Well, stocks got racked on Friday And in this video, we've got to talk about are households going to drive us right into an earnings recession? And when could they potentially drive us into an earnings recession? So far, with over 72 percent of S P 500 companies beating estimates for their earnings which is slightly less than what you would usually get in terms of upside surprises for earnings, but still not in an environment where we're substantially recessionary. What are we facing in terms of an earnings recession? And when could it actually come? Well, Morgan Stanley has a piece on when we might actually see a bottom in consumers ability to continue to spend money. After all, after the reports that we've gotten for January, it certainly seems like the consumers are still doing just fine, unfortunately, leading to propped up inflation which is creating fears that uh oh, the Federal Reserve might have to do a whole lot more. And it's not just individual retail investors who are fearing that I believe based on on stock market activity, it's also institutions.

We're not yet convinced that inflation is absolutely on a downtrend. Once we have confirmation that inflation is, without, without a doubt on a downtrend. I Expect a lot of cash that is sitting on the sidelines that hedge funds Pension funds institutions, and Retail investor accounts to start flowing right back into the stock market. We're at some of the lowest allocations from cash to the stock market that we've seen in decades right now.

and part of that is due to substantially High bond yield rates. look for example, at the two-year or six month treasury bonds and bills you're looking at near a five percent yield, you could throw your money into Robin Hood or wealthfront or even Sofi right now and earn anywhere between four and a half to maybe five and a quarter percent in yield just sitting around even JP Morgan is picking up the phone calling people with balances in their bank accounts going, hey, want to lock up your money for six months and we'll give you a CD like those old things that Banks give for people who lock up their money and get a yield in return? Yeah, it's crazy right now. So the question is, why would you even bother investing in into stocks? The only rational explanation is that you would expect that once inflation provides confirmation that inflation is indeed trending down, all that money on the sidelines will look and say five percent is nice, but my opportunity cost sitting out on stocks might be 10 15, 20 percent. So maybe now is the opportunity to hop in even if we're slightly off lows and ride that wave.

Of course, the last reports that we've gotten with a Hot Jobs report that came out the day after the Federal Reserve meeting with a lot of folks putting on the tinfoil hat saying sure y'all scheduled a Fed meeting for a day after the Labor report and In Fairness. Usually the FED has their Fed meeting a week prior. It's the third week of January They usually have it here. They had it in the last week of January which rolled into February 1st thanks to the calendar of the FED generally holding this meeting on a Tuesday and then press conference on Wednesday And then of course, right after that, we got a CPI report that was hotter than expected with hotter revisions.

For the prior month, we got a Producer Price Index report with hotter than expected results and hotter revisions. From the prior month, we got a retail sales report that gave us a hotter than expected Report with hotter than expected revisions and then just yesterday we got a Pce, which is the Fed's preferred inflation gauge for January other than expected Pce report and hotter with more revisions. All this, while you've got multiple credit card companies suggesting boy, it just seems like people are still spending money. So when does that spending go away? And is it possible that this inflation is just going to continue? Well, let's take a look at what Morgan Stanley suggests is going on with individual household balance sheets, and maybe when those excess savings will go away.

Keep in mind, right before we look at this household report from Morgan Stanley there are really two trains of thought right now. One is that inflation is transitory. and yeah, we might have some volatile January data thanks to massive seasonal adjustments or just the January effect of going from a cold December to a warm Seas unseasonably warm January leading potentially to more spring style sales in January and a boost in temporary inflation. That is sort of the transitory argument.

And then of course there's the argument that, well, the numbers we had in the last three months of 2022 were all outliers now are facing slowing disinflation and we're probably going right back to the racist with inflation. So what says Morgan Stanley Well, of course Morgan Stanley says use that investor day a flash A sale linked down below for the programs on building your wealth, you get lifetime access to all of the new content that's added. All the new content I added now or ad now is done on our Blackboard which is really phenomenal for uh, teaching. People are really enjoying it and loving it.

