Monthly Archives: June 2021

Junk Bonds Have No Fear

A recession is very unlikely if the only recession gauge one was following is the spread of junk bond yields to U.S. Treasuries. Typically, leading up to a recession, junk bond spreads versus Treasuries increase as earnings waver and the risk of default increases. Despite a very aggressive Fed, higher borrowing costs, and weakness in equities, junk bond spreads are hovering near their pre-pandemic averages. The graph below shows the yield spread of BB-rated junk bonds to U.S. Treasuries is nearly 1% above its 2021 lows but slightly below its pre-pandemic average. Further, as shown in blue, the average spread between junk and investment-grade (BB and BBB) bonds is also near historical averages.

There is no stress in the corporate bond markets. As we saw in 2020 and 2015, financial stress and instability can happen quickly, and junk bond yield spreads can rise rapidly. Investment grade and junk bond spreads to Treasuries are an important gauge the Fed closely follows. Seeing that spreads are normal likely gives the Fed confidence that they can continue to raise rates.

junk bond breadth spreads

What To Watch Today


  • Dallas Fed Manufacturing Activity, November (-23.0 expected, -19.4 prior)


  • No notable earnings reports

Market Trading Update

This past week, the market jumped to the top of its recent trading range and continues to work in a consolidative manner. While the MACD “buy signal” is overbought, the market’s momentum is still bullish. The 200-dma will provide the next level of serious resistance.

Market Trading Update

Most notably, the number of stocks trading above their respective averages continues improving. While this is bullish, it is also typical, at these levels, to align with short-term market peaks.

Market Breadth stocks above moving averages

One issue challenging this rally remains the drop in the volatility index. As noted last week, net bullishness rose to the highest level since the July rally. That bullish increase coincides with a sharp decline in the volatility index as investors think the “bottom is in. So far this year, a reading of 20 or below has provided a good signal to take profits and reduce risk.

Market vs volatility index

As noted, the Wednesday rally followed the release of the FOMC minutes, which read more “dovish.” While there was no mention of a “pivot” or a “stall,” investors seem to like the idea of a slower pace of rate hikes. However, traders overlooked the Fed’s statement they will increase rate hikes in 2023.

The rally reversed a majority of the previous oversold conditions and net bearishness. Therefore, some profit-taking and risk reduction in portfolios remain prudent. While the expectation for a rally into year-end remains, we could see some selling in the first half of December from tax loss harvesting and portfolio rebalancing. Such will likely provide a tradeable opportunity into year-end and the beginning of 2023.

The Week Ahead

The next two weeks will be important as the Fed and investors will see the latest inflation and employment data. ADP on Wednesday and the BLS Jobs Report on Friday are expected to show the labor force grew by about 200k jobs in November. Besides the recent uptick in jobless claims, nothing leads us to believe labor data will be disappointing. However, there are an increasing number of corporate layoff actions. Therefore a lower-than-expected number and increase in the unemployment rate should not come as a total surprise.

The Fed’s preferred inflation gauge, PCE, will be released on Thursday. Expectations are for the monthly core PCE to remain the same as last month at 0.5%. The year-over-year rate is expected to decline to 4.9% from 5.1%. Investors hope PCE comes in below expectations, as CPI did a few weeks ago.

Chairman Powell will speak at 1:30 PM ET on Wednesday. He has been quiet since the last Fed meeting, so this engagement allows him to update investors on the Fed’s path ahead.

Improving Market Breadth

The graph below from Bank of America provides a little optimism. Breadth is improving, and a bottom might be forming in the S&P 500. Throughout the decline in 2022, the percentage of S&P 500 stocks trading above their 200dma was trending lower, similar to the index. With the recent rally, the percentage of stocks trading above their 200dma is now above the prior peak. The higher high in the breadth indicator introduces a positive divergence. Ideally, we want to see the S&P 500 trade above the 200dma to confirm this signal. The 200dma capped the prior rally. Caution is warranted as the S&P 500 rose above it for a short period during the April rally, but it turned out to be a trap for bulls.

S&P 500 market breadth

Fed Tightening Cycles

The graph below compares the current Fed tightening cycle to the previous four. The recent 3.75% increase in nine months is more aggressive than the previous four. However, when assessing the amount of tightening, we must also consider the rate itself. Even with the sharp increase in Fed Funds, Fed Funds only stands at 3.75%. That is decently higher than the prior hiking cycle ending in 2018, when the terminal rate hit 2.5%. But it remains well below the prior three. Fed Funds topped at 6.0%, 7.0%, and 5.5% in chronological order from 1994 to 2006.

fed tightening cycles

Tweet of the Day

rosenberg tweet um sentiment

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Continuing Jobless Claims and Recessions

The most closely followed measures of employment tend to be lagging indicators. However, there is one indicator that assesses the labor market in near real-time. Initial and continuing jobless claims, published weekly, provide up-to-date information on the number of employees recently fired and their ability to find new jobs. While understanding how many people are being let go is important, the health of the labor market is best gauged by how quickly those recently unemployed find new work. Therefore, continuing jobless claims provide valuable and current insight into the labor market’s health.

Continuing jobless claims have been ticking higher since May but are still below pre-pandemic levels. Weekly data can be volatile, especially around the holidays. Therefore, we present the graph below, which shows the three-month percentage change in continuing jobless claims. As noted by the dotted line, a recession occurred each time the percentage change in continuing jobless claims rose above 10%. Since June 2020, the three-month change in the number of continuing claims has been negative. In July, that number flipped to positive. It is now quickly creeping up to 10%. The number of claims and continuing jobless claims remains low, but the rate of change in both is picking up and bears watching closely in the coming months.

continuing claims

What To Watch Today


  • The market is only open until 1 pm Eastern Time.


  • No Notable Earnings Releases

Market Trading Update

The market traded nicely higher on Wednesday ahead of the Thanksgiving holiday. Again, don’t read too much into it, as the volume was light, and professional traders were mostly absent. However, the market dipped ahead of the release of the FOMC minutes and then rallied back to the day’s highs on some “dovish” reads that the Fed will now reduce the pace of rate hikes. However, the Fed did suggest they could hike rates more than expected next year, which seems to bypass traders that this was NOT a pivot in monetary policy. The Fed is still hiking rates which will negatively impact economic activity in 2023.

Nonetheless, market action remains bullish but is now getting extended. Take profits for now. If the market can break above the 200-dma, we will reassess our positioning but will need confirmation of that breakout before increasing risk exposure.

Market Trading Update

S&P 500 – The Moment of Truth

Heading into year-end, the S&P 500 faces tough resistance. The top graph shows the strong downward-sloping resistance line starting at the late 2021 record high. Conversely, the lower chart shows that the VIX volatility index has followed an opposite path, bouncing off a rising support line. A definitive breakthrough in both lines, and the S&P 500 rising above key moving averages, would provide a little comfort that the 2022 downward trend may be over. However, if both indexes repel the technical lines, new lows on the S&P 500 are certainly possible.

S&P 500 VIX

Divergence at the Fed

Based on the most recent FOMC minutes, there may be a growing divergence of policy thinking at the Fed. Per Bloomberg:

There may be signs of growing divisions on the (FOMC) committee. A group led by Fed Vice Chair Lael Brainard- the most dovish committee member, in our view – still believes inflation is largely transitory, and is more concerned about the employment outlook. Another group believes inflation is more persistent and the Fed still has a long way to go on rates. We think Chair Powell is in the second group.

Powell leads the Fed and will push his views as those of the Fed. However, his job as the Fed Chair is to align the members’ policy prescriptions and find common ground. We may see Powell become a little less hawkish to keep a large majority on the same page.

Shrinking Margins Ahead

The graph below shows that companies are finding it increasingly harder to pass on inflation to their customers. Sales remain near record highs in large part due to inflation. However, earnings are no longer keeping pace with sales. As a result, corporate earnings margins are slipping. Our Tweet of the Day also eludes to the possibility of shrinking margins.

margins earnings sales

Tweet of the Day

corporate margins

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Financial Stability or Is Something Breaking?

Recently we have noted that the odds are increasing that financial instability, or as we say, “something breaks,” is the likely culprit to force the Fed to reverse course. Given the strong link between Fed policy and asset prices, it’s valuable to appreciate how the Fed monitors financial stability. The illustration below categorizes the four factors the Fed assesses in its Financial Stability Report. The red-shaded areas provide a current update on the four financial stability categories. While conditions can change rapidly, there are few signs of financial instability rearing its ugly head.

Some may argue that stock and bond prices are down 15-20%, which does not portend financial stability. However, as noted, they have been offset to some degree by rising home prices. If stock and bond prices stay down and house prices start falling as many expect, we might see one of the four financial instability measures trigger a warning. However, such would likely not be enough for a pivot unless stock and or bond prices decline further from current levels. As for the three other categories, there is nothing concerning at the moment, but conditions can change quickly.

financial stability

What To Watch Today


  • 7:00 a.m. ET: MBA Mortgage Applications, week ended Nov. 18 (2.7% prior)
  • 8:30 a.m. ET: Durable Goods Orders, October preliminary (0.4% expected, 0.4% prior)
  • 8:30 a.m. ET: Durables Excluding Transportation, October preliminary (0.0% expected, -0.5% prior)
  • 8:30 a.m. ET: Initial Jobless Claims, week ended Nov. 19 (225,000 expected, 222,000 prior)
  • 8:30 a.m. ET: Continuing Claims, week ended Nov. 12 (1.520 million prior)
  • 9:45 a.m. ET: S&P Global U.S. Manufacturing PMI, November preliminary (50.0 expected, 50.4 prior)
  • 9:45 a.m. ET: S&P Global U.S. Services PMI, November preliminary (48.0 expected, 47.8 prior)
  • 10:00 a.m. ET: University of Michigan Consumer Sentiment, November (55.0 expected, 54.7 prior)
  • 10:00 a.m. ET: New Home Sales, October (570,000 expected, 603,000 prior)
  • 10:00 a.m. ET: New Home Sales, month-over-month, October (-5.5% expected, -10.9% prior)
  • 2:00 p.m. ET: FOMC Meeting Minutes, November 1-2



Market Trading Update

Yesterday, the market traded all day positively, building on the gains from the morning open. As noted previously, there is little volume this week due to the holiday-shortened trading week, so don’t read too much into yesterday’s action. The market has been trading in a consolidation pattern for the last two weeks, and a rally tomorrow will set up a test of the 200-dma, which has acted as important resistance to the market all year. A confirmed break above the 200-dma would suggest a continued rally higher, but there are still many headwinds currently facing asset prices.

Market Trading Update

While the bulls are getting excited short-term by the action, the longer-term picture remains challenging, with numerous weekly moving averages sitting just above the market. We still suspect a rally into year-end, but the beginning of next year will likely be more challenging. Continue to use rallies to raise cash and rebalance positions heading into year-end.

Market trading update weekly.

Another Day, Another Recession Warning

The graph from Charles Schwab shows that the Conference Board’s Leading Economic Indicators (LEI) is -2.7%, below -2.2%, the average start of recessions since 1960. The second chart shows the factors that make up the LEI. It shows that market indicators for a recession portend flat growth. Non-financial indicators are flashing red. Of note, the biggest drag to the LEI index is Consumer Expectations. Consumer consumption accounts for almost two-thirds of GDP, so it is not surprising consumers’ dour outlook raises the odds of a recession.

lei recession alert
recession indicators

Inflation Set To Plummet

The graph below shows the robust correlation between the NFIB (small business owners survey) and CPI. Assuming the correlation holds up as it has for the last 20 years, we should expect inflation to normalize quickly. It is worth caveating that the reasons for inflation today are unlike any prior experiences of the last 20 years. While we think inflation will decline, we are not sold it will be as much or as fast as the graph portends.

inflation nfib

Crypto vs. Sub-Prime, Perspective Matters

Joe Weisenthal of Bloomberg, in his daily commentary, reminds us there is a vast difference between the popping of the cryptocurrency bubble and the subprime/mortgage meltdown of 2007-8. People need housing. Nobody needs cryptocurrency. Accordingly, there is a natural bottom to home prices and, therefore, a limit to losses for mortgage debt investors. In contrast with crypto, “There’s no obvious circuit breaker or curb to stem the decline.”

Tweet of the Day

tweet 200 week moving average

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Coinbase Bankruptcy Risks Rise

On April 14, 2021, shares of Coinbase, a cryptocurrency broker/custodian, were first publically traded. The shares peaked at $429.50 a share that day, well above the reference point of $250 set the night before. Since peaking in its first hours of trading, Coinbase has grossly underwhelmed expectations. Coinbase shares are now down nearly 90% from the intraday peak and under severe pressure due to FTX’s bankruptcy and the poor performance of cryptocurrencies.

Further stoking concerns, Coinbase bonds are under similar pressure. The graph below charts the price of a 2028 Coinbase bond issued with a coupon/yield of 3.375%. The bond is now trading at 54 cents on the dollar, making its yield north of 15%. Accordingly, the bond market is pricing in a decent chance of bankruptcy. While removing FTX as a competitor may be good for Coinbase, evaporating confidence and skepticism in crypto and its infrastructure are weighing on the entire industry.

coinbase bonds

What To Watch Today


  • 10:00 a.m. ET: Richmond Fed Manufacturing Activity Index, November (-8 expected, -10 prior)



Market Trading Update

With the holiday-shortened trading week upon us, the market drifted sideways yesterday, still holding above key support of the 100-dma. The 20-dma is rapidly approaching the 100-dma, which provides additional support at that level. We reduced some additional risk yesterday in portfolios and raised some more cash, as we have suggested for the last couple of weeks. The rally is getting a bit long, and after the holidays, we could see some tax loss harvesting and mutual fund rebalancing lower stocks a bit. However, this week, don’t pay too much attention to the overall action as it is low volume and will likely have little direction.

Market Trading Update

Spinning Tops and the Latest Rally?

A spinning top is a technical pattern using candlestick charts. The illustration below shows that a spinning top denotes a period where the market opens and closes at similar levels. Still, within the period, it witnesses significant upward and downward volatility. A spinning top represents indecision and tends to be more relevant in trending markets. Per Think Markets:

In a strong uptrend or downtrend, the spinning top shows there is a new balance of forces in the price action. Unlike the previous sessions, where one side dominated the market and pushed the price action in its desired direction, a spinning top signals that the opposite side of the market is now growing in the game, and the short-term outcome is uncertain.

As with almost all candlestick patterns, the role of the next candle is important.

In case of a reversal, the candle next to the spinning top should be opposite of the prevailing trend, while for continuation patterns, you look for a candle that goes in the same direction to confirm that the price action is continuing in the same direction.

bullish bearish spinning tops

We introduce spinning tops as they have marked the peaks in the recent trend channel, as shared below. After setting a record high in late 2021, the S&P 500 proceeded lower in downward movements and sharp relief rallies. The first two rallies, using weekly charts, were capped by spinning tops. Does last week’s spinning top candle signify the recent bounce is over?

spinning tops s&p 500

Bullish and Bearish Market Analogs

Market analogs compare chart patterns from two periods to help forecast the future. Some believe that prior trends and patterns often repeat themselves. One popular analog today is a comparison of 2008 to current conditions. The first chart below shows that the year’s sell-off remains similar to 2008. This bearish analog suggests a significant decline ahead.

The second set of graphs presents a more bullish analog. The decline this year has formed a declining trend channel. The top resistance line connects the three lower highs. Support is formed by connecting the two lower lows. 1981-1982 played out similarly, with three peaks and troughs defining the channel. Ultimately the third low was the final low, and the market broke upward through the channel. By mid-July 1982, when it broke out of the channel, inflation was still hot at 6.5% but well below the recent high of 14.5%. Inflation is showing signs of peaking and declining, albeit at much lower levels than in 1981. Analogs can be helpful at times but are often right until proven wrong.

2008 market analog
1982 analog
1982 analog 2022

Crude Oil Keeps Falling

Crude oil fell over 5% Monday morning on a report that OPEC may boost production by half a million daily barrels. Within hours the report was rebuked, and crude oil erased the morning’s decline. While trading has generally been bearish over the last few weeks, President Biden may supply a bid to the market as he seeks to replenish the Strategic Petroleum Reserves (SPR).

crude oil

Tweet of the Day

small cap tweet

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More Bearish Market Action Before The Bull Can Run

Following the weaker-than-expected October inflation report, stocks surged on hopes the Fed will pivot” sooner than later. As we discussed recently, a “policy pivot” is not necessarily bullish but instead suggests more bearish market action will come first. To wit:

“Such leaves only two trajectories for monetary policy. The first option is for central banks to pause rates and allow inflation to run its course. Such would potentially lead to a softer landing in the economy but theoretically anchor inflation at higher levels. The second option, and the one chosen, is to hike rates until the economy slips into a deeper recession. Both trajectories are bad for equities. The latter is substantially riskier as it creates an economic or financial “event” with more severe outcomes.

While the U.S. economy has absorbed tighter financial conditions so far, it doesn’t mean it will continue to do so. History is pretty clear about the outcomes of higher rates, combined with a surging dollar and inflationary pressures.”

Monetary conditions index vs market

The “monetary policy conditions index” measures the 2-year Treasury rate, which impacts short-term loans; the 10-year rate, which affects longer-term loans; inflation which impacts the consumer; and the dollar, which impacts foreign consumption. Historically, when the index has reached higher levels, it has preceded economic downturns, recessions, and bear markets.

Not surprisingly, the tighter monetary policy conditions become, the slower economic growth tends to be.

Graph of monetary policy conditions index vs. GDP

The bullish expectation is that when the Fed finally makes a “policy pivot,” such will end the bear market. However, while that expectation is not wrong, it may not occur as quickly as the bulls expect.

Notably, the monetary policy conditions index suggests that more bearish action is likely before the next bull market cycle can begin.

