Mainstreet and Wallstreet

The economic tale of two cities

Why is there such a persisting dichotomy between Mainstreet and Wallstreet? In May so far, softer data have been giving wings to stocks and bonds alike. The S&P500 is up ~5% month-to-date, while US aggregate bonds post a 1.8% return.

The main reason is that rates are in retreat, and the US 10-year dropped by 30bps, despite the fact the the Fed doubles down on “higher-for-longer”.

What gives then? On the one hand, retail sales and consumer price advanced less than expectations month-on-month in April. On the other hand, prices are much higher year-on-year for non-discretionary goods and services, as much as 23% for vehicle insurance, or 8% for vehicle maintenance. Granted prices declined by 6% for airlines fares, but not everybody has to take the plane everyday.

What it goes to say is that Mainstreet is feeling the inflation much harder, and despite inflation is stabilizing, it remains the key concern for small businesses. As per the NFIB small business optimism index, the “soft” components say things are as bad as they were during the Global Financial Crisis, even though earnings, jobs and capex plan are not anywhere as bad, even after a sharp decline over the past 2 years.

The decay in part of the sentiment is confirmed by ever increasing delinquency rates on credit cards and auto-loans. This reflects the struggle consumers with sub-prime credit scores, while on average consumption is still supported by non-discretionary spending by wealthier consumers and looks rather strong.

The market caught the full sense of this tale of two cities, and is betting on an inevitable decrease in rates to alleviate the credit pressures that are building up.

In my sense, it is overplaying it. Mechanically, it is entirely justified that asset prices would go up as discount rates go down. The rally is all the stronger in Small caps value than these companies are more rate sensitive. Month-to-date, companies of smaller size with higher leverage rallied by 4.86%, against only 3.12% for their larger equivalent.

Frankly, the rebalancing we advocated for over time, taking profit out of Tech, and rebalancing into interest-rate sensitive assets, would rather look smart in retrospect.

However, I can’t help sensing some hubris in this move. As the market expects rates to go down, it also expects that the economic situation for the smaller actors of the economy would be bad enough for forcing the rates down. These two things can’t be true at the same time, and I expect loss-making smaller companies to be a major area of disappointment for investors who extended too far out in lower credits.

A city’s view looks always better form the high ground, so I’d stick to quality as the market rips up. Besides, I still find good solace in 3y to 5y fixed income, even though the sharp retracement of yields over the past week is leaving less money on the table.

That’s all for now !

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