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“Those that fail to learn from history are doomed to repeat it.”
– Sir Winston Churchill
If you’ve listened to any kind of news over the past several months, you’ve likely heard the term “soft landing” thrown around.
That hope that we’ll exit this Federal Reserve rate-hiking cycle without entering a destructive recession. It’s a hope shared by retail and institutional investors, not to mention economic forecasters.
But this soft landing obsession is hardly unique.
Professor Herman Liebling coined the term "soft landing" in 1973, while he was a top forecaster at the U.S. Treasury. Liebling actually predicted a soft landing in the mid-1970s… but of course he turned out to be wrong.
In fact, every time the Fed gets to the end of a major hiking cycle, the crowd gets suckered by alluring (and extremely laggy) data.
They start cheering and editorializing that the Fed has somehow pulled off a miraculous longshot.
But it almost always ends in disaster…
In mid- to late-1989, markets and media outlets were celebrating the prospects of a soft landing. The Washington Post and even the Federal Reserve Bank of Cleveland asked the very question, “How soft a landing?”
In late 2000 we saw it again. A column in the New York Times by Edward Yardeni, chief investment strategist at Deutsche Bank Securities, opined on just “how soft” the landing could be.
Then in late 2007, forecasters at the Federal Reserve Bank of Dallas concluded the U.S. should manage to make it through the subprime mortgage crisis without a downturn.
I think we all know how that turned out.
All three of these soft landing scenarios had one thing in common: A bright ray of hope… and within weeks or months, the economy had plunged into recession, unemployment shot up, businesses closed, and growth contracted.
History is practically howling for us to pay close attention at a time when soft landing optimism is gaining steam.
And with yesterday’s Consumer Price Index print, we saw inflation has begun to cool meaningfully. But here’s why you need to be careful of this narrative…
The Economy Is Still Very Hot
Inflation has eased when looking at year-over-year numbers. And that’s precisely what we saw Wednesday morning.
Year-over-year CPI rose 3.2%. This indicates inflation has lost at least some of its steam from a year ago.
But unemployment remains historically low at 3.5%. And hiring has held up. Both are signs of a hot economy.
Consumers also continue to spend at a solid pace. And that’s helping boost overall growth as witnessed by gross domestic product (GDP) figures last month.
Given all the positive momentum Jerome Powell and the Fed have seen in their fight against inflation, it’s no surprise there’s optimism in the air around the unicorn that is a soft landing.
But it can be difficult - if not impossible - to tell in real time whether the economy is smoothly decelerating… or we’re in for something much worse.
The way I see it, the data potentially points to a second wave of inflation.
First, crude oil, off recent lows, is now up more than 20% to its highest level this year. Natural gas is up more than 40%. Meanwhile, iron ore, soybeans, sugar, and many other commodities are up double digits.
That price action doesn’t spell “S-O-F-T L-A-N-D-I-N-G” in my book.
In fact, I see the potential for “echo inflation.” These waves are a product of economic cycles and basic math.
Base effects – comparing current prices to the same period a year earlier – were disinflationary over the past twelve months. But they’ll turn inflationary next year as prices will be measured against a lower base.
Second, the disinflation of 2023 contains the seeds of the reflation of 2024.
Personal income grew 4.75% last month, outpacing inflation of 3.1%. But with income growth driving demand, this could force prices to continue to increase in an economy that’s already running hot.
And that spells “T-R-O-U-B-L-E.”
Soft Landings Always Look Likely… Until They Don’t
The consensus right before things went south in 1990, 2000, and 2007 was for a soft landing.
It can be tough to see the cracks when markets are performing as they are today. Especially given the inherently forward-looking nature of the stock market.
While we may not see a recession like we saw in the 2008 crash, we could very well see some major impacts to the economy.
Remember, financial institutions are still in flux:
- Moody’s downgraded the credit ratings of 10 small- and mid-sized banks…
- Mortgage rates are at 20-year highs above 7%…
- Fitch has downgraded U.S. sovereign debt…
At the same time stocks have all but rebounded from a tumultuous 2022, when interest rates were hiked at a record pace.
It’s strong medicine for sure. But we need to see lower demand and a higher unemployment rate. If we don’t, given full employment and high disposable incomes, the risks of food and energy inflation could feedback into wages.
That would start a “second wave” of inflation at precisely the moment the Fed runs out of ammo to respond.
Now, it’s not all bad news. We have actually seen soft landings… they’re just rare.
In 1994 and 1995 the Fed managed to slow the economy gently without plunging it into a downturn. That was perhaps the most famous soft landing in American economic history.
But the future is notoriously hard to predict. And while the Fed may be convinced we’re headed towards a soft landing, I’m watching for when the data might turn and tell us otherwise.
Until then, the key is to play the hand we’re dealt.
How to Profit on the Latest Inflation Numbers
The Fed still has its work cut out for it, but in the here and now, seeing inflation flatten out is bullish news for the markets. That’s because the U.S. central bank now has more wiggle room to keep rates steady versus another raise this year.
As Garrett Baldwin always says, “Momentum trumps all.” If stocks continue to go up, you can trade until they don’t.
Right now, I’m watching several artificial intelligence (AI) names that are poised to see an outsized benefit from this tech megatrend. Microsoft (MSFT) is still my top pick given its recent 365 Copilot launch, which adds AI to its suite of products. In the next year, I could easily see Microsoft surpassing Apple (AAPL) as the largest publicly-traded company in the world given the current momentum behind its products.
And my colleague Shah Gilani has also been watching the AI industry very closely and is getting ready for what he calls “AI Singularity”, the moment when artificial intelligence surpasses human intelligence. It’s only three months away and he has just the way to play this megatrend.
Until next time,
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