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Outlook Remains Bearish For Now

Investors are dealing with a bearish market for the first time in over a decade. Such is something that many investors in the stock market today have never witnessed firsthand. Nonetheless, it has been a challenging year on many fronts, given the enormous number of negative days and increases in daily volatility.

However, we warned this could be the case in 2021 when we discussed that “low volatility begets high volatility.”

“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.”

(I have updated the chart to the present.)

Graph of daily point change of S&P Index

While periods of high volatility eventually subside, the bearish period for stocks is ultimately tied to the monetary conditions present in the economy at the time. If we invert our monetary conditions index and compare it to the annual changes in the price of the S&P 500 index, the correlation becomes apparent.

Graph of annual change in S& P 500 earnings vs monetary policy conditions index

As should be expected, with the Federal Reserve aggressively hiking rates and the US dollar index surging in 2022, monetary conditions are extremely tight. Such suggests that until those monetary conditions reverse, the market will continue to trade within a bearish trend. Such is because, as should be apparent, tighter monetary conditions reduce corporate earnings and profit margins.

Graph of annual change in S&P 500 earnings vs. monetary conditions index

The strong dollar alone is problematic for companies with foreign sales, which account for nearly 40% of corporate revenue. However, adding to that risk, higher borrowing costs, wages, input prices, and the ability to maintain margins in a slower economic environment becomes exceedingly difficult.

Therefore, it should be unsurprising that stocks will need to reprice lower in the coming year to adjust for slower earnings growth.

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7-Rules To Navigate The Final Leg Of A Bearish Market

While anything is possible in the near term, complacency has quickly returned to the market. Investors are very optimistic that the Fed will pivot and the next bull market will start. However, there are numerous reasons to remain mindful of the risks.

  • Earnings and profit growth estimates are too high.
  • Deflation will become more prevalent
  • The Fed will continue to hike rates.
  • Economic data will surprise on the downside.
  • Consumer spending will slow.
  • Inventory overhang will impact manufacturing.
  • Valuations remain high by many measures.
  • The risk of a credit-related event is rising.

So what do you do?

We remain optimistic about the markets due to share buybacks, seasonality, and bullish sentiment. As we have repeatedly stated, the market could rise to between 4000 and 4100 by year-end. However, as we enter 2023, we remain concerned about the broader macro risks and the risk the Federal Reserve will “break something” by hiking rates too much. Such keeps us cautious, so we continue reiterating the importance of remaining unemotional and focusing on managing portfolio risks.

  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 about 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. You will sell many positions 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.

Everyone approaches money management differently. Our process isn’t perfect, but it works more often than not.

The important message is that this bearish cycle will end, and the next bull cycle will begin.

Remember, if you “run out of chips” beforehand, you are out of the game.

Will The World Cup Kick Off Weakness?

Markets were spared when the Houston Astros won the world series. As we highlighted in the 10/12/2022 Commentary, markets tumbled every time a Philadephia professional baseball team won a championship. Should we be anxious as the 2022 World Cup kicks off?

To see how the World Cup may sway markets, we share research from Is There a Correlation Between World Cups and the S&P 500? written by Ralph Baddour. He uses four trading strategies, which vary slightly by the starting and ending trade dates. The S&P 500 return for the four strategies ranged from -1.86% to -2.47%, with a mean return of -2.11%. Baddour’s World Cup trading advice:

Therefore, the ideal trading strategy for the S&P 500, as suggested by these empirical results, is to short the index prior to the start of a World Cup and cover the position immediately following the tournament’s final match.

The World Cup, like Philadelphia baseball, has zero effect on the fundamental or technical underpinnings of markets. However, as Baddour writes:

Whether it’s the potential for worker and investor distraction, or effects on investor morale (positive or negative, depending on which team one is supporting) spanning multiple weeks, there is clearly the possibility of a calendar effect tied to the World Cup, scheduled every four years.

world cup

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What To Watch Today


  • No Notable Releases Today



Market Trading Update

This week, the market touched our initial objective of 4000, but as we will discuss momentarily, tough talk from Federal Reserve officials knocked the markets back a bit. However, despite those comments, the sell-off was mild, holding above key supports heading into the holiday-shortened and light volume trading week where the “inmates will run the asylum.”

Market Trading Update.

The good news is that the market tested, and held, 100-dma with the 20-dma crossing above the 50-dma. With the market contained in a rising trend channel, this all suggests the bulls remain in control for the time being. Speaking of “inmates,” the net bullishness of investors is now at the highest level since the July market peak.

Net investor bullishness

With next week a holiday-shortened trading week, a continued advance through the end of the month is likely.

The Week Ahead

The week ahead will be quiet heading into the Thanksgiving holiday. A slew of data will be released on Wednesday, including jobless claims, durable goods, new home sales, and the University of Michigan Consumer Sentiment Index. We will focus on jobless claims and, in particular, continuing claims. This data point helps us understand how quickly recently laid-off people can find new employment. The figure remains historically low, but it has been rising since June. Of all employment indicators, this is often the first to signal changes in the labor market.

We suspect a few more Fed members will emphasize the Fed’s hawkish position. Further, the FOMC minutes, due on Wednesday, from the last meeting will likely stress the Fed’s sole intention to fight inflation with an extremely tight monetary policy.

continuing jobless claims

Housing Market Standstill

The housing market has ground to a halt as many sellers are unwilling to drop prices enough to compensate potential buyers for higher mortgage rates. With mortgage rates around 7%, mortgage payments have risen sharply. Consider the graph below to stress how mortgage rates have affected homebuyers’ payments. As it shows, a homebuyer wanting to buy a median-priced home with a mortgage payment equal to 30% of their income must have an income of $107,000. At the start of 2021, less than two years ago, the same buyer would only have needed about $62,000 to buy the same house. The combination of higher prices and mortgage rates puts the real estate market at a standstill. This will likely continue until house prices and mortgage rates decline to more economically feasible levels.

Housing market standstill

A Bearish Signal with Bullish Implications

The graph below plots the number of positive trading days per the prior 252-day periods going back 50 years. Over the last 252 trading days, only 111 days, or 44%, have been positive. The red diamonds highlight that such a low occurrence has only happened three other times, two of which were over 40 years ago. From oldest to newest, the annual return for the next 252 trading days following those highlighted lows are as follows: +28.02%, +57.73%, and +40.36%. Therefore, we may have quite a rally in the coming year if this indicator proves worthy.

bearish bullish trading days positive

Tweet of the Day

onshoring trade

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Tech Layoffs, Who Cares?

Meta cut 11,000 jobs. Twitter let 3,700 employees go. Stripe, Coinbase, and Microsoft all fired about 1,000 employees. The list of tech layoffs continues, and the media is hyping it. While the number of announcements of tech-related layoffs seems problematic, should we care about it from a broader macroeconomic viewpoint?

Per the BLS, information technology jobs constitute 1.8% of the workforce. Even in a depression where half of those jobs could be lost, the unemployment rate would only rise by 0.9%. During the 2008 recession, the unemployment rate increased by 4.5%. So while tech layoffs make for great headlines and likely attract many readers, they do not represent a big enough part of the economy to overly worry about. Further, many tech companies overstaffed over the last two years. Some of these layoffs are not necessarily economic warnings but a normalization of staffing to better match normalizing demand for tech products.

tech layoffs

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What To Watch Today


  • 10:00 a.m. ET: Existing Home Sales, October (4.40 million expected, 4.71 million prior)
  • 10:00 a.m. ET: Existing Home Sales, month-over-month, October (-6.6% expected, -1.5% prior)
  • 10:00 a.m. ET: Leading Index, October (-0.4% expected, -0.4% prior)



Market Trading Update

Tough talk from Fed officials (Daly and Bullard) put investors in a sour mood yesterday as the “pivot” was pushed out. While the market ended lower yesterday, the was buying in the early afternoon, with the market almost returning to breakeven before selling off into the close. This kind of action is bullish from a short-term standpoint and suggests that buyers continue to bid for stocks even on down days.

After running into the top of the rising trend channel, the market is seemingly in a healthy correction process. The market held support at the 50-dma, and the 20-dma is just below, which also defines the current uptrend. If these supports hold, another rally attempt into month-end will not be surprising. However, we suggest using any such rally to reduce risk and rebalance portfolio exposures. We suspect we could see some heavier selling in the first two weeks of December, which could retest recent lows.

Market trading update

December 15th- Dot Plot Warning

The Fed has numerous ways to convey its policy expectations to the market. The FOMC meetings, associated press conferences, and speeches and articles garner significant attention and alert investors to what the Fed is thinking. Not followed as closely are the quarterly Fed “dot plots.” The dot plots are each Fed member’s expectations for the Fed Funds rate, GDP, unemployment, and inflation. The September Fed Funds dot plot below is the latest release. The median estimate for year-end 2022 was 4.4%. The rate increases to a peak of 4.6% in 2023. Note that six members, at the time, thought Fed Funds would peak at 4.875% in 2023. As we share below, we believe the December 15th dot plots have the potential to stun the markets.

fed dot plots

The Fed Funds futures market is in line with the September dot plots. The implied Fed Funds curve peaks in April at 4.91 and falls to 3.60 in two years. Recent comments by Fed President Esther George, shown below, make us think the Fed might use the dot plots in December to shock the markets. Pay close attention to the second paragraph. If the Fed takes this route, they might raise the terminal rate well above 4.91% and or increase 2024’s expectation to convey the Fed will not be pivoting anytime soon.

esther george dot plot

Bullard Piles on to the Hawkish Rhetoric

St. Louis Fed President Jim Bullard sent shivers through the markets on Thursday. In his presentation, he states:

“The policy rate is not yet in a zone that may be considered sufficiently restrictive.”

The graph below, from his discussion, claims a rules-based approach to monetary policy suggests the Fed Funds terminal rate should be above 5%. That rate may be as high as 7%. Stocks immediately fell upon learning that Fed Funds may increase more than anyone expects.

bullard fed fomc

Foreigners Selling Treasury Bonds

We have noted in the past the likelihood that foreign nations are selling their holdings of U.S. Treasury bonds to help support their currencies versus the dollar. The latest round of data shows that this is indeed occurring. Foreign holdings of U.S. Treasuries fell to $7.297 trillion in September from $7.571 trillion a year ago. The largest holder, Japan, shed $179 billion of Treasury bonds. China, the second largest holder, sold $113 billion.

The problem is not just their selling. They are selling while the supply of bonds is increasing rapidly. Total debt outstanding rose by $2 trillion over the last year. Further, the Fed has added another $200 billion in its actions to reduce its balance sheet. We are bullish bonds because we think the Fed ultimately breaks something and causes economic deterioration and much lower inflation. However, we are mindful that the supply outlook is a factor working against us.

bond foreign holdings

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Hard Landing Coming? Investors Don’t Think So.

Is a “hard landing” coming, economically speaking, as the Fed continues its most aggressive rate hike campaign in 40 years? Investors don’t seem to think so as investors continue to chase economically sensitive stocks despite the underlying economic deterioration. Such was a point made recently by Jesse Felder, noting:

“The cyclicals-to-defensives ratio has yet to really react even to the slowdown in the economy we have already seen over the past year or so as indicated by the reversal in the ISM Manufacturing PMI. If the latter continues to deteriorate in the months ahead, cyclicals (like the tech and consumer discretionary sectors) could have a great deal of pain still in front of them.

Manufacturing vs the market

His point is worth noting because investors have piled into stocks historically sensitive to economic changes. This year, however, has been a bit of a conundrum as the Energy sector, normally the most sensitive to economic weakness surged due to the Russia/Ukraine war, supply challenges, and political restrictions that keep oil prices elevated.

Such is notable because while corporate earnings have declined this year, much of the weakness is masked by the exceptionally strong results from the energy sector.

Earnings with and without energy

However, the risk going into 2023 is that those “cyclically sensitive” sectors catch down to economic realities as the impact of the Fed’s rate hikes begins to affect consumers.

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Economic Hard Landing Very Likely

As noted previously, the Federal Reserve has never entered into a rate hiking campaign with a ” positive outcome.” Instead, every previous adventure to control economic outcomes by the Federal Reserve has resulted in a recession, bear market, or some “event” that required a reversal of monetary policy. Or, rather, a “hard landing.”

Federal Reserve vs financial crisis

Given the steepness of the current campaign, it is unlikely that the economy will remain unscathed as savings rates drop markedly. More importantly, the rate increase directly impacts households dependent on credit card debt to make ends meet. This has been the case over the last 30 years as the rise in consumption, which is ~70% of economic growth, was supported by an increasing debt as wages failed to keep up.

consumption vs debt

Such is why, as seen in the last National Federation Of Independent Business (NFIB) survey, the number of businesses with souring economic outlooks continues to rise. Of course, if business owners expect weaker economic growth, they won’t invest in business expansion or increasing employment.

NFIB capital expenditures vs economic expectations

Since employment is one of the highest costs to business profitability, reductions in employment become initially concentrated at firms where higher prices reduce sales quickly. As the “hard landing” becomes more evident, firms will reduce headcount more rapidly as high wages are corrosive to earnings and corporate margins.

PPI CPI inflation vs GAAP earnings

While investors may not think a hard landing is coming, the risk to consumption due to indebtedness and surging rates suggest differently. Importantly, what matters most for investors is the coincident repricing of assets as earnings decline due to the contraction in consumption.


Economic Recessions Leads To Earnings Recessions

We previously discussed that estimated earnings for the S&P 500 companies remain highly elevated. Such gives investors a false sense of security by assuming “forward valuations” suggest stocks are priced fairly. In reality, many companies in the index remain overvalued despite the price decline in 2022. More importantly, earnings have not accounted for a potential “hard landing” economically. In 2019, earnings declined by more than 30%. Even the “soft landing” in 2015 saw earnings decline by more than 10% compared to current estimates.

Earnings annual percent change vs market

More importantly, despite recent downward revisions, current estimates still exceed the historical 6% exponential growth trend. That trend has contained earnings growth since 1950. Currently, earnings estimates exceed that trend by one of the most significant deviations ever. The only two previous periods with similar deviations are the Financial Crisis and the bubble.

Earnings vs deviation of growth trend

More significant is that earnings estimates DO NOT SURVIVE economic “hard landings.

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 vs market annual percent change

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

Annual change in earnings vs market

The whole point of the Fed hiking rates is to slow economic growth, thereby reducing inflation. As such, the risk of a recession rises as higher rates curtail economic activity. Unfortunately, with the economy slowing, 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.

Fed funds vs earnings growth

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

A “hard landing” will likely reveal how much lower that could be.

Target FedEx and Amazon Caution About The Holidays

Tar­get reported poor earnings ($1.54 versus $2.13 expected) and revised its outlook lower. They claim con­sumers are pulling back on spend­ing in re­cent weeks, which hurt sales and prof­its in Q3, and will continue to do so going forward. Along with Target’s warnings, recent actions from FedEx and Amazon do not bode well for the coming holiday shopping season.

Adding industry-wide concern for Target’s statements are recent actions from FedEx and Amazon. FedEx plans to furlough freight workers through the holiday season. At the same time, Amazon will lay off 10,000 employees starting this week. Typically both companies are aggressively hiring going into their busiest time of the year. While the warnings from Target and other companies keep coming, retail sales are seemingly strong. Retail Sales for November rose 1.3%, above expectations for a 1% increase. The problem, as Charlie Bilello shares below, is that the gains are solely due to inflation. Strip-out inflation and total retail sales are slightly below their March 2021 peak. Further, as we learned on Tuesday, credit card debt outstanding is surging. It is helping keep many consumers afloat. We share more on this below.

retail sales

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What To Watch Today


  • 8:30 a.m. ET: Housing Starts, October (1.411 million expected, 1.439 prior)
  • 8:30 a.m. ET: Building Permits, October (1.515 million expected, 1.564 million prior)
  • 8:30 a.m. ET: Housing Starts, month-over-month, October (-2.0% expected, -8.1% prior)
  • 8:30 a.m. ET: Building Permits, month-over-month, October (-3.2% expected, -1.4% prior)
  • 8:30 a.m. ET: Philadelphia Fed Business Outlook Index, November (-6.0 expected, -8.7 prior)
  • 8:30 a.m. ET: Initial Jobless Claims, week ended Nov. 12 (228,000 expected, 225,000 prior)
  • 8:30 a.m. ET: Continuing Claims, week ended Nov. 5 (1.510 prior)
  • 11:00 a.m. ET: Kansas City Fed Manufacturing Activity, November (-8 expected, -7 prior)


Earnings 111722

Market Trading Update

After strong retail sales data this morning, the market traded lower on profit-taking after the recent spurt higher. The strong retail numbers suggest the economy is doing just fine and would not halt the Fed from hiking rates further. Also, comments from the Fed suggesting the same took some of the “wind out of the sails.” Given that a big chunk of the retail sales data for October came from Halloween spending and California stimulus payments, we will likely get some clawback in the November report.

For now, the market tested the upper rising trend line, got overbought, and is now correcting to some degree. Initial support is the 100-dma. The 20-dma has crossed above the 50-dma, which is bullish and will increase support for any short-term correction. Take profits and rebalance risks. We will likely get another trading opportunity in the next week or two.

Market trading update

Loading Up On Credit Card Debt

Just as Target, FedEx, and Amazon warn about the coming holiday season, the recent Federal Reserve data on credit card debt offers another signal that consumers are in trouble. Consumers borrow heavily to fuel purchases as their incomes fail to keep up with inflation. Revolving credit, primarily outstanding credit card balances, increased at an annual rate of 8.7% to a record $1.162 trillion in September.

Confronted with negative real wage growth and dwindling savings, many consumers resort to credit to keep up their consumption. The graph below from Fabian Wintersberger shows a robust correlation between real wages and credit card debt. Given credit card limits and the likelihood of increased unemployment, real retail sales will likely remain under pressure. The scenario is likely fueling worries of Target, FedEx, Amazon, and many other retailers.

credit card debt

Just How Much Credit Card Debt Are We Talking About?

