Monthly Archives: September 2018

Is Credit Suisse On The Ropes?

Rumors are floating around that Credit Suisse, Switzerland’s second-largest bank, is having financial difficulties. Accordingly, many investors are starting to look to the Swiss National Bank (SNB) and ECB to bail them out. The credit default swap markets can quantify how serious the market thinks the situation is. Currently, a five-year CDS contract on Credit Suisse costs 2.5% per year. Therefore, a bondholder can pay 2.5% yearly to hedge against default. At that level, CDS is pricing in approximately a 17% chance the bank defaults, assuming bondholders recover 25 cents on the dollar. As a point of reference, Citi and Goldman Sachs trade around 135bps, or about half of Credit Suisse’s level.

The more significant issue here is not Credit Suisse but increasing signs of broader financial instability rising throughout the European banking sector. Therefore, keep a close eye on central banks and treasury departments for signs of willingness to step in and arrest the growing problems.

credit suisse

What To Watch Today


  • 10:00 a.m. ET: Factory Orders, August (0.0 expected, -1.1% prior)
  • 10:00 a.m. ET: Factory Orders Excluding Transportation, August (0.2% expected, -1.0% prior)
  • 10:00 a.m. ET: Durable Goods Orders, August final (-0.2% prior)
  • 10:00 a.m. ET: Durables Excluding Transportation, August final (0.2% prior)
  • 10:00 a.m. ET: Non-defense Capital Goods Orders Excluding aircraft, August final (1.3% prior)
  • 10:00 a.m. ET: Non-defense Capital Goods Shipments Excluding Aircraft, August final (0.3% prior)
  • 10:00 a.m. ET: JOLTS Job Openings, August (11.088 million expected, 11.239 million prior)


Market Trading Update

“Stocks and bonds were bid on Monday after the September decimation for both assets, perhaps on oversold conditions but there are also murmurings of investors bracing for a Fed pivot – although this is very speculative, but the US data on Monday was also weaker than expected. Fed speakers have noted they are keeping an eye on events abroad and the potential impact it has on the US, although Fed Vice Chair Brainard on Friday did stress she is committed to avoiding pulling back prematurely while Williams noted inflation is far too high and the Fed’s job is not done. The talk of a Credit Suisse collapse has led to a jump in the Credit Suisse CDS and a tumbling share price, exacerbating these concerns despite pushback from management but nonetheless adding to woes about financial stability.” – Newsquawk

While there were a lot of reasons presented by the media for the rally on Monday, the truth was simple. Last Tuesday’s blog post, “The Big Short Squeeze,” and this past weekend’s Newsletter laid out the case for a reflexive rally given the extreme oversold conditions. To wit:

As noted, every technical indicator is now screaming oversold. As shown by the vertical lines, when the market had previously hit such lows across indicators, such was typically near a short-term bottom. We suspect that as we enter into October, we could see a more sustainable reflexive rally to roughly 3850 on the S&P 500. Investors should continue to use such rallies to raise cash and rebalance risk accordingly.

Such is likely a tradeable rally so that short-term traders can add exposure. For longer-term investors, until proven otherwise, treat this rally as a “bear market rally” and rebalance risk accordingly.

OPEC Leads Oil Prices Higher

Crude oil was over 5% higher on Monday as OPEC mulls production cuts of around 1 million barrels daily. One million barrels is equivalent to approximately 1-2% of the global supply. OPEC’s decision could come on Wednesday after it meets. The New York Times reports that Saudi Arabia wants to bring oil prices back up to $90 a barrel.

crude oil and opec

ISM Sparks Rally

The ISM manufacturing survey came in weaker than expected at 50.9. A reading below 50 signals economic contraction. Within the index, the employment sub-component was 48.7, weaker than expectations of 53.0. Prices paid were slightly more fragile than expectations at 51.7. New orders, a forward-looking sub-component, suggest an economic contraction is underway at 47.1. The graph below shows the strong correlation between ISM prices paid and CPI. The current divergence is massive, but if the correlation holds, we should expect a sharp drop in inflation.

ism prices paid cpi

The Fed purposely tries to slow economic activity and increase the unemployment rate to bring inflation down. While the ISM data is not good from an economic or corporate earnings perspective, the market is rejoicing as it is a sign the Fed may be getting what they want. That means the most hawkish Fed era in over 40 years might be in its latter innings. The Fed will need a few months of similarly weak data before it considers changing its tone. However, as we note in the opening, financial instability, not the economy or inflation, might be what gets the Fed to take its foot off the brakes.

Sectors- Bearish Deviations

The graph below shows how far each sector trades below its 20, 50, and 200-day moving averages. The distance is measured in standard deviations. Often, trading two or more standard deviations (sigmas) below a moving average denotes an oversold situation. Three or more is uncommon and often results in a decent counter-trend move. Staples, one of the better-performing sectors this year, is the only sector with all three moving averages below negative two standard deviations. Utilities, which has also outperformed the market this year, is trading over three standard deviations below its 200 dma.

sector analysis

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“Market Instability” Causes BOE To Reverse QT. Is The Fed Next?

Market Instability Originally Appeared At MarketWatch

“Market instability” remains the most significant risk to central banks globally. Despite their desire to combat surging inflation, market instability is a greater risk to global economies due to the massive amounts of leverage. We previously discussed the importance of controlling instability. To wit:

Interestingly, the Fed is dependent on both market participants and consumers, believing in this idea. With the entirety of the financial ecosystem now more heavily levered than ever due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the “instability of stability” is now the most significant risk.

The ‘stability/instability paradox’ assumes that all players are rational, and such rationality implies avoidance of complete destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’”

So far, the Fed remains fortunate with a low volatility decline in markets. In other words, “market stability” continues to afford the Federal Reserve the operating room needed for the most aggressive rate hiking campaign since the late 70s. Market volatility and credit spreads remain “well contained” despite drastically higher interest rates and an ongoing stock market decline.

Credit spreads to market

However, stable markets can become unstable rapidly when something breaks due to rising rates or volatility. The Bank of England (BOE) is an excellent example of what happens when things go awry. The BOE was forced to start buying bonds to solve a potential crisis with U.K. pension funds. The pension funds receive margin with yields fall and post additional collateral when yields rise. However, when yields spike, as they have recently, the pension funds are hit with “margin calls,” which have the potential to cause market instability. Due to leverage built up through the entire financial system, market instability can spread like a virus through global markets. Such was last seen with the Lehman Crisis in 2008.

Is the BOE’s actions an isolated event? Maybe not. According to Charles Gasparino, the Fed could be next.

The Market Instability Risk

The Federal Reserve is deeply committed to its aggressive campaign to quell surging inflation. As Jerome Powell stated at this year’s Jackson Hole Summit:

Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

While the Federal Reserve is willing to cause “some pain” to achieve victory, they hope to do so without evoking a recession. Such may be a challenge for two primary reasons:

  1. The Fed remains focused on lagging economic data, such as employment, which are highly subject to future revisions, and;
  2. Changes to monetary policy do not show up in the economy until roughly 9-12 months in the future.

The problem with the Fed’s use of economic data to guide monetary policy decisions was the subject of a St. Louis Federal Reserve research note. To wit:

“In the two quarters leading up to the average recession, all measures were still experiencing varying degrees of positive growth. Meanwhile, immediately following the onset of the average recession, all six indicators declined, which ultimately persisted for the entirety of the recession.”

St Louis Fed Economic indicators

Such brings us to the second most critical point.

Changes to monetary policy have a 9-12 month lag before showing up in the economy. Therefore, as the Fed is hiking rates based on lagging economic data, the risk of a “policy mistake” becomes heightened. By the time the economic data deteriorates, the preceding rate hikes have yet to impact the economy, which eventually deepens the recession.

As shown, the annual rate of change of the Fed Funds rate is now the most aggressive increase in history. However, every previous rate hiking campaign has led to a recession, bear markets, or economic event.

Fed Funds

However, the Federal Reserve does not operate in an economic vacuum. Other factors also contribute to the tightening of monetary policy and the impact on economic growth. When those other factors such as higher interest rates, falling asset prices, or a surging dollar coincide with the Fed’s policy campaign, the risk of “market instability” increases.

A Policy Mistake In The Making

The current bout of inflation is vastly different than that seen in the late 70s.

Milton Friedman once stated corporations don’t cause inflation; governments create inflation by printing money. There was no better example of this than the massive Government interventions in 2020 and 2021 that sent subsequent rounds of checks to households (creating demand) when an economic shutdown constrained supply due to the pandemic.

The following economic illustration shows such taught in every “Econ 101” class. Unsurprisingly, inflation is the consequence if supply is restricted and demand increases by providing “stimulus” checks.

Econ 101 supply and demand

The problem for the Fed is the influence of lagging economic data on its decisions. In contrast, forward estimates for inflation are already falling quickly as economic demand falters due to collapsing liquidity.

5 year inflation rates

Historically, the “best cure for high prices is high prices.” In other words, inflation would resolve itself as high costs curtail consumption. However, the Fed is not operating in a vacuum. While the Fed is hiking interest rates to slow economic activity, interest rates and the dollar have also increased dramatically in recent months. Those increases apply further downward economic pressures by increasing costs domestically and globally. Not surprisingly, sharp annual increases in the dollar are coincident with market instability and economic fallout.

Dollar vs market

Furthermore, the surge in the dollar accompanied the sharpest increase in interest rates in history. Sharp increases in interest rates, particularly in a heavily indebted economy, are problematic as debt servicing requirements and borrowing costs surge. Interest rates alone can destabilize an economy, but when combined with a surging dollar and inflation, the risks of market instability increase markedly.

Dollar vs rates

After more than 12 years of the most unprecedented monetary policy program in U.S. history, the Federal Reserve has put itself into a poor situation. They risk an inflation spiral if they don’t hike rates to quell inflation. If the Fed hikes rates to kill inflation, the risk of a recession and market instability increases.

As noted at the outset, the behavioral biases of individuals remain the most serious risk facing the Fed. For now, investors have not “hit the big red button,” which gives the Fed breathing room to lift rates. However, the BOE discovered that market instability surfaces quickly when “something breaks.”

When will the Fed find the limits of its monetary interventions? We don’t know, but we suspect they have already passed the point of no return, and history is an excellent guide to the adverse outcomes.

  • In the early ’70s, it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • anything was an excellent investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy.
  • Today, it’s real estate, FAANNGT, debt, credit, private equity, SPACs, IPOs, “Meme” stocks…or rather…” everything.”

The Federal Reserve continues to state its intentions to hike rates and reduce its balance sheet at the fastest pace in history, as inflation is the enemy it must defeat. However, while high inflation is detrimental to economic growth, market instability is far more insidious. Such is why the Federal Reserve rushed to bail out banks in 2008.

Unfortunately, we doubt the Fed has the stomach for “market instability.” As such, we doubt they will hike rates as much as the market currently expects.

Q4 Brings Hope After a Dismal Q3

This past quarter (Q3), investors took their lumps. However, seasonality analysis points to a positive Q4. The graph below shows that during the mid-term of past Presidential cycles, as we are in, S&P 500 average returns are the highest in the fourth quarter. Two thirds of the time, Q4 returns are positive, easily beating any other quarter. As we have recently highlighted, via bearish sentiment and record put options trading, sentiment is washed out. Heavy volatility in the final week of Q3 was likely related to quarter-end posturing by investment professionals. Often such “window dressing” reverses in the next quarter. Given the technically oversold market and weak sentiment, a bounce to start Q4 would not be surprising. The bigger question for Q4 is how the Fed, inflation, the dollar, mid-term elections, and geopolitics affect stock prices.

seasonality q4

What To Watch Today


  • 9:45 a.m. ET: S&P Global U.S. Manufacturing PMI, September final (51.8 expected, 51.8 prior)
  • 10:00 a.m. ET: Construction Spending, month-over-month, August (-0.2% expected, -0.4% prior)
  • 10:00 a.m. ET: ISM Manufacturing, September (52.1 expected, 52.8 prior)
  • 10:00 a.m. ET: ISM Prices Paid, September (52.0 expected, 52.5 prior)
  • 10:00 a.m. ET: ISM New Orders, September (50.5 expected, 51.3 prior)
  • 10:00 a.m. ET: ISM Employment, September (53.0 expected, 54.2 prior)
  • WARDS Total Vehicle Sales, September (13.50 million expected, 13.18 million prior)


  • No earnings releases today

Market Trading Update

On Friday, the market took out the June lows but is testing support going back to the peaks in 2020. As noted, every technical indicator is now screaming oversold. As shown by the vertical lines, when the market had previously hit such lows across indicators, such was typically near a short-term bottom. We suspect that as we enter into October, we could see a more sustainable reflexive rally to roughly 3850 on the S&P 500. Investors should continue to use such rallies to raise cash and rebalance risk accordingly.

Volatility Spikes, Volatility Spikes As The Quarter Comes To An End

So far, the Federal Reserve has remained blessed with a very stable market environment. However, on Wednesday, the Bank of England started buying bonds as the U.K. pension system faced potential insolvency from surging margin calls. Investors should not overlook the importance of those actions. Such was the subject of an article I wrote for MarketWatch. The crux of the article was the combined impact of tighter monetary policy combined with a surging dollar and rates was the recipe for “financial instability.”

“Furthermore, the surge in the dollar, driven by higher rates, accompanied the sharpest increase in interest rates in history. That’s problematic, particularly in heavily indebted economies, as debt-servicing requirements and borrowing costs surge. Interest rates alone can destabilize an economy, but when combined with a surging dollar and inflation, the risks of market instability increase markedly.”

Volatility Spikes, Volatility Spikes As The Quarter Comes To An End

The risk of market instability is rising, as seen in the volatility spike this past week. While that volatility spike remains subdued, it has reached the warning zone, suggesting something may be near breaking in the markets.

Volatility Spikes, Volatility Spikes As The Quarter Comes To An End

We will continue to watch volatility closely. In the meantime, both markets and sentiment are at such bearish levels the risk-reward is now favorable for traders.

The Week Ahead

The week starts off with the ISM manufacturing survey. Like most surveys, the inflation and employment subcomponents will be the most important to watch. Analysts expect ISM prices to fall from 52.5 to 51 and employment to remain stable at 54. Tuesday, Wednesday, Thursday, and Friday offer important updates on the labor markets. Tuesday’s JOLTs reading provides an update on job openings and the tight labor market. Thursday’s jobless claims number sheds more light on people being let go from jobs. Claims are worth following as they tend to lead to other employment data. ADP on Wednesday and the BLS labor report on Friday will be the most followed labor data. Analysts expect 290k jobs, leaving the unemployment rate at 3.7%.

Q4 corporate earnings season starts this week; however, there will be no reports of substance. Because of those coming earnings reports, most corporations are in “blackout periods” and can’t buy back their own stock. There are also a plethora of Fed speakers this week. Be alert for financial instability concerns and how that might affect monetary policy.

Bonds are Historically Cheap

The scatter plot below from Fidelity plots weekly levels of the ten-year UST yield and 5×5 inflation expectations. 5×5 inflation expectations is the implied five-year inflation rate bond traders expect five years from now. The current 5×5 rate is 2.28%. As a comparison, the next five-year implied inflation rate is 2.18%. The graph shows the current ten-year yield of 3.68% is 1.33% above the 2.35% trend line rate.

We took the analysis a step further and compared the ten-year rate to the five-year implied inflation rate average and the 5×5 inflation rate. This method captures yields versus the full ten-year of inflation expectations. Since 2010, on average, the Treasury note was 0.21% above the aggregate expected inflation rate. Currently, it is 1.40% above it. Both methods show that bond yields are over 1% too high based on inflation expectations. Bottom line: bonds are a buy, but there are many financial undercurrents, such as the U.K. pension fund selling, that are unpredictable and, in some cases, unknown. These events can create significant volatility and temporarily increase yields further.

bond are cheap 10 year

PCE Inflation

The financial media closely follows and reports on CPI inflation data. However, the Personal Consumption Expenditures (PCE) Price Index is the Fed’s preferred inflation gauge. Friday’s headline PCE price index met expectations for an increase of 0.3%. Stripping out food and energy, the core PCE rose 0.6%, 0.1% more than expectations. Zacks Research offers the following commentary:

The main aspect of these figures market participants pay closer attention to are the year over year numbers: +6.2% for the PCE Price Index, down 20 bps from July. Core year over year reached +4.9%, 20 bps above consensus and the upwardly revised previous month read. This suggests “transitory” inflation metrics have somewhat been absorbed into the stickier parts of the economy, making inflation more difficult to tame.

That said, +4.9% on core, while still historically high, is well below the +6.8% we saw in June of this year, which was the highest print we’d seen since Ronald Reagan’s first year as President. What we would rather see, of course, is these numbers come down on core as well as headline to have a better grasp of controlling overall inflation metrics. Clearly this is still a work in progress.

pce inflation prices

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Pension Funds and Leverage Threaten Financial Stability

Thursday’s Daily Commentary led with the story of the Bank of England’s (BOE) temporary purchases of British bonds (Gilts) to stem sharply rising rates. It turns out the root cause for the emergency action was not higher rates but irresponsible pension funds. Large U.K. pension funds were buying Gilts and likely U.S. Treasury bonds with leverage. Leverage requires the borrower maintains ample collateral to ensure repayment of the loan. As the price of Gilts fell, lenders required the pension funds to post more collateral. The speed and severity of the drop in Gilt prices forced pension funds to sell bonds in illiquid market conditions to raise money. These actions made yields rise further, making a bad problem worse. The situation also helps explain why U.S. Treasury bonds got slaughtered on Monday. In hindsight, it was likely U.K .pension funds selling U.S. bonds to meet margin calls.

