PPI comes in soft … bankruptcies hit a 13-year high … keep an eye on the slope of the unemployment rate … Luke Lango likes the Mag 7 stocks here

We’re in a busy news cycle. Today, let’s take a tour through some of the major headlines impacting the markets.

This morning’s Producer Price Index showed that inflation continues falling

Wholesale inflation increased 0.1% month-over-month, less than the 0.2% forecast.

The real eye-catcher, however, was the year-over-year reading. It came in at 2.2% which was miles below last month’s yearly reading of 2.7%.

Core PPI, which strips out volatile food and energy prices, was unchanged from June.

Now, this reading looks good on the surface – and frankly, it is a good reading. But let’s be aware of one contrarian analysis.

Santander’s chief economist Stephen Stanley has been one of the most accurate Wall Street forecasters on inflation in recent years. And he highlighted that this cool reading benefited from the erratic “trade” category which measures profit margins. Said margins aren’t the same thing as what producers charge for their goods.

If we strip out this category from the reading, core PPI climbed 0.3% on the month.

From Stanley:

The guts of the report are, if anything, pointing in the opposition direction [of slowing inflation].

We’ll get additional color as to whether Stanley is correct in tomorrow’s CPI report, which is the main inflation gauge the market is watching. As I write, the Cleveland Fed’s Nowcast model predicts the year-over-year headline reading will come in at 3.01%.

In any case, no curveballs are expected that would derail a rate cut from the Fed next month.

Switching gears, the number of bankruptcies just hit the highest level in 13 years

Chapter 11 bankruptcies just hit a new multi-year high of 2,462. This figure has more than doubled in the last two years.

Below, we look at a chart dating to 2010 for broader historical context. Note how we haven’t seen this volume of bankruptcies since the aftermath of the Great Financial Crisis.

From Former White House Economic Advisor Steve Moore:

Those numbers don’t lie. Those are just for the half of the year. I think that the high interest rate costs are a problem.

When I talk to people who run manufacturing firms and construction firms, they remind me that the inflation affects them too.

The cost of their materials, their cost, their labor, the cost of all of the things that they have to buy is up 20% and it makes it really difficult for small businesses to make a profit.

Clearly, businesses need lower interest rates – and they’re not the only ones.

Below, we look at unrealized gains and losses on investment securities held by U.S. banks. Thanks to the Fed’s rate hikes, banks now sit on $517 billion of unrealized losses.

Is that a lot?

You decide. Here’s a chart dating to 2008 to provide some context…

Due in part to deteriorating data such as this, futures traders are certain we’re in for rate cuts next month

The question is “will it be one or two quarter-point cuts?

As you can see below, it’s pretty much a coin flip today with 53.5% odds we get a 50-basis-point cut versus a 46.5% probability it’s just 25 basis points.

It’s worth noting that this morning’s PPI report flipped these numbers. As of yesterday, the probability of one quarter-point cut was 52.5%, while the odds of 50 basis points of cuts came in at 47.5%.

Now, this certainty about rate cuts reflects a recent shift in thinking – namely, that the Fed views its war against inflation as largely won, so now it’s time to shore up recent weakness in the labor market.

But former Treasury Secretary Larry Summers fears this is misguided. It’s worth paying attention to Summers as he predicted the soaring inflation, as well as how markets and policy makers were way off base earlier this year, overstating how many rate-cuts we’d get.

Let’s go to MarketWatch:

Summers said that recent data indicating a slowdown in inflation are somewhat of a mirage caused by the normalization of prices following the pandemic — a trend that he said markets shouldn’t expect to continue.

“Given the magnitude of our fiscal challenges … I think there’s a bit of excessive optimism about inflation,” Summers said, referring to a recent trend of record budget deficits that he believes will continue to support demand and put upward pressure on prices.

Summers added that the Fed is underestimating the long-term level of interest rates, known as the neutral rate, that will be necessary to keep prices from rising too quickly.

“My best guess is [the Fed] is badly wrong that the neutral interest rate is 2.5%,” he said. “My guess is that the neutral rate is 4.5%.” Fed officials raised their estimate of the neutral rate to 2.8% earlier this month.