“American household debt has hit a new high, with the collective tab rising $351bn in the latest quarter, taking the total owed by households to more than $16.5 trillion. There are not many comparisons to give that number context, but it is roughly 5x the size of the UK economy, or just shy of 7x what Apple is worth.

All told, household credit card debt grew 15% year-on-year, the largest annual jump for more than 20 years. A group of Federal Reserve researchers, hardly known for their sensationalist exaggeration, said the increase ‘towers over the last 18 years of data.’

With over 500 million accounts open in the US, credit cards are a staple of consumer spending — more than 190 million Americans have at least one account, and 13% reported having five or more cards.” – Chartr

Credit Card Debt

Short Covering Rally Ahead In Bonds?

The current speculative trader net short positions in 2yr UST futures are at a record level. Looking at the graph below, we see the prior record short position in November of 2018 preceded a nearly 3% decline in two-year yields. Can that happen again?

To help understand the bet the short traders are making and answer our question, we review what speculative traders think will happen. The price of Fed Funds futures denotes where traders believe the Fed Funds rate will be in each future month. The two-year yield tends to track Fed Funds futures closely. Therefore, given the strong correlation, we can take the average of the next 24 monthly Fed Fund futures contracts and compare it to the 2-year yield. The second graph below shows the 24 individual Fed Fund contracts comprising the lifetime of a current two-year note. The average of the 24 contracts is 4.33% on top of the 4.34% two-year note yield.

Short sellers are betting that Fed Funds futures are underestimating the Fed’s resolve. They must believe that Fed Funds will peak above 4.91 and or not decline as much as futures imply.

two year bonds specs
bonds fed funds

Fed President Esther George Targets Labor

“I’m looking at a labor market that is so tight, I don’t know how you continue to bring this level of inflation down without having some real slowing, and maybe we even have contraction in the economy to get there.”

The following quote from a WSJ article offers insight into the resolve of many Fed members to bring down inflation. Not surprisingly, they appear somewhat bewildered that their aggressive actions have had minimal economic and labor market impact. George and other members appear resigned to the fact that a recession is inevitable. She further states:

“I have not in my 40 years with the Fed seen a time of this kind of tightening that you didn’t get some painful outcomes.”

Therefore, it appears labor is in the Fed’s crosshairs.

“we’re really looking at labor as the driver here.”

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New York Fed Points to Higher Inflation Expectations

In addition to CPI, PPI, and PCE data, the Fed relies on consumer inflation expectations to guide its actions. The most recent round of data from the New York Fed’s Survey of Consumer Expectations should concern those who think the latest CPI and PPI reports warrant a change in the Fed’s mindset. The New York Fed survey points to higher inflation expectations. Per the survey: “Median inflation expectations increased at both the one- and three-year-ahead horizons in October, by 0.5 and 0.2 percentage points, respectively, to 5.9% and 3.1%. Both increases were broad-based across age, education, and income groups.” Equally concerning, the difference between the expectations of the top and bottom quartile of those surveyed decreased. There is less disagreement among consumers about higher inflation expectations.

The graph below shows the recent uptick in inflation expectations using New York Fed data. Further, consumers remain very uncertain of how much inflation to expect. Uncertainty, or fear that inflation remains high, will drive consumers to demand higher wages. The Fed remains fearful of a wage-price spiral, and the New York Fed survey data only heightens its concerns.

inflation expectations new york fed

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What To Watch Today


  • 8:30 a.m. ET: Retail Sales, October (1.0% expected, 0.0% in September)
  • 8:30 a.m. ET: Import Price Index, October (-0.4% expected, -1.2% in September)
  • 8:30 a.m. ET: Export Price Index, October (-0.3% expected, -0.8% in September)
  • 9:15 a.m. ET: Industrial Production (0.1% expected, 0.4% in September)
  • 9:15 a.m. ET: Capacity Utilization (80.4% expected, 80.3% in September)
  • 10:00 a.m. ET: Business Inventories (0.5% expected, 0.8% in September)
  • 10:00 a.m. ET: NAHB Housing Market Index, November (36 expected, 38 in October)
  • 4:00 p.m. ET: Net Long-term TIC Flows, September ($197.9 billion in August)
  • 4:00 p.m. ET: Total Net TIC Flows, September ($275.6 billion in August)


Earnings 111622

Market Trading Update

The market traded up strongly at the opening yesterday as the Producer Price Index (PPI) confirmed the inflation peak is likely behind us. However, the market sold off at about midday as missiles hit Poland, sending concerns about expanding Russia/Ukraine conflict. Russia quickly rejected the allegations, and the market recovered somewhat into the day’s close.

The market has now rallied to the top of the rising bullish trend channel and, while not extremely overbought, is approaching our initial 4000 targets. Notably, we see a little exhaustion in the rally as morning rallies fail to hold. Also, the MACD “buy signal” is moving toward the top of its channel range. All of this suggests that the rally could have some additional upside, but it is most likely becoming more limited. Continue to take profits and rebalance risk accordingly.

We sold half of our AMD and NVDA positions ahead of earnings tomorrow, so we will see how NVDA reports and plan our next trades.

Market trading update

Another Good Inflation Reading

PPI, following last week’s CPI, was better than expected. Monthly PPI only rose 0.2% versus expectations of 0.5%. The year-over-year rate of producer inflation fell from 8.5% to 8.0%. Excluding food and energy, PPI was flat for the month. The data add credence that inflation is peaking. The bigger question, however, remains how fast inflation will fall to get the Fed comfortable it is no longer a problem.

Based on the CPI and PPI reports, a 75bps rate hike is likely off the table. Implied Fed Futures rates agree. They assign an 86% chance of a 50bps at the mid-December meeting. The next relevant inflation reading will be the monthly PCE report on December 1st.

inflation ppi

Macro Alf and the Recent Rally

@MacroAlf, Alfonso Peccatiello, puts out some great work with his publication The Macro Compass. In his most recent article, Bear Market Rally or Turning Point (Again)?, Alfonso highlights a couple of charts that are worth considering. The first graph below shows the ratio of the implied volatility of out-of-the-money (OTM) puts versus calls. The ratio is now over two standard deviations cheap. Per Alf-

“In other words, at this point of the year, incentive schemes drive people to be much more willing to pay and chase upside moves than they are to chase downside moves.”

Option activity helped fuel the market higher last week. With calls now so expensive versus puts, it will be hard for options traders to continue to fuel the rally. That said, the current level is at a similar point as the beginning of the 2020 bull run.

put vol ratio rally

Alf’s second graph shows that last week’s rally drove the S&P 500 equity risk premium to its lowest level in over a year. The equity risk premium (the implied extra yield stock investors should expect to earn versus buying bonds) is about 1% below the average for the last fifteen years. Given the market’s economic and monetary uncertainty, investors should demand an above-average risk premium for buying stocks. In Goodbye TINA, Hello BAAA, we also noted that expected stock returns are too low versus guaranteed bond yields. To wit:

Expected stock returns are on par with risk-free Treasury yields but woefully below the premium spread investors should demand.

equity risk premium rally

Stagflation Says BofA

The chart below from BofA shows that stagflation is the expectation of professional fund managers. The last time such an expectation occurred was in mid-2008. In July 2008, CPI peaked at 5.50% and a year later was -2%. Profession investors were wrong about inflation at that time. However, they were correct that economic activity would slow appreciably. We think inflation will continue to fall from its peak, and economic activity will likely slow. While the circumstances today are very different from 2008-2009, we expect the light blue line, signifying below-trend growth and inflation, will become the new expectation as it did then.


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Our Currency, The World’s Problem Part 1

The Bank of England is bailing out U.K. pension funds. The Bank of Japan uses excessive monetary policy to protect its currency and cap interest rates. China encourages its banks to buy stocks. The dollar, the world’s currency, is on a tear, interest rates are surging, and the financial world is fracturing.

Unlike any other currency, the U.S. dollar drives the global economy and financial markets. Because of the dollar’s status as the world’s reserve currency, the Fed’s monetary policy actions play a critical role in steering the U.S. economy and all global economies and financial markets.

To foresee the next crisis, it is imperative to understand the dollar’s role in global finance and economics and the resulting role that the Fed plays in influencing international monetary policy. To do so, we start with insight from Triffin Warned Us, an article we published in 2018.   

These “cliff notes” for the article lay the groundwork for Part 2. Following this article, we will discuss the risks investors face as the Fed attempts to quell inflation.

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The Bretton Woods Agreement

In 1944, the United States and many nations forged a significant financial arrangement in Bretton Woods, New Hampshire. The agreement has paid enormous economic dividends to the United States. However, it has a flawed incongruity with a dear price that is rearing its ugly head today.

Per the terms of the 1944 Bretton Woods Agreement, the U.S. dollar supplanted the British Pound to become the world’s reserve currency. The agreement assured a large majority of global trade would occur in U.S. dollars, regardless of whether the United States was participating in such trade. Additionally, it set up a system whereby other nations would peg their currency to the dollar. This arrangement is akin to the global currency concept made popular by John Maynard Keynes. Keynes’s brainchild was Bancor, a supranational currency.

Within the terms of the agreement was a supposed remedy for one of the abuses that countries with reserve currency status typically commit, running continual trade and fiscal deficits. The pact discouraged such behavior by allowing participating nations to exchange U.S. dollars for gold. Therefore, other countries that were accumulating too many dollars, the side effect of American trade deficits, could exchange their excess dollars for U.S.-held gold. As a result, a rising price of gold, indicative of a devaluing U.S. dollar, would be a telltale sign that America was abusing her privilege.

London Gold Pool

The agreement started fraying shortly after. In 1961, the world’s leading nations established the London Gold Pool. The objective was to fix the price of gold at $35 an ounce. The action was an attempt to maintain the Bretton Woods status quo. By manipulating the price of gold, an important gauge of the size of U.S. trade deficits was broken. Therefore, there was less incentive to swap dollars for gold.

Seven years later, France broke the ranks. France withdrew from the Gold Pool and demanded large amounts of gold in exchange for dollars. As a result, in 1971, President Richard Nixon, fearing the U.S. would lose its gold, suspended the convertibility of dollars into gold.

From that point forward, the U.S. dollar was a floating currency. There was no longer the discipline imposed upon it by gold convertibility. Nixon’s actions essentially annulled the Bretton Woods Agreement. 

The following decade saw double-digit inflation, persistent trade deficits, and weak economic growth. These were signs that America was abusing its privilege as the reserve currency. The first graph below shows that, like clockwork, the U.S. began running annual trade deficits in 1971. The second graph highlights how inflation picked up markedly after 1971.

london gold pool deficits
cpi london gold pool

By the late-1970s, Fed Chair Paul Volcker raised interest rates from 5.875% to nearly 20.00% to break inflations back decisively. While economically painful, Volcker’s actions not only ended ten years of persistently high inflation and restored economic stability but, more importantly, satisfied America’s trade partners. The now floating rate dollar regained the integrity required to be the world’s reserve currency. This was despite lacking the checks and balances imposed upon it by the Bretton Woods Agreement and the gold standard.

Our article The Fifteenth of August discusses how Nixon’s “suspension” of the gold window unleashed the Federal Reserve.

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Enter Dr. Triffin

In 1960, 11 years before Nixon’s suspension of gold convertibility and the effective demise of the Bretton Woods Agreement, Robert Tiffin foresaw this inevitable problem in his book Gold and the Dollar Crisis: The Future of Convertibility. According to his logic, the privilege of becoming the world’s reserve currency would eventually carry a heavy penalty for the U.S.  

At the time, few paid attention to Triffin’s thesis. However, he was invited to a congressional hearing of the Joint Economic Committee in December of the same year. 

What he described in his book and Congressional testimony became known as Triffin’s Paradox. Events have played out primarily as he envisioned.

Essentially, he argued the reserve status forces a good percentage of global trade to occur in U.S. dollars. For trade and global economies to grow under such a system, the U.S. must supply the world with U.S. dollars. 

To supply the world with dollars, the United States must consistently run a trade deficit. Running persistent deficits, the United States would become a debtor nation.

Foreign Creditors Enable U.S. Deficits

Foreign nations accumulate and spend dollars through trade. They keep extra dollars on hand to manage their economies and limit financial shocks. These dollars, known as excess reserves, are invested primarily in U.S.-denominated investments ranging from bank deposits to U.S. Treasury securities and a wide range of other financial securities. As the global economy expanded and more trade occurred, additional dollars were required. As a result, foreign dollar reserves grew and were lent back to the U.S. economy.

Making the world even more dependent on the dollar, many foreign countries and companies issue U.S. dollar-denominated debt to better facilitate trade and take advantage of America’s liquid capital markets.

The arrangement benefits all parties involved. The U.S. purchases imports with dollars lent to her by the same nations that sold the goods. Additionally, the need for foreign countries to hold dollars and invest them in the U.S. results in lower U.S. interest rates, further encouraging domestic consumption and providing relative support for the dollar.

For their part, foreign nations benefit as manufacturing shifted away from the United States to their countries. As this occurred, increased demand for their products supported employment and income growth, thus raising the prosperity of their respective citizens.

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A Win-Win or a Ponzi Scheme?

While it may appear the post-Bretton Woods covenant is a win-win pact, there is a massive cost accruing to everyone involved.

The U.S. has too much debt. As such, it has become increasingly dependent on low-interest rates to spur debt-driven consumption and to pay interest and principal on existing debt.

Lower than appropriate interest rates lead to unproductive debt, as can be seen with debt outstanding rising at a much faster pace than GDP. Simply the growing divergence between debt and the ability to pay for it, GDP, is unsustainable.

total leverage ponzi debt


Triffin’s paradox states that with the benefits of the reserve currency also comes an inevitable tipping point or failure.

As we see with the current instance of rising interest rates and inflation, that point of failure is closing in on the U.S. and the rest of the world.

Part two of this article will focus on the dollar and Fed monetary policy and what it may entail as the Fed continues to push interest rates higher.

Waller Reminds Investors “We’ve got a ways to go”

“The market seems to have gotten way out in front over this one CPI report. Everybody should just take a deep breath and calm down. We’ve got a ways to go ” -Federal Reserve Governor Christopher Waller.

After the market’s powerful reaction to CPI, investors woke to words of warning from Christoper Waller. In addition to the quote above, he added the Fed has a “long, long way to go to get inflation down.” Waller believes rate hikes will continue until inflation falls consistently over many months and nears the Fed’s 2% target. The important takeaway from Waller’s comments and Chair Powell’s FOMC press conference is the Fed has significant concerns about taking its foot off the monetary brakes too early. Waller said the worst possibility is that Fed stops raising rates and inflation reignites. Powell and Waller are looking to the 1970s and 1980s inflation outbreaks for guidance. Such a mindset leads us to believe the market may be getting ahead of itself in thinking the Fed is anywhere close to a policy pivot.

The graph circles the first two outbursts of inflation in 1968-1970 and 1973-1975. In both cases, the Fed hiked aggressively but eased equally aggressively once inflation peaked. The box covering the third instance of high inflation highlights the Fed kept Fed Funds above 10% for three years after inflation topped. Since then, Paul Volcker has preached the Fed’s extremely tight policy for an extended period, ultimately slayed the inflation problem.

waller, cpi, fed

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What To Watch Today


  • 8:30 a.m. ET: Empire Manufacturing, November (-6.0 expected, -9.1 prior)
  • 8:30 a.m. ET: PPI Final Demand, month-over-month, October (0.4% expected, 0.4% prior)
  • 8:30 a.m. ET: PPI Excluding Food and Energy, MoM, October (0.3% expected, 0.3% prior)
  • 8:30 a.m. ET: PPI Excluding Food, Energy, and Trade, MoM, October (0.3% expected, 0.4% prior)
  • 8:30 a.m. ET: PPI Final Demand, year-over-year, October (8.4% expected, 8.5% prior)
  • 8:30 a.m. ET: PPI Excluding Food and Energy, year-over-year, October (7.2% expected, 7.2% prior)
  • 8:30 a.m. ET: PPI Excluding Food, Energy, and Trade, YoY, October (5.6% expected, 5.6% prior)
  • 9:00 a.m. ET: Bloomberg Nov. United States Economic Survey



Market Trading Update

Unsurprisingly, the market traded off yesterday after a strong advance last week. The 100-dma is now important support for the market to hold. The 200-dma is important resistance. Such suggests that while there is some upside currently, it is limited, and we could see more volatile trading into the end of November.

We have recommended using the rally for the last several weeks to raise cash and reduce equity risk. We did that again yesterday by reducing equity exposure to 38% of the portfolio (our target allocation is 35%, and increasing cash to 17.5%. The rest of the portfolio is most short-duration fixed income for now. While we still expect some short-term upside to the market, we suspect next year will be challenging, at least initially, as tighter Fed policy takes effect.

Market trading update

Quantifying The Lag Effect

Over the years, economic activity has become increasingly reliant on debt. As evidence, the Fed’s primary monetary policy to increase or slow economic growth and inflation is the cost of borrowing money- interest rates. However, as we have been consistently warned, Fed policy changes take a long time to fully affect the economy.

The graph below from Pictet Asset Management provides strong evidence that the lag time between interest rate changes and economic activity may be as long as four quarters. It shows it can take a year before actual bank lending reacts to tighter or looser bank lending standards. The second graph below from MacroCompass similarly shows it takes four to five quarters for a decline in credit conditions to weigh on inflation and earnings growth.

The Fed started aggressively raising rates about a year ago, when bank lending standards tightened. As such, we should expect lending, the gasoline fueling economic growth, will slow significantly in the coming months.

lag effect and bank lending
credit lag

Put Call Ratio Hits 2022 Lows

The put-call ratio (number of puts as a ratio to the number of calls) is trading at a 2022 low. Viewing this through a bullish lens may provide relief that positive sentiment is finally returning to markets. The bearish camp would counter it signals investors are too complacent and ignoring the plethora of macroeconomic and liquidity risks. Unlike in 2021, when the ratio was very low, today, the volatility index (VIX) remains well above levels seen throughout most of 2021. Are we in a regime change, or are investors getting ahead of themselves?

put call ratio

Crypto and Liquidity

The recent FTX news should raise deep concern for crypto investors. Your assets are only as good as the custodian of said assets. The FTX event calls into question the infrastructure backing how many investors hold crypto assets.

