Chart of the Day - financial conditions
I am on an email thread with some very savvy market observers. There is some discussion and consternation on the move in the equity market of late.

A couple people think we are close to a turn in the economy & the mkt is looking through the bottom. I have respect for their opinions. However, many others point to the falling new orders for ISM mfg & services, or the increase in continuing jobless claims, as a sign that we are in or about to be in a recession.

Another gauge to consider is the change in the ISM headline itself. When we look at the yoy change in ISM & compare it to the SPX equity risk premia, equities appear too optimistic. This risk premia considers the relative change in SPX vs. Treasuries & thus takes into account the rate environment.

Of course I love the use of ISM, ISM new orders and jobless claims. Those are among my favorite indicators. However, I wanted to add something different to the discussion and so I looked at financial conditions.

Recall JayPo said this in June of last year: "We have, of course, ways—rigorous ways to think about it, but, ultimately, it comes down to, do we think financial conditions are in a place where they’re having the desired effect on the economy?"

Then in December, he gave us an update: "Financial conditions fluctuate in the short term in response to many factors, but it is important that, over time, they reflect the policy restraint that we are putting in place to return inflation to 2 percent."

The top chart shows fincl conditions (inverse) vs. the yoy PCE the Fed's preferred inflation gauge. Yes, conditions in white have tightened back to 2019 levels. These are well above 2020 & 2008 levels. These conditions do not appear to be quite where needed to get PCE to 2%.

In fact conditions appear to be running at levels we saw before the GFC when inflation was above 2% & that was in a benign inflation environment.

The bottom chart shows the same fincl conditions index (not inverse this time) & compares to my bond vs. stock indicator (ttl return of SPX vs. Treasuries ttl return). We can see that even with conditions where they are now, we should expect to see bonds outperforming stocks to catch up to the monetary policy tightness already in the pipeline.

We are all data dependent right now. The Fed, the market, the pundits & politicians. Decisions are made on the data that comes out. However, if we step back & listen to what has been said & the effect it has had already, we may be better served in anticipating the action we will see.

Stay Vigilant
#markets #investing #stocks #bonds

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