The BOJ currency intervention a week ago and the BOE move Wednesday are important signals that financial instability is rising. The question facing U.S. stock investors is, will the Fed acknowledge instability with words and or actions? The graphic below, discussing how dire the situation was, is courtesy of the Financial Times.

pension funds lehman gilts

What To Watch Today


  • 8:30 a.m. ET: Personal Income, month-over-month, August (0.3% expected, 0.2% prior)
  • 8:30 a.m. ET: Personal Spending, month-over-month, August (0.2% expected, 0.1% prior)
  • 8:30 a.m. ET: Real Personal Spending, month-over-month, August (0.1% expected, 0.2% prior)
  • 8:30 a.m. ET: PCE Deflator, month-over-month, August (0.1% expected, -0.1% prior)
  • 8:30 a.m. ET: PCE Deflator, year-over-year, August (6.0% expected, 6.3% prior)
  • 8:30 a.m. ET: PCE Core Deflator, month-over-month, August (0.5% expected, 0.1% prior)
  • 8:30 a.m. ET: PCE Core Deflator, year-over-year, August (4.7% expected, 4.6% prior)
  • 9:45 a.m. ET: MNI Chicago PMI, September (51.8 expected, 52.2 prior)
  • 10:00 a.m. ET: University of Michigan Consumer Sentiment, September final (59.5 expected, 59.5 prior)


Market Trading Update

Another day of disappointment for the markets. After a sharp rally yesterday on the back of BOE market interventions, the market reversed course yesterday, once again testing the June lows. For the week, despite a wild ride, the market remains mostly unchanged heading into today’s trading. Part of the reason for yesterday’s volatility likely rests on quarter-end portfolio rebalancing. With the market extremely oversold on multiple levels, as noted in Tuesday’s blog, “The Big Short Squeeze,” a reflexive rally is likely. I would expect better price action as we enter the month of October, which historically tends to denote the end of bearish market action, at least in the short term. We look to use that rally to raise additional cash levels in portfolios for now.

The Big Short Bounce

The Bloomberg graph below strongly argues that stock prices may bounce soon. Essentially it shows that speculators are making a record number of short bets against the S&P 500. The short bets have been profitable over the last few weeks, but they will have to buy back their shorts at some point. Either they are happy with their fans and cover, or the market starts rising, forcing them to buy. Short covering rallies can be powerful when the market is as short as it is today.

big short sp500

To the Fed’s Dismay, Jobless Claims Fall Again

Jobless Claims fell last week to 193k. Jobless Claims have been falling steadily over the previous two months. Since 1967 there have been 2908 weekly jobless claims reports. Over that period, there have only been 68 other times jobless claims were below yesterday’s figure.

While this appears to be great news, the Fed may think otherwise. The Fed is concerned that tightness in the labor market contributes to higher inflation. They have openly stated they would like to see joblessness rise. The latest data argues the Fed may need to remain very hawkish in the coming months to ease the labor shortage and ultimately tame inflation.

bls jobless claims data
jobless claims

Are Zero Corporate Defaults Sustainable

The corporate bond market trades at low yield premiums to risk-free U.S. Treasury bonds despite the recent economic and financial turmoil. The first graph shows that the yield difference between investment grade corporate bonds and Treasury bonds has risen recently but remains in the lower end of the range of the last 25 years. The second graph below helps explain why. As it shows, corporate bankruptcies have been non-existent over the last year. The problem with expecting that to continue is the economy; therefore, defaults are cyclical. As you can see, the number of bankruptcies troughs and peaks every four years or so. Simply, corporate defaults will increase over the coming few years.

The economy is weakening, and corporate profits, or their ability to make good on the debt, are likely to struggle as the economy weakens. As investors, we must ask if the additional yield we get for buying a corporate bond fully incorporates the risk of default.

corporate default bond spreads
corporate defaults

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Mild Recession Likely To Be Worse Than Expected

A recent MarketWatch article discussed JPMorgan’s Chief Operating Officer, Daniel Pinto, views about a coming mild recession.

“Pento said he’s reluctant to shed talent right away and may look to pick up bankers let go by other firms as inflation feeds talk of layoffs and recession on Wall Street.

Acknowledging that there could be a roughly 50% chance of a ‘mild recession’ ahead, Pinto said Tuesday he’s not expecting the investment banking business to come anywhere near the blockbuster results of 2021.”

However, it isn’t just JP Morgan. The global rating agency, Fitch, and Deutsche Bank recently slashed growth forecasts, predicting a “mild recession.”

“The eurozone and UK are now expected to enter recession later this year and the US will suffer a mild recession in mid-2023.”FItch

“We forecast that the U.S. economy will enter a mild recession in H1 2023.” – Christian Nolting, Deutsche Bank

These are only a few of the analysts’ comments of late. As the Federal Reserve continues reiterating a more aggressive monetary policy stance, analysts are finally shifting from a “slow growth” to a “mild recession” view.

The problem, however, is that analysts are almost always overly optimistic. Therefore, the risk of a recession becoming “worse than expected” is a rising probability.

Such is the case given U.S. inflationary pressures and crushingly high energy prices in the Eurozone. Given the global linkages in supply chains, consumption, and production, a deeper recession in the Eurozone will add to the domestic downturn, leading to a policy mistake.

Such was a point recently by Paul La Monica via CNN Business:

“The big problem facing the Fed: The economy still seems to be running too hot for its taste. Inflation is undoubtedly a major problem, but the job market is strong, consumers are still spending at a healthy clip, and housing prices remain high despite a substantial spike in mortgage rates.

‘This data will likely encourage the Fed to continue staying in overdrive but also increases the odds that sooner or later they will make a policy mistake by tightening financial conditions too much to fight inflation,’ said Timothy Chubb, chief investment officer at Girard, in a report.

In other words, the Fed’s rate hikes could ultimately lead to the economy cooling off more than the central bank would like.”

In other words, a “mild recession” in the U.S. could be much worse.

Downgrades To Come

The problem for the Fed, and Wall Street economists and analysts, is they make assessments based on lagging economic data like employment. Yes, employment was strong last month, but as shown below, that data has a historical tendency to reverse sharply.

Fed Rate Hikes and Unemployment

Furthermore, that type of data is also regularly subject to extensive negative revisions in the future. The other problem is that monetary policy has a 9-12 month lag effect. As noted previously:

As the Fed continues to hike rates, each hike takes roughly 9-months to work its way through the economic system. Therefore, the rate hikes from March 2020 won’t show up in the economic data until December. Likewise, the Fed’s subsequent and more aggressive rate hikes won’t be fully reflected in the economic data until early to mid-2023. As the Fed hikes at subsequent meetings, those hikes will continue to compound their effect on a highly leveraged consumer with little savings through higher living costs.

Given the Fed manages monetary policy in the “rear view” mirror, more real-time economic data suggests the economy is rapidly moving from economic slowdown toward recession.”

The Economic Output Composite Index (EOCI) is a comprehensive measure of the overall economy. The EOCI index contains more than 100 leading and lagging economic data points covering the economy’s manufacturing and service sectors. Some data points included are the ISM surveys, Chicago PMI, CFNAI, Fed regional surveys, the NFIB survey, and the Leading Economic Index. Not surprisingly, the EOCI composite index has a very high correlation with economic growth, and readings below 30 indicate recessions. With the EOCI index currently below 32, the risk of a recession is rising.

Economic composite index vs GDP

As the economic data continues to weaken, we are seeing analysts slashing earlier estimates of solid growth at the beginning of the year to slow growth in the second quarter, and now a “mild recession.” To wit:

“On its own, the higher rates path and lower growth trajectory imply higher odds of a recession, although the increase in recession risk is partially offset by an improving outlook for goods inflation and recent declines in inflation expectations that lower the chances that the Fed will hike aggressively enough to cause a recession. In addition, strong household balance sheets and an improving outlook for real income limit the odds that the economy will slip into a recession in the near-term and are part of the reason why we expect that any post-covid US recession would likely be mild. Nevertheless, on net we see somewhat higher risks of a recession following our forecast changes, and are therefore raising our odds of a recession in the next 12 months to 35%.” – Goldman Sachs

The problem with Goldman Sachs’s comments is that the average American household balance sheet is anything but strong. As we showed just recently:

Debt used to maintain living standard

In other words, the coming recession will likely not be a “mild one.”

Earnings Recession To Follow

Why is this important from an investment view?

As discussed recently, the estimated earnings for the S&P 500 companies remain highly elevated. Such gives a false sense of security to investors looking at “forward valuations,” assuming stocks are fairly priced. In reality, most companies in the index remain overvalued despite the price decline in 2022.

“Despite the recent downward revisions, the current estimates still exceed the historical 6% exponential growth trend, which contained earnings growth since 1950, by one of the most significant deviations ever. The only two previous periods with similar deviations are the ‘Financial Crisis’ and the ‘’ bubble.

Earnings deviation from growth trend.

More significant about that analysis is that earnings estimates DO NOT SURVIVE recessionary drags in the economy. As shown, the composite economic index (EOCI) is already signaling that earnings will decline further as the economy slows. The deeper the recession, the deeper the earnings decline will be.

Economic composite index vs earnings

The “forward” earnings estimate annual change also suggests even a “mild recession” will push estimates substantially lower. During every previous recessionary period since the turn of the century, forward estimates declined to a negative 20% annual rate of change.

Annual rate of change in earnings vs market

Given that the whole point of the Fed hiking rates is to slow economic growth, thereby reducing inflation, the risk of a recession remains elevated. Unfortunately, with the economy slowing, as higher interest rates and prices weigh on consumers, additional tightening could exacerbate the risk of a recession.

Therein lies the risk. Since earnings remain correlated to economic growth, earnings decline as rate hikes ensue. Such is especially the case in more aggressive campaigns. Therefore, market prices have likely not discounted earnings enough to accommodate a further decline.

Earnings and Fed funds

In other words, “fair value” for the market could still be substantially lower.

Navigating The Recession

From our perspective, the risk of deeper recession remains elevated, particularly as the Fed aggressively hikes rates.

While there is always a possibility that the economy could avoid a “recession,” those odds are slim at best. Therefore, as investors, we should at least prepare for a storm and then cross our fingers and hope for the best. The guidelines are simplistic but ultimately effective.

  1. Raise cash levels in portfolios
  2. Reduce equity risk, particularly in high beta growth areas.
  3. Add or increase the duration in bond allocations which tend to offset risk during quantitative tightening cycles.
  4. Reduce exposure to commodities and inflation plays as economic growth slows.

If a recession occurs, the preparation will allow you to survive the impact. Protecting capital from the inherent destruction will mean less time spent getting back to even after the storm passes.

Alternatively, it is relatively straightforward to reallocate funds to equity risk if we avoid a recession or if the Fed does revert to monetary accommodation.

Investing during a recession is difficult. However, you can take some steps to ensure that increased volatility is survivable.

  • Have excess emergency savings so you are not “forced” to sell during a decline to meet obligations.
  • Extend your time horizon to 5-7 years, as buying distressed stocks can get more distressed.
  • Don’t obsessively check your portfolio.
  • Consider tax-loss harvesting (selling stocks at a loss) to offset those losses against future gains.
  • Stick to your investing discipline regardless of what happens.

While the media tries to pick the next market bottom, it is better to let the market show you. You will be late, but you will have confirmation the selling is over.

If I am correct, the recession could be worse than expected, and prices will decline further.

Bank of England Cries Uncle

Just days after raising interest rates and starting QT, the Bank of England is taking aggressive actions to halt the recent surge in UK bond (Gilts) yields. As we show below, the yield on 10-year gilts has risen by over 2% in just the last two months. On Wednesday morning, the Bank of England cried uncle. It announced an emergency measure to temporarily buy long-dated gilts to attempt to stop yields from rising further. Simply, the bank is scared of financial instability. “To achieve this (financial stability), the Bank will carry out temporary purchases of long-dated UK government bonds from September 28.” Within the same statement, the Bank of England affirmed that its annual QT target of reducing its balance sheet by 80 billion is “unaffected and unchanged.”

Quite simply, the Bank of England will be conducting QE and QT simultaneously. Desperate times call for desperate measures!

bank of england gilt yields

What To Watch Today


  • 8:30 a.m. ET: Initial Jobless Claims, week ended Sept. 24 (215,000 expected, 213,000 prior)
  • 8:30 a.m. ET: Continuing Claims, week ended Sept. 17 (1.385 million prior)
  • 8:30 a.m. ET: GDP Annualized, quarter-over-quarter, 2Q third (-0.6% expected, -0.6% prior)
  • 8:30 a.m. ET: Personal Consumption, quarter-over-quarter, 2Q third (1.5% expected, 1.5% prior)
  • 8:30 a.m. ET: GDP Price Index, quarter-over-quarter, 2Q third (8.9% expected, 8.9% prior)
  • 8:30 a.m. ET: Core PCE, quarter-over-quarter, 2Q third (4.4% expected, 4.4% prior)



Market Trading Update

The markets were set to struggle at the open yesterday until the Bank of England reversed QT and stepped in to rescue both pension funds facing margin calls but a massive number of variable rate mortgages on the verge of repricing. As is always the case, “market instability” is a far more insidious risk than inflation, and the Central Banks will come to the rescue.

As such, pretty much everything rallied sharply yesterday, helping the markets hold key support. This is probably the beginning of that counter-trend rally we expected, and some follow-through is needed to confirm. The initial target will be approaching the 50-dma with the 3900-4000 level on the S&P 500 index. If the MACD turns onto a bullish buy signal, given the extreme negativity in the market, a rally could go further. However, we suggest using that rally to raise cash and reduce risk as we are likely facing another leg down before this bear market is over.


Apple Cuts iPhone Production

Apple stock traded lower yesterday after announcing it is backing off plans to increase iPhone production due to weaker than expected demand. While the news appears bad, Morgan Stanley thinks it is “more bark than bite.”

suggests that the upside from better-than-expected iPhone 14 Pro/Pro Max demand is likely being offset by weaker initial iPhone 14/14 Plus demand. ..does not imply any downside to our iPhone shipment forecasts. – Morgan Stanley

Demand for its higher-priced new iPhone 14 Pro line is better than its entry-level versions. Our take- inflation is taking its toll on demand for cheaper phones as lower and middle-class consumers are struggling. At the same time, many of Apple’s wealthier clients are still in good shape.

apple morgan stanley

Stocks vs. Bonds- Volatility

The graph below is very telling. As it shows, the MOVE index is similar to the VIX, except it measures bond volatility. Bond volatility is approaching the high water mark from the initial shock of the pandemic. At the same time, stock volatility (VIX) is high but well below the pandemic highs and less than quite a few instances over the last two years. Typically, the correlation between the two indexes is strong. We must ask whether bond volatility will fall back in line with the VIX, or will equity market volatility play catch up to bonds? The graph argues an allocation toward bonds from stocks may be an intelligent rotation.

stocks vs bonds volatility

Corporate Profit Growth Will Slow

Yesterday we published Corporate Profit Growth Will Slow, Says the Fed. The article looks at corporate profits and profit margins. The article’s simple conclusion is that corporate profit growth will likely slow in the future. The article piggybacks on a Fed white paper that comes to the same conclusion. Per the Fed:

Over the past two decades, the corporate profits of stock market-listed firms have been substantially boosted by declining interest rate expenses and lower corporate tax rates. This note’s key finding is that the reduction in interest and tax expenses is responsible for a full one-third of all profit growth for S&P 500 nonfinancial firms over the prior two-decade period. I argue that the boost to corporate profits from lower interest and tax expenses is unlikely to continue, indicating notably lower profit growth, and thus stock returns, in the future.

In our article, we take the Fed analysis and dig deeper. One of the factors further affirming the Fed view is rising labor costs. Therefore, as we share below, labor costs as a share of profits are set to rise from 50-year lows as de-globalization and less friendly immigration laws make labor more expensive.

The graph below shows that from 1970 to 2000, wages accounted for almost 100% of corporate profits. Over the last twenty years, they averaged 77%.

corporate labor costs versus profit

The summary from the Fed paper:

The overall conclusion, then, is that—with the expected slowdown profit growth and the associated contraction in P/E multiples—real longer-run stock returns are likely to be notably lower than in the past.

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Stocks or Bonds?

Many investors are frequently reallocating their holdings between stocks and bonds. This year, figuring out the correct ratio of stocks to bonds has been difficult as both have performed similarly poorly. While it is tempting to assume that stocks will outperform bonds as they tend to do over longer periods, the graph below from Pervalle Global provides insight into the relative performance we should expect between stocks and bonds over the next two years.

The graph compares the return of the price ratio of SPY to TLT versus the average of the S&P 500 dividend yield and earnings yield less the thirty-year US Treasury yield. If the correlation holds, TLT may significantly outperform SPY over the coming year.

