Monthly Archives: April 2017

Bob Farrell’s 10-Investing Rules For A “QE” Driven Market

A recent post on CNBC discussed Bob Farrell’s 10-Investing Rules. These rules have withstood the test of time as it relates to long-term investing.

Here’s a list of Farrell’s 10-rules:

  1. Markets tend to return to the mean over time
  2. Excesses in one direction will lead to an opposite excess in the other direction
  3. There are no new eras — excesses are never permanent
  4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
  5. The public buys the most at the top and the least at the bottom
  6. Fear and greed are stronger than long-term resolve
  7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
  8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
  9. When all the experts and forecasts agree — something else is going to happen
  10. Bull markets are more fun than bear markets

However, given more than a decade of QE-driven bull market advance, I wondered what they might be like if Bob Farrell was alive today. Would he have changed his mind?

With this in mind, I present Bob Farrell’s 10-Investing Rules For A “QE” Driven Market. (Tounge firmly implanted into the cheek, of course.)

Daily Market Commnetary

1) Markets Remain Deviated From The Long-Term Means Over Time

Bob believed that stock prices get anchored to their moving averages. As such, with regularity, prices must and will revert to and beyond those means over time.

However, as any young retail investor will tell you, such “boomer” ideas must be “put out to pasture,” as they say in Texas. All you need is a fresh round of “stimmies,” some “rocket emojis,” and you have all the ingredients necessary for a bull market.

Sure, prices certainly get overextended, but any dip is a buying opportunity because the “Fed put” ensures any downside is limited.

2) Excesses In One Direction (On The Upside) Lead To More Excesses

“Ole’ Boomer Bob” antiquated notion that markets, which can and do overshoot on the upside, will also overshoot on the downside, is also clearly wrong. The further markets swing to the upside, the higher they should go.

There is no reason not to buy stocks as long as there are low interest rates, liquidity, and a mobile trading app. Sure, prices are a “smidge” above fair value, but valuations are such an antiquated metric. Also, plenty of articles suggest the “P/E” ratios are terrible market timing devices, so why even pay attention to them?

Sure, the market-capitalization ratio is almost 3x what the economy can produce, but we have never been in a market like this before. With all the Fed and Government money paying for everything, there is no reason to be productive when everyone can stay home, trade stocks and play “Call of Duty – Warzone.”

3) There Are No New Eras – Except This Time As Excesses Are Permanent

There will always be some “new thing” that elicits speculative interest. Over the last 500 years, there were speculative bubbles involving everything from Tulip Bulbs to Railways, Real Estate to Technology, Emerging Markets (5 times) to Automobiles, Commodities, and Bitcoin.

Jeremy Grantham posted the following chart of 40-years of price bubbles in the markets. During the inflation phase, each got rationalized that “this time is different.” 

Bubbles Evident Pop, Technically Speaking: Bubbles Are Evident After They Pop

But Jeremy is an old “boomer” that doesn’t understand current markets.

Multiple media sources pen articles stating valuations don’t matter. As long as interest rates are low, the Fed provides liquidity; stocks can only go up. That is a much better narrative, and if I put out a 1-minute video on “Tik-Tok, I can get a bunch of followers.

4) Rapidly Rising Markets Go Further Than You Think, But Correct By Going Even Higher.

The reality is that excesses, such as we are seeing in the market now, can indeed go much further than logic would dictate. However, these excesses, as stated above, are never worked off simply by trading sideways. Instead, excessively high prices are “corrected” by prices just going higher in this new market.

That makes complete sense to me.

5) The Public Buys The Most And The Top, And More At The Next Top

After more than a decade of Fed interventions, investors believe that buying at the current “top” will be a bargain compared to an even higher top coming. Sure, logic would dictate the best time to invest is after a sell-off, but if you have “Diamond Hands,” you need to keep buying because prices will only go up.

6) Fear (Of Missing Out) And Greed Is All That Matters

As stated in Rule #5, emotions cloud your decisions and affect your long-term plan.

“Gains make us exuberant; they enhance well-being and promote optimism,” says Santa Clara University finance professor Meir Statman.  His studies of investor behavior show that “Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks.”

What is clear is that Meir Statman does not have “Diamond Hands.” While he is correct, there are only two primary emotions any investor should have.

  1. FEAR – The “Fear Of Missing Out;” and,
  2. GREED – The “Cojones” to take out debt, lever up. and ramp your “risk bets” in this one way market.
Markets Minsky Moment, Technically Speaking: The Markets Next “Minsky Moment”
Markets Minsky Moment, Technically Speaking: The Markets Next “Minsky Moment”

In the words of Warren Buffett:

“Buy when people are fearful and sell when they are greedy.”

Clearly, “Boomer Buffett” doesn’t get it either. But, of course, he is the same idiot sitting on $150 billion in cash whining because he can’t find anything to buy. So if he was indeed an “Oracle,” why didn’t he load up on AMC and GameStop?

7) Markets Are Strongest When The Fed Is Dumping Liquidity Into The System

“Breadth is important. A rally on narrow breadth indicates limited participation and the chances of failure are above average. The market cannot continue to rally with just a few large-caps (generals) leading the way. Small and mid-caps (troops) must also be on board to give the rally credibility. A rally that “lifts all boats” indicates far-reaching strength and increases the chances of further gains.” – Every “Old” Technical Analyst

Sure thing, “Boomer.”

To crush the market, all you have to do is buy the 10-fundamentally worst companies that have the highest short-ratios, leverage it up with margin debt and options, and sit back. Then, the “ATM” will start spitting out money.

All you need to watch is for a change in the Fed.

The high correlation between the financial markets and the Federal Reserve interventions is all you need to know to navigate the market.

Those direct or psychological interventions are all you need to justify taking on all the speculative “risk” you muster.

8) Bear Markets Have Three Stages – Up, Up, and Up.

“We don’t have no stinkin’ bear markets.”

Any decline in the market is just a good reason to take on even more risk. Given the Fed will stop any market crash by injecting trillions in liquidity, buy.

After all, before the “economic shutdown,” I had to work three jobs (Uber, Lyft, and Amazon delivery) to make ends meet. Now, I sit at home, trade stocks, and make “TikTok” videos about all the money I am making. Plus, once I get to 100,000 followers, I increase my income by doing affiliate marketing and getting my followers to trade on Robinhood.

What could go wrong with that?

9) When All Experts Agree – Whatever They Agreed On Is Likely To Happen

Another old “boomer,” Sam Stovall, the investment strategist for Standard & Poor’s, once quipped:

“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”

Well DUUHHHH!!! Who wants to sell? That is just stupid.

10) Bull Markets Are More Fun Because Bear Markets Don’t Happen Any Longer.

What should be clear by now to anyone is that after 12-years of monetary interventions, “Bear Markets” can no longer happen.

So, suck it up, quit your complaining, and “Party On Garth.”

This Time Isn’t Different

If you detected a hint of sarcasm in today’s post, don’t be surprised.

Like all rules on Wall Street, Bob Farrell’s rules are not hard and fast. There are always exceptions to every rule, and while history never repeats exactly, it often “rhymes” closely.

Nevertheless, these rules get ignored during periods of excess in markets as investors get swept up into the “greed” of the moment.

Yes, this time certainly seems different. However, a look back at history suggests it isn’t.

When the eventual reversion occurs, individuals, and even professional investors, try to justify their capital destruction.

 “I am a long term, fundamental value, investor. So these rules don’t really apply to me.”

No, you’re not. Yes, they do.

Individuals are long-term investors only as long as the markets are rising. Unfortunately, despite endless warnings, repeated suggestions, and outright recommendations, getting investors to manage portfolio risks gets lost in prolonged bull markets. Unfortunately, when the fear, desperation, and panic stages get reached, it is always too late to do anything about it.

Those with “Diamond Hands” will eventually sell at the worst possible time.

Just remember, “Old ‘Boomer Bob'” did warn you.

Stocks Surge As Earnings Roll-In, But Is Risk Gone?

In this 10-22-21 issue of “Stocks Surge As Earnings Roll-In, But Is Risk Gone?”

  • Market Surges Toward Previous Highs
  • It’s Been A Very Long-Time WIthout A Deeper Correction
  • A Sea Of Liquidity
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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Market Surges Toward Previous Highs

Last week, we discussed the “correction being over” for the time being.

“While the market started the week a bit sloppily, the bulls charged back on Thursday as earnings season officially got underway. With the market crossing above significant resistance at the 50-dma and turning both seasonal “buy signals” confirmed, it appears a push for previous highs is possible.

Two factors are driving the rebound. Earnings, so far, are coming in above estimates. Such isn’t surprising as analysts suppressed estimates going into reporting season. Secondly, bond yields declined.

Chart updated through Friday.

However, to expand on a point from last week, breadth remains dismal, with only 60% of stocks above their respective 50-dma even though the index is at all-time highs.

Moreover, our “money flow buy signal” has reversed to previous highs, but volume has dissipated sharply during the advance.

Our concern is that while the expected rally from support occurred, there has been very little “conviction” to that advance. Therefore, we tend to agree with David Tepper of Appaloosa Management when he stated:

Sometimes there are times to make money…sometimes there are times not to lose money.

While the market is within the seasonally strong year, the risk of a correction remains. Such is particularly the case as we head into 2022.


Its Been A Very Long Time Without A Deeper Correction

While investors are quickly returning to a more “bullish” excitement about the market, it is worth remembering the recent 5% correction did little to resolve the longer-term overbought conditions and valuations.

In mid-August, we discussed the market’s 6-straight months of positive returns, a historical rarity. To wit:

Market Months, Technically Speaking: 6-Positive Market Months. What Happens Next?

“There are several important takeaways from the chart above.”

  1. All periods of consecutive performance eventually end. (While such seems obvious, it is something investors tend to forget about during long bullish stretches.)
  2. Given the extremely long-period of market history, such long-stretches of bullish performance are somewhat rare.
  3. Such periods of performance often, but not always, precede fairly decent market corrections or bear markets.

Unfortunately, as we now know, that streak ended in September with a 5% correction that sent investors scurrying for cover.

There is another streak that is also just as problematic. Currently, the S&P 500 index has gone 344-days without violating the 200-dma. Such is the sixth-longest streak going back to 1960.

While investors are currently starting to believe that a test of the 200-dma won’t happen, there are several points to be mindful of.

  1. Corrections to the 200-dma, or more, happen on a regular basis.
  2. Long-stretches above the 200-dma are not uncommon, but all eventually resolve in a mean-reversion.
  3. Extremely long periods above the 200-dma have often preceded larger drawdowns.

The most crucial point to note is that in ALL CASES, the market eventually tested or violated the 200-dma. Such is just a function of math. For an “average” to exist, the market must trade both above and below that “average price” at some point.

However, a “correction” requires a “catalyst” that changes the investor psychology from “bullish” to “bearish.”

Extremely Depressed Volatility

At the moment, there are plenty of concerns, but investor psychology remains extremely bullish. Most concerns are well known, and, as such, the market discounts them concerning forward expectations, valuations, and earnings projections. However, what causes a sudden “mean reverting event” is an exogenous, unexpected event that surprises investors. In 2020, that was the pandemic-related “shutdown” of the economy.

However, as with an empty “gas can,” a catalyst is ineffective if there is no “fuel” to ignite. Currently, that “fuel” is found in the high levels of market complacency, as shown by the collapse in the volatility index over the last couple of weeks.

“The Volatility Index (VIX) closed at a new 18-month low as the S&P 500 closed at a new multi-year high on Thursday, 10/21/21. If you were wondering, the 18-month low in the VIX Index represents the first occurrence since November 2017.” – Sentiment Trader

It is worth remembering the market had three 10-20% corrections in 2018 as low volatility begets high volatility.

Another measure is the P/E to VIX ratio which recently also peaked at 2.0. Previous peaks have been coincident with short-term corrections and bear markets.

While anything is possible in the near term, complacency has returned to the market very quickly. As noted, while investors are very bullish, there are numerous reasons to remain mindful of the risks.

  • Earnings and profit growth estimates are too high
  • Stagflation is becoming more prevalent
  • Inflation indexes are continuing to rise
  • Economic data is surprising to the downside
  • Supply chain issues are more presistent than originally believed.
  • Inventory problems continue unabated
  • Valuations are high by all measures
  • Interest rates are rising

You get the idea.

But a more significant problem will set in next year – a contraction of liquidity.


In Case You Missed It


A Sea Of Liquidity

As noted, the unexpected “pandemic-driven economic shutdown” sent the Federal Reserve and Government into fiscal and monetary policy overdrive. Such led to an unimaginable influx of $5 trillion into the economy, sending the “money supply” surging well above the long-term exponential growth trend.

The importance of that “sea of liquidity” is both positive and negative. In the short term, that liquidity supports economic growth, the surge in retail sales into this year, and the explosive recovery in corporate earnings. That liquidity is also flowing into record corporate stock buybacks, retail investing, and a surge in private equity. With all that liquidity sloshing around, it is of no surprise we have seen a near-record surge in the annualized rate of change of the S&P 500 index.

However, as stated, there is a dark side to that liquidity. With the Democrats struggling to pass an infrastructure bill, a looming debt ceiling, and the Fed beginning to “taper” their bond purchases, that liquidity will start to reverse later this year. As shown below, if we look at the annual rate of change in the S&P 500 compared to our “measure of liquidity” (which is M2 less GDP), it suggests stocks could be in trouble heading into next year.

While not a perfect correlation, it is high enough to pay attention to at least. With global central banks cutting back on liquidity, the Government providing less, and inflationary pressures taking care of the rest, it is worth considering increasing risk-management practices.

You can see a complete list of our portfolio management guidelines here.



Portfolio Update

As noted last week, we increased our exposure to technology stocks heading into earnings season. Over the last half of September, the recent additions have paid off well, with the current run back to all-time highs. In our bond holdings, we remain nearly fully exposed to equities, slightly overweight cash, and a tad underweight target duration.

As noted last week:

“While our positioning is bullish, we remain very concerned about the market over the next several months. Historically, stagflationary environments do not mix well with financial markets. Such is because the combination of inflationary pressures and weaker economic growth erodes profit margins and earnings.

Furthermore, expectations heading into 2022 remain exceptionally optimistic, which leaves much room for disappointment. With liquidity getting drained, the Fed reducing monetary accommodation, and two rate hikes scheduled next year, the risk to investors remains elevated.”

A Note On Bond Positioning

I got asked last week to discuss our bond positioning. So we posted the following to RIAPRO subscribers on Friday morning.

“5-year implied inflation expectations are up over 40 basis points (bps) since October 1st. They now stand at a 15+ year high of 2.94%. While inflation expectations rise, the yield curve is flattening. In this case, short maturity bonds are rising in yield much more than longer maturity bonds. The graphs below show what has happened to bond yields since the inflation expectations last peaked on May 18th. As we show the 30-year bond is 26 bps lower since then, while the 2-year note is 26 bps higher. As a result, the 2/30 yield curve has flattened 52 bps over the period.

Our portfolios are set up for the yield curve flattening. The portfolio’s largest bond holding is TLT with a duration of 20 years. The benchmark, AGG, has a duration of 8 years. The models are also not fully vested in the fixed income sleeves to further protect against higher yields.’ – Michael Lebowitz

Conclusion

As noted throughout this week’s message, there are many reasons to suspect the recent rally will fail as the impact of weaker economic growth begins to temper expectations. However, that is not the case today, and the current momentum can undoubtedly carry the markets higher next week.

We will continue to maintain our more bullish stance from that position until the market begins to falter. After that, numerous support levels and warning triggers will tell us it is time to become more “risk-averse” in our allocations.

While that time is not now, don’t become overly complacent, thinking this market can only go higher. Markets have a nasty habit of doing the unexpected just when you feel you have everything figured out.

Have a great weekend.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data. Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 83.20 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

Our “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 88.34 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

The market continued its bullish advance this week after eclipsing the 50-dma last week. Such is good news, as our recent additions to portfolio allocations have performed well. Currently, our portfolios are outperforming our global benchmark by roughly 300 basis points with lower volatility than the S&P 500 index.

There was no need to make changes to our portfolio this week. However, we are watching interest rates closely as it looks like we may be approaching another “buy point” to increase our duration in our bond holdings further. As noted last week:

“We are watching our positions closely and have moved stops up to recent lows for all positions.

Furthermore, after increasing the duration of our bond portfolio, the recent uptick in rates provides another entry point to lengthen our duration once again. If there is a risk-off event in the market, yields will drop to 1% or less providing a nice bump in appreciation in our bond portfolio. In the meantime, we are collecting a bit of income while holding the hedge.

While it may seem counter-intuitive at the moment, the current bout of inflation will turn into deflation next year as liquidity gets drained from the system. As such, we want to continue to buy bonds at a discounted price to benefit from deflationary pressures when they return.

As noted, while there seems to be minimal risk in the market, don’t be misled. There are numerous risks we are watching that could lead us to reverse course rapidly. Our job remains to protect your capital first and foremost, but we want to capture gains when we can.

Portfolio Changes

During the past week, we made only a single change to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

“This morning we sold 100% of SHY which is under pressure as the market gets more aggressive about pricing in future interest rate hikes. As shown, there is currently a 100% chance the Fed will hike rates twice in 2022, and a 70% chance of three rate hikes.” – 10/22/21

“When the Fed gets more aggressive about rate hikes, the long end of the curve will fall. Therefore, as the 10-year moves toward 1.8-2%, we will become more aggressive buyers of duration. For the meantime, we will leave the money in cash and over the next week or so decide how to deploy it within the fixed income sector.”

All Models:

  • Sell 100% of SHY

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors



Attention: The 401k plan manager will no longer appear in the newsletter in the next couple of weeks. However, the link to the website will remain for your convenience. Be sure to bookmark it in your browser.

Commentary

The market is now back to a highly overbought position after a sizable rally over the last 7-days. The triggering of the underlying MACD “buy signals” suggests we have entered into the seasonally strong period of the year, which supports keeping allocation long-biased.

However, this is probably a decent opportunity to rebalance holdings and reduce your risk heading into November. In the short term, we suggest maintaining exposures in plan portfolios but start putting new contributions back into cash or stable value holdings for now.

While we have not removed international, emerging, small and mid-cap funds from the allocation model, we suggest avoiding these areas for now and moving those allocations to domestic large-cap.

If you are close to retirement or are concerned about a pickup in volatility, there is nothing wrong with being underweight equities. However, there is likely not a lot of upside in markets heading into next year.

Model Descriptions

Choose The Model That FIts Your Goals

Model Allocations

If you need help after reading the alert, do not hesitate to contact me.

Or, let us manage it for you automatically.


401k Model Performance Analysis

Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only, and one should not rely on it for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.

Have a great week!

Technical Value Scorecard Report – Week Ending 10-22-21

Relative Value Graphs

  • The consumer discretionary sector has been trading well of late. Its performance can be misleading as Amazon (22%) and Tesla (13%) represent a third of the index. Amazon and Tesla shares are up 3.75% and 8.50%, respectively, over the last five days.
  • The energy sector finally took a bit of a break, falling 1.6% versus the S&P 500. Staples continue to trade poor as many of these companies are struggling to pass higher costs onto consumers. The theme was evident in a slew of earnings reports this past week and will likely continue in the coming weeks.
  • Over the last month, our inflation index outperformed our deflation index by 10%. The outperformance is not surprising as TIPs implied inflation expectations have risen half a percent, from 2.42% to 2.94%. With the recent uptick, expectations are now at the highest levels in at least fifteen years. In the third table below, note the 30-day excess returns. In particular, staples, utilities, and healthcare, sectors that struggle with inflation, have greatly lagged. Conversely, financials, energy, and transports are leading the way over the period. Despite the sharply rising prices of many commodity prices, the materials sector is not keeping pace with the inflationary trade.
  • Communications are decently oversold. Traditional communications companies like Comcast, AT&T, and Verizon are dragging on the sector. Adding to the pressure is Facebook, constituting nearly 25% of the sector. They are coming under increasing political pressure, and the stock will open nearly 4% weaker this morning on bad earning from SNAP.
  • Developed markets (EFA) remain weak versus the S&P, as do longer-maturity Treasury bonds (TLT). Both are a function of rising inflation expectations.

Absolute Value Graphs

  • Discretionary, financials, transports, and energy are grossly overbought from an absolute perspective, potentially nearing a short-term top or consolidation. The factors/indexes also show strength in the inflation rotation, with the equal-weighted, mid-cap, and value sectors decently overbought. Unlike the stock sectors noted above, the indexes have more room on the upside before a more robust signal is triggered.
  • The S&P is fairly oversold but still has more room to the upside, as shown on the chart in the lower right.
  • Discretionary is over two standard deviations above its 20, 50, and 200 dma. This further confirms the sector is overbought and due for a pullback or consolidation. Other than that, there are no sectors or factors/indexes too far extended from the 200 dma.

Users Guide

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take any action if other research and models do not affirm it.

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner is the most bearish.

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

Stocks Hit All-Time Highs As Rally Continues

After six exciting green days, stocks hit all-time highs on Thursday as the rally continues. This morning, futures are softer following weak earnings reports from Snapchat (SNAP) and Intel (INTC).

Earnings continue to dominate the news feeds and push individual stocks and markets around. Expect those stocks with earnings announcements to have larger than normal moves. Jerome Powell speaks this morning at 11 am ET. Pay attention to whether or not he sticks with the plans for QE as the recent Fed minutes discuss.

We suspect he will.

Daily Market Commnetary

What To Watch Today

Economy

At 9:45 ET this morning we will see:

  • Markit U.S. Manufacturing PMI, October preliminary (60.5 expected, 60.7 in September)
  • Markit U.S. Services PMI, October preliminary (55.2 expected, 54.9 in September)
  • Markit U.S. Composite PMI, October preliminary (55.0 in September)

Earnings

Pre-market

  • 6:30 a.m. ET: Honeywell International (HONto report adjusted earnings of $2.00 per share on revenue of $8.64 billion
  • 6:55 a.m. ET: VF Corp (VFCto report adjusted earnings of $1.15 per share on revenue of $3.50 billion 
  • 7:00 a.m. ET: American Express (AXP) to report adjusted earnings of $1.77 per share on revenue of $10.54 billion 
  • 7:00 a.m. ET: Schlumberger (SLB) to report adjusted earnings of 36 cents per share on revenue. of $5.94 billion

Courtesy Of Yahoo

Market Getting Very Overbought Near Term

Very shortly, we will be releasing our Money Flow Indicator for all RIAPRO users. However, for now, I wanted to show you the current setup which is suggesting the current market rally may be approaching a short-term peak, and consolidation, following the recent run.