And of course we do our daily course member live streams which you get lifetime access to if you join. So check that all out link down below. So what do we have here Morgan Stanley Telling us households have been using their excess savings savings level now? uh, however, now under shooting Trend Okay, this is this is the usual thing that I talk about where I get a little frustrated when people only look at the savings rate because excess savings are still so positive after the pandemic. but just so you can visualize the savings rate.

Some of y'all were asking that we visualized the savings rate, This is where you can visualize the savings rate you can see. Here, we sit roughly at the beginning of 2023, and that savings rate bottomed roughly around October September of 2022, that savings rate is returning slightly to Trend. However, we still sit below trend on that savings rate you can see. Obviously, during the Covet bubble, we had a massive increase in the savings rate and generally we match Trend right after all, that's why it's called Trend We kind of make the trend and then the trend line comes afterwards.

But anyway, right now, we are still substantially below that trend line. Uh, we're approaching that trend line though. Uh, we're expected to approach that trend line. uh by about 2024..

See if I draw this. Maybe to Q1 2024. Let's see, let's draw a line up to that. Yeah, I'd say that's about Q1 2024.

Still got a little bit of work to do. Maybe by Q2 Q3 2024, you actually get to Trend again on the savings rate. But right now where we sit, we're still quite a bit below trend on the savings rate. Generally, the personal savings rate sitting somewhere around five to seven percent.

Us right now sitting at about 3.4 percent. So this is where a lot of folks are concerned. Hey, how can the consumers hold up right? Well, graphically, here's one we expect. Maybe we see a bottom in earnings, right? So first, and we're going to align excess Savings to try to figure that out because we assume that if the savings rate is below Trend then people right now are still able to spend money to sort of avoid a recession.

But people are only able to exp essentially spend money to the point where they have excess savings or excess available debt, right? There are two ways you can continue to spend money when your income goes away, and that's either debt or money that you have saved up. And if we first start by aligning where we sit right now, I'm going to draw a red line going up roughly to where we sit right now. And when we look at cumulative excess savings, this chart here suggests we're still sitting at levels that's somewhere around. uh, two billion.

I'm sorry. this is two trillion dollars of excess savings. The chart is provided in billions and uh, we are. We're looking at thousands of billions, which are trillions and we're still sitting at quite a bit a high level of excess savings.

It doesn't really matter so much how much that number is though. I Think what matters more, and what is more telling is, where's the inflection point? Where do we go potentially? And this is Morgan Stanley's estimate from excess savings to a deficit of excess savings. So a negative excess savings means you have less money than you had before the pandemic, right? And so where does the chart go? negative Well, in my opinion, based on the sort of analyzing and sort of drawing a line on this chart, it looks to me like we don't go negative in excess savings until May of 2024.. Now that's pretty remarkable.

That really suggests that consumers have roughly another 14 to 15 months of excess savings. Which is really interesting because if you look at the inversion of the three-month 10-year yield curve which usually projects a recession within the next 6 to 18 months, it's worth worth noting that we've already been inverted for about seven to eight months. So if we take that off, the inverted yield curve we're looking at maybe about 10 to 11 months to go. that potential recession signal of of the latest The inverted yield curve would generally signal a recession somewhat aligns with the beginning of 2024, which is pretty close to aligning with when Morgan Stanley thinks we're going to go to negative excess savings.

So maybe the inverted yield curve is approximately saying q1 of 2024 for a recession, excess savings are roughly saying Q 2 of 2024. Now that's really interesting because it suggests that uh oh well. if we go into a recession, that could mean the most pain is still ahead of us, right? Well, that's maybe something where we have to look at history a little bit and think about this. So uh, we'll look at history and we'll We'll make some sort of uh, conclusions in terms of what we think in terms of stock market pricing.

