Fall in to the gap! The gap between expectations and reality, that is—always stocks’ chief driver. Today it’ss a big, yawning chasm. The tragic, grinding Ukraine war, hot inflation, rising interest rates, a negative GDP quarter, central bank “tightening,” China’s lockdowns—all this and more torpedoed sentiment during 2022’s first third. Beneath this sour surface stir powerful positives—doubly strong because they are unseen. Their stealthy presence amid widespread gloom is more evidence this downturn is a classic correction, not a new bear market.
You needn’t look far to see rampant negativity and recession fears. Nearly 60% of respondents were bearish in April’s final American Association of Individual Investors’ survey, the highest since March 5, 2009—four days before the financial crisis’s low. Fund managers have slashed equity allocations and raised cash, according to Bank of America’s latest survey. Global growth pessimism levels, part of that poll since 2007, soared to record highs. Last spring’s budding euphoria feels ancient now.
Backward-looking metrics like inflation and Q1 GDP’s small, inventory-and-import skewed dip provide more fear fodder. But forward-looking indicators tell a nuanced tale. The Conference Board’s US Leading Economic Index rose 0.3% in March after a 0.6% February jump.
One big reason: the yield curve. Yes, you read that right. 2022’s wrongheaded headlines harped on parts of the US curve inverting, ones that don’t really matter, like the 10-year minus 2-year Treasury yield spread. Those spreads aren’t useful. The segment that matters—the meaningful part and that which is officially a leading economic indicator and has been for many decades—is the 10-year minus 3-month spread. Even after the Fed’s early-May 50 basis point hike, it is nearly a half percentage point wider than a year ago.
And why does it matter when the 10-year minus 2-year doesn’t? Because banks borrow short term money from depositors to fund long-term loans. They borrow from depositors heavily in very short 0-90 day periods, much with no duration at all, and fund lending almost not at all off of 1-3 year or longer deposits (there aren’t that many relatively….and far less than in decades back). So the 10 year minus 90-day spread serves as a pretty good proxy for banks’ profits on future loans. The wider, the more banks become willing to lend—bullish! The Conference Board’s Leading Credit Index, which features other forward-looking factors like credit swap spreads and senior loan officer surveys, boosted LEI, too.
Other components showed demand staying strong despite hot inflation. After slipping -0.3% m/m in February, nondefense durable goods orders excluding aircraft—a proxy for business investment—surged 1.0% in March. Manufacturing new orders pointed to growth, according to the Institute for Supply Management’s purchasing manager index. Service sector new orders—not an LEI component, but a gauge covering America’s dominant economic sector—were also strong. Typically, today’s new orders are tomorrow’s production. Supply chain snarls muddy that maxim some but the overall signals are positive.
Outside America and locked-down China, stealthy positives percolate—even in Europe—where broadly loosening COVID restrictions are an underappreciated tailwind unleashing restaurant, travel and entertainment activity—juicing service sectors region-wide. Services-heavy countries lead the way.
Composite manufacturing and services PMIs for Germany, Spain and Italy also showed output rising. France’s hit a four-year high. New business volumes across the bloc accelerated amid improving demand. All this more than compensates for new manufacturing orders slowing (even contracting in Germany). If Europe—far more affected by rising energy prices and the Russian fiasco—isn’t evolving to marked economic contraction, global recession’s likelihood becomes very low.
Despite months-old fears of galloping prices stunting demand or squashing profit margins, myriad S&P 500 executives said on Q1 calls that they aren’t seeing it. Procter & Gamble’s CFO said customers haven’t switched to cheaper brands as prices rise—many even trading up to pricier offerings!
Bank of America’s CEO said March credit card spending jumped 13% y/y—despite stimulus checks arriving a year earlier. One reason: Travel, entertainment and restaurant spending rebounded, a trend high-frequency data bear out.
Restaurant reservation service OpenTable’s April US reservations were within 1.3% of April 2019’s pre-pandemic levels. Globally they were up 5.5%. April US Transportation Security Administration checkpoint traffic was 52.5% higher than April 2021—and just 9.5% off April 2019 levels. Hotel occupancy is up, too, despite higher prices. Reopening is shifting demand and buoying activity.
Crucially, companies haven’t had to slash margins to stoke demand. S&P 500 firms’ gross profit margins are 33.8% presently, up slightly from 33.5% in Q4 2021—even higher than the 32.0% registered at 2019’s end.
These data aren’t predictive. But they show all that is feared isn’t tanking commerce—quite the opposite. They depict a moderately growing economy defying widespread scare stories.
Always remember: Stocks don’t care whether news is inherently “good,” “bad” or “meh.” They care how it evolves against expectations. So-so news is just fine if everyone expects ugly. Today, dour sentiment and sneaky positives present a beautifully bullish gap you should leap into like a trampoline—to catch the bounce.