Per the chart creator, Teddy Vallee: “The regression implies a negative return for stocks relative to bonds 2 years out.

stocks or bonds vallee

What To Watch Today


  • 7:00 a.m. ET: MBA Mortgage Applications, week ended Sept. 23 (3.8% prior)
  • 8:30 a.m. ET: ​​Advance Goods Trade Balance, August (-$89.0 billion expected, -$89.1 billion prior)
  • 8:30 a.m. ET: ​​Wholesale Inventories, month-over-month, August preliminary (0.4% expected, 0.6% prior)
  • 8:30 a.m. ET: ​​Retail Inventories, month-over-month, August (1.0% expected, 1.1% prior)
  • 10:00 a.m. ET: ​​Pending Home Sales, month-over-month, August (-1.5% expected, -1.0% prior)
  • 10:00 a.m. ET: ​​Pending Home Sales NSA, year-over-year, August (-24.5% prior)


Market Trading Update

The market tried to rally yesterday morning until St. Louis Fed President, James Bullard, reiterated the Fed’s “hawkish stance” of combatting inflation at all costs. That language sucked the air out of the stock and bond rally, sending yields up and stocks down. Currently, the market is holding support at the June lows and is extremely oversold, pushing well into 3 standard deviations below the 50-dma. As yesterday’s blog post noted, the setup for a relatively strong “short squeeze” is in place. Use that rally to reduce risk and raise cash accordingly.

Et Tu China Yuan?

We have been focusing on the rapid depreciation of the British pound, euro, and Japanese yen over the past few months. There is another currency in similar shoes as those well-followed currencies. The Chinese yuan, as shown below, has been depreciating versus the dollar. The yuan now sits at similar levels as its peaks in 2019 and March 2020. Before those peaks, one has to go back to 2008 to find similar levels.

The strong dollar means China must weaken its currency to avoid the yuan appreciating in line with the dollar. Doing so makes its products more expensive for foreign nations. As a substantial exporting nation, it must be careful to retain its pricing edge. While trying to stay competitive by weakening the yuan, such actions spark fears that capital will leave China to avoid depreciation. Accordingly, capital outflows can build on themselves and leave the Chinese government in a precarious position.

china yuan

Bank Risk Rising

Yesterday’s Commentary showed how CDS (credit default swaps) rates are rising for the United Kingdom. A UK default is not likely. However, investors are hedging bets against such an event. It’s not just the UK or other nations with rising CDS rates, as the graph below shows. In all six instances, the five-year CDS of the major banks and brokers are trading at their highest levels since the pandemic first broke out. The graphs below and the UK graph are not dire by any stretch, but they point to rising risks. Further, if they continue to increase, financial instability will become a concern for the Fed. As we wrote yesterday, the Fed considers financial stability their third mandate. It will do whatever it takes to provide ample liquidity to the financial markets and critical financial institutions well before a “Lehman moment” surfaces.

banks five year cds

Easing Housing Fears

Sam Ro of Yahoo put out an article with a few good graphs to help ease concerns that some similarities, like surging prices and higher mortgage rates that triggered the financial crisis, are occurring today. Per Sam:

First, lenders have been much more disciplined with their lending practices. According to New York Fed data, the vast majority of new mortgage loans in recent years have gone to prime borrowers with the highest credit scores.

housing credit scores

“Second, adjustable rate mortgages are nowhere near as popular as they were during the housing bubble. This means very few new buyers are vulnerable to interest rate volatility.”

housing adjustable rate mortgages

“Third, about 99% of outstanding mortgages have a locked-in rate that’s lower than the current market rate, according to Goldman Sachs analysts. In other words, the vast majority of homeowners are not materially affected by rising mortgage rates.”

housing pmms

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Corporate Profit Growth Will Slow, Says the Fed

Michael Smolyansky, a senior Fed economist, claims corporate profit growth will slow appreciably. His case rests on corporate tax rates and interest rates. Access to his white paper, The coming long-run slowdown in corporate profit growth and stock returns, can be found HERE.

As if his case was not strong enough, we provide other supporting evidence, including the newfound leverage of employees and labor unions, deglobalization, and long-term economic growth trends.

In the long run, stock prices and returns have a fundamental anchor in the cash flows that companies ultimately provide investors. If profits grow slower than expected, stock return projections must be recalibrated.

Summary of the Fed’s Article

Michael Smolyansky leads his article with the following paragraph:

Over the past two decades, the corporate profits of stock market-listed firms have been substantially boosted by declining interest rate expenses and lower corporate tax rates. This note’s key finding is that the reduction in interest and tax expenses is responsible for a full one-third of all profit growth for S&P 500 nonfinancial firms over the prior two-decade period. I argue that the boost to corporate profits from lower interest and tax expenses is unlikely to continue, indicating notably lower profit growth, and thus stock returns, in the future.

He presents the following graphs to support his case.

interest and taxes
corporate taxes
corporate taxes

His theory is simple. Low-interest rates and corporate tax rate reductions significantly boosted corporate earnings growth. Further amplifying the abovementioned factors, financial leverage has risen over the past 15 years, as shown below.

corporate leverage
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In the following graph, he dissects earnings to show how lower taxes, interest rates, and more leverage boosted corporate profit growth. The critical takeaway is that GDP and sales, the sustainable driver of profits, have only been growing by about 2% annually over the last 15 years. Corporate profit growth would have been minimal without the three factors above driving double-digit growth.

corporate profits

Margin Growth

Michael argues that lower interest rates and tax rates boosted profit margins, resulting in earnings growth beyond what the economy dictates.

Can profit margins stay at current levels or expand?

The graph below is a proxy for margins. It calculates an aggregate corporate profit margin based on nonfinancial corporate profits divided by nominal GDP.

corporate margin proxy

Our margin proxy has risen by approximately 3% over the last 20 years.

In addition to corporate taxes and interest rates, corporate margins also benefitted from beneficial trends in labor costs and globalization. Both may work against margins in the future.

Below, Kailash Concepts provides longer-term perspectives on profit margins. The last time margins were as high as current levels were in 1929.

kailash corporate margins

Per Kailash:

We have watched as corporate investors feasted on a record amount of the pie for nearly 10 straight years.

Over that horizon, we have seen social discord in this country unlike any time we can recall. The Financial Times recently reported that “More than a third of Republicans and Democrats today believe violence is justified to achieve their political ends.” Nobody can predict the future, but this hardly seems to be a backdrop to sustain profit margins last seen in 1929.


Labor costs

Outsourcing and friendly immigration policies allowed companies to reduce domestic labor costs by increasingly relying on foreign labor at much cheaper wages. The graph below shows that from 1970 to 2000, wages accounted for almost 100% of corporate profits. Over the last twenty years, they averaged 77%.

labor share of profits

The recently averted rail workers’ strike and the employee-friendly settlement is just one of many recent events that suggest employees and their unions are gaining leverage over their employers.

The friendly settlement is a result of extremely tight labor markets. For instance, the number of job openings is over 11 million, almost three times the average from 2000-20019. With an unemployment rate near 50-year lows, filling many of these jobs will be difficult.

labor job openings

The labor tightness will diminish as the economy continues to normalize from the pandemic shock. Further economic weakness will speed up the process.

However, even if the current labor market tightness vanishes, other longer-term macro trends will likely weigh on corporate profits.

Deglobalization and “insourcing” or “friend sourcing” of production will inevitably raise wage expenses. The days of outsourcing to the country with the cheapest labor costs may be over. Domestic labor costs are much higher than in the rest of the world. Sourcing labor to allies may be cheaper but still more expensive than it has been. 

Further, stricter immigration policies make cheap labor from new immigrants less available.

Labor market tightness, deglobalization, and immigration trends lead us to believe that employees are finally gaining the upper hand after years of being expendable.

GDP Trends

Earlier, we wrote:

The critical takeaway is that GDP and sales, the sustainable driver of profits, have only been growing by about 2% annually over the last 15 years.

If interest rates and corporate tax rates remain steady or rise in the future, labor demands a bigger share of profits, and deglobalization weighs on profits, margins will shrink.

Sales are directly linked to the economy. Therefore, to estimate corporate profit growth, what can we expect from the economy? The graph below helps answer the question. It shows GDP has been trending lower for the last 70 years. The trend will likely continue, given increasing amounts of non-productive debt, slowing productivity growth, and weakening demographic trends.

gdp trend


Michael Smolyansky makes a great case that recent boosts to profit margins are likely to give way. We add to this theory with compelling arguments that higher labor costs, deglobalization, and weakening GDP growth will also limit corporate profit growth.

Since we piggyback on Michael’s theory, we let him have the final word.

The overall conclusion, then, is that—with the expected slowdown profit growth and the associated contraction in P/E multiples—real longer-run stock returns are likely to be notably lower than in the past.

FX Volatility Threatens The Fed’s Plans

The British Pound (GBP) opened trading on Sunday night at 1.08. Within the first hour of trading, the GBP hit a low of 1.04. While a 4% decline may not seem like much to stock traders, FX volatility of that magnitude is extremely rare. The graph below shows Monday’s opening bashing. Statistically, such FX volatility (6.29 standard deviations) should occur once every 500 million trading days.

FX markets are seeing high levels of volatility in recent months as dollar appreciation is gaining momentum. The Fed intends to keep raising rates and doing QT to arrest inflation. However, their plans may be interrupted if they cannot calm FX volatility. While Congress mandates the Fed use policy for maximum employment and price stability, they have self-proclaimed that avoiding financial instability is their third mandate. FX volatility, the likes of which we are experiencing with increasing frequency, may get the Fed to rethink its hawkish plans.

uk gbp

What To Watch Today


  • 8:30 a.m. ET: Durable goods orders, August preliminary (-0.3% expected, -0.1% prior)
  • 8:30 a.m. ET: Durables excluding transportation, August preliminary (0.2% expected, 0.2% prior)
  • 8:30 a.m. ET: Non-defense capital goods orders excluding aircraft, August preliminary (0.2% expected, 0.3% prior)
  • 8:30 a.m. ET: Non-defense capital goods shipments excluding aircraft, August prelim(0.3% expected, 0.5% prior)
  • 9:00 a.m. ET: FHFA Housing Pricing Index, July (0.0% expected, 0.1% prior)
  • 9:00 a.m. ET: Case-Shiller 20-City Composite, month-over-month, July (0.20% expected, 0.44% prior)
  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite, year-over-year, July (17.10% expected, 18.65% prior)
  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller U.S. National Home Price Index (17.96% prior)
  • 10:00 a.m. ET: Conference Board Consumer Confidence, September (104.5 expected, 103.2 prior)
  • 10:00 a.m. ET: Conference Board Present Situation, September (145.4 prior)
  • 10:00 a.m. ET: Conference Board Expectations, September (75.1 prior)
  • 10:00 a.m. ET: Richmond Fed Manufacturing Index, September (-10 expected, -8 prior)
  • 10:00 a.m. ET: New Home Sales, August (500,000 expected, 500,000 prior)
  • 10:00 a.m. ET: New Home Sales, month-over-month, August (-2.2% expected, -12.6% prior)


Market Trading Update

The market started out yesterday with a rally to the upside, but such was short-lived as the U.S. dollar exploded higher amidst global foreign exchange (FX) volatility. As discussed in yesterday’s 3-Minutes Video, the market is now standard deviations below the 50-dma, and, as noted below, every sector and market is oversold. Such conditions do not last long, and a fairly strong reflexive rally is likely. Use that rally to reduce equity risk and raise cash.

The long-dollar, short-bond trade is now extremely stretched. If you are looking for a place to invest capital, a bet on an unwind of that trade is a high probability outcome over the next 3 months or so.

Technical Analysis Calls for a Bounce- Can we Trust it?

In this past weekend’s Newsletter, No Pivot on the Horizon, we shared the graph below. As it shows, all S&P 500 sectors are grossly oversold. The second graph is from our proprietary technical model. It uses 13 technical gauges to arrive at a technical score. Often a score near -.75 signals grossly oversold conditions. Currently, all but two sectors signal such a condition. In typical markets, we would consider a relief rally or oversold bounce is probable. However, remember that the most significant past declines have come from very oversold levels. Trade with caution; these markets are challenging.

overbought over sold

Most Bearish Market in 13 Years

The graph below from Sentimentrader shows that the AAII individual investor survey reports that 60% of its respondents are bearish. Such a high level is on par with the bear market bottoms of 2009 and the early 90s. Investors were not this bearish in 2020 or in June when markets were last at current levels. The commentary above the graph is courtesy of Callum Thomas.

aaii survey

More than 33 million puts traded last Friday. That marks the highest single day of put volume since data was first collected about 30 years ago. The second graph shows the equity put-call ratio is also trading near extreme levels. The ratio measures the number of put options trading versus the number of call options. Lastly, the third graph measures the price premium investors are paying for puts versus calls. Like the information above, Friday’s trading activity marks extreme bearishness and possibly capitulation.

bearish put volumes
bearish put call ratio
bearish put call premium

UK CDS Warns

CDS or credit default swaps are financial derivatives that allow participants to buy or sell insurance on the bankruptcy of a corporation or country. The swap is quoted in the annual percentage rate (bps) a buyer of insurance must pay annually. The graph below shows that a 5-year CDS contract on the UK spiked over the last month from 10bps to 35bps. While 35bps is very low, the surge in CDS, and recent FX volatility is worth paying attention to. The UK is not going bankrupt, but investors are showing worrying signs that financial instability is rising.

uk cds

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The Big Short Squeeze Is Coming

The latest rate hike announcement by the Fed sent stocks tumbling to the year’s lows. While last week’s market action was brutal, the good news is the markets are set up for a rather significant short squeeze higher.

It is quite likely the Fed has already tightened more than the economy can withstand. However, given the lag time of policy changes to show up in the data, we won’t know for sure for several more months. However, with the Fed removing liquidity from the markets at a most aggressive pace, the risk of a policy mistake is higher than most appreciate. I added some annotations to a recent graphic from Chartr.

, No Pivot On The Horizon As Fed Hikes 75bps

With the Fed now hiking rates, seemingly intent on doing so at every meeting in 2022, has the correction priced in the “bad news?”

The issue, of course, is that we never know where we are within the current cycle until it is often too late. An excellent example is 2008, as I discussed recently in “Recession Risk.”

The problem with making an assessment about the state of the economy today, based on current data points, is that these numbers are only ‘best guesses.’ Economic data is subject to substantive negative revisions as data gets collected and adjusted over the forthcoming 12- and 36-months.

Consider for a minute that in January 2008 Chairman Bernanke stated:

‘The Federal Reserve is not currently forecasting a recession.’

In hindsight, the NBER, in December 2008, dated the start of the official recession was December 2007.”

A Historical Analog

I am NOT a fan of market analogs because it is simplistic to “cherry-pick” starting and ending dates to get periods to align. However, I am going to do it anyway to illustrate a point. The chart below aligns the current market to that of 2008.

2008 Analog

Notably, I am NOT suggesting we are about to enter a significant bear market.

I want to point out that in the first half of 2008, despite the collapse of Bear Stearns, the mainstream media did not foresee a recession or bear market coming. The mainstream advice was to “buy the dip” based on views that there was “no recession in sight” and that “subprime debt was contained.”

Unfortunately, there was a recession and a bear market, and there was NO containment of subprime mortgages.

However, even if a deeper bear market is coming, a “short squeeze” can allow investors to reduce the risk more gracefully.

Investor Sentiment Is So Bearish – It’s Bullish

Once again, investor sentiment has become so bearish that it’s bullish.

As we have often discussed, one of the investors’ most significant challenges is going “against” the prevailing market “herd bias.” However, historically speaking, contrarian investing often proves to provide an advantage. One of the most famous contrarian investors is Howard Marks, who once stated:

Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, particularly when momentum invariably makes pro-cyclical actions look correct for a while.

Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it’s challenging to be a lonely contrarian.”

Currently, everyone is once again bearish. CNBC is again streaming “Markets In Turmoil” banners, and individuals are running for cover. Our composite investor sentiment index is back to near “Financial Crisis” lows.

Net bullish sentiment

We agree investors should be more cautious in their portfolio allocations. However, such is a point where investors make the most mistakes. Emotions make them want to sell. However, from a contrarian view, such is the time you need to avoid that impulse.

While many investors have never witnessed a “bear market,” the current market volatility is not surprising. As we discussed previously, Hyman Minsky argued that financial markets have inherent instability. As we saw in 2020-2021, asymmetric risks rise in market speculation during an abnormally long bullish cycle. That speculation eventually results in market instability and collapse.

We can visualize these periods of “instability” by examining the daily price swings of the S&P 500 index. Note that long periods of “stability” with regularity lead to “instability.”

Periods of low volatility vs high volatility

The markets could and possibly will fall further in the coming months as the Fed most likely makes a “policy mistake,” such doesn’t preclude a rather sharp “short squeeze” that investors can use to rebalance risks. Such is just part of the increased market volatility we will likely deal with for the rest of this year.

A Short Squeeze Setup

Currently, everybody is bearish. Not just in terms of “investor sentiment” but also in “positioning.” As shown, professional investors (as represented by the NAAIM index) are currently back to more bearish levels of exposure. Notably, when the level of exposure by professionals falls below 40, such typically denotes short-term market bottoms.