So first of all, let's look a little bit historically. So if we look at the S P 500 at least as of the last recession, uh, well, that goes back to to I can't really get a chart going back further I'd like to get one to go back further. The covet pandemic was a little bit of an outlier. I'd like to get uh, the S P 500 going back a little bit more.

So let's go ahead and look at this together. here. let's see if we can get the S P 500 historical on St Louis Fed, uh or the Fred website. This is a fantastic way, uh, to see or to visualize what, uh, what valuations for stocks are doing.

Going back, uh, over time. Oftentimes able to Overlay this with recessions. but right now we're having a little bit of trouble getting that graph. so let's just Google it.

Say it. Let's go. Let's just go with S P 500. Uh, overtime with recession chart.

So that way we can kind of visualize that. Okay, let's try what Yardini has for us: S P 500 with recessionary Cycles There we go. Okay, that's exactly what we're looking for. Sorry for the delay there, All right.

So what's interesting here is recessions. When we zoom in, we see these sort of bluish lines here. Oftentimes we go back to recessionary eras, we'll see that recessions. align.

Potentially, at least in the last crisis. it looks like the recession almost aligned with this with the start of the recessional line with the top of the market, and we know that the recession and stock market bottomed in about February of 2009. which is interesting because it potentially suggests uh-oh as historically this start of a recession. Really? where stocks bottom out.

And this is something where Goldman Sachs told us about three weeks ago that recessions are usually when recessions start. they usually start the bottoming process for stocks. And that's because when we align the start of recessions with when we have a bottom of an earnings cycle, we could see that the stock market usually bottoms out about six to nine months before the bottom in earnings. So that's interesting because if we go back to 2009, potentially because this recessionary period over here lasted uh, really, about two years, it's possible that we bottomed out in earnings somewhere around the end of 2008, and we didn't actually hit our stock market bottom until the Federal Reserve broke something in February of 2002.

And so that makes us Wonder today. Okay, well, if earnings potentially are going to be at a bottom in well October of 2022, then maybe we've already hit a bottom in the stock market, right? Although what if earnings don't actually hit a bottom until we inflect a negative in excess savings? Well, that would align more with Q1 of 2024, which potentially suggests maybe the bottom is still ahead of us, right? If the recession is, maybe in the bottom of earnings is the first part of 2024. Oops. Let's actually go ahead and show the screen there.

There we go. Bottom of 2024 does that potentially forecast a bottom of the stock market and a leg lower still coming before the worst gets priced in. And this is really where you have two trains of thought. You have the historical argument that yeah, look, we aren't going to hit bottom until in the stock market until we actually price in that bottom of earnings and that bottom of earnings.

If it wasn't Q4 2022, more people are still spending through this earnings quote unquote recession. So maybe the worst is still to come. So this is where there are really two trains of thought that you have to evaluate. Okay, what works best for your situation? What do you believe? Because I believe there are two trains of thought.

Train of thought. Number one is, if we're going to have a bottom in earnings in Q1 Q2 bottom of 2024, bottom of Eps, then you're probably looking at a bottom in the stock market of somewhere around Q3 to Q4 23. that probably aligns with another large leg lower, and it probably also aligns with sticky inflation right? Because if we have sticky inflation, we're going to see that terminal rate from the Federal Reserve likely move from where we sit right now, which is about 5.43 percent when I checked this morning, to potentially a rising of six to maybe even 6.5 percent. Some even say seven percent as a terminal rate.

This is one scenario where when we align this this sort of historical data which is provided by Goldman Sachs. And of course, we can see this chart wise as well that generally the stock market bottoms about six to nine months before the bottom in earnings and the beginning of a recession can often start the bottoming process. So that means stocks eventually pull you out of a recession. So you don't generally want to invest in stocks at the sort of technical end of a recession, right? Then you can almost sort of align this here.

See, let's draw this graphically because there's a lot to align. So if we go over here and we suggest that a recession might be over by Q324, let's say let's call it recession over well. And then we have a stock market that pulls us out of a recession. And maybe that recession begins somewhere in Q423 where earnings basically hit rock bottom and that recession begins.

