Fantasies Unraveled

A couple of trade deals, accompanied by an equity rally, and all of a sudden the recessionistas go running for the hills. It's almost as if we're reliving the exploits of

primetime TV in the 1980s. I like to incorporate pop culture into each week's musings, but I have to admit, I've been running low on ideas that involve just music or movies. A fellow advisor gave me the idea to start incorporating television shows into the mix, which allows me a new universe from which to pluck inspiration for the weekly musings. This week's inspiration comes from the TV show, "Fantasy Island." Here's some trivia to consider:

• This show aired for 7 seasons, from 1977 to 1984, and achieved a Nielson Rating of 21.4, which was for the pilot episode. That means that nearly a quarter of the television audience in the late 1970s watched the show. While not having won, the show was nominated for 7 Emmy Awards.

• The show featured Richardo Montalban as the charming Mr. Roarke who would welcome guests to the island to play out their fantasies - some good, some bad. Herve Villechaize played Roarke's assistant, Tattoo, who famously rang the bell in the opening credits to signify that the guests were arriving as he yelled out, "De plane! De plane!"

• The opening scene showed the island coast of Kauai, Hawaii. However, the bulk of the show was shot in Burbank, CA. The famous tower where Tattoo would ring the bell was located in the Los Angeles County Arboretum in Arcadia.

• The original pitch for the show was a joke. Famous TV producer Aaron Spelling was pitching ideas for shows to ABC executive Brandon Stoddard, who rejected all of his ideas. Finally, Spelling blurted out, "What do you want? An island that people can go to and all their @$%&! fantasies will be realized?!" Stoddard loved the idea.

Here's what we've seen so far this week..

Powell's Inflation Fantasy. Last week, we mentioned how the Fed's latest FOMC statement noted "risks of higher unemployment and higher inflation have risen."

Things didn't play out the way Powell expected this week, as inflation data was weaker, not stronger. The Consumer Price Index came in lower than expected for April (+0.2% vs +0.3%) and the Producer Price Index came in much lower than expected (-0.5% vs +0.2%). April was the first full month for the rise in tariffs to be reflected in the data. It's curious how Powell is expecting higher inflation when CPI has dropped for four consecutive months on a year-over-year basis. The Cleveland Fed's Nowcast publication of inflation for May shows little change at +0.1%.

The steep drop in the Producer Price Index could bode well for consumers moving forward, as producers will be hard pressed to keep current prices where they are and run the risk of losing customers. While services still remain elevated in the CPI numbers, everyday goods such as meat products, fruits & vegetables, dairy, and bakery products were lower in April. The cost of items that were expected to be most affected by the U.S.-China trade war - Apparel and Agriculture were lower in April. While a few items in the Producer Price Index went up in April, Transportation and Warehousing plummeted.

At the same time, April saw a record amount of Customs Duties collected (+$16.3 billion). While tariffs were higher, consumers didn't seem to suffer much at the cash register. Due to the current trade agreement with China, the U.S. Effective Tariff Rate came down. Prior to the "China Pause," the effective rate was 24%. Currently, the rate stands at 14%, which begs the question, where are the risks for higher inflation? Could inflation rise - sure. But we have to keep in mind that even a 1% increase (100 basis points) in the CPI from 2.3% to 3.3% would still have inflation running below the historical average.

The Market's Fantasy Recession. During the first few days of April, when stocks were down about 16% from the highs, the Wall Street Journal decided to post a

headline declaring that the Dow Jones Industrial Index was headed for the "Worst April Since Great Depression." Keep in mind, this was posted only a week and a half into the month, with no regard for how the rest of the month might turn out. At best, this headline was misleading and at worst, it was journalistic incompetence. The Dow Jones would go on to finish down only -2.8% for the month of April, hardly comparable to the 22% drop for the Dow Jones in April of 1932. The financial media are one thing, as they are compensated to keep people clicking on their articles or watching their programs. However, when it comes to the so-called "experts," more objective commentary should be expected.

Trade progress has definitely led to a reduction Just six short days ago, Goldman Sachs stated that the market could drop another 20% and that recession risks were much higher. Now, there's no guarantee that recession is non-existent, just like there's no guarantee that recession is imminent. Either scenario is possible, but to try and scare people with "what ifs" and "maybes" is just not responsible. By the way, that headline with the Goldman quote was published just after the market had already recovered 11% off the April.

7th low. If that were not comical enough, JP Morgan released a statement just 4 days after the Goldman headline stating that they were dropping their earlier call of a recession in the U.S. All-in-all, a more reasonable and measured communication with the public has been warranted over the past 60 days instead of grandiose headlines and yet unproven possibilities. If investors could accurately predict the beginning and end of recessions, there would be a lot more billionaires in the world.

Back To Reality.  The weekly guests on Fantasy Island would come to their senses and realize the errors of their ways by the end of each episode. As investors, we too can learn from following grandiose and fantastic commentary in favor of rational investment advice and sound economic data. So far, the recovery from

the April lows has mirrored the speed and voracity of the post-COVID rally. However, what is more impressive and, in our opinion, healthier about this recovery is the fact that it took place without extraordinary fiscal and monetary intervention. Could we retest the lows? That's always a possibility. However, there are good reasons to believe the worst is over. I have touched on the Zweig Breadth Thrust having triggered a couple of weeks go. Now, investors are certainly hearing about the dreaded "Sell in May and Go Away" trading

moniker, but this year could be different. Typically, the Zweig Breadth Thrust doesn't trigger prior to the month of May (see our commentary from last week). However, May is looking especially positive this year, as the S&P 500 Index is up more than 6% at the half-way mark this month. When the month of May is up more than 4%, the forward returns for equities are quite strong, with the index being higher in every instance and the average return greater than 19%. On the economic front, both the consumer and corporations in the U.S. appear quite healthy. First, on the corporate side, when compared to previous recessions, U.S. corporations remain prosperous and profitable.

Going back to 1950, data on corporate health shows that during the median recession case, corporate profitability declines substantially. That's not the case at present. What's more interesting, is even in those periods with corporate profitability is strong with no resulting recession, profitability pales in comparison to the current state of U.S. companies. In addition, with more than 90% of S&P 500 companies having already reported Q1 earnings, 78% have beat analysts' estimates, which is above both the 5-year and 10-year averages.

Speaking of earnings, companies typically forecast bad news on earnings calls with the hope of getting some of the bad news out in the public early to go ahead and let the stock adjust before the really bad news comes out. So far, only 2% of companies have mentioned "layoffs" in Q1 earnings calls. This would indicate that there are few plans to layoff workers for the time being. That supports the latest labor market data as Initial Jobless Claims came in as expected this week and Continuing Claims came in lower than expected. As it stands, there is no ramp up in claims remotely close to pre-recessionary periods.

Second, consumers remain resilient. Retail Sales came in slightly higher than expected for April (the month that tariffs were supposed to cripple consumers). Other than Student Loans, all other areas of consumer debt are being paid in timely fashion. Obviously, recent executive action by the White House has caused delinquencies on student debt to rise. An interesting note about delinquencies is that with regard to Credit Card debt, delinquencies have declined. Like the weekly guests on Fantasy Island, it's time to learn from past mistakes and move forward with some comfort that the world isn't coming to an end - at least not yet.

The famous opening credits...

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