and lenders usually expect borrowers to hedge with an interest rate cap. The article said that pre 2022, “The cap on a multi million dollar mortgage could be had for as little as $10,000.” Now? “In some cases, renewing this protection at the old interest rate now costs 10 times as much as it did 12 months ago, analysts and brokers said.” Here is an example given where it’s much worse, “In 2020 apartment owner Investors Management Group took out a $24.4mm loan at a 300 unit apartment complex in San Antonio, with a 5% interest rate cap that cost $22,000 said Karlin Conklin, the firm’s principal. That cap will expire in September. Ms. Conklin estimates that purchasing a new two-year hedge will cost $1 million, which is about 40% of the property’s annual net income. Her company will likely either sell the property or refinance at a fixed rate instead of paying for the new cap, she said.” Assume a fixed rate would be north of 8% I say vs the 3% when this deal took place. This is going to be a big area of problems in 2023 for those not conservatively financed because the shock therapy rate rise in a year after 15 yrs of cheap capital.
With respect to yesterday’s Beige Book which is chock full of info, I’m just going to hone in what was said about wages as we filter thru all the earnings reports, focus on profit margins and know the Fed is watching too.
Boston:
“Wage growth proceeded at an above average pace…Firms in diverse sectors commented that wage growth was above average (if mostly stable) and that employment costs continued to eat into profit margins…No firms planned to undertake significant reductions, not even those that had experienced weak results recently.”
NY:
“Business contacts reported steady and modest wage growth, though one upstate employment agency noted some slowing…Businesses across all major industry sectors plan to raise wages in the months ahead – particularly in wholesale trade, transportation, and leisure and hospitality.”
Philly:
“Wage inflation remained pervasive” but “Most contacts expect future wage growth to return to near pre-pandemic rates.”
Cleveland:
“Wage pressures eased over the past year, though they did not change meaningfully in recent weeks. There were a few new reports of increased worker availability, but most contacts suggested that labor markets remained very competitive, keeping wage pressures from easing further. While fewer firms raised pay compared to those that did a year previous, some offered their employees more generous year end bonuses or accelerated the timeline for merit increases to help employees mitigate the impact of higher inflation.”
Richmond:
“Several contacts reported being at a breaking point on increasing wages as they cannot pass through costs anymore to consumers. Inflation has been a major drain on margins as firms raised wages multiple times to keep up with increased wage expectations for current and potential employees.”
Atlanta:
“Most employers reported persistent upward wage pressures. Many anticipate wage growth will remain elevated in 2023 but will ease somewhat. Several noted that they could be creating more equitable pay across their organization based on market survey results. Some contacts indicated that overall pay raises would be modest, but bonuses would be used to retain and recruit specific talent.”
Chicago:
“Wage and benefit costs continued to increase, though at a slower pace than in the prior reporting period. Compensation increases were aimed both at attracting new workers and retaining existing talent.”
St. Louis:
“Wages have growth slightly since our previous report. Staffing shortages persist, and companies are continuing to raise wages to attract and retain new workers. One Arkansas brewery offered loans to employees to help with housing costs and considered buying property to rent apartments to employees. Other firms reported slowing the rate of wage increases. An education contact in Tennessee reported having to find other ways of retaining employees since salaries could be raised only minimally.”
Minneapolis:
“Wage pressures fell slightly but remained at high levels. Firms reported minor softening in the pace of wage growth, more so for salaried than hourly workers. But overall pressure was still well above average…A Minnesota contact said that more employers were offering sign-up or retention bonuses rather than higher wages.”
KC:
“District contacts broadly indicated that wage growth continues to have momentum due to ongoing imbalances in the labor market. In particular, wage growth in the lodging sector, where employment shortfalls remain pronounced, increased robustly. Most contacts reported they expect wages to increase at either the same rate, or a pace that is slightly faster, than wage growth over the past year.”
Dallas:
“Wage growth remained elevated. In a Dallas Fed survey of 265 executives in the service sector, average wage growth in 2022 was 7.4%. Reported wage growth was even higher in manufacturing and retail – averaging 8.5% and 8.2%, respectively…Looking ahead to next year, contacts overall expect to raise wages 5.6%, on average.”
SF:
“Wages grew further, albeit at a slower pace. Workers continued to ask for higher pay and end of yr bonuses in response to elevated living costs. Employers continued to use bonuses and comprehensive benefits packages to attract and retain talent and reported more willingness to push back against flexible work arrangement requests.”
A notable quote from Fastenal’s earnings press release, a good bellwether on the manufacturing economy and talking about their y/o/y sales gain, “This was due to further growth in underlying demand in markets tied to industrial capital goods and commodities, which more than offset softer markets tied to consumer goods and relatively lower growth in construction.”
Discover Financial saw notable increases in delinquencies that is worth watching and they referred to it as ‘normalization.’ “The total net charge off rate of 2.13% was 76 bps higher vs the prior year reflecting credit normalization across the portfolio. The credit card net charge off rate was 2.37%, up 87 bps from the prior year period and up 45 bps from the prior quarter. The 30+ day delinquency rate for credit card loans was 2.53%, up 87 bps y/o/y and up 42 bps from the prior quarter.”
Notable from JB Hunt’s earnings call yesterday, a major player in truck transportation: “we see some loosening in the labor market and some modest improvements in equipment availability. Conversely, demand for transportation service in the fourth quarter was seasonally weak as customers managed through levels of elevated inventories…we are approaching 2023 with some caution around recent demand trends, but remain highly confident in our ability to thrive in any environment.”
The Bank of Indonesia raised rates by 25 bps to 5.75% as expected and hinted they may now pause. Pausing was the Malaysian central bank who unexpectedly did not raise rates by 25 bps and instead kept its benchmark rate at 2.75%. Norway held rates unchanged at 2.75% but that was expected.
Finally, in yesterday’s November TIC data, foreigners bought a net $54.2b of US notes and bonds but again, most of it is coming from the Cayman Islands and via banks in the UK. I’m guessing hedge funds and insurance companies. Japan sold a net $20b, further reducing their holdings and China a net $2b. Foreign central banks continue to be sellers of US Treasuries in the aggregate.