Then potentially that stock market bottom sits somewhere over here between Q4 and maybe Q1 2024. right? If we look at our crystal ball, maybe that's what we're looking. 2024. That's the thesis of sticky inflation aligning with excess savings are gone, and that is provided obviously by Morgan Stanley because that's what we're looking at here.

So again, if you want to see that here, when do we go to negative excess savings where consumers can no longer spend through a recession? Well, that's potentially uh, you know, Q3 Q4 or sorry, rather, uh, bottom of of people's ability to spend right? Uh, potentially aligns with Q4 q1 Q2 2023 to 2024 and when does that align with the bottom of of potentially earnings? Well, potentially that Q4 to Q2 as well. And then according to Goldman Sachs bottom of the stock market might be six months before that. So going back to this drawing over here that might say bottom is somewhere Q4 2023 I would say probably out to yeah, q1 2024 in this scenario because even if earnings bottom in Q uh, three, a Q2 Q3 with that excess savings, right? Q2 Q3 bottom and earnings over here, you've got that six to nine month rule that aligns your bottom a little bit earlier there, which aligns with the inverted yield curve, right? This is what the 310 is telling you. So bottom line scenario number one suggests sticky inflation, higher terminal yield.

When do earnings potentially bottom and how much before, uh, earnings bottom does the stock market tend to bottom? That's your scenario one where a lot of bears right now are saying you've got Morgan Stanley's Mike Wilson you've got Goldman Sachs you've got JP Morgan The the bear position is hey, look, we've still still got another big leg lower and that could potentially align with that recessionary Dynamic we're seeing now. Or oh yeah, maybe you do still have another leg lower and maybe that's what you want to be prepared for. And that's roughly what the timing would look like when we look at negative excess savings. and also looking at Q4 2022 is basically not that bad.

Like, sorry, not there yet, right? That's scenario number one. Scenario number two: is this idea that? okay, well, maybe maybe that bear case could play out, but maybe inflation proves itself as declining in the months of February Remember, these are February reports which come out a month later. so we would get these reports in March April May and those reports would be for Feb March and April. Maybe these inflation reports end up proving hey, don't worry, the January data was an anomaly and if the January data was an anomaly, then you know what? Maybe inflation will prove to be transitory.

We top out at 5.25 percent, we level off, and the stock market starts pricing. In all right, the bottom is behind us. We can continue to spend money, and by the time we actually get to where we get to negative excess savings, what potentially helps, refill the savings pot? Well, this is where in the favor of the Bulls In scenario two, you look over here at your savings rate, rebounding roughly at the beginning of 2024, second quarter of 2024, to where you could. Then, even though you've depleted all your excess savings, you're going right back to spending the money that you're making.

It's a thesis. Both the Bears and the Bulls have an argument here. The bear argument actually calls for a substantial amount of patience, right? Think about the bear argument. The Bears right now are saying: look, we're not going to hit that earnings bottom probably until Q2 2024.

we got a long way to go. That means the reset the bottom of the market might not be until Q4 2023 to Q1 2020. Uh, four, and uh. And that essentially also aligns with the three-month 10-year treasury.

So you get alignment with the inverted yield curve, negative excess savings a bottom, and EPs. And there's your bear case whereas your bull case is no, no, the January data is an anomaly. January is an um, you can't spell that at 5am. Uh, January is an anomaly and don't worry.

Feb March and April data will be great and we'll be back to the Moon. Okay, those are your two Theses and your two scenarios uh and I. Think Ultimately, there's probably a case for making a balanced portfolio allocation here, where you increase a higher level of uh of of your savings. So that way you're prepared in the event we do go through another layoff cycle, which is entirely possible.