For non-crypto investors, there is also an important takeaway. Changes in liquidity are often most appreciable in the riskiest asset classes. As we saw with Bernie Madoff and Jon Corzine, removing liquidity often uncovers fraud and unsustainable market schemes. While we are not overly concerned the FTX crisis will infect more traditional asset markets, we harbor concerns that the instance highlights that QT and higher rates are slowly taking liquidity from the markets. In time, the lack of liquidity, if it continues, will likely creep into the stock market.

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Midterm Elections Are Bullish Even In A Bear Market

With the midterm elections behind us, does the market outlook improves given a now gridlocked Congress? Historically speaking, such is the case. As noted by Michael Cannivet via Forbes:

“Before you hit the panic ‘Sell Everything’ button, though, it’s worth considering at least one bullish catalyst on the horizon—voters head to the ballot box on November 8th.

The data is clear: Midterm elections are historically bullish for the stock market.”

While garnering less attention than a presidential election, midterm elections are important because they could lead to a change in control of the U.S. Senate and House of Representatives. Such can significantly impact policy, laws, and foreign relations. Historically, markets tend to favor “gridlock” in Washington as it dramatically reduces the risk of an adverse policy change regarding taxation, geopolitical conflict, or substantive changes to spending and debt.

Since 1950, there have been 18 midterm election cycles, and in the twelve months following each of those cycles, the stock market has had positive returns. Over the subsequent 12 months, stocks delivered an 18.56% average annualized gain compared to just 10.6% over all other years.

Midterm Election Returns

Over a more extended 24-month period, stocks returned an average of 33.7% after a midterm election.

Midterm 12 and 24 month returns.

However, while the data above goes back to 1958, the last time the S&P 500 produced a negative return over the 12 months following a midterm election was 1939. Of course, there was a massive economic contraction and uncertainty at that time as the U.S. battled the Great Depression and World War II began in Europe.

Another period of interest is the late 1960s and 1970s, marked by slow economic growth, high unemployment, rising energy prices, and significant inflation. Given the similarities currently, the bearish pre-midterm market returns and an un-accommodative Federal Reserve, the outlook, while bullish, is less clear.

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Getting Back To Even Is Not The Same Thing

There are a couple of caveats to this analysis that must be considered. The first is that while returns tend to be positive post-midterm elections, several times, it coincides with when the midterm elections fell. The chart below shows the S&P 500 with the years of midterm elections marked and significant events.

For example, in 1966, 1970, and 1974 the midterm elections coincided with the bottom of the three recessionary bear market cycles. Coincidence? Probably. More importantly, on a longer-term basis, returns on a “buy-and-hold” basis were negative as the secular bear market continued. We see the same effect between 1998 and 2014, midterm elections yielded positive short-term results, but long-term returns were near zero.

SP500 mid-term elections

The second caveat to the historical data is the difference between making money and getting back to even. While the mainstream analysis suggests investors should buy the midterm elections for positive 12-month returns, most are already invested. In a year where the midterm elections fall in the middle of a bear market, like 1974, 2002, or 2022, most investors used those returns to “get back to even.”

The chart below shows the S&P 500 for 2022, starting at 4796. It will require a return of 26% over the next 12 months for investors to break even. Notably, that does not include the rate of return necessary to meet their financial goals. For example, if your financial plan requires 6% annualized returns, the 26% advance still leaves you another 12% short of your annual return goals (6% for 2022 and 2023). Given the average yearly return post-midterm elections is 18.6%, investors will fall short of their goals.

Getting back to even

While I am not discouraging you from taking advantage of a robust post-midterm election rally, there is a vast difference between “getting back to even” and “making money.”

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The Difference This Time May Be The Fed

While the history following midterm elections is bullish, there is a difference this time that could produce a less-than-optimistic outcome. That difference is Fed and their current fight against inflation. We have previously discussed the “lag effect” of monetary policy and its impact on economic growth and earnings. To wit:

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.”

Currently, the Fed is still tightening monetary policy to further slow economic growth. As shown, when the Fed has previously stopped hiking rates, forward stock returns tended not to be robust.

Fed rate hikes, stock market, and crisis

Another difference is that previous market lows, which coincided with bear markets and midterm elections, were low valuations. Despite the market decline in 2022, valuations remain elevated relative to historic market bottoms.

S&P 500 vs valuations CAPE

Given the more extreme negative market sentiment, a substantial rally is undoubtedly possible through year-end and early 2023.

However, we suspect following that, the market environment will become more challenging. Particularly as the Fed’s monetary tightening becomes more evident in slower economic activity, declining inflation, and slower earnings growth. If that is the case, asset prices, and ultimately valuations, will need to drop before the final market low.

There are no guarantees in the financial market. While history certainly supports the bullish outlook, it should not be considered gospel. Bull markets happen in bear markets. However, many factors could negatively impact returns over the next 12- to 24 months. As such, investors should measure and manage their risk accordingly.

The good news is the negative backdrop will pass, and longer-term returns will become evident. Of course, to participate in the next bull market, you must ensure you survive the bear market.

This returns me to my main point. Spending the next bull cycle “getting back to even” is not the same as making money.

A Sigh of Relief for Bulls

Bulls released a huge sigh of relief last week after encouraging inflation data prompted a sharp move lower in bond yields and the USD. This allowed stocks to rally nearly 1% into the close Friday after surging 5.5% on Thursday. With the USD approaching three standard deviations oversold, a short-term retracement would not be surprising. This would put the rally in equities on hold for now, but given the volatility crush following CPI, we could drift higher for a few more weeks.

The chart of the Euro/USD exchange rate shows the extremely overbought condition of the Euro relative to the USD currently. While the Euro could rise further relative to a weakening USD, a much-needed relief for weaker European countries, a reversion first would not be surprising.

Euro USD Exchange

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What To Watch Today


  • No notable economic data is scheduled for release.



Market Trading Update

From a technical perspective, the market tested and held crucial support again at the 20-dma after the FTX (cryptocurrency) blowup on Wednesday. The subsequent rally off support turned our MACD “buy signal” higher, keeping it intact, and the market cleared critical resistance at the 100-dma. Such now sets the stage for a rally to the 200-dma between 4000 and 4100.

Market Trading Update

The surge in asset prices also cleared levels that are now forcing short-sellers to cover positions which will add “fuel to the rally” over the next few days. As noted by Goldman Sachs, CTAs bought $43BN last week and $79BN the previous month. Now that we are above the short-term trigger, Goldman calculates a whopping $38 billion to buy over the next week and substantially more (green line) if the market is up big. The chart below shows that the bank expects more than +$79 billion of net buying over the month.

CTA fund flows and levels to cover in the market

While weaker inflation was evident in the latest report, such does not mean the Fed will stop hiking interest rates. However, as discussed last week following the FOMC meeting, the Fed has already clarified that they will slow the rate hike pace. Such was a point made by Philadelphia Fed President Patrick Harker on Thursday:

“In the upcoming months, in light of the cumulative tightening we have achieved, I expect we will slow the pace of our rate hikes as we approach a sufficiently restrictive stance.”

Moving from 75bps rate hikes to 50bps in December is still a significant “aggressive action” that will impact economic growth in 2023.

The surge in markets, while much needed, is likely another opportunity to reduce risk and rebalance portfolios as we head into 2023. Slower economic growth and falling inflation do not support currently elevated earnings and profit margins.

The Week Ahead

This week starts with another year-ahead consumer inflation expectations survey this morning. While the University of Michigan’s survey is trending higher lately, expectations, as measured by this survey, have not. Its year-ahead expectations for inflation have decreased for three consecutive months, most recently falling to 5.4%. The market will shift focus to October PPI on Tuesday now that CPI is out of the way. As we’ve written previously, the relationship between the two can provide insight into what to expect from profit margins. The consensus estimate is an increase of 0.5% MoM, compared to the October CPI growth of 0.4% MoM.

We’ll get October retail sales on Wednesday, and Thursday will bring an update on the state of the housing market with housing starts and building permits. Estimates bet on housing starts falling again in October to an annualized 1.41 million. Friday, we’ll end the week with existing home sales data for October. The consensus is for another decline to 4.39 million annualized as Fed policy roils the housing market.

Labor Market May Not be As Tight as We Think

According to an article published by the Harvard Business Review, the labor market may not be as tight as we think. Three researchers at LinkedIn created a new measure of labor market tightness by leveraging the company’s vast data. The authors explain:

“The ratio of job openings to unemployment is over 1.85 today, suggesting that there are nearly two job openings for every unemployed individual looking for a job. This ratio is considerably higher than its pre-pandemic level and higher than the historical norm of about 0.7 since 2000. But if the job openings to unemployment ratio is indicative of a very tight labor market, then why does real wage growth continue to be so tepid? One potential reason for this anomaly is that the labor market is not actually that tight — that is, the standard measures of slack might not be telling the whole story.”

The LinkedIn model of tight labor market conditions attempts to account for active job openings and job seekers. It analyzes the ratio of active job openings posted directly on LinkedIn to active applicants.

“Active applicants are members who submit at least one application to a job opening in a given month. We measure active job openings as the stock of open job positions on the last business day of the month multiplied by an index of recruiting intensity. The idea behind recruiting intensity is to measure how actively employers are looking to fill vacant jobs.”

The chart below plots labor market tightness measured by the JOLTS survey against LinkedIn’s new measure. The stark but plausible difference raises the question of whether the Fed is walking into a trap, given its focus on the labor market.

Labor Market

The Technicality That Bolstered the CPI Report

Last week’s inflation data looked great from a high level prompting a sigh of relief for many— but digging into the numbers reveals a slightly less bullish story. The CPI for health insurance contributes 0.9% of headline and 1.1% of core inflation, dove -4%. This was the largest MoM drop in the data going back to 2005, and it was due to a periodic adjustment that has little to do with actual insurance premium inflation. Without that effect, month-over-month inflation (40bps) would have been 5bps higher.

So why does it matter that this technicality juiced the report? Because the market is taking this report in a more positive light than it should. The adjustment isn’t factored in the Fed’s preferred measure of inflation, the Core PCE Price Index. Furthermore, October PCE data won’t be released until two weeks before the next FOMC meeting, December 13th-14th. The FOMC won’t even consider a quarter of the MoM CPI surprise, so the excitement may be slightly overdone.  

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Good Inflation Print, But Is It Enough for Powell?

Stocks and bonds had an especially bullish reaction to new data out Thursday showing that inflation continues to moderate after reaching a 40-year high over the summer. But is it enough for Powell to back off from more aggressive rate hikes?

MoM inflation was unchanged at 0.4% versus estimates of 0.6%. Core inflation MoM fell to 0.3% in October from 0.6% in September and beat the consensus estimate of 0.5%. Here is the breakdown, with every inflation sector down except recreation (Halloween tweet).

The favorable print crushed the dollar and sent bonds and equities flying as investors reassessed their expectations for the path of rate hikes. The data was enough to spark a rally, but is it enough for Jay Powell and the FOMC? We share two quotes below from last Wednesday’s FOMC press conference Q&A. Keep in mind that at the time of the meeting, Powell likely had a good idea of the data released yesterday.

“And trying to make good decisions from a risk management standpoint, remembering of course that if we were to over-tighten, we could then use our tools strongly to support the economy, whereas if we don’t get inflation under control because we don’t tighten enough, now we’re in a situation where inflation will become entrenched and the costs, the employment costs in particular, will be much higher potentially. So, from a risk management standpoint, we want to be sure that we don’t make the mistake of either failing to tighten enough, or loosening policy too soon.

“And the last thing I’ll say is that I would want people to understand our commitment to getting this done. And to not making the mistake of not doing enough or the mistake of withdrawing our strong policy and doing that too soon. So those, I control those messages and that’s my job.”

What To Watch Today


  • 10:00 a.m. ET: University of Michigan Consumer Sentiment, November Preliminary (59.5 expected, 59.9 prior)
  • 10:00 a.m. ET: U. of Mich. Current Conditions, November Preliminary (62.8 expected, 65.6 prior)
  • 10:00 a.m. ET: U. of Mich. Expectations, November Preliminary (55.5 expected, 56.2 prior)
  • 10:00 a.m. ET: U. of Mich. 1 Year Inflation, November Preliminary (5.1% expected, 5.0% prior)
  • 10:00 a.m. ET: U. of Mich. 5-10 year Inflation, November Preliminary (2.9% expected, 2.9% prior)



Market Trading Update

Stocks surged yesterday as weaker inflation data gave the bulls a reason to celebrate, hoping that a Fed “pivot” is closer at hand. While we believe that is overly optimistic, the market tested and held key support again at the 20-dma after the FTX (cryptocurrency) blow-up on Wednesday. The subsequent rally off support turned our MACD “buy signal” higher, keeping it intact, and the market cleared critical resistance at the 100-dma. Such now sets the stage for a rally to the 200-dma between 4000 and 4100.

market trading update

The surge in asset prices also cleared levels that are now forcing short-sellers to cover positions which will add “fuel to the rally” over the next few days. As noted by Goldman Sachs, CTAs bought $43BN last week and bought $79BN last month; now that we are back over the short-term trigger, Goldman calculates that there is a whopping $38BN to buy over the next week and substantially more (green line) in an up big market: as shown in the chart below, the bank expects more than +$79B of Buying over a month.

CTA Analysis

While the rally certainly has some legs, be sure and use it to take profits, rebalance risks, and adjust portfolio exposures accordingly. We aren’t through with the bear market just yet.

The Myth of the Strong Consumer

There’s quite a difference between consumption remaining strong and consumers remaining strong. Even so, many Wall Street pundits continue to advise that consumers remain strong. We’d argue that while consumption has held up in the face of inflation, the consumer is showing clear signs of struggle.

TransUnion reports that credit card balances surged 19% YoY in the 3rd quarter to an all-time high of $866B. This followed a 12% increase in credit cards issued to subprime consumers in Q2, the surge was driven by card use across all risk tiers. Furthermore, the chart below shows that savings as a portion of disposable income have significantly deteriorated as inflation has picked up. Consumers aren’t strong. Consumption is. They are just using credit to bridge the gap, which works against their future prosperity as more income goes to service debt.

Myth of the Strong Consumer

Is Elon Driving Twitter into the Ground?

Elon Musk is truly on a rampage at Twitter after taking the company private two weeks ago today. He fired most top executives when the acquisition closed, and two resigned yesterday. He laid off 50% of the staff disorganizedly and is now asking some to return after they were let go “by mistake.” His controversial status lost the company’s advertising revenue after he saddled it with debt in the takeover. On top of that, his first email to Twitter staff ended remote work for everyone and said bankruptcy was possible. For those who are left, employee morale is most likely in the dirt.

The Twitter fiasco may start bleeding over to Tesla as well. But is it enough to remove the “Musk hype” premium from TSLA’s stock price? Wedbush analyst, Dan Ives, removed the stock from their Best Ideas list yesterday. He wrote:

“In what has been a dark comedy show with Twitter, Musk has essentially tarnished the Tesla story/stock and is starting to potentially impact the Tesla brand with this ongoing Twitter train wreck disaster… Musk’s attention focus from Tesla to Twitter, and ultimately the fear that this Twitter lightening rod of controversy on a daily (almost hourly) basis starts to negatively change the Tesla brand globally.”

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The “Policy Pivot” May Not Be Bullish

Since June, the market rallied on hopes of a “policy pivot” by the Federal Reserve. However, those hopes got dashed each time as Jerome Powell clarified that the “inflation fight” remained the primary focus. Mr. Powell made that point very clear following the latest FOMC announcement.

“The question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive.”

Before the pandemic, the Fed’s storyline was to let inflation run hot rather than allow inflation to stay too low for too long. Such makes sense as inflation is easy to deal with by hiking rates and slowing the economy. Deflation is a far different story, as it becomes an entrenched psychological impact that becomes difficult to dislodge.

Today, Powell says the Fed’s concern is entrenched inflation which causes pain to the economy.

The reality is that inflation is not the problem.

If the Fed did nothing, “high prices will cure high prices.” The real risk remains a “deflationary” spiral that depresses economic activity and prosperity. Deflation is a far more insidious problem than inflation longer term.

Such is why, over the past decade, the Fed flooded the economy with liquidity and zero interest rates to boost economic activity. The chart below shows the periods inflation ran above or below the average inflation rate from 1982. Since the “Great Financial Crisis,” inflation has run consistently well below that average and even the Fed’s 2% target rate.

Inflation vs Fed Funds

While monetary interventions and zero interest rates failed to generate organic growth above 2% annually, they increased asset prices, inflated asset bubbles, and expanded wealth inequality.

Fed Funds vs GDP vs Household net worth

What is important to note is that since the turn of the century, the outcomes have not been positive each time the Federal Reserve has started an aggressive rate hiking campaign. Notably, the Fed is well aware of this but no longer fears creating economic havoc. As Powell recently stated,

“If we overtighten, we can support economic activity.”

In other words, for the bulls hoping for a “pivot,” Powell made it clear that a “policy pivot” is coming. It is only the function of time until it is evident that something breaks in the economy and bailouts are required.

The Policy Pivot Is Coming

One of the interesting comments by Jerome Powell was the “window for a soft landing in the economy was narrowing.” Such confirms what we already know that the Fed is starting to realize the risk of a “hard landing” is becoming increasingly elevated.

Such leaves only two trajectories for monetary policy. The first option is for central banks to pause rates and allow inflation to run its course. Such would potentially lead to a softer landing in the economy but theoretically anchor inflation at higher levels. The second option, and the one chosen, is to hike rates until the economy slips into a deeper recession. Both trajectories are bad for equities. The latter is substantially riskier as it creates an economic or financial “event” with more severe outcomes.

