Make the Trend Your Friend

Certainly, a lot of data this past week.

The ISM Manufacturing data on Friday was slightly on the weak side, but not terribly so. The PCE core came in exactly as expected, a relief after the PPI and CPI were both hotter than expected causing fears of the Fed staying too high for too long. Durable goods were a little bit on the weak side, but that was mostly due to aircraft orders and nothing to worry about. We had a tick up in the weekly jobless claims, one of my favorite high frequency data points, and that tick higher is nearing the mid-range of what I think is the sweet spot of 200,000 to 240,000.

The Case-Shiller and the FHFA housing indexes came in slightly weak, actually. The FHFA was up 1/10th of a percent, which was the smallest increase in a year, and Case-Shiller has definitely slowed. There's pressure on those housing prices since, even though the long rates have stabilized, mortgages are still in the 7% range.

Money supply came out for the month and was surprisingly weak. I've been following the weekly deposits and I've seen an increase, and I thought it would translate into an increase in the M2. We basically have seen a tiny increase over the last year in the M2 money supply—and we want this measure to grow around 5% per year—to coincide with 2 - 3% real economic growth and 2 - 3% inflation.

A sluggish growth in the money supply coincides with a too restrictive Fed if inflation comes down and the Fed doesn’t cut rates—that is the sentiment that Chicago Fed President Austan Goolsbee relayed in an hour long interview I watched last week.

Goolsbee believes real rates are highly restrictive, inflation expectations are stable, and the Fed should lower rates unless inflation flares up again. Goolsbee talked about the increased amount of financing that comes from non-bank sources, such as car loans and commercial paper. This might explain why the money supply has not grown much in the traditional M2 measure, and why the economy can still be strong despite a flat money supply, but this needs to be studied more. The velocity of money, which is tied to interest rates, has increased, and allowed more GDP with the same amount of M2.

Goolsbee admitted that the shelter component of CPI, which accounts for a large part of the stickiness of core inflation, was faulty and dramatically lagged actual costs. He expects the February CPI to be better than the January one, which he thought might be a one-off spike. He also showed a graph of apartment list rental rates, which showed zero increase over the last two years. This is exactly the view I have been sharing in these commentaries, that official BLS shelter is faulty being so lagged. It is good someone at the Fed is paying attention to the real-world housing data.

Where I disagree with Goolsbee is that I think the Fed needs to revise their long-run neutral rate higher, while Goolsbee hasn’t yet been convinced that the higher productivity levels we are seeing should be moving the R* higher. Whereas the Fed Dot Plot suggests that current policy rates are almost 300 basis points restrictive to a long-run neutral stance, I think we are only about 200 basis points too restrictive. But the key is, Goolsbee and I both think rates should be coming down with real-world inflation trending lower.

I had the honor of being able to meet with Burton Malkiel, American economist, and author of A Random Walk Down Wall Street last week. He's in his 90s, remarkably sharp, and we agreed on almost everything regarding the economy and the stock market. He's a little bit more worried than I am that we're currently at the beginning of a bubble like 1996-97. I say it’s possible we will get there, but at this point we are not in a bubble.

For the equity markets, I think investors should “make the trend your friend” and don't fight the tape—which has been consistently higher.