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July 10, 2020

Initial Jobless Claims continue to decline slowly and remain at levels well above anything witnessed since the advent of unemployment insurance. The highest weekly total prior to this year was 692k. Last week 1.314 million people filed for insurance. Continued claims continue to drop but remain stubbornly high at 18 million. Most concerning within this report is that persons claiming benefits in all programs, Federal and state, rose from 31.5 million to 32.92 million. The data however, is two weeks old. This LINK contains the full set of data if you are interested.

The CBO released the latest Monthly Budget Deficit, which reports that the federal deficit for June was $863 billion. The current deficit for the fiscal year (October 1, 2019 – September 30, 2020) is already $2.7 trillion. In regards to June’s deficit, there have only been five annual deficits that have been greater. Four were in the years surrounding the financial crisis and the other was last year. The total annual deficit is already nearly two times the largest annual deficit from 2009 with three months remaining.

Yesterday we discussed the sharp decline in consumer credit. The graph below, courtesy Brett Freeze puts historical context to the drop.

Yesterday, the NASDAQ was up by .92% while the Dow fell by 1.39%. It seems that such divergences have been occurring with increasing frequency.  As shown below, we analyzed historical data to see just how uncommon this is. To qualify as a daily divergence in the graph, one of the indexes needs to be up or down by more than half a percent. At the same time, the other index had to move in the opposite direction. For example, if the Dow was down .75% and the NASDAQ was higher on the day, that daily instance would qualify. The graph shows the number of such instances in rolling 50 day periods. Over the last 50 days, it has happened 11 times or more than 20% of the time. The last time there were 11 instances in a 50 day period was during the Financial Crisis. Before that in 2002.

July 9, 2020

Initial Jobless Claims, for release at 8:30, are expected to fall from 1.427 million to 1.375 million. Like the previous few weeks, we will pay close attention to continued claims.

Total consumer credit declined by over $18 billion, marking the third monthly decline in a row.  Revolving credit, mainly credit cards, fell by $24 billion and has declined by over $100 billion in the last three months. Total revolving credit is now under $1 trillion, a level last seen in 2007. The decline in consumer credit is due to reduced spending, as well as individuals using stimulus money to pay down their cards.

Every Tuesday, Redbook Research Inc. publishes its proprietary Johnson Redbook Index. The index tracks retail sales on a weekly basis. We usually do not pay much attention to the index, but given the situation, it provides us with near real-time data on the health of consumers, which is about 2/3rds of GDP. More popular Retail Sales from the Census Bureau is monthly and lags by a few weeks.  As shown below, the level of activity in the Redbook survey is still well below the same week last year. More concerning, it is aligning with other high-frequency data and signaling a stagnation in the recovery.

The Citigroup Economic Surprise Index measures how well economic analysts are forecasting economic data. When the index is high, it means the analysts are underestimating economic data and vice versa for low readings. As shown, the degree in which they have underestimated data is literally off the charts. This index tends to oscillate as analysts reformulate their forecasts. Given the volatility of economic data and highly unusual circumstances, the record level is not surprising. Also, notice that bond yields are well correlated to the index. This time however, bond yields are not reacting. The odd divergence is the result of the unprecedented economic environment, many unknowns regarding the virus, and importantly the Fed/QE. If historical correlations held up, Ten-year Treasury yields would increase by about 2%

Piper Sandler conducted the poll below to gauge the spending habits of those currently receiving unemployment benefits. The obvious take away is that about half of those receiving unemployment would cut their spending if the additional $600 Federal unemployment benefit were eliminated. Currently, that is scheduled to happen at the end of July. What we find stunning in the survey, however, is that only 2% of the people surveyed expect to be back on the job at the end of the month.

July 8, 2020

Atlanta Fed President Raphael Bostic voiced concern that the recent uptick in COVID cases is potentially slowing the recovery. In particular, he said the Fed is closely examining high-frequency data and seeing signs that businesses are “getting nervous again.” Further, “there are a couple of things that we are seeing and some of them are troubling and might suggest that the trajectory of this recovery is going to be a bit bumpier than it might otherwise.” His concerns are in line with recent credit card data (high-frequency), showing that spending growth has flattened.

The table below provides a big clue as to what is driving the S&P this year. First, the S&P 500 is market cap-weighted meaning as a company’s market cap increases relative to the market its weighting in the index increases and by default other company’s decline. The table is sorted by market cap deciles with the largest at the top. As you read down, from top to bottom, notice that the year to date returns (far right column) are largely ordered from highest to lowest. Also, note that the four fundamental ratios are also ordered mainly from most expensive to cheapest.

The table has the earmarks of passive investors driving the market. As investors buy the index, they indirectly are buying more of the largest companies and less of the smaller companies. For example, for every $100 invested in the S&P 500, an investor buys $6 of MSFT but only .01 cents of Xerox. As the index rises, the larger companies become a higher percentage of the index and the smaller ones diminish in their contribution. The process repeats over and over again. The trade today is to chase the largest companies. Conversely, the appropriate strategy for a market sell off is to rotate to the smallest companies. The interesting aspect of the table is that large-cap value stocks (those at the bottom of the list) are trading at respectable valuations in aggregate but are being shunned, simply because they have a relatively smaller market cap.

Over the coming few weeks, second-quarter corporate earnings will be released. As such, we thought we would share a graph from J.P. Morgan comparing how the first quarter stacked up in terms of margins, share counts, revenues and earnings per share versus the past twenty years. Keep in mind, while the earnings data was awful for Q1 and will be for Q2, many companies will experience earnings growth in the third and fourth quarters, which will improve the annual numbers for 2020. Currently, analysts expect 2020 EPS to fall 23% versus 2019. As is typical, that estimate will likely be revised lower over the coming quarters.

July 7, 2020

Jobless Claims on Thursday and PPI on Friday will be the two big economic data releases this week. There are a few Fed speakers on the docket, but we do not expect to hear anything new from them. Congress started a two week vacation, so news on potential stimulus renewals/extensions or new stimulus will likely be muted this week and next.  Second-quarter earnings announcements will commence this week but mainly for smaller, lesser known companies. They begin in earnest next week when the banks and airlines release their financials.
This week the U.S. Treasury will offer $29 billion Ten-year notes on Wednesday and $19 billion 30-year Bonds on Thursday. Frequently, in advance of these offerings, bond yields rise and then reverse course after the auction. Given the Fed’s involvement via QE, prior trends may not hold.
The ISM Services survey broke into expansionary mode, showing that service managers are optimistic that the economy is getting better. The only concern in the report, and as we saw in the manufacturing surveys last week, is that the employment sub-index is still in contraction mode, which signals further job cuts.
While most Universities are working on a mix of online and live classes, Harvard bucked the trend and announced yesterday that all classes would be held on line. Further, they will limit dormitory housing to 40% of students.
The SBA put out a list of all the businesses that received at least $150,000 under the PPP program. The chart below provides some context as to how much was borrowed by industry and average loan size.
The graph below, courtesy of J.P. Morgan, tracks Chase consumer credit card spending. Consumer spending bottomed in early April and has been rising since. Over the last two weeks, however, the gains appear to stabilize. As we have mentioned, consumer stimulus, the largest driver of consumer spending, is waning.  Credit card data, as shown below, should provide us an early indication that further gains in consumption are in jeopardy. This assumes, of course, that additional stimulus is not approved by Congress.

July 6, 2020

For the second month in a row the BLS employment data was much better than expected. The economy added 4.8 million jobs after adding 2.7 million last month. The unemployment rate fell to 11.1%.
Initial Jobless Claims, on the other hand, continue to paint a different picture. New claims remain stubborn at 1.427 million, a slight decline from 1.482 million last week. More troubling, continuing claims, or those that filed claims and have yet to be rehired, rose slightly to 19,290 million. The running rate before COVID was approximately 1.7 million, resulting in approximately 17.2 million unemployed.
On Friday, the U.S. Treasury bailed out trucking firm YRC Worldwide Inc with $700 million of funding. The government package required YRC to give up almost 30% of ownership to the government.
Per a CNBC article, Joe Biden told his donors that he would erase most of Trump’s tax cuts. The corporate tax cut signed in late 2017 reduced the corporate tax rate from 35% to 21%. Wall Street is in agreement that the legislation boosted S&P 500 earnings by at least 20%. If Biden is elected, and his plan passes through the Senate and House, which are two big ifs, S&P 500 EPS would likely decline by at least $25-$30 dollars.
Tesla, rallied 8% on Thursday based on better than expected deliveries. As shown below, its deliveries are in line with the prior four quarters and showing no growth over the last year. Regardless of fundamentals, Tesla now has the largest market cap ($222 billion) of all auto manufacturers. It is now almost $50 billion larger than Toyota, the previous largest manufacturer by market cap. To say Tesla is priced for perfection is an understatement.