While the index has not turned negative yet, it is currently at a very high level. Normally, such positioning suggests more limited upside to markets near term. As you will notice, not all signals immediately result in a rally or correction, however, more often than not, the signals are worth paying attention to.

Federal Reserve Trading Policy

With the cat out of the bag, and many high-ranking Fed officials caught actively trading the markets with inside knowledge of what the Fed would say and/or do, the Fed is finally taking action. Per the press release below, Fed members are now subject to a number of strict rules that will greatly limit their ability to trade markets. For what it’s worth, the banks they regulate have had trading rules in place, like the ones below for decades.

Tight Labor Market Leading To Higher Wages – More Inflation

“People are quitting low-paying jobs for higher-paying jobs. They are quitting great jobs for even better jobs. People are quitting to become their own boss. People are quitting because they don’t actually need the income.

To summarize, workers are not only quitting at historically high rates, but they’re also being increasingly choosy about picking their next jobs. The tight labor market is creating a self-reinforcing loop: Demand is strong, and prices are rising everywhere, but so are wages, as desperate employers trip over themselves to hike pay in a bid to retain and attract talent.” – YahooFinance

It is worth noting there is an almost PERFECT correlation between incomes and economic growth. When wages rise, particularly when that increase is fast, it has preceded economic slowdowns.

With Q3 GDP dropping sharply, and Q4 unlikely to accelerate much, high wages will continue to pressure economic growth slower. As a consequence, employers will begin to reduce CapEx, employment, etc. in order to protect profitability. (Also why stock buybacks are at a record.)

Philly Fed

The Philadelphia Fed Manufacturing index came in below expectations at 23.8 down from 30.7 in October. However, the details were not as bad as the headline. Employment, new orders, and the 6-month outlook for capital spending all rose.

The index is composed of indicators that tend to lag economic activity and ones that lead economic activity. The graph below, courtesy of Nordea, shows how the difference between the leading and lagging indicators leads the broader index by about 10 months. As shown, the leading-lagging differential portends the index will fall back into economic contraction in the coming months. This chart affirms the sharp deceleration in growth currently being forecasted by the Atlanta Fed GDPNow.

Third Quarter Earnings Pageant Continues

$BITO is Not Perfect

Subscribers have asked our thoughts on the new Bitcoin ETF (BITO) as a substitute for Bitcoin. The biggest drawback appears to be the cost structure is not as friendly as owning Bitcoin. First, the ETF’s management fee is 0.95%. Second, and this is a flaw with many commodity ETFs, holders pay to “roll” contracts. BITO is fully invested in the October Bitcoin futures contract. Accordingly, they will have to buy the November contract and sell October. Currently, the November contract is trading at a premium of 1.27% to the October price. If the futures curve remains steep, holders of BITO will pay 15% or more annualized to roll contracts.  Including the management fee, BITO could underperform Bitcoin by nearly 20%. Obviously, that estimate will change based on the shape of the futures curve. Click HERE for Bitcoin futures prices for current and out months.

Oil CAPEX Declining

On Tuesday we shared a WSJ article that discusses the lack of investment in energy exploration (CAPEX). We just stumbled upon the graph below which shows the problem has been brewing for about five years. Political and economic incentives favor green energy, leading us to believe that unless oil prices stay at current levels or higher and can sustain such levels, there is little reason to expect investment to pick up.

A Day Late & A Dollar Short – The Fed’s Coming Policy Mistake

An honest review of history shows the Fed is consistently a “day late and a dollar short” regarding monetary policy. With the market trading at historical extremes, it is clear the Fed is about to make another policy mistake.

The history of “financial accidents” due to the Fed’s monetary intervention schemes is evident. Not just over the last decade, but since the Fed became “active” in 1980.

What should be evident is that before the Fed became active, economic growth was accelerating. There were few crisis events and economic prosperity was broad. However, post-1980, the trend of economic growth declined. There are many reasons leading up to each event, However, the common denominator is the Fed tightening monetary policy.

Notably, Fed rate hiking campaigns also correlate with poor financial market outcomes, as higher rates impacted the credit and leverage markets.

Once again, the Fed is discussing tightening monetary policy. The first step would be reducing their $120 billion monthly bond purchases, then potentially hiking rates. While they believe they can achieve this reduction without disrupting the equity markets or causing an economic contraction, history suggests otherwise.

Right Idea. Wrong Implementation.

The Fed’s assumption is that by providing excess reserves to the banking system, the banks would lend those funds, thereby expanding economic activity. Furthermore, as discussed previously, the Federal Reserve’s entire premise of inflating asset prices was the subsequent boost to economic activity from an increased “wealth effect.”

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.” – Ben Bernanke

However, after more than a decade of “monetary policy,” little evidence supports that claim. Instead, there is sufficient evidence “monetary policy” leads to other problems. Such include greater wealth inequality, speculative investment activity, and slower economic growth.

Current monetary policy has its roots in Keynesian economic theory. To wit:

A general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.”

In such a situation, Keynesian economics states that fiscal policies could increase aggregate demand, thus expanding economic activity and reducing unemployment. 

The only problem is that it didn’t work as planned because “monetary policy” is NOT expansionary.

“Since 2008, the total cumulative growth of the economy is just $3.5 trillion. In other words, for each dollar of economic growth since 2008, it required $12 of monetary stimulus. Such sounds okay until you realize it came solely from debt issuance.

Monetary Policy Expansionary, #MacroView: Monetary Policy Is Not Expansionary.

Fed Should Have Already Hiked Rates

The problem for the Fed is they are always a “day late and a dollar short.” Where the Fed repeats its mistake is keeping monetary policy accommodative for too long.

Instead, the Fed should use Government interventions to hike rates from zero while the excess liquidity supports economic growth.

For example, during the “Financial Crisis,” the Fed should have hiked rates as the spike in economic growth occurred in 2010-2011. At that point, both the Fed and Government had flooded the economy with liquidity. Yes, hiking rates would have slowed the advance in the financial markets. However, the excess liquidity would have offset the impact of tighter monetary policy.

If they had hiked rates sooner, interest rates on the short-end would have risen. Such would have given the Fed a policy tool to combat economic weakness in the future. But, of course, such assumes a historically normal response to economic recoveries. In that case, the yield curve would steepen sharply, providing higher yields to lenders.

Higher yields would slow speculative investment activity in the financial markets, housing, and other leveraged market investments. Such would reduce the financial risks to markets and potentially the need to continually “bailout” bad actors.

Such was a point made by Don Kohn, the Fed’s former vice chair for financial supervision.

“Dealing with risks to the financial stability is urgent. The current situation is replete with unusually large risks of the unexpected, which, if they come to pass, could result in the financial system amplifying shocks, putting the economy at risk.”

Policy Mistake In The Making

Don Kohn explicitly noted the Fed’s mention of “notable” vulnerabilities in the financial system. With asset values at historical highs, and record levels of financial debt, the concerns are valid.

The problem for the Fed is that interest rates are already at zero, the Government is running a massive deficit, not to mention $120 billion in QE monthly. Such puts the Fed in a poor position to respond to an economic downturn resulting from the bursting of an asset bubble or a debt crisis.

Our view aligns with GMO co-founder Jeremy Grantham. He argued:

“The Fed should act to deflate all asset prices carefully, knowing that an earlier decline, however painful, would be smaller and less dangerous than waiting.”

Yes, if the Fed had acted earlier to start hiking rates in which QE was in full swing, the market indeed would not have doubled in a year. However, the Fed would be in a much better position to minimize the damage from the next recessionary spat.

“Right now, systemic risk is not something the Fed is required to take into account as they carry out their missions. They should be required to broaden their perspective to consider the systemic implications of their actions and of the activities and firms they oversee and be held accountable for doing this.Kohn

Maybe, if such were the case, the Fed would not have to “bailout” the financial institutions every time the market declines.

In the end, the Fed will be a “day late and a dollar short” once again.

Stocks Climb Toward Highs As Earnings Roll In

Yesterday, stocks advanced for the 6th day heading towards previous highs as earnings roll in. With little economic news on the calendar, there was little to worry traders currently. The S&P closed inches shy of a record high, while the Dow Jones Industrial Average did set a new high. The NASDAQ fell slightly as technology got weighed down by rising interest rates.

The volatility and downward momentum of just a few weeks ago seems like a long-lost nightmare. The trend is clearly upward, although a test of the 50-dma is still in order to confirm the recent break above resistance.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Initial jobless claimsweek ended Oct. 16 (297,000 expected, 293,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended Oct. 9 (2.548 million expected, 2.593 million during prior week)
  • 8:30 a.m. ET: Philadelphia Fed Business Outlook, October (25.0 expected, 30.7 in September)
  • 10:00 a.m. ET: Leading Index, September (0.4% expected, 0.9% in August)
  • 10:00 a.m. ET: Existing Home Sales, September (6.09 million expected, 5.88 million in August)

Earnings

Pre-market

  • 6:00 a.m. ET: Danaher (DHRto report adjusted earnings of $2.16 per share on revenue of $7.03 billion
  • 6:00 a.m. ET: Dow Inc. (DOW) to report adjusted earnings of $2.56. per share on revenue of $14.25 billion
  • 6:00 a.m. ET: Alaska Air Group (ALK) to report adjusted earnings of $1.36 per share on revenue of $1.94 billion
  • 6:30 a.m. ET: Valero Energy (VLOto report adjusted earnings of 94 cents per share on revenue of $25.13 billion
  • 6:30 a.m. ET: AT&T (Tto report adjusted earnings of 79 cents per share on revenue of $40.48 billion
  • 6:45 a.m. ET: Quest Diagnostics (DGXto report adjusted earnings of $2.88 per share on revenue of $2.45 billion
  • 6:45 a.m. ET: Southwest Airlines (LUVto report adjusted losses of 26 cents per share on revenue of $4.64 billion
  • 7:00 a.m. ET: American Air Lines (AAL) to report adjusted losses of $1.03 per share on revenue of $8.94 billion
  • 7:00 a.m. ET: Pool Corp. (POOLto report adjusted earnings of $3.84 per share on revenue of $1.37 billion
  • 8:00 a.m. ET: Union Pacific (UNP) to report adjusted earnings of $2.48 per share on revenue of $5.39 billion

Post-market

  • 4:00 p.m. ET: Intel (INTCto report adjusted earnings of $1.11 per share on revenue of $18.36 billion
  • 4:05 p.m. ET: Whirlpool (WHRto report adjusted earnings of $6.12 per share on r revenue of $386.20 million
  • 4:10 p.m. ET: Chipotle Mexican Grill (CMG) to report adjusted earnings of $6.35 per share on revenue of $1.94 billion

Bitcoin ETF Sets Record Climbing To $1 Billion In AUM In 2-Days

Amazing….and yes, there is no speculation in the market.

A Rally To 4800?

Heading into year-end, if the market continues its current advance, consolidation, advance profile from earlier this year, the current year-end target could be as much as 4800.

While that is a very bullish outlook, it is likely much of the upside has already gotten priced in. With inflationary pressures rising, the threat of a Fed taper, and weaker economic growth, further gains could become more challenging.

However, this year has been a year of “bullish exuberance,” so we aren’t ruling out the possibility of a sharp advance into year-end in hopes of a stronger 2022.

Verizon (VZ) Earnings

VZ reported third-quarter GAAP EPS well above consensus at $1.55 versus expectations of $1.35. Revenue was $32.9B (+4.4% YoY), which missed estimates of $33.2B. Wireless retail net adds surprised to the upside with 699K net adds versus 566K expected.

Guidance for FY21 adjusted EPS was raised to $5.35-$5.40 from $5.25-$5.35. The new range is well above the consensus estimate of $5.29. Management also narrowed FY21 guidance to a 4% increase in total wireless revenue from the previous range of 3.5%-4%. VZ is trading 2.1% higher this morning following the results. We hold a 1.5% position in the Equity Model.

NextEra Energy (NEE) Earnings

NEE reported third-quarter GAAP EPS of $0.23, which missed analyst estimates of $0.71. Adjusted EPS did beat estimates, however, at $0.71 versus expectations of $0.67. Revenue came in short of consensus at $4.4B (-8.8% YoY) versus expectations of $5.4B.

Guidance for FY21 adjusted EPS remains unchanged at $2.40-$2.54, with the mid-point slightly below the consensus of $2.52. NEE expects adjusted EPS growth of 6%-8% from FY21 in 2022 and 2023. NEE is trading 2.3% higher this morning after the release. We hold a 2% position in the Equity Model.

Abbott Labs (ABT) Earnings

ABT reported third-quarter GAAP EPS of $1.17, which beat analyst estimates of $0.67. Revenue of $10.9B (+22.8% YoY) also beat the consensus of $9.56B. Revenue growth was driven, in part, by strong results in COVID-19 testing products. Excluding COVID-19 related testing products, organic sales grew 11.7% versus the third quarter of 2019.

Guidance for FY21 GAAP EPS was set to $3.55-$3.65, while FY21 adjusted EPS guidance was boosted to $5.00-$5.10 from a prior range of $4.30-$4.50. This compares to a consensus estimate of $4.45. Following the positive results and guidance, the stock is trading 3.9% higher this morning. We hold a 2% position in the Equity Model.

Why Stocks and Bonds Do Not Agree

Tweet Of The Day

Stocks Should Be 40% Lower

In an upcoming article, I am discussing the chart below which shows the decomposition of the S&P index returns over the last decade. From the article:

  • 21% from multiple expansion,
  • 31.4% from earnings,
  • 7.1% from dividends, and
  • 40.5% from share buybacks.

“In other words, in the absence of share repurchases the stock market would not be pushing record highs of 4600, but rather levels closer to 2700.

To put that into context, the high water mark for the S&P 500 in October 2007 was 1556. In October 2021, after 14-years, the market would be 2700 without share buybacks. Such would mean that stocks returned a total of about 3% annually or 42% in total over that 14-year period.

Before you scoff at a 3% annualized return, such would equate to an economy growing at 2% with a roughly 1-2% dividend yield. Such would align with historical norms going back to 1900.”

Paltry Growth Forecast

The Atlanta Fed GDPNow forecast for Q3 economic growth fell to 0.5%, down from 1.2%. The chart below shows how each major subcomponent contributed to the forecast. Increasing private inventories, adding 2.1%, is keeping the GDP forecast above zero. Typically accounting for two-thirds of GDP, Consumer Spending is only contributing 0.31% to the forecast, well off the 2.70% rate in August.

Industrial Production

In Monday’s Industrial Production report, Industrial Production fell 1.3%, and the lesser followed capacity utilization fell from 76.4% to 75.2%. The data is a little surprising given the shortage of goods available to the public. At first blush, one would think factories would be running at maximum capacity and production rising rapidly. Unfortunately, manufacturers face the same problem as their consumers, a shortage of goods needed to produce products. For example, it is well documented most auto manufacturers are cutting production due to a chip shortage. The graph below shows capacity utilization for the auto industry is at recession levels of 55%. It was running between 70-80% before the pandemic and had prior peaks over 90%. Auto manufacturing contributes about 3% to GDP.

Patrick Hill: Is a Volatility Storm Coming?

Is A Volatility Storm Coming?

Volatility often refers to the amount of uncertainty or risk related to the size of changes in a security’s value. A higher volatility means that a security’s value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction.”    – Investopedia

Federal Reserve Bond Tapering & Interest Rate Hikes Reduce Liquidity

Federal Reserve liquidity injections have bailed out the economy and equity markets for the last 18 months. And as a result, the bailout created a relatively low volatility environment for equity and bond markets.  Will the announced withdrawal of Fed injections of $120B per month set up the monetary system for higher volatility?  We see major economic forces combining in the intermediate future to create a possible ‘volatility storm’ driving valuations down. These economic forces include:

  • Fed tapering
  • Interest rate hikes
  • Inflation
  • Labor wage increases.

One of these macro factors is a challenge for monetary policymakers to mitigate damage to the financial system.  But, a combination of these factors already building may overwhelm the monetary system. Further, markets are at historic high valuations today. But, market weaknesses and structure, along with valuations may create optimal conditions for a volatility storm.

Taper Is Coming

In September, the minutes of the September Federal Open Market Committee meeting noted that most participants agreed that tapering of treasury and mortgage bond purchases should begin in December, but analysts expect a formal announcement at the November Fed meeting.  Accordingly, here is a forecast of how the projected tapering may occur into mid – June 2022.

Sources: Zero Hedge, Real Investment Advice – 10/15/21

The financial markets enjoyed about $2.16T in liquidity injections resulting in a low volatility monetary environment for the S&P 500 to bull market from a March 2020 low of 2191 to 4471. The impact of tapering is both real and psychological.  However, some analysts argue that the real reduction in bond purchases will have a minimal effect on bond markets.  Others note that while the actual withdrawal of treasury bond purchases in the $21.9T treasury market is small, the psychological aspects of tapering are significant.  Investors will feel the Federal Reserve is not ‘covering their downside risk’ anymore.

Some economists see an increase in volatility due to the end of bond purchases and increasing interest rates.  On Fox News, October 17th, Mohammed El-Erian, Chief Economic Advisor at Allianz SE, said he sees increased volatility in the future.

“I worry…that this wonderful world we’ve been living in of low volatility, everything going up, may come to a stop with higher volatility. If I were an investor, I would recognize that I’m riding a huge liquidity wave thanks to the Fed, but I would remember that waves tend to break at some point, so I would be very attentive.”

Inflation Surges to Decade Highs

The Consumer Price Index, CPI has moved above 5% on a year-over-year basis and it continues to rise.  Housing rent prices are up by 17.9%, according to the Case – Shiller housing September index.  Rent increases lead owner equivalent rent housing costs by five months based on a model by Macrobond and Nordea. This means that the 14% jump in existing home prices YoY is likely to extend into next year.   Below is a chart of the CPI since 2017 and major components such as housing and gasoline.

Sources: Bloomberg, Bureau of Labor Statistics – 10/13/21

The record prices of key commodities continue to drive the price of manufactured goods higher. Oil prices settled at $85 per barrel, a three-year high on October 15th.  Aluminum prices have increased by 40% in the last year.  The metal price hit a 13 year high on the London Metal Exchange on October 15th as well.  Copper prices surged by12% in the last week to the highest price since May 12th with a 74 year low in inventories.  Demand for primary metals has soared due to power generation demand and the shift to green power infrastructure systems. If passed, the $1T Bipartisan Infrastructure Bill agreed upon in Congress will likely keep commodities prices high for a couple of years.

China Boosting Demand

Plus, China continues to make considerable investments in manufacturing and power generation projects keeping global demand high for commodities.  Container shipping of commodities adds to their price.  Container shipping rates from Shanghai to Los Angeles have increased by ten times in the last year. Computer chip shortages continue with the highest delays on record in chip shipments for September and auto manufacturers have reduced production on some models by 10 – 20% reducing car inventories at dealers and supporting high new and used car prices.  Mitigating the surge in inflation would be declining consumer sentiment and buying, plus a possible slowdown in the global economy.  Yet, wages may continue to climb, causing businesses to respond with price increases.

Increased Wages Drive Demand Inflation

Increases in wages will possibly sustain demand.   Weekly earnings have soared to almost 10%.  This chart shows weekly earnings back to 1983, the last time earnings increased at this high level.

Source: Bloomberg – 10/12/21

Worker earnings increases continue to be driven by a labor shortage. There are 4.3M jobs left to fill since the labor force participation rate high of February 2020. Critical factors in many jobs not being filled include: 3.6M retirees not returning to the labor force, lower-wage hospitality workers into higher-paying warehouse and delivery jobs, and 2.5M workers staying at home to care for Covid-19 relatives.  The Wall Street Journal reports on October 14th the labor participation rate is at 61.6% versus 63.3% in February 2020. As a result, the labor force participation rate continues to be below pre-pandemic levels. 

Sources: Labor Department, The Wall Street Journal – 10/14/21

Sources: Labor Department, The Wall Street Journal – 10/14/21

Labor Shortages Aren’t Helping

The National Federation of Independent Businesses recently reported that their Hard Jobs to Fill indicator shows that wages are likely to continue to soar. The following chart shows how the labor shortage is fueling a rise in wages.

Sources: NFIB, The Daily Shot 10/12/21

In many industries, the labor shortage is forcing employers to hire key employees away from competitors.  Accordingly, employers report in tight markets such as software programming offering 20% hire-on bonuses.   The restaurant industry’s average wage now stands above $15 per hour to attract workers in this 400% yearly worker churn sector.  Further, recruiters report that some workers seeing a tight labor market are evaluating work-life balance choices.  Also, drop-out workers in some cases are taking vacations, pursuing hobbies, or just taking a break.  Remote work-from-home options will continue to create tighter labor conditions for the foreseeable future.  A September Wall Street Journal survey of 52 economists showed that 42% expect the economy to not recover to pre-pandemic workforce levels for years to come.

Next, let’s look at how weaknesses in the market can provide clues on a gathering volatility storm.

Monthly, Weekly Time Frames Show Bearish Market Direction

Brett Freeze, principal at Global Technical Analysis (GTA), uses a unique set of time frames matched with trend models to identify support and resistance levels. Markets behave in different ways based on different time periods and participants. For example, institutional investors tend to make long-term investments quarterly. GTA analysis reports on quarterly, monthly, weekly, and daily trends. The following chart shows ES futures contract prices are below Monthly and Weekly Trends. The model notes a one period or two-period move as below trend.  When ES future prices make three consecutive period moves, a trend is indicated for that timeframe.

Source: Brett Freeze, Global Technical Analysis – 10/15/21

Note: PQH = Previous Quarter High, PQL = Previous Quarter Low, PMH = Previous Month High, PML = Previous Month Low, PWH = Previous Weekly High, PML = Previous Weekly Low, PDH = Previous Daily High, PDL = Previous Daily Low

Realized Volatility Is Relatively Low, Yet Implied Volatility Is Rising

Realized volatility is the change in price between the daily closes of a stock, ETF, or financial instrument.  The following chart from Lance Roberts and CNBC shows how price changes in the S&P 500 have been above average but are still within a 2% daily range since the March 2020 SPX lows.

Source: Real Investment Advice – 10/6/21

Realized volatility shows how market participants are actually driving market price swings by direct trading.  The limited movement of realized volatility obscures the impact of implied volatility of markets.

Implied Volatility

Implied volatility is the range of prices based on speculation of where a price may be for underlying security or index at a specific date. Overall implied volatility has been climbing the past few years.  The Volatility Index (VIX) is an indicator of implied volatility. The Chicago Board Options Exchange developed the VIX as a real-time index representing market expectations for the relative strength of near-term price changes of the S&P 500 index (SPX). It is calculated based on the ratio of puts (an option to sell underlying security) to calls (an option to buy underlying security) for near-term (30 days or less) options contracts.

VIX – Bullish or Bearish?