NAAIM index sentiment

Another historically good indicator of extreme bearishness is the CBOE put-call ratio. Spikes in the put-call ratio historically note a surge in bearish positioning. Previous spikes in the put-call ratio have aligned with at least short-term market lows, if not bear market bottoms. The current surge in the bearish positioning suggests the markets could be setting a short-term low, particularly when a short squeeze occurs.

Put Call Ratio vs Market

Lastly, the number of stocks with “bullish buy signals” is also plumbing extremely low levels. Like positioning and the put-call ratio, the bullish percent index suggests stocks have seen rather extreme liquidations. Such low levels of stocks on bullish buy signals remains a historically reliable contrarian buy signal.

Bullish percent index vs market

As shown, when levels of negativity have reached or exceeded current levels, such has historically been associated with short- to intermediate-term market bottoms.

However, there are two critical points to note:

  1. During bull markets, negative sentiment was a clear buying opportunity for the ongoing bullish trend.
  2. During bear markets (2008), negative sentiment provided very small opportunities to reduce risk before further declines.

Such raises the question of what to do next, assuming a bear market is in full swing.

Navigating A Reflexive Rally

As Bob Farrell’s rule number-9 states:

When all the experts and forecasts agree – something else is going to happen.

As a contrarian investor, excesses get built when everyone is on the same side of the trade. 

Everyone is so bearish that the reflexive trade will be rapid when sentiment shifts.

There are plenty of reasons to be very concerned about the market over the next few months. We will use rallies to reduce equity exposure and hedge risks accordingly.

  1. Move slowly. There is no rush to make dramatic changes. Doing anything in a moment of “panic” tends to be the wrong thing.
  2. If you are overweight equities, DO NOT try and fully adjust your portfolio to your target allocation in one move. Again, after significant declines, individuals feel like they “must” do something. Think logically above where you want to be and use the rally to adjust to that level.
  3. Begin by selling laggards and losers. These positions were dragging on performance as the market rose, and they led on the way down.
  4. Add to sectors, or positions, that are performing with or outperforming the broader market if you need risk exposure.
  5. Move “stop-loss” levels up to recent lows for each position. Managing a portfolio without “stop-loss” levels is like driving with your eyes closed.
  6. Be prepared to sell into the rally and reduce overall portfolio risk. There are many positions you will sell at a loss simply because you overpaid for them to begin with. Selling at a loss DOES NOT make you a loser. It just means you made a mistake.
  7. If none of this makes sense to you, please consider hiring someone to manage your portfolio. It will be worth the additional expense over the long term.

Follow your process.

A “short squeeze” is coming, but we aren’t out of the woods yet.

Dollar Strength Leading to Investor Pain

Why are stocks, bonds, and commodities tumbling? To answer, one only needs to look at one price. The recent strength of the U.S. dollar is pushing most other risk assets lower. For instance, the table below shows the markets that investors woke up to on Friday morning. The U.S. dollar index was higher by almost one dollar, and virtually every asset was red. Dollar strength is occurring in part because the Fed is much more aggressive than all other nations about fighting inflation. Importantly, dollar strength is feeding on itself. As the dollar rises, bond yields are following higher. The result is that U.S. bonds attract foreign money, which must sell their current currency to buy dollars.

Further fueling U.S. dollar strength, many foreign entities borrow in dollars. As dollar appreciation occurs, their ability to repay in dollars becomes more costly, requiring more dollars to satisfy interest and principal requirements. It’s also worth adding rapid dollar appreciation can lead to global financial instability and weaker earnings for U.S. companies. The dollar spiral higher may continue. However, the world’s central banks closely monitor the U.S. dollar and will likely react powerfully. Such may lead to a robust risk-on rally, but there is no telling how much longer the U.S. dollar will appreciate first.

dollar bonds stocks futures

What To Watch Today


  • 8:30 a.m. ET: Chicago Fed National Activity Index, August (0.27 prior)
  • 10:30 a.m. ET: Dallas Fed Manufacturing Activity Index, September (-12.0 expected, -12.9 prior)


  • No notable earnings releases today

Market Trading Update

It was a tough week for equities as the Fed hiked 75bps and signaled that “no pivot” in policy is coming. Such disappointed the markets in desperate need of some “encouraging news,” but none was to be had. Furthermore, the Fed slashed economic growth drastically, upped their unemployment projections, and kept inflation expectations elevated through 2023. The dollar strength is also exacerbating issues.

Markets broke through support and tested this year’s lows on Friday as selling was broad-based. The market is now figuring out the rising risk of a policy mistake. On Friday, Goldman Sachs slashed their year-end price targets for the S&P 500 index. The “hard landing” scenario was most important.

In a recession, we forecast earnings will fall and the yield gap will widen, pushing the index to a trough of 3150. Our economists assign a 35% probability of recession in the next 12 months and note that any recession would likely be mild given the lack of major financial imbalances in the economy. As we previously outlined, in the event of a moderate recession, our top-down model indicates EPS would fall by 11% to $200.

For context, a 34% peak-to-trough decline in the S&P 500 index during a recession would only be slightly worse than the historical average of 30%. We see two risks that would create a more dramatic sell-off in equities during a recession. First, if inflation concerns were to limit the degree of monetary or fiscal policy support and interest rates did not fall, it could lead to even lower valuations or even larger economic and earnings growth declines than we model. Second, concentrated sector weakness, such as Information Technology in 2001 and Financials in 2008, could lead to an even sharper earnings and price decline.

Market drawdowns and recessions

While Goldman is finally coming to grips with economic and fundamental realities, its expectations for only modest earnings and margin decline are still exuberant. As we discussed recently, earnings will likely revert to below $200/share just to reach the median long-term growth trend.

“More importantly, despite the recent downward revisions, the current estimates still exceed the historical 6% exponential growth trend, which contained earnings growth since 1950, by one of the most significant deviations ever.

Earnings estimates

Such leaves the markets in a very tenuous position. However, in the short-term, markets are testing this year’s lows and are sufficiently oversold to provide a relief rally. However, there is little to get excited about until the Fed stops hiking rates aggressively and reducing its balance sheet. We will cut equity exposure levels on the next rally and raise cash levels further. Keep a watch on the MACD signal (top of the chart), as it will provide the best guidance for a sellable rally near term. There is a lot of congestion at the 3900-4000 level, which will provide sufficient resistance to cap a reflexive rally. Those levels provide a reasonable “sell” target for now.

market trading update

The Week Ahead

A decent amount of economic data is spread throughout the week, but Friday will likely be the most important day. The PCE price index is the Fed’s preferred inflation gauge. Analysts expect it to show a 0.1% and a year-over-year inflation rate of 6.2%. The more critical core index should rise from 4.6% to 4.7%. Investors will also focus on other inflation indicators this week, such as Chicago PMI, University of Michigan inflation expectations, and the Dallas, Richmond, and Chicago Fed manufacturing indexes.

As we have noted, over a third of CPI is from the housing sector. The Case-Shiller Home Price index will come out tomorrow. Expectations are for a 0.2% increase but a decline in the annual index from 16.2% to 15%.

This Friday will be the last trading day for the quarter. Therefore we may see window dressing trades add to the recent spate of equity volatility.

Is The Fed Trapped?

Over the last few months, we have discussed how this instance of fighting inflation is far different from that of the 70s and 80s. This time, the Fed must deal with excessive leverage in the public and private sectors. As such, raising interest rates is a much more powerful tool, but it also presents much more economic and financial damage if rates rise too much. Below are a couple of quotes from articles Michael and Lance put out last week on the topic.

Restrictive policy, including double-digit interest rates, quelled Volcker’s high inflation regime. This time that anecdote is not feasible. Unlike the 70s and early 80s, when debt levels were low and equity valuations cheap, today’s economic and financial environments are the opposite.

Today’s economy relies heavily on debt for consumption and to roll over maturing debt and avoid bankruptcy. High-interest rates will be exponentially more damaging than they were forty years ago.Tail Risk and Persistent Inflation – Michael Lebowitz

The reason that slowing economic growth, and killing inflation, is critical for the Fed is due to the massive amount of leverage in the economy. If inflation remains high, interest rates will adjust, triggering a debt crisis as servicing requirements increase and defaults rise. Historically, such events led to a recession at best and a financial crisis at worst. Debt & Why The Fed is Trapped – Lance Roberts

fed inflation trap

The Fed Is Hiking At A Record Pace

“This week, the Federal Reserve signed off on its third consecutive three-quarter point rate hike, lifting the benchmark federal funds rate to a range of 3-3.25%.

That’s an unprecedented pace of rate rises in modern history, signaling the Fed’s strong resolve to get double-digit inflation under control. No other hiking cycle has started this steeply since the Fed started targeting the Effective Funds Rate in the 1980s.

Unlike when it first appeared on your lockdown dating profile, the Fed’s new-found fondness for hiking looks here to stay. Officials project that rate rises will continue into 2023, with estimates that the target rate will hit around 4.6% by the end of next year. Equity investors were surprised again by this week’s news, with US stocks down another 3% since Monday.”
– Chartr

Annotations to chart added by Real Investment Advice

Fannie Mae’s Housing and Mortgage Outlook

The table below shows Fannie Mae’s latest monthly update and forecast on the housing market and mortgage rates. Since its last update a month ago, there have been significant revisions. For instance, they revised lower home sales. In August, Total home sales were expected to fall by 16.2% and 10.3% this year and next year. In just one month, they revised both figures lower by 1% and 2.5%, respectively. The downgrade is likely in large part due to their outlook on mortgage rates. Fannie Mae expects mortgage rates to average 5% this year and 5.6% in 2023. Current mortgage rates are near 6.50%.

fannie mae mortgage

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How Could Inflation Impact Corporate Retirement Plans?

Increasing prices may put pressure on employers and delay workers from retiring

Inflation is the increase in the general price of goods and services, which can decrease the purchasing power of American workers. So how does this recent upward trend affect your workplace benefits, employees and retirement plan?

Salaries, Flexibility and Savings

When inflation goes up, the same paycheck doesn’t stretch as far. With the increased costs of food & beverage, transportation, housing, apparel, medical care, recreation, education & communication and other goods & services, your employees might not be able to afford the same lifestyle.

To maintain a similar standard of living, your employees may request salary increases and it might be more than the typical 2% raise (year-to-date salary increases have been more than 4%).
Other employers, however, are considering shortening the work week as opposed to a salary increase. Benefits like flexible schedules may be appreciated more than a raise.
Another employee benefit that is gaining interest is the emergency savings account. Sixty percent of employers said they are interested in offering emergency funds and 1 out of 4 employees said they’d consider a job change if a new employer offered this benefit.

Robbing Peter to Pay Paul

Increased costs may cause your employees to redirect funds designed to be saved for retirement. Whether it is reducing their current retirement deferrals and/or an increase in loan requests, it may be a way to keep up with the rise of inflation.

Delaying Retirement

Starting this year, all participants will receive a statement that includes a monthly income projection. The income illustration will be based on their retirement savings and lifetime payout assumptions. But what happens when those numbers are much lower than anticipated?

For older employees, they may feel additional savings worries, inflation stress and they could potentially delay their exit from the workforce. It is projected that 79% of older generations will react negatively to their predicted monthly retirement income.

To prepare them, education is key. Emphasize the financial resources that come with your retirement plan, including our services and resources like participant infographics.

Hedging for Inflation

Companies and workers are likely to feel instability during this time of inflation-driven economic swing and may need extra support.

Here are some helpful solutions for your company’s retirement plan

● Explore portfolio diversification to include investments that may be correlated to inflation
● Consider a financial wellness program that educates employees on topics like inflation
● Get creative with contributions — 70% of workers support a 3% 401(k) contribution over a salary increase
● Stay in close contact with our team to track evolving trends

Here are suggestions for participants of all generations to keep retirement savings on track, despite inflation:

● Utilize budgets for each area of monthly spending
● Prioritize where extra funds are allocated
● Promote healthy savings habits because 9/10 employees believe their workplace retirement plan is one of the most important benefits
● Speak with a financial advisor to review current investments and goals

On the Horizon

To calm inflation fears, employers can provide financial wellness resources to help employees focus on their long-term financial objectives, which in turn can also improve retention rates and onboarding new hires.
Other benefits to consider include flexible work arrangements, remote work options, additional sick time and/or access to emergency savings so employees can concentrate on tInflation, unfortunately, is a part of our society and most likely will be a factor for the foreseeable future. Whether it’s high or low, a best practice is to continually explore ways of improving and protecting plan assets for your retirement plan and its participants.

How We Can Help

Employers, contact us to discuss how your plan can meet business goals and motivate employees to save more for retirement.

Reach out to us today to explore opportunities.

[1] Kropp, Brian, and Emily Rose McRae. “11 Trends That Will Shape Work in 2022 & Beyond.” Harvard Business Review, 13 Jan. 2022.

[2] Kropp, Brian, and Emily Rose McRae. “11 Trends That Will Shape Work in 2022 & Beyond.” Harvard Business Review, 13 Jan. 2022.

[3] Dhue, Stephanie. “No Emergency Savings? New Workplace Benefits Aim to Help.” CNBC, 7 Jan. 2022.

[4] Cohen, Josh. “Lifetime income illustrations: Preparing for participant reactions.” PGIM. Summer 2021.

[5] Chalk, Steff. “Retirement Planning Trends on the Horizon for 2022.” , 15 Dec. 2021.

[6] American Century Investments. “8th Annual Survey of Retirement Plan Participants.” 2020.

[7] American Century Investments. “8th Annual Survey of Retirement Plan Participants.” 2020.

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance or tax/legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation.

©401(k) Marketing, LLC. All rights reserved. Proprietary and confidential. Do not copy or distribute outside original intent.

Employees Want Paychecks for Life: Pros and Cons of Guaranteed Lifetime Income

Annuities and similar products may help address retirement readiness in an aging workforce

People are living longer, which means they may need their retirement savings to last decades. As a result, nearly half (48%) of participants are concerned about outliving their retirement savings. Many Americans don’t know how to transform their savings into retirement income.

Guaranteed income offerings can help ease this concern by providing consistent, predictable payments for life. Research shows a majority of 401(k) participants (75%) are “very” or “somewhat” interested in putting some or all of their savings into a guaranteed income option.

Employers are on board, too — 4 in 5 believe employees want guaranteed income products in their retirement plans. However, with new retirement strategies comes opportunities, uncertainty and risks. Here are some of the benefits and risks of in-plan guaranteed income.

What is Guaranteed Lifetime Income?

Think of it as a “paycheck for life.” Essentially, it is a retirement income strategy guaranteed every month once a 401(k) participant reaches retirement (generally speaking at 65 years old). These investment solutions are gaining in popularity because they are easy for employees to understand, which helps instill more confidence in their retirement outlook.

Retirement Income Hurdles

For decades, workplace plans have helped workers save, invest and accumulate as much as possible. Yet, few plans offered a decumulation strategy to provide a steady, predictable flow of retirement income.

Guaranteed income solutions aim to solve three primary participant concerns:

  1. Running out of money: The average American retiree could potentially outlive their savings by nearly 10 years. Guaranteed income products help address this risk by delivering a steady, predictable lifetime income stream.
  2. Reducing or eliminating early withdrawals: Taxes and penalties alone may not discourage participants from tapping into their retirement savings early. Guaranteed income products may be a deterrent, as pre-retirement withdrawals will notably reduce retirement income.
  3. Lacking flexibility: Guaranteed income options can be tailored to an individual’s needs, from the type of product to the way they receive payments, who is covered and for how long.

Key Benefits and Risks

As with any investment solution that has various pros and cons, guaranteed lifetime income is no different.

Advantages include

• Potential for increased retirement confidence because participants can more readily project their anticipated retirement income which can help them retire on time.
• Enhancing motivation and desire to save because participants will know their real monthly payouts, which may prompt them to save more proactively to reach their goals.
• It could help reduce employer healthcare costs since older employees may retire earlier and, thus, exit the health insurance plan.
• This strategy may improve your company’s competitiveness, boosting recruiting and retention.

Disadvantages include

• Each guaranteed income contract is different and the terms need to be clearly understood.
• Contracts may not be ported (moved from one employer to the next).
• Participants must elect guaranteed income far in advance of retirement; this decision typically cannot be reversed.
• Payouts may end when the participant dies.
• Participants may incur additional costs.

Your Fiduciary Role

The SECURE Act and pending SECURE Act 2.0 were designed to help Americans save for retirement; and while the law and pending update seek to improve our retirement system, it can be hard to decode. To boil it down, selecting a guaranteed income provider is still considered a fiduciary duty, so this should be done with care and diligence. Contact us for support.

Lifetime Income Illustrations

Another SECURE Act requirement goes into effect this year; lifetime income illustrations will begin appearing on participant statements. These projections may motivate your employees to save, or they could instill a sense of dread if the illustration paints a bleak picture. Either way, this may prompt some employees to knock on your door and ask questions about the company’s retirement plan.

How We Can Help

If you are curious about guaranteed income options or other ways to enhance your retirement plan, we can help. Whether you need plan assistance or help getting your employees on track toward retirement, we support our clients through every step of the journey.

[1] Nationwide Retirement Institute. “2021 In-Plan Lifetime Income survey.” Sept. 2021.

[2] Employee Benefit Research Institute. “2021 Retirement Confidence Survey.” June 2021.

[3] Nationwide Retirement Institute. “2021 In-Plan Lifetime Income survey.” Sept. 2021.