While the U.S. economy has absorbed tighter financial conditions so far, it doesn’t mean it will continue to do so. History is pretty clear about the outcomes of higher rates, combined with a surging dollar and inflationary pressures.

Monetary Policy Index

Naturally, once the Fed’s aggressive rate hike campaign “breaks” something, the “policy pivot” will occur. Such will occur as the realization that inflation has now become a “disinflationary” wave in the economy. As Michael Wilson recently noted:

M2 is now growing at just 2.5%Y and falling fast. Given the leading properties of M2 for inflation, the seeds have been sown for a sharp fall next year. The implied fall in CPI outlined would be highly out of consensus, and while it won’t necessarily play out exactly, we believe it’s directionally correct. We’re closer today [to a ‘policy pivot’] because M2 growth is fast approaching zero, and the 3-month-10-year yield curve finally inverted last week, something Chair Powell has noted is important in determining if the Fed has done enough.

M2 money supply vs CPI

Given the surge in inflation was caused by increased demand due to “stimmy checks” against a drastic drop in supply as the Government shuttered the economy, the reversal of those dynamics is disinflationary. Notably, inflation will fall in 2023 much faster than the Fed expects, leading to the rapid “policy pivot” the bulls continue to hope for.

However, the bulls may not like what they get.

The Bulls May Not Like The “Pivot”

The bullish expectation is that when the Fed finally makes a “policy pivot,” such will end the bear market. While that expectation is not wrong, it may not occur as quickly as the bulls expect.

Historically, when the Fed cuts interest rates, such is not the end of equity “bear markets,” but rather the beginning. Such is shown in the chart below of previous “Fed pivots.”

Fed Funds vs the Market

Notably, the majority of “bear markets” occur AFTER the Fed’s “policy pivot.”

The reason is that the policy pivot comes with the recognition that something has broken either economically (aka “recession”) or financially (aka “credit event”). When that event occurs, and the Fed initially takes action, the market reprices for lower economic and earnings growth rates.

Currently, forward estimates for earnings and profit margins remain elevated. The spread between the Producer Price and Consumer Price Indices remains problematic. Historically, this suggests that producers will absorb inflation, thereby eroding profit margins as consumer demand deteriorates from inflationary pressures.


Such is what Michael Wilson also concluded:

Bottom line, inflation has peaked and is likely to fall faster than most expect, based on M2 growth. This could temporarily relieve stocks in the short term as rates fall in anticipation of the change. Combining this with the compelling technicals, we think the current rally in the S&P 500 has legs to 4000-4150 before reality sets in on how far 2023 EPS estimates need to come down.”

Once the reversion sets in, the Fed cuts rates to zero and restarts the next “Quantitative Easing” program, such will start the next bull market cycle.

We will certainly want to buy that opportunity when it comes.

Our warning is that bulls may be early trying to “buy” the initial “policy pivot.”

Just Left Hanging

As we reported yesterday, a liquidity crunch brought cryptocurrency exchange FTX to its knees on Tuesday. Hours later, FTX announced it had entered a non-binding agreement to be acquired by its rival, Binance. The acquiring exchange would’ve been able to provide market liquidity and bridge the gap if the deal closed. This helped cool surging fears and kept a lid on volatility across cryptocurrencies at the time.

In another turn of events yesterday, Binance left FTX hanging less than a day after entering the agreement. Rumors had begun surfacing of a hole in the FTX balance sheet that could be as large as $5-10B. We suspect something along these lines to be the case after Binance announced:

“Our hope was to be able to support FTX’s customers to provide liquidity, but the issues are beyond our control or ability to help.

Every time a major player in an industry fails, retail consumers will suffer. We have seen over the last several years that the crypto ecosystem is becoming more resilient and we believe in time that outliers that misuse user funds will be weeded out by the free market.”

This turn of events sent crippling fear right back into crypto markets—putting significant pressure on both Bitcoin and Ethereum for the second day in a row. Both the SEC and CFTC are said to be investigating FTX as we speak.

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What To Watch Today


  • 8:30 a.m. ET: Consumer Price Index, month-over-month, October (0.6% expected, 0.4% prior)
  • 8:30 a.m. ET: CPI excluding Food and Energy, MoM, October (0.5% expected, 0.6% prior)
  • 8:30 a.m. ET: Consumer Price Index, year-over-year, October (7.9% expected, 8.2% prior)
  • 8:30 a.m. ET: CPI excluding Food and Energy, YoY, October (6.5% expected, 6.6% prior)
  • 8:30 a.m. ET: CPI Index NSA, October (298.488 expected, 296.808 prior)
  • 8:30 a.m. ET: CPI Core Index SA, October (300.094 expected, 298.660 prior)
  • 8:30 a.m. ET: Real Average Hourly Earnings, year-over-year, October (-3.0% prior)
  • 8:30 a.m. ET: Real Average Weekly Earnings, year-over-year, October (-3.8% prior)
  • 8:30 a.m. ET: Initial Jobless Claims, week ended Nov. 5 (220,000 expected, 217,000 prior)
  • 8:30 a.m. ET: Continuing Claims, week ended Oct. 29 (1.487 million expected, 1.485 prior)
  • 2:00 p.m. ET: Monthly Budget Statement, October (-$90.0 billion expected, -$429.7 billion prior)



Market Trading Update

The last couple of days of the “midterm election” rally got wiped out as disappointment over Republican performance in key Senate races. At the moment, it appears there will still be gridlock, with the Senate split and control of the House falling to Republicans. The Georgia Senate seat is still up for grabs with a runoff deciding the majority control of the Senate. As we’ve written previously, investors hoping for the post-election rally could be left hanging this time.

Other pressures also weighed on the stock market yesterday as Cryptocurrencies were decimated over fallout from the FTX failure. Also, there was a terrible auction for 10-year Treasuries, highlighting the lack of liquidity in that market. Lastly, investors are also pairing back exposure ahead of the CPI report tomorrow, which could see stocks either surge higher or retest recent lows.

The CPI report this morning will set the tone for equities today. The market is flirting with important support at the 20-dma. The action yesterday was not good, and the MACD “sell signal” is dangerously close to flipping. Caution remains advised.

Market Trading update

Market Matters

The main source of banking profits is Net Interest Income (NII). Banks generate NII by borrowing on the short end (deposits are liabilities) and lending at higher rates on the long end (loans are assets). Massive consumer banks like JPM and BAC have benefited from the Fed’s rate hikes by charging more on loans while still paying low rates on liabilities. Despite the inverted yield curve, they can generate higher NII margins since deposits aren’t chasing rates to a great degree.

Be careful of falling into the trap of thinking all banks will benefit, given the inverted yield curve, however. First Republic Bank (FRC) serves wealthy clients who are more deliberate with their cash. The bank has been forced to pay higher rates on liabilities to keep deposits from leaving. According to the WSJ, FRC is seeing NII margins decline, and its stock price has followed suit after shareholders were left hanging. SIVB is running into a different problem. Deposits fell 6% in the 3rd quarter as its start-up clients burn cash while new funding rounds have drastically slowed. Market matters- and these banks have unfortunate exposures in this environment.

Market Exposure Matters

Disney Missed on Top and Bottom Line – Guess What Happened Next?

In a quarter where punishments have been especially harsh for those missing expectations on both their top and bottom lines, DIS did just that. Revenue of $20.2B came up short of expectations of $21.4B, while adjusted EPS of $0.30 missed the consensus of $0.56. Their Parks segment failed to continue showing strong results as margins missed expectations, and guidance raised concerns about profitability going forward. There was a bright spot in the dismal results- Disney+ subscriber growth of 12.1M users. Unfortunately, this wasn’t enough to keep the stock from getting clobbered. DIS stock fell over 13% in yesterday’s trading. The handy chart below from App Economy Insights illustrates how Disney’s quarter went.

Disney Earnings

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Get Ready for Some Holiday Deals!

Remember the bullwhip effect? Retailers and wholesalers massively over-ordered merchandise following supply chain shocks just as the stimulus sugar high began waning. The missteps led to a severe inventory problem at several retailers, who warned of impacts on margins as they get ready to clean up mistakes.

The holiday season is quickly approaching, which means it’s time for retailers to buckle down on their inventory overhang. How so? Deals! And lots of them. Discounts may get competitive as retailers fight to move inventory, with discretionary incomes still being squeezed by inflation. Some could be in store for large losses as massive brands race to liquidate high-cost inventory in a demand-constrained environment. Per Bloomberg yesterday:

“Even just in the past three days, we’ve seen some of the biggest or most valuable brands in the world contact us for help with excess inventory,” Kaplan said. “It’s a full tidal wave at this point. We need the customer to be spending, and until that happens, the product’s not going to move.”

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What To Watch Today


  • 7:00 a.m. ET: MBA Mortgage Applications, the week ended Nov. 4 (-0.8% prior)
  • 10:00 a.m. ET: Wholesale Trade Sales, month-over-month, September (0.4% expected, 0.1% prior)
  • 10:00 a.m. ET: Wholesale Inventories, month-over-month, September Final (0.8% expected, 0.8% prior)



Market Trading Update

Yesterday, stocks broke above the 50-dma resistance but failed at the downtrend line from the August peak. This morning stocks are set to open slightly lower but look to hold the 50-dma support at the open. With markets not overbought, there is reason to expect the current rally to continue, with the 100-dma being the initial objective. The CPI report tomorrow will likely decide the fate of this rally short term.

The Fed Giveth and the Fed Taketh Away

Capital markets activity surged throughout 2020 and 2021 as companies welcomed cheap debt and voracious investor risk-appetite. This was, of course, courtesy of the Fed’s response to the Pandemic. While we wait for rate hikes and QT to flow through to the real economy and CPI, let’s see how they are already impacting capital markets.

Skyrocketing financing costs and economic uncertainty have curbed capital markets activity to a trickle recently, according to the Wall Street Journal. Mergers and acquisitions activity fell 43% through September and October versus the same period last year. Even more alarming, IPO activity dropped 95% from last October as the Fed’s liquidity drain takes a toll on risk-appetite. October hasn’t seen this little activity since 2011- the hangover is kicking in now that the Fed is taking the punch bowl away. Get ready for a rough 2023 in investment banking.

“The new reality has crashed down on companies and their investors in a matter of months. Bankers and private-equity firms have gone from funding takeovers at lofty prices with ease to scrambling to raise debt at any price.”

The Fed Taketh Away

Treasuries Got You Spooked? Consider This Chart

Treasury debt is traditionally a risk-off investment that offers protection through stock market downturns. This year has been quite different, however, with Treasuries seeing their worst year in over a century amidst a correction in stocks. The chart below, courtesy of Michael Venuto, plots annual total return of the 10-Year Treasury note going back to the late 19th century.

Every time the total return was less than -5% in a year, the subsequent year provided a positive total return. In many cases, investors were rewarded with a relatively large total return in the next year. This chart isn’t to suggest you should go put your entire portfolio in long-term Treasuries, but to show that based on historical returns, the risk-reward dynamics look quite favorable after a year like we’ve experienced. For those risk-averse investors who might be second-guessing whether Treasuries have a place in their portfolio after this year, to shy away now could be costly.

Historical Returns on Treasuries

Liquidity Crunch in Crypto Land

Speaking of ‘the Fed taketh away’, yesterday cryptocurrency exchange Binance entered a non-binding agreement to acquire a rival exchange, FTX. It appears to be coming from a place of necessity rather than opportunity. With that said, get ready for some volatility in crypto land. The CEO of Binance, Changpeng Zhao, tweeted yesterday:

“This afternoon, FTX asked for our help. There is a significant liquidity crunch. To protect users, we signed a non-binding LOI, intending to fully acquire and help cover the liquidity crunch. We will be conducting a full DD in the coming days.”

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There Really Is No Middle Class Any Longer

There was a time when a large portion of Americans belonged to the “middle class.” It meant you could afford a decent living standard, such as owning a house and a car and had savings in the bank. When “baby boomers” reminisce about the “good ole days,” they are referring to when being middle-class was normal.

However, the American middle class has continued to contract over the past five decades. According to Pew Research, the share of adults who live in middle-class households fell from 61% in 1971 to 50% in 2021.

The shrinking of the middle class is accompanied by an increase in the share of adults in the upper-income tier which increased from 14% in 1971 to 21% in 2021. At the same time, there was an increase in the share who are in the lower-income tier, from 25% to 29%. These changes have occurred gradually, as the share of adults in the middle class decreased in each decade from 1971 to 2011, but then held steady through 2021.

The Census Bureau clearly shows the problem in the “mean household income data” through 2021.

Median annual income Top 20% and bottom 80%.
Source: Census Bureau Chart: Real Investment

That dotted black line is the most important. As with the PEW Research data looking at incomes alone obfuscates the most important part of income analysis. The question is how much income it takes to maintain a “middle-class” lifestyle. Or rather, what does it take to buy a house and a car and feed two kids?

Most importantly, and what is often not included in the analysis, is the standard of living gets “paid for” on an “after-tax” basis. When we include taxation, it becomes clear that roughly 80% of America is failing to support the “middle-class” lifestyle.

After tax incomes by 5ths

As we discussed recently, Harvard Business Review noted::

“Besides a booming labor market, exceptionally strong household balance sheets help keep spending high. Households’ net worth is far higher than pre-Covid for every single income quintile, providing some buffer to the headwinds of inflation and dour consumer sentiment.” – Harvard Business Review

Again, it is a true statement that household net worth has increased since the Covid lockdown lows. However, household net worth is predominately held by the top 10% of income earners, leaving the bottom 90% fighting over the remaining 30% of the wealth.

Breakdown of net worth

Debt is not a choice for most “middle-class” Americans.

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More Debt Isn’t A Choice

I recently discussed “Recession Fatigue” that is plaguing more individuals, according to a survey. To wit:

“When broken down by generation, younger adults, or Gen Zers, are more likely to experience ‘recession fatigue’ than millennials, Gen Xers, and baby boomers. In the report, ‘recession fatigue’ is primarily afflicting younger generations, leaving them unprepared to face a recession. Such data certainly flies in the face of media reports of households having ‘strong financial balance sheets.’”

Survey percentage unprepared for recession

With the Federal Reserve focused on combatting inflation by tightening monetary policy, the financial pressures on households will continue to increase. Given the already high levels of “unpreparedness” for a recession, such leaves a majority of families dependent on additional debt to make ends meet.

“According to the latest New York Federal Reserve report, credit card debt surged by $46 billion in the second quarter. As shown above, such is not surprising as consumers struggled to maintain their standard of living. The 13% annualized increase in new debt was the largest in more than 20 years. Moreover, aggregate limits on cards marked their most significant increase in the last decade.”

Consumer credit balances

With the pandemic-driven savings now spent, 60% of Americans say they are living paycheck-to-paycheck. While consumers can supplement their disposable incomes with debt to offset rising inflationary pressures, it is not a long-term solution. The chart below, which requires a brief explanation, shows the problem clearly.

Between 1959 and 1990, individuals could sustain their inflation-adjusted standard of living with only incomes and savings. There was roughly a $4700 surplus yearly as households had very low debt levels. However, beginning in 1990 and accelerating following the Financial Crisis in 2008, it requires an increasing level of debt to “fill the gap” between what income and savings can afford and the cost of the current living standard. You will notice a brief spike in 2020-2021 as “stimmy checks” hit household bank accounts. However, that surplus has reversed to the deepest deficit on record.

Consumer Spending GAP

As the “wealth gap” continues to widen between those in the top 10% of income earners and everyone else, the ability to maintain a “middle-class” lifestyle becomes more challenging.

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The Road To Serfdom

In a recent U.S. News article, many forces shape an individual’s economic class and their views of where they rank.

“When asked how they identify their social class, 73% of Americans said they belonged to the middle or working classes, according to an April 2022 survey from Gallup. Fourteen percent identified themselves as an upper-middle class and 2% categorized themselves as upper class. In determining their social class, people often don’t just think about income, experts say, but other factors, including education, location, and family history.”

However, statistics suggest that if 89% of surveyed individuals identify as middle to upper-class, that only leaves 11% of the population at the other end. However, income, debt, and net worth statistics clearly show such is not the case.

The reality is that middle-class America continues to shrink as the rich-get-richer and the poor-get-poorer. The rich can invest, save and use very little debt to sustain their living standard, while the poor rely on debt, making long-term prosperity an impossible goal.

Furthermore, as the peasants demand “more free stuff” from the Government, such requires more debt and higher taxes. Those demands then divert more capital away from productive investment leading to slower economic growth. As growth slows, businesses shift to the lowest labor costs, or automation, to lower income growth for domestic workers. Such leads to more demands from “free stuff” from the Government, and the cycle intensifies, pushing more of the middle class downward.

The share of annual incomes between the bottom 80% and the top 5% is evidence of that wealth transfer from the middle class.

Share of income bottom 80% top 20%
Source: Census Bureau

The road to serfdom is paved with good intentions. After decades of piling on increasing debt levels to generate economic growth, the damage to economic growth is becoming more visible. As shown, economic growth trends are already falling short of both previous long-term growth trends.

GDP New Normal Inflation Adjusted

The end game of too much debt, combined with an aging demographic, is the “deflationary disaster” apparent in Japan’s economy.

Of course, Japan doesn’t have a middle class any longer, either.

All Eyes on Midterms Today

All eyes will be on the Midterms today as investors assess the outcome’s implications for markets. Historically, Wall Street prefers gridlock between party lines, and performs well in the period following Midterms. Many are banking on the seasonality to spark a rally this year, but with the Fed in the way, is this time different? Further, will an absence of political pressure post-election allow the Fed to be more aggressive in fighting inflation?