The lower the VIX index and the more calls to puts is considered bullish.  Conversely, the more puts to calls driving and higher VIX is deemed to be bearish.  The VIX uses put and call options set at specific strike price levels that traders speculate the SPX maybe, not the actual SPX index value. The VIX is one gauge of market sentiment on the direction of prices for the SPX.  Over the past several years, the baseline VIX has been climbing as the SPX has rallied.  Higher lows indicate growing anxiety about high valuations.  The following monthly chart shows the VIX levels since 2014 with higher lows (red arrow) as it spikes at market lows like March 2020.

Source: Patrick Hill – 10/16/21

The VIX reached a low of 9.51 in 2017 and today stands at 16.30 on October 15th as a rally continues.  The VIX reached a high of 53.54 at the SPX March 2020 decline. It would seem with higher lows that a higher spike is possible. Daily options market volume as of September is higher than the volume of underlying stocks. This means that speculation on where the SPX level will be is overtaking market flows.

Options Levels Point to A Volatility Storm Zone – Below 4400

Options analysts note last week’s bounce in S&P 500 Index is likely due to traders selling put options at monthly expiration, which crushed implied volatility.  The VIX indicator fell to 16.80 from 20. Dealers began setting up ‘short volatility positions and buying calls supporting the rise in market prices. SPX levels of open interest in puts and calls identify where there may be support or resistance to prices.

The following chart shows a gamma pivot point at 4400.  Gamma is the rate of change of the delta or sensitivity of the option price to a $1 change in the underlying stock price.  It measures the rate at which dealers must adjust their hedged positions. Positive gamma is above 4400, where there are more calls than puts and traders are net-long options.  As a stock price goes up, the dealer sells the stock and buys it as it goes down.  Dealers dampen price changes in a positive gamma environment.

Conversely, when a dealer is net short options, they must hedge by selling the stock as it goes down and buying the stock as price rises triggering increased volatility.  Today, 4400 is the pivot point between positive and negative gamma. Below 4300, we added a Volatility Zone where a volatility storm may build. The chart shows total open interest with puts below the zero line and calls above, with current expiration darkly shaded.

Sources: SpotGamma.com and Patrick Hill – 10/15/21

Watch out Below 4400

Brent Kochuba, a co-founder of SpotGamma, notes likely increased volatility below 4400,

We currently see fairly light put positions below 4400. This implies that traders may need to purchase put options on a break of 4400, which could in turn force options dealers to short futures. This could lead to dealers shorting into a down market, which increases volatility.”

We have located where the volatility storm may develop. But, what factors might trigger a storm?

Factors Triggering a Volatility Storm

The critical triggering events will be Federal Reserve tapering and interest rate increases planned for 2022.  The financial markets depend on high levels of liquidity, so any reduction in liquidity could act as a catalyst for a volatility storm.  Other factors that may magnify a liquidity crunch include:

  1. The debt ceiling not being raised in December
  2. Options hedgers overreach and can’t cover margin positions, triggering forced selling
  3. Inflation roaring further ahead beyond the Fed’s ability to control it, so the market loses confidence in the Fed
  4. The Fed raises interest rates higher and faster than the market expects
  5. Consumers quit spending, causing retail sales to drop, corporations sales fall, and stock buybacks end that were sustaining high market valuations
  6. The economy goes into a recession as GDP drops, employment falls, and corporate valuations fall
  7. Any black swan event like the pandemic

Any volatility storm as markets decline is likely to force analysts to shift from valuing stocks based on market speculation to actual GAAP earnings (not stock buyback inflated EPS), fundamentals, and related unused valuation tools.  The TINA – ‘there is no alternative’ trading phenomenon would be over.  Investors will need to be mindful of the extreme volatility posed by a volatility storm. Accordingly, wild rallies and steep falls will require portfolio managers to sharpen their hedging and volatility strategies to maintain portfolio value.

Author

Patrick Hill is the Editor of The Future Economy, https://thefutureconomy.com/, the site hosts analysis of the real economy, ideas on a new economy, indicators, labor-capitalism trends, and posts to start a dialog. He writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like H.P., Genentech, Verigy, Informatica, and Okta to provide investment and economic insights. Twitter: @PatrickHill1677, email: patrickhill@thefutureconomy.com

David Robertson: Market Review And Update Q3-2021

Market review and update for the third quarter of 2021.

After a solid performance in both July and August, the S&P 500 was considerably weaker in September. It was more than just passing weakness, however. The stock market looked much less the cocksure prizefighter than the contender who took a shot to the jaw that wobbled his knees.

There are plenty of explanations for the market’s diminished presence. Oil prices have remained stubbornly high. GDP estimates are coming down. Stagflation is a common topic again. The problems with real estate debt in China are metastasizing. But, perhaps most importantly, rates are going up again, and because of inflation concerns, not better than expected growth. This witches brew may be entertaining for those caught up in the Halloween spirit, but long-term investors wonder if this will bring trick or treat.

Rising prices

Much of the concern starts on the energy front, where prices from oil to natural gas to coal have all risen. The outstanding question is, “How much should we make of this?”

Robert Armstrong from the FT caught up with Jason Bordoff, the director of Columbia University’s Center on Global Energy Policy, to provide some context on energy prices:

The only thing that helps the climate is if demand falls with supply. Demand falls because of policy, and because technology drives the costs of the alternatives down, and capital goes into them. Some will say higher [fossil fuel] prices are what cause higher investment in alternatives. But they are going to cause a backlash against the climate policies that we really need.”

“What this [crisis] shows is how difficult, disruptive and messy this transition is going to be. Who thought we could replace the lifeblood of the world economy and that would be easy? It’s going to be super volatile.

The Economist also addressed the policy of decarbonization and its effects on energy markets. However, it also reached a similar conclusion: “The age of abundance [of energy] is dead.”

Slowing growth

At the same time, GDP estimates for the third quarter have been falling precipitously to where the Atlanta Fed’s GDPNow estimate is only 1.3%. Not only is this a striking change from only six months ago, but the deterioration in the last month has also been substantial. Are higher energy and food prices already constraining other spending?

If a marked slowdown in the world’s largest economy wasn’t enough of an issue, the world’s second-largest economy is also slowing down. As Zerohedge reports:

“Having already suffered the fastest drop on record, Chinese junk bond markets – where property developer issuers dominate – were routed once again as fears about fast-spreading contagion in the $5 trillion sector, which drives a sizable chunk of the Chinese economy, continued to savage sentiment.”

The unsurprising conclusion is, “Evergrande’s contagion risk is now spreading across other issuers and sectors.” With the property market being ground zero for China’s economic growth, all signals point to a slowdown.

Stagflation

Combine stubbornly rising prices and rapidly slowing growth in the world’s two largest economies, and the subject of stagflation suddenly begins to take hold. The emergence of stagflation as a scenario to be considered gets depicted in the graph from themarketear.com (Oct 10, 2021).  

While the merits of the stagflation concern can get debated, those of us who experienced it in the 1970s remember it vividly. The heightened sensitivity is partly due to the unusual confluence of conditions and partly due to the devastating effect on financial assets.

Transitional transitory

While the Fed’s line has been for only “transitory” inflation, new indications of inflationary conditions keep popping up, and something more seems to be at work. This week, Atlanta Fed President Raphael Bostic characterized the price increases resulting from supply chain disruptions as likely to last, implying they are not transitory. The CPI for September also came in very warm at 5.4% and 4.0% on a core basis. In that number, the owner’s equivalent rent (OER) jumped to 0.4% month over month, indicating higher home prices are beginning to filter through into inflation.

In addition, the ability of supply to adjust to demand conditions is being constrained by more than just supply chains. As Jason Bordoff intimates, energy production gets constrained by public policy. However, the challenge is even worse than that, as activist investors are pressuring Exxon Mobil and Chevron to reduce investment in oil fields. If supply cannot respond to demand by way of price signals, words such as “difficult,” “disruptive,” “messy,” and “super volatile” are appropriate for describing the energy transition.

Not to be left out, the labor market is also showing signs of transitioning awkwardly from transitory issues to more persistent ones. What we know is voluntary quit rates are up. The Washington Post reported:

“Some 4.3 million people quit jobs in August — about 2.9 percent of the workforce, according to new data released Tuesday from the Labor Department. Those numbers are up from the previous record, set in April, of about 4 million people quitting, reflecting how the pandemic has continued to jolt workers’ mindset about their jobs and their lives.”

Widespread reasons

The reasons are widespread. Many jobs are getting tougher. Videos show flight attendants getting punched by unruly passengers. Restaurant servers are hassled for slow orders – because there aren’t enough restaurant servers. Healthcare workers, no strangers to adverse work conditions, have had to endure multiple waves of Covid. They are now getting rewarded for their (sometimes heroic) efforts by exceedingly ill-tempered patients.

Southwest canceled 1900 flights over the weekend and hundreds more early in the week in what does not appear to be an exclusively weather-related incident. So is this an aberration or the beginning of a disturbing trend? We’ll have to wait and see, but signs point to more takes on the sickout theme.

Jeremy Rudd tackles yet another issue in his recent paper on inflation expectations:

“Likewise, the survey evidence on why people dislike inflation reported in Shiller (1997) indicates that a major concern is that their wages won’t keep up with price increases—which certainly doesn’t suggest that they view themselves as having much bargaining power with their existing employer.”

In other words, in many situations, you have to quit a job and get a better one to get a raise. Many employees do not have the bargaining power to get raises, even if they are deserved.

Other paths

While there are several indications of pricing pressure across various dimensions, there is also evidence deflation may be the more significant threat. Rising commodity prices have stoked recent concerns about inflation, but Gary Shilling outlines eight reasons why the rally in commodities is likely to end soon in his latest newsletter. Slower growth globally and in China are the top two reasons. Excess supply and the strength of the US dollar also contribute. All the ideas are sound.

In addition, while longer-term interest rates have been trending up since early August, they have reversed the last few days. This flattening of the yield curve, while still very preliminary, presents troubling evidence for the inflation case.

So, where does this leave investors? The most obvious conclusion is the environment is becoming considerably more muddled than “The Fed has our back.” As a result, the prescription must be more nuanced than “Buy the dip.” As The Market Ear described on Oct. 13, “The aggregate psychology of this market is very complex and interesting right now.”

Implications

Investors who have profited by riding the wave of ever-higher stock prices should probably read “complex” and “interesting” as “harder.” One of the most powerful tailwinds for both stocks and bonds has been declining interest rates. If rates continue rising, much of the old playbook is going to get reconsidered.

For one, protection or risk management will have a valuable role to play again. On Wednesday, at the Global Independent Research Conference, Jim Grant explained, “the muscle memory of four decades of declining rates conditioned people to expect anything but inflation.” As a result, he thinks people have become conditioned to “disregard the usefulness of margin of safety.” So, it’s a good time to bone up on the margin of safety or to take a refresher course.

Dylan Grice (on the same panel at the conference), along the same lines, “all roads lead to duration.” In other words, the phenomenon of declining interest rates has been an enormous tailwind for a vast array of investment strategies. But, given the many miscues on inflation the last several years, he suggested: “we should have learned some humility.”

His investment answer is to avoid taking a big bet on the inherently uncertain prospect of inflation altogether. More specifically, he prefers to “sit on the fence” and avoid taking the big duration bets inherent to owning stocks and bonds. His point is, “it is easier to find duration-free investments than picking the direction of rates.”

Conclusion

Since early September, the S&P 500 has looked uncharacteristically lethargic. Yet, even with a big pop on Thursday (10/14/21), it is hard to deny the landscape is becoming more “complex.”

A big part of the problem has been the persistence of inflationary forces. So while it may be tempting to determine the most likely direction of price pressures, some of the most brilliant people are advocating for humility. Indeed, the avoidance of purely directional plays, and implementation of risk management, are pages from a different playbook.

Bitcoin and $BITO Mania Grip the Stock Market

$BITO, the first Bitcoin ETF was issued Tuesday morning. The ETF provides retail investors their first true access to Bitcoin without having to open up a crypto wallet account. BITO tracks bitcoin futures and is expected to track the cryptocurrency much closer than the Grayscale Trust (GBTC).

Stocks rallied alongside BITO and posted a fifth straight green day. The index is now well established above its 50dma and aiming for new record highs. However, not surprisingly, the market surge has quickly taken the index back to overbought conditions short-term. Such suggests we could see some consolidation, or a potential retest of the 50-dma, before attempting all-time highs.

Daily Market Commnetary

What To Watch Today

Economy

  • 7:00 a.m. ET: MBA mortgage applications, week ended Oct. 15 (0.2% during prior week)
  • 2:00 p.m. ET: Federal Reserve releases Beige Book

Earnings

Pre-market

  • 6:00 a.m. ET: Anthem (ANTM) to report adjusted earnings of $6.37 per share on revenue of $35.39 billion
  • 6:25 a.m. ET: Citizens Financial Group (CFG) to report adjusted earnings of $1.17 per share on revenue of $1.64 billion
  • 7:00 a.m. ET: Biogen (BIIB) to report adjusted earnings of $4.10 per share on revenue of $2.68 billion
  • 7:00 a.m. ET: Nasdaq (NDAQ) to report adjusted earnings of $1.73 per share on. revenue of $830.82 million
  • 7:00 a.m. ET: Baker Hughes (BKRto report adjusted earnings of 21 cents per share on revenue of $5.34 billion
  • 7:15 a.m. ET: Abbott Laboratories (ABT) to report adjusted earnings of 94 cents per share on revenue of $9.54 billion
  • 7:30 a.m. ET: Verizon Communications (VZ) to report adjusted earnings of $1.36 per. share on revenue of $33.24 billion 

Post-market

  • 4:00 p.m. ET: Las Vegas Sands Corp. (LVS) to report adjusted losses of 23 cents per share on revenue of $1.16 billion
  • 4:05 p.m. ET: Tesla (TSLA) to report adjusted earnings of $1.67 per share on revenue of $13.91 billion
  • 4:05 p.m. ET: Kinder Morgan (KMIto report adjusted earnings of 22 cents per share on revenue of $3.2 billion
  • 4:10 p.m. ET: IBM (IBM) to report adjusted earnings of $2.53 per share on revenue of $17.83 billion
  • 4:15 p.m. ET: Equifax (EFX) to report adjusted earnings of $1.71 per share on revenue of $1.18 billion

Courtesy of Yahoo!

20-Strongest Relative Strength Candidates

Using RIAPRO’s Active Trade screen, I ran a screen on the 20-strongest relative strength stocks in the S&P 500 to look for some portfolio candidates.

Johnson & Johnson (JNJ) Earnings

JNJ reported third-quarter earnings today before the open. GAAP EPS of $1.37 missed the consensus estimate of $2.17. However, non-GAAP EPS of $2.60 beat expectations of $2.35. Revenue of $23.3B (+10.7% YoY) missed the consensus of $23.7B. According to the CFO, the revenue miss was just a matter of the timing of shipments in the COVID vaccine and medical devices businesses. That revenue should be made up for in Q4 results.

JNJ increased guidance for FY21 revenue at the low end to a range of $92.8B-$93.3B from $92.5B-$93.3B, but guidance remains below the consensus estimate of $93.97B. Guidance was also boosted for FY21 adjusted EPS to $9.77-$9.82 from $9.50-$9.60 previously. This is well above the consensus estimate of $9.64. The stock is trading 2.6% higher on the results. We hold a 1.5% position in the Equity Model.

Proctor & Gamble (PG) Earnings

PG reported third-quarter earnings this morning before the open. GAAP EPS came in slightly above expectations, at $1.61 (-1% YoY) versus the consensus of $1.59. Revenue of $20.3B (+5.3% YoY) also beat expectations of $19.9B. Organic sales growth of +4% YoY was driven by increased volume (+2%), increased pricing (+1%), and a positive sales mix (+1%). Gross margin, however, decreased by 3.7% YoY due to increased commodity and transportation costs as well as a less profitable sales mix.

PG is planning to raise prices on certain beauty, oral care, and grooming products to offset increasing costs. According to the Wall Street Journal, “‘We do not anticipate any easing of costs,’ P&G Finance Chief Andre Schulten said in an interview. ‘We continue to see increases week after week, though at a slower pace’”. The article continues, “Despite the higher expenses, P&G maintained its sales and profit outlooks for the year, saying increased revenue and cost reductions will enable the company to stay on track”. The stock is trading roughly 2% lower this morning in light of the margin concerns. We hold a 2% position in the Equity Model.

For more on how cost pressures are affecting PG and many other companies, check out this article from the Washington Post.

Stocks to Watch as the Earnings Parade Continues

The Crash of 1987

“Despite varying perceptions, there were clear fundamental and technical warnings preceding the crash that were detected by a few investors. For the rest, the market euphoria raging at the time blinded them to what in hindsight seemed obvious.”

The quote comes from an article we wrote on the stock market crash of 1987. Today, being the 34th anniversary of the crash of 1987, we revisit some important lessons from that era.  Read The Article.

Will Higher Oil Prices Become The Norm?

The Wall Street Journal ran an article discussing a growing investment deficiency into traditional and renewable energy sources. As a result oil prices may stay high until the industry closes the gap.

Per the article:

“Global oil and gas exploration spending, excluding shale, averaged about $100 billion a year from 2010 to 2015, but dropped to an average of around $50 billion in the years that followed after a crash in crude prices, according to Rystad Energy. Total global oil and gas investment this year will be down about 26% from pre-pandemic levels to $356 billion, the IEA said Wednesday.”

Green investments are not growing quickly enough to offset reduced CAPEX in the energy industry. Per the article:

To meet global energy demand, as well as climate aspirations, investments in clean energy would need to grow from around $1.1 trillion this year to $3.4 trillion a year until 2030, the Paris-based agency found. Investment would advance technology, transmission, and storage, among other things.

The bottom line: “The world isn’t investing enough to meet its future energy needs, and uncertainties over policies and demand trajectories create a strong risk of a volatile period ahead for energy markets,” the IEA report said.

Labor Market

Over the last six months, the Fed has been dragging its feet and delaying the inevitable tapering of QE due to perceived weakness in the labor market. The graph below shows the unemployment rate less those labeled “quitters” is near 20-year lows. Quitters are those that left their jobs voluntarily and, in theory, are in search of better or higher-paying jobs. The current quit rate at 2.9% is the highest in its 20-year history. A high quit rate is a signal of labor market strength. Between 5.4% inflation and the graph below, is it any wonder the market is starting to think the Fed is behind the eight ball in tightening?

Persistent Inflation Poses a Real Threat to Stock Prices

Persistent Inflation Poses a Real Threat to Stock Prices

  • Inflation is running hot at 5.4%.
  • The unemployment rate less “quitters” is 1.9%.
  • QE is still running full throttle at $120 billion a month.
  • The Fed will not even think about raising interest rates until QE ends.  

If you do not think inflation can be persistent, think again.

The Fed repeatedly tells us the rationale to keep the monetary pedal to the metal is a weak labor market. The graph below calls their logic into question.

Quitters are defined as those leaving jobs voluntarily and, in theory, in search of better or higher-paying jobs. The current quit rate of 2.9% is the highest in its 20-year history. A high quit rate is a signal of a healthy labor market.

It is not just high inflation and a strong labor market forcing prices high. We must also factor in supply line difficulties and shortages of many goods and commodities.

It is time we best start thinking outside of the stable inflation box. The inflation environment most investors are very comfortable with may be collapsing. 

As we have seen for the past few weeks, equities are becoming sensitive to the rising possibility of persistent, not transitory, inflationary pressures. As such, it is worth revisiting equity analyses we shared in May 2020.

The Specter of Inflation

In May of 2020, we wrote the following: “we raise the specter that inflation may result from the synchronized combination of a variety of factors, including surging money supply, fractured supply chains, and in time, economic resurgence.”

All three factors are now resulting in rising inflation. In mid-2020, no one thought supply line problems and product shortages would linger for over a year. As a result, few economists foresaw inflation running hot for such a long period.

The Fed is starting to acknowledge this bout of inflation may last longer than a “transitory” period. Per Atlanta Fed President Raphael Bostic, “U.S. inflation is broadening, not transitory.” His statement is the first recognition from a Fed member that higher inflation may no longer be transitory.

He started that speech with the following: “You’ll notice I brought a prop to the lectern. It’s a jar with the word “transitory” written on it. This has become a swear word to my staff and me over the past few months. Say “transitory,” and you have to put a dollar in the jar.”

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Investors Prefer Stability

Equity investors should be willing to pay a premium for price stability. Price stability makes corporate forecasting more reliable, allowing executives to manage expenses better and ultimately increase profitability.

To understand why let’s buy a pizza shop. As a potential owner, wouldn’t you be willing to pay more if you knew worker wages, rent payments, and the prices of dough, sauce, cheese, and pepperoni will be constant for the next ten years? Price stability allows for better order management enabling the owner to manage costs efficiently. As a result, the pizza shop can be more profitable.

Equity investors like price stability for the same reason the owner of a pizza shop does. Since the 2008 Financial Crisis, equity investors have been treated to a healthy dose of price stability.   

The orange line below charts CPI since 1948. The blue line shows the running one-year standard deviation or volatility of inflation. Before the pandemic, CPI’s standard deviation was near the lows of any period in the last 70 years (dotted red line).

As we show, with the recent spike in price volatility and 5.40% inflation print, investors should not be so confident of the future. Price behavior of the last year looks nothing like the last ten. That said, there are numerous other periods over the previous 70 years with similar sharp rises in inflation. 

The graph below shows investors are willing to pay a premium when inflation is in the sweet spot. As shown, valuations are highest when CPI runs above 1% and below 4%.

Before today’s instance in red, the highest CAPE occurring when inflation ran between five and six percent was 22.42. At 34.77, the S&P 500 would have to fall 36% to match that high.  

There are two considerations to explain today’s extremes valuations. Either investors do not care anymore, or they believe higher inflation will not last. If it is the latter, we best have a plan if they are wrong. 

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What if Inflation is Persistent?

Given the uncertainty, we should strategize around an array of inflation options. One of those options is not just high inflation, but crippling stagflation like the 1970s and early 1980s.  

In The Crosscurrents of In/De-flation Part 2, we assess seven prior inflationary periods of the last 75 years to gauge how different industries and sectors perform in various inflationary environments. The graph below highlights those periods and their respective levels of inflation. We highlight the current period as well.

The bar graph below shows cumulative returns for each industry if you only held each sector during the inflationary periods.

Materials, drugmakers, and commodity companies tend to do the best in inflationary environments. On the flip side, the S&P 500 is in the red, as are financials, transports, retail, and real estate. Roughly two-thirds of the industries had a positive performance.

The vast amount of data behind the graph is mixed. We do not show that performance for most industries is abysmal during the high inflation spikes of the 1970s and early 1980s. In most other inflationary cases, stocks hold their own, at least on a nominal basis.