[4]World Economic Forum. “Investing in (and for) Our Future.” June 2019.

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance or tax/legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation.

©401(k) Marketing, LLC. All rights reserved. Proprietary and confidential. Do not copy or distribute outside original intent.

Debt & Why The Fed Is Trapped

The massive debt levels provide the single most significant risk and challenge to the Federal Reserve. It is also why the Fed is desperate to return inflation to low levels, even if it means weaker economic growth. Such was a point previously made by Jerome Powell:

“We need to act now, forthrightly, strongly as we have been doing. It is very important that inflation expectations remain anchored. What we hope to achieve is a period of growth below trend.”

That last sentence is the most important.

There are some important financial implications to below-trend economic growth. As we discussed in “The Coming Reversion To The Mean Of Economic Growth:”

“After the ‘Financial Crisis,’ the media buzzword became the ‘New Normal’ for what the post-crisis economy would like. It was a period of slower economic growth, weaker wages, and a decade of monetary interventions to keep the economy from slipping back into a recession.

Post the ‘Covid Crisis,’ we will begin to discuss the ‘New New Normal’ of continued stagnant wage growth, a weaker economy, and an ever-widening wealth gap. Social unrest is a direct byproduct of this “New New Normal,” as injustices between the rich and poor become increasingly evident.

If we are correct in assuming that PCE will revert to the mean as stimulus fades from the economy, then the ‘New New Normal’ of economic growth will be a new lower trend that fails to create widespread prosperity.”

As shown, economic growth trends are already falling short of both previous long-term growth trends. The Fed is now talking about slowing economic activity further in its inflation fight.

Markets, Markets Hold Support As Bulls Defy The Fed

The reason that slowing economic growth, and killing inflation, is critical for the Fed is due to the massive amount of leverage in the economy. If inflation remains high, interest rates will adjust, triggering a debt crisis as servicing requirements increase and defaults rise. Historically, such events led to a recession at best and a financial crisis at worst.

Treasury rates, total debt and inflation

The problem for the Fed is trying to “avoid” a recession while trying to kill inflation.

Recessions Are An Important Part Of The Cycle

Recessions are not a bad thing. They are a necessary part of the economic cycle and arguably a crucial one. Recessions remove the “excesses” built up during the expansion and “reset” the table for the next leg of economic growth. Without “recessions,” the build-up of excesses continues until something breaks.

In the current cycle, the Fed’s interventions and maintenance of low rates for more than a decade have allowed fundamentally weak companies to stay in business by taking on cheap debt for unproductive purposes like stock buybacks and dividends. Consumers have used low rates to expand consumption by taking on debt. The Government increased debts and deficits to record levels.

The assumption is that increased debt is not problematic as long as interest rates remain low. But therein lies the trap.

The Fed’s mentality of constant growth, with no tolerance for recession, has allowed this situation to inflate rather than allowing the natural order of the economy to perform its Darwinian function of “weeding out the weak.”

The chart below shows total economic system leverage versus GDP. It currently requires $4.82 of debt for each dollar of inflation-adjusted economic growth.

Total debt to GDP

More Debt Doesn’t Solve Problems

Over the past few decades, the system has not been allowed to reset. That has led to a resultant increase in debt to the point that it impaired the economy’s growth. It is more than a coincidence that the Fed’s “not-so-invisible hand” has left fingerprints on previous financial unravellings. Given that credit-related events tend to manifest from corporate debt, we can see the evidence below.

Corporate debt to GDP vs Fed Funds

Given the years of “ultra-accommodative” policies following the financial crisis, most of the ability to “pull-forward” consumption appears to have run its course. Such is an issue that can’t, and won’t be, fixed by simply issuing more debt. Of course, for the last 40 years, such has been the preferred remedy of each Administration. In reality, most of the aggregate growth in the economy was financed by deficit spending, credit creation, and a reduction in savings.

Debt free real growth GDP

In turn, this surge in debt reduced both productive investments and the output from the economy. As the economy slowed and wages fell, the consumer took on more leverage, decreasing the savings rate. As a result, increases in rates divert more of their disposable incomes to service the debt.

Debt used to maintain a standard of living.

A Long History Of Terrible Outcomes

After four decades of surging debt against falling inflation and interest rates, the Fed now faces its most difficult position since the late 70s.

The U.S. economy is more heavily levered today than at any other point in human history. Since 1980, debt levels have continued to increase to fill the income gap. Bigger houses, televisions, computers, etc., all required cheaper debt to finance them.

The chart below shows the inflation-adjusted median living standard and the difference between real disposable incomes (DPI) and the required debt to support it. Beginning in 1990, the gap between DPI and the cost of living went negative, leading to a surge in debt usage. In 2009, DPI alone could no longer support living standards without using debt. Today, it requires almost $7000 a year in debt to maintain the current standard of living.

Consumer spending gap

The rise and fall of stock prices have little to do with the average American and their participation in the domestic economy. Interest rates are an entirely different matter. Since interest rates affect “payments,” increases in rates quickly negatively impact consumption, housing, and investment, which ultimately deters economic growth. 

Why rates can't rise much

Since 1980, every time the Fed tightened monetary policy by hiking rates, inflation remained “well contained.” The chart below shows the Fed funds rate compared to the consumer price index (CPI) as a proxy for inflation. The current bout of inflation is entirely different, and as the Fed hikes interest rates to slow economic demand, it is highly probable they will over-tighten. History is replete with previous failed attempts that created economic shocks.

Fed funds rate vs inflation

The Fed’s Challenge

The Fed has a tough challenge ahead of them with very few options. While increasing interest rates may not “initially” impact asset prices or the economy, it is a far different story to suggest that they won’t. There have been absolutely ZERO times in history the Federal Reserve began an interest-rate hiking campaign that did not eventually lead to a negative outcome.

The Fed is now beginning to reduce accommodation at precisely the wrong time.

  • Growing economic ambiguities in the U.S. and abroad: peak autos, peak housing, peak GDP.
  • Excessive valuations that exceed earnings growth expectations.
  • The failure of fiscal policy to ‘trickle down.’
  • Geopolitical risks
  • Declining yield curves amid slowing economic growth.
  • Record levels of private and public debt.
  • Exceptionally low junk bond yields

Such are the essential ingredients required for the next “financial event.” 

When will that be? We don’t know.

We know that the Fed will make a “policy mistake” as “this time is different.”

Unfortunately, the outcome likely won’t be.

Japan Says Enough is Enough


The Bank of Japan (BOJ) is now publicly intervening in the currency markets to support the slumping yen. While they have likely been intervening behind the scenes to stem yen deprecation, they are now doing it publicly. Japan appears to be drawing a line in the sand regarding how far they will let the yen fall. Japan has a tough battle ahead of them. They have significantly more debt than the U.S. and other developed nations. As such, their ability to fight inflation with higher interest rates, as all other central banks are now doing, is minimal. Overtly buying the yen, versus adapting hawkish monetary policy, may not yield their desired results as large institutional investors may bet against their efforts given its poor fundamental backdrop.

japan yen boj

What To Watch Today


  • 9:45 a.m. ET: S&P Global U.S. Manufacturing PMI, September Preliminary (51.1 expected, 51.5 prior)
  • 9:45 a.m. ET: S&P Global U.S. Services PMI, September Preliminary (45.0 expected, 43.7 prior)
  • 9:45 a.m. ET: S&P Global U.S. Manufacturing PMI, September Preliminary (46.0 expected, 44.6 prior)


  • No notable earnings releases today

Market Trading Update

Markets sank again yesterday following the Fed’s more aggressive stance and signaled that “no pivot” in policy is coming. Such disappointed the markets in desperate need of some “encouraging news,” but none was to be had. The Fed slashed economic growth drastically, upped their unemployment projections, and kept inflation expectations at high levels through next year.

With markets sitting on the last level of support above this year’s lows, the oversold conditions could provide a relief rally short-term. However, there is little to get excited about currently. We will likely cut equity exposure levels on the next rally to even lower levels heading into the end of the year.

Keep a watch on the MACD signal (top of the chart), as it will provide the best guidance for a more sustainable rally near term.

Bank of England Follows the Fed

The Bank of England (BOE) followed the Fed’s footsteps and raised rates by 50bps to 2.25%. Further, they will be selling (QT) some of its bond holdings. They plan to reduce the balance sheet by about 10%, or £80 billion, over the next year. While much smaller than the Fed’s $95 billion a month, their actions are similar as a percentage of the balance sheet.

The Swiss, Taiwanese, and Norwegian central banks also raised rates yesterday. As you may recall, the ECB increased rates by 75bps two weeks ago. As the world’s central bankers finally start to take the fight against inflation seriously, dollar strength should run into a headwind.

The dollar rose in part this year because the Fed was aggressively raising rates while the other central banks did nothing. Not only did Fed actions cause higher interest rates for dollar investments, but they also reduced the odds inflation would become a bigger problem. With other central banks finally taking action and the Fed starting to near their terminal rate, dollar appreciation may slow or even reverse. However, the dollar is the world reserve currency and often a safe harbor when financial instability occurs. Higher interest rates often result in financial difficulties. As such, the dollar may rise further even if other central banks are on par with the Fed’s fight against inflation.

bank of england raises rates

Happy Anniversary Plaza Accord

It’s fitting Japan chose September 22 to intervene in the currency markets. On September 22, 1985, the world’s largest economic forces signed the Plaza Accord. The Plaza Accord was a joint–agreement signed at the Plaza Hotel in New York City. At that time, France, West Germany, Japan, the UK, and the U.S., agreed to depreciate the dollar versus the currencies of the aforementioned nations.

The graph below shows the incredible dollar appreciation leading to the accord. Equally stunning is dollar depreciation following the signing of the Plaza Accord. From 1980 to September 1985, the dollar index rose from $95 to $165, or about 70%. Over the last two years, the dollar has appreciated by about 25%. While today’s appreciation pales in comparison to 1985, the amount of debt and leverage in the global economy is significantly higher now. As such, the effect of the recent appreciation may be much more akin to the early 80s than it appears.

plaza accord dollar yen bank of england

Luxury Home Sales Plummet

A recent RedFin report states: “luxury-home purchases plummet 28%, the biggest drop on record.” Higher mortgage rates, inflation, and falling stock prices are weighing on high-end home purchases. Per the report:

High-end-house hunters are getting sticker shock when they see the impact of rising mortgage rates on paper. For a luxury buyer, a higher interest rate can equate to a monthly housing bill that’s thousands of dollars more expensive,” Fairweather said. “Someone who was in the market for a $1.5 million home last year may now have a maximum budget of $800,000 thanks to higher mortgage rates. Luxury goods are often the first thing to get cut when uncertain times force people to reexamine their finances.

While sales plummet, prices have yet to fall. We suspect that will change in the coming months.

Home sales: Luxury home sales fell in all top 50 metros. The biggest declines were in Oakland, CA (-63.9% YoY), San Jose, CA (-59.6%), Miami (-55.5%), San Diego (-55.3%) and Seattle (-52%). The smallest decreases were in Indianapolis (-7.5%), Kansas City, MO (-10.4%), Columbus, OH (-11.4%), New York (-11.8%) and Boston (-14.7%).

Prices: The median sale price of luxury homes rose in all top 50 metros, with the largest gains in Florida. It was up the most in Tampa (39.3% YoY), West Palm Beach (34.2%), Jacksonville (30.5%), Orlando (29.6%) and Fort Lauderdale (28%). It climbed the least in St. Louis (3.5%), New York (4%), Washington, D.C. (6.7%), Nassau County, NY (7.8%) and Portland, OR (8.4%).

luxury home sales

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Hawkish Tone Prevails at the Fed

As we and many suspected, the Fed and Jerome Powell are not backing off their hawkish tone. Hawkish monetary policy will continue this year and likely through next year. The Fed raised the Fed Funds rate by .75bps to 3.00%-3.25%. The last time they raised by 75bps or more in three consecutive meetings was 1980. The Fed expects Fed Funds to end the year at 4.40%. Hawkishness continues next year, with a slight rate increase expected in 2023. Since Powell’s Jackson Hole speech, market expectations have aligned with the Fed’s hawkish plans. The graph below shows how Fed Funds futures changed following yesterday’s policy statement and its revised forward projections. Fed Funds futures imply year-end 2023 rates at 4.30%

The table below shares the Fed’s median projections and their respective changes from June. Its GDP projection for 2022 fell from 1.7% to 0.2%. 2023 GDP is also revised lower to 1.2%, while PCE (inflation) projections rose by +0.2% in 2022 and 2023.

fed hawkish projections
fed funds futures

What To Watch Today


  • 8:30 a.m. ET: Current Account Balance, Q2 (-$260.8 billion expected, -$291.4 billion prior)
  • 8:30 a.m. ET: Initial jobless claims, week ended September 17 (218,000 expected, 213,000 prior)
  • 8:30 a.m. ET: Continuing claims, week ended September 10 (1.400 expected, 1.403 prior)
  • 10:00 a.m. ET: Leading Index, August (-0.1% expected, -0.14% prior)
  • 11:00 a.m. ET: Kansas City Fed. Manufacturing Activity, September (5 expected, 3 prior)



Market Trading Update

As noted above, the Fed announced its widely expected 75bps increase in the Fed funds rate yesterday. What wasn’t as expected was the Fed more “hawkish” stance suggesting it will maintain higher rates “for longer” than many market participants expected. Stocks fell, rallied, and fell again as investors parsed every word of Powell’s statements to determine what may come next.

The market spent most of the day trading above the May support level but fell below that to close out yesterday’s trading. With the market oversold, it would not surprise us to see a bit of a relief rally today or tomorrow. However, as we reiterated as of late, investors should use rallies to rebalance risk accordingly. The Fed’s more aggressive stance suggests we could see lower markets soon as investors reprice both economic and earnings risks from tighter monetary conditions.

Government Has To Get Spending Under Control

paper published by the Kansas City Federal Reserve Bank acknowledged that the central bank can’t slay inflation unless the US government controls its spending. In a nutshell, the authors argue that the Fed can’t control inflation alone. US government fiscal policy contributes to inflationary pressure and makes it impossible for the Fed to do its job.

Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.”

This isn’t in the cards.

“As interest rates rise and the nation’s debt grows, it will become even more expensive to borrow in the future. Congresses and presidents of both parties, over many years, have avoided making hard choices about our budget and failed to put it on a sustainable path. It is vital for lawmakers to take action on the growing debt to ensure a stable economic future,” the Peter Peterson Foundation said.

Understanding Warren Buffett’s Moats

Warren Buffett uses the term “economic moat” to describe a company’s ability to maintain a competitive advantage. A moat allows a company to better protect its market share and, ultimately, longer-term profits. At a 1995 shareholder meeting, Buffett explained key traits a moat must have.

“What we’re trying to find is a business that, for one reason or another — it can be because it’s the low-cost producer in some area, it can be because it has a natural franchise because of surface capabilities, it could be because of its position in the consumers’ mind, it can be because of a technological advantage, or any kind of reason at all, that it has this moat around it.”

The illustration below provides examples of moats broken down into five key sources of profits.

corporate moat

Housing Supply Coming

The graph below potentially paints an ominous picture of new home prices soon. For the first time in over 50 years, there are more homes under construction than those recently completed. If mortgage rates remain high, new homes coming to the market in the coming months could create quite a housing glut, resulting in lower prices. This fact is not lost on homebuilders. According to the NAHB survey, the collective sentiment of homebuilders is at 8-year lows.

housing supply completions

America’s Gerontocracy

Interesting note from Chartr discussing the “Congressional Gerontracy” in the U.S.

“Data compiled by Insider, and visualized above, shows how dramatically Congress has aged in recent years. A stunning 23% of Congress’ members are now over 70 years old, compared to twenty years ago when just 8% of legislators were 70+. If they keep their seats in November, two members would even turn 90 whilst serving in Congress next year.

With midterms just around the corner (8th of November) and POTUS’s 80th birthday not far behind, discourse around America’s aging congresspeople is getting louder — with a CBS poll showing remarkable bipartisan support for age limits of elected officials.”

While there is a louder rumbling of voices for changes to the law to fix the issue, there is one absolute certainty. Time will solve the problem.

Congress Gerontracy

Stock Expectations Are Not Bottom-Like

Markets often bottom when almost everyone thinks they are going lower. As the chart from The Daily Shot below shows, investors are largely bullish on their one-year expectations. If we are indeed in a bear market, this one chart signals we may not have seen the bottom. Ideally, we want to see the bell curve below shift lift to call a bottom using sentiment. Therefore, it’s worth sharing some sage advice: markets usually do what is most painful to the largest number of investors.

stock returns

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FOMC Policy Alternatives- Hawkish or Dovish?

