Folks, the US economy is falling off a cliff without a parachute. The Berg of Bloom reported this morning that the Institute of Supply Management's gauge of factory activity is the lowest since May of 2020. And you look at the overall trend. we've dropped from just under 65 to 50 on the index in such a short amount of time.

And for relevancy, if you look at the pre-pandemic Regents 2017 and 2018, we are now trending well below those areas and soon enough, maybe dropping below 2019 levels. Now, Why does U.S Manufacturing slow down? Why are we seeing this massive drop in production in this country? Well, because companies are seeing less and less demand, so they are ordering less and less from these manufacturers. and thus manufacturers are responding by making less and they're anticipating even less orders down the road. And Bloomberg reports some industry members complaining about the canceling of orders, inventories of finished goods increasing dramatically, flat business activity and over overall pullbacks in capital budgets reducing the orders that they are seeing.

AKA We are seeing the cracks of this economy are merging rapidly Now of course, this is a horrible thing in terms of companies and their bottom lines, but it is a good thing for Supply chains and pricing pressures moving forward. In recent months, manufacturers have seen a decline in the prices for oil, metals, and other Commodities used for production. The group's measure of prices paid for raw materials fell in October for a seventh straight month to the lowest level since May 2020, the last time costs contracted. Now remember, the Fed's Mandate right now is to destroy completely and utterly destroy demand in hopes that inflation goes down a little bit and the lost manufacturing activity the less the man there is for these crucial raw materials and the more prices drop.

Which then means the faster we get to the next stage of this crisis where you go from hyperinflation to lower inflation still probably well above the Fed's target rate and at the same time recession. Once we get into the deeper and undeniable recession chapter, All of a sudden, you get into a new paradigm where the FED is starting to think about pivoting. So when you start seeing these massive contractions, think that we're closer. way closer to the pivot now I Want that? I Pulled up the price points for different Commodities and materials that we need in our everyday economy.

You look at Lumber You had a massive increase in 2021 and early 2022, but they've come down and studied out a lot. still averaging out higher than 2019 by quite a lot. But it is down. Cotton has also fallen off a cliff, Aluminum is down a lot to iron ore is down a lot.

That means that sword prices are going to be lower, which is going to be very, very important in this new economy that we're heading into. But then you go and you take a gander at certain crucial food components like corn feeder cattle, live cattle, kofifi, coffee, wheat, sugar. Most of these are down a bit, but they are being a lot more stubborn and the difference between food commodities versus materials like Lumber is pretty obvious. The FED doesn't have much of an impact on food commodities, whereas with Lumber it has a huge impact on it.

It can destroy housing demand and thus destroy the incentive for Builders to even build things. Which means the overall Lumber cost goes down. You can raise rates and Destroy future demand for houses, but you'd have to force consumers to starve to bring down the demand on the food supply chain. Thus, the FED at best has a very, very indirect impact on food prices.

The FED has to go and nuke three or four other areas of the economy for food prices to go down at all. One of the best ways to bring down the price of food is to bring down the price of energy. and the best way to bring down the price of energy is to Nuke The entire manufacturing sector which depends on energy and bids up the price is to Nuke overall economic activity which is transported using energy and hope and pray that those pricing decreases trickle over to the food segment. As we know, energy commodity prices set the price for fertilizers and of course set the price for transportation of food which then gets baked into the final retail price that you pay at the grocery store.

The other issue driving inflation right now is the presence of heightening labor costs. Because of the still tight job market, many employers are raising pay to attract and hold more workers, holding workers for longer even if they don't need them because they're worried that if they fire them and demand picks up to three months from now, they won't be able to hire anybody with the same qualifications back and job openings in September Rose Alongside wages and economists are expecting October's report to show another Advance forward in wages, which is not a good sign from a labor cost standpoint and suggests a lot more sticky inflation, the U.S employment Cost index is rising at a five percent annual clip, and obviously we all want workers to do better and better and become more and more productive and make more and more money. But from the Fed's perspective, this is a massive massive fail. If they don't see employees getting destroyed, they're not going to believe inflation is over and they're going to continue trying to destroy them with Rising borrowing costs.

Pretty soon, borrowing costs are going to be so high that if you take out a dollar, you're gonna have to pay a hundred bucks in yearly interest and Biden's going to be like, come on man, the economy strong as hell. Fact of the matter is, folks that if labor costs are going up, that means that this inflation battle is prolonged. Folks, the FED has two simple mandates to promote price stability, to promote maximum employ appointment, and a third unofficial one is to promote and induce widespread hemorrhoids in the American population, which of course is just an inevitable result of the financial constipation that the FED causes. Quite frankly, the lower this unemployment is, the more Firepower that the FED has to unleash in order to promote its price stability goal.

And it's also true that at the same time, keep in mind that this unemployment rate that they look at is very, very misleading in and of itself. If somebody looks at this, they might be fooled into believing that all the jobs here are equal in quality. In reality, this rate does not. It does not discriminate between full-time and part-time jobs, or temporary or long-term jobs.

Or if employers have a job that matches their skill set and full earning capacity. If you have a surgeon working at a minimum wage job, well, if they can't find a job as a surgeon, this unemployment rate does not take that into consideration. Even if every single person in this economy was working a sub-optimal job and was very unproductive at it, the unemployment rate would still be virtually around. But that doesn't actually say anything about the health of the economy.

You have to look at a lot of different factors, not just this one static rate which is very much curved in favor of the government and policy makers. Which is a huge problem because when policy makers at the FED use this to gauge their decisions on how much they're going to raise rates or how healthy the economy is. Well, all of a sudden, the data that they're relying on isn't even real. Another thing, which the unemployment rate is famous for, is that it doesn't include everyone who doesn't have a job.

