Coiled Spring Capital Macro Report 10/22/23

Another difficult week in the stock market with the indexes pulling back materially. Trying to time bottoms has been a bit tricky in the face of relentlessly climbing treasury rates, volatile oil prices on the backs of the Israel conflict, and a stubbornly resilient $USD. We have been referring to these three instruments as the “Three Horsemen,” and proclaiming that the stock market will not be able to find meaingful footing or sustain any upward momentum with these continuing their trajectory.

The weekly change posted below paints the picture.

The 10 year topped 5% for the first time since 2007.

The same for the 30 year.

The 30 year mortgage national average rate is now over 8%, the highest since 2000.

Leading to a significant decline in Housing Starts since the beginning of the year (-7% yr/yr), although multi-family starts produced an uptick for the last reading.

And the FOMC, namely Powell splashed more cold water on any enthusiasm by doubling down on the rhetoric for higher rates for longer. While this is not new news there are pockets of the economy that are starting to show stress. We have written many times that the Fed’s track record of orchestrating soft landings are spotty at best. This implies, the stock market may be starting to price in that rates have become too restrictive.

TSLA has been cutting prices aggressively this year but still has not been able to escape the grips of a hesitant consumer. Musk himself, sounded quite dire on his conference call over the outlook for the economy. While this is just one company’s perspective, we doubt we will hear much rosier outlooks from the parade of companies slated to report over the next couple of weeks. When in an environment of deteriorating sentiment, with a forward picture of the economy murky at best, and most stocks having rolled over significantly from their July highs, it doesn’t behoove management teams to stick their neck out and present an overly optimistic view of the future. Earnings are a game of expectations and being too aggressive with forecasts in an uncertain time with an unrelenting higher rate picture, seems not only misplaced but irresponsible. We have seen many cycles in our tenure, and the outlook for next year is quite opaque and fraught with risk. This implies the next couple of weeks will be quite volatile. Over the next 2 weeks we get the bulk of the large cap companies reporting, along with most of the SPX. The datapoints will be swirling and will set the tone for the index trajectory for the remainder of the year. This begs the question, are numbers for next year too high? We have made the argument that they are, and likely need to come down. While they are still showing growth year over year, these numbers have started moving lower.

We actually see this as a positive, if growth can remain intact and forward estimates remain more realistic, then stocks can work again. We suspect more retrenchment here as we work through earnings season.

Besides ~1/3 of the SPX reporting this week, we will also get 3Q GDP. GDP is a lagging indicator, so it possesses little predictability when thinking about the future. Nonetheless, the forecast is quite robust and likely expanded at the fastest pace in nearly 2 years, on the backs of a stubbornly resilient consumer. Remember, GDP is ~70% driven by personal consumption. GDP advanced at a 4.3% annualized pace in July/Sept according to a median survey from Bloomberg.

This level of GDP is not likely going to cause Powell or the Fed to relent, and thus could be viewed negatively by the stock market. We doubt it will be enough to get them off the fence for a Nov meeting rate pause, but it’s certainly not going to get them believing their work with rates is complete. Is this what the bond market is reflecting? We think so. The term premium for holding longer dated paper rose considerably for the 10 year over the last 3 months as the anticipated rate cuts in ‘24 has largely been erased.

Much like the stock market priced in a no recession scenario all year and got as high as 4600 on the SPX, maybe it’s now starting to price in a recession for ‘24. Time will tell as predictability for this cycle seems more difficult than previous one’s as the rate escalation is unprecedented and the fallout from that tightening is still unknown. Are we facing the possibility of a credit event? This is an argument that we’ve raised to ourselves multiple times throughout the year. It’s easier to make a philosophical argument that we should expect one but it’s much more complicated than that. The bottom line is the stock market is reflecting a much more uncertain future, and the tail risk of escalating rates is rising, which implies that the risk of a credit event is growing.

On the flip side, the stock market is not the economy, and despite the news we see in front of us, it’s possible the stock market is discounting something that will never come. If that scenario is true, we will see that reflected in various instruments and indicators very early on, and we will capture a reversion index move while most news chasers will fight every uptick.

Is that moment closer than most believe?

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