At 2 pm ET, the Fed’s FOMC will update monetary policy. Given the Fed’s role in managing liquidity, investors should be very interested in how the FOMC talks about inflation, growth, interest rates, and QT, as well as any adjustments they make to monetary policy. The table below from ING provides interesting guidance on what we might expect. While we agree on the range of possible outcomes, we disagree on ING’s hawkish-dovish characterizations. ING believes the base case is moderately hawkish. Using their table, we think it’s hawkish. Many FOMC members, including Jerome Powell, want to keep policy rates at 4% or higher and keep them there through next year. We also disagree with them on interest rates. As we discussed yesterday, markets imply a .75bps rate hike, which we believe is hawkish, not moderately hawkish. A 100bps rate increase would be very hawkish.

federal reserve fomc outcomes

What To Watch Today


  • 7:00 a.m. ET: MBA Mortgage Applications, week ended August 12 (0.2% prior)
  • 10:00 a.m. ET: Existing Home Sales, August (4.70 million expected, 4.81 million prior)
  • 10:00 a.m. ET: Existing Home Sales, month-over-month, August (-2.3% expected, -5.9% prior)
  • 2:00 p.m. ET: FOMC Rate Decision (Lower Bound), September 21 (3.00% expected, 2.25% prior)
  • 2:00 p.m. ET: FOMC Rate Decision (Upper Bound), September 21 (3.25% expected, 2.50% prior)
  • 2:30 p.m. ET: FOMC Press Conference


Market Trading Update

After a small rally yesterday, the market sold off ahead of today’s FOMC meeting announcement. After the surprise comments by Jerome Powell at Jackson Hole, the markets were unwilling to take on risk ahead of the meeting announcement. We expect a 75bps hike today with no real change to the messaging, which could provide a bit of a relief rally to the markets. As shown, the support level did give way yesterday, which will be critical for the market to recover by the week’s end. Otherwise, we will likely see a test of the July lows.

As noted, the markets are oversold, but the “sell signal” remains intact, keeping downward pressure on stocks. We suggest using any rallies toward the 50-dma as an opportunity to reduce risk and raise cash levels as needed.

Are 4% One-Year T-Bills A Good Investment?

The graph below shows the long-term history of one-year T-bill yields and compares the recent surge in yields versus prior periods. While many investors focus on the 4% yield and the fact that it is now at its highest point in almost 15 years, the bigger story is the recent surge in yields. In just one year, the one-year yield has risen 4%. The last time yields rose that much in one year was about 40 years ago.

one year t-bills

German Inflation Off The Charts

Germany’s year-over-year PPI accelerated to 45.8% in August from 37.2% in July. As shown below, that is the largest annual price increase since at least 1949. The monthly figure jumped by 7.9% in August, also the highest monthly increase since 1949. Germany is a major industrial power. There is little doubt that its manufacturers and chemical producers will pass on these rising costs to its customers, many of which are U.S. companies. German PPI will keep pressure on U.S. PPI and CPI.

german germany ppi fiscal

Fiscal Tightening is Underway

It’s not just the FOMC and monetary policy that is slowing economic activity. The graph below from the Tax Foundation shows that Federal tax collections as a percentage of GDP are 3% above the average of the last 70 years and even more so versus the last 20 years. Further, they are at their highest point as a percentage of GDP since WWII. Larger tax collections mean less consumption and will negatively impact economic growth. We will have to watch this closely to see if the recent high will likely stay at current levels or is just a temporary reaction to the massive fiscal response during the pandemic.

taxes fiscal tightening

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Tail Risk and Persistent Inflation

Tail risk is the danger that asset prices move significantly more than what is considered normal. Given the lasting financial toll often caused by severe and unexpected adverse price movements, investors must appreciate potential causes of tail risk.

Today, the leading tail risk potential is increasing odds that high inflation remains stubborn, and the Fed continues to fight those odds aggressively. The Fed is trying to clarify that fighting inflation is job number one. They aggressively “whack” down dovish market narratives to get investors to believe them as part of their hawkish campaign.

Based on implied market expectations, investors are betting that inflation will quickly normalize and the Fed will promptly lower rates. The tail risk is that inflation proves sticky, and the Fed maintains a heavy foot on the financial brakes and continues to “whack” markets lower.

powell volcker whac a mole


To better appreciate today’s tail risk, it’s worth reviewing the monumental burden put upon Fed Chair Paul Volcker to tackle inflation in the 1970s and early 80s.

Paul Volcker was not always a revered Fed Chair. During his watch, first as the President of the New York Fed and later as the Fed Chairman, he was tasked with crushing double-digit inflation, the likes of which hadn’t been seen in 25 years. Doing so required inflicting financial pain upon Americans. Not surprisingly, few appreciated his efforts at the time.

Everyone was really after him. There are famous stories of people even sending him their car keys because their car loans were so expensive – Volcker: The Triumph of Persistence- by William Silber

volcker inflation

Based on comments from Volcker and others, it appears the Fed was able to limit inflation temporarily but struggled to put an end to persistent levels of high inflation. Success didn’t ultimately occur until they realized they had to change how people and companies thought about inflation.  

The situation forty years ago and today are different. That said, we are growing increasingly concerned Jerome Powell and his colleagues are dealing with persistent inflation, not the brief bouts of transitory inflation seen over the last forty years.

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This Time is Different

While inflation rates may be similar today to those of Volcker’s era, it is worth providing context for how today’s financial and economic environments are vastly different from Volcker’s experience and why it matters.

There is anxiety among Fed members that the low inflation era may be ending. If so, a new, high inflation regime and behaviors that accompany it will likely spell more restrictive Fed monetary policy.

Restrictive policy, including double-digit interest rates, quelled Volcker’s high inflation regime. This time that anecdote is not feasible. Unlike the 70s and early 80s, when debt levels were low and equity valuations cheap, today’s economic and financial environments are the opposite.

Today’s economy relies heavily on debt for consumption and to roll over maturing debt and avoid bankruptcy. High-interest rates will be exponentially more damaging than they were forty years ago.

As the graph below from Brett Freeze shows, an increasing amount of debt has been misallocated. The only way to pay interest and principal on such unproductive debt is to issue new debt to replace it.

misallocated debt

The following graph shows the CAPE valuation hit a ‘dirt cheap’ level of 6.64 in the early 80s. Today, CAPE stands at 28.90, about 50% above the historical average. The risk to investors of just a normalization of valuations is palpable.

valuations this time vs then

As we share, there is significantly more financial market and economic risk today than in the 70s and early 80s if high inflation becomes entrenched.

Crushing high inflation immediately before it becomes persistent will take harsh measures, but it may be the best action given the nation’s financial vulnerability. If they fail at the task and let high inflation persist, there will be much bigger problems. 

Persistent Inflation- The Fed’s Nightmare Scenario

In Persistent Inflation Scares the Fed, we discussed one of the Fed’s greatest fears, a price-wage spiral. To wit:

The BIS argues that inflation drives consumer and corporate spending decisions in a high inflation regime. This results in behavioral changes, which cause individual prices of goods and services to become more correlated. Inflation begets inflation and therefore becomes persistent.


Once the general price level becomes a focus of attention, workers and firms will initially try to make up for the erosion of purchasing power or profit margins they have already incurred.

Essentially once people think that high inflation is permanent, their behaviors change. As prices rise, workers demand higher wages, companies raise prices to compensate, and on and on in a circular motion. Wages are already rising as employees and unions have new-found leverage. Thus far, companies are raising prices to offset higher wages.

price wage inflation

The graphs below point to a very tight labor market. Based on corporate margin data, companies are thus far able to raise prices to help offset higher wages. The first revolution of a potential price-wage spiral has already begun.  

job openings
job labor shortage

The Fed must be forceful in changing the inflation expectations of employees and employers. They must be willing to take action to increase the unemployment rate, thereby reducing employees’ leverage over employers. Doing so involves weakening the economy and punishing asset prices. Their ability to eliminate the odds of a new inflation regime rests on their ability to convince employees, corporations, and the markets that high inflation will not be lasting.

Unlike prior monetary policy, the goal is not just about changing our consumption habits but, more importantly, changing our inflation outlook.


Is The Fed Up For The Task?

In his unexpectedly hawkish Jackson Hole speech, Jerome Powell made it clear that fighting inflation is vital to longer-term economic health. He also seems very aware of the dangers of changing attitudes about high inflation. To wit:

If the public expects that inflation will remain low and stable over time, then absent major shocks, it likely will. Unfortunately, the same is true of expectations of high and volatile inflation. During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision-making of households and businesses. The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions. As former Chairman Paul Volcker put it at the height of the Great Inflation in 1979, “Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations.”

On the heels of Powell’s speech Neel Kashkari, President of the Minneapolis Fed, stated, “I was actually happy to see how Chair Powell’s Jackson hole speech was received. People now understand the seriousness of our commitment to getting inflation back down to 2%.” The market’s reception of the Chairman’s speech was a 3%+ decline in the S&P 500.

Yes, the Fed seems to get it. But will the Fed have the nerve to do whatever it takes to crush inflation?

Will Investors Get Caught Offsides?

Even after Powell’s speech, investors continued to underestimate what the Fed may have to do. If inflation drops quickly back to 2% and a price-wage spiral fails to materialize, investors will be correct.

Might they be wrong? The graph below shows economists have grossly underestimated the persistence and amount of inflation for almost two years.

bad inflation forcasting

The market is now aligned with recent Fed speak of a 4.00-4.50% Fed Funds rate. However, as shown below, it starts leaning toward a Fed easing by the spring of 2023. Most recent Fed members have been clear that Fed Funds will likely stay above 4.00% for 2023. To wit:

We’re going to have to get interest rates up probably a little above 4% by sometime early next year, and hold them there.  – Cleveland Fed President Mester

We’re going to stick at this until the job is done, until the job is done. I don’t think markets are pricing in the fact that not only could rates get up to 4-4.5%, they could stay there for all of 2023.  -Jerome Powell

fed time expectations


Persistently high inflation is the tail risk that few investors seem to appreciate.

Dovish market narratives and investors betting on them are like the moles in the arcade classic Whac-A-Mole. Any bit of dovish inflation news and the market narrative shifts to a less aggressive Fed and soon-to-be lower interest rates. Once such sentiment gains momentum, Fed members pull out the mallet and whack the dovish narrative down.

If inflation remains persistent, even in the 4-6% range, investors will appreciate that the Fed’s job is not easy. In this case, the tail risk is the market’s realization that the Fed needs to take a page from Volcker’s book and raise rates beyond 4.50% and possibly keep them there well beyond 2023.

100bps? Fed Meeting Kicks Off

The Fed’s two-day policy meeting kicks off this morning with expectations of a 75bps Fed Funds rate hike and a slight chance of 100bps. Currently, the odds of a 100bps rate hike stand at 20%. While inflation has stabilized, it is not coming down as quickly as the Fed was forecasting when they started fighting inflation earlier this year. Jerome Powell was incredibly hawkish at Jackson Hole. Raising by 100bps would further affirm Powell’s rhetoric and the Fed’s determination to beat inflation before it becomes persistent.

The graph below shows that October Fed Funds futures imply Fed Funds of 3.13% (100-96.87). Currently, Fed Funds are trading around 2.33%. A 75bps rate increase would bring it to 3.08%. Therefore, the market implies an additional 5bps. 5/25ths equates to a 20% chance of 100bps on Wednesday.

fed funds futures 100bps

What To Watch Today


  • 8:30 a.m. ET: Building permits, August (1.610 million expected, 1.674 million prior)
  • 8:30 a.m. ET: Building permits, month-over-month, August (-4.8% expected, -1.3% prior)
  • 8:30 a.m. ET: Housing Starts, August (1.445 million expected, 1.446 prior)
  • 8:30 a.m. ET: Housing Starts, month-over-month, August (0.3% expected, -9.6% prior)



Market Trading Update

As noted in yesterday’s commentary:

“If you want to call it that, the good news is that Friday, which was options expiration, saw a massive surge in volume, suggesting a temporary low. The market also held vital support at the May lows (dotted red line). With the market oversold on a short-term basis, a reflexive rally next week is likely.”

Two pieces of positive action in yesterday’s reflex rally. First, the market bounced off that important support level from the May lows. Secondly, as shown, the market triggered a short-term Stochastics and Williams %R “buy signal.” While the market rally yesterday was weak, the market could have a bit more upside near term. We continue to suggest using any rally toward the 50-dma as an opportunity to reduce portfolio risk for now.

Market Trading Update

The Last Part Of September Sucks

While discussing the potential for a reflexive rally, it is worth noting that the last part of September tends to “suck” from a return perspective. This note from Sentiment Trader makes an excellent point:

“It is a mistake to assume that the stock market will decline simply because the calendar reads September. However, long-term results suggest that caution is clearly in order during September – particularly when we get to the last ten trading days of the month.  For 2022, this particularly unfavorable period extends from the close on 2022-09-16 through the close on 2022-09-30.”

See more in my Tweet below on September stats.

September market action.

The good news is that October begins the seasonally strong period of the year. So, hopefully, we will have some better trading days ahead.

Don’t Fight The Trend

1. The Trend is Your Friend? 

They say “don’t fight the Fed,” but another key market aphorism is **don’t fight the trend** (which is kind of in many ways driven by the Fed). But either way, as the chart shows, there are clear trends at play across assets as the liquidity tides go out and the cycle progresses…

The comment comes from Callum Thomas and is accompanied by the graph below. Regardless of asset class, one of the most critical market indicators today is the dollar. As we discuss in the next section, when will the world’s central banks say enough is enough regarding recent dollar strength? When or if they take forceful action to stop the dollar, the world’s risk markets may get a little relief.

dont fight the trend

Currency Intervention


The following headline scrolled across the screens on Monday. Remember that the BIS is often referred to as the “central banker’s bank.” They are a powerful player coordinating central bankers’ actions and policies. Its warning is likely a foreshadowing of aggressive actions soon to occur. In Yields Are Defying Yesterday’s Logic, we noted the likelihood of currency intervention. To wit:

Given soaring inflation rates, especially energy prices, this instance of a stronger dollar is wreaking havoc on Europe and Japan.

Making matters worse, many foreign borrowers borrow in dollars. If they don’t hedge the currency risk, as many do not, a strong dollar results in higher interest and principal payments. Simply, they must acquire more expensive dollars to pay interest and principal. As such, a strong dollar is a de facto tightening of global monetary policy.

Europe is doing everything possible to solve its energy crisis, but its options are limited as it is primarily a supply problem. While alleviating supply challenges is difficult, they can reduce the cost with a stronger currency.

We suspect that the ECB and BOJ have been selling dollar assets, predominately Treasury bonds, to prop up their currencies.

dollar currency intervention

Amazon versus FedEx

On Monday, we commented on FedEx’s poor earnings and forward guidance. Ourselves and others warned that what ills FedEx is problematic as they are representative of the broad economy. We still think FedEx and its competitors are well correlated with economic activity. However, some of FedEx’s problems may also be market share related. Amazon is now a larger carrier than FedEx and closing in on UPS.

amazon fedex carriers

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Buffett Indicator Says Markets Are Going To Crash?

“The ‘Buffett Indicator’ says the stock market will crash. Such was an email I received recently and was worthy of a more detailed discussion. Let me begin with my favorite line from “The Princess Bride.”

“I do not think it means what you think it means.”

The Buffett Indicator is a valuation measure that compares the stock market’s capitalization to the Gross Domestic Product. A favorite of Warren Buffett, the indicator sits shy of 2.44 times market-cap to GDP. That number doesn’t mean much on its own, but it’s striking when placed in a historical context. Even after the recent fall in markets, the ratio is still one of the highest on record, north of the 2.11 level recorded during the dot-com bubble of 2000, and considerably elevated compared to the average since 1950.

Buffett Indicator vs Market

Since 2009, repeated monetary interventions and zero interest rate policies have led many investors to dismiss any measure of “valuation.” The reasoning is that since there was no immediate correlation, the indicator is wrong.

The problem is that valuation models are not, and were never meant to be, market timing indicators.” The vast majority of analysts assume that if a measure of valuation (P/E, P/S, P/B, etc.) reaches some specific level, it means that:

  1. The market is about to crash, and;
  2. Investors should be in 100% cash.

Such is incorrect. Valuation measures are just that – a measure of current valuation. More importantly, when valuations are excessive, it is a better measure of “investor psychology” and the manifestation of the “greater fool theory.”

What valuations do provide is a reasonable estimate of long-term investment returns. It is logical that if you overpay for a stream of future cash flows today, your future return will be low.

Why The Buffett Indicator Is Valuable

While often overlooked, the Buffett Indicator tells us much as it measures “Market Capitalization” to “GDP.” To understand the relative importance of the measure, we must understand the economic cycle.

Consumer spending cycle.

The premise is that in an economy driven roughly 70% by consumption, individuals must produce to have a paycheck to consume. That consumption is where corporations derive their revenues and, ultimately, profits. If something occurs, which leads to less production, the entire cycle reverses, leading to an economic contraction.

The example is simplistic, as many factors impact the economy and markets short term. However, economic growth and corporate earnings have a long-term historical correlation. Therefore, while it is possible for earnings to grow faster than the economy at times, i.e., post-recession, they can not outgrow the economy indefinitely.

GDP vs Earnings vs Appreciation

Since 1947, earnings per share have grown at 7.72% annually, while the economy has expanded by 6.35% annually. Again, the close relationship in growth rates should be logical. Such is particularly the case given the significant role spending has in the GDP equation.

Therefore, the Buffett Indicator tells us that overvaluation is not sustainable when the market capitalization of stocks grows faster than what economic growth can support. Therefore, a market capitalization ratio (the price investors are willing to pay times the total number of shares outstanding) greater than 1.0 is overvalued, and below 1.0 is undervalued. Today, investors are paying almost 2.5x what the economy can generate in revenues and earnings.

