Is the Bidenomics electoral focus a contrarian economic indicator?

In many ways, politicians are worse than magazine covers as contrarian indicators. Magazine editors focus on an economic issue when it moves from page 20 to page 1 in the public’s mind. By that time, it’s been largely discounted by the market. Politicians are worse. They follow the trends raised by magazine editors and are even more reactive.
 

It was therefore of great interest that President Joe Biden kicked off his re-election by running on his economic record, which he called “Bidenomics”, which is composed of a grab bag of his past legislative initiatives such as infrastructure, renewable energy and semiconductors. The main theme is a focus on an economic revival for the middle class by emphasizing the addition of 1.3 million jobs and the achievement of a historically low unemployment rate.
 

The Bidenomics focus raises a contrarian risk that the President is touting his economic record just when recession odds are elevated. Consensus expectations for a recession from a variety of surveys of economic forecasts call for a recession to begin in H2 2023.
 

 

Did Biden just top tick the economy?
 

The effects of monetary tightening

A new Fed paper, “Distressed Firms and the Large Effects of Monetary Policy Tightenings”, offers some clues to the timing of a downturn. The paper found that a combination of high financial distress significantly exacerbates the effects of tight monetary policy:

Our results suggest that in the current environment characterized by a high share of firms in distress, a restrictive monetary policy stance may contribute to a marked slowdown in investment and employment in the near term.

 

 

 
The Fed researchers concluded that the worse effects may be seen in 2023 and 2024:

Do our results suggest that the monetary policy tightening engineered since 2022 might have substantial effects on investment and employment given the high share of firms currently in distress relative to previous tightening cycles? While answering this question is difficult, back of the envelope calculations indicate that the effects may be large….With the share of distressed firms currently standing at around 37 percent, our estimates suggest that the recent policy tightening is likely to have effects on investment, employment, and aggregate activity that are stronger than in most tightening episodes since the late 1970s. The effects in our analysis peak around 1 or 2 years after the shock, suggesting that these effects might be most noticeable in 2023 and 2024.

Indeed, stress levels are rising. Even though the latest Fed stress tests show that the 23 banks all passed with flying colours, market signals are indicating distress. The relative performance of the Regional Banking Index shows that it is testing an important relative support level (bottom panel). Regional banks have a higher exposure to the troubled office commercial real estate exposure than the big money centre banks, which is a concern.

 

The labour market is also showing signs of stress. New Deal democrat recently highlighted the Sahm Rule, which he caked “a rule of thumb started by [former Fed] economist Claudia Sahm, stating that the economy is in a recession when the three-month average of the unemployment rate rises 0.5% from its low of the previous 12 months.” He found that the Sahm Rule, which is based on the unemployment rate, is at best a nowcast of the economy, but the more weekly reports of initial jobless claims tend to lead unemployment and the Sahm Rule. The latest readings of the 4-week average of initial jobless claims shows three consecutive weeks of unemployment rate forecasts consistent with a recessionary reading.
 

 

The initial jobless claims data series is noisy and New Deal democrat would prefer to see two consecutive months of year-over-year increases in claims above 12.5%. So far, we have only seen three consecutive weeks. While these readings are not definitive evidence of a recession, they do signal upward pressure on the unemployment rate, which will be reported on Friday.
 

 

 

The devil is in the details and some of these indicators are too correlated with each other to signal new information. Consumer confidence is highly influenced by stock prices (strong), housing prices (strong), the unemployment rate (low) and inflation (elevated). The Conference Board’s Expectations Index rose to 79.3, but has been below 80, which is the level associated with a recession within the next year, since February 2022.
 

Moreover, analysis from JPM Asset Management found that consumer sentiment is a contrarian indicator for stock prices. Forward 12-month equity returns tend to be strong when confidence is low and weak when confidence is high.
 

Consumer savings from the pandemic stimulus are mostly exhausted and the savings rate is depressed.
 

 

 

The earnings season acid test

For equity investors, the recession question will be decided by the earnings report acid test. Forward 12-month EPS has been rising. The upcoming Q2 earning season has the potential to alter the trajectory of earnings estimates.
 

The stakes are high. An analysis of the stock market shows a bifurcated market. The Dow, which represents the “old economy”, has been trading flat while the NASDAQ 100, which represents the “new economy”, has been surging. A similar pattern was seen during the Tech Bubble of late 1990s. Moreover, both period show similar patterns of small-cap underperformance and inverted yield curves, which is a recession signal.

 

The S&P 500 is trading at a forward P/E ratio of 18.9, which is elevated by historical standards, and so are 10-year Treasury yields, which is creating competition for stocks. The last time the 10-year Treasury yield was at similar levels was during the 2008–2010 period, when the forward P/E of the S&P 500 traded in the 12–16 range.
 

 

n conclusion, President Joe Biden’s focus on his economic record based on Bidenomics may be a contrarian economic signal in the current environment of elevated recession risk. While indicators show a mixed picture, equity risk is high. Investors should find better clarity from the results and guidance from Q2 earnings season.