July 2, 2020

As we noted yesterday, Consumer confidence bounced in the latest report by the Conference Board. However, that bounce in confidence came from those in higher income classes who participated in the market surge from the Fed’s liquidity. For the vast majority of citizens, confidence slipped.
We apologize, ADP was released yesterday, not today as we thought. The ADP jobs number showed an increase of 2.369 million jobs which was 1.1 million below expectations. However, ADP revised last month’s number from -2.76 million to +3.015 million. Considering ADP does not estimate and uses real payroll data, it is a bit confounding how they can have such a large revision.
ISM positively diverged from the Chicago PMI number on Tuesday. National manufacturing is now expanding, versus contracting in the Chicago data. Again, the critical point to consider is that while more companies are expanding versus contracting, these surveys do not quantify the degree of expansion. As we saw in Chicago, the employment sub-index in the national data also remains in contraction. The positive takeaway from the report is that it appears manufacturers are recovering.
The table below shows expectations and the prior month readings for today’s BLS employment report. Note the massive range in estimates. Initial Jobless Claims, also at 8:30, is expected to be 1.4 million for the week, versus 1.48 million last week.
The Fed minutes from the June FOMC meeting were released. As we suspected, yield curve control (YCC- also know as Yield Curve Targeting YCT) is actively being discussed at the Fed. In fact, the first topic of the meeting was a “Discussion of Forward Guidance, Asset Purchases, and Yield Curve Caps or Targets (YCC/YCT).” The discussion ended with the following statement: “All participants agreed that it would be useful for the staff to conduct further analysis of the design and implementation of YCT policies as well as of their likely economic and financial effects.” As we discussed in The Next Iteration, What is Yield Curve Control, YCC will be used by the Fed, we believe it is just a question of when.
The Fed continues to maintain a realistic view of the economy, to wit: “Officials saw extraordinary uncertainty and considerable risks for the economy.” The statement further confirms the Fed has no intention of letting its foot off the monetary gas pedal and will use its full range of tools to support the economy.

July 1, 2020

With quarter-end in the rearview mirror, some of the window dressing trades from the prior week will likely be reversed over the next few days. In other words, investment managers that put on new positions before quarter-end to make their quarter-end investment statements look favorable to clients, may sell and buy back what they previously owned. Given the volatile quarter we just had, it is likely some added risk in recent days to show they were aggressively chasing the rebound, while others reduced risk to show concern. This dynamic makes it tough to handicap.

Jerome Powell and Steven Mnuchin testified to Congress yesterday. Of interest, Mnuchin said: “Treasury and the Fed have not yet figured out a way to help commercial real estate.”

United States Consumer Confidence was encouraging. It jumped to 98.1 versus a consensus forecast of 91.8.  It is still way off of January’s level of 131.6.

Despite increasing, Chicago PMI was disappointing, only rising to 36.6 versus 32.3 last month. While better than last month, it was well off of expectations of 45. Employment and new orders, which are good leading economic indicators, both contracted. The survey had a special question as follows: “What are your personnel plans for the rest of the year?” 55.8 of those surveyed said they were going to freeze new hires, 23.3% expect layoffs, and 18.6% plan to increase their workforce.  The graph below shows the recovery in the PMI survey has been much weaker than consumer related industry data points. This should not be surprising as much of the stimulus thus far is geared towards employment and consumption, not manufacturing. The broader ISM manufacturing survey, released at 10am, will help affirm the PMI report.

On Monday, we wrote the following: “A second important factor driving consumer confidence and consumption are the benefits associated with Federal and state stimulus programs.” The graph below from the Hutchins Center quantifies and substantiates our concern. Per their forecasts, Federal and state stimulus will positively impact 2nd quarter GDP by 9.25%. That amount is projected to fall considerably to 4.55% in the 3rd quarter and .86% in the fourth quarter. By the 2nd quarter in 2021, they expect an economic drag with a negative fiscal impact of -5.35%.

We also recently explained the ongoing debate among investors on whether the stock (amount of total QE) matters more or less than the flow (recent percentage change in QE). The following graph, courtesy of Strategas, shows that as the percentage change in QE stabilized in recent weeks, the market has followed its cue and consolidated.

 

June 30, 2020

This week is short due to the Friday, July 4th holiday, however, it will be a busy one. Important manufacturing survey data will be released, including Chicago PMI today, and the PMI and ISM manufacturing surveys tomorrow. Keep in mind the surveys are misleading as the survey asks whether conditions are better this month as compared to last month. In almost all cases the answer is probably yes. The bigger question, which these surveys do not ascertain, is how much better.

Also, on Wednesday, ADP will release its employment report. Because of the holiday, the BLS will release the June employment report on Thursday, along with Initial Jobless Claims. Jerome Powell will speak at 12:30 this afternoon.

Late yesterday afternoon U.S. Commerce Secretary Wilbur Ross revoked Hong Kong’s special status. State Department Secretary Mike Pompeo tweeted: “If Beijing now treats Hong Kong as “One Country, One System,” so must we.”  The U.S. actions were likely in response to China passing a national security law for Hong Kong. Details are light, but it is believed the law further restrains Hong Kong’s autonomy.

Many large companies are suspending advertising campaigns on Facebook and other social media sites. These actions are likely temporary, but for investors of social media companies, they will reduce revenue and profits. In 2017 we wrote about how social media are really just advertising companies. To wit:

“With that example of how the automobile industry grew revenue from all of the aforementioned highlighted sources, we consider social media. 88%, 95%, and 90% of revenue from three of the largest social media/internet firms, Google, Facebook, and Twitter respectively comes from advertising (data sourced from their most current annual reports). Needless to say, when we think about social media’s “product”, it is not cutting edge technology as some claim, but instead they are simply a new breed of mad men, in a mature advertising industry.”

The Small Business Administration will stop approving PPP loans on Wednesday. More than $134 billion has not been used. As the Daily Shot points out below, this is a common theme.

June 29, 2020

Concerns over the increasing number of COVID cases in Texas and Florida prompted their respective governors to walk back their reopening processes. Per CNN, California’s Governor is advising the county’s health department to reinstate its stay-home orders after it had a rise in COVID cases. The recent outbreak may also explain why the University of Michigan Consumer Sentiment Survey fell from 78.9 to 78.1. Given that personal consumption is about two-thirds of GDP, we will closely follow how consumers react to the surge in new cases.

A second important factor driving consumer confidence and consumption are the benefits associated with Federal and state stimulus programs. The first chart below, courtesy of Zero Hedge, shows that personal income has risen sharply over the last few months. Unfortunately, all of the increase is due to the $1200 stimulus checks and enhanced unemployment insurance benefits (transfer receipts). In fact, without the stimulus, personal income would be down sharply. The second graph shows the unprecedented extent to which unemployment benefits are supplementing lost wages. Given the large degree to which stimulus has supported personal consumption, we must be prepared for a situation in which any new rounds of stimulus are not large enough. More troubling would be the possibility of further stimulus getting caught up in election politics.

The June rally in the equity markets should really be called the Apple rally. Here is a tidbit from Philip Davis at www.philstockworld.com explaining:

AAPL is up 14% in June and the Nasdaq has gained 600 points or 6.3% so, essentially all of June’s gains so far have come from Apple’s $45 run and, in the Dow, each component $1 is worth about 8.5 Dow points (yes, it’s an idiotic index) so AAPL contributed 382 points to the Dow’s 400-point gain for the month.  That would be 95.5% of the gains…

The Wall Street Journal had an interesting article about the way Starbucks plans to adopt to COVID and post-COVID consumer trends. To wit:  “For their part, Starbucks is planning to build more locations in urban areas designed specifically for takeout and advance ordering. While these locations will have lower sales potential than a traditional cafe, the savings on labor and occupancy costs will be significant.”

June 26, 2020

Initial Jobless Claims continue to remain at high levels. The non-seasonal adjusted number of claims fell by a meager 6,000 people. Total continuing claims including Federal programs rose from 29.2 million to 30.5 million. More importantly, despite the reopening of the economy. unemployment claims have flattened out at levels higher than any previous point in history.