Next, we look at the two periods with double-digit inflation, the 1970s, and early 1980s. The graph below shows only gold, oil, ships, and guns produce positive returns. Everything else is in the red. In those two environments, the S&P fell over 50% cumulatively.

Profit Margins Matter

Inflation tends to shrink profit margins and is, therefore, a critical factor in forecasting stock prices. Below we share a proxy for profit margins using total corporate profits as a percent of GDP. Our data is closely aligned with data from Standard and Poors but covers a more extended period allowing us to analyze all seven inflationary periods.

In six of the seven inflationary periods, including both episodes in the 1970s, corporations experienced margin compression. The era of moderate inflation, following the 2008/09 recession, was the only period where margins improved.  

Profit margins are now at their highest levels since at least 1947. If inflation continues higher and margins decline, profits will suffer. Now recall the graph we shared earlier with valuations. If earnings decline due to declining margins and valuations fall to levels in line with prior periods of inflation, stocks could easily fall by 40-50%. Even more significant declines would not be abnormal. 

In the event of persistent inflation, stocks that can protect margins that are not trading at high valuations have the best chance of retaining their value. Conversely, beware of those trading at high margins with limited ability to pass on higher costs to consumers.  

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Conclusion

We still maintain a deflationary bias longer term. That said, we do not know what the future holds, nor does anyone else. It is not a given anymore that supply lines will moderate, and inflation will normalize in a short while. Workers are becoming more emboldened to seek higher wages, threatening a wage-price spiral.

The Fed is running policy as if the economy were in a depression when it is booming. More inflation is probable, at least in the short run, and we best appreciate how inflation can wreak havoc on stock prices.

Given record profit margins and valuations, there appears little upside, especially if inflation remains problematic. Throw stagflation into the formula, and the outlook is bleak.

We urge you carefully consider the risks and rewards in various inflation environments and trade accordingly. This time is different!

Technically Speaking: The Bullish & Bearish Market Case

We dig into the bullish and bearish case for the market as we head into the end of the year. Currently, investors face a conundrum between year-end seasonality and the Fed starting to taper its bond-buying program. Such was evident in a recent email I received from a reader:

“I am holding a lot of cash, and am worried about a deeper correction. While I understand that you recently got more aggressively allocated due to improving short-term technicals, the risk of the Fed beginning to taper their bond-buying seems to be problematic. What do you think I should do?”

It’s a great question, and one that I think represents many of our readers.

One of the biggest challenges investors always face is allocating capital to markets once a correction has occurred. The concern is purely emotional as investors worry the market may continue to decline. While specific reasons suggest a deeper correction is possible, other factors are supporting a more positive outcome.

In the longer term, it is only fundamentals that matter. So what is happening between the economic and earnings data is all you need to know if you are a long-term investor.

Unfortunately, you aren’t.

Despite all of the protestations that you are a long-term investor, most are not. The emotional biases of being either bullish or bearish, primarily driven by the media, keep you from truly focusing on long-term outcomes. Instead, you either worry about the next downturn or are concerned you are missing the rally. Therefore, you wind up making short-term decisions that negate long-term views.

Understanding this is the case, let’s look at the markets from both a bullish and bearish perspective. From there you can decide what to do next.

The Bullish Case

1) Seasonality

With the recent correction in October now behind us, the market is entering into the “seasonally strong” period between November and May. While this period does not always provide positive returns, the statistical tendencies favor increased equity exposure. The chart below from TheMarketEar shows the average return profile from October through the end of the year.

Importantly, notice the corporate stock “buyback” window that opens on November 1st.

2) Corporate Share Buybacks

A significant source of liquidity over the last several years, and in this year, in particular, has been the record levels of cash utilized by companies to repurchase their shares. Such has provided underlying support to asset prices as corporations provide a consistent bid for stocks.

In Q4, the GS buyback desk estimates +$230B repurchases, this is broken down by +$70B in October during the blackout window using 10b5-1 plans and +$160B in November and December.” – Zerohedge

According to GS Research, November is the best month for buyback executions, November plus December is the best two month period of the year for executions. November 1st is the defacto start to the buyback season with 65% of corporations in the open window. That is followed by November 8th where 90% of corporates are in the open window.”Zerohedge

3) Money Flows Remain At Historic Highs

Of course, it is not just corporate share buybacks supporting asset prices currently, but record global inflows of capital at a pace never before seen in history. Now at $982 billion, and counting, the flood of liquidity globally into equities is unprecedented.

Global equity inflows surpassed $774.5 billion on a year-to date basis. It is the best year on record by a mile. In the 190 trading days ending on October 6th. This will be roughly $1 Trillion worth of inflows for 2021. That is approximately +$4.1 billion worth of [retail] demand every single day of 2021.” – Goldman Sachs

The bulls are carrying solid arguments for being long equities currently. With earnings season underway, sentiment reversed from recent bullish extremes, and an ongoing flood of liquidity, there is an inherent bias to the upside.

However, while the bulls case is strong, the bears have equally valid arguments for remaining cautious.

Oil Rates Dollar, Traders Are Pushing Oil, Rates & The Dollar. Are They Right?

The Bearish Case

1) The Fed Is Set To Taper

The most obvious concern for the “bears” is the Fed reducing their bond-buying activity starting in November. While many argue that “QE” has no impact on financial markets, as shown below, the “psychological” link between the Fed and the financial markets is apparent. Such is known as the “Fed put.”

The chart below shows the correlation between the monthly change in the S&P 500 Index and the Fed’s balance sheet. At 82%, there is a sufficient correlation to suggest a direct link between the markets and monetary policy.

With such a high correlation, it is not surprising that periods of a contraction in liquidity corresponds with increased market volatility and corrections in the markets. Thus, the grey shaded bars highlight the periods where the Fed’s balance sheet contracted in size.

2) Profit Margins

Another concern is the surging level of inflation in the economy currently. Between supply line disruptions, inflationary pressures, and rising wages, corporations will face margin compression. Thus, the considerable risk to the bullish argument is that earnings fail to support currently high valuations.

Peaks in real (inflation-adjusted) profit margins correspond with peaks in financial markets. However, with profit margins currently elevated due to the $5 trillion in “pandemic relief” in 2020, the current contraction in fiscal policy supports combined with higher inflation could well deteriorate profits into next year.

3) Economic Growth Continues To Weaken

While over the short-term markets can certainly rally on hope and optimism, there is a high correlation between economic growth, revenue, and stock market returns in the longer term.

Risk Bigger Correction, Technically Speaking: Is The Risk Of A Bigger Correction Over?

Early this year, estimates were for extraordinary rates of economic growth in 2021. However, as the months progressed and fiscal liquidity ran dry, economic growth rates are quickly reverting to the long-term means.

At the begging of Q2, the Atlanta Fed pegged economic growth at 13.5%. By the time GDP got reported by the Bureau of Economic Analysis, it was just 6.5%. The Atlanta Fed has ratcheted down Q3, which will get reported later this month, to just 1.2%. So far, while hopes are for more robust economic growth in Q4, there is a high probability of disappointment.

For the bearish view, the implications of substantially weak economic growth are broad. Consumer sentiment will continue to remain weak, and increased inflationary pressures will further undermine consumption. The impact on earnings will leave the bulls disappointed.

You Don’t Have To Pick A Side

So what do you do?

As we discussed previously, we believe there is enough to the bullish case to warrant additional equity exposure in portfolios. However, the longer-term dynamics are bearish. 

But here is the crucial point – you don’t have to “choose.”

While many think you have to be either “bullish” or “bearish,” the reality is you don’t. In the short term, we can be “bullish” with our equity positioning. However, we can also be “bearish” in our longer-term views.

Regardless of whether you are bullish or bearish, we noted guidelines to increase your odds of success this past weekend.

  1. Move slowly. There is no rush in making dramatic changes.
  2. If you are under or over-weight equities, DO NOT try and fully adjust your portfolio allocation in one move. 
  3. Begin by selling laggards and losers. 
  4. Add to sectors, or positions, that are performing with, or outperforming the broader market.
  5. Move “stop-loss” levels up to recent lows for each position. Managing a portfolio without “stop-loss” levels is foolish.
  6. Be prepared to sell into the rally and reduce overall portfolio risk. Not every trade will always be a winner. Get rid of losing positions as redeploy capital as needed.
  7. If none of this makes any sense to you – please consider hiring someone to manage your portfolio for you. It will be worth the additional expense over the long term.

For now, we remain optimistic about the markets due to liquidity, seasonality, and a reversal in bullish sentiment. However, we remain concerned about the broader macro risks, which keep us cautionary.

There is little value in trying to predict market outcomes. The best we can do is recognize the market environment for what it is, understand the associated risks, and navigate accordingly to achieve the desired outcome.

China Slows As The S&P 500 Goes Into Rally Mode

Despite China’s economic growth coming to a standstill, with only 0.2% growth in Q3, the S&P 500 was in rally mode. While stocks grind higher, bond traders are warning of slowing growth in the U.S. ahead. Treasury yields curves are flattening as the probability for the Fed to increase interest rates rises. Based on the market-implied expectations, traders now think the Fed will raise rates by 25 basis points twice next year.

U.S. stock futures ticked up as a slew of companies released earnings, which investors parsed for insight into how corporates are faring with inflation and supply-chain disruptions. Via the WSJ:

“Futures for the S&P 500 rose 0.4% Tuesday, indicating that the broad market index will rise after the New York opening bell. Contracts for the tech-focused Nasdaq-100 gained 0.4% and futures for the Dow Jones Industrial Average also rose 0.4%.

Shares of Johnson & Johnson rose 1.6% premarket after it logged a larger profit in its third quarter from a year earlier, lifted by higher sales in its pharmaceutical, medical-device and consumer-health divisions.  Travelers shares rose 3.4% after the insurance company beat estimates for revenue and core income per share.

Procter & Gamble ‘s shares fell 1.1% premarket after the consumer-product giant said it was raising prices on a host of household staples, as costs for freight and raw materials rose faster than anticipated. Netflix will report earnings after the closing bell.

Investors are using earnings and companies’ guidance for the future to assess how corporations are faring with a number of issues. Inflation is expected to be stickier than originally anticipated by central-bank officials, exacerbated by continued supply-chain disruptions, higher energy costs and labor shortages.”

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Building permits, month-over-month, September (-2.4% expected, 5.6% in August)
  • 8:30 a.m. ET: Housing starts, month-over-month, September (-0.2% expected, 3.9% in August)

Earnings

Pre-market

  • 6:00 a.m. ET: Synchrony Financial (SYFto report adjusted earnings of $1.49 per share on revenue of $2.5 billion
  • 6:30 a.m. ET: Bank of New York Mellon (BKto report adjusted earnings of $1.00 per share on revenue of $3.96 billion
  • 6:30 a.m. ET: Fifth Third Bancorp (FITB) to report adjusted earnings of 90 cents per share on revenue of $1.99 billion
  • 6:45 a.m. ET: Johnson & Johnson (JNJ) to report adjusted earnings of $2.37 per share on revenue of $27.74 billion
  • 6:45 a.m. ET: Halliburton (HAL) to report adjusted earnings of 28 cents per share on revenue of $3.90 billion
  • 6:55 a.m. ET: Procter & Gamble (PG) to report adjusted earnings of $1.59 per share on revenue of $19.89 billion
  • 6:55 a.m. ET: The Travelers Cos. (TRV) to report adjusted earnings of $1.94 per share on revenue of $8.61 billion
  • 7:00 a.m. ET: Phillip Morris International (PM) to report adjusted earnings of $1.56 per share on revenue of $7.99 billion
  • 8:00 a.m. ET: Kansas City Southern (KSUto report adjusted earnings of $2.07 per share on revenue of $730.91 million

Post-market

  • 4:00 p.m. ET: Netflix (NFLXto report adjusted earnings of $2.63 per share on revenue of $7.48 billion
  • 4:30 p.m. ET: United Airlines (UAL) to report adjusted losses of $1.61 per share on revenue of $7.64 billion

S&P 500 In Rally Mode

The S&P 500 started off weakly yesterday morning but rallied all day after briefly reaching the 50-dma moving average for support. We have now completed a bulk of the retracement from the recent lows, and markets are now moving back into the overbought and extended territory.

While we are not ready to start taking profits just yet, it is likely a good bit of the rally has occurred which makes chasing stocks here a bit riskier. We like our positioning currently, and our increased bond exposure provides us with some hedging capabilities if markets do reverse suddenly. Upside remains limited to recent highs where fairly heavy resistance will get encountered.

China’s Economic Growth is Slowing Rapidly

As shown below, China’s economic growth rate for the third quarter was negligible at +0.2%, bringing the annual growth rate to just 4.9%. While still high, the annual rate is down from 7.9% last quarter. China’s economic slowdown bears watching as they are the marginal driver of global economic growth.

Will You Trade The First Bitcoin ETF?

As noted in our 3-minutes video below, the SEC has approved the first Bitcoin Futures ETF which will open cryptocurrency to a much wider investor base. On the news, bitcoin moved above $60,000.

Last week, flows into Bitcoin surged in anticipation of the approval, pushing the total cryptocurrency market capitalization to a record of $2.5 Trillion.

We discuss it more here.

The Yield Curve Is Flattening

Equities are recently showing a little hesitation as investors gear up for QE in November. The bond market has been a lot more vocal about more hawkish Fed policy and the implications for growth. Over the last 5 months, as shown below, the Treasury yield curve (30yr-5yr) has collapsed by three-quarters of a percent. Over the last week or two, the rate of flattening picked up markedly.

A yield curve flattening trade should not be surprising. In Taper is Coming, Got Bonds? we wrote: “The yield curve and yield graphs look similar. Short-term yields were relatively constant during QE while long-term yields rose. In all three QE examples, the yield curve quickly flattened after QE ended.”  The graph below, from the article, shows how the 10yr-2yr yield curve fell rapidly after the three prior episodes of QE ended.

The Earnings Week Ahead

We take a bit of a break this week after last week’s full calendar of important economic data. On the docket is Industrial Production on Monday, Housing and Building Permits on Tuesday, and Jobless Claims on Thursday.

More important for the markets this week will be Fed speeches and earnings. Recently Fed members have become increasingly vocal about their concern for the recent rise in inflation overstaying its welcome. Last week Bostic led the charge saying “inflation is broadening, not transitory.”  If others use similar rhetoric, we will see the market continue to price in a quicker pace of QE tapering and rate hikes coming sooner than previously expected.

This is will be the first of a few important weeks for corporate earnings as shown below.

Vacant Offices

The graph below, courtesy of Jim Bianco, shows that a majority of employees in eight major cities are still not going back to their offices. While the number of employees going back to their offices will rise we think it’s likely the number falls well short of pre-pandemic levels. Per Jim Bianco “What a year at home did was open our eyes to what we are were capable of outside the office and what it was really like in the office. Few were ready to do this pre-pandemic.”

Viking Analytics: Weekly Gamma Band Update 10/18/2021

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

Gamma Band Update

The S&P 500 (SPX) had a strong rally last Thursday and Friday to close the week above our calculated gamma flip level. The gamma band model began the week with a 100% allocation to SPX.  The gamma flip level can be viewed as having served as resistance; once it was broken, the market moved meaningfully higher,.

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can be viewed conceptually as a risk management tool. When the daily price closes below Gamma Flip level (currently near 4,415), the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,290), the model will reduce the SPX allocation to zero.

The main premise of this model is to maintain high allocations to stocks when risk and corresponding volatility are expected to be low.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report).  

With stocks climbing to historically high valuations, risk management tools have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to show how tail risk can be reduced by following a few simple rules.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size DAILY based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. He has deep experience with market data, software and model building in financial markets.  Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.


S&P 500 Retakes 50-dma As Bulls Swoop In

The S&P 500 finished the week above its 50-dma after bulls sparked a mid-week rally that carried into Friday’s close. The yield curve flattened last week as 10Y Treasury yields gave up a few basis points, while 2Y yields increased due to rising inflation expectations. Earnings will be the primary focus this week as we get into the thick of reporting season.

This morning futures are slightly lower which is not surprising after a big move last week. A test of the 50-dma that holds will be a bullish indication setting the markets up for a test of all-time highs. Upside momentum is returning to the markets and in the process, the technical damage done to stocks from early September through early October is getting repaired.

The big concern in the near term remains the fundamentals of the market with inflation and higher wages weighing on corporate profit margins and earnings. So far, earnings have been positive, but it has been primarily banks who aren’t exposed to supply chain disruptions. The next couple of weeks will give us a much better picture. 

Daily Market Commnetary

What To Watch Today

Economy

  • 9:15 a.m. ET: Industrial production, month-over-month, September (0.2% expected, 0.4% in August)
  • 9:15 a.m. ET: Capacity utilization, September (76.5% expected, 76.4% in August)
  • 10:00 a.m. ET: NAHB Housing Market Index, October (75 expected, 76 in September)
  • 2:00 p.m. ET: Total Net TIC Flows, August ($126.0 billion in July)
  • 2:00 p.m. ET: Net long-term TIC flows, August ($2.0 billion in July)

Earnings

Pre-market

  • 7:30 a.m. ET: Albertsons Cos. (ACIis expected to report adjusted earnings of 46 cents per share on revenue of $15.88 billion
  • 7:30 a.m. ET: State Street Corp. (STTis expected to report adjusted earnings of $1.92 per share on revenue of $2.96 billion 

Post-market

  • 4:30 p.m. ET: Steel Dynamics. (STLD) is expected to report adjusted earnings of $4.69 per share on revenue of $5.04 billion

Courtesy of Yahoo.

Bulls Retake 50-dma As Seasonally Strong Period Starts

As noted above, while the market started last week a bit sloppily, the bulls charged back on Thursday as earnings season officially got underway. With the market crossing above significant resistance at the 50-dma and turning both seasonal “buy signals” confirmed, it appears a push for previous highs is possible.

Bulls Market Fed 10-15-21, Bulls Regain Control Of The Market As Fed Taper Looms 10-15-21

Two factors are driving the rebound. Earnings, so far, are coming in above estimates. Such isn’t surprising as analysts suppressed estimates going into reporting season. Secondly, bond yields declined.

However, there are still reasons to remain cautious near term. As shown below, the internals of the market, while improved slightly, remain negatively diverged. The number of stocks above respective 50- and 200-dma remains low, the bullish percent index remains weak, and relative strength declines.

Bulls Market Fed 10-15-21, Bulls Regain Control Of The Market As Fed Taper Looms 10-15-21

Furthermore, most companies haven’t reported earnings yet, and macroeconomic challenges still exist. So far, large banks beat estimates on reduced loan loss reserves, but they don’t deal with supply-chain limitations. We are about to see earnings from companies directly impacted by and don’t benefit from, higher inflation, labor costs, and supply line disruptions.

S&P Stocks With The Strongest Relative Strength

Looking for ideas of where to put money to work for the “seasonally strong” period of the year? We ran a quick scan on RIAPRO of the strongest relative strength stocks. Not surprisingly, given the surge in inflationary pressure, commodity, and oil prices, the majority of stocks on the list fell into those sectors.

Inflation Concerns Weigh on Sentiment

The October University of Michigan consumer sentiment survey came in weak at 71.4 versus a consensus estimate of 74. The result, which fell from 72.8 in September, registered as the second-lowest outcome since 2011. The chart below, courtesy of Bloomberg, shows year-ahead inflation expectations based on the survey have risen to 4.8%, their highest point in 2021.

Retail Sales Surprise

September retail sales surprised to the upside this morning at +0.7% MoM versus estimates of -0.1%. Retail sales ex-vehicles grew +0.8% MoM versus +0.4% expected, and ex-vehicles and gas rose in line with expectations of +0.7%. Retail sales remain extremely elevated above the long-term trend. The eventual reversion to the mean will weigh on economic growth.

Incorporating Wednesday’s September CPI release, real growth in retail sales for September was only +0.3% MoM. Thus, over half of the nominal growth in September came from rising prices. Treasury yields are moving higher following the release, reflecting the market’s increasing expectations for taper.

The trimmed-mean CPI has now diverged from the trimmed-mean PCE inflation measure. Explanation below.

Cleveland Fed Trimmed Mean Inflation

On a monthly basis, the Cleveland Fed puts out the 16% trimmed mean inflation rate. Their modified inflation rate trims price change outliers, both high and low, from CPI. Currently, as shown below, the index is just short of the 2008 highs. At that time oil was nearly $150 a barrel and up well over 100% from where it was a year earlier. Take away that short burst higher and the trimmed measure is at its highest level since the late ’80s. The takeaway from this inflation gauge is that the number of goods driving higher inflation is broadening and not just confined anymore to a few extremes like used cars and gasoline.

EPS and Returns

The graph below, courtesy of Fidelity, shows the correlation between S&P earnings growth (EPS – X-axis) and price performance on the Y-axis. The EPS data is broken into 8 tiers and color-coded. Each color, or specific range of EPS, has a trend line drawn through it. In general returns and EPS are positively correlated as should be expected. There are exceptions. In particular, there seems to be no correlation when EPS is very strong -on the right side of the graph. This is likely due to strong but unsustainable earnings growth coming out of recessions. Conversely, the red circles on the far left are likely periods at market bottoms where prices rose in expectations of a rebound in EPS.

Investors Starting To Realize “Stagflation” Is A Problem.

Investors are slowly waking up to the realization that “stagflation” is a problem. For years, the term “stagflation” has been thrown around and dismissed like a sighting of “Bigfoot.” However, rising inflationary pressures are now colliding with slowing economic growth. This collision presents a challenge for Central Bankers and their monetary policy experiments.

Let’s start with a definition of “stagflation.”

“Stagflation is characterized by slow economic growth and relatively high unemployment—or economic stagnation—which is at the same time accompanied by rising prices (i.e. inflation). Stagflation can be alternatively defined as a period of inflation combined with a decline in the gross domestic product (GDP).”Investopedia

As stated, many believe stagflation is impossible due to the economic theories that dominate academic and policy-making circles. The construction of the economic models ruled out the possibility that you could have slow economic growth and high inflation simultaneously. To wit:

“In particular, the economic theory of the Phillips Curve, which developed in the context of Keynesian economics, portrayed macroeconomic policy as a trade-off between unemployment and inflation.

As a result of the Great Depression and the ascendance of Keynesian economics in the 20th century, economists became preoccupied with the dangers of deflation and argued that most policies designed to lower inflation tend to make it tougher for the unemployed, and policies designed to ease unemployment raise inflation.” – Investopedia

The problem with economic “theories” is they rarely properly account for individuals’ behaviors. Stagflation is an excellent example of how real-world economic data often diverts from widely accepted economic theories and policy prescriptions.