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What To Watch Today


  • 6:00 a.m. ET: NFIB Small Business Optimism, October (91.4 expected, 92.1 prior)



Market Trading Update

The market rallied late into the day yesterday ahead of the midterm elections, where the polls now suggest a “red wave” will send control of both House and Senate to the Republicans. For Wall Street, this is the most optimal outcome as it assures gridlock in Washington, with neither party having the supermajority needed to override a Presidential veto.

From a technical perspective, the rally yesterday bolstered the retest of the 20-dma support level from Friday and is now firmly testing the 50-dma resistance level. If the market can rally today and reclaim that previous support level, such will clear the way for another retest of the 100-dma. Notably, the action on Friday and yesterday kept the MACD “buy signal” intact and triggered a stochastic “buy signal” as well. Once we get through the election, there isn’t much news flow until we get to the October CPI on Thursday.

Market trading update

“Don’t Be an Idiot,” Says Mr. Market

“Don’t be an idiot” crudely- but adequately- summarizes investor sentiment towards to Mark Zuckerberg following META’s latest earnings report. Already trading down over 60% YTD, the report saw the stock gap down another 20%. The company has added over 42,000 employees since 2020, with roughly 15,000 added YTD. In total, META has spent $15B since the beginning of last year developing its Reality Labs V.R. and A.R. segment. Although it acknowledged a deteriorating economic outlook, META wasn’t yet doing enough in the way of controlling costs. That is until this week.

The Wall Street Journal reports that META is expected to begin large-scale layoffs as soon as Tomorrow.

“The planned layoffs would be the first broad head-count reductions to occur in the company’s 18-year history. While smaller on a percentage basis than the cuts at Twitter Inc. this past week, which hit about half of that company’s staff, the number of Meta employees expected to lose their jobs could be the largest to date at a major technology corporation in a year that has seen a tech-industry retrenchment.”

Perhaps it took another gut punch to his net worth, but Zuckerberg heard the message from Mr. Market loud and clear. META gained 6.5% yesterday on the news.

Disinflation is in the Wind, But Stay Patient

Signs of disinflation remain ahead of the October CPI report set to be released on Thursday. The Manheim US Used Vehicles index for October recorded the largest annual decline (-10.4%) since December 2008. It’s easy to point to declines in used car prices and shout “deflation!”, but patience remains the name of the game. Used car prices count for about 4% of the CPI basket, but still, the Fed has clearly stated that it needs strong evidence before blinking on inflation. We don’t expect any meaningful surprises, given that Powell had the data when he reiterated this last week. Maybe Powell is trying to get ahead of something with all eyes on CPI Thursday. Regardless, it will take longer for the effects of monetary policy to flow through to lagging indicators such as CPI. In any way that’s meaningful to the Fed, at least.

Disinflation in the Wind

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Dashed Hopes for a Different Perspective

As we wrote on Friday, investors were disappointed again last week after Jerome Powell failed to take a different perspective on the path of monetary policy. Bets that Powell will say something even slightly dovish this year are misplaced, given the implications for financial conditions based on what we’ve seen already. Instead, Powell will likely let other FOMC members float those ideas to the public between meetings.

No Pivot coming

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What To Watch Today


  • 3:00 p.m. ET: Consumer Credit, September ($30.000 billion, $32.241 billion)



Market Trading Update

The October employment report on Friday was also strong, printing a 261,000 job increase, but the unemployment rate rose to 3.7%. Initially, stocks sold off but then rallied on expectations that future reports would begin to weaken. Notably, the market defended the important 20-dma moving average, keeping the bull market rally from the September lows alive. However, the MACD “buy signal,” which signaled the start of the most recent rally, is dangerously close to flipping.

Stock market update

The Week Ahead

Fed speakers will be out in droves this week following the end of the FOMC blackout period. Any remotely dovish comments from Powell this year led to loosening financial conditions- which directly works against the Fed’s goal. As mentioned above, the Fed may be tweaking its communication strategy by having Powell convey a strictly hawkish tone and allowing other members to walk it back slightly. Thus, we will be watching for comments supporting slowing the pace of rate hikes this week.

This week will be light on economic data. The BLS will release October’s CPI report Thursday morning— expectations for broad and core inflation are 0.7% and 0.5% MoM, respectively. While economists forecast broad CPI growth to accelerate MoM, they expect the pace of core inflation to slow from September. We’ll cap off the week with Friday’s preliminary consumer sentiment data for November. Expect consumer sentiment to take a breather after four consecutive increases from the low in June.  

October Delivers Another Strong Jobs Report

Non-farm payrolls increased by 261,000 in October (200,000 expected), adding another month to the recent track record. Stocks ended 1.4% higher in a volatile session Friday, as the USD was crushed (-1.9%) and investors tempered expectations for future job growth. The unemployment rate ticked up to 3.7%, while the labor force participation rate fell to 62.2%.

As noted in this weekend’s Newsletter, the Household Survey offers a different perspective.

“While the BLS employment report suggested employment was strong, the Household Survey, which is where the BLS report comes from, showed a rather significant loss of 328,000 jobs. Also, wage growth continues to slow, and the labor force participation rate dropped. That data suggests the Fed’s rate hikes are beginning to have an effect.”

Jobs report

Employment Not As Strong As It Appears

While the BLS employment report suggested employment was strong, the Household Survey, which is where the BLS report comes from, showed a rather significant loss of 328,000 jobs. Also, wage growth continues to slow, and the labor force participation rate dropped. That data suggests the Fed’s rate hikes are beginning to have an effect. As shown, while the BLS report continues to report strong monthly job growth, the Household Survey (which the BLS draws its report from) suggests a far weaker picture showing NO job gains since March of 2022.

Employment vs household survey

We suspect that after the Midterm elections are behind us, we may see a “catch down” in the data. Such is especially the case with the rising number of layoff announcements almost daily.

List of tech layoffs

While the Fed continues looking at inflation and employment for clues on when to stop hiking rates, they may have already gone too far.

A Different Perspective

The rise of passive investing, along with other factors, led to a handful of stocks comprising a large portion of the market-cap weighted S&P 500 index. The FAANG stocks (including MSFT), which have held up relatively well YTD, now account for about 20% of the index. With the S&P buoyed by mega-caps holding on to lofty valuations throughout widespread carnage, a narrative developing in many circles held that passive investors would get killed when the “big boys” caved.

The tide is beginning to turn as the market generals took a beating on 3rd quarter earnings announcements. However, the index has held up surprisingly well so far due to solid performance by the other 80% of constituents. Now, a different perspective is coming to light. Is it a bullish sign that the overall index is still holding up as several generals make 52-week lows?

Perspective on Generals

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Charlie Brown Syndrome Strikes the Markets Again

Stock investors are screaming “AAUGH!” as Jerome Powell duped them again. In one of the more iconic scenes in Charlie Brown, his sister Lucy holds a football for him to kick. Charlie Brown runs up to kick the ball, and Lucy pulls it away. Charlie Brown vows never to trust her again, yet he always does.

Investors are falling for the same trick. Investors get bulled up after each of the last few Fed meetings. They expect the Fed to relent on its super-hawkish policy. They presume that they must be near the end because the Fed has hiked so much. However, they fail to listen to the Fed. The Fed is demanding concrete proof that inflation is falling rapidly. It is not! They want the labor market to loosen up and crush a potential price-wage spiral. It is not! Until Powell sees evidence of consistently lower prices and a higher jobless rate, the Fed will continue to pull the pivot ball from investors. Don’t be Charlie Brown and presume the next meeting will be different solely because the Fed is closer to its terminal Fed Funds rate.

charlie brown
Image Courtesy Of

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What To Watch Today


  • 8:30 a.m. ET: Change in Nonfarm Payrolls, October (195,000 expected, 263,000 prior)
  • 8:30 a.m. ET: Change in Private Payrolls, October (200,000 expected, 288,000 prior)
  • 8:30 a.m. ET: Change in Manufacturing Payrolls, October (12,000 expected, 22,000 prior)
  • 8:30 a.m. ET: Unemployment Rate, October (3.6% expected, 3.5% prior)
  • 8:30 a.m. ET: Average Hourly Earnings, month-over-month, October (0.3% expected, 0.3% prior)
  • 8:30 a.m. ET: Average Hourly Earnings, year-over-year, October (4.7% expected, 5.0% prior)
  • 8:30 a.m. ET: Average Weekly Hours All Employees, October (34.5 expected, 34.5 prior)
  • 8:30 a.m. ET: Labor Force Participation Rate, October (62.3% expected, 62.3% prior)
  • 8:30 a.m. ET: Underemployment Rate, October (6.7% prior)


Market Trading Update

The market traded off yesterday as concerns over a continued “hawkish” Fed put the bears back in charge of the market. After the recent 4-week bullish rally, the trade is currently lower. The good news, at the moment, is the market managed to hold onto the 20-dma yesterday, although just barely. If the market sells off again today, the retest of recent lows becomes increasingly likely. This morning we have the jobs report, which will further incite the Fed to remain aggressive on rate hikes if it comes in exceptionally strong. We reduced equity exposure again yesterday, and depending on what happens following this morning’s employment report, may take further actions.

Also concerning is the MACD signal, which is set to trigger a “sell signal” if market weakness continues. Today will be a critical day for the bulls if they are going to maintain control.

The ADP Jobs Report is Strong, But…

The ADP jobs report, a precursor to today’s BLS labor report, was stronger than expected at +239k. However, looking beneath the surface of the data leaves much to be desired. Nearly 100% of job growth came from the leisure and hospitality sectors. Most jobs in those sectors are low-paying and quite often temporary jobs. Of the other nine sectors, five were lower, and two were slightly higher. While labor data, in general, remains robust, there should be concerns that the quality of job growth is poor.


Measuring Stock Sensitivity to Interest Rates

On Wednesday, we published Finance is at Fault.  The article quantifies how higher interest rates weighed on stock prices this year. Understanding the relationship between stock prices and interest rates helps us better formulate what type of stocks may do better when interest rates reverse course.  

The trajectory of future earnings (cash flows) plays a critical role in calculating how sensitive stock prices are to changes in interest rates. Simply, the more front-loaded the earnings, the less sensitive. This helps explain why many value stocks outperformed growth stocks as interest rates rose this year. To further clarify this point, we compare three hypothetical companies with vastly different projected growth rates.

earnings growth

With interest rates likely peaking, and the probable path over the coming year lower, what type of stocks will benefit most from lower interest rates? Per the graph below using our hypothetical companies shown above, growth companies with increasing and longer-dated cash flows should rise the most in a lower-rate environment.

earnings and price sensitivity

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Are The FANG Stocks Dead?

Are the FANG stocks dead? Or, to be clear, are the MANNGMAT stocks dead? Of course, we are talking about the big technology heavyweights of Meta (FB), Apple (AAPL), Netflix (NFLX), Nvidia (NVDA), Google (GOOG), Microsoft (MSFT), Amazon (AMZN) and Tesla (TSLA). According to a recent article via the WSJ, such seems to be the case. To wit:

“Big technology stocks are in the midst of their biggest rout in more than a decade. Some investors, haunted by the 2000 dot-com bust, are bracing for bigger losses ahead. 

Some investors say the decadelong era of tech dominance in markets is coming to an end.”

In the short-term, it certainly seems that value investors, after more than a decade of underperformance, are finally taking a victory lap as the long-awaited resurgence occurs. The value trade was something we wrote about extensively in 2020, as many believed “value investing was dead.”

“Such certainly seems to be the mantra as investors continue to pile into growth stocks while rationalizing valuations using methodologies that historically have not worked well.”

The chart below shows the annual performance difference between the Vanguard Value and Growth Index funds. The surge in value in 2022 is unsurprising as investors look for a “safe place” to hide as markets stumbled.

value vs growth annual return differential

The brief periods of outperformance of value versus growth occurred during rough patches in the financial markets. However, as the following chart shows, there is a massive performance gap between value and growth.

Value vs Growth performance

Since 2008, much of that “gap” remains attributable to three primary factors – FANG stocks, buybacks, and passive investing.

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Buybacks & Safe Havens

We have previously discussed the impact of share buybacks on the overall market.

“The chart below via Pavilion Global Markets shows the impact stock buybacks have had on the market over the last decade. The decomposition of returns for the S&P 500 breaks down as follows:

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

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

Bull Market Buybacks, 40% Of The Bull Market Is Due Solely To Buybacks

Of course, most of those “share buybacks” were concentrated in the largest market-capitalization stocks with the free cash flow, or borrowing capacity, to affect those transactions. For example, Apple Corp (AAPL) has repurchased more than $500 billion of its shares. But these buybacks occurred across the entirety of the FANG complex to help boost share prices higher.

Not surprisingly, with earnings under pressure due to higher interest rates, companies have announced a record of more than $1 Trillion in buybacks for this year.

Buyback authorziations

Importantly, what these “buybacks” provide to FANG stocks is an “artificial buyer.” Therefore, when asset managers are looking for a “safe haven” to hold capital, the FANG stocks were the stocks of choice. Such was because they maintained a high level of liquidity, and the buybacks provided a ready buyer when needed. Such allowed asset managers to quickly move hundreds of millions of dollars in and out of positions without substantially impacting the price.

Investors should not readily dismiss the impact of share buybacks. As John Arthurs previously penned.

“For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.”

In other words, between the Federal Reserve injecting a massive amount of liquidity into the financial markets, and corporations buying back their shares, there have been effectively no other real buyers in the market. 

However, another aspect of the FANG stocks remains vital to their future performance.

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It’s A Function Of Passive

One of the problems with the financial markets currently is the illusion of performance. That illusion gets created by the largest market capitalization-weighted stocks. (Market capitalization is calculated by taking the price of a company multiplied by its number of shares outstanding.)

Notably, except for the Dow Jones Industrial Average, the major market indexes are weighted by market capitalization. Therefore, as a company’s stock price appreciates, it becomes a more significant index constituent. Such means that prices changes in the largest stocks have an outsized influence on the index.

You will recognize the names of the top-10 stocks in the index.”

The top-10 stocks in the S&P 500 index comprise roughly 1/3rd of the entire index. In other words, for every $1 that flows into a passive S&P 500 index, $0.31 flows into the top 10 stocks.

Buybacks, As Buybacks Return Can The Market Continue To Rally

Currently, roughly 2165 ETFs are trading in the U.S., with each of those ETFs owning many of the same underlying companies. For example, how many passive ETFs own the same stocks comprising the top 10 companies in the S&P 500? According to

  • 403 own Apple
  • 437 own Microsoft
  • 275 own Google (GOOG)
  • 345 own Google (GOOGL)
  • 347 own Amazon
  • 251 own Netflix
  • 377 own Nvidia
  • 310 own Tesla
  • 216 own Berkshire Hathaway
  • 269 own JPM

In other words, out of roughly 2165 equity ETFs, the top-10 stocks in the index comprise approximately 20% of all issued ETFs. Such makes sense, given that for an ETF issuer to “sell” you a product, they need good performance. Moreover, in a late-stage market cycle driven by momentum, it is not uncommon to find the same “best-performing” stocks proliferating many ETFs.

One of the reasons that FANG stocks may not be “dead” going forward is the same reason they were the leaders in the past. Despite the market decline this year, investor capital flows are still headed into passive funds.

passive vs active fund flowsl

Of course, as investors buy shares of an ETF, the shares of all the underlying companies also get purchased. When the bearish market cycle reverses, the increase in flows into passive ETFs will push those FANG stocks higher along with the market.

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Disinflation May Be The Catalyst

As we head into 2023, there is one final reason why FANG stocks will likely perform much better than many currently expect – “disinflation.”

In a disinflationary/deflationary environment, particularly in an economic recession, investors seek out companies with sustainable earnings growth rates. While many of the FANG stocks have come under pressure as of late due to “disappointing” earnings and forecasts, it is worth noting the earnings growth rates of these companies remain high over the next 3-5 years, according to Zacks Research:

  • AAPL – 12.5% Annually
  • GOOG – 11.3% Annually
  • MSFT – 10.8% Annually
  • NVDA – 12.3% Annually
  • AMZN – 20.2% Annually

You get the idea. The point here is that the impact of higher rates on economic growth will lead to a disinflationary environment. However, it isn’t just interest rates weighing on the economy but the extraction of the massive monetary injections over the last two years that fostered the inflationary surge. The reversal of the money supply, which leads the inflation measure by about nine months, suggests inflation will fall sharply next year.

m2 money supply and inflation

As investors seek out investments with sustainable earnings growth rates in a slowing economic environment, many FANG stocks will garner their attention. Combine that focus with the inflows from passive investors when the market cycle turns, ongoing share buybacks, and the liquidity needs of major investors; likely, FANG stocks will still find some favor.

Does this mean they will perform as well as they have in the past? No. They could underperform other assets in a disinflationary environment, like bonds, where yields fall sharply.

The point is that investors should not dismiss FANG stocks entirely because the media says they are “dead.” It is worth remembering many said the same about Energy stocks in late 2020. Of course, that was just before that “dead asset” outperformed everything else in the market.

Another Step On The Path To 5%

The Fed took another step Wednesday on its path to slay inflation. As widely expected, the Fed increased rates by .75%. The next steps for the Fed likely include a 50bp increase in December and 25bp hikes in February and March. Currently, Fed Funds futures imply 5% Fed Funds by the spring of 2023. At that point, many, including Fed members, think the next step is to wait and see. As we have noted numerous times, the biggest risk with aggressive Fed hikes is the lag effect. Steps to raise interest rates last spring and early summer are just starting to take a bite out of inflation and economic activity.