The combination of Fed intervention and record debt issuance pushed trading volumes in investment grade corporate bonds to a record high as shown below.

With the large increase in equity prices, many funds are likely over-allocated to equities and under-allocated to bonds. As such, large pension funds and other balanced funds will need to rebalance their portfolios at quarter-end. CNBC published There’s a wave of selling estimated to be in the billions that’s about to hit the stock market which discusses how this quarter’s imbalance could lead to a large trade out of equities and into bonds. Given the size of the potential trades and the desire to front-run the market, these trades are already being done and will continue throughout the month.

Calculated Risk put out an interesting article discussing how commercial real estate construction is struggling to recover. Specifically, the article mentions the AIA Architecture Billings Index which has stopped declining and is not recovering like other sectors. It currently sits below the trough of 2008. Given the overbuilding of commercial real estate over the past ten years in many areas and now the work from home movement, this sector will likely struggle.

While economic data bounced over the last month, this has simply been a function of going from extremely depressed levels to less depressed levels. This was seen yesterday in the Durable Goods report which showed a large bounce in the headline number but new orders remain substantially below 2019 levels.

Lastly, one of the big risks to the market has been the potential for a “second wave” of the virus, which curtails the economic recovery. The surge in new cases is coming at a time when the “first wave” had not fully subsided as of yet pushing both Texas and Florida to “pause” their reopening plans. As JPM noted yesterday, there is already evidence that rising cases are stating to hit consumer spending again with restaurant bookings declining.

With the inability to get activity back to normal levels, the risk of more business closures and job losses puts the hope of a “V-shaped” recovery at risk.

Lastly, we have avoided banks in our portfolios as zero interest rates, monetary interventions, and a weak consumer don’t lend to stronger profitability or stability of major banks. Yesterday, another hit came to the financial sector as the latest Fed “stress test” found potential threats to the financial system which resulted in both a capping of bank dividends and restricted stock buybacks for the sector. Given that stock buybacks have been a major source of producing Wall Street “EPS beats,” expect banks to continue to underperform the broader markets in the months ahead.

June 25, 2020

Initial Jobless Claims will be released at 8:30. The current estimate is for 1.38 million people to file initial claims. The chart below shows how the claims stimulus is monetarily incentivizing people to stay at home versus seeking employment. This odd dynamic makes it hard to truly assess the labor market until unemployment insurance reverts back to its old pay rate.

The winds of trade war are starting to blow again. Earlier in the week Peter Navarro hinted at trouble with the China Trade deal. Now there is talk that Trump is considering $3.1 billion of new tariffs on exports from France, Germany, Spain, and the U.K.

Fitch downgraded Canada’s credit rating from AAA to AA+. The combination of weaker growth and more debt drove the action.

One of the factors making the current recession worse than prior recessions is that it is occurring simultaneously around the world. As shown below, the World Bank expects more than 90% of economies to be in a recession this year. The percentage dwarfs all prior recessions and is even greater than the Great Depression.

The following graph plots forward estimates for the Dollar index versus the current value of the index. As shown, the dollar has mostly been above forecasts and is currently above future expectations. Interestingly, these bearish outlooks have not fallen over the last few months as the Fed’s balance sheet has surged in size and the Federal deficit is ballooning. We must keep in mind, dollar demand increases as foreigners borrow more dollar-denominated debt to fight the economics effects of COVID.

The following Tweet and graph from Troy Bombardia is interesting.

June 24, 2020

Texas Governor Greg Abbott said he might stop or slow down the state’s reopening plans if the contagion keeps expanding at what he calls an “unacceptable rate.” California is considering similar steps. New York City and other major east coast cities, on the other hand, are taking steps towards reopening. Reopening will like likely have fits and starts due to the size of the country and the different timing in which the virus hit each geographic area. The following graph shows how the recent outbreak in the Houston area has weighed on restaurant traffic.

Over the last few weeks, one of the more notable oddities of the equity markets has been the daily performance divergences between the major indexes. In previous commentaries we made a note of the uncorrelated relationship between the Dow Jones Industrial Average and the NASDAQ. The Wall Street Journal picked up on this as well. They wrote:

A surge in big technology stocks has helped the Nasdaq Composite rally 12% in 2020, while the Dow Jones Industrial Average of blue-chip stocks is down 8.8%. The benchmark S&P 500 is hovering in between them, off 3.5%.

The Nasdaq’s advantage over the Dow and S&P 500 is the biggest since 1983. The gap between the S&P 500 and the Dow is the widest since 2002, when the Dow was ahead.

There has been a lot of debate about how much economic damage was caused by the economic shutdowns and what a second round of shutdowns might mean for the economy. Data out of Sweden and Denmark helps shed more light on the question. Sweden, which did not shut down, saw spending decline by about 25%. Neighbor, Denmark, which had a full shutdown, saw spending fall about 30%. While a small sample set, the government imposed shutdowns may not matter as much as what individuals do or do not do. As we learned, despite complete freedom to consume, the Swede’s, by and large, voluntarily shut themselves down. Click LINK for the whitepaper by the University of Copenhagen.

The following graphs show the yields on junked rated BB and CCC corporate bonds. As shown below, the recent spike in yields pales in comparison to the prior recessions of 2008 and 2001. The red lines show the current yield to compare to historical levels. Note that BB-rated securities are just about at all time record low yields despite a deep recession. CCC-rated bonds are not as overbought, but still well below where they should be given that we are in a recession and credit losses are picking up. The outperformance of BB versus CCC is likely due to the fact that the Fed is predominately buying BB-rated securities in its corporate bond QE program. Returns on junk rated debt are now heavily dependent on the Fed’s activities and not the underlying fundamentals of the corporations themselves. This is yet another massive market distortion caused by the Fed.

On the topic, American Airlines is in the market with a secured junk bond offering. The company just increased the offering yield from 11% to 12% as demand was tepid. The offering gives us some hope that there are some instances within the junk-rated bond market where investors are still being paid to take risks.

June 23, 2020

Like the previous night, the overnight session witnessed a bout of volatility. After trending higher after the close, Peter Navarro said the trade deal with China is “off.” The markets plummeted on the news, with the S&P down almost 60 points from its highs.  Navarro quickly backtracked and said the comments were taken out of context. The market rebounded quickly and is set to open about 15 points higher.

This week is expected to be quiet on the Fed front with only two speakers. The Fed’s annual Jackson Hole retreat/meeting scheduled for late July will now be held virtually. In recent years, the Fed Chairman has used the event to announce new policies or discuss changes in their economic forecast. We suspect that yield curve control could be discussed at length at the meeting.

A few manufacturing surveys will be released this week and as always Initial Jobless Claims on Thursday. We continue to closely follow claims data as it has a strong correlation to employment, and in turn, greatly affects the Fed’s operations.  Next week’s BLS employment report will be a test for the V-shaped recovery camp. The consensus estimate is for a gain of 3.6 million jobs on top of the 2.5 million from May. The unexpectedly strong May report raised the bar for how quickly investors expect the labor force to be redeployed. Given optimistic expectations, any significant downside miss versus expectations will bring into question the trajectory of the recovery and the reliability of economic data during this period of economic turmoil.

There is a big debate among investors about the market benefits of QE. In particular, whether it is the stock or total amount of QE, or the flow, the weekly change in QE that drives the market. The graphs below show that while the stock of QE administered over the last few months has been massive, even when compared to 2008, the flow has slowed dramatically. In fact, as can be seen in both graphs the Fed’s balance sheet shrunk last week. The decline was primarily due to a reduction in repo operations and foreign currency swaps. This should be a one-time event but the growth in the stock and rate of flow will be minimal compared to the prior months.

Shown below is a graph from J.P. Morgan in which they highlight that correlations amongst a wide variety of global assets have increased sharply to its highest level in at least the last 20 years. Correlations spiked briefly in 2008 as economies struggled (represented by the red line). At that time QE was introduced by the Fed, ECB and BOE and markets around the world benefited in unison from the liquidity. This crisis is seeing unprecedented monetary liquidity in terms of the amount of securities the banks are buying but also in terms of the number of different asset classes they are buying. One of the downsides to their actions is the benefits of diversification are diminished.