So, are we witnessing what many economists deemed impossible?

Inflation Is It Transient, Or Not?

Inflation is a problem resulting from an economic imbalance between supply and demand.

Following the “economic shutdown,” the Government created a massive amount of artificial demand by sending checks directly to households. However, because of the shutdown, production and manufacturing facilities could not meet the surge in demand. So naturally, the inevitable result was higher prices for the number of goods and services available to meet overwhelming demand.

As shown below, the surge in inflationary pressures is not surprising. However, the question is whether the current inflationary spike is transient or persistent?

There are two problems surfacing that suggest inflation may be less transient than previously believed.

  1. The supply chain disruptions are not resolving themselves, but worsening; and,
  2. Incomes are not keeping up with inflation.

Furthermore, as noted in the definition of “stagflation” above, employment is not recovering to a level to support an economy devoid of fiscal stimulus. As shown below, the gap between the stimulus-driven PCE (Personal Consumption Expenditures) and the jobs to keep consumption at those levels is significant.

Such is problematic economically speaking.

When consumers experience higher costs without a commensurate increase in incomes, consumption will fall. Given that consumption comprises nearly 70% of U.S. economic growth, the problem becomes readily apparent.

Daily Market Commnetary

“Stagflation” Is Now A Thing

With this foundation, it is easy to understand “stagflation” has now manifested itself. Atlanta Fed President Raphael Bostic recently admitted the same:

“It is becoming increasingly clear that the feature of this episode that has animated price pressures, mainly the intense and widespread supply chain disruptions, will not be brief. Data from multiple sources point to these lasting longer than most initially thought. By this definition, then, the forces are not transitory.”

Inflationary pressures are antagonistic, thereby slowing economic growth. Goldman Sachs recently slashed 2022 economic prospects over continuing supply chain disruptions, lack of fiscal policy, and higher inflationary pressures.

“A little over a month ago, Goldman surprised Wall Street when it slashed its Q3 GDP forecast to just 5.5% from 9.5%. That was a move the bank’s chief economist Jan Hatzius said reflected “hits to both consumer spending and production.” Then last weekend, confirming the stagflationary direction of the US economy, Goldman once again cut its Q3 and Q4 GDP forecasts again, from 5.5% to 4.5% and from 6.5% to 5.0%, respectively.” – Zerohedge

While the IMF, Goldman, and many other Wall Street banks are slashing economic growth estimates, they remain on the high end of what reality will likely be. With inflationary pressures surging, without wages compensating, economic growth will continue to weaken as stagflation weighs on the average family.

That is why we agree with Bostic’s conclusion:

“The real danger is that the longer the supply bottlenecks and attendant price pressures last, the more likely they will shape the expectations of consumers and businesspeople, shifting their views on pricing and wages in particular,”

If inflationary pressures remain, as Bostic suggests, such will subtract from economic growth in the future, indicating a sub-2% growth rate in 2022.

Then there is the actual labor problem.

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

The Labor Conundrum

Inflation is not a “bad” thing when combined with strong employment rates and wage growth which supports much higher levels of economic activity. But therein lies the problem in the current economy.

The official employment measures suggest we are nearly back to full employment. Yet, the participation rate in the economy remains deeply depressed. Such explains why real incomes remain stagnant, and a rising share of Americans are dependent on some form of governmental support.

The problem of participation also shows up in the rising levels of income and wealth inequality in the U.S. Since the turn of the century, the top 10% of income earners have accumulated a significant share of overall wealth. In comparison, the bottom 50% continue to struggle.

The labor force participation rate continues to decline after each recession, as companies opt to replace employees with technology to increase profits and reduce costs.

While the “official” rate suggests the U.S. is near full unemployment, the labor force participation rate argues otherwise.

If the definition of “stagflation” is a period of high inflationary pressures, coupled with high “real” unemployment and slowing economic growth – I would argue we have achieved that definition.

The question is whether or not it is sustainable?

Stagflation Now, Deflation Later

While the factors creating stagflation currently are problematic, they are likely transient.

Eventually, the supply chain disruptions will get resolved. Supply will increase, and demand will decline as needs get met. Furthermore, the overarching deflationary thesis remains.

  • A decline in organic savings that depletes productive investments
  • An aging demographic that is top-heavy and drawing on social benefits at an advancing rate.
  • A heavily indebted economy with debt/GDP ratios above 100%.
  • The decline in exports continues due to a weak global economic environment.
  • Slowing domestic economic growth rates.
  • An underemployed younger demographic.
  • An inelastic supply-demand curve
  • Weak industrial production
  • Dependence on productivity increases to offset reduced employment

Furthermore, given deflationary pressures due to weak wage growth, automation, and mounting debts, it is unlikely inflation can rise much before it triggers an economic contraction. Moreover, since interest rates adjust for inflation, a rise in inflationary pressures is a “double whammy” on consumption.

The debt problem remains a massive risk to monetary and fiscal policy. If rates rise, the negative impact on an indebted economy quickly depresses activity. But, more importantly, the decline in monetary velocity clearly shows that deflation remains a persistent threat.

Whether it’s “stagflation” or “deflation,” the problem for the Fed is that monetary policy has little effect on either one.

Bulls Regain Control Of The Market As Fed Taper Looms

In this 10-15-21 issue of “Bulls Regain Control Of The Market As Fed Taper Looms.”

  • Market Rallies As Earnings Season Kicks Off
  • FOMC Minutes Confirm Fed Taper Coming
  • Navigating Uncertainty
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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Market Rallies As Earnings Season Kicks Off

Two weeks ago, we laid out the case for why we started increasing our equity exposure in portfolios.

“It is worth noting there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

The rally back above the 100-dma on Friday was strong and sets up a retest of the 50-dma. If the market can cross that barrier we will trigger the seasonal MACD buy signal suggesting the bull market remains intact for now.

Chart updated through Friday.

While the market started the week a bit sloppily, the bulls charged back on Thursday as earnings season officially got underway. With the market crossing above significant resistance at the 50-dma and turning both seasonal “buy signals” confirmed, it appears a push for previous highs is possible.

Correction Is Over For Now

After nearly a month of selling pressure, the rally over the last couple of days came on cue and supported our recommendation to increase exposure to equities. As noted by Barron’s:

“Market sentiment is getting more buoyant. Thursday, the S&P 500 saw its largest gain since March 5, according to Instinet. The percent of stocks on the index that rose, 95%, was the highest since June 21. Friday, about 90% of components were positive. Instinet sees a high likelihood that the index will reach 4.570 fairly soon, for a more than 2% gain.” 

Two factors are driving the rebound. Earnings, so far, are coming in above estimates. Such isn’t surprising as analysts suppressed estimates going into reporting season. Secondly, bond yields declined.

However, there are still reasons to remain cautious near term. As shown below, the internals of the market, while improved slightly, remain negatively diverged. The number of stocks above respective 50- and 200-dma remains low, the bullish percent index remains weak, and relative strength declines.

Furthermore, most companies haven’t reported earnings yet, and macroeconomic challenges still exist. So far, large banks beat estimates on reduced loan loss reserves, but they don’t deal with supply-chain limitations. We are about to see earnings from companies directly impacted by, and don’t benefit from, higher inflation, labor costs, and supply line disruptions.

Technically, If the current rally is going to push back to all-time highs, the market’s underlying strength must begin to improve markedly over the next couple of weeks. If not, the current rally will likely fail sooner than later. Furthermore, the odds of a correction increase as the Fed begins to reduce monetary accommodation.


FOMC Minutes Confirms Taper Is Coming

In the most recent release of the Federal Reserve’s FOMC minutes, the much anticipated “taper” of bond-buying programs got confirmed. To wit:

The illustrative tapering path was designed to be simple to communicate and entailed a gradual reduction in the pace of net asset purchases that, if begun later this year, would lead the Federal Reserve to end purchases around the middle of next year.

The path featured monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities (MBS). Participants generally commented that the illustrative path provided a straightforward and appropriate template that policymakers might follow, and a couple of participants observed that giving advance notice to the general public of a plan along these lines may reduce the risk of an adverse market reaction to a moderation in asset purchases.

While the Fed did not explicitly discuss rate hikes, as noted in our Daily Commentary, the futures market has already priced in two rate hikes next year.

Between reducing bond purchases and lifting overnight rates, the risk to investors is more than evident. As we noted in “3-Things That Will Trigger The Next Bear Market:”

“The risk of a market correction rises further when the Fed is both tapering its balance sheet and increasing the overnight lending rate.

What we now know, after more than a decade of experience, is that when the Fed starts to slow or drain its monetary liquidity, the clock starts ticking to the next corrective cycle.”

Next Bear Market, When Is The Next Bear Market? 3-Things Will Tell You

The problem for the Fed is that while they suggest they will “adjust” based on incoming data, they may well get trapped between surging inflation and a recessionary economy.

Inflation: Transient Or Persistant

As noted, the risk to the Fed is getting trapped by inflation. The hope has been that current inflationary pressures from the economic shutdown would be “temporary” or “transient” and resolved as the economy reopened. However, nearly 18-months later, with the economy booming, employment running hot, and more job openings than unemployed persons, the disruptions remain. Notably, prices are surging, particularly in the areas that affect households the most.

If inflation is running ‘hot” and employment is full, the Fed should remove monetary accommodation and hike interest rates. However, with economic growth weak, financial stability dependent on monetary interventions, and record numbers of near-bankrupt companies dependent on low-interest-rate debt, a reversal of accommodation could be disastrous.

The hope was inflation would be transient and monetary accommodations could continue unfettered. Now, as noted by St. Louis President James Bullard, this year’s surge in inflation may well persist amid a strong U.S. economy and tight labor market.

While I do think there is some probability that this will naturally dissipate over the next six months, I wouldn’t say that’s such a strong case that we can count on it,” Bullard said Thursday during a virtual discussion hosted by the Euro 50 Group.

“I would put 50% probability on the dissipation story and 50% probability on the persistent story.”

As Michael Lebowitz noted this week:

“If demand stays high, and supply lines and production remain fractured, inflation will continue to run hot. If such occurs, CEOs may decide not to invest in new production facilities where ‘persistent’ inflation becomes more likely.   

Primarily, ‘persistent’ is not ‘transitory.’ Nor is persistent in the Fed’s forecast. Persistent inflation requires the Fed to take detrimental actions to investors.

Given the oddities of the current environment, and our fiscal leaders’ carelessness, it is something we must consider.” 


In Case You Missed It


Both Bulls And Bears Have Valid Views

Given the potential for a “policy mistake” and our cautionary views, the following email question currently sums up many investors’ views.

“I really am not sure what to do. Should I raise more cash and be defensive with inflationary pressures rising, and the Fed set to taper. Or, should I just stay invested given the market seems to be doing okay?”

For investors, they have gotten caught between logical views.

From the bullish perspective:

  • The market just completed a much-needed 5% correction.
  • Short-term conditions are oversold.
  • Bullish sentiment is largely negative.
  • Earnings season should be supportive.
  • Stock buybacks are running at a record pace.
  • The seasonally strong period of the year tends to be positive for stocks.

However, those views get countered by the bearish perspective discussed last week.

  • Valuations remain elevated.
  • Inflation is proving to be sticker than expected.
  • The Fed confirmed they will likely move forward with “tapering” their balance sheet purchases in November.
  • Economic growth continues to wane.
  • Technical underpinnings remain weak.
  • Corporate profit margins will shrink due to inflationary pressures.
  • Earnings estimates will get downwardly revised keeping valuations elevated.
  • Liquidity continues to contract on a global scale
  • Consumer confidence continues to slide.

Given this backdrop, it is understandable why investors are finding reasons “not” to invest. However, as stated previously, avoiding crashes and downturns can be as costly to investment outcomes as the downturn itself.

Navigating Uncertainty In Your Portfolio

As noted above, the market has not done anything technically wrong. Longer-term, the bullish trend remains intact, the recent correction worked off much of the overbought condition, and investor sentiment is negative enough to support a short-term rally.

However, while we think a rally is likely near-term, there is considerable risk to the market as we head into 2022. Such is why we stated last week:

If you didn’t like the recent decline, you have too much risk in your portfolio. We suggest using any rally to the 50-dma next week to reduce risk and rebalance your portfolio accordingly.

So here are some guidelines to follow.

  1. Move slowly. There is no rush in making dramatic changes.
  2. If you are over-weight equities, DO NOT try and fully adjust your portfolio to your target allocation in one move. Think logically above where you want to be and use the rally to adjust to that level.
  3. Begin by selling laggards and losers. 
  4. Add to sectors, or positions, that are performing with, or outperforming the broader market.
  5. Move “stop-loss” levels up to recent lows for each position. Managing a portfolio without “stop-loss” levels is foolish.
  6. Be prepared to sell into the rally and reduce overall portfolio risk. Not every trade will always be a winner. But keeping a loser will make you a loser of both capital and opportunity. 
  7. If none of this makes any sense to you – please consider hiring someone to manage your portfolio for you. It will be worth the additional expense over the long term.

While we remain optimistic about the markets, we are also taking precautionary steps to tighten up stops, add non-correlated assets, raise some cash, and hedge risk opportunistically on any rally.



Portfolio Update

As we head into the heart of earnings seasons, we slightly increased our exposure to technology stocks while maintaining the balance of our allocations. After making additions to equities over the last couple of weeks, we are nearly fully exposed to equities, slightly overweight cash, and a tad underweight target duration in our bond holdings.

While our positioning is bullish, we remain very concerned about the market over several months. Historically, stagflationary environments do not mix well with financial markets. Such is because the combination of inflationary pressures and weaker economic growth erodes profit margins and earnings.

Furthermore, expectations heading into 2022 remain exceptionally optimistic, which leaves much room for disappointment. With liquidity getting drained, the Fed reducing monetary accommodation, and two rate hikes scheduled next year, the risk to investors remains elevated.

So, why aren’t we sitting in cash? Because our job is to take advantage of markets when a reasonable risk/reward opportunity presents itself, like now. However, we do understand there is a significant risk. Or, as Seth Klarman from Baupost Capital once stated:

“Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

We are not in the “prediction business.”

We are in the “risk management business.”

For now, we are giving the market the benefit of the doubt. However, we are keeping our positioning on a very short leash. With valuations still elevated, the technical deterioration of the market remains a primary concern.

Have a great weekend.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data. Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 68.13 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

Our “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 70.8 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

As noted last week,

“The markets finally appeared to have bottomed this week as the debt ceiling debate got resolved until December. But, while the pressure was relieved somewhat, there is still risk heading into the end of the year.”

Such remains the case this week. While the market started weakly, it successfully retested and held the 100-dma. Such bolsters our case, with both MACD signals confirming that the “seasonally strong” period has begun. While such does not eradicate any downside risk, it does reduce the risk of a significant correction near-term.

As noted below, we continued adding to our equity exposure this week and are currently carrying nearly full allocations. While such leaves us a little uncomfortable given the Fed, valuations, and a stagflationary environment, we think the short-term benefits offset the risk.

We are watching our positions closely and have moved stops up to recent lows for all positions.

Furthermore, after increasing the duration of our bond portfolio, the recent uptick in rates provides another entry point to lengthen our duration once again. If there is a risk-off event in the market, yields will drop to 1% or less providing a nice bump in appreciation in our bond portfolio. In the meantime, we are collecting a bit of income while holding the hedge.

For now, there seems to be minimal risk in the market. However, don’t be misled. There are numerous risks we are watching that could lead us to reverse course rapidly. Our job remains to protect your capital first and foremost, but we want to capture gains when we can.

Portfolio Changes

During the past week, we made minor changes to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

“As we kick off earnings season in earnest we are increasing our technology exposure where we have been underweight previously. In the equity model, we are adding 1% to our current holdings of ADBE and initiating a 2% position in AMD due to its breakout above its recent downtrend.

In the ETF model, we are adding 3% to XLK.” – 10/14/21

Equity Model

  • Add 1% to ADBE bringing the total weight to 2.5%
  • Initiating a 2% position in AMD.

ETF Model

  • Add 3% to XLK bringing total weight to 13.5%

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors



Attention: The 401k plan manager will no longer appear in the newsletter in the next couple of weeks. However, the link to the website will remain for your convenience. Be sure to bookmark it in your browser.

Commentary

As noted last week, the market finally bounced solidly off of support and broke above the overhead resistance at the 100-dma and the 50-dma. The triggering of the underlying MACD “buy signals” suggests we have entered into the seasonally strong period of the year.

However, our weekly signals continue to suggest some caution despite the current short-term bullish improvements. There are currently several essential catalysts that could derail the market rally over the next couple of months, the most prominent of which is the Fed.

In the short term, we suggest maintaining exposures in plan portfolios and putting stored cash back to work in your selected allocation model. While we have not removed international, emerging, small and mid-cap funds from the allocation model, we suggest avoiding these areas for now and moving those allocations to domestic large-cap.

If you are close to retirement or are concerned about a pickup in volatility, there is nothing wrong with being underweight equities. However, there is likely not a lot of upside in markets heading into next year.

Model Descriptions

Choose The Model That FIts Your Goals

Model Allocations

If you need help after reading the alert, do not hesitate to contact me.

Or, let us manage it for you automatically.


401k Model Performance Analysis

Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only, and one should not rely on it for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.

Have a great week!

Technical Value Scorecard Report – Week Ending 10-15-21

Relative Value Graphs

  • The S&P 500 is 0.9% higher versus last Friday, as the weakness in the first half of this week was relieved by a rally yesterday where the index closed about 1.7% higher. Most cyclical sectors outperformed the index, with energy and materials leading the way. However, financials were left behind as the 10Y Treasury yield fell almost 10 bps from its recent high to 1.54% this morning.
  • The third graph shows the strong excess returns in energy (XLE) and broad relative weakness in most other sectors over the last 35 trading days.
  • Energy moved further into overbought territory as crude oil broke above $82. As we noted last week, on a technical basis, there is little to stop crude from rising to $100, but supply could increase should OPEC deem it appropriate.
  • Small and mid-caps remain the most overbought factors, but their scores are still low enough to provide more upside. Emerging markets had a great week on a relative basis, moving from moderately oversold to slightly overbought. International markets remain oversold relative to the S&P 500 but saw a slight improvement.
  • In the upper right corner in the first graph, note the inflation vs. deflation index moved well into overbought territory. TLT moved into slightly overbought territory versus IEI from deeply oversold as we saw a flattening in the yield curve last week.

Absolute Value Graphs

  • On an absolute basis, the energy sector continues nearing overbought extremes. As we noted last week, there is still more upside, but a healthy consolidation may be in store over the coming weeks. XLV is the most oversold sector on an absolute basis after struggling to find its footing over the past few weeks.
  • Both materials and discretionary saw substantial increases in their absolute scores, while financials and transportation saw some relief from overbought conditions.
  • TIP moved into overbought territory as inflation expectations have ticked up recently, while TLT moved to fair value from moderately oversold, reflecting some relief in the 10Y Treasury yield.
  • Momentum and mid-caps are the most overbought factors, while emerging markets and international markets are the most oversold. Emerging markets saw an improvement last week but remain oversold on an absolute basis.
  • The S&P 500 is still slightly overbought on an absolute basis after an intra-week dip last week.
  • As shown in the fourth graph, all sectors are above their 200dma. Materials are over two standard deviations from its 20dma, and energy is over two standard deviations from its 50dma. Energy moved from 1.3 standard deviations above its 200dma last week to 1.8 standard deviations this week.

Users Guide

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take any action if other research and models do not affirm it.

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner is the most bearish.

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

Bulls Charge As Earnings Season Gets Underway

Yesterday, the “Bulls” gained control of the ball from the “Bears” as earnings season got underway. After a successful retest of the 100-dma, the bulls charged to the critical 50-dma resistance level. The S&P 500 remains stuck between the 50-dma and the 100-dma over the last month. However, with the “seasonally strong” period of the year underway, the bulls look like they will attempt a run to all-time highs.

There are quite a few headwinds that could still trip up the bulls, so it is worth keeping some risk controls in place. In addition, as we have noted previously, breath and participation remain weak, which historically tends to limit upside in the near term.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Empire Manufacturing, October (25.0 expected, 34.3 during prior month)
  • 8:30 a.m. ET: Retail sales, month-over-month, September (-0.2% expected, 0.7% during prior month)
  • 8:30 a.m. ET: Retail sales excluding autos and gas, month-over-month, September (0.4% expected, 1.8% during prior month)
  • 8:30 a.m. ET: Import price index, month-over-month, September (0.6% expected, -0.3% during prior month)
  • 10:00 a.m. ET: University of Michigan sentiment, October preliminary (73.5 expected, 72.8 during prior month)

Earnings

Pre-market

  • 5:45 a.m. ET: Truist Financial Corp. (TFCis expected to report adjusted earnings of $1.18 per share on revenue of $5.52 billion
  • 6:45 a.m. ET: PNC Financial Services (PNC) is expected to report adjusted earnings of $3.59 per share on revenue of $5.03 billion
  • 8:30 a.m. ET: Goldman Sachs (GS) is expected to report adjusted earnings of $9.92 per share on revenue of $11.60 billion
  • 8:45 a.m. ET: The Charles Schwab Corp. (SCHW) is expected to report adjusted earnings of 81 cents per share on revenue of $4.52 billion

Courtesy Of Yahoo

Markets Sustain Key Support, as Banks Soldier On

A Major Support Of Asset Prices Remains

With companies struggling with slower economic growth, higher input costs, and weaker consumption, the need to manufacture earnings to beat estimates remains a high priority. Therefore, it is not surprising to continue seeing companies utilize their cash hoards to buy back stock at a record pace.

As note previously, it is the corporate insiders who benefit from these activities.

It’s the insiders, of course, as changes in compensation structures since the turn of the century became heavily dependent on stock-based compensation. Insiders regularly liquidate shares that were “given” to them as part of their overall compensation structure to convert them into actual wealth. As the Financial Times recently penned:

‘Corporate executives give several reasons for stock buybacks but none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay and in the short-term buybacks drive up stock prices.

A recent report on a study by the Securities & Exchange Commission found the same:

SEC research found that many corporate executives sell significant amounts of their own shares after their companies announce stock buybacks, Yahoo Finance reports.’

What is clear, is that the misuse and abuse of share buybacks to manipulate earnings and reward insiders has become problematic.”

Jobless Claims and PPI

Initial Jobless Claims had another nice decline and now sits at +293k, the lowest level since the pandemic. The last two weekly claims reports bode well for the upcoming unemployment report. Unlike CPI, PPI was generally weaker than expectations. The headline number rose 0.5% versus +.07% last month. However, the year-over-year number was +8.6%, lower than expectations for +8.7% but above last month’s +8.3%. Core PPI, excluding food and energy, rose 6.8% on an annual basis.

