Peter Navarro’s Weekly Market Wrap – Cinco de mayo, 2023

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Hi. Peter Navarro here and in this episode, I’m going to introduce what I hope will be a weekly feature of this substack and podcast – an end of week wrap on the economy and financial markets.

I’m trying this based on the polling feedback you kind folks in my substack audience have provided: Over 40% of you said you wanted to see more about the economy and markets.

In fact, your request is in my old wheelhouse. Back in the day, when I was a professor at the University of California Irvine and before my days in the Trump White House, I published my Savvy Macrowave Investor newsletter.

In that newsletter, I made several of my best market calls, including a call to cash in November 2007 – you may recall November 2007 was the eve of the biggest stock market crash since the Great Depression.  In that newsletter, I also was months ahead of the collapse of the housing bubble, to which I had a front row seat in Southern California.

Two basic concepts underlay that original newsletter. The first is the idea of a “Macrowave”.

Macrowaves represent economic shocks that can come about through random exogenous events like hurricanes or tsunamis or through geopolitical events like Russia’s invasion of Ukraine. These Macrowaves ripple through the economy and financial markets in ways which, if you are savvy enough to understand, can either make you money as a nimble investor or protect your own portfolio.

Perhaps the best example of a Macrowave is embodied in the title of my first book on investing in 2004, “If It’s Raining in Brazil, Buy Starbucks.” For more than 150 years, Brazil has been the largest coffee producer in the world.  So if it rains in Brazil to break a drought, the coffee crop will likely be more plentiful and coffee beans will fall in price. Starbucks will therefore pay less for its coffee beans and make a better profit margin. Because stock prices represent investor expectations about a future stream of a company’s profits, Starbucks stock should rise on the news of raining in Brazil. So buy Starbucks stock when you see that Macrowave hit.  QED

The second big concept underlying the way I think about the economy is a simple forecasting model that tells us that the growth of any country’s gross domestic product or GDP is driven by only four engines: consumption, investment, government spending, and net exports, which is simply the difference between how much a country exports and how much its imports.

And here, it should be obvious that if America runs a trade deficit, its net exports will be negative and this will be a drag on growth.  That’s why trade deficits are bad for America.

Alright let’s quickly put some of this thinking to work: In the last print out, real, inflation-adjusted GDP growth was at a stagnant 1.1% annually, significantly less than the roughly 3% our economy should at least hit.  

To figure out which of the four engines of GDP growth are hitting on all cylinders or sputtering, we can go the Department of Commerce’s Bureau of Economic Analysis and look at Table 2 in the BEA’s GDP report.  This Table 2 measures the “contributions to percent change in real [inflation-adjusted] gross domestic product” by each of the four major growth drivers.

Here, we see that despite consumer confidence falling to a nine-month low, which should depress consumer spending, consumption actually ran hot, contributing 3.7% to the calculation.   

On the downside, however, business investment contributed a minus -2.34%, as companies ran down their inventories in lieu of production while nonresidential investment also fell.

Rounding out the calculation, government spending contributed a little less than a point and the net export contribution was close to a wash. 

So what does this tell us? First, the question of whether we will have a recession will hinge upon how resilient the consumer remains despite being battered by rising credit costs, tightening credit, a wave of evictions and repos, the prospect of job loss in a possible recession, and falling spending power as inflation erodes wages which are not keeping up with said inflation.

Second, businesses as a whole seem to be reacting quite strategically to what they see as a looming recession by trimming inventories.  Paradoxically, this in some sense is bullish as tight inventories will encourage businesses to quickly ramp up production should the economy ramp back up.

The other bullish news for the corporate sector is that the earnings season appears to be treating many companies kindly. In fact, S&P 500 companies are recording their best performance relative to the expectations of Wall Street analysts since the fourth quarter of 2021 and, quoting John Butters from FACTSET, “both the number of companies reporting positive EPS surprises and the magnitude of these earnings surprises are above their 10 year averages.”

So looking at the GDP equation alone, it is sending neither overtly bullish or bearish signals but suggests more of a coin toss.  With such only 50-50 odds, an intelligent speculator understands that it is dangerous to go either long or short in the market and cash is the preferred position for now.

Now here’s my last point: The US labor market remains very tight, which makes any large-scale layoffs at least at this point unlikely. So as long as people keep picking up paychecks, the economy may be able to limp along and corporations will at least be able to beat expectations with their earnings. And that is bullish for the financial markets and Wall Street, no matter how painful it is for Main Street.  And please note here, the ongoing Biden border invasion is disproportionately inflicting great pain on black, brown, and blue-collar Americans in particular as the several million new arrivals over the last several years are pushing down wages and pushing Americans out of their jobs.

The other part of this big picture is the set of Macrowaves now simmering on the geopolitical risk pot. Most prominently, Russia’s war on Ukraine continues to drive inflation in the oil and grain markets.   And Communist China continues to beat the drum of war over Taiwan which has major implications for commodity markets and is triggering major supply chain structural adjustments as foreign investment flees the Chinese mainland.  Each of these Macrowaves must be closely monitored as any major negative development will trigger a big market selloff.

Last but not least, domestically, the commercial real estate market is a ticking time bomb as corporations go to remote work and flee to the burbs.  There is also the looming political war over the debt limit which is rattling Wall Street. ….  Stay tuned on both of these risks.

Okay, that’s quite enough for one sitting. There is a lot of meat on this particular bone, but I always urge my readers to improve their economic and financial market literacy so they can make their own choices – I’m not an investment advisor here, just an economist with some ruminations.

To the goal of boosting market literacy, and in appreciation, I’m going to once again offer my substack subscribers a free coupon to my online Strategic Macroeconomic Course. It’s the one I taught for years at the University of California-Irvine to MBA and undergraduate students. 

If you are interested, JUST click on THIS LINK for your free coupon.

Peter Navarro. Out.