June 22, 2020

Quadruple witching day proved to be volatile, especially around the time options were to expire. The market opened up higher, soared minutes before the options were set to expire, reversed the gain equally as fast, and then proceeded to fall for the remainder of the day. Stock futures fell sharply after the close but rebounded in Sunday night trading and recaptured most of the losses. The NASDAQ bucked the trend on Friday as investors again flocked to the “safety” of tech stocks.

The ring leader of the fad of buying junk companies provided us with yet another entertaining view of how “newbie” investors are deciding what stocks to buy. In the video linked below, David Portnoy literally pulls three Scrabble letters out of a bag and proceeds to buy 200k worth of the stock (RTX). Fortunately, or unfortunately, we hold RTX in our equity portfolios.

The current Atlanta Fed GDP Now forecast for second quarter growth is -45.5%. While improving since early June, it is still well below the consensus forecast of -35%. One reason for the difference is that GDP Now uses only available data while most forecasts use actual data and estimates for unknown data. June should see continued improvement, which will push GDP Now higher over the coming weeks.

In a recent interview on Bloomberg, Kevin Warsh, former Fed member, criticized the Federal Reserve’s policy efforts. In particular he stated: ” They (Fed) seem to be incredible aggressive even as risk assets are at incredible highs.” He followed that with “I wish the same aggressiveness was being felt in the policies they are putting on Main Street.”

Like, Mr. Warsh, we believe the Fed is doing everything in its power to keep asset prices stable or even higher. The problem is that so little of their efforts will help the economy in the short run but are accompanied by negative economic and societal consequences in the long run. From a macro perspective, higher stock prices despite weakened long term economic growth do not bode well for investors in the future.

June 19, 2020

Initial Jobless Claims came in higher than expected at 1.51 mm versus 1.29mm expected, and 1.57mm last week. Of concern, continuing claims have been relatively flat for four weeks running. This number should be declining rapidly if the economy is to recover as quickly as many think it may. The chart below shows state and federal unemployment continuing claims.

The Philadelphia Fed Business Outlook Survey showed great improvement from -43.1 to +27.5. Diffusion indexes like this survey do not report actual levels of activity but simply whether or not things were better or worse. Given the poor conditions in May and reopening in June, it is not surprising that there was an improvement in the outlooks of business managers’.

It is widely reported that U.S. shale producers will bring about 500K barrels per day back online by the end of June. The price of crude oil has consolidated in the $35-40 range over the past few weeks in what is hopefully a sign that the gross supply/demand imbalance that caused negative oil prices has corrected.

The graph below from the Man Institute shows the degree to which “garbage” stocks have outperformed the market during the most recent leg of the rally. They define garbage stocks as those having a credit default swap price of over 1000. In other words, these companies are solidly in junk-rated corporate debt territory.

The graph below compares the strong recovery in Retail Sales versus the nascent recovery in Industrial Production. Retail sales are directly boosted by a variety of stimulus programs. On the other hand, Industrial Production has not benefited to nearly the same degree from fiscal stimulus. This divergence, in the words of @peter_atwater, is a “K-shaped” recovery. Basically, Peter argues there are the haves and the have nots of this recovery.

The biggest question facing the economy is can consumers continue to carry the weight as fiscal stimulus programs wane. If not, can the government pass another round of stimulus before the election?

June 18, 2020

Initial Jobless Claims, released at 8:30 am, are expected to fall from 1.542 mm to 1.22 mm.

The following Tweet and graph from @renmacllc raise the question of whether the recovery in employment is starting to level off. The data in the graph is based on daily readings.

Friday is Quadruple Options Expiration day, meaning that four sets of stock options expire, including futures options, index options, single stock options, and single stock futures options. This event, occurring four times a year (3rd Friday of March, June, September, and December) tends to result in increased volume and volatility as securities and options are bought and sold to replace expiring options, re-hedge positions, or to meet the needs of a contract expiring. This Friday will see a larger than normal number of options expiring, which could result in additional volatility.

Per the Mortgage Bankers Association (MBA) 8.55% of mortgages are in forbearance, equating to approximately 4.3 million households. The graph below shows the percent of loans in forbearance by the three mortgage types and the total. For consideration, would retail sales have been as strong if 4.3 million households made mortgage payments?

 

It is not all gloom in housing. Also, according to the MBA, mortgage purchase applications hit an 11 year high. The data is seasonally adjusted so it is likely skewed as March and April activity got pushed to May and June.

The chart below from Moody’s shows its baseline, optimistic, and pessimistic expectations for global corporate default rates. Based on the fact that U.S. credit spreads are nearing record low levels, the market is clearly banking on a better than best case scenario. Keep in mind the Fed is buying corporate bonds so yield levels and spreads do not properly account for market default expectations.

June 17, 2020

In testimony to the Senate, Chairman Powell largely reiterated the same overall message from last Wednesday’s FOMC meeting. While he is encouraged with signs of recovery, he said the economy would continue to struggle until a cure or vaccine is discovered. Facing some Senator’s concerns about the Fed’s burgeoning balance sheet, Powell said the Fed’s intention is not to monetize Federal debt. Whether that is their intent or not, the Fed’s balance sheet has grown by $2.95 trillion while the amount of federal debt outstanding has risen by $2.88 trillion since the new year. He also said the Fed is “some years away” from halting asset purchases.

Like unemployment, Retail Sales far exceeded the best expectations. On a monthly basis, retail sales rose 17.7%, almost double what economists expected. Retail sales are off 10% from the peak. Sales are greatly benefiting from the various forms of government stimulus. As those benefits wane, we will get a clearer reading of retail sales and other consumer spending data.

On Tuesday morning, the market rallied strongly on an infrastructure bill. While stimulus is frequently good for the markets, the chances of a major bill happening before the election is very low. For one, we must ask how likely is it that House Democrats pass a bill that would help Trump’s reelection chances. Equally important, we have heard more about deficit and spending concerns from some Republicans. Given the political climate and upcoming election, a big funding bill, barring a reemergence of crisis conditions, will be very difficult to pass.

The May monthly Treasury statement shows that federally withheld income tax receipts fell 33% from May of 2019. Given that withheld taxes are directly tied to paychecks, the massive gap between this data point and the May employment report raises a lot of questions.

According to a popular Bank of America survey, a record amount of professional money managers think the stock market is overvalued. While seemingly a bearish signal, markets are known to climb a wall of worry. It is worth noting that in the recent market decline, the survey never reached low levels, let alone the levels achieved at the end of the last two bear markets (2003 and 2009).

June 16, 2020

The Fed announced they will start buying individual corporate bonds as part of their corporate bond-buying QE program. The specific bonds they intend to buy will be based on an index which will satisfy the Fed’s criteria. LINK to the press release. Before the announcement, the Fed was only buying corporate bond ETFs. The stock market took the statement as a positive, but it represents no change in strategy or in the amount they will buy in the corporate bond market.  The Fed just seems to have cleared an operational hurdle and will go ahead with their original intentions.

Yesterday was another roller coaster in the markets. The S&P 500 was down nearly 90 points or 3% in the overnight session. It came back throughout the morning and then took off on the Fed announcement. It closed up nearly 1% on the day and is up another 1% coming into this morning’s session. The culprit for the latest rally is a proposal from Trump for $1 trillion infrastructure spending.

Jerome Powell will speak today at 10 am and tomorrow at noon. Last week he came off as bearish about a swift economic recovery and did not commit to more stimulus. In times of economic crisis, which we are still in despite the market rebound, investors always want more. We have no doubt the Fed will do more if “needed.”

Retail Sales and Industrial Production will be released this morning and Jobless Claims on Thursday. Retail Sales are expected to rebound sharply, following a drop of 8.7% in March and 16.4% in April. The consensus of economists is calling for a +7.5% rebound in May. Like all economic data, Retail Sales has a massive range of estimates (+2.3% to +12.2%).

In one of the more bizarre events we have witnessed, Hertz will offer new equity. The proceeds will be used to pay back bondholders that are being defaulted upon. Despite the new funds, bondholders will still be owed money, which leaves the new and existing equity holders with little to no value. The bondholders are taking advantage of investors that have flocked to shares of bankrupt companies. In the SEC filing for the new shares, Hertz makes it clear that the offering is fraught with risk. To wit: “Consequently, there is a significant risk that the holders of our common stock, including purchasers in this offering, will receive no recovery under the Chapter 11 Cases and that our common stock will be worthless.”

