The U.S. Consumer keeps spending … the financial press has it wrong … the key variable that will impact your portfolio next year … how to navigate what’s coming
I’ve been wrong.
I thought we’d see the U.S. consumer roll over by now.
To be clear, I still think that’s our eventual outcome. But relentless consumer spending continues to come in red hot. And whether it’s sourced from healthy disposable income, unhealthy credit card debt, non-replenishable pandemic savings, or even checks from grandma, it doesn’t change today’s reality – consumers keep consuming.
Yesterday’s GDP report provides the latest evidence.
Whereas economists surveyed by Dow Jones had forecasted 4.7% GDP growth, the number came in at 4.9%. And consumer spending was a huge contributor to this increase.
Personal consumption expenditures (how we measure consumer spending) increased 4% in Q3. This blew away Q2’s 0.8% growth. In fact, the spending was so robust that it accounted for 2.7 percentage points of the total 4.9 percentage point GDP increase.
While the financial media is quick to speculate about how this GDP data might impact the Fed’s upcoming rate hike decision, they’re missing the bigger picture
Before we highlight that “bigger picture,” here’s an example of the financial media’s focus after yesterday’s data. From CNBC:
While the report could give the Federal Reserve some impetus to keep policy tight, traders were still pricing in no chance of an interest rate hike when the central bank meets next week, according to CME Group data.
Futures pricing pointed to just a 27% chance of an increase at the December meeting following the GDP release.
This interest in what the Federal Reserve does in December is a waste of mental energy because whatever happens in December is immaterial.
If you’re standing before a blazing bonfire with 10-foot flames, is it going to make any meaningful difference if someone adds one more splash of gasoline?
Today’s issue with the Fed policy isn’t whether it will raise rates another 25, or even 50 basis points. It’s how long they’ll remain at today’s elevated levels.
But that’s just one important variable. We’ll get to the second momentarily…
The core influences that will make or break the economy in 2024…and by extension, your portfolio
Do you want to succeed in the market?
Then learn from the world’s most successful investors who have created multi-billion-dollar empires. There’s a handful of them. But even amongst this elite circle, there’s a Hall of Fame group. And this is where we find Stanley Druckenmiller, founder of Duquesne Capital.
“The Druck” has averaged 30% annual returns…for three decades. More mindboggling is that the man has never had a single down year. In fact, he’s only had five losing quarters out of 120.
In Jack Schwager’s book The New Market Wizards , Druckenmiller told a story from early in his career. He submitted a research paper on the banking industry to his research director. Druckenmiller thought he’d done a great job. But rather than giving Druck a pat on the back, the research director had sharp words:
This is useless. What makes the stock go up and down?
Since then, Druck has focused his analysis on the factors that are strongly correlated to a stock’s price movement.
So, what moves a stock price?
Let’s pick up with Druckenmiller:
Frankly, even today, many analysts still don’t know what makes their particular stocks go up and down…
Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures.
It’s liquidity that moves markets.
Now, one tweak to Druckenmiller’s comment (which I submit with humility) is that earnings do matter to individual stock prices – a lot. Countless studies prove this.
Yet, to Druckenmiller’s point, liquidity – or lack thereof – is potentially the greatest macro influence on earnings themselves.
After all, if liquidity dries up for consumers, they can’t spend, which impact corporate earnings…
If liquidity dries up for businesses, they often face trouble meeting payroll and operating expenses, which impacts revenues and earnings…
If liquidity dries up for banks, they’ll pull back on lending to business, which impacts future growth initiatives, hurting forward earnings.
So, I believe Druckenmiller wouldn’t conclude that earnings don’t matter, but rather, the primary driver of earnings – liquidity – is the cornerstone variable.
But we can also take Druck’s comment about liquidity literally, as in “more currency in the market”
In the wake of Covid, the government printed trillions of dollars of new currency. Much of that found its way into the investment markets. How do we know?
Well, below, let’s look at the S&P 500 alongside the M2 Money Supply, which measures cash, checking deposits, and other types of deposits that are readily convertible to cash.
