Every investor and fiduciary strive to better understand the direction of markets and the economy. But all of us look at incoming data through the lens of our own preconceived bias that leads us to cherry pick the data that confirms what we already think is going to happen. The current state of the economy and markets offers a little something for everyone. Those of us who are bearish can find data every day to confirm our existing thesis, but so can the bulls. In Edwin Lefevre’s truly timeless investing classic, Reminiscences of a Stock Operator, the protagonist is advised by a sage elder to never describe oneself as a Bull or a Bear, because it will color how you process new information. Instead, every day the goal should be to have an open mind.

I don’t exclude myself from, at times, failing to overcome the dissonance that invariably emerges when the data come in different than I thought. Every year somehow, I expect and predict the Mets to have a better record than the Yankees, and almost every year, I’m wrong. Professional gamblers will always warn the novices to keep emotion out of betting. Never bet on your favorite team to win. Why? Because emotion is guaranteed to be involved when someone is analyzing the likely winner of a game when one has a rooting interest in the outcome. With investing, the battle to overcome cognitive dissonance is no different as both money and ego are involved. Money and ego are powerful forces that can overwhelm calculated decision making.

Stocks are up this year or are stocks down this year? It all depends on what data you choose to look at. The most popular way to look at equity performance is the Market-cap weighted S&P 500®, which is up roughly 9% this year, but more than 100% of the upside contribution can be attributed to seven mega-cap tech names. The balance of the other 493 stocks is down for the year. If we were to look at the Equal-weighted S&P, that index is down small for the year. The small-caps that make up the 2000 companies in the IWM index have been sideways to down all year long and micro-caps (IWC) have been worse.

The economy has grown net of inflation this year or the economy is already in recession? It all depends on whether you choose to look at GDP, GDI or the average of both. GDP measures all that we produce while GDI measures all the income that comes from all that production. Ideally, these numbers should show the same results, but the reality is that due to error in the data the two series diverge. GDP suggests the economy is growing in real terms at around 1% while GDI (net of FED P&L) has been contracting. THE NBER, the entity that officially declares and dates recessions, uses the average of both. That series, called the GDO has been slightly negative four of the last five quarters.

How about labor? Is the labor market strong or weakening? Here we have lots of metrics to support both contentions. The three-month average growth in Non-Farm Payrolls is still over 200,000 jobs a month, but it was previously running at over 300,000, and negative revisions seem to be accelerating as they always do at this point in the cycle. Job Openings relative to unemployed are off the highs but still well above the highs of previous cycles. The quits rate has fallen which indicates less confidence among workers that they can leave to find a better job. Hours worked are falling at a precipitous rate but have only fallen to around the long-term average. Weekly claims have risen off historical lows but lately have been settling in at a low level. Ultimately, the labor market remains incredibly strong, but it is softening very, very slowly.

I could go on. Housing prices remain resilient but overall housing activity is the lowest in decades. Accumulated savings are just off all-time highs but the savings rate is terrible and credit card balances are making new highs. Overall delinquency rates remain low but they’re hooking higher. The consumer is still strong but traffic trends at retail and restaurants continue to weaken, and recently, at an accelerating rate. Liquidity is being drained but liquidity (by various measures) remains above long-term trends. Corporate earnings were “better than expected” in Q1, but equal weighted Nasdaq earnings are down roughly 8% y/y.

So where does that leave us? It leaves reflecting on one of our favorite quotes from one of the world’s greatest macro investors, Stan Druckenmiller who said simply, “Never, ever invest in the present”. The “present” situation remains strong, but the weakening trend, when we take in the preponderance of data, is increasingly clear. We believe that the Fed’s tightening manifests in the economy with “long and variable lags”. Every day another business is rolling debt to a far higher cost of capital than they enjoyed previously.

What is also clear is that the labor market is secularly tight, and it will take a meaningful recession to weaken the inflationary contribution from higher wages. Our view is that the Fed has expressed the will to stay “higher for longer”, because they appreciate that the constrained labor supply is not going away outside of a much weaker demand environment.

In the spirit of always being open minded, if we see inflation continue to decelerate while growth remains about static, I would have to be willing to capitulate and turn more bullish. That however, is not the trend.

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