'The private sector data tells us that the economy is weakening': Green on U.S. economic outlook

Key Concepts

• Personal Consumption Expenditures (PCE) Price Index: A key inflation measure watched by the Federal Reserve.
• Hawkish Cut: A Federal Reserve interest rate cut accompanied by language suggesting a potential pause or future tightening.
• Labor Market Data: Indicators of employment and economic health, including official government data and private sector reports.
• MAG 7: A group of seven large technology stocks that have historically driven market performance.
• Late-Stage Cyclicals: Companies whose performance is tied to the later stages of an economic cycle, such as energy and industrials.
• Consumer Sentiment: A measure of consumer confidence and optimism about the economy.
• Fixed Income Markets: Investments in debt securities, such as bonds.
• Equity Markets: Investments in stocks.
• Real Yields: The yield on a debt instrument after accounting for inflation.

Inflation Data and Federal Reserve Policy

The discussion begins with the release of delayed inflation numbers for September in the US, specifically the Personal Consumption Expenditures (PCE) price index, which registered at 2.8%. Michael Green, Chief Investment Strategist at Simplify Asset Management, expresses that this data is unlikely to significantly influence the Federal Reserve's upcoming announcement. He anticipates a Federal Reserve rate cut, noting that multiple Fed members have signaled this possibility. Green characterizes this potential cut as "hawkish," meaning it will likely be accompanied by language indicating a potential pause or even future tightening, despite the cut itself. The rationale for this cut is attributed to muted inflation data compared to earlier expectations and growing concerns about the labor market.

Labor Market Concerns and Data Sources

Green elaborates on the labor market concerns, highlighting that official government data is delayed and will not be available to the Fed before their announcement. However, the Fed is closely monitoring private sector data. Reports from Rellio and ADP suggest a weakening economy and labor force. While there are some positive developments, such as a potential rebound in employment for US-born individuals (an objective of the Trump administration), the private sector data points towards economic weakening. Green emphasizes that the "private sector data is telling us that the economy is weakening."

Market Impact of Expected Fed Cut

Given the high expectation of a Federal Reserve cut, Green does not anticipate it to "meaningfully move the markets." However, he suggests that the language accompanying the Fed's announcement and the subsequent speech could lead to a "backup in long-end yields." He clarifies that long-end yields are not "running away from the Fed," meaning a cut is unlikely to trigger a scenario of 6-7% 10-year yields, as such outcomes appear implausible given the current economic conditions.

Market Volatility and Sector Rotation

The conversation shifts to recent market volatility, particularly in tech stocks, and a general movement of money across the board. Green describes this as a "tug-of-war." He observes that leading stocks are losing momentum, and the reliance on "MAG 7" stocks is diminishing. Instead, there's a rotation into "late-stage cyclicals" like energy, and commodities have seen a rally. These movements could indicate an early-stage recovery or simply a late-cycle rotation where investors are uncertain about the direction. Green notes that the significant capital that could be deployed from a company like Nvidia to buy the entire small-cap index suggests this rotation could continue, contributing to the ongoing volatility. He also mentions that the US has experienced a "near manufacturing recession for roughly two years," and Canada has suffered alongside.

Consumer Sentiment and Retail Outlook

Regarding consumer sentiment, Green acknowledges a slight improvement, attributing it to a combination of factors. Firstly, fears about inflation have receded, a key finding in surveys like the Michigan survey (though he cautions about its methodological issues). Secondly, he reiterates that some job losses appear concentrated in the immigrant community, while native-born employment is rising, which is expected to positively impact consumer sentiment.

Looking ahead to Christmas retail, Green observes less discounting compared to the previous year, when fears of tariffs pulled forward spending. Inventories are at lower levels. He notes an uptick in credit usage (credit cards, buy now pay later), suggesting consumer hope and spending. However, the "absolute quantities that people are buying are not nearly as robust as what we're seeing in the pricing components," which reflects the reduced discounting.

Investment Strategy for Year-End and Beyond

Green offers advice for investors heading into year-end and the next year. His primary recommendation is to view rising fixed rates, particularly the 10-year yield moving above 4%, as an "opportunity to lock in real yields." He expresses skepticism about equity market valuations, which he believes remain "highly contingent on employment in the United States," making him "nervous about the equity markets." Conversely, he is "opportunistic in the fixed income markets."

Conclusion

The discussion highlights that the upcoming Federal Reserve decision is largely priced in, with a hawkish cut anticipated due to weakening labor market data, despite delayed official figures. Market volatility is expected to persist as investors rotate out of tech and into cyclical sectors. While consumer sentiment shows some improvement, the retail outlook for the holidays is characterized by less discounting and increased credit usage, with concerns about the absolute volume of purchases. For investors, the current environment presents opportunities in fixed income due to attractive real yields, while caution is advised regarding equity market valuations.