$15 Billion Is The Benchmark

The latest Fed minutes show that tapering of QE purchases is likely to begin in November. It appears they will reduce purchases by $15 billion a month, which should eliminate this round of QE by July 2022. $15 billion now serves as a benchmark. Any changes to that amount will help us gauge if they are becoming more aggressive or conservative. Some members prefer a faster pace. Per the minutes- “Several participants indicated that they preferred to proceed with a more rapid moderation of purchases than described in the illustrative examples.”

Liquidity Remains Very Accommodative

Despite the Fed beginning to “taper” their balance sheet purchases, monetary accommodation remains extremely “accommodative” currently. As discussed previously in 3-Triggers Of The Next Recession,” monetary accommodation is the key to determining the start of the next recession and bear market. As shown, such is not the case currently but will become a more significant concern when the Fed begins to hike rates.

#FedGrammarMatters

We often note how the Fed uses language at times to complicate matters. Their word choice often puts their policies and forecasts beyond the grasp of many non-economics or finance professionals. Fed members use vague terminology, allowing them to be technically correct through a wide range of outcomes.

In our latest article, What Causes “Transitory” Inflation to Become “Persistent,” we write:

“Transitory is a vague term. It can mean minutes or hours. Or, it can infer years or decades. Over 400 economics Ph. D.s can not be dumb. They likely chose the word because it has no clear-cut definition.

The Fed itself supports our notion of the high-level language they use. For example, in a recent article, the Fed states:

Hernández-Murillo and Shell (2014) showed that the complexity of the language used in the FOMC statement increased towards the end of Bernanke’s tenure to a reading grade level of 20 to 21, equivalent to a least a doctoral degree level of education. The circles in Figure 2 illustrate that since then the Flesch-Kincaid grade level for the FOMC statement language gradually declined under Yellen and has averaged between grades 16-17 thus far under Chair Powell, equivalent to a bachelor’s or master’s degree level of education.

The following graph accompanies the article. In short, Fed communications remain technical. In normal times, such may not matter. However, with inflation running hot and the word stagflation used regularly, the Fed may want to simplify their language. Otherwise, they risk creating even more confusion, fear, and behaviors that foster even more inflation.

Traders Are Pushing Oil, Rates & The Dollar. Are They Right?

With inflation fears getting stoked by the mainstream media, traders are pushing oil, interest rates, and the dollar higher. Are they right? Or, are they about to get smacked by a slower economy and deflationary headwinds?

Once a quarter, I dig into the Commitment of Traders data to see where speculators are making their bets. Such is an excellent metric to watch from a contrarian view. Generally, when traders are positioned either very long or short in a particular area, it is often a good bet something will reverse.

Positioning Review

The COT (Commitment Of Traders) data, which is exceptionally important, is the sole source of the actual holdings of the three critical commodity-trading groups, namely:

  • Commercial Traders: this group consists of traders that use futures contracts for hedging purposes. Their positions exceed the reporting levels of the CFTC. These traders are usually involved with the production and processing of the underlying commodity.
  • Non-Commercial Traders: this group consists of traders that don’t use futures contracts for hedging and whose positions exceed the CFTC reporting levels. They are typically large traders such as clearinghouses, futures commission merchants, foreign brokers, etc.
  • Small Traders: the positions of these traders do not exceed the CFTC reporting levels, and as the name implies, these are usually small traders.

The data we are interested in is the second group of Non-Commercial Traders (NCTs.)

NCT’s are the group that speculates on where they believe the market will head. While you would expect these individuals to be “smarter” than retail investors, we find they are just as subject to “human fallacy” and “herd mentality” as everyone else.

Therefore, as shown in the charts below, we can look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. 

Volatility 

Since 2012, the favorite trade of bullish speculators has been to “short the VIX.” Shorting the volatility index (VIX) remains an extraordinarily bullish and profitable trade due to the inherent leverage in options. Leverage is one of those things that works great until it doesn’t.

Currently, net shorts on the VIX are still very elevated but reduced from 2020 levels. However, speculators have once again started to increase their net short-positioning over the last several weeks as the market declined.

The current positioning is large enough to fuel a more substantial correction if markets fail current support levels. Moreover, as noted on Tuesday, weekly signals suggest that downside risk is present. To wit:

“The recent decline triggered both weekly signals for the first time since the March 2020 correction. (The chart below is the same model we use to manage 401k allocations. You can see the related models and analysis here)

Given that volatility has remained compressed during the entirety of the September correction, a break below recent support will trigger short-covering of VIX options. Such would also be coincident with a more significant decline in the index.

Crude Oil Extreme

Crude oil has gotten a lot more interesting as of late. After a brutal 2020, the price of oil futures going negative at one point, oil is now pushing above $80/bbl. Given current views of “inflation” from the massive liquidity infusions and supply chain disruptions, the focus on speculative positioning is not surprising.

As shown in the monthly chart below, the price advance in crude oil is now back to historical extremes that have previously denoted tops in oil prices. As a result, the current extreme overbought, extended, and deviated positioning in crude will likely lead to a rather sharp correction. (The boxes denote previous periods of exceptional deviations from long-term trends.)

The speculative long-positioning is driving the dichotomy in crude oil by NCTs. While levels fell from previous 2018 highs during a series of oil price crashes, they remain elevated at 398,307 net-long contracts and rising quickly.

The good news is that oil did finally break above the long-term downtrend. However, it is too soon to know if these prices will “stick.” 

Furthermore, the deflationary push and the dollar rally will likely derail oil prices if it continues.

U.S. Dollar Rally Is Here

As I stated earlier this year:

“There are two significant risks to the entire ‘bull market’ thesis: interest rates and the dollar. For the bulls, the underlying rationalization for high valuations has been low inflation and rates. In February, we stated:

Given an economy that is pushing $87 trillion in debt, higher rates and inflation will have immediate and adverse effects:

  1. The Federal Reserve gets forced to begin talking tapering QE, and reducing accommodation; and,
  2. The consumer will begin to contract consumption as higher costs pass through from producers. 

Given that personal consumption expenditures comprise roughly 70% of economic growth, higher inflation and rates will quickly curtail the ‘reflation’ story.

A few months later, the Fed started to talk about tapering their balance sheet purchases.

With the market currently priced for perfection, the disappointment of economic growth caused by the rising dollar, interest rates, and a contraction in consumer spending is a significant risk to the market. As shown, the rally in the dollar is already starting to weaken the inflationary impact of higher import prices and suggests a peak in CPI.

The one thing that always trips the market is what no one is paying attention to. For me, that risk lies with the US Dollar. As noted previously, everyone expects the dollar to continue to decline, and the falling dollar has been the tailwind for the emerging market, commodity, and equity risk-on trade. 

As noted previously,

“Whatever causes the dollar to reverse will likely bring the equity market down with it.”

The dollar has been rising very quietly, and traders are becoming more aggressively long the dollar trade.

Interest Rate Conundrum

Over the latest several years, I have repeatedly addressed why financial market “experts” remain confounded by rates failing to rise. In March 2019, I wrote: “The Bond Bull Market,” which followed our earlier calls for a sharp drop in rates as the economy slowed.

At that time, the call was a function of the extreme “net-short positioning” in bonds, which suggested a counter-trend rally was likely. Then, in March 2020, unsurprisingly, rates fell to the lowest levels in history as economic growth collapsed. Notably, while the Federal Reserve turned back on the “liquidity pumps,” juicing markets to all-time highs, bonds continue to attract money for “safety” over “risk.” 

Recently, “bond bears” have again returned, suggesting rates must rise because of inflationary concerns. However, again, such is unlikely as economic growth is quickly stalling as liquidity runs dry.

Currently, traders are more aggressively long contracts suggesting rates could still rise a bit further. However, while there is upside to rates, it is likely limited to less than 2% before economic growth gets impacted.

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

Conclusion

The markets are oversold enough on a short-term basis to rally. However, numerous headwinds are mounting from higher rates, inflation, oil prices, and the dollar. So while traders are piling into inflationary trade, they are likely going to be disappointed.

While the markets can undoubtedly discount these headwinds short-term, they won’t be able to do it indefinitely. Such is why we remain concerned over the weekly and monthly “sell signals,” which are suggestive of increasing risk.

The biggest problem is that technical indicators do not distinguish between a consolidation, a correction, or an outright bear market. As such, if you ignore the signals as they occur, by the time you realize it’s a deep correction, it is too late to do much about it.

I suggest that with our “sell signals” triggered, taking some action could be beneficial. 

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

There is minimal risk in “risk management.” In the long term, the results of avoiding periods of severe capital loss will outweigh missed short-term gains.

The Fed’s FOMC Minutes Suggests Taper Will Start In November

The Fed’s FOMC minutes from the September meeting suggest the Fed will taper its asset purchases by $15 trillion a month starting in November. At that pace, the current $120 trillion of QE will get zeroed out by July. Currently, there was no timeline to raise interest rates, but over the last few weeks, Fed Funds futures have priced in greater odds of rate hikes in 2022.

For instance, the June 2022 contract now implies a 25% chance of a tightening by June. The odds were near zero in mid-September. The December 2022 contract suggests a 100% chance of a 25bps rate hike and a 50% chance of a second hike by the end of the year.

With more certainty around the Fed’s next steps, the markets are entering a new regime. Is your portfolio ready?

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Initial jobless claimsweek ended Oct. 9 (320,000 expected, 326,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended Oct. 2 (2.670 million expected, 2.714 million during prior week)
  • 8:30 a.m. ET: Producer price index, month-over-month, September (0.6% expected, 0.7% during prior month)
  • 8:30 a.m. ET: PPI excluding food and energy, month-over-month, September (0.5% expected, 0.6% during prior month)
  • 8:30 a.m. ET: PPI, year-over-year, September (8.7% expected, 8.3% during prior month)
  • 8:30 a.m. ET: PPI excluding food and energy, year-over-year. September (7.1% expected, 6.7% during prior month)

Earnings

Pre-market

  • 5:55 a.m. ET: UnitedHealth Group (UNH) to report adjusted earnings of $4.39 per share on revenue of $71.13 billion
  • 6:45 a.m. ET: Bank of America (BACto report adjusted earnings of 71 cents per share on revenue of $31.74 billion
  • 6:45 a.m. ET: US Bancorp (USBto report adjusted earnings of $1.15 per share on revenue of $5.76 billion
  • 7:00 a.m. ET: Walgreens Boots Alliance (WBA) to report adjusted earnings of $1.00 per share on revenue of $33.07 billion 
  • 8:00 a.m. ET: Wells Fargo (WFCto report adjusted earnings of 97 cents per share on revenue of $18.40 billion
  • 8:10 a.m. ET: The Progressive Corp. (PGR) to report adjusted earnings of 21 cents per share on revenue of $11.96 billion
  • 7:30 a.m. ET: Morgan Stanley (MS) to report adjusted earnings of $1.69 per share on revenue. of $13.92 billion
  • 7:30 a.m. ET: Domino’s Pizza (DPZ) to report adjusted earnings of $3.11 per share on revenue of $1.04 billion
  • 8:00 a.m. ET: Citigroup (C) to report adjusted earnings of $1.79 per share on revenue of $16.93 billion 

Post-market

  • 4:10 p.m. ET: Alcoa (AA) to report adjusted earnings of $1.71 per share on revenue of $2.93 billion

Courtesy of Yahoo

Market Testing Overhead Resistance

Yesterday, the market rallied back to the 100-dma, which now acts as resistance to higher prices. However, while the market tried to climb above it during the trading day, it failed to do so. This morning, futures are pointing higher which will push the index above both the 100-dma and 20-dma. If the rally holds, such will set up an advance to the important 50-dma.

With Friday being options expiration, the volatility seen this week is not surprising. However, the good news is that the overall decline has been very orderly, with no real signs of panic. Such suggests that once the current consolidation period is behind us, we will see a modest advance into year-end.

On a longer-term basis, valuations, internal deterioration, reduction in liquidity, and slower economic growth pose serious challenges to the markets in 2022. As such, we continue to suggest a modicum of risk management currently, with a more deliberate approach to protecting capital as the calendar changes.

Will The Fed Taper Sooner and Harder?

How Do Stocks Perform Under Stagflation?

Goldman Sachs recently published some analysis showing how stocks perform under various inflationary and economic environments. The most notable is the relative performance of stocks in a “slow growth and high inflation” environment. Or, rather what is more commonly known as “stagflation.”

Everything You Need To Know On “Net Zero”

Over the next couple of decades it is expected that global governments will pursue $150 Trillion in spending (mostly derived from debt) to achieve a victory over climate change. While this is great for wealthy, the poor and middle classes will ultimately pay the price through slower economic growth and inflationary pressures. BofA produced the following graphic on where the money will go and, by extension, who will benefit.

CPI Hotter than Expected

CPI came in slightly higher than expectations. The monthly rate of price increases is 0.4%, 0.1% higher than last month. The year-over-year rate, at 5.4%, is also a tad above expectations. The core monthly and annual rates, excluding food and energy, are in line with consensus.

It is important to note that some inflation resulted from deflation or lower prices this time last year. While “base effects” are rapidly lessening, they are still in play. Per Ben Casselman of the N.Y. Times- “Base effects” — the impact of the drop in prices earlier in the pandemic — are still playing some role in lifting year-over-year inflation. If prices had kept rising at their pre-Covid rate last year, September inflation would have been 5% instead of 5.4%.”

Chaikin is Providing a Warning

The graph below shows the S&P 500 with the Chaikin Money Flow indicator below it. The indicator looks back over 20 days and multiplies the daily volume with the market closing within each day’s trading range. The multiplier is positive when the S&P closes in the upper half of a day’s trading range. Likewise, where the market closes in relation to the high or low is multiplied by the volume. Thus, high volume and a close at the high or low for the day will produce a strong signal.

Technical analysts use the indicator to help determine if institutions are accumulating or distributing. A green reading (above zero) signals accumulation as it is believed institutions tend to buy late in days. Conversely, the strength of the recent string of red days signals early strength gets followed by late-day weakness. Such is a sign of institutional distribution (selling). The Chaikin indicator has not been this profoundly negative since 2018.

“Broadening, Not Transitory”

Atlanta Fed President Bostic went where no Fed member has gone since the pandemic. He stated, “U.S. inflation is broadening, not transitory.” Such appears to be the first time a Fed member voiced concern that higher inflation is no longer transitory. If other Fed members join him in this view, it might speed up the tapering process and bring forward the date of the first rate hike.

Humorously, he started his speech with disdain for the use of “transitory” to describe the recent bout of inflation. To wit: “You’ll notice I brought a prop to the lectern. It’s a jar with the word “transitory” written on it. This has become a swear word to my staff and me over the past few months. Say “transitory,” and you have to put a dollar in the jar.”

Inflation Is On Today’s Docket As Fed Gears For Taper

Today we will get the latest reading on inflation as the Fed tapering QE in November seems to be a foregone conclusion by the markets. At this point, today’s CPI report, tomorrow’s PPI release, and other inflation data, along with continuing improvement in the labor markets are key factors for investors to watch. It is these economic stats that will help guide the Fed’s pace of reducing QE. JOLTS information, discussed below, provides more evidence the labor market is healing nicely.

Daily Market Commnetary

What To Watch Today

Economy

  • 7:00 a.m. ET: MBA Mortgage Applications, week ended Oct. 8 (-6.9% during prior week)
  • 8:30 a.m. ET: Consumer price index, month-over-month, September (0.3% expected, 0.3% during prior month)
  • 8:30 a.m. ET: CPI excluding food and energy, month-over-month, September (0.2% expected, 0.1% during prior month)
  • 8:30 a.m. ET: CPI year-over-year, September (5.3% expected, 5.3% during prior month)
  • 8:30 a.m. ET: CPI excluding food and energy, year-over-year, September (4.0% expected, 4.0% during prior month) 
  • 8:30 a.m. ET: Real Average Hourly earnings, year-over-year, September (-1.1% during prior month)
  • 8:30 a.m. ET: Real Average Weekly earnings, year-over-year, September (-1.4% during prior month)
  • 2:00 p.m. ET: FOMC meeting minutes

Earnings

  • 6:15 a.m. ET: BlackRock (BLK) is expected to report adjusted earnings of $9.39 per share on revenue of $4.84 billion
  • 7:00 a.m. ET: JPMorgan Chase (JPM) is expected to report adjusted earnings of $2.97 per share on revenue of $29.86 billion
  • 7:00 a.m. ET: First Republic Bank (FRCis expected to report adjusted earnings of $1.84 per share on revenue of $1.27 billion 
  • 8:25 a.m. ET: Delta Air Lines (DALis expected to report adjusted earnings of 17 cents per share on revenue of $8.45 billion 

Market Loses Support Yesterday On Weak Trading

Yesterday, the market traded sloppily all day eventually losing the support at the 100-dma. Such keeps the market at risk of a retest of recent lows. As noted yesterday, with weekly and monthly “sell signals” in place, a longer, and potentially deeper, correction period is possible.

If the market is going to maintain its bullish bias, it needs to hold support at the recent lows and rally back above current resistance by next week. A failure to do so, and we will likely see the recent lows taken out and a test of the 200-dma becomes a high probability event.

Some caution is advised until we get through “options expiration” this Friday.

JOLTs

Per the JOLTs report, the number of job openings fell for the first time since April. The number of openings in August was 10.43 million versus expectations of over 11 million. This may be a signal the labor market is getting better, or at least less bad, at matching workers with openings. The quits rate rose to a record 2.9% of the workforce. Typically workers quit jobs when they have confidence in finding a better, higher-paying job. Prior to Covid, the quit rate was around 2.2%.

As shown below the number of openings is still well above normal levels. The second graph below, the Beveridge Curve, highlights the anomaly. At the current unemployment rate of 5.2%, we should expect a job openings rate of about half of what it is. The million-dollar question is whether employers truly have as many job openings as advertised or are there too many unemployed workers either not trained for certain jobs or not willing to accept offered wages.

Can Markets Maintain Support?

Is The 50DMA Trying To Tell Us Something?

As we show below circled in red, the 50dma is turning lower for only the second time since the market rebounded in April of 2020. In late October and early November of last year, the 50dma turned lower for six days on a relatively steep 7.5% decline. The current market decline causing the 50dma to fall is only a 4% decline but its duration is almost twice as long as the prior one.

Used Car Prices En Fuego

After a brief rest bit, used car prices rose again in September back to all-time highs as shown in the Manheim Used Vehicle Value Index below. The accompanying report notes: “According to Cox Automotive estimates, total used vehicle sales were down 13% year-over-year in September.”  Prices rising with sales falling clearly points to a lack of supply.

Per the report: “Using a rolling seven-day estimate of used retail days’ supply based on vAuto data, we see that used retail supply peaked at 114 days on April 8, 2020. Normal used retail supply is about 44 days’ supply. It ended September at 37 days, which is below normal levels. We estimate that wholesale supply peaked at 149 days on April 9, 2020, when normal supply is 23. It ended September at 18 days.”

What Causes “Transitory” Inflation to Become “Persistent”?

What Causes “Transitory” Inflation to Become “Persistent”?

You are the CEO of Acme Widget Factory. Among your many duties is overseeing production and profit margins related to your core product, widgets. Competition in your industry is stiff, with over a half dozen widget producers.

The pandemic and recovery are throwing the widget industry for quite a loop. In the spring of 2020, there was no demand for widgets. You laid-off employees and limited production while focusing on survival. During the summer of 2020, fiscal stimulus was percolating through the economy, and demand soared. It continues at a robust pace.

Acme’s future is brighter, but as CEO, you face a new set of problems. Your factories are running at full force, as are your competitors, but demand appears insatiable. At the same time, the prices of the materials needed to make widgets keep rising. Further, new and existing workers are demanding higher wages.

The problem facing Acme’s CEO is occurring in executive suites across America. Their decisions about how to navigate through 2022 and beyond in this unprecedented period illuminates a potential source for “persistent” inflation. 

Acme Widgets

The price of widgets is up 20% in just the last year. However, demand weakens with each recent price increase. In economic speak, demand for widgets is elastic. Consumers demand fewer widgets as prices rise.  

Even with the slight reduction in demand, the industry cannot produce enough widgets. The good news is profit margins are higher than average as widget prices are rising faster than expenses.

As the CEO of Acme, you have a tough decision to make. Do you keep production capabilities as is or boost production with a new factory and more employees?

The CEO’s Transitory Dilemma

The biggest unknown you, the CEO, face in making the decision above is forecasting the future. In particular, the following questions:

  • How will widget sales be in 2023 and beyond?
  • Will input prices continue to rise?
  • Can you pass on rising costs to consumers?
  • Assuming inflation remains hot, will employees demand higher wages and more benefits?
  • If needed, can I even hire more capable employees?  

Most CEOs closely track economic activity and forecasts. Unless they are hiding under a rock, they recognize recent economic strength is primarily driven by the pandemic – specifically, the government’s massive spending and benefits programs.

CEOs, aiming to make the right decisions, must appreciate the economy’s heavy reliance on Washington in their strategic plans.

The President and Democrats are trying to keep money flowing through the economy. They are currently proposing massive spending bills. Blocking their plans is the upcoming 2022 midterm elections. Political games will make it much trickier to pass spending bills than in 2020. Democrats in office realize weak economic growth is not a winning ticket. Those Republicans, wanting their seats, also understand that.

 As CEO, we are beholden to our lobbyists to help us make decisions about Widget production. A strong economy typically results in better widget sales. As the economy continues to re-open and consumer behaviors normalize, personal consumption is likely to revert to longer-term averages unless Uncle Sam continues to be very generous to consumers.

As the CEO, we must determine if continued massive fiscal spending is likely or a one-time pandemic action.

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The Fed’s Opinion

CEOs also need to decipher what the Fed thinks of future economic growth and how they may steer policy.

Per the Fed- “The Federal Reserve Board employs just over 400 Ph.D. economists, who represent an exceptionally diverse range of interests and specific areas of expertise.”

The Fed has the greatest army of economists in the world. What they say and their economic forecasts should have a profound impact on our decisions. Unlike guessing about how Washington plans on spending money, the Fed is easier to decipher.  

Transitory

Via official policy statements and minutes, the Fed describes the recent bout of strong economic growth and inflation as “transitory.” By this, they suggest economic growth will moderate, and swelling inflation will revert to norms.

According to Merriam-Webster’s dictionary, transitory implies a short period.

Transitory is a vague term. It can mean minutes or hours or infer years or even decades. 400+ economics Ph. D.s are not dumb. They likely chose the word because it has no clear-cut definition.

Had they defined the period of excessive price and economic growth with a specific range of months, they risk being wrong. They will be technically correct with the current phrasing if inflation and growth normalize tomorrow or in two years.