We’re evaluating the period between 2016 and the end of 2021. Notice what happened to the S&P (in green) after the M2 Money Supply exploded (in black) thanks to stimulus printing.
Chart showing the S&P soaring after the Fed prints trillions and floods the M2 money stock
Source: StockCharts.com
This is not a coincidence.
The point is that whether we’re discussing liquidity in the context of earnings, or liquidity that funnels directly into the investment markets, inflating prices, the Druck it right – liquidity moves stock prices.
Now, how does the Fed turn up or down the dial on liquidity?
Well, by the interest rate levels we’ve been discussing. But also, through the second variable we hinted at a moment ago…
Quantitative tightening.
Even if the Fed is done hiking rates, “higher for longer” combined with the Fed’s quantitative tightening program is rapidly draining liquidity from the system
What do interest rates at “restrictive” levels do?
Well, they’re a de facto liquidity drain. Banks lend less. Consumers borrow less. Shoppers spend less (eventually).
So, are rates restrictive today? Even if the Fed never hikes again?
From Federal Reserve Chairman Jerome Powell at his post-September FOMC press conference:
…Since early last year, we have raised our policy rate by 5¼ percentage points. We see the current stance of monetary policy as restrictive, putting downward pressure on economic activity, hiring, and inflation.
In addition, the economy is facing headwinds from tighter credit conditions for households and businesses.
And now, when might the Fed finally ease up on this restrictive, liquidity-draining level?
Last week, Atlanta Federal Reserve President Raphael Bostic said it would be late 2024.
So, ballpark another year.
Now, what about direct liquidity drains from the Fed’s quantitative tightening program?
For any readers less familiar, since June 2022, the Fed has slashed its balance sheet by about $900 billion to $7.6 trillion. Those cuts would be even higher if the Fed hadn’t injected $400 billion of liquidity to contain the regional banking crisis back in March.
Here’s how this looks…
Chart showing the Fed's total asset ballooning then bleeding off as QT has begun
Source: Federal Reserve data
This is a significant liquidity drain.
And how much longer will it last?
From Reuters earlier this month:
A survey of major banks by the New York Fed released in August eyed an end to QT in mid-2024.
Mark Cabana, rates strategist with Bank of America, said QT likely has around a year to go and that reserves are already more scarce than many recognize because banks are already hoarding cash.
So, roughly eight-to-12 more months.
Tying everything together, the focus on the possibility of more rate hikes is misguided
The combination of “higher for longer” rates at today’s elevated level and a continuation of quantitative tightening suggest we’re in for an industrial strength liquidity drain through summer 2024 at a minimum, potentially longer.
So, if Druckenmiller, perhaps the greatest trader of all time, is right about liquidity moving stock prices, this is a bright red warning flag.
One final chart for you…
The bulls have done their best to ignore this liquidity drain. Below, we look again at the M2 Money Supply and the S&P 500 through today.
Notice that the S&P (in green) initially fell as M2 Money Supply (in black) began draining from the system. But then bulls ran up prices again, defying the M2’s sideways/down movement.
If the Druck is right, this incongruence will only exacerbate the coming reckoning in stock prices.
Chart showing the S&P beginning to fall as M2 dropped, but then rising again in defiance of falling M2
Source: StockCharts.com
Our advice remains the same…
View this market as a trader.
As to defense, mind your position sizes and stop-losses. Do not allow a small, acceptable loss to snowball into a massive portfolio-busting loss.
As to offense, keep your eyes peeled for fear-based overblown selloffs. We’ve discussed the RSI and MACD indicators in recent Digests as two powerful ways to identify oversold stocks.
And yesterday, we put a free trading resource from our corporate partner TradeSmith on your radar: https://analytics.tradesmith.com/. It’s a fantastic way to zero in on oversold sectors, as well as surging performance leaders.
Pulling back, if Druck is right (and he has a track record that suggests he usually is), then liquidity is the single greatest influence on your portfolio today. Unfortunately, the Fed is dead-set on removing liquidity from the market.