Which means that the real unemployment rate is much higher. Just if you included the people that don't have a job, You'd think, oh, unemployment rate. That's the percentage of people that don't have a job, But a lot of those people that don't have a job aren't included in labor participation in the U.S The amount of people willing to work has been going down for decades and is still below pre-pandemic levels. A lot of that is the Aging population and lower birth rates, but not all of it.

After C19, a lot of people left the workforce and they said, you know what? I'm never getting back to work, which means you still have all those people demanding on the overall supply chain, but you don't have them creating more economic output anymore apply. Meanwhile, you still have around 40 percent of households who will pay no Federal Income tax this year, and while this is down from 56 percent in 2021 and 60 in 2020, this is actually a pretty big deal. What does this mean? Well, it implies that despite the incredibly low unemployment rate, a lot of households aren't even earning enough to get into the tax bracket where they pay Federal income taxes. And these are entire households.

And so, if you're saying oh, this economy is so great, why is it that 40 of these households don't even qualify to pay Federal income taxes? That doesn't sound like a very sustainable system. But now all of these households that are earning very, very little because they haven't even gone to the tax bracket to pay Federal income taxes while they are now getting crushed by four decade High Inflation and inflation is having a very, very sizable impact on the consumer behavior of your average consumer right now. According to a survey by online financial Advisor Personal: Capital they said one in five Americans Doubted whether they would have enough money to cover the cost of Thanksgiving this year. Oh, I Know what we can give thanks for this year: 300 Bird Meet Apparently Gen Z is going to swap turkey for soup, salad, and pizza.

Imagine that pizza for Thanksgiving although that too might not even last for long. Next, your pizza will cost you 25k a slice and you'll have to pay a reverse windfall tax to pay for your neighbor Susan's basket weaving degree. But realistically here, a spiraling recession starts. It starts with consumers starting to make different decisions on what they purchase, and when you start seeing that in food, that means you're heading for a pretty bad environment.

Let's see how long the FED is going to be able to hold this trajectory now. I Want to go ahead and move over to forward earnings estimates on the S P 500 for 2023.. So as you know, analysts make estimates throughout the year for future periods of time and that's part of how they base their Equity allocation decisions. This here is a chart for consensus earnings estimates for 2023, and you could see that analysts got more bullish on 2023 all the way up to about late March 2022 and April 2022, which is when the FED really started Hocking up.

and since then, earnings estimates for the next year have just been falling off a cliff and it's not super complicated to see why. Throughout this entire period, the FED has gotten more and more restrictive and reported earnings have been of companies complaining more and more about the macro situation and this is where the consensus is right now. Where do you think the consensus is going to be adjusted down as we go into the next couple of months and actually end to 2023? But then you look at the Deutsche Bank forecast. it's way down here.

Why What do the Germans know that we don't? Well, they know how to make better pretzels. That's a big thing, but also, it's fairly obvious Deutsche Bank was the only one that really adjusted to factor in the current trajectory. If you really break down this chart, the consensus estimate for 2023 is still higher now than they were forecasting a year and a half ago for 2023.. a year and a half ago, the Fed's policy trajectory looked a lot less restrictive, if at all restrictive.

Yet, the average analyst in the consensus still thinks that we're going to be be growing at a rapid Pace The analyst industry is still factoring in a soft Landing or really, no need for landing at all. And Deutsche Bank is saying. We don't believe that we believe that when you go and you tighten at a rate that you haven't seen in four decades. with inflation, that's at four decade highs.

With all these other macro problems, well, that's going to be worse. That's going to be worse for the consumer, and that's going to be worse for businesses that sell things to the consumer. Most analysts right now are saying, hey, you're gonna have just a shallow little pansy recession, nothing to worry about, nothing and Deutsche Bank saying, wait, why would you think that the macro situation is worse than we've seen in four decades? And the fact that the consensus is that earnings aren't going to adjust that much? Well, that means that there's a lot of shock and awe that's going to happen when earnings do start dropping dramatically. What are some reasons that analysts at Big firms wouldn't want to adjust earnings down very, very quickly? Well, because maybe their clients would rush to cash if they knew how bad things were going to be.

Most of their clients, most of the big fund managers clients while they're working like dogs in the economy and they're stalking away a bunch of cash and giving it to these money managers that take two, three percent, sometimes five percent. So the fund managers have to give them a reason to say, hey, you need to stay invested, You need to stay with us. We got your back. Earnings are gonna go down a little bit, but stay invested because in the long term things are going to look up.

They don't want their people to know, they don't want their people to know how bad it's going to get because then they would all cash out and they'd lose their fees. They lose their power in the market. If Wall Street Firms were honest about the financial crisis that we are heading into. you would see the financial sector decimated overnight.

people would withdraw like crazy. Some analysts go and they respond by only lowering estimates at best when companies report earnings and they lower just a little bit. if they lowered a lot, people panic, people, sell, they lose their fees. now.

Heading into tomorrow's Fomc meeting, we highlighted four outcomes that we see as the most likely. But to simplify this even further, you look at the most recent expected Fed Futures rate trajectory implied by Traders in the derivatives. Marketa It's projecting a terminal rate in early 2023, topping out at 5 set and then dropping down. This has heightened substantially from September 28th and Leaps and Bounds from June 30th and January 3rd.

So a simple way to forecast how markets are going to react tomorrow and through the end of the week is whether or not the FED indicates that this trajectory is heightened further. If it goes up, you've got a sell-off. If it dips, you've got a green light for equities to go back up. So pay very, very close attention to how the FED guides markets tomorrow.

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