The graph below from Google Trends shows the search term “transitory inflation” is popular after being largely non-searched.

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Fed Forecasts

Since the Fed is not defining transitory in terms of a specific time, we need another way to quantify their vagueness.  Fortunately, the Fed’s FOMC members periodically put out expectations for growth, inflation, and unemployment. While the results are based on the forecasts of FOMC board members, we have little doubt they represent the work of the Ph.D. army.

The three charts below show their expectations for the remainder of this year as well as 2022, 2023, and 2024. We also include their “long-run” forecast and the average from 2017-2019 for historical context.

The first graph points to economic growth normalizing in 2023. After that, they expect GDP growth to be weaker than pre-pandemic levels.

Inflation will return to near normal but run a little hotter than before the pandemic.

Fed members expect the unemployment rate to fall below the pre-pandemic average in 2022 and remain there for at least two more years.

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Transitory vs. Persistent

With our fiscal policy expectations and the opinions of over 400 Ph. D.s, we, as CEO, have a tough decision to make. Should we construct a new factory, hire workers, and boost production to meet current demand?

If the Fed is correct, the recent boost in widget sales is transitory. Further, per their expectations, future economic growth, ergo widget sales, may be weaker than pre-pandemic levels. Adding a new factory and more workers may be profitable while the boom lasts. However, doing so may result in excess capacity and too many workers in the long run. If the industry adds production capability, supply will certainly outstrip demand and reduce prices down the road.

In addition to weaker expected economic growth, we must also consider expectations for a lower unemployment rate and higher prices than were normal pre-pandemic. In theory, those conditions should result in higher wages and production costs in a few years.

As CEO, we must think in terms of at least 5-10 years. While the current outlook is good, it may also be transitory. Per the Fed forecasts, our sales and margins are likely to shrink. Boosting capacity into such an environment seems foolish.

Taking permanent steps to cure short-term needs can be a costly trap. Unless runaway fiscal spending becomes the norm.

Conclusion

As COVID spread around the globe, economies were shuttered. At the same time, governments around the world flooded consumers and some companies with unprecedented amounts of cash.

As a result of limited production and strong demand, prices soared. This is the source of current inflation.

If demand stays high, in part due to more fiscal spending and supply lines and production remain fractured, inflation will continue to run hot. If such a scenario plays out as many CEOs decide not to invest in new production facilities, “persistent” inflation becomes much more likely.  

We strip you of the CEO title. As an investor with CEO insight, you have a lot to consider. Primarily, “persistent” is not “transitory.” Nor is persistent in the Fed’s forecast. Persistent inflation requires the Fed to take detrimental actions to investors.

This is not our outlook but given the oddities of the current environment and our fiscal leaders’ carelessness, it’s one we must consider. 

Market Sell-Off Sets Up Critical Test Of Support

The market’s sell-off yesterday sets up a critical test of support at the 100-dma. Last week, the market was able to regain the 100-dma as stocks rallied off lower support. The decline yesterday left stocks touching the running moving average. It is a critical technical juncture for stocks. If stocks can hold the 100-dma, it will provide a support level stocks can build off of for a push higher to the 50-dma. A failure of that support will lead to a retest of recent lows or potentially more. With a lot of economic news and earnings releases this week, it is hard to guess where markets will head to next.

Daily Market Commnetary

What To Watch Today

Economy

  • 6:00 a.m. ET: NFIB Small Business Optimism, September (99.5 expected, 100.1 during prior month)
  • 10:00 a.m. ET: JOLTS Job Openings, August (10.954 million expected, 10.934 million during prior month)

Earnings

  • No notable reports scheduled for release

Politics

Courtesy of Yahoo

Pain In The Supply Chain

(By @marketoonist)

Oil Prices May Peak Here Soon

Crude oil has gotten a lot more interesting as of late. After a brutal 2020, the price of oil futures going negative at one point, oil is now pushing above $80/bbl. Given current views of “inflation” from the massive liquidity infusions and supply chain disruptions, the focus on speculative positioning is not surprising.

As shown in the monthly chart below, the price advance in crude oil is now back to historical extremes that have previously denoted tops in oil prices. The current extreme overbought, extended, and deviated positioning in crude will likely lead to a rather sharp correction. (The boxes denote previous periods of exceptional deviations from long-term trends.)

The speculative long-positioning is driving the dichotomy in crude oil by NCTs. While levels fell from previous 2018 highs during a series of oil price crashes, they remain elevated at 398,307 net-long contracts and rising quickly.

The good news is that oil did finally break above the long-term downtrend. However, it is too soon to know if these prices will “stick,” or as the economy decelerates towards the end of the year, oil prices will decline.

Furthermore, the deflationary push and the dollar rally will likely derail oil prices if it continues.

Earnings Will Begin To Slow

As we kick off the Q3 earnings season, expectations are still for a very robust earnings season. However, given much tougher year-over-year comparisons, rising inflationary pressures, ongoing supply chain disruptions, and declining consumer confidence, there is risk to those outlooks. We expect forward estimates will start to ratchet down sharply over the next couple of quarters as slower economic growth drags on margins.

Staples Getting Historically Cheap

In last Friday’s Technical Value Scorecard in RIA Pro we discussed how cheap the consumer staples sector was getting. To wit: “However, staples are nearly three standard deviations below its 50dma, arguing for a bounce in the coming days.

SentimentTrader follows up our work with a much longer-term view. As shown below, staples, at about 6% of the S&P 500, have the lowest weighting in the S&P 500 since the tech boom in late 1999. In the year 2000 when that bubble popped, staples (XLP) ended the year up 42%. The S&P was down 10% and the technology sector (XLK) was down over 40%.

The Real Impact of $80 Oil

A Big Week Ahead

Buckle up!  This is a big week for key economic data. The JOLTs report on Tuesday will provide more color on the labor market and specifically if job openings continue to at record levels. Wednesday features CPI and the Fed minutes from their September meeting. Given the importance of inflation to the Fed, CPI will help them further hone in on how to taper QE, in regards to amounts and timing. More inflation data follows Thursday with PPI. Retail Sales and the University of Michigan Consumer Sentiment Survey come out on Friday.

Also on tap are the 10 and 30-year Treasury auctions on Tuesday and Wednesday respectively. It will be interesting to see if demand is strong given the recent backup in yields.

If you crave more information, have no fear, earnings for the major banks start on Wednesday with JPM. Many of the largest banks follow them on Thursday. Most other companies will release earnings over the coming six weeks. Beyond earnings and revenues, investors will be paying close attention to forward guidance, in particular how inflation is affecting their bottom line.

Dividends Over Oil Production

Last Friday we wrote how oil rig counts were rising slower than is typical considering the current price of oil. Another consideration is the transition to cleaner forms of energy. As Reuters writes below, companies like Occidental are not clamoring to increase production.

(Reuters) – U.S. oil and gas producer Occidental (OXY.N) wants to raise margins and re-establish dividend payments for its shareholders rather than focus on growing its production volumes, Chief Executive Vicki A. Hollub said on Thursday.

Oil companies can best contribute to the energy transition by producing just enough oil to meet demand in a way that is more efficient and produces fewer emissions, the CEO said.

“We don’t see that in 2022 and beyond that we need to grow significantly,” Hollub said at an online event by the Energy Intelligence Forum.

“Our growth in the period, and maybe over the next ten years, will more be to reestablish dividend and grow that dividend”.

Technically Speaking: Is The Risk Of A Bigger Correction Over?

Is the risk of a more significant correction over now that the expected 5% decline is complete? That was a hotly debated question after this past weekend’s newsletter supporting the idea of a reflexive rally into year-end. As I stated:

“After a harrowing 5% decline, sentiment is now highly negative, supporting a counter-trend rally in the markets. Thus, we think there is a tradeable opportunity between now and the end of the year. But, as we will discuss below, significant headwinds continue to accrue, suggesting higher volatility in the future.

That comment sparked numerous debates over market outlooks through year-end. To wit:

So, who is right? A hard rally into the end of the year, or a major low?

While we certainly hope for the former, some risks support a further correction on both a fundamental and technical basis.

Fundamental Warnings

In Andrew’s comment, he suggests that economic growth will accelerate through the end of the year. If such is the case, that will support a pick up in earnings growth and outlooks that would bolster higher asset prices.

The problem with that view is two-fold.

In Q2 of this year, G.D.P. estimates started that quarter at 13.5% and ended at 6.5%. The third quarter started at 6% and is now tracking at 1.3%, as shown below.

As we discussed in “The Coming Reversion To The Mean,” the “second derivative” effect of economic growth is manifesting itself. To wit:

“We are at that point in the recovery cycle. Over the next few quarters, the year-over-year comparisons will become much more challenging. Q2-2021 will likely mark the peak of the economic recovery.09/24/21

Reversion Economic Growth, The Coming “Reversion To The Mean” Of Economic Growth

When writing that blog, our estimates were for a cut in growth to 3.9%. We are currently closer to 1%.

Secondly, fourth-quarter growth will also remain under significant pressure for several reasons:

  1. Year-over-year comparisions remain challenging.
  2. Manufacturing surveys look to slow in a challenging enviroment.
  3. Employment continues to quickly revert to long-term norms.
  4. Liquidity continues to turn negative.

The last point is the most problematic. The massive surge in economic growth in 2020 was a direct function of the massive direct fiscal injections into households. With that support gone, economic growth will revert to normality, particularly in an environment where wage growth does not keep up with inflation.

Given that earnings and revenue are a function of economic growth, the most considerable risk to Andrew’s fundamental view is slower growth and valuations.

Confirmed Weekly Warnings

When discussing the market, distinguishing time frames becomes critically important. As noted in the newsletter, we suggested the market got oversold enough short-term to elicit a rally.

The rally above the 100-dma and the trigger of both M.A.C.D. “buy signals” (lower panels) are supportive of a short-term rally over the next few days to weeks.

However, the sell-off yesterday is retesting that 100-dma and will turn it into important support if it holds through the end of the week. If not, we are going to challenge the recent lows.

It is not uncommon to see such counter-trend rallies, even powerful ones, during a longer-term corrective process. Such is an important consideration given the weekly “sell signals.”

The recent decline triggered both signals for the first time since the March 2020 correction. (The chart below is the same model we use to manage 401k allocations. You can see the related models and analysis here)

Since 2006, when we developed and started publishing this “risk management model” each week, the signals continue to signal critical periods for investors to watch. Market returns have a very high correlation to the confirmed “buy” or “sell” triggers.

There are also two other important points. First, the current signals are occurring at elevations we have never witnessed previously. Secondly, the confirmed signals are happening with the market at the top of its long-term bullish trend from the 2009 lows. Thus, a correction to the bottom of that long-term bullish trend channel will encompass a nearly 30% decline without violating the bullish uptrend.

Daily Market Commnetary

Longer-Term Signals Suggest Caution

Again, even with the broader macro issues facing the market, we can not dismiss the possibility of a near-term reflexive rally. However, the monthly signals are also confirming the weekly alerts.

Monthly “sell signals” are more rate and tend to align with market corrections and bear markets. However, like the confirmed weekly signals above, the monthly “sell signal” was triggered for the first time since March 2020.

While the longer-term M.A.C.D. has not yet confirmed that monthly signal, it is worth paying close attention to. Historically, the monthly signals have proven helpful in navigating correction periods and bear markets.

Let me reiterate these longer-term signals do not negate the possibility of a counter-trend bull rally. As noted, in the short term, the market is oversold enough for such to occur.

Bullfights And Matadors

On the surface, it seems like “bull markets” are extremely difficult to kill as they keep rising despite the increasing number of warnings suggesting differently.

If you have ever witnessed a bullfight, the bull will keep charging the matador even though it has been continually impaled. However, even though the bull keeps trying to get his antagonist, it begins to slow from exhaustion and blood loss until the final blow gets dealt.

Bull markets are much the same. The advance will continue until it becomes exhausted, which is why it seems like bull markets end “slowly and then all at once.”

Currently, numerous internal technical and fundamental measures are providing warnings that investors are currently ignoring because the “bull is continuing to charge the matador.”

Such is why it is essential to align time frames with your portfolio management process.

If you are trading your portfolio with a relatively short holding period, you want to focus on hourly to daily charts. Currently, those suggest a near-term rally is possible.

However, if you employ a longer-term “buy and hold” type philosophy, you will want to pay attention to the longer-term charts. Those suggest the risk of a more substantial correction is increasing.

These longer-term signals suggest investors should be using such rallies to rebalance portfolio risks, raising some cash, adding hedges, and reducing overall portfolio volatility. Our best guess is that we are still in the midst of a short-term, sentiment (F.O.M.O.) driven bull market.

While it is entirely possible we could see the market rally back towards its previous highs before year-end, you need to decide if you want to be the “bull or the “matador” when it comes to your portfolio.

The “matador” walks out of the arena more often than not while the “bull” gets carried out.

Viking Analytics: Weekly Gamma Band Update 10/11/2021

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

Gamma Band Update

The S&P 500 (SPX) had a strong rally last Thursday and closed the week just under our calculated gamma flip level. This Friday, we have the October monthly option expiration in stocks, which has seen volatility and a pullback in and around this day over the last several months.  The gamma band model began the week with an allocation of 30% to SPX and 70% cash.   

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can conceptually be viewed as a risk along with other tools. When the daily price closes below Gamma Flip level (currently near 4,400), the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,260), the model will reduce the SPX allocation to zero. The range between Gamma Flip and the lower gamma has tightened because risk is higher.

The main premise of this model is to maintain high allocations to stocks when risk and corresponding volatility are expected to be low.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report).  

With stocks climbing to historically high valuations, risk management tools have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to show how tail risk can be reduced by following a few simple rules.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

 

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size DAILY based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. He has deep experience with market data, software and model building in financial markets.  Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.


The 5000-Year View Of Rates & The Economic Consequences

The fact we have the lowest interest rates in 5000-years is indicative of the economic challenges we face. Such was a note brought to my attention by my colleague Jeffrey Marcus of TPA Analytics:

“BofA wants you to know that ‘Interest rates haven’t been this low in 5,000-years.‘ That’s right, 5000 years. ‘In the next 5,000 years, rates will rise, but no fear on Wall Street this happens anytime soon,’ said David Jones, director of global investment strategy at Bank of America. This should not come as a shock to anyone who has been watching, given that the FED’s balance sheet is now an astonishing $8.5 trillion and that fiscal spending has caused the U.S. debt to balloon to over $28 trillion (For reference, the U.S. GDP is $22 trillion).

All of this really means that the FED and the U.S are in a tough spot. They need a lot of growth to dig out from mountains of debt, but they cannot afford for rates to move too high or debt service will become an issue.

Yes, rates will probably rise at some point in the next 5000-years. However, currently, the primary argument is that rates must increase because they are so low.

That argument fails in understanding that low rates are emblematic of weak economic growth rates, deflationary pressures, and demographic trends. 

Short-Term Rate Rise Can’t Last

In recent weeks, interest rates rose sharply over concerns of a debt-ceiling default and inflationary fears. But, as Mish Shedlock noted, five factors are spooking the bond market.

  1. Debt Ceiling Battle: Short Term, Low Impact
  2. Supply Chain Disruptions: Medium Term, Medium Impact
  3. Trade Deficit: Long Term, Low-to-Medium Impact
  4. Biden’s Build Back Better Spending Plans: Long Term, High Impact
  5. Wage Spiral: Long Term, High Impact

“I said early on that if Progressives get their way on spending plans, especially their demands to have 80% clean energy by 2030 it would set off a bout of stagflation. The rise in bond yields and a slowing economy are now linked.” – Mish Shedlock

He is correct. The problem, however, between today, and the 1970s, is the massive debt and leverage levels in the U.S. economy. Thus, any significant rise in rates almost immediately leads to recessionary spats in the economy.

A Long History Of Rates & Economic Growth

The chart below shows a VERY long view of interest rates in the U.S. (equivalent rates to the Federal Funds Rate and 10-year Treasury) since 1854.

Interest rates are a function of the general trend of economic growth and inflation. More robust rates of growth and inflation allow for higher borrowing costs to be charged within the economy. Such is why bonds can’t be overvalued. To wit:

“Unlike stocks, bonds have a finite value. At maturity, the principal gets returned to the lender along with the final interest payment. Therefore, bond buyers are very aware of the price they pay today for the return they will get tomorrow. As opposed to an equity buyer taking on investment risk, a bond buyer is loaning money to another entity for a specific period. Therefore, the interest rate takes into account several substantial risks:”

  • Default risk
  • Rate risk
  • Inflation risk
  • Opportunity risk
  • Economic growth risk

Since the future return of any bond, on the date of purchase, is calculable to the 1/100th of a cent, a bond buyer will not pay a price that yields a negative return in the future. (This assumes a holding period until maturity. One might purchase a negative yield on a trading basis if expectations are benchmark rates will decline further.) “

What Caused Rates To Rise Previously

Interest rates rose during three previous periods in history. During the economic/inflationary spike in the early 1860s and again during the “Golden Age” from 1900-1929. The most recent period was during the prolonged manufacturing cycle in the 1950s and 60s. That cycle followed the end of WWII where the U.S. was the global manufacturing epicenter.

However, notice that while interest rates fell during the depression era, economic growth and inflationary pressures remained robust. Such was due to the very lopsided nature of the economy at that time. Much like the current economic cycle, the wealthy prospered while the middle class suffered. Therefore, money did not flow through the system leading to a decline in monetary velocity.

Currently, the economy once again is bifurcated. The upper 10% of the economy is doing well, while the lower 90% remain affected by high joblessness, stagnant wage growth, and low demand for credit. Moreover, for only the second time in history, short-term rates are at zero, and monetary velocity is non-existent.

The difference is that during the “Great Depression,” economic growth and inflationary pressures were at some of the highest levels in history. Today, the economy struggles at a 2% growth rate with inflationary pressures detracting from consumptive spending. 

Low Rates Can Last A Long Time

Interest rates are ultimately a reflection of economic growth, inflation, and monetary velocity. Therefore, given the globe is awash in deflation, caused by weak economic output and exceedingly low levels of monetary velocity, there is no pressure to push rates sustainably higher. The dashed black line is the median interest rate during the entire period.

(Note: Notice that a period of sustained low interest rates below the long-term median averaged roughly 40 years during both previous periods. We are only currently 10-years into the current secular period of sub-median interest rates.)

The following chart overlays the 10-year average economic growth rate. As you will notice, and as discussed above, rates rise in conjunction with more substantial levels of economic growth. Such is because more substantial growth leads to higher wages and inflation causing rates to rise accordingly.

Today, the U.S. is no longer the manufacturing epicenter of the world.  Labor and capital flow to the lowest cost providers to effectively export inflation from the U.S., and deflation gets imported. Technology and productivity gains ultimately suppress labor and wage growth rates over time. The chart below shows this dynamic change which began in 1980. A surge in debt was the offset between lower economic growth rates and incomes to maintain the “American lifestyle.”

A Demographic Challenge

The chart below shows both the long-view of real, inflation-adjusted, annual GDP growth and on a per-capita basis. I have also included the annual growth rates of the U.S. population. [Data Source: MeasuringWorth.com]

There are some interesting differences between the “Great Depression” and the “Great Recession.” During the depression, the economy grew at 13% and 18% on an annualized basis. Today, the current economic cycle of 2.5% and 2.7%. What plagued the economic system during the depression was the actual loss of wealth following the “Crash of 1929” as a rash of banks went bankrupt, leaving depositors penniless, unemployment soaring, and consumption drained. While the government tried to assist, it was too little, too late. The real depression, however, was not a statistical economic event but rather an absolute disaster for “Main Street.”

During the current period, real economic growth remains lackluster. In addition, real unemployment remains high, with millions of individuals simply no longer counted or resorting to part-time work to make ends meet. Finally, with more than 100-million Americans on some form of government assistance, the pressure on “Main Street” remains.

One crucial difference is the rate of population growth which, as opposed to the depression era, has been on a steady and consistent decline since the 1950s. This decline in population growth and fertility rates will potentially lead to further economic complications as the “baby boomer” generation migrates into retirement and becomes a net drag on financial infrastructure.

Today, despite trillions of dollars of interventions, zero interest rates, and numerous bailouts, the economy has yet to gain any real traction, particularly on “Main Street.” 

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

The End Of The Bond Bubble

The problem with most forecasts for the end of the bond bubble is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds.

However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American’s participation in the domestic economy. Interest rates, however, are an entirely different matter.

While there is not much downside left for interest rates to fall in the current environment, there is not a tremendous amount of room for increases. Moreover, since interest rates affect “payments,” increases in rates quickly negatively impact consumption, housing, and investment.

Will the “bond bull” market eventually come to an end?  Yes, eventually. However, the catalysts needed to create the economic growth required to drive interest rates substantially higher, as we saw previous to 1980, are not available today. Such will be the case for decades to come. The Fed has yet to conclude we are caught in a “liquidity trap” along with the bulk of developed countries.

Over the following 5000-years, rates will eventually rise. But for now, I am long bonds and continue to buy more whenever someone claims the “Great Bond Bull Market Is Dead.”

Market Futures Sink As Oil Breaks Above $80

This morning market futures are pointing lower as oil breaks above $80 and bond yields rise. Furthermore, investors need to fasten their seat belts, for a busy week full of economic data, Fed minutes, and corporate earnings. The market gets a rest from data today due to the Columbus day holiday. Between CPI, PPI, Retail Sales, and JOLTs, all set for release this week, the Fed will have a new round of data to guide their tapering decision. Expect more tug of war in the markets as investors deal with new data.

Daily Market Commnetary

What To Watch Today

Economy

  • No notable reports scheduled for release

Earnings

  • No notable reports scheduled for release

Politics

  • The U.S. House of Representatives and Senate are both out of session until Oct. 18.
  • The World Bank Group and the International Monetary Fund (IMF) kick off their annual meetings in Washington D.C. They will release the World Economic Outlook tomorrow morning.

Courtesy of Yahoo

Oil Breaks Above Key Resistance

This morning oil futures are pointing significantly higher with oil breaking above key resistance levels going back to 2009. While oil is very overbought, and a very overcrowded trade, at the moment, such does not mean prices can’t surge higher given the bottlenecks in the system. There is a good bit of overhead resistance as oil prices move into the $90-$100 range, and the bigger issue becomes the inflationary backlash of higher prices on consumption and economic growth.

Stock Futures Are Lower To Start The Week

“Stock futures were slightly lower on Monday to start the week as traders eyed surging energy prices and the start of earnings season around the corner.