Tesla’s stock recently surpassed $1000 per share and, in doing so, topped Toyota with the largest market cap in the industry, as shown below. To help assess whether its current price is fair or not, we can compare Tesla to Toyota. The bet on Tesla is a big bet on its abilities. For Tesla to justify its current valuation it would need to increase its car sales by nearly 30x. That is a tall order, especially considering that over the next year or two all of the major auto manufacturers will be selling electric vehicles and, in many cases, at more reasonable prices than Tesla.

June 15, 2020

Friday was a volatile day. After the sharp loss on Thursday, the market opened up nearly 3%. It proceeded to give up the entire gain and fall slightly below the 200-day moving average. Toward the end of the day, it rallied again to close up 1.30%. This morning the market is weaker and trading below its 200-day moving average.

The June Preliminary University of Michigan Consumer Sentiment Survey was positive, coming in at 78.9 versus estimates of 75. It was 72.3 in the prior month. Current conditions and future expectations both rose nicely. While the data is encouraging, it comes with a disclaimer. Per Barrons: “The interesting thing to note is that the recent improvement in sentiment has a partisan skew. The improvement in sentiment as reported by the University of Michigan is being driven almost entirely by self-identified Republicans and independents.” The political divide may not be as much about politics but a result of the larger cities, which tend to have more democrats, getting hit harder by COVID and enduring longer shutdowns.

The New York Fed puts out the Weekly Economic Index (WEI), a real-time estimate of economic growth. After bottoming in late April, the index has slowly risen. Of concern, the latest reading fell slightly from -9.6% to -10%. While one weekly decline is not concerning, it does point to a slow and tenuous recovery, unlike what the market and most pundits seem to be expecting.

As we have shown, economic data has been very volatile, at times misleading, and often data is at odds with other data. Such confusing economic data may remain with us for a few months as the economy levels off and begins to rebound. Given the unique situation, we are looking for signs that economic data is generally trending in the same direction and are careful not too read too much into one piece of data.

In its latest Quarterly Refunding projection, the U.S. Treasury estimated it will have a cash balance of approximately $800 billion at quarter-end, down significantly from its current $1.5 trillion surplus. A big reason for the massive surplus is the fact the Treasury is holding reserves for PPP loans and other CARES Act expenditures. In the case of the PPP loans, the Treasury will need to make the banks whole for loans that are forgiven or defaulted upon.

June 12, 2020

The media headlines explaining yesterday’s decline were as follows: COVID cases in states that re-opened early are surging, Jerome Powell was not optimistic about a strong economic rebound, and Trump’s poll numbers are slipping. Those are the narrative. The primary reason is that the market was technically grossly overbought. Going forward, it will be important assess whether the decline is part of a healthy correction/consolidation or a reversal. The S&P 500 broke slightly below the important 200-day moving average, but is trading above it this morning, and it is still well above the 50-day moving average. Where the market closes to end the week will be important as to our positioning going forward. We will have more on this topic in this weekend’s newsletter.

The yield on the 5-year U.S. Treasury note is just one basis point from its all-time low. With yields nearing record low levels, stock investors hedging with bonds have a problem. As long as the Fed steers away from a negative rate policy, Treasury yields will likely have a floor. Therefore, with limited price upside, the offsetting benefit of holding bonds is potentially much less than in years past.

The graph below shows the difference between current yields and the record lows achieved over the last few months. The table below the graph calculates the potential price gain if the bonds were to fall back to their respective record lows. As shown, other than 30 years bonds, there is little room to profit, unless the bond market begins to price in negative yields.

Initial Jobless Claims met expectations for a decline of 1.542 million jobs. Continuing claims were higher than expectations and largely unchanged from the prior week. The bottom line from recent claims data is it seems like there is a lot of job churning as some people are getting laid off while others are getting re-hired. Producer Prices (PPI) were slightly higher than expectations at +0.4% versus 0.1%. Excluding food and energy, PPI met expectations at 0.1%. The Fed tends to rely on the data excluding food and energy as they tend to be volatile.

Not surprisingly, the Baker Hughes oil rig count and Crude oil are well correlated. With the price of crude back to near $40 a barrel, we are interested to see if rig counts start rising. If not, it may be that the financial damage to oil producers of the last few months will preclude a lot of wells from being put back online in the short run. If this is the case, reduced supply and increasing demand for oil would be a nice tailwind for the price of oil. Despite the strong rally in crude, it still about 30% below where it started the year.

June 11, 2020

The Fed statement was very similar to what we have heard from numerous Fed speakers in that the Fed will do whatever it takes. The only statement of note is that the Fed will buy bonds “at least at the current pace” for now. This appears to be a floor they are putting under QE in regards to the amount of weekly purchases. Per Bloomberg- “In a related statement, the New York Fed specified that the pace of the increase would be about $80 billion a month for purchases of Treasuries and about $40 billion of mortgage-backed securities.” As we discussed yesterday, it is likely that massive Treasury supply and the inability of the market to absorb the bonds concerns the Fed.

The table below shows the new Fed economic and rate forecasts through 2022. Of note, they expect the unemployment rate to end 2020 between 9% and 10% and Fed Funds are expected to stay at zero through 2022. The Fed expects inflation to run below 2% for the period and GDP to recover back to 2019 levels by the end of 2022.

Per Jerome Powell’s testimony:

  • Yield Curve Control (YCC), in which the Fed manages QE toward specific yield targets across the maturity spectrum of Treasuries, was discussed and will be in upcoming meetings, but they are not ready to act upon it yet. They also do not appear to have any interest in negative rates.
  • Powell doesn’t believe that the additional stimulus related debt being added to federal and corporate balance sheets will dampen future economic growth. This “logic” flies in the face of data from the last 40 years.
  • We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.”

May CPI fell 0.1% monthly and annually versus expectations of a 0% inflation rate for both. Core CPI (excluding volatile food and energy prices) was also down 0.1%. Food prices rose 0.7% for the month, the largest monthly gain since 1984. Lower energy prices offset the gain in food prices. This trend will reverse as recent increasing energy prices take a few months to show up in CPI data.

This was the first time since at least 1957, in which Core CPI fell for three straight months. Since 1957 there have been 761 monthly CPI reports. In only 12 of them, including the three most recent, have core CPI prices declined.

Starbucks announced weaker than expected earnings yesterday. In particular, we thought the following data was interesting: In China, 99% of their stores have opened but sales are still down 21% from a year ago. In the U.S., 91% have opened and sales are down 43%. As the economy continues to reopen and people feel comfortable going out, sales will rise. The question is how much will the recession hamper sales versus customers concern over the virus.

Tesla’s stock surpassed 1000 yesterday and is now up 235% on the year. Its market cap is almost three times larger than that of GM and Ford combined.

June 10, 2020

The key event today will be the Fed’s statement at 2pm and Jerome Powell’s press conference following at 2:30. We expect the Fed will keep promoting their aggressive policy actions and offer to do more if needed. We doubt they will give any indication that they are considering taking their foot off the gas pedal.

In yet another sign of bullish exuberance, the Put/Call ratio continues to fall to multi-year lows. As of Tuesday, the index stood at .37, a level last seen five years ago. The ratio measures the proportion of put options to call options purchased on each day.

The market rotated back to its favorite sector yesterday as the NASDAQ crossed 10,000 for the first time. Yesterday the NASDAQ was up .29% while the Dow fell 1.09%. We are watching to see if the divergence is the beginning of a rotation back to larger cap and higher quality companies from poorer quality stocks that have recently been playing catch up. We noted in last Friday’s Sector Relative Value Report, that the tech sector (XLK) was moving towards deeply oversold territory versus the S&P.

On Friday June 5th, the Fed’s overnight repo program for Treasuries exceeded $100 billion for the first time since early March, as shown below. The recent uptick may be an early warning that the banks are struggling to absorb record amounts of Treasury debt issuance. Making the task harder is that the Fed is drastically slowing their purchases of Treasury securities. Fed Treasury bond purchases peaked in late March at $362 billion per week. Since then, it has declined to about $25 billion per week.  In May, the amount of Treasury debt outstanding rose by $759 billion, or $190 billion a week.

If the Fed is concerned that banks and investors are struggling to buy the massive debt issuance at current rates, we should expect them to increase the amount of QE directed toward Treasuries. The topic may be mentioned by Powell today, but we suspect any changes will show up in their weekly QE guidance.