The risk here is that the Fed cuts rates too soon, which reignites inflation at a time when the economy is teetering on the edge.

While that is a risk, in our view, the Fed is right to focus on the labor market

No one likes inflation. But with a significant risk of a labor-market induced recession, there’s a strong argument that the Fed should accept a potential resurgence in inflation as collateral damage of bolstering the jobs market.

As we’ve detailed in the Digest, the latest job statistics revealed that unemployment has jumped to 4.3%.

Remember, it was only in June that the Federal Reserve members forecasted that the median unemployment rate would come in at 4.2% at the end of 2025.

The fact that we’re already clocking in above that projection is concerning.

We’ve also detailed how this 4.3% reading has triggered the Sahm Rule, which is one of the most accurate recession indicators we have. Since 1950, there has only one false positive (in 1959). But even in that case, the U.S. entered a recession six months later. The indicator correctly flagged the other 11 recessions.

Now, our Editor-in-Chief Luis Hernandez has pointed out that it’s hard to have a recession when so many people have jobs. He’s right – but the wildcard issue that could complicate things is the speed at which unemployment is accelerating.

Below is a chart that shows how this acceleration has manifested in past recessions.

You’ll see that unemployment usually begins to rise at a relatively tepid pace before angling sharply higher after passing a “point of no return.”

The blue path is today’s latest unemployment progression. The gray lines show prior recessions from 1960 through 2008. Notice their slopes.

This is partly why legendary investor Louis Navellier recently said:

Unemployment has risen from 3.4% to 4.3% in the last 15 months. It’s going to be 5% by October…

So, the Fed has to do something. They can’t just be like an ostrich with their head in the sand and be oblivious to everything.

However, other indicators suggest the economy is humming along just fine

The research shop Apollo just posted about what the daily and weekly indicators are telling us about the U.S. economy. Its conclusion was that a recession still isn’t in sight.

Here’s some of that data from Apollo to give you a flavor for this:

Daily Data

Restaurant bookings: Strong

TSI air travel data: Strong

Tax withholdings: No signs of a slowdown

Weekly data

Atlanta Fed GDPNow: 2.9%

Fed’s weekly GDP index: 2.2%

Retail sales: Strong

Jobless claims: Slightly weaker

Hotel occupancy rate, daily, rate, and RevPA: strong

Bank Lending to firms and consumers: Growing

Meanwhile, if we look at the Mag 7 stocks, it appears the recent selloff might have been overdone relative to earnings – is this a buying opportunity?

As you can see below, relative earnings growth of the Mag 7 stocks has continued climbing despite their relative prices getting hammered.

Our tech expert Luke Lango has been stressing this same point to his readers.

Let’s go to Luke’s Daily Notes in Innovation Investor:

Big Tech stocks have been punished in the recent stock market sell-off amid worries about the AI Bubble popping. But recent earnings reports from AI companies suggest that the AI investment super-cycle remains vigorous.

That – plus recent persistent underperformance in Big Tech stocks and discounted valuations – should force a rotation back into Big Tech.

The S&P 500 Equal Weight Index has outperformed the S&P 500 for five straight weeks. That is only the second time in this tech bull market that the S&P 500 Equal Weight has outperformed the S&P 500 for five straight weeks. The other time was in early January 2023 – right before the S&P 500 outperformed the S&P 500 Equal Weight for five straight weeks as investors rotated back into Big Tech.

Also, every single one of the Mag 7 stocks now trades at or below their 5-year average forward earnings multiples except for Apple, so valuations on these hot stocks have fully reset. We think money will flow back into them over the next few weeks. 

By the way, Luke has been on a buying spree of top-tier tech stocks over the last week in Innovation Investor. If you’re a subscriber, make sure to log in to review the recent additions. And if you’d like to learn more about joining Luke in Innovation Investor, click here.

So, how do we handle today’s seeming inconsistency between bearish and bullish news?

The same way we’ve handled it for over a year at this point…

Mind your stop-losses, use appropriate position sizes, and maintain a diversified, balanced portfolio. But with those protections in place, keep riding your positions for however high they’ll take you. You never want to fight a bullish trend.  

We’ll keep you updated on all these stories here in the Digest.

Have a good evening,

Jeff Remsburg