The Transcript Commentary

Themes from our newsletter

Editor’s Note: We’d like to start writing a weekly commentary to highlight some of the themes we’re seeing in our newsletter. This first edition will be available to all readers but subsequent editions will only be available to our premium subscribers.

Please consider a premium subscription to support our work and let us know what you think of this new piece!

-Scott

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Clear Signs of Softening

Earnings season began last week, and we titled this week’s newsletter “clear signs of softening.” The title borrowed a quote from Citi’s CFO who said that there were “clear signs of a softening labor market.“ This continues the slowing trend that we’ve seen in consumer and labor markets over the last several weeks. This is a noteworthy shift in the environment and something that we think capital markets aren’t yet fully appreciating.

"We are not seeing the same growth in consumer spending that we had in prior quarters. There was less traffic in the retail venues that we partner with…there are clear signs of a softening labor market and the tightening of the consumer budget." - Citigroup (C 0.00%↑) CFO Mark Mason

Struggling but Spending No More?

We’ve highlighted that lower-income consumers are struggling for many months, but up until the last few weeks, I would have said that this consumer is “struggling but spending.” We are now picking up some signals that the “spending” piece may be changing as confidence remains low, excess savings are depleted, and, most importantly, labor markets are softening. In addition to Citi’s comment on labor markets, Fastenal also noted that “sluggish business activity…has persisted long enough at this point to be spurring an uptick in layoffs and shift reductions.” Strong labor markets have been the lynchpin of current economic strength. If they are beginning to weaken, then it could cause a more significant consumer pullback.

The signs of a possible pullback extended beyond Citi and Fastenal. Helen of Troy noted that the health of the consumer had “worsened,” and Pepsi reported a sharp drop in growth. While not a major economic player, small-cap sushi chain Kura gave insightful commentary about its restaurants. It saw a “sudden and unexpected” drop in traffic in mid-April, which it believes was caused by macroeconomic trends including a perception among consumers that restaurants have become poor value.

"What we have seen instead is a general perception that restaurants as a category have become expensive introducing industry-wide pressures regardless of a given restaurant's relative value." - Kura Sushi USA (KRUS 0.00%↑) CEO Hajime Uba

Toward a Mild Recession?

Taken together, these data points seem to be more significant in magnitude than they have been in previous months and may be the beginning of a downward trend, perhaps towards a mild recession that most had been expecting for years. In retrospect, it’s possible that NBER may ultimately determine that we have already been in a recession for some time. As Fastenal noted, ISM has been sub-50 for 19 of the last 20 months and the unemployment rate has now risen by 0.7% from its lowest point of the cycle. 

Source: Fastenal

The AI Craze

Arguably the strongest force preventing a recession to this point has been the AI craze. But even here the fervor seems to be calming some, at least in the near term. Our technology section is still dominated by comments on AI, but this week it felt most appropriate to highlight a bearish argument from Goldman Sachs’ head of global equity research, Jim Covello. Covello’s argument isn’t new (AI is too expensive) and it’s a classic bear perspective on new technology (that ultimately is likely to look foolish), but it may reflect some shifting change in general mindset.

“Currently, AI has shown the most promise in making existing processes—like coding—more efficient, although estimates of even these efficiency improvements have declined, and the cost of utilizing the technology to solve tasks is much higher than existing methods. For example, we’ve found that AI can update historical data in our company models more quickly than doing so manually, but at six times the cost” - - Goldman Sachs (GS 0.00%↑) Head of Global Equity Research Jim Covello

Still, it’s important to note that the consensus seems to be much more positive than what we’re highlighting. JP Morgan and Wells Fargo both reported last week and characterized the economy as stable and moderately slowing, not really a cause for concern. Delta, despite missing earnings, also said that travel demand was still strong. In editing this week’s newsletter, I did struggle to weigh this more positive commentary against the more pessimistic commentary highlighted above. Ultimately, I thought that the more optimistic comments were more lagging than leading indicators though.

Fed's Balancing Act and Uncertain Outcomes

Clearly, the slowing data is impacting Jerome Powell. Last week he said that the balance between inflation coming down and labor markets cooling is the thing “[keeping him] awake at night.” It suggests that the Fed is getting much closer to lowering interest rates. It still sees policy as restrictive. As such, rate cut expectations are rising and many are hoping that the Fed will start to communicate a change in policy direction at Jackson Hole in August.

If our reading on the current balance is correct, it’s not clear whether looser monetary policy or slowing growth will end up being the more dominant factor over capital markets. However, typically, monetary policy is the stronger force.