As we have discussed, the nationwide protests are largely propelled by racism and police misconduct. Still, they are also driven by economic dissatisfaction due to the growing divergence of wealth and poor. This should not be surprising given the wealth inequality gap is now the widest since the late 1920’s. Given that the latest crisis is substantially widening the gap even further, we should expect protests here and abroad to be a mainstay at least through the election. We recently read an article from Albert Edwards of SocGen in which he shows the recent protests in America are part of an increasing trend of global protests occurring over the last decade. His paragraph is below. (CLICK TO ENLARGE)

S&P cut Japan’s sovereign A+ rating outlook from positive to stable. While not a rating cut per se, it does set the stage for S&P to reduce the rating soon. We will likely see more negative ratings moves on sovereigns, municipals, and corporations as debt levels have increased markedly against a backdrop of slower growth and decreased revenues.

June 9, 2020

Inflation data and the Fed take center stage this week. CPI will be released Wednesday, followed by PPI on Thursday. The consensus expectation for CPI is for 0% inflation on a monthly and annual basis.

Also of interest is the NFIB Small Business Optimism Index released this morning. After falling sharply in March and April, it improved in May. Given the importance of small businesses, this is another potential sign that a recovery has begun.

The Fed meets on Tuesday and Wednesday, followed up with the FOMC statement and Jerome Powell press conference at 2:00 and 2:30, respectively, Wednesday afternoon. In addition to updates on the state of monetary policy and the economy, we are looking for hints on whether yield curve control (YCC) may be the next iteration of QE. We will have more on YCC in an upcoming article. We are also on the lookout for any signs of taper, as the financial markets appear to be liquid and on a sound footing.

The ramp in equities has been increasingly led by a rotating set of stocks, many of which were the most beaten down in March. The action appears to be largely momentum based. In other words,  those stocks up the most in the previous days are likely to be attractive today. Caution is warranted as the list of “in” stocks changes quickly and without much reason. To  that point, Chesapeake Energy (CHK) rose 181% yesterday but is slated to open down 50% this morning as they are preparing to file for bankruptcy.

Robinhood is a rapidly growing broker designed for small retail investors. Robinhood is popular, in part, because it allows partial share trading and markets to younger investors. The graph below shows how their popularity accelerated at the market lows in March.

Robinhood publishes daily data on which stocks its users are holding. On June 4th we downloaded their top ten holdings and found that those stocks in aggregate beat the S&P by about 15% since May 1st.  In the list are many companies hobbled by the recession such as Ford, American Airlines, Delta, Carnival Cruise Lines, and Norwegian Cruise Lines. While Robinhood users are small and not big enough to move markets, we do believe their mindset of chasing momentum, regardless of valuation, applies to a much larger population of investors. To wit, we saw a tweet from a well-known options trader as follows: “Between $AAL $DAL $UAL $SAVE $LUV the five Airlines have traded 1.3M calls today Then $CCL $NCLH $MGM another 588,000 calls Never seen this amount of activity, crazy

Speaking of excessive bullishness comes the following tweet and graph from @sentimentrader.

“This is stunning. At the peak of speculative fervor in February, small traders bought to open 7.5 million call contracts. This week, they bought 12.1 million. Watch what people do, not what they say. They’re full-bore bullish, on steroids.”

The takeaway is that this bout of speculation can certainly continue, but be careful as excessive speculation is a hallmark of a market top, not the beginnings of a bull market.

June 8, 2020

The employment data on Friday was truly stunning. The BLS reported that 2.509 million jobs were added in May versus expectations for a 7.725 million decline. Considering a miss of 100,000 used to be considered significant, we do not know how to describe a miss of 10 million. March and April were revised lower by a combined 640k jobs. The unemployment rate fell from 14.7% to 13.3%.

Making the report even more confounding is that the data is at odds with initial jobless claims data from the BLS. Also leading us to question their findings is the following from AP and this LINK from the BLS.

Friday’s report made it clear the government continues to struggle with how it classifies millions of workers on temporary layoff. The Labor Department admitted that government household survey-takers mistakenly counted about 4.9 million temporarily laid-off people as employed.

The government doesn’t correct its survey results for fear of the appearance of political manipulation.

Had the mistake been corrected, the unemployment rate would have risen to 16.1 percent in May. But the corrected April figure would have been more than 19 percent, rather than 14.7 percent.

If you are interested in learning more about how difficult measuring employment is today, the following LINK from the BLS is worth a read.

Regardless of the accuracy of the data, the good news is that the labor market appears to be improving. We hope the rest of May’s economic data being released throughout June confirms the strong BLS report. In case you still crave more on employment, here is our take from this past weekend’s Newsletter.

The Wall Street Journal recently published the graph below which helps us better formulate our employment outlook for the next six months. Per the chart of small business employment expectations, small businesses expect to end the year with 75% of the employees they started the year with. In January, small businesses, defined as 49 employees or less, employed 33.1 million employees. If these companies get payrolls back to 75% of January’s level, it implies that over 8 million jobs will not return. The total workforce in January was about 151 million people. If we make the bold assumption that all other companies (more than 49 employees) return to peak employment levels and the survey in the graph is correct, we can expect an unemployment rate of 8.8% at yearend. That includes the 8 million from small businesses and the 3.5% unemployment rate from January.

Late on Friday it was reported April revolving credit for April fell -$55.7 billion, a record decline at -5.4% month over month. That follows a $29.7 billion decline in March. The combination of $1200 CARES Act checks and sharp spending declines are driving this unprecedented drop in revolving consumer debt, such as credit cards and home equity loans.

OPEC agreed to extend the current 9.7 million barrels per day cuts by one more month. All members appear to agree on the extension except Mexico.

June 5, 2020

Initial Jobless Claims were slightly worse than expectations at 1.87 million versus the consensus estimate of 1.79 million. Continuing claims increased by 649k to 21.48 million. Interestingly, the BLS added a new table, shown below, which shows that total claims, including state and Federal programs, are close to 30 million. 30 million unemployed should equate to an unemployment rate of 23%.

With the BLS jobs number being released at 8:30 today, we shed a further thought on Wednesday’s surprising ADP number to help us better appreciate what may be reported this morning. ADP reported that 2.76 million jobs were lost based on data from mid-May when the survey was taken. During the same period in May, 5.133 million initial jobless claims were filed. The only explanation for the difference is that 2.3 million people found jobs in the first two weeks of May.

The updated estimate for this morning’s BLS report, with consideration for the ADP report, is for the workforce to shrink by 7.725 million jobs, bringing the unemployment rate to near 20%. Prior to the release of the ADP report, the consensus was for a loss of 8.663 million jobs. Clearly, the consensus of economists is not putting much faith in the ADP report.

The ECB increased its sovereign bond buying program by 600 billion euros. The increase allows them to buy up to 1.35 trillion by June 2021. They kept their main deposit rate unchanged at -.50%. The latest action shows the ECB doesn’t seem to care about the recent ruling by a German high court in which they said the ECB’s QE Program breached Germany’s constitution. We will wait to see if Germany responds to the ECB’s announcement.

As shown below, courtesy Bianco Research, small caps are now more overvalued than at any time in at least the last 25 years.

June 4, 2020

The ADP report was much better than expected. For the month of May, ADP reports that 2.76 million jobs were lost. While a large number, it was well below estimates of 8.663 million. We are hopeful the report signals that the trough in job losses will occur over the next month or two, and job gains begin. ADP has a good historical correlation with the BLS report coming Friday, so fingers crossed that the BLS number is equally as strong.

On the heels of the ADP report, Mark Zandi Chief Economist at Moody’s, said “the good news is I think the recession is over, the COVID 19 recession is over, barring a second wave, a major second wave, or real serious policy errors.” While job growth and an end to the recession would certainly be welcome news, it could be many years before GDP gets back to its pre-COVID levels. Despite what appears to be positive quotes from Mr. Zandi h he projects unemployment will level off around 10%, unless there is more fiscal stimulus.

Since 1947, there have been 11 recessions, and only one of them, 1981-1982, saw the unemployment rate surpass 10%.  In February, the month prior to the COVID shutdowns, the unemployment rate was 3.5%, the lowest in nearly 50 years. For more context on historical unemployment rates see the graph below.

It is being reported that the President and Mitch McConnell have started discussions about a new round of economic stimulus. Apparently, McConnell wants to keep the amount below $1 trillion with a focus on initiatives that encourage people to go back to work and consume. Consumption within the travel and leisure industry is being specifically mentioned. Given the riots and upcoming election, along with strong markets and moderating economic data, we believe passing a new round of stimulus through both houses of Congress will be significantly more complicated than the last round.