Waiting and watching, aka pausing, allows for the 3.75% in hikes we have already witnessed, plus future rate hikes to get digested into the economy. Regardless of market narratives, pausing is not a pivot. A pivot, which the stock market anxiously awaits, starts with a Fed discussion of steps to lower rates and or reduce the amount of QT. That did not occur yesterday. A pause is also not on the immediate horizon. Per Powell: “it’s very premature to talk about pausing policy.”

fed funds

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What To Watch Today


  • 7:30 a.m. ET: Challenger Job Cuts, year-over-year, October (67.6% prior)
  • 8:30 a.m. ET: Trade Balance, September (-$72.3 billion expected, -$67.4 billion prior)
  • 8:30 a.m. ET: Nonfarm Productivity, Q3 preliminary (0.5% expected, -4.1% prior)
  • 8:30 a.m. ET: Unit Labor Costs, Q3 preliminary (4.0% expected, -10.2% prior)
  • 8:30 a.m. ET: Initial Jobless Claims, week ended Oct. 29 (220,000 expected, 217,000 prior)
  • 8:30 a.m. ET: Continuing Claims, week ended Oct. 22 (1.450 million expected, 1.438 million prior)
  • 9:45 a.m. ET: S&P Global U.S. Services PMI, October final (46.6 expected, 46.6 prior)
  • 9:45 a.m. ET: S&P Global U.S. Composite PMI, October final (47.3 expected, 47.3 prior)
  • 10:00 a.m. ET: Factory Orders, September (0.3% expected, 0.0% prior)
  • 10:00 a.m. ET: Factory Orders Excluding Transportation, September (0.2% prior)
  • 10:00 a.m. ET: Durable Goods Orders, September final (0.4% expected, 0.4% prior)
  • 10:00 a.m. ET: Durables Excluding Transportation, September final (-0.5% prior)
  • 10:00 a.m. ET: Non-defense Capital Goods Orders Excluding aircraft, September final (-0.7% prior)
  • 10:00 a.m. ET: Non-defense Capital Goods Shipments Excluding Aircraft, September final (-0.5% prior)
  • 10:00 a.m. ET: ISM Services Index, October (55.4 expected, 56.7 prior)


Market Trading Update

The market traded higher yesterday immediately after the FOMC rate announcement. However, it didn’t last long as “Super Hawk” Jerome Powell spoiled the party by stating the Fed had more work to do. To wit:

“The labor market continues to be out of balance, with demand substantially exceeding the supply of available workers” reinforces the notion that the Fed is looking at both employment and inflation as giving it plenty of reasons to keep tightening.

He then reiterated previous comments that “at some point,” it will become “appropriate to slow the pace of increases.” The problem came as he most notably pointed out that there is “significant uncertainty” around that end-point which he indicated by stating, “we have some ways to go.” 

However, just to make sure there were no questions about the Fed’s intentions, Powell said:

“The question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive.”

That comment pushed terminal rate expectations above 5% and sank the market.

Yesterday’s sell-off took out important supports and pushed the market back below 3800. While there is some minor support at the closing levels, the main level to defend is the 20-dma which is just below the close. More importantly, short-term sell signals were triggered, and our primary MACD indicator turned lower. If that indicator triggers, such would indicate the current reflexive rally is over. The failure at the 100-dma is not a good position for the bulls and suggests the bears remain in control of the market for now.

A Path to a Pivot

With Wednesday’s solid ADP employment report and Tuesday’s strong JOLTs data, the labor market is showing no signs of slowing down. Given the Fed’s concern that higher wages will keep prices higher for longer, the Fed is not relenting from its hawkish narrative. However, they are providing themselves an out, of-sorts. The following statement was added to the FOMC statement:

In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.

As the redlined statement shows, the only edits of note were the addition of this caveat of sorts.

fed statement

The Fed is not pivoting, but they are telling us that stopping rate hikes at some will be appropriate due to the effects of “cumulative tightening” and “the lags with which monetary policy affects economic activity and inflation.” Equally important, they acknowledge that “financial developments” will also factor into policy decisions. Prior to the statement, the Fed seemed to ignore liquidity issues in the U.S. Treasury market and weaker stock prices. At some point, a crisis here or abroad may be cause for a Fed pivot.

In our opinion, the Fed is not breaking new ground. By default, with each rate hike, they are closer to the terminal rate. We also knew the Fed would come to the rescue if financial conditions worsened. Lastly, of course, a sharp slowdown in the economy which will drive inflation much lower, will get them to rethink policy.

Alternative Idea- Cannabis Stocks

Biden recently took action to remove the Schedule I classification that Cannabis currently falls under. While his actions do not Federally legalize it, they make it much easier and more profitable to operate cannabis businesses. 37 states have legalized medical marijuana, and 19 have legalized the recreational use of marijuana. Further, 5 states are voting on recreational use at this year’s elections.

Despite the consistent progress toward legalization and increasing accessibility at the state level, cannabis companies and valuations have faltered. AdvisorShares Pure US Cannabis ETF- MSOS is down 80% since February 2021. The fund’s largest holding, Green Thumb Industries, is nearing five-year lows. The graph below shows that Price to Sales multiples for the industry is back to the lowest level in at least four years. With valuations relatively cheap and the rising odds for strong growth, Cannabis stocks may be a sector worth following.

cannabis valautions

Who’s Buying and Who’s Selling?

The media often claims that either sellers or buyers drove the market’s direction. The truth is that every time a stock trades, there is a buyer and seller. By understanding that simple fact, we can gain an edge by distinguishing what type of investors are buying or selling.

It is often said retail investors are dumb money and institutional and hedge funds are smart money. The table below from AEI argues otherwise. Per AEI- “The S&P 500 Index Out-performed Hedge Funds over the Last 10 Years. And It Wasn’t Even Close!” Given the significant popularity of passive investment strategies that buy the major indexes, it’s fair to say a good number of retail accounts and 401ks have beaten hedge funds over the last decade.

The second graph highlights how retail and hedge fund investors are currently positioning themselves. As it shows, retail investors (private clients) have been buying throughout the year. Right now, they do not seem very smart. Our concern is that the traditional “smart money,” the hedge funds, which have been aggressively selling, are correct. That said, hedge funds have been buying recently, which may be a good sign if it continues. If retail becomes net sellers in 2023 and hedge funds large buyers, we may see active investment strategies beat out passive ones. Such would prove worrisome for the FAANG stocks and other mega-cap stocks. Small and mid caps, which are not well represented in passive funds, may outperform in such an environment.

hedge funds vs retail  buying vs selling
retail buying hedge funds selling

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Monetary Headwinds Accentuate Q4 Risks

Monetary headwinds, already proving difficult for stock prices, are expected to strengthen in the next two months. The U.S. Treasury announced its Q4 borrowing estimates would be $150 billion more than expected. Further, they expect to increase its cash balances held at the Fed (Treasury General Account -TGA) to $700 billion. Increased debt issuance forces investors to carry more Treasury assets, leaving less cash for other investments. Further, the higher Treasury cash balances will accentuate monetary headwinds already weighing on stock prices.

As we wrote in 3500 By Year End if QT Continues, liquidity is governed by the Fed’s balance sheet, the Fed’s RRP program, and Treasury balances held at the Fed (TGA). The size of the Fed’s balance sheet less the sum of the TGA and RRP equals the amount of Fed-generated liquidity in the system. The Fed, via QT, will continue to reduce its balance sheet by $95 billion a month. RRP is expected to be flat over the coming months, neither adding nor subtracting liquidity. As we noted, the TGA will rise to $700 billion, pulling an additional $75 billion of liquidity from the markets by yearend. The updated graph below shows that increasing monetary headwinds still project the S&P 500 toward 3500.

Graph of monetary liquidity sp 500.

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What To Watch Today


  • 7:00 a.m. ET: MBA Mortgage Applications, week ended Oct. 28 (-1.7% prior)
  • 8:15 a.m. ET: ADP Employment Change, October (180,000 expected, 208,000 prior)
  • 2:00 p.m. ET: FOMC Rate Decision (Lower Bound), Nov. 2 (3.75% expected, 3.00% prior)
  • 2:00 p.m. ET: FOMC Rate Decision (Upper Bound), Nov. 2 (4.00% expected, 3.25% prior)
  • 2:00 p.m. ET: Interest on Reserve Balances Rate, Nov. 2 (3.90% expected, 3.15% prior)



Market Trading Update

The market traded up nicely yesterday morning until a much stronger-than-expected Job Opening Survey (JOLTS) sent stocks lower over concerns that the report will keep the Fed more hawkishly biased for now. Today, we will have the Fed’s latest commentary following the November FOMC meeting, where rates will increase by 0.75% bps. That rate hike is well expected; however, the markets will be looking for Powell’s commentary about future rate hikes and a reduction in the pace of those hikes. Also, markets are hoping for signs the Fed may be closer to suggesting they are closer to the end of hikes than not. We will see, but for now, we continue to reduce exposure to stocks on this rally and will likely take further action following the outcome of the meeting and how the market responds.

Yesterday, the market struggled with the 100-dma after an intraday test of the 50-dma. Support also remains at the 3800 level, which is critical for the current rally. A failure of that support will set the market up for a test of the rising 20-dma. With the market short-term overbought, a bit of pullback is likely.

Graph of Market Trading Update.

Is a Reprieve of Monetary Headwinds Possible

The opening paragraph discusses the prospects for strong monetary headwinds to continue through yearend. There may, however, be a silver lining. The Treasury Department has been raising the prospect of conducting a yield curve control (YCC) program. The gist would be the Treasury would buy back long-term debt and issue short-term debt. Such a program would not affect the amount of debt outstanding, but it may benefit liquidity. In Quantitative Buybacks, Joseph Wang explains how YCC could boost liquidity and dampen the monetary headwind. To wit:

A Treasury buyback program today would be mechanically equivalent to quantitative easing and a tailwind for risk assets. Buybacks funded by bill issuance would move cash out of the RRP and into the broader financial system.

Joseph makes the case that a larger supply of short-term debt would increase money market yields. Therefore it entices money market funds to buy the higher-yielding Treasury debt instead of investing cash in the Fed’s RRP program. As we wrote earlier, an increase in RRP drains liquidity from the system. Ergo, a decrease in RRP increases liquidity. Joseph ends as follows:

The combination of a large primary deficit and QT is creating a wave of selling that the market is having trouble digesting. A sizable buyback program would in effect make the Treasury a dealer of last resort like the Fed. The result is likely comparable to the Fed QE: improved market liquidity and lower yields.

The following graph charts the Fed’s RRP balances. If the Fed enacts YCC, investors should pay close attention to RPP balances. YCC may be just the medicine Mr. Market needs to end the fourth quarter on a high note.

repo headwinds

Small Businesses are Struggling

As you read the following commentary and view the graph from Liz Ann Sonders at Charles Schwab, consider small businesses employ about half of all Americans in the private sector. If the rental delinquency trends continue, layoffs will likely surge in the coming months.

Reeling from rent: per ⁦@Alignable, ~37% of U.S. small businesses were unable to pay their rent in full in October, up 7% from September and the highest pace of 2022 … Massachusetts and New Jersey led in delinquency surge

small business rent delinquency

“Nominal” ISM Portends Plunging Bond Yields

The ISM report showed that manufacturing activity is growing at its slowest rate in about 2.5 years. The index, at 50.2, sits just above economic contraction territory. The good news is that prices paid fell 46.6, the seventh straight monthly decline and the lowest level since May 2020. While prices are falling, the labor market continues to remain strong. The ISM employment index ticked up slightly. Additionally, the JOLTS report came in shockingly higher. There are now 10.7 million job openings. That is 1 million more than expected and 700k higher than last month.

The graph below from Brett Freeze shows the strong correlation between “nominal” ISM and 10-year UST yields. Per Brett, nominal ISM is the average of ISM activity and ISM prices. The higher the number, the more robust growth, and inflation. Bond yields tend to rise in such an environment. The takeaway from the graph is that the two figures diverge on occasion, but importantly, those periods are brief and always converge afterward. Will growth and prices accelerate to justify bond yields, or will yields plummet by over 3% in the coming year?


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Finance Is At Fault, Not Russia, Powell, or Biden

It’s Russia’s fault, cries the media. Others put the blame for recent stock declines at the feet of the Federal Reserve. Some fault Biden, the dollar, and OPEC. The financial media likes to have definitive explanations for every market gyration. We venture that in their current quest to explain this bear market, few media professionals realize that a simple Finance 101 formula accounts for about 90% of recent stock market losses. On the other hand, maybe they just don’t care. Biden, Russia, and OPEC garner many more viewers and advertising dollars than finance 101 basics.

This article explores finance’s discounted cash flow model (DCF) and the discount rate embedded within the formula. The DCF model provides critical insight into how interest rates affect stock prices. With an appreciation for how the recent surge in yields impacted stock prices, we can focus on the future path of interest rates and earnings to formulate a clearer picture of where stock prices may be heading. Accordingly, we use our knowledge to better assess how economic activity, inflation, and interest rates will drive stock prices.

Finance 101

Whether buying shares of Apple or a stake in a local grocery store, you are sacrificing current capital in exchange for future cash flows. Accordingly, our job as investors is to calculate a fair price for said cash flows. To do so, first, we need to forecast the cash flows. Then we need to calculate a present value for the cash flows using an appropriate discounting factor.

The discounted cash flow model (DCF), a staple in entry-level finance classes, allows us to formulate a present value of future cash flows. The following example helps us appreciate the model.

Someone approaches you with an opportunity to buy a $55 cash flow occurring this year and another $55 next year. How much would you pay?

The DCF model calculates how much money today, growing at the discount rate, equals the future cash flows. In our example below, we use a 5% discount rate to find the present value of the $55 cash flows. The sum of the present values of the two cash flows equals $102.27. If we aim to earn 5%, a price of $102.27 for the two cash flows is fair.

finance 101
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Variability in Discount Rates

We can use the same formula to help approximate how changing discount rates affect cash flow valuations. Keep in mind our example above was only two years. Valuing stocks entails much longer periods and with it, more variability based on changes to the discount rate.

From January 1, 2022, through October, the ten-year U.S. Treasury yield has risen from 1.63% to 4.05%. Over the same period, the S&P 500 has fallen from 4,796 to 3,856. Coincidence? We share the graph below to help answer our question. It charts the S&P 500 and the running present value of a $100 cash flow expected ten years from each date on the x-axis. The discount rate to formulate the blue line equals the appropriate ten-year Treasury yield plus a constant 5.5% risk premium. The graph shows that about 90% of the S&P 500 loss is attributable to higher interest rates. Therefore, assigning blame for the stock market declines is not too difficult.

Graph of discount rate attribution.

Given that surging interest rates accounted for a good deal of the price decline, what impact did earnings changes have on the price?

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Valuation Contraction

S&P 500 earnings per share were 197.87 in the fourth quarter of 2021. Current expectations peg them at 190.91 at the end of the third quarter. The price-to-earnings multiple started the year at 24.09 and currently sits at 18.78. The multiple contracted by over five. The question worth pondering is how much of the contraction is due to earnings.

If we take the current EPS and solve for price assuming price to earnings didn’t change this year, the result equals the S&P 500 price change related solely to the decline in EPS. 

The slight $6.96 decline in EPS only accounts for about 3.5% of the 20+% change in the S&P 500.

A large majority of the market decline is due to interest rates, and a marginal percentage is because of earnings.

What’s Next?

Understanding how interest rates (discount rates) and earnings influenced stock prices this year, we can now consider how they may change in the future to better form expectations.

Let’s start with earnings per share. Higher interest rates and the Fed’s QT program will likely result in a recession and weaker earnings.

The graph below shows the Fed’s favorite yield curve indicator of recessions, the 3-month/ 10-year yield curve, is negative. Typically, a recession doesn’t start until the yield curve troughs and then turns positive. From the trough in the yield curve, which likely hasn’t happened yet, to the start of a recession, it can take three months to over a year based on the prior four recessions. 

Graph of 3m/10y yield curve recessions valuations.

Recessions and Earnings

How much may EPS decline if we enter a recession?

recessions and eps drawdowns discount rate

Since 1920 there have been 18 recessions. On average, EPS falls by 30.8% from its peak. The median decline is 20.5%, and the average of the last four is 53.7%.

The current P/E is close to the average of the last ten years. Assuming the P/E doesn’t decline further and conservatively assuming earnings fall by the median of 20.5%, we should expect another 20% decline in stock prices.

A more bearish scenario arises if we assume the P/E declines to 15 and earnings fall by 30.8%. In such a case, the S&P could dip as low as 1,981. An even worst-case scenario using single-digit P/E ratios and a 50+% drawdown in EPS would result in a dire outlook.

There is some good news to temper the bearish outlook. Interest rates will likely fall appreciably in a recession. Accordingly, a declining discount rate factor increases the present value of expected cash flows. If rates fall back to where they were at the start of the year, a positive 20% contribution to share prices is expected.

There are bullish scenarios in which the economy remains stable and earnings flat. At the same time, inflation normalizes, and interest rates fall. Such a scenario likely means a bottom in stock prices is very near if it hasn’t been reached already.

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Value isn’t measured by the extent that prices have declined, but by the relationship between prices and properly discounted cash flows. – John Hussman

Higher interest rates have taken a toll on stock prices. The rate increases thus far will inevitably hamper economic activity and inflation, ultimately resulting in lower discount rates. The bad news is that reduced economic activity will weigh on profits which can easily counter the benefits of falling interest rates.

We have outlined the two most significant factors (interest rates and EPS) likely to explain forward returns. Finance 101 formulas may not be sexy rationales like Biden, OPEC, or Putin, but you should focus on them.

Commodity Miners Are The Lynchpin To EV Production

The Financial Times reports that Tesla is holding preliminary talks with Glencore, a large commodity producer. It appears they have an interest in acquiring a 10-20% stake in Glencore. Tesla and Elon Musk are well aware of the commodity supply restraints facing EV production. They are the first automaker working on attaining an appreciable stake in a miner, thus helping secure its commodity sourcing for the future. Glencore primarily mines or drills for copper, crude oil, and coal, but per the article, they are “starting to wade in the lithium market.