No matter what job you have, it is entirely possible to get laid off. And that's unfortunate, right? It's very difficult right now, especially on small businesses to survive. I Was just talking to a commercial property manager about uh, which divisions in the commercial real estate space they're anecdotally seeing as most pained. and it's small mom and pop retail stores very difficult to get new business formation right now taking leases at least yesterday when I was in the Vegas Market to explore um, uh, real estate.

There where the most pain seems to be medical real estate obviously doing well, but hey, you could still have pain in medical real estate if rents go down, cap rates go down because you're saying Office Buildings or other spaces that could become medical spaces drive those rents down. So a lot of various pain it seems like uh, lower income and smaller businesses likely to get hit hardest the most. Though that doesn't mean larger companies aren't going to go through their layoff Cycles as we already know they very well are Wells Fargo laying off lenders almost all of the large Banks whether it's Goldman JP Morgan layoffs in multiple different departments from Financial advising to trading to Consulting consulting's getting hit, texts getting hit I would guess small businesses right now or potentially still jaded about having a hard time hiring. And so there's this idea that some of that employee hoarding is going on.

but what if that that employee hoarding ends up turning into employee paper handing in this bear case, right? Employee paper handing could actually align with the bear case I Hate to say it because obviously I lean more bullish. That's my bias. but the more you know I study the bear case, the more I realize yeah, there's there is a very much valid argument and we'll know within the next few months which scenario is more likely to play off. We can't just keep trying to explain away High Inflation As an anomaly.

the January reports fair game, massive seasonal adjustments uh, and massive. uh, a massive potential for anomaly with higher energy costs in January compared to December so pushes up your month over month cost both core and non-core thanks to the flow through of higher energy costs, but also going into a much seasonably Warner warmer. January Right, That's that's the way you could try to explain that away. But seriously, the the paper handing of the hoarding of employees.

So let's write that on paper handing of employee hoarding. That's not going to happen in the first quarter of 2023. First quarter of 2023, people still have hopium. People still have this belief that it's okay.

let's use our excess savings. Let's get through this recession. Let's just keep trying to expand the business and maybe take on a little bit more risk to expand the business once we once we bottom out and the reality is, that's not a bad Strat Strategy: If we end up having great reports in Feb March and April If we have great inflation reports Feb March and April and you are a small business that invested heavily at the end of 2022, you're going to get massively rewarded going into a bull cycle with more employees, more efficiency, and more capability of selling your goods and services. However, if you go into the bear cycle and you spend money on yourself or your business or whatever going into higher debt, well now all of a sudden you're going to have those higher debt payments for longer.

you're not going to be able to refinance your home or your property or or your rental property or business as quickly as you thought your credit lines for your business or your properties are more expensive. Now all of a sudden, you potentially actually have to start paper handing your employees because even though you thought you could hold on to everyone now, all of a sudden, you're like crap. I Actually can't That's the bear case. That's the bear case and so that that's really going to be a personal decision for you in terms of what you want to hedge for.

But boy, I mean I I mean some people come to me and they say Kevin what do you think about my situation I'm like 20 in margin right now because I think we've bottomed out and I'm like, well, that's fantastic if you're a scenario number two, that's miserable. If you're scenario number one, you know, even if you're all in right now, but you're not in margin. Okay, great yeah. Scenario number One's Gonna Hurt But at least it won't take you out.

Uh, right, you just have to basically dime in hand. Uh yeah. However, if you're leveraged and you're going into a scenario number one, it's gonna suck. And that's the case for still having some cash In my opinion, you know, whether that's 10, 15, 20, whatever.

That's roughly what I've been looking at in terms of Uh allocations now then then at least you have a little bit of insulation going into the scenario number one. So uh, that's that I think is very, very important and hopefully brings together some of the madness that's happening. Uh, look, there is. Still there is still an argument for Rapid disinflation occurring I mean look for example, at uh at what's happening with with uh, vehicle inventory and new vehicles I mean uh, you're getting smashed Morgan Stanley talks specifically about that.