The graph below, courtesy Bloomberg, shows that the Barclays index of investment-grade corporate bonds is now close to the record low for yields.

Illinois will be the first state to tap the Feds new Municipal Liquidity Facility. Per the FT, they will borrow $1.2 billion at a rate of 3.82%. The interest rate is lower than that in which they can borrow in the open market. The Fed has allotted $500 billion to lend to states and local municipalities.

 

June 3, 2020

On Monday, Amazon locked in record low borrowing costs with a $10 billion, multi-maturity debt offering. The issuance included 3 year, 5 year, 7 year, and 10 year maturities. The 3 year notes carry an interest rate of only 0.40%.

Bank of America and JP Morgan have tightened credit standards for new mortgages and refinancings. Yesterday, Wells Fargo said they would stop making loans to most independent car dealerships. While these actions are probably smart credit decisions, they will no doubt cause borrowers (mortgage or auto dealers) to seek higher rate loans or possibly falter. Tightening credit standards is another headwind to the recovery.

Corporate debt issuance has surpassed $1 trillion for the year, already matching the record annual pace of the last few years. Prior to the COVID crisis, the amount of corporate debt was rising faster than corporate earnings and GDP. The pace has accelerated under the crisis due to reduced economic activity and more debt.  If corporations use the borrowed money toward productive purposes, the borrowing is beneficial. If it is used for buybacks, dividends, or short term liquidity, the debt will hamper earnings and long term economic growth. As shown via the increasing trends below, debt has primarily been employed for non-productive purposes. If that were not the case, higher levels of debt would be more than offset with even higher profits and GDP and thus declining ratios.

ADP, a reliable proxy for Friday’s job report, will be released at 8:30. The estimate is for a decline of 8.663 million jobs versus last month’s reading of 20.236 million. The range of estimates is extremely wide, ranging from -11mm to -3.3mm.

As shown below, non-commercial positioning of S&P 500 futures (mini contracts) shows that traders are as net short today as anytime since 2015. Despite the rally of the last two months, the net short position has not alleviated as is typical. During Q4 of 2015, the last time net shorts were at equivalent levels, the market rallied but sold off sharply later that year and early into 2016.

June 2, 2020

The ISM manufacturing survey rose slightly from 41.5 in April to 43.7 in May. While still deeply in contraction territory, the increase from last month is a hopeful sign that April marked the economic bottom. On Wednesday, ADP will release its employment report, followed by Jobless Claims on Thursday and the BLS monthly employment report on Friday. The current estimate for Friday’s labor report is a loss of 7.725 million jobs bringing the unemployment rate to 19.8%.

As shown below, protests have occurred in over 140 cities and  almost every state. The demonstrations and looting will further hamper economic activity and may lead to a resurgence of COVID cases in many places that were seeing good progress in slowing the spread. Per Thomas Lee @fundstrat: Whatever ‘stay at home’ restrictions, limits on gathering size, etc., — these ended this weekend., … these large gatherings effectively cancelled all the efforts over the past 10 weeks to .. mitigate transmission. So, the next 2 weeks will be important to watch.

China is taking actions that appear to signal that they are walking away from the trade agreement. Per Reuters – CHINA HAS ASKED MAJOR STATE FIRMS TO HALT PURCHASES OF SOYBEANS, PORK FROM U.S. AFTER U.S. ACTIONS ON HONG KONG

Now for a bit of Macroeconomics. Demographics play an important role in forecasting economic growth. Much has been written on the aging of the baby boomers and the effect that reduced spending and saving of this oversized generation will have on economic activity. We think the status of the Millennials deserves equal if not greater focus. They are quickly becoming the nation’s prime consumer and political leaders.

The graph below, dating back over 200 years, shows that economic growth per capita during the first 15 years of Millenials careers has been the slowest on record. Weak economic growth along with onerous debt levels, and relatively low wage growth will weigh heavily on the generations ability to consume. The generational changing of the guard, so to speak, should be taken into deep consideration when thinking about the long run growth potential of the nation.

June 1, 2020

Personal income rose by 10.5%, while personal spending fell by 13.6%. As shown below, courtesy @ErnieTedeschi, the sharp and unexpected rise in income is due solely to unemployment benefits and the $1200 checks from the government. As a result of the large divergence in income and spending, the savings rate surged to 33%. To be honest, it is hard to make sense of the data and what it may mean for the state of the economy. All three data points were the largest increases or decreases on record.

Jerome Powell made some interesting comments on Friday.

  • Negative rates interfere with bank credit intermediation” and “Not clear that negative rates are appropriate for the U.S.” – The Fed is holding off on negative rates as they hurt banking profit margins. As such, we do not expect the Fed to reduce the Fed Funds rate to below zero unless things get very dire. For what it’s worth, the Fed Funds futures market is still priced for a 50% chance of negative rates throughout most of 2021.
  • Forward guidance and QE are no longer standard tools” – As we learned after 2008, QE is here for good.
  • Fed’s Balance sheet can’t go to infinity” “Fed is not close to any limits on its balance sheet” -A lot more QE is possible but it’s not unlimited. The limit is inflation.

Powell did not mention yield curve control yesterday but, Cleveland President Mester added her support for it. Per Reuters: FED’S MESTER SAYS SHE VIEWS YIELD CURVE CONTROL IS A SUPPORT FOR FORWARD GUIDANCE IF FED WERE TO USE IT

The Atlanta Fed’s GDPNow forecasts that the second quarter’s economic growth (not annualized) will be -51.2% versus -40.4% on Thursday. Personal spending, noted above, was responsible for the downward revision to the prior forecast.

From the latest available data, ranging from May 20th to the 27th, the Treasury’s outstanding debt rose by $222 billion and the Fed’s balance sheet increased by $60. The net effect is a drain of $162 billion of liquidity from the markets. A continuation of the trend would raise our concerns over the sustainability of the current stock market rally and the tightening of corporate bond spreads.

At the start of the March sell-off, as shown below, the NASDAQ (QQQ) fell in line with the S&P 500 (SPY) and the Dow Jones (DJI). However, once the market began to recover in mid-March, the QQQs outperformed the other two indices by 10-15%. Over the past week, the QQQ’s have come under pressure relative to the broader market. The recent divergence is likely the result of investors rotating into stocks that are still beaten down from the QQQ leaders that rallied back to their prior record highs. Based on our relative value model, QQQ has returned to fair value versus the S&P 500, after having been overbought. Conversely DJI, which was nearly 1.5 standard deviations oversold a week ago, is closing in on fair value versus the S&P 500. As an aside, small-cap and mid-cap stocks are now grossly overbought relative to the S&P 500, having been in oversold territory for the last two months. Value has improved but still remains oversold versus growth.

May 29, 2020

Initial Jobless Claims were slightly higher than expectations at 2.123 million, down from 2.446 million last week. Federal Unemployment Assistance rose by 1.192 million. There was some good news as well in the report. The number of insured unemployment claims fell by 3.86 million to 21.052 million. The decline means that some people who filed claims in the last two months have been rehired by their employer or found a new job. Georgia, one of the first states to reopen, saw the largest drop in weekly claims at -65,000.

First Quarter GDP was revised slightly higher to -5% from -4.8%. Of note, the price index was revised upwards to +1.4% from 1.3%.

We have been reading that retail traders, and in particular small investors using the brokerage service Robin Hood, are driving the market higher. To debunk the theory first consider, and as discussed yesterday, the market gains are mainly occurring during the nighttime futures sessions, where retail traders have little to no access. Second, retail traders are small by definition and pale in comparison to the institutional traders that move the markets.

While the stock market continues to grind higher and check off technical signals supporting a bullish thesis, the VIX is not confirming the move.  Since May 11th the VIX has risen marginally despite the S&P 500 gaining over 4%. We suppose there are a lot of leery investors and traders using options to hedge their increased equity exposure.

The 2yr/10yr U.S. Treasury yield has slowly widened to 50bps. We would have expected the curve to widen much more due to the uber-aggressive Fed operations and the longer term inflationary consequences of their actions. This time is different, however. The Fed is concerned that higher long term rates would be too large a burden on the government and corporations due to record debt levels. The market understands their fear, which is likely keeping longer term rates from going much higher and the yield curve from widening as it normally would. On the topic, we will be very interested to see if Jerome Powell brings up yield curve control in his speech this morning at 11am.