Dow Jones Industrial average futures fell 107 points, 0.3%. S&P 500 futures lost 0.5% and Nasdaq 100 futures shed 0.7%. The Dow is coming off its best week since June.” – CNBC

As noted in “Is The Great Bear Market Of 2021 Over?” We need to see some follow through buying this week in markets to confirm the break above resistance last week. If we fall back below the 100-dma, stocks will retest recent lows. The risk is that continued failures to advance will lead to a break of support and a deeper correction will ensue.

Great Bear Market 10-08-21, Is The Great “Bear Market” Of 2021 Finally Over? 10-08-21

GDP Revised Down As Expected.

Futures also took a hit as Goldman Sachs cut its economic growth forecast. Goldman cut its 2022 growth estimate to 4% from 4.4% and took its 2021 estimate down a tick to 5.6% from 5.7%. The firm cited the expiration of fiscal support from Congress and a slower-than-expected recovery consumer spending, specifically services.” – CNBC

Such is not a surprise and is a function of the “second derivative” effect we have discussed since the beginning of this year.

In Q2 of this year, G.D.P. estimates started that quarter at 13.5% and ended at 6.5%. The third quarter started at 6% and is now tracking at 1.3%, as shown below.

As we discussed in “The Coming Reversion To The Mean,” the “second derivative” effect of economic growth is manifesting itself. To wit:

“We are at that point in the recovery cycle. Over the next few quarters, the year-over-year comparisons will become much more challenging. Q2-2021 will likely mark the peak of the economic recovery.09/24/21

Reversion Economic Growth, The Coming “Reversion To The Mean” Of Economic Growth

When writing that blog, our estimates were for a cut in growth to 3.9%. We are currently closer to 1%.

Secondly, fourth-quarter growth will also remain under significant pressure for several reasons:

  1. Year-over-year comparisions remain challenging.
  2. Manufacturing surveys look to slow in a challenging enviroment.
  3. Employment continues to quickly revert to long-term norms.
  4. Liquidity continues to turn negative.

The last point is the most problematic. The massive surge in economic growth in 2020 was a direct function of the massive direct fiscal injections into households. With that support gone, economic growth will revert to normality, particularly in an environment where wage growth does not keep up with inflation.

Payrolls Report

The BLS Jobs report was weaker than expected, with job growth of 194k. Expectations were for a gain of between 475k and 500k jobs. The BLS revised the prior month higher to 366k from 235k. The unemployment rate did fall from 5.1 to 4.8%, however, it was in part due to people dropping out of the workforce. 183k people left the workforce causing the participation rate to fall from 61.7 to 61.6%. With the number of job openings so high and jobless benefits ending we find it surprising people are leaving the workforce. Also interesting was temporary help fell slightly. With so many job openings one would expect many companies to hire temporary workers to fill gaps until they can hire permanent workers. The graph below from True Insights shows payroll growth is starting to fall back in line with pre-pandemic rates of 150-200k per month.

The Danger of Fighting the “Last War”

Bill Dudley, President of the New York Fed from 2009 to 2018, in a Bloomberg editorial, voices concern the Fed is too worried about deflation, or as he says, the “last war.”  He argues the Fed should be concerned inflationary pressures are more than transitory. He prefers the Fed take on a more hawkish tack sooner rather than later. Per Dudley:

This dovishness increases the risk of a major policy error. If the economic outlook evolves in unexpected ways, Fed officials will almost certainly be slow to respond. Hence, if inflation proves more persistent than anticipated and even accelerates as the economy pushes beyond full employment, they’ll have to tighten much more aggressively than they expect.

A faster pace of tightening would come as a shock for financial markets and could risk tipping the economy back into recession. That’s the danger of fighting the wrong war.

Oil Prices and Rig Counts

The graph below compares oil prices to rig counts. After falling to recent lows, rig counts are rising. However, they are still well less than should be expected given current oil prices. Why are oil producers not adding rigs and producing more oil to take advantage of higher prices? There are a few reasons.

First, OPEC is increasing production and will get more aggressive if prices keep rising. Second, oil producers realize the current economic boom and spike in economic activity, and demand for oil is temporary. It is the result of short-term fiscal stimulus and economic normalization. Lastly, President Biden is threatening to release oil from the strategic oil reserves. If the government indiscriminately caps the price of oil via rhetoric and action, the incentive to produce and add rigs is lessened.

Is The Great “Bear Market” Of 2021 Finally Over?

In this 10-08-21 issue of “Is The Great ‘Bear Market’ Of 2021 Finally Over.?

  • Is The “Great Bear Market” Finally Over?
  • Debt Ceiling Resolution Is Only Temporary
  • Odds Are We’ve Seen The Highs For The Year
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

Follow Us On: Twitter, Facebook, Linked-In, Sound Cloud, Seeking Alpha


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Schedule your “FREE” portfolio review today.


Is The Great “Bear Market” Finally Over?

In last week’s newsletter, we stated:

“It is worth noting there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

The rally back above the 100-dma on Friday was strong and sets up a retest of the 50-dma. If the market can cross that barrier we will trigger the seasonal MACD buy signal suggesting the bull market remains intact for now.

Chart updated through Friday

Notably, the very short-term moving average convergence divergence (MACD) indicator (lower panel) did trigger this past week. With markets not yet back to extremely overbought territory, and sentiment still very negative, the bulls are trying to reclaim the 50-dma.

Our seasonal MACD indicator (next to the bottom panel) also triggered, but just barely. We need to see some follow-through buying action next week.

Money Flow Buy Signal Also Positive

The RIAPRO Money Flow indicator also triggered a buy signal, becoming more robust support for a short-term rally this past week.

So, do all these signals mean the “Great Bear Market Of 2021” is behind us?

After a harrowing 5% decline, sentiment is now highly negative, supporting a counter-trend rally in the markets. Thus, we think there is a tradeable opportunity between now and the end of the year. But, as we will discuss below, significant headwinds continue to accrue, suggesting higher volatility in the future.

I want to reiterate our conclusion from last week:

If you didn’t like the recent decline, you have too much risk in your portfolio. We suggest using any rally to the 50-dma next week to reduce risk and rebalance your portfolio accordingly.

While the end of the year tends to be stronger, there is no guarantee such will be the case. Once the market “proves” it is back on a bullish trend, you can always increase exposures as needed. If it fails, you won’t get forced into selling.

That advice remains apropos this week as well. The biggest mistake investors make is allowing emotion to dominate their investment decision-making process. Such is why “buy and hold” investing is appealing during a bull market because it removes decisions from portfolio management.

However, as we discussed this past week in “The Best Way To Invest.”

“Buy and hold” strategies are the “best way” to invest until they aren’t.



The Debt Ceiling Non-Crisis

As discussed in the “Debt Ceiling Non-Crisis,” the hyperbole surrounding the debt limit was on full display, culminating with this tweet from Bernie Sanders:

While “Ole’ Bernie” is trying to coerce his counterparts to raise the debt limit, his statement is full of misinformation to scare individuals. As noted in our article:

“In 1980, that all changed, and seven administrations and four decades later, Government debt surged, deficits exploded, and the debt ceiling rose 78 times. (49 times under Republicans and 29 times under Democrats.)

As Congress lifts the debt ceiling for the 79th time, the runaway spending and deficit increases continue to accelerate. The consequence of increasing debts and deficits is evident in the declining economic growth rates over the past 40-years.”

Debt Ceiling Rates, The Debt Ceiling Non-Crisis & Why Rates Will Fall.

In other words, this isn’t about paying bills from the Trump Administration, but also every President before him back to Ronald Reagan. For each year that we amass more enormous debts and deficits, the interest payments increase along with the growing burden of “mandatory spending.”

The problem today, as discussed in the “Insecurity Of Social Security,”

“In the fiscal year 2019, the Federal Government spent $4.4 trillion, amounting to 21 percent of the nation’s gross domestic product (GDP). Of that $4.4 trillion, federal revenues financed only $3.5 trillion. The remaining $984 billion came from debt issuance. As the chart below shows, three major areas of spending make up most of the budget.”

Social Security Insecurity, #MacroView: The Insecurity Of Social Security

In 2019, 75% of all expenditures went to social welfare and interest on the debt. Those payments required $3.3 Trillion of the $3.5 Trillion (or 95%) of the total revenue collected. Given the decline in economic activity during 2020, those numbers become markedly worse. For the first time in U.S. history, the Federal Government will have to issue debt to cover the mandatory spending.

Only A Temporary Fix

Think about that for a moment. In 2021, we will spend more on our “mandatory spending” than “revenue” will cover. Such means the Government will continue to go further into debt every year just to run the country. On top of the required spending, our politicians now want to add another $5 trillion in debt for “infrastructure.”

See the problem here.

The “debt ceiling” was always a “non-crisis.” It was just political brinksmanship playing out on national television. The resolution, as expected, came last week with Senate Minority Leader, Mitch McConnell, proposing a debt limit ceiling lift to $29 trillion. Such will fund the government through December.

“Senate leaders reached a bipartisan agreement Wednesday to defuse the impending debt limit crisis by allowing for a short-term increase in the statutory borrowing cap while lawmakers negotiate a longer-term solution.

Democrats said they would agree to an offer from Minority Leader Mitch McConnell that would pave the way for an increase in the debt limit into December. But the two parties still disagreed on any long-term strategy.” – Roll Call

While raising the debt ceiling may look like a victory for the Democrats, it may not be.

“While raising the debt ceiling just once is proving to be a challenge, the only thing worse would be having to vote to raise it twice

From a political perspective, the only thing less attractive than voting to raise the debt limit to $31 trillion is voting to raise it to $29 trillion and then voting a second time to raise it to $31 trillion’” – Zerohedge


In Case You Missed It


Odds Increasing We’ve Seen The Highs For This Year

There are reasons to be optimistic as we head into the seasonally strong period of the year. However, while the seasonal and technical backdrop is improving short term, we should not dismiss the numerous headwinds.

  • Valuations remain elevated.
  • Inflation is proving to be sticker than expected.
  • The Fed will likely move forward with “tapering” their balance sheet purchases in November.
  • Economic growth continues to wane.
  • Corporate profit margins will shrink due to inflationary pressures.
  • Earnings estimates will get downwardly revised keeping valuations elevated.
  • Liquidity continues to contract on a global scale
  • Consumer confidence continues to slide.

While none of these independently suggest a significant correction is imminent, they will limit the market’s advance making new highs less attainable. Furthermore, given the “debt crisis” will return in December, the risk of volatility remains elevated.

Much of the mainstream media overlooks the rapid decline in liquidity that supported the market over the last year. While the “human infrastructure” bill will provide some support, the difference is the spending is spread out over 10-years versus the “checks to households” in 2020.

Furthermore, that liquidity drain is rapidly deteriorating the outlook for economic growth. Here is the latest report from the Atlanta Federal Reserve:

“The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2021 is 1.3 percent on October 5, down from 2.3 percent on October 1.

As BCA Research shows, as we head into the last quarter of the year and 2022, the slower economic growth rates will coincide with corporations’ weaker revenue and earnings growth.

As noted, with valuations already elevated, a reversal in earnings growth will likely limit a stronger advance.



Portfolio Update

We discussed last week that after taking profits in August and raising cash, we slowly started adding back into our equity holdings. The recent spike in bond yields also allowed us to increase the duration of our bond portfolio this week.

We continued that process early this week, adding additional exposures and rebalancing portfolio risk by reducing laggards.

We are now at target weight in our equities, slightly overweight in cash, and our duration is somewhat shorter than our benchmark. As noted above, while we are looking for a market recovery through year-end, we are keeping a slightly cautious positioning bias to our models. If we are wrong and the market breaks vital support levels, we will reverse our positioning.

For now, we are giving the market the benefit of the doubt. However, we are keeping our positioning on a very short leash. With valuations still elevated, the technical deterioration of the market remains a primary concern. Such was a point we made in our Daily Market Commentary this week:

On RIAPRO, we provide the sentiment and technical measures we follow. The number of oversold stocks is back towards extremes, which supports the idea of a short-term rally.”

manic monday, Will Stocks Bounce After a Manic Monday

“However, the overall “breadth” and “participation” of the market remains highly bearish. Thus, to avoid a deeper correction, breadth must improve.

manic monday, Will Stocks Bounce After a Manic Monday

We are watching these technical measures very closely as they will dictate our next course of action.

Have a great weekend.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data. Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 51.27 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

Our “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 64.2 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

The markets finally appeared to have bottomed this week as the debt ceiling debate got resolved until December. But, while the pressure was relieved somewhat, there is still risk heading into the end of the year.

Nonetheless, our job is to make money when we can while maintaining our discipline of risk controls. As noted below, we made a couple of minor additions to our portfolios this week and reduced areas that broke through technical supports and our stop levels.

We are now at target weight in our equities, slightly overweight in cash, and our duration is somewhat shorter than our benchmark. As noted above, while we are looking for a market recovery through year-end, we are keeping a slightly cautious positioning bias to our models. If we are wrong and the market breaks vital support levels, we will reverse our positioning.

We continue to be mindful of the risk exposure the portfolio has currently, but we are also entering into the seasonally strong period of the year. With a much-needed correction now behind us, we don’t want to get too conservative just yet, particularly as global money flows remain exceptionally strong currently. Furthermore, as we head into Q3 earnings season, corporations are now on a “buyback spree” that supports stocks.

We continue to monitor our portfolios closely. However, if you have any questions, do not hesitate to contact us.

Portfolio Changes

During the past week, we made minor changes to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

“This morning we added 1% to COST and PG. We also bought a new 1% position in WM.  WM allows us to increase exposure to industrials without taking on China’s risk, as many industrials have.” – 10-07-21

Equity Model

  • Add 1% to COST bringing the total weight to 2.5% of the portfolio.
  • Adding 1% to PG bringing the total weight to 2% of the portfolio.
  • Initiating a 1% position in WM.

We just reduced our exposure in both portfolios slightly in part because of recent volatility and what we view as a poor risk/reward skew.

In the Equity model, we sold the entire position in UPS. It broke through key technical support and is trading poorly. FDX recently had poor earnings and UPS will likely follow suit when they report on October 26th. We also sold the entire stake of IYT in the ETF model as well.

We also cut JNJ to 1.5% from 2.5%. It has also broken through key technical support, but we like the fundamental story longer-term. We will look for an opportunity to add back into the position once it strengthens technically.” – 10-06-21

Equity Model

  • Sell 100% of UPS
  • Reduce JNJ from 2.5% to 1.5% of the portfolio.

ETF Model

  • Sell 100% of IYT

“We added 1% of XLP to the sector model. It is turning up on a buy signal from a very oversold condition. The inflationary impulse is likely to fade or at least take a break, arguing for sectors like staples, technology, and healthcare should begin to perform better.” – 10-08-21

ETF Model

  • Add 1% of the portfolio to XLP increasing weight to 5% of the portfolio.

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors



Attention: The 401k plan manager will no longer appear in the newsletter in the next couple of weeks. However, the link to the website will remain for your convenience. Be sure to bookmark it in your browser.

Commentary

This past week, the markets finally bounced solidly off of support and above the 100-dma. With the markets approaching the “seasonally strong” period of the year, we are looking for our MACD signals to confirm our current positioning. As noted in this week’s newsletter, we may have seen the highs for this year, and 2022 may well see an increase in volatility.

As noted last week:

“With the correction complete, and markets very oversold short-term, portfolio allocations can remain at current levels. Cash that accumulated over the past few weeks can now get deployed to allocations. Also, rebalance your bonds back to weightings after the recent rise in rates.”

That remains the case again this week. Importantly, continue to remain overweight large-cap domestic stocks and vastly underweight international, emerging markets, small and mid-capitalization stocks. Inflationary pressures will hit those areas the hardest in the future.

There is no need to be aggressive here. There is likely not a lot of upside between now and the end of the year.

Model Descriptions

Choose The Model That FIts Your Goals

Model Allocations

If you need help after reading the alert, do not hesitate to contact me.

Or, let us manage it for you automatically.


401k Model Performance Analysis

Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only, and one should not rely on it for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.

Have a great week!

Technical Value Scorecard Report – Week Ending 10-08-21

Relative Value Graphs

  • The S&P 500 is about 1% higher versus last Friday, as the selloffs from earlier in the week were bought vigorously over the previous two days. Energy continues to lead the way, beating the S&P by nearly 1%. Other cyclical sectors outperformed as well, including Industrials, materials, and financials. Transportations stocks were the odd sector out as higher energy prices and poor earnings from FedEx held the sector back.
  • The third graph shows the strong excess returns in energy (XLE) and broad relative weakness in most other sectors over the last 35 trading days.
  • Energy and financials are overbought but still have some room to run, as we noted last week. Crude oil is close to breaking above $80 a barrel. On a technical basis, there is little above $80 to stop it from rising to $100. However, OPEC may increase production and/or Biden release strategic reserves if higher prices occur.
  • Small and mid-caps are among the most overbought sectors but still at scores low enough to provide more upside. International markets, developed and emerging, maintain oversold scores. Given recent dollar strength, the trends may continue.
  • In the upper right corner in the first graph, note the inflation vs. deflation index and TIPs vs. TLT are both overbought. This corresponds with the leading sectors benefiting from another inflationary impulse.

Absolute Value Graphs

  • On an absolute basis, the energy sector is nearing overbought extremes. As we noted earlier, there is still more upside, but a healthy consolidation may be in store over the coming weeks. Staples have the worst absolute score. This sector is feeling the pressure of rising prices, and at this point, it is not clear if they can pass them on to consumers.
  • Discretionary, financials, industrials, and materials all had big jumps in their absolute scores. In the case of industrials and materials, they are now at fair value.
  • All bonds are oversold but not quite to the degree that would warn a rally is in store. Similar theme as we discussed earlier, bond yields are rising, prices falling due to a renewed inflationary scare.
  • Most factors are near fair value. RSP, the equal-weighted S&P 500, is the most overbought, and the NASDAQ is the most oversold. Quite the reversal from a few weeks ago!
  • The S&P 500 is back to slightly overbought but still well below its average score from the prior year.
  • As shown in the fourth graph, all sectors are above their 200dma, except for staples, which is slightly below it. However, staples are nearly three standard deviations below its 50dma, arguing for a bounce in the coming days. Conversely, energy is over two standard deviations above its 50dma, but only 1.3 above its 200dma. As we noted earlier, a consolidation is likely, but more upside would not be surprising. The NASDAQ is two standard deviations below its 50dma, arguing for a bounce, similar to staples.

Users Guide

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take any action if other research and models do not affirm it.

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner is the most bearish.

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

The Bulls Have The Ball And Are Running For The 50-dma

After Wednesday’s impressive rebound the bulls are regaining confidence and attempted a run for the 50-dma yesterday. With control back in their hands, the first big test will be getting the ball past the 50-dma for an attempt at the “end zone” of all-time highs. The bears will likely set us a strong defensive front at the 50-dma, leading to a battle royale for market control in the coming days. Today’s BLS unemployment report may play a big role in picking the winner of this battle.

This morning futures are flattish (at the time of this writing) as we await the employment report at 7:30 am this morning. Will the report be strong enough to cement the Fed’s “taper” decision in November? Or, will a weak report potentially put a pause on the reduction of liquidity? For the markets, this could be bad news is good news if a poor jobs report keeps the “punch bowl” full.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Change in non-farm payrolls, September (500,000 expected, 235,000 in August)
  • 8:30 a.m. ET: Unemployment rate, September (5.1% expected, 5.2% in August)
  • 8:30 a.m. ET: Average hourly earnings, month-over-month, September (0.4% expected, 0.6% in August)
  • 8:30 a.m. ET: Average hourly earnings, year-over-year, September (4.6% expected, 4.3% in August)
  • 8:30 a.m. ET: Labor force participation rate, September (61.7% in August)
  • 10:00 a.m. ET: Wholesale inventories, month-over-month, August final (1.2% expected, 1.2% in prior estimate)

Earnings

  • No notable reports scheduled for release

Politics

Courtesy of Yahoo

A Run For The 50-dma

As noted, the market cleared the all-important hurdle of the 100-dma resistance level yesterday and made an initial attempt at the 50-dma. However, such proved to be “too far, too fast” for the bulls. The key is with the markets not yet overbought, and the MACD signal still on a sell signal, but improving, that the 100-dma holds and becomes support.

With earnings season approaching, the bulls have their work cut out for them. Risk is elevated, so we still consider this rally a counter-trend bounce until the 50-dma is taken out.

The concerns over the next several months are several.

  1. Economic growth is slowing fast.
  2. Earnings and revenue are tied to economic growth which puts equities at risk.
  3. The fiscal drag is become much more prevalent.

“Inflation” is Coming Next Week

The graph below, courtesy of the Market Ear, shows how mentions of inflation are a hot topic for earnings calls. As we gear up for another round of earnings releases starting in earnest next week, there is little doubt the number of “inflation” mentions will increase further. The question facing shareholders is how well can companies deal with inflation? Can they take advantage of higher prices or will they negatively impact profit margins? Each company and industry has different factors to consider that will help answer those questions.

From a macro perspective, we will also learn a  good deal about expectations for continued inflation in the coming quarters. The Fed speaks with executives at many large companies, so this information will also help us better assess our outlook on the potential pace at which the Fed tapers QE.

Jobless Claims

Following yesterday’s strong ADP report, the labor market showed more improvement.  Weekly Initial Jobless Claims fell back toward a post-covid low of 326K. This was below expectations of 348k and well below last week’s 364k.

Market Rise On Debt Ceiling Increase

St. Louis Fed Expects an Ugly Jobs Report While JPM is Optimistic

Per Market News (MNI), the St. Louis Federal Reserve expects to see an 818k decline in tomorrow’s BLS payrolls report. St. Louis Fed economist Max Dvorkin states: “There’s still “a lot of uncertainty around these figures,” but the model has tracked actual CPS employment “quite well” through the summer, he said.” He blames the recent uptick in Covid cases and the impact on global supply lines. The current forecast is for a gain of 410k jobs. If the Fed’s forecast is proven correct the Fed might delay what appears to be a tapering announcement in early November.

On the other hand, JP Morgan is optimistic “we are looking for a 575,000 gain in jobs and a drop in the US unemployment rate to 5%. The driver for an above-consensus forecast is the expected rebound in the leisure and hospitality sectors.”

Our expectations are roughly in line with JPM in that we will see a seasonal adjustment boost to the employment report which could make it look stronger than reality.

Retail Inventories are Low

Price pressures, especially on retail goods, will likely continue into the holiday season. The graph below shows the ratio of Retailers’ inventories to sales is at a 25+ year low and well below pre-pandemic levels. Given there appears to be little let-up in supply line problems, it’s becoming increasingly probably that many retailers will not be able to fully stock their shelves to meet the heavy demand for Christmas presents. With, the limited inventory we suspect many stores, both online and brick and mortar, will be able to raise prices over the next few months.