Let's go a little bit further here. Let's go through some more of these charts. Here we go: look at this: uh. motor vehicle spending weaker than other durable goods due to a 5 million unit Supply glut notice I I Wrote this here in red but GM pause production to optimize inventory according to Detroit News Uh, the shutdown should be lasting two weeks in light.

uh in due to light duty um, truck inventory being so high that they're just pausing production completely because there's so many new vehicles right now and we're potentially expecting tighter land loan standards destroying demand for lower income vehicles, but also a glut of inventory leading to Rapid disinflation. That's your Kathy Woody in argument. Right now, we've had some signs that used car prices popped in November and December which is a little bit of a concern. These charts right here showing you the CPI metric for used vehicles and new vehicles.

Uh, and so uh. there is an argument that hey, you know rapid disinflation is coming, but the counter right away to that is, well, we've actually still seen household wealth hold up pretty dang well. mostly because a lot of household wealth is in in real estate and this is why I Suggest: when people want to start becoming a millionaire, the easiest way to do it is real estate. That's why I Have a course called Zero to Millionaire Real Estate Investing.

Link down below: I've got a flash sale going on Anyway, you you look at the decline in in household net worth and it's nominal. I Mean here's a chart on the right side that goes all the way back to the 90s and you can see net worth as a percentage of disposable income has never been as high as it is. Now if for a moment. I take for example I'll take a a white eraser here sort of and I'll just draw over the top of this chart to get rid of the fact that right now we're a little bit lower than the peak, right? But I Just want you to compare.

Where are we? Now There we go. Okay, so now compare the chart to where we are now. We're substantially higher than anywhere we've been during the pandemic, and 17 and 14 in 2006 in in the 90s substantially higher net worth as a percentage of disposable income. Today, even though that's come down in 2022, it's still so much higher.

and that's helping support some of this excess spending. And while yeah, we're starting to see an inflection point in wage growth, which is good, it's still incredibly. High We haven't seen some of these inflation levels for job stayers since before the.com bubble. We've never seen this high of wage inflation for job switchers.

Uh and uh. and yeah, hopefully we get rapid disinflation of goods. When is that actually going to show up? Services Well, what if it takes another year, right? Well, then you reiterate the bear case. If it takes another year to get rid of the sticky inflation, you're just reiterating the bear case scenario number one over here, which aligns really with sticky inflation actually.

I Already wrote that there on the left, the bare case aligns with sticky inflation so you actually don't have in the long term bears. And Bulls who are too terribly different, right? I Think that a lot of bears and Bulls agree that look in the longer term you don't want to bet against America right? but that that next leg down seems to be the case or that individuals make as a bear versus the Bulls And there's data supporting arguments on both sides. Uh, Although leading indicators in my opinion, lean heavily towards the bull case via what we're seeing in earnings calls, it's unclear if the Federal Reserve is going to align with what we're seeing as a leading indicator in earnings calls of Rapid disinflation, a rapid availability of workers I should say a supply chains normalizing substantially and rapidly, and really a lack of pricing power. Any lingering or or should I say the ability to raise prices Since pricing power is really the ability to raise or lower prices while still maintaining margins.

the lack of uh, sort of inelastic or a demand elasticity, right? So uh, back in the day, uh, and like you know, beginning of 2021, uh, demand was was almost uh, I should say perfectly inelastic. In other words, you could raise the price as much as you wanted and people were still buying. And now you're seeing a return to demand elasticity which is basically saying eh, you raised the price I stopped buying right? My demand becomes flexible as opposed to perfectly inflexible. Uh, anyway.

so TBD but this is the bare bull case and which side I think will be heavily I mean we know it'll be heavily dictated by what happens in these February March April reports the January is is is I mean the Bears are cheering January and if we get a bad Feb March April report the Bears will probably end up being right. So fingers crossed. Uh, you know for for a bullish Feb March April.