Does that excess valuation mean the stock market is going to crash? No.

However, there are significant implications that investors should consider.

Valuations & Forward Returns

As is always the case, while valuations are a terrible “market timing” indicator, they are an excellent predictor of future returns. I previously quoted Cliff Asness on this issue in particular:

“Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase. Also, as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker.

If today’s Shiller P/E is 22.2, and your long-term plan calls for a 10% nominal (or with today’s inflation about 7-8% real) return on the stock market, you are basically rooting for the absolute best case in history to play out again, and rooting for something drastically above the average case from these valuations.”

We can prove that by looking at forward 10-year total returns versus various levels of PE ratios historically.

CAPE Valuations vs forward 10-year returns.

Asness continues:

“It [Shiller’s CAPE] has very limited use for market timing (certainly on its own) and there is still great variability around its predictions over even decades. But, if you don’t lower your expectations when Shiller P/E’s are high without a good reason — and in my view, the critics have not provided a good reason this time around — I think you are making a mistake.”

And since we are discussing Mr. Buffett, let me remind you of one of Warren’s more insightful quotes:

“Price is what you pay, value is what you get.” 

The “Buffett Indicator” confirms Mr. Asness’ point. The chart below uses the Willshire 5000 Market Capitalization versus GDP and is calculated on quarterly data.

Buffett Indicator vs 10-year forward returns.

Not surprisingly, like every other valuation measure, forward return expectations are substantially lower over the next ten years than in the past.

Fundamentals Don’t Matter Until They Do

In the “heat of the moment,” fundamentals don’t matter. As stated, they are poor timing indicators. 

In a market where momentum is driving participants due to the “Fear Of Missing Out (FOMO),” fundamentals are displaced by emotional biases. Such is the nature of market cycles and one of the primary ingredients necessary to create the proper environment for an eventual reversion.

Notice, I said eventually.

As David Einhorn once stated:

“The bulls explain that traditional valuation metrics no longer apply to certain stocks. The longs are confident that everyone else who holds these stocks understands the dynamic and won’t sell either. With holders reluctant to sell, the stocks can only go up – seemingly to infinity and beyond. We have seen this before.

There was no catalyst that we know of that burst the dot-com bubble in March 2000, and we don’t have a particular catalyst in mind here. That said, the top will be the top, and it’s hard to predict when it will happen.”

Furthermore, as James Montier previously stated:

Current arguments as to why this time is different are cloaked in the economics of secular stagnation and standard finance workhorses like the equity risk premium model. Whilst these may lend a veneer of respectability to those dangerous words, taking arguments at face value without considering the evidence seems to me, at least, to be a common link with previous bubbles.

Stocks are far from cheap. Based on Buffett’s preferred valuation model and historical data, return expectations for the next ten years are as likely to be negative as they were for the ten years following the late ’90s.

Investors would do well to remember the words of the then-chairman of the SEC, Arthur Levitt. In a 1998 speech entitled “The Numbers Game” he stated:

“While the temptations are great, and the pressures strong, illusions in numbers are only that—ephemeral, and ultimately self-destructive.”

Regardless, there is a straightforward truth.

“The stock market is NOT the economy. But the economy is a reflection of the very thing that supports higher asset prices: earnings.”

No, the Buffett Indicator doesn’t mean markets will definitely crash. However, there is a more than reasonable expectation of disappointment in future market returns.

This Week’s Top 10 Buys And Top 10 Sells

Clcik on the link below for the full report and all charts….

Fed Ex Says Global Recession is Here

Fed Ex stock fell about 20% after they delivered disappointing earnings and significantly lowered forward guidance. Fed Ex’s warning is concerning because they are a good barometer of the domestic and global economy. In fact, Alan Greenspan used them to gauge the state of the economy. FedEx reported first-quarter EPS of $3.44 versus expectations of $5.14. They also revised next quarter’s EPS estimate from $5.48 to $2.75.

CEO Raj Subramaniam stated: “global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the U.S.” As we have said, traditional economic indicators often lag real-time data by a month or two. Based on the statement that economic trends “significantly worsened later in the quarter,” it seems conventional data has yet to pick up on what Fed Ex is witnessing. Fed Ex is “aggressively accelerating cost reduction efforts.” These efforts, including closing 90 Fed Ex offices, should “mitigate the effects of reduced demand through the remainder of fiscal 2023.”

FedEx reports earnings off cycle. Accordingly, its 2023 fiscal year ends on June 30, 2023.


What To Watch Today


  • 10:00 a.m. ET: NAHB Housing Market Index, September (47 expected, 49 prior)



Market Trading Update

Technically, this past week was not good. The market failed at the downtrend resistance line (dotted black), broke below the 50 and 100-dmas, and took out the rising bullish trendline from the June lows. Those levels remain key resistance for the market currently. Furthermore, the MACD signal, close to triggering a “bullish buy signal,” also failed to trigger and continues to work its way lower.

If you want to call it that, the good news is that Friday, which was options expiration, saw a massive surge in volume, suggesting a temporary low. The market also held vital support at the May lows (dotted red line). With the market oversold on a short-term basis, a reflexive rally next week is likely.

Market Plunge, Market Plunge Took The Bulls By Surprise

As I noted in Friday’s Daily Market Commentary(be sure and subscribe for free pre-market email delivery), the period following options expiration tends to be more positive.

However, investors should sell any rally next week. The technical backdrop remains bearish, and with Fed Ex’s bombshell announcement, the fundamental backdrop likely took a sharper turn for the worse.

Remain cautious for now.

The Week Ahead

The Fed is the headline of the week. The FOMC meets Tuesday and Wednesday, with the policy statement and press conference occurring on Wednesday at 2 pm ET and 2:30 pm ET, respectively. The market expects the Fed to increase rates by .75bps to 3.25%. There is an outside chance they move by 100bps. FedEx and the recent weakness in the stock market may have squashed those chances. We suspect the hawkish, inflation-driven tone from Jackson Hole will be maintained with the policy statement and press conference.

It will be quiet on the economic front. Of note will be new home construction and homebuilder sentiment. The NAHB housing market index will come out today. Housing starts and building permits follow tomorrow. Continued weakness and poor sentiment in the home building industry are widely expected, given mortgage rates are north of 6%.

mortgage rate week

Adobe Sinks on Figma Purchase

FedEx is not the only company suffering significant losses. Adobe’s (ADBE) stock fell 17% on Thursday after announcing it will buy Figma for $20 billion. Based on the market reaction, it appears the price is too high. Adobe is paying 100x Figma’s expected 2022 revenue. That compares to ADBE’s price-to-sales ratio of 9, which is already considered very high. Further, half of the purchase will be funded with stock, diluting current shareholders by about 12%. Before the announcement, ADBE shares were already down 33% for the year.

adobe adbe

Ethereum Merge

“For those with crypto-loving colleagues or friends, you may be sick of hearing about “the merge”. For the uninitiated however, there was some big news in the crypto corner of the internet this week as Ethereum underwent a transformation in a bid to reduce the complexity and energy consumption of the world’s second-largest cryptocurrency.

Developers successfully executed on the plan, known as the “Ethereum merge”, which fundamentally changes how the cryptocurrency validates transactions on the Ethereum chain. The move, away from a type of blockchain that uses “proof-of-work” towards an architecture using “proof-of-stake”, is set to reduce the need for power-hungry computers. According to crypto researchers, the change is set to reduce Ethereum’s energy consumption by some 99.95%.

That’s a big deal because, like Bitcoin, Ethereum has historically used an enormous amount of energy to validate its transactions. Digiconomist estimates that the energy consumption of the two combined would rank 27th on a list of the world’s most energy-intensive countries.


Oil and Gas Drilling

The graph below from Crescat Capital shows the domestic oil and gas rig count is contracting. This is occurring, despite the relatively high price of gas and oil. President Biden has said he will refill the SPR when oil hits $80 a barrel. OPEC started reducing production targets to $90 a barrel. It seems the oil industry is also trying to put a floor on the price of oil. Even if the global economy sinks into a recession, oil prices may prove more resilient than in prior recessions.

oil gas rig count

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Rail Strike Averted- Price Wage Spiral Accentuated

The nation’s supply lines were spared a massive blow as the rail workers union and management reached a tentative deal to avoid a strike. A rail worker strike would have pushed prices higher for many goods and further heightened the Fed’s inflation worries. While the risk of a rail strike was averted, the agreement may play into another Fed worry- a price-wage spiral.

Per CNN Business: “The deal gives the union members an immediate 14% raise with back pay dating back to 2020, and raises totaling 24% during the five-year life of the contract, that runs from 2020 through 2024. It also gives them cash bonuses of $1,000 a year. All told, the backpay and earlier bonuses will give union members an average of an $11,000 payment per person once the deal is ratified.” It’s highly likely rail companies will increase their freight rates. If so, a price wage spiral in rail shipping is upon us. Similar spirals are occurring in many other industries.

price wage spiral

What To Watch Today


  • 10:00 a.m. ET: University of Michigan Consumer Sentiment, September preliminary (60.0 expected, 58.2 prior)


  • No earnings releases today.

Market Trading Update

There isn’t a lot of good news to report. After the bullish advance last week that took markets onto a more bullish footing, that was completely reversed this week. Yesterday, the market did break the important bullish trend line. However, it did hold important support going back to the May lows. With the market back to more oversold levels, a bounce is likely.

Market Update

Today is a large options expiration day, so market volatility will likely be high. As noted yesterday, the returns post options expiration day tends to be better, so if your inclination is to panic sell, you may want to wait for a bounce.

The MACD signal remains on a “sell signal,” which also continues to suggest downward pressure on prices, so rallies should continue to be used to raise cash and reduce risk.

The Dollar and Earnings

Dollar strength has been on center stage and many investors are trying to figure out what it may entail. From an equity perspective, consider that approximately a third of S&P 500 earnings come from foreign countries. As a result, the link between profits and the dollar is strong. The graph below shows the strong correlation between changes in the dollar and earnings revisions. With the dollar index up about 20% over the last year and sitting at 20-year highs, we argue that earnings are even more sensitive to dollar strength than is typical.

Further bolstering the relationship, bond yields and the dollar are recently showing high levels of correlation. As the dollar and yields rise, the present value of corporate profits declines. Additionally, higher bond yields increase corporate borrowing costs, thereby reducing earnings.

dollar earnings

The Economy Is Sick

“Echoing Jim Cramer’s infamous 2007 “they know nothing” rant, a far more calm and eloquent Barry Sternlicht, Chairman and CEO of Starwood Capital, warned the co-anchors on CNBC this morning that if the Fed doesn’t pump the brakes on its rate hikes, the US economy is facing a serious downturn.” – Zerohedge

“The economy is braking hard,” Sternlicht told the outlet.

“If the Fed keeps this up, they are going to have a serious recession and people will lose their jobs.”

He was proved right quickly as The Atlanta Fed cut its GDP forecast for Q3 to just +0.5%.

Atlanta Fed

Buy and Rent or Buy a T-Bill?

Buying a single-family home and renting it out should provide a much better return than buying no-risk Treasury bills. The graph below shows that over the last ten years, such an investment strategy would yield an additional 2.5% to 5% more than a six-month Treasury bill. Today the reward for buying and renting is less than 1%. Now consider that for less than 1%, someone doing a buy and rent strategy runs the probable risk that home prices depreciate over the short run, maintenance costs are higher than expected, and you can not rent the property 100% of the time. Either bill yields are too high, or house prices are too high. The second graph below helps answer the question.

t-bill buy rent house cap rate
shiller home house price index

Mixed Economic Data

Jobless Claims continue to decline. This week claims fell to 213k, well below the recent high point of 261k in mid-July. Continuing claims are not dropping. This is potentially a sign that the recently laid-off workers are finding it hard to get a new job. That said, continuing claims can often lag jobless claims by a few months.

economic data jobless claims

Retail sales were a mixed bag. The headline number was +0.3% versus expectations of 0.0%. However, July was revised lower by 0.4%. Further, if we strip out volatile auto sales, retail sales were down 0.4%.

The Philadelphia Fed and Empire State Manufacturing Indexes were also mixed. Philly Fed was much weaker than expected at -9.9 versus +2.3. Empire state was negative at -1.5, but it was much better than expectations of -13.5. Both had good news on the inflation front as they both recorded the lowest levels of prices paid since December 2020.

Economists closely follow new orders within the surveys as they are robust leading economic indicators. Despite the proximity of New York to the Mid-Atlantic, the new orders data is strikingly different. New order fell sharply in the Philly survey from -5.1 to -17.6. New orders in the Empire survey rose from -29.6 to +3.7

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Asset Bubbles & Forward Returns

Asset bubbles have been prevalent throughout history. Whether it was the “Tulip bubble” in the 1600s, the South Sea bubble of the 1700s, or the bubble of 2000, they were all a result of excessive investor speculation.

Of course, the other side of the inflation was the long unwinding of those bubbles as valuations mean reverted from their previous extremes. Such reversion led to long periods of very low returns for investors, as shown below.

Rolling 10-year returns.

Another way to look at valuations and forward returns is with a scatterplot. As you will notice, real total returns over the next decade are near zero at current valuations.

Forward 10-year returns.

While none of this is news, it is a good reminder of where we are currently in the financial cycle. While many hope the last decade’s bull market will continue for another, history suggests such may be a challenge.

However, as we stated previously:

Valuations are a terrible market timing indicator. However, in the short term valuations tell you everything about market psychology. In the long term, they tell you everything about expected returns.

Currently, every measure of valuation suggests investors have thrown all “caution to the wind.”

As noted, valuations are a reflection of investor psychology. As such, it is not surprising that investors’ allocations to equities are at record levels.

Equity ownership vs market.

Not surprisingly, since asset bubbles are a function of investors’ “buy high and sell low” syndrome, allocations also tell us much about future returns.

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Investor Allocations & Future Returns

My friend and colleague, Jim Colquitt of Armor ETFs, made a salient point. The chart below shows the standard deviation between investor allocations and future 10-year returns. Per Jim:

“Note that the most recent data point (51.8% as of 12/31/21) is now the highest value in the history of this index.  Using this data, I created a regression model to forecast the 10 Year Forward Annualized Price Return for the S&P 500.  The result is that from 12/31/21 forward, we should expect a return of -3.85% over the next 10 years for the S&P 500.”

Average investor allocations and forward returns.

“We can use a scatterplot of the same data. Note the “you are here!” in the bottom right corner and the R-squared value in the top right corner. This is an extremely tight fit for 70 years’ worth of data.” 

Investor allocations and forward returns

Here is the noteworthy takeaway from his analysis.

If history is any guide, current valuations, which reflect investor psychology, suggest that markets remain overvalued. If that is true, we can construct a “fair value” model for markets as per Jim’s hypothesis. To wit:

“The chart below plots the S&P 500 and the model’s estimated fair value price. The Z-score gets based on the difference between the actual and model estimates (histogram).”

Asset Bubbles and Valuations

As Jim notes, this allows for an interesting observation that most major market corrections do not end until either:

  1. The market reverts to, or violates, the model estimate and/or
  2. The Z-score declines to somewhere between -3.0 & -4.0. 

This Time Likely Won’t Be Different

As stated at the outset, valuations are a terrible market timing metric. However, they tell us much about asset bubbles, investor psychology, and future returns.

No matter how many valuation measures we use, the message remains the same. From current valuation levels, the expected rate of return for investors over the next decade will be low.

There is a large community of individuals who suggest differently as they make a case as to why this “bull market” can continue for years longer. Unfortunately, any measure of valuation does not support that claim.

But let me be clear, I am not suggesting the next “financial crisis” is upon us either. I am suggesting that based on various measures, forward returns will be relatively low compared to what we witnessed over the last eight years. Such is particularly the case as the Fed, and Central Banks globally, begin to extract themselves from the cycle of interventions. 

That statement does not mean that markets will produce single-digit rates of return each year for the next decade. There will be some great years to invest during that period. Unfortunately, the bulk of those years will get spent making up for the losses from the coming recession and market correction.

That is the nature of investing in the markets. There will be fantastic bull market runs as we have witnessed over the last decade, but for you to experience the up, you will have to deal with the eventual down. It is part of the full-market cycles that make up every economic and business cycle.

Despite the hopes of many, no one can repeal the cycles of the market and the economy. While artificial interventions can delay and extend the cycles, the reversion will eventually come.

No. “This time is not different,” and in the end, many investors will once again get reminded of this simple fact:

 “The price you pay today for any investment determines the value you will receive tomorrow.” 

Unfortunately, those reminders tend to come in the most brutal of manners.  


  • SRCL rose above its 15-month downtrend line in August. The zoom chart reveals that the rally in August also put SRCL above 3-month resistance at the 50 level. SRCL has established a pattern of higher lows=uptrend and the recent decline puts it at uptrend support. The weekly chart shows that the low is June was a true long-term inflection point as it matches up with support from 2019 and 2020. The weekly chart also shows that SRCL is very close to the bottom of its 10-year trading range.

RRG analysis shows that SRCL has moved out of the Lagging quadrant, into the Improving quadrant, and is headed to the Leading quadrant. (see RRG below).