The Bloomberg graph below graphs the commodity growth required to meet projected EV needs by 2030. Glencore is one of the world’s largest producers of copper but not nickel, aluminum, and lithium. Over the coming years, we may see Tesla and other car companies recognize the potential for critical metals shortages and take actions to better secure future supply.

demand for metals

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What To Watch Today


  • 9:45 a.m. ET: S&P Global U.S. Manufacturing PMI, October final (49.9 expected, 49.9 prior)
  • 10:00 a.m. ET: JOLTS Job Openings, September (9.750 million expected, 10.053 million prior)
  • 10:00 a.m. ET: Construction Spending, month-over-month, September (-0.6% expected, -0.7% prior)
  • 10:00 a.m. ET: ISM Manufacturing, October (50.0 expected, 50.9 prior)
  • 10:00 a.m. ET: ISM Prices Paid, October (53.0 expected, 51.7 prior)
  • 10:00 a.m. ET: ISM New Orders, October (47.1 prior)
  • 10:00 a.m. ET: ISM Employment, October (48.7 prior)
  • WARDS Total Vehicle Sales, October (14.50 million expected, 13.49 million prior)


Market Trading Update

With October now in the rearview mirror, the month of November lies ahead. This week the markets must deal with the Fed meeting announcement on Wednesday and the employment report on Friday. Next Tuesday is the midterm elections. After that, the news flow will slow heading into the holidays as earnings mostly wind down. For now, technically speaking, the market remains in a bullish trend, with important resistance points mostly behind us for now. With the market not extremely overbought, there is room for a further advance to our target of 3900-4000 level, with an upside potential of 4100.

We are using the current rally to raise cash in steps by reducing positions we want to keep and tax loss harvesting others. The goal is to increase cash levels near term and reduce overall portfolio risk heading into year-end. There is no indication; currently, the bearish market trend is behind us, particularly as everything hinges on whatever the Fed says. Of course, if something changes the market trajectory or outlook, we will change our view accordingly.

Does Money Supply Portend Inflation will “Crash?”

The Tweet below from Henrik Zeberg portends that inflation will follow the downward path of the M2 money supply and “crash” just as quickly as it rose over the last two years. While we hope he is correct, he is missing a vital part of the inflation equation. Inflation is not just a function of the amount of money but equally important monetary velocity, which measures how often the money circulates through the economy. The combination of monetary velocity and money supply is a much better indicator of inflation. The series of graphs from Brett Freeze warn us inflation may not “crash,” as Henrik states. As Brett shows in his third graph, monetary velocity is turning up and offsetting the decline in M2. Brett also shows how monetary policy tends to mimic velocity. This is not surprising as velocity tends to be a good indicator of economic activity.

m2 money supply inflation
velocity money supply

Eurozone Inflation Keeps Going

Unlike the United States, where inflation is showing signs of turning around, inflation in the Eurozone is rising to new records. Eurozone prices jumped by a record 10.7% in October, exceeding expectations for a 10.3% increase. Core Inflation accelerated to 5%, a new record as well. Not only is the Eurozone dealing with higher commodity prices, but they also have the currency effect. The euro is down about 15% this year. Almost all commodities imported into the Eurozone are priced in dollars. As such, Eurozone countries must pay the higher prices for said commodities plus 15% due to currency depreciation.

eurozone inflation cpi

The Chase for Junk

The graph below shows that inflows into JNK, the popular junk bond ETF hit an all-time high last Friday. JNK, which holds junk bonds, is currently sought after as investors pick up additional yield over investment-grade corporate bonds and U.S. Treasuries. The second graph shows the yield differential between junk bonds and Treasuries is nearing the lowest levels seen in the last 10+ years. Clearly, junk bond buyers are not worried about a recession in the near future.

jnk junk bond inflows
junk bond spreads

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October Market Lows And The End Of Bear Markets

October started strong and then slid to new lows but managed to rally back toward the month’s end. As noted in “As Buybacks Return:”

The Dow is on pace for its best month since 1976. It is also close to its best month since 1938. So far, the Dow is up four straight weeks (+14%) and is posting its biggest 4-week gain since April 2020. Despite dismal FANG earnings, the Nasdaq is ‘only’ up 5% on the month.”

With those gains, it was not surprising to see articles flipping bullish. To wit:

“Here’s a little news flash. Tech stocks have entered a brand-new bull market that could be the start of a massive 50%-plus melt-up. And certain tech plays could see a 10X surge higher!

So, did October mark the bottom and the end of the bear market? Or is this rally that fails as the bear market continues?

The honest answer is no one knows for sure. However, as Yahoo Finance recently noted, October market lows did historically mark the end of bear markets more often than not.

Bear Market Bottoms By  Month

As Stock Trader’s Almanac’s Jeffrey Hirsch recently noted:

“Not all indices have bottomed on the same day for all bear markets, but the lion’s share, or bear’s share I should say, bottomed in October.”

October market lows have also occurred regularly before a midterm election, such as in 2022. As Deutsche Bank recently observed:

“The S&P 500 has risen in the year after every single one of the 19 midterm elections since World War II, with not a single instance seeing a negative return.”

Performance of SP500 before and after Midterms.

However, while there is undoubtedly historical precedent to suggest October market lows may be in, it is crucial to remember there are “no sure things” in the financial markets. ‌

“History is a great guide, but it’s not gospel.” – Sam Stovall

The Lows Are Likely Not In

After ten months of a brutal grind lower in the markets, it is no wonder why investors are looking for any sign the selling may be over. As Bob Farrell once quipped:

“Bull markets are more fun than bear markets.”

There is little doubt as to the veracity of that statement. However, while we can certainly hope that the October market lows marked the bottom, there are reasons to expect such is not the case. At least not yet.

While the mainstream media continues to define the current decline as a “bear market,” it remains a “correction” within the bullish trend. Several reasons for that statement will determine whether the October market lows were just that.

The current decline in the market has only reversed the extreme extension above the 200-week moving average. That long-term moving average continues to define the bullish market trend from the 2009 lows. It also defined the bullish trend following the previous bear market lows. Most importantly, the 50-week moving average has not crossed below the 200-week, representing each previous bear market and recession.

Market vs Recessions vs 50- and 200-week moving average

Most notably, many factors are currently missing that coincided with each previous bear market cycle.

  • Surging unemployment
  • Recession
  • Bankruptcies
  • Defaults
  • Fed cutting rates
  • Falling 2-year and 10-year Treasury yields
  • Un-inversion of the yield curve.
  • Spiking credit spreads

Further to this point, BofA recently published a checklist of “signposts” that previously signaled bear market lows. Currently, only 2 of the 10-signposts are registered.

Market bottom table

While the market will likely have a sustained rally from the recent October market lows, it is probably not the bottom of the bear market. In fact, there a numerous reasons to suspect that lower market lows are coming in 2023.

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The 2023 Market Bottom

As we move into 2023, the markets will have much to contend with. With valuations still elevated by many measures, earnings are weakening, and profit margins under pressure from inflation, a repricing risk of equities remains. Investors should remain cautious until the economy shows signs of improvement.

Earnings vs market indicator

Notably, markets tend to bottom and recover before the economic data, which is why it tends to be a leading indicator of economic activity. However, the risk to investors in 2023 is an economic recession, which is most likely not accounted for currently.

As we have noted previously, each increase in the Fed funds rate takes between 9 and 12 months to impact the economy. At the same time, the economy is already slowing, and assuming the Fed hikes to its predicted target, that 4% increase in rates has yet to impact growth. If such is the case, earnings growth will slow considerably more.

Fed funds vs annual earnings growth rate

But critically, the Fed is not operating in a vacuum. Accompanying that surge in the dollar was 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.

Annual change in rates and the dollar

We suspect that the risk of a recession in 2023 is substantially higher than most economists expect. Such is particularly the case when the lag effect of monetary policy collides with economic weakness from reduced consumer demand.

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Navigating What Comes Next

As noted, the biggest problem of investing during a recession is knowing that you are in one. Many indicators suggest we could be heading into a recession next year, but unfortunately, we won’t know for sure until after the fact.

Therefore, we must respond to market warnings and take action to prepare for a recession in advance. That said, the most important thing isn’t necessarily what steps to take but what behaviors to avoid. During market downturns, our emotional and behavioral biases tend to inflict the most damage on our financial outcomes.

“Loss aversion” is one of the leading factors influencing investment decisions, according to a recent survey from the CFA Institute.

Psychological factors of investing.

“Loss aversion is a tendency in behavioral finance where investors are so fearful of losses that they focus on trying to avoid a loss more so than on making gains. The more one experiences losses, the more likely they are to become prone to loss aversion.” – Corporate Finance Institute

Therefore, to avoid losing money in a recession, you must:

  • Avoid trying to time the exact bottom.
  • Don’t try to “day trade” markets.
  • Reduce leverage and speculative bets
  • Avoid selling quality companies just because they are down.

I agree with Motley Fool’s conclusion:

“The bottom line is that, during recessions, it’s important to stay the course. It becomes a bit more important to focus on top-quality companies in turbulent times, but, for the most part, you should approach investing in a recession in the same manner you would approach investing any other time. Buy high-quality companies or funds and hold on to them for as long as they stay that way.”

Most importantly, you must know the difference between a “top-quality” company and one that isn’t.

FAANGs Make for a Scary Halloween

The FAANGs are taking a Halloween bite out of many investors’ goody bags. FAANG stocks, known as the market generals because they are the most widely held stocks, took a beating this past week on earnings announcements. Included in the FAANG acronym are Facebook (now Meta), Apple, Amazon, Netflix, and Google. Most investors also include Microsoft. The graph below shows the FAANGs performance this past week and year to date. Apple is the only FAANG stock beating the S&P 500 this year. But, it is doing so by a slim margin. Interestingly, the FAANGs, including MSFT, have a market cap accounting for about 20% of the S&P 500, yet the S&P 500 outperforms the FAANGs by 10% on average for the year. Looking past Halloween toward year-end and 2023, are we entering a market not led by the FAANGs? Might small caps or value stocks finally take the reigns?

A vampire went to an exclusive Halloween party. It was for FAANG members only. It sucked. Happy Halloween!

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What To Watch Today


  • 9:45 a.m. ET: MNI Chicago PMI, October (47.0 expected, 45.7 prior month)
  • 10:30 a.m. ET: Dallas Fed Manufacturing Activity, October (-18.5 expected, -17.2 prior month)


Market Trading Update

The market rallied above the 3800 level, retested it Thursday, and then rocketed higher on Friday, breaking above the 50-dma and touching the 100-dma. Such confirms the bear market rally remains intact.

Over the last several weeks, we have repeatedly made the case why this market rally was likely, and all that we needed was some news flow to spark a buying panic. Of course, the rise in market chatter about a Fed’ pause’, ‘mini-pivot,’ or ‘step-down’ in its hawkishness provided the narrative to send shorts scurrying to cover.

For some context, the Dow is on pace for its best month since 1976. It is also close to its best month since 1938. So far, the Dow is up four straight weeks (+14%) and is posting its biggest 4-week gain since April 2020. Despite dismal FANG earnings, the Nasdaq is ‘only’ up 5% on the month.

However, we are not out of the woods yet, with an earnings recession coming in the new year. In Q1 we suspect we will see potential new lows in stocks as an economic recession becomes visible so continue to use this rally to lighten up on exposure to equities into year-end.

Buybacks, As Buybacks Return Can The Market Continue To Rally

The Week Ahead

With earnings for the FAANG stocks and many others out of the way, we can regain focus on the economy and the Fed. The Fed meets on Wednesday for its FOMC meeting. It is widely expected they will increase Fed Funds by .75%. However, more importantly to investors, will they hint at stalling rates or acknowledge the financial problems that higher rates and the dollar are having on foreign markets? For the first time in quite a few meetings, it’s easier to make a case that the Fed will be less hawkish than at the previous meeting.

The state of the labor market is the predominant focus of this week’s economic calendar. On that front, the BLS is expected to report that the unemployment rate will be stable at 3.5% with 240k new jobs added. On Tuesday, economists expect JOLTs to slightly increase job openings. If labor market data comes as expected, the labor market will show no signs of weakening. The Fed is hoping for some weakness to curtail high levels of inflation. Also of interest will be a few regional manufacturing surveys and the national ISM manufacturing survey. The consensus ISM forecast is 50. A level below 50 portends negative economic growth. Like leading indicators, ISM may also be forecasting a recession ahead.

Exxon Shines as FAANGs Falter

Exxon (XOM) blew the door off of earnings expectations. In the third quarter, they reported an EPS of $4.68, almost a dollar above expectations. Revenue also well-exceeded expectations. Q3 net income of nearly $20 billion marks the highest income in the company’s 152-year history. Even more impressive, it is on par with Apple’s $20.7 billion for the same quarter. Not surprisingly, Exxon’s stock is trading at an all-time and up nearly 70% this year. Compare that to the performance of the FAANGs in the lead graph.

exxon vs amazon tesla pg

Confidence in CEO Confidence

The graph below speaks volumes about the value, or lack thereof, of tracking CEO sentiment. While many investors believe CEO’s have unique insights into their companies and, therefore, the economy, the graph below argues they may not. As the graph shows, CEO confidence regarding the near-term economic outlook is always the poorest toward the end of recessions. Accordingly, the weakest CEO confidence readings have marked market lows. Currently, CEO confidence is at a 35-year low. The worst confidence reading since 1985 might just be a massive buy signal. Stay tuned.

ceo consumer confidence

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Fed’s Yield Curve Forecasts Recession

Q3 GDP rose nicely, but the Fed’s preferred yield curve has spoken. It says a recession is imminent. The graph below charts the yield difference between the 3-month Treasury bill and the 10-year Treasury note. The Fed often reminds us that an inversion in the 3m/10yr UST curve is a precursor for recessions. Every time, as we annotate in red, the ten yield is lower than the three-month yield for more than a few days, a recession follows.

When should we expect a recession? As the graph highlights, it has taken between three and thirteen months from the trough of the yield curve inversion until the official NBER recession declaration.  Making timing a little tricky is the clock doesn’t start ticking until the yield curve troughs. Based on Fed Funds futures, we expect the three-month yield will rise from 4.05% to 4.80%. Unless the 10-year yield falls by .75% over the coming months, the Fed’s yield curve will invert further. Such a trough in the Fed’s yield curve may take another couple of months to form. Then we can start the recession clock.

fed yield curve recession

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What To Watch Today


  • 8:30 a.m. ET: Employment Cost Index, 3Q (1.2% expected, 1.3% prior)
  • 8:30 a.m. ET: Personal Income, month-over-month, September (0.4% expected, 0.3% prior)
  • 8:30 a.m. ET: Personal Spending, month-over-month, September (0.4% expected, 0.4% prior)
  • 8:30 a.m. ET: Real Personal Spending, month-over-month, September (0.2% expected, 0.1% prior)
  • 8:30 a.m. ET: PCE Deflator, month-over-month, September (0.3% expected, 0.3% prior)
  • 8:30 a.m. ET: PCE Deflator, year-over-year, September (6.3% expected, 6.2% prior)
  • 8:30 a.m. ET: PCE Core Deflator, month-over-month, September (0.5% expected, 0.6% prior)
  • 10:00 a.m. ET: Pending Home Sales, month-over-month, September (-5.2% expected, -2.0% prior)
  • 10:00 a.m. ET: Pending Home Sales NSA, year-over-year, September (-22.5% prior)
  • 10:00 a.m. ET: University of Michigan Consumer Sentiment, October final (59.6 expected, 59.8 prior)


Market Trading Update

Another tough day of trading yesterday as Facebook’s massive disappointment sent the stock plunging to the lowest levels in several years, closing below $100/share. After the close, Amazon disappointed as well, another Megacap name that will weigh on the S&P 500 today. While reporting some weaknesses in product sales, Apple did better and may provide some support.

The market did manage to hold onto the 3800 level, but unless the markets can muster a rally, that support is now at risk of getting broken today. If it does, the 20-dma remains the last support level before a retest of lows. If that does become the case, the risk to the downside increases markedly. We are starting to reduce risk in portfolios further today and raising additional cash for the time being. Once markets stabilize we will look to rebuild allocations accordingly.

GDP Oddities

GDP was stronger than expected, growing at 2.6%. Growth is now positive for the year, after -.6% and -1.6% GDP in the second and first quarters, respectively. The table below from Charles Schwab breaks down GDP into its components.

gdp components

There are two extreme readings within the report worth noting. First, fixed investment, accounting for about 18% of GDP, detracted from growth. The decline was due to a sharp fall in investment in residential housing. In fact, residential investment single handily reduced GDP by 1.4%, the largest negative contribution since 2007. Given high mortgage rates and plummeting homebuilder sentiment, this was expected. The concern, however, is that residential fixed investment (RFI) tends to lead the economy by about a year. The graph below shows the strong leading relationship between RFI and ISM.

gdp residential investment vs ism

The second outlier is foreign trade. Net exports (exports minus imports) are often a negative component of GDP as America runs a perpetual trade deficit. However, in the third quarter, exports handily outstripped imports adding 2.8% to GDP growth, accounting for its largest contribution to GDP in over 40 years. This is somewhat surprising, given a strong dollar favors imports. Looking into the data, we find exports were led higher by “petroleum and products.” We think increased natural gas needs from Europe, along with higher energy prices, are the likely culprit.

The GDP price index was +4.1%. While high, it is a welcome sign inflationary pressures are easing. The Q2 price index was +9.1%.

Seasonality in a Bear vs. Bull Market

The graph below, from Top Down Charts, sheds new and concerning light on seasonality patterns for the S&P 500. As it shows, markets tend to go higher in the fourth quarter. However, in bear markets, October’s tend to have decent gains but said gains are often erased in November or December.

bear market seasonality bull

Larger Federal Deficits

The Tweet below from Samantha LaDuc shows how the surge in interest rates is pushing the interest expense for the U.S. Treasury higher. To put $716 billion, and rising, into perspective, the entire deficit for 2019 was just under $1 trillion. From 2013 to 2017, the entire deficit was less than $716 billion. This is yet another reason that higher interest rates are not sustainable.

Federal deficits

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