A couple of decades ago, a movie called “The Shipping News” came out. It was an adaptation of a book by the same name by Annie Proulx. If you haven’t seen it yet, there is no need to be in a rush to watch it on Netflix tonight. If you have, you probably remember the film as a mostly passable way to kill a couple of hours.
In truth, all these years later, I can’t tell you much about the plot, the characters or the ending. However, I do remember one particular passage between the characters Billy and Quoyle. In it, the former is trying to teach the latter how to be an effective journalist. In so many ways, it effectively sums up so much.
Billy: It’s finding the center of your story, the beating heart of it, that’s what makes a reporter. You have to start by making up some headlines. You know: short, punchy, dramatic headlines. Now, have a look, what do you see? [Points at dark clouds at the horizon]
Billy: Tell me the headline.
Quoyle: Horizon Fills With Dark Clouds?
Billy: Imminent Storm Threatens Village.
Quoyle: But what if no storm comes?
Billy: Village Spared From Deadly Storm.
That is pretty clever, isn’t it? Primarily because it is true. After all, would you bother to read an article with a headline such as, “Horizon Fills with Dark Clouds?” Perhaps. However, what about “Imminent Storm Threatens Village?” There you have it. Fear and misery sells. It always has, and it always will. Be honest; don’t you typically click on the worst headline first thing in the morning?
But, but, what if the worst-case scenario doesn’t happen? What if the deadly storm spares the village? What if the U.S. economy doesn’t slump into recession? What if? It is a very common question.
On March 16, 2022, the Federal Open Market Committee (FOMC) raised the upper range of the target overnight lending rate by 25 bps to 0.50%. It had been at that lower rate for two years and one day. The markets had anticipated the move but disliked it nonetheless.
What’s more, investors absolutely loathed the remaining 400 bps (4.00%) of rate hikes that followed in 2022. After all, these aggressive moves would certainly kill the economy. Drive it into the ditch. Return us to the glory days of 2008 and all of that. Am I right? I mean, what if the Fed goes all Paul Volker-esque on the economy in order to crush inflation? What if it does too much? What if the pendulum swings too far the other way?
These were, and arguably still are, real fears. However, sober analysis of the economic data suggests the worst-case scenario, the deadly storm if you will, just might not happen.
This week, the Bureau of Economic Analysis (BEA) announced the U.S. economy grew at a 2.9% annual rate in the 4th quarter of 2022. This was after a 3.2% increase in the 3rd quarter. The underlying data was perhaps not as good as the headline but still showed modest growth. Interestingly, the inverse was true for the first two quarters of 2022. The headline(s) then were worse than the data.
However, what were we worried about last year? What are we worried about this year? Dare I say recession? Of course.
In keeping with the last several years, the economic data doesn’t make a lot of sense. Fed tightening cycles will ordinarily slow borrowing and lending. After all, that is the whole point. Slower levels of borrowing and lending historically have led to slower growth in the money supply. Less money sloshing about, intuitively, should lead to lesser economic activity.
So, what is going on here? How is the economy apparently accelerating almost 12 months into a tightening cycle? Or at least that is what the last two GDP reports suggest. That isn’t usually the case, is it? What if this time is different? What if the economy actually isn’t headed into the ditch? What if the Fed really can engineer a so-called soft landing?
Here is the drill. The economy was tepid last year, pretty much throughout. However, the way the BEA reports the data it was/is/always will be somewhat wonky. No, the economy is not as hot as the last two quarters’ reports. Nor was it as cold as the previous two. What’s more, there is nothing in the crystal ball or the proverbial tea leaves to suggest either Nirvana or Armageddon moving forward. In truth, the vision in said crystal ball looks a lot like, say, Louisville.
Why Louisville? Why not? It seems like a reasonable place, and far from the two extremes.
Moving forward, the probable-case scenario, regardless of the wildly fluctuating and confusing data, is the U.S. economy will likely limp along the first two quarters of 2023. If the inflation data continues to trend downward, the Fed might just take a pause at 5.00%. If that is the case, investors could feel better about taking on some additional risk. After all, it is the prospect of higher rates, more expensive money, that often keeps people on the sidelines. The potential is often worse than the reality, if you catch my drift.
Then, if this happens, the economy and the markets should stagger back to life. The deadly storm will spare the village. But what if the Fed doesn’t take a pause? What if it continues raising rates until the economy is flat on its back? What if the price of a dozen eggs remains as high as it currently is? Bad things will happen, won’t they? Perhaps, but not probably.
After all, dark clouds on the horizon don’t always mean deadly storms. In fact, they usually don’t.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist & Conspiracy Theorist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.