Relative Rotation Graphs (RRG) – explanation video

RRG – written explanation

4 Percent Money Market Yields- Is It Enough?

In the tweet below, Lance asks investors a critical question. Is 4 percent enough of a return to warrant parking some of your portfolio’s cash in a money market fund? The graph below shows that investors have not seen 4 percent money market yields in over 12 years. 4 percent is not a game changer, but money market funds, once considered a “penalty” for reducing risk in stocks and bonds, are now an acceptable reward. As money market yields rise to 4 percent and beyond, marginal trades to cash will weigh on stock and bond returns.

This topic is another reminder of why Fed policy is so important to follow. When yields are zero, there is no incentive to sit on cash. Accordingly, many portfolios were fully invested. Today that equation is changing. Is it any wonder why investors are anxious over every little Fed statement?

4% money market funds

What To Watch Today


  • Initial jobless claims, week ended September 10 (227,000 expected, 222,000 prior)
  • Continuing claims, week ended September 3 (1.478 million expected, 1.473 prior)
  • Empire Manufacturing, September (-15.0 expected, -31.3 prior)
  • Retail Sales, month-over-month, August (0.0% expected, 0.0% prior)
  • Retail Sales excluding autos, month-over-month, August (0.1% expected, 0.4% prior)
  • Retail Sales excluding autos and gas, month-over-month, August (0.8% expected, 0.7% prior)
  • Philadelphia Fed Business Outlook, September (3.0 expected, 6.2 prior)
  • Import Price Index, month-over-month, August (-1.2% expected, -1.4% prior)
  • Export Price Index, month-over-month, August (-1.1% expected, -3.3% prior)
  • Industrial Production, month-over-month, August (0.1% expected, 0.6% prior)
  • Capacity Utilization, August (-0.1% expected, 0.7% prior)
  • Manufacturing (SIC) Production, August (-0.1% expected, 0.7% prior)
  • Business Inventories, July (0.6% expected, 1.4% prior)



Market Trading Update

As noted below, Tuesday was the worst day for stocks since 2020. Mind you that 4% down days do not occur during bull markets and suggest markets remain confined in a more bearish environment. The good news is that yesterday markets did hold an important support at the rising bullish trend line, although it was a weak test of support. The markets need to hold this support through Friday and close the week off the recent lows if the bulls are going to defend their current positioning. As noted in yesterday’s commentary, Friday is a huge options expiration day which could lead to increased volatility today and tomorrow.

While we suspect this market may have another rally attempt as we head into year-end, we are becoming more convinced that any such rally should be sold and cash levels increased heading into 2023. However, much can happen between now and then, so we remain focused on short-term technical drivers to manage our current exposures.

Market Trading Update

Markets Spooked

“It’s not what you don’t know that gets you in trouble, it’s what you know that just ain’t so“. Those words from Mark Twain were relevant again yesterday as markets digested the latest inflation data. Investors were expecting inflation in August to follow the good news in July and continue to cool off. Instead, consumer prices actually rose 0.1% relative to July and core inflation, which strips out energy and food, rose 0.6% in the month.

That rise caught investors off guard, as higher inflation gives the Fed a stronger incentive to keep raising interest rates, sending US stocks (S&P 500 Index) down more than 4% yesterday. As visualized above, that was the worst day of the year so far and you have to go back to the highly volatile 2020 to find a sharper one-day decline for US equities.” – Chartr

Market worst day since 2020

PPI- A sigh of Relief

PPI fell by 0.1% in August, as expected. The year-over-year figure was 8.7%, lower than expectations of 8.8% and down from last month’s 9.8%. Following Tuesday’s higher-than-expected CPI report, the PPI data should provide some relief to investors. That said, core PPI was slightly higher than expected. As we noted yesterday, core prices are stickier and thus take longer to come down. The Fed will likely offer caution about this at next week’s FOMC meeting.

Forecasting Next Month’s CPI

The Cleveland Fed has an inflation “nowcasting” model on its website. The forecast has generally proven to be more reliable than consensus estimates. The graph below shows the daily forecasts and the actual readings for CPI and PCE. The CPI and PCE data are highlighted with vertical black lines, while the remaining dots are the forecasts. Unlike most inflation data, they present it in a quarterly/annualized format. Therefore the data may seem different from monthly and annual data, as is commonplace. Before Tuesday’s CPI report, the Cleveland Fed was one of a small handful of forecasts, not expecting a decline.

The second table shows the PCE forecast for later this month and next month, as well as next month’s CPI report. Year-over-year, core PCE is expected to increase 4.68%, a .1% uptick from last month. September CPI is forecast to show core CPI rising .51% monthly and 6.64% annually. Headline CPI should fall by .10% to 8.2%. Their expectation is for inflation stability, not the rapid decline market participants are hoping for.

cleveland fed cpi nowcast
cleveland fed cpi forecast

How Is The Economy Doing?

Great question! Some measures of economic activity are strong, and others are weak. Unlike most other economic environments, the pandemic, massive fiscal/monetary response, and major supply line problems continue to cause gross economic distortions. As a result, economic data shows little consistency from report to report. The New York Times describes and helps visualize the confusing economic data we face with an article entitled How is the Economy Doing? The article starts as follows:

The U.S. economy is in a strange place right now. Job growth is slowing, but demand for workers is strong. Inflation is high (but not as high as last spring). Consumers are spending more in some areas, but cutting back on others. Job openings are high but falling, while layoffs are low and … well, it depends on what indicator you watch.

The graph below from the article shows that important pieces of economic data are all over the map. For instance, capital goods expenditures are “good and getting better,” while personal income is “bad and getting worse.” Retail sales and consumer spending are “good,” but consumer sentiment is “bad.”

economy graph

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PYPL, CDAY, PINS – positive

PYPL rose above both its 11-month and 7-month downtrend lines in August. The gap higher in August also marked a breakout from 2-month resistance at the 90 level (zoom chart). The zoom chart also reveals that PYPL has now formed a pattern of higher lows and higher highs since mid-June=uptrend. The long-term chart shows that PYPL is still far below the next long-term resistance level, which is around 140 (47% higher than Tuesday’s close.

CDAY rose above its 8-month downtrend line in July. Even after the recent rally, CDAY is still down over 50% from its 2011 highs. A gap higher in August pushed CDAY above 3-month resistance at the 57 level. TPA recommended CDAY on 8/2/22 and closed out the rec up 22% a week later and it was overbought. CDAY is now at support from its 2-month uptrend line (zoom chart).

RRG analysis shows that CDAY has moved out of the Improving quadrant and has just entered the Leading quadrant. CDAY was one of the Top 20 in this week’s TPA-RRG Report (see RRG below).

  • PINS rose above its steep 23-month downtrend line in August. PINS is still down 72% from its February 2021 highs. Chart 2 shows that the gap higher day in August also put PINS above its 6-month downtrend line. PINS has put in a pattern of higher lows and higher highs since the send of July=uptrend (zoom chart).

RRG analysis shows that PINS has moved out of the Improving quadrant and has just entered the Leading quadrant. PINS was one of the Top 20 in this week’s TPA-RRG Report (see RRG below).

Relative Rotation Graphs (RRG) – explanation video

RRG – written explanation


Click on the image below for the full report and all charts….

Options Expiration On Friday: Buckle Up

This Friday’s quad witching options expirations can generate a lot of market volatility. At the end of each quarter, the options markets’ align, and the options for futures, stock futures, indexes, and individual stocks expire on the same day. During quad witching options expiration, trading volumes are heavy, and volatility often spikes as options traders simultaneously cover or roll their options.

Friday’s option expiration of equity options is unusually large. As we share from Goldman Sachs, about $3.2 trillion notional of options are expiring. Almost two-thirds of the contracts directly impact the S&P 500. As we discussed in yesterday’s Commentary, options traders are close to neutral gamma in aggregate. While that argues that hedging needs are minimal, they can exponentially change as stocks rise or fall. Therefore, market moves may be exaggerated due to options expiration. Be careful not to read too much into this week’s price action!

options expiration quad witching

What To Watch Today


  • 7:00 a.m. ET: MBA Mortgage Applications, week ended September 9 (-0.8% prior)
  • 8:30 a.m. ET: PPI final demand, MoM, August (-0.1% expected, -0.5% prior)
  • 8:30 a.m. ET: PPI excluding food and energy, MoM, August (0.3% expected, 0.1% prior)
  • 8:30 a.m. ET: PPI final demand, year-over-year, August (8.8% expected, 9.8% prior)
  • 8:30 a.m. ET: PPI excluding food and energy, year-over-year, August (7.1% expected, 7.6% prior)



Market Trading Update – The Best Laid Plans

Well, sometimes things don’t work out as anticipated. Yesterday, we discussed the more bullish setup to the market, with the MACD very close to triggering a “buy signal” and markets above important moving averages. However, the “hotter” than expected inflation report reversed all that and wiped out the last 4-days of gains with a brutal dive in the markets by the end of the day of more than 4%. Such seems a bit excessive given that it didn’t change the Fed’s trajectory of higher rates, but the markets had been hoping for some data to slow the pace. Alas, that was not the case. Today, we have the PPI report, which may show some softness as seen in some of the manufacturing indices, so maybe that will give the bulls something to hang onto.

For now, markets did reverse the previous 4-day gain and are now back to support from last week. Notably, the oversold conditions have returned. Notably, the current support levels need to hold, or as noted previously, a retest of lows is very likely. As noted above, with huge options expiration on Friday, the rest of this week could be bumpy. Buckle up for now.

Market trading update

CPI Comes In Hotter Than Expected

Both headline CPI and core CPI came in above expectations. Monthly CPI rose 0.1% versus expectations of a 0.1% decline. Many market pundits thought the data would show an even steeper decline than expected. Core CPI, which excludes food and energy and is, therefore, stickier inflation, is the focus of the Fed’s attention. Core CPI YOY is now 6.3%, a 0.4% increase from last month. Shelter prices are up 0.7%, a new high for this cycle. They last reached that level in 1991. Shelter, predominately rental prices, constitutes about 40% of CPI.

The Fed Funds futures markets are pricing in a 100% chance for a 75bps rate hike next week. Further, it is pricing a 20% chance the Fed will raise rates by 100bps.

cpi inflation shelter
cpi inflation shelter

Are Equity Valuations Too High?

Jurrien Timmer of Fidelity posted the graph below. It shows the trailing 12-month P/E on the S&P 500 may be a few points overvalued based on two-year yields. As he writes:

Despite strong earnings, the rally from June lows led to a significant valuation creep. The key for this cycle: As the two-year yield goes, so goes the P/E ratio. The S&P 500 gave back two P/E points during the latest down leg, but it’s still more than three points overvalued.

S&p 500 equity valuations

Jobs Fully Recovered

Two weeks ago, the BLS reported the economy added 315k jobs. Those gains mark a full jobs market recovery from covid. While the total number of jobs is up 240k since February 2020, the mix of jobs has changed markedly. As we show below, the CRFB reports the leisure and hospitality industry lost 1.2 million jobs over the last 2.5 years. At the same time, over one million jobs were gained in the professional and business service industries. Transportation and warehousing businesses added about 750k jobs. This is primarily due to the shift many consumers made to order goods online for delivery. With the pandemic largely passed, will consumers continue to prefer online shopping, or will brick-and-mortar retail see bigger gains over the coming year?

jobs recovery

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Yields are Defying Yesterday’s Logic

Many astute bond investors are baffled by rising bond yields. Economic activity is slowing, inflation expectations are falling, the Fed is aggressively fighting inflation, and QT has begun. In the past, those factors were a surefire recipe for a rip-roaring bond rally. Today bond yields defy yesterday’s logic.

Clearly, something else is at play, and we think we know what it is.

Before we share our theory on why bond yields are rising, let’s review how very dependable yield relationships have been turned on their head this year.

Economic Activity and Bond Yields

Bond yields are predominately a function of economic activity, expected inflation rates, and the balance between the supply and demand for bonds. 

Economic activity correlates well with bond yields for a couple of reasons. When the economy slows, inflation tends to weaken, thus making bond yields more attractive. Second, in times of economic weakness and uncertainty, investors often reduce exposure to risky assets in favor of more conservative ones, such as Treasury bonds.

The graph below shows the relationship between the ISM Manufacturing Index, a strong proxy for economic activity, and ten-year UST yields. Before 2022 the positive correlation was relatively strong. As we circle, the relationship has reversed this year. Yields are rising despite weaker ISM readings.

The second graph uses the same data but displays it in a scatter plot. The divergence between the relationship in 2022 versus the prior seven years is stunning.

ism economy yields
economic and yields

Before 2022, an increase in economic activity, therefore higher ISM readings, generally resulted in higher yields. In 2022, weaker ISM data is accompanying higher bond yields. 

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Inflation Expectations and Bond Yields

Most bond investors seek a yield above the expected inflation rate. If not, they are effectively losing purchasing power. Given this reasoning, higher inflation expectations should cause investors to demand higher yields and vice versa.

Like the relationship between ISM and yields, the connection between yields and inflation expectations was positively correlated before 2022, as we share below. This year, however, something is amiss.

Ten-year inflation expectations started this year at 2.46%. They are currently at 2.51%. Yet, ten-year yields have doubled over the same period from 1.47% to 2.90%. As a result, real yields have surged by almost 1.50%.

The data in scatter plot form in the second graph shows the relationship this year is counter to what has been the norm.

inflation and yields
inflation and yields

Supply and Demand

Some investors believe that heavy Treasury issuance is oversupplying the bond market and leading to higher yields. The reality is that Treasury issuance net of Federal Reserve purchases or sales is growing at a slightly sub-average rate. The one-year change in net issuance this year has averaged almost +4%. That compares favorably to over +6% from 2004 to 2021.

Historically, more debt issuance often accompanies lower bond yields. While counterintuitive, the Treasury tends to increase its debt load when the economy ails. This is often the result of more stimulus spending and reduced tax revenue. As previously noted, weak economic growth and lower inflation often result in lower bond yields.

supply yields treasury fed

Contrary to history, net debt issuance is relatively low this year, but the correlation between net supply and yields is the opposite of what investors have grown accustomed to.


It Must be QT

You are probably wondering about the elephant in the room, Quantitative Tightening (QT). Like debt issuance and bond yields, the relationship between Fed bond transactions and bond yields is counterintuitive. Bond yields tend to rise when the Fed buys bonds (QE) and fall when it is inactive or reduces its holdings (QT).

There is a sound rationale behind this seemingly irrational relationship. When the Fed buys bonds, they provide liquidity to markets. As such, the equity markets tend to rise and, in doing so, attract bond investors. The term “risk on” and QE are synonymous with each other.

When the Fed sells bonds (QT), they remove liquidity. Over time this leads to equity volatility and pushes investors to the safety of low volatility assets like bonds. This environment is called “risk off.”

The graph below shows bond yields often rise during QE and fall during QT or when the Fed is inactive. Unlike the prior episode of QT or the periods where the Fed was doing nothing, bond yields are rising.

yields qe qt

Who is Selling and Why

As we highlight with numerous examples, the once dependable relationships of bond yields to economic and supply/demand factors are not holding up this year.

There is a new factor pushing yields higher. To shed light on whom or what it might be, we share a portion of a SimpleVisor update explaining a trade we did on September 7, 2022.

The euro has lost 12% to the U.S. dollar this year, while the Japanese yen has ceded nearly 20%. Those losses may not seem out of the ordinary compared to stocks or even bonds, but they are. Foreign exchange markets tend to be much less volatile. 

A weak currency versus the dollar is often good for a country as it makes its exports more price competitive. However, a weaker currency makes imports more expensive. Given soaring inflation rates, especially energy prices, this instance of a stronger dollar is wreaking havoc on Europe and Japan.

Making matters worse, many foreign borrowers borrow in dollars. If they don’t hedge the currency risk, as many do not, a strong dollar results in higher interest and principal payments. Simply, they must acquire more expensive dollars to pay interest and principal. As such, a strong dollar is a de facto tightening of global monetary policy.

Europe is doing everything possible to solve its energy crisis, but its options are limited as it is primarily a supply problem. While alleviating supply challenges is difficult, they can reduce the cost with a stronger currency.

We suspect that the ECB and BOJ have been selling dollar assets, predominately Treasury bonds, to prop up their currencies.

The graph below shows the strong negative correlation between ten-year UST yields and the Euro and Yen.

yields euro yen

Fed and Currency Swaps to the Rescue

Further in the commentary, we write:

In the past, the U.S. Treasury helped foreign countries manage their currencies via currency swap lines. Swap lines are off-market currency trades that allow countries to better manage their currency instead of selling dollar assets or printing their currency.

Given the sharp dollar appreciation and acute energy and inflation problems, we think the Treasury will reopen swap lines. Once open, the nations will not need to sell Treasury bonds. Further persuading the Treasury to curb dollar appreciation, they have significant funding needs, and the Fed is reducing its holdings of Treasury debt. The growing supply of bonds from the Fed and the Treasury creates a powerful desire to cap yields.

Essentially swap lines kill two birds with one stone.

Such action should cap U.S. yields and help limit inflationary pressures in Europe and Japan. Equally important, it helps defuse what is slowly becoming a financial crisis in those countries.


Tried and trustworthy relationships are failing bond investors. While powerful and concerning, we think the abnormal relationships are temporary. When the supply and demand for bonds normalize, bond investors will likely realize that economic, inflation and other factors warrant much lower yields.