 

May 28, 2020

A pattern has been easy to spot over the last two days in which the market rallies at night and then sells off during the day session. This action has been somewhat consistent throughout the year. Per Bespoke, if you bought at the close and sold at the next days opening you would be up 19.7% this year versus losing 16.9% if bought at the open and sold the close. Holding for the full period would leave you down 6.1%.

As we have mentioned, the value of the Chinese yuan versus the U.S. dollar can serve as a barometer for the China-U.S. relationship. A weaker yuan is a sign that things are not going well. Not surprisingly, given the pressure China is applying to Hong Kong and the rhetoric being spewed between both leaders, the yuan has depreciated (higher price versus the dollar in the graph below). The yuan/USD depreciated to 7.17 yesterday, surpassing the prior high of last August and matching the weakest level since January 2008.

New York Fed President Williams said the Fed is “thinking very hard” about targeting yields along the Treasury yield curve. This is not surprising given the massive amount of debt the Treasury will be issuing and, therefore the need to keep interest rates low.  We could see such an announcement as early as the next Fed meeting on June 10th.

As shown below, Commercial and Industrial loans (C&I) spiked by $367 billion in the last month as corporations aggressively drew down their credit lines to build liquidity.

The figure above does not include corporate debt issuance, which also increased markedly over the last month. In fact, as shown below, per the Financial Times, U.S. companies have already borrowed near similar amounts this year versus the annual entire amounts of each of the last eight years. Before the crisis, corporate debt was already at a record high versus GDP. These new borrowings will be a further drain on earnings going forward and potentially negatively impact their respective credit ratings. Per a new S&P report-Downgrade Potential Rises to All-Time High” “The number of potential downgrades has widened to 1,287 as of April 28, from 860 in March and 649 in February.

May 27, 2020

The S&P 500 was up over 1% yesterday despite three of its four largest stocks being lower (AAPL -.68%, MSFT -1.02%, and AMZN -.62%). The divergence can be interpreted as a bullish sign, in that the broader market is carrying more of the weight. It can also be seen in a bearish light as the market’s generals tend to lead. This was but one day of trading so do not read too much into its significance yet, but it is worth paying attention to.

One of the broadest measures of economic activity, the Chicago Fed National Activity Index, fell well below the consensus -3.5% expectation. For what it’s worth, a value below -0.70% has historically indicated the increasing likelihood of a recession. The index is comprised of 85 data points covering all relevant sectors of the economy.

This week will be quiet in regards to economic data. Of importance will be Initial Jobless Claims on Thursday (expectation 2.05mm) and the revised Q1 GDP report also on Thursday. Jerome Powell will speak on Friday at 11am.

A few weeks ago, a German court ruled that parts of the ECB’s QE operations were illegal under German law and needed to be changed. The ECB responded yesterday by saying they would launch infringement procedures against Germany if they stop buying bonds. Further, they are working on contingency plans to carry out purchases of German bonds even if the Bundesbank were to quit the program. The euro rallied yesterday to 1.10/dollar, which is about 5 euros above the lowest levels since 2003. If the spat between the central banks escalates, the euro could fall sharply, resulting in appreciation of the dollar, which is what the Fed has been trying to prevent over the last two months.

The graph below charts the popular crude oil ETF (USO) versus the price of the front-month crude oil. As shown, USO and crude had a nearly perfect correlation when oil sold off from January through April. At the time, USO largely held the front-month futures contract as they do not physically store oil. Accordingly, a strong correlation between futures and USO should have been expected.

The ETFs structure became problematic when the price of the front-month contract fell in price much more than the rest of the oil complex. When the price of the front contract approached zero, the price of the ETF should have theoretically also fallen to near zero. Instead of an ETF failure, the manager opted to change the structure, electing to hold less of the front-month contract and more later maturity contracts. Management did save the ETF and their management fees going forward, but investors locked in losses as they did not partake in the recent recovery in the front-month contract as shown below. Currently, the ETF owns seven different contracts out to June 2021, with the front-month contract only representing 15% of the ETF.

May 26, 2020

Hertz went bankrupt this past weekend. While widely expected, the event is unusual because the Fed, due to its holdings of junk ETFs HYG and JNK, is an indirect holder of HTZ debt and now a creditor in the bankruptcy process.

A sharp decline in the number of oil rigs has helped the price of crude oil surge. The latest data from Baker Hughes shows the North American rig count fell to 237, the lowest level since 2009. The current number of operating rigs is about one-third of the count at the beginning of the year.

Fed Vice Chairman Richard Clarida gave his inflation outlook in a recent speech. To wit: “While the COVID-19 shock is disrupting both aggregate demand and supply, the net effect, I believe, will be for aggregate demand to decline relative to aggregate supply, both in the near term and over the medium term. If so, this decrease will put downward pressure on core inflation.”  The important takeaway is that Clarida believes the inflationary tug of war will favor deflation over the “medium term.” His outlook, which is likely the same view as Powell and a large majority of the Fed, provides the Fed cover to continue QE and possibly negative rates. While we suspect they will tout deflation to justify their actions, keep an ear out for changes in the forecast by Clarida or other Fed members as any concerns of inflation could prevent the Fed from being as aggressive as they currently are.

The graph below shows that over the last 20 years, the correlation between forward earnings expectations and the S&P 500 has been very strong (.90). The relationship has fallen apart in the recent rally with the correlation over the last two months falling to -.90. Will the relationship correct with improved earnings forecasts or lower stock prices? To wit we wrote the following recently (LINK):

“As stated, over short-term periods, the stock market often detaches from underlying economic activity as investor psychology latches onto the belief “this time is different.” 

Unfortunately, it never is. 

While not as precise, a correlation between economic activity and the rise and fall of equity prices does remain. In 2000, and again in 2008, as economic growth declined, corporate earnings contracted by 54% and 88%, respectively. Such was despite calls of never-ending earnings growth before both previous contractions. “

May 22, 2020

Initial Jobless Claims were slightly higher than expectations at 2.438 million. We are now over two months into the economic crisis, and the number of weekly new claims is still multiples of what is typically seen at the troughs of recessions. Continuing claims just elapsed 25 million.

In addition to the aforementioned data from the states, 2.22 million people filed for Federal Pandemic Unemployment Assistance (PUA- CARES Act) last week. The PUA is for those ineligible for state jobless claims programs. The right weekly initial claims number, adding the state and federal numbers together, is more like 4.6 million.

The recently released Fed minutes from their April meeting included the following statement:

A few participants also noted that the balance sheet could be used to reinforce the Committee’s forward guidance regarding the path of the federal funds rate through Federal Reserve purchases of Treasury securities on a scale necessary to keep Treasury yields at short- to medium-term maturities capped at specified levels for a period of time.” 

In other words, the Fed might enlarge its mandate to manage not only the Overnight Federal Funds Rate but also target yields of longer Treasury maturities. Japan is already capping interest rates, and the United States did it during and after WWII (1942-1950). One look at the 10-year U.S. Treasury yield makes one wonder if they have already started informally capping the yield at 0.75%.

The Wall Street Journal reported (LINK) that about 15 million credit card accounts and 3 million auto loans did not get paid in April. The numbers will be larger in May. As these delinquencies age, they become default risks for the banks. Lack of solvency for millions will not just be the banks’ problem but a significant drag on the economy.

One of the questions we are frequently asked is how do the Fed’s QE operations support stock prices. To help answer the question, consider that in March, as shown below, foreigners (net) sold $387 billion of U.S. Treasury securities. At the same time, the U.S. Treasury debt outstanding rose by $242 billion. Had the Fed not bought Treasury securities via QE, domestic investors would have needed to buy the $629 billion worth of bonds from the foreigners and the Treasury. Those dollars would mostly have come from investors selling other investments, including stocks.

Further, the Treasury bonds would have required a higher interest rate to attract the funds. Instead, the Fed bought $1,570 billion of securities in March, more than covering the $629 billion shortfall. Not only did they cover the gap but they took an additional trillion of bonds from the market. As such, those investors that sold bonds to the Fed needed to reinvest in other markets. In some cases, that was the stock market.

 

May 21, 2020

Crude oil rose 5% to $33.50 as President Trump issued a new round of sanctions on Iran and is “mulling” the seizure of Iranian oil tankers involved in trade with Venezuela.

The Treasury issued $20 billion of a 20 year bond. It was the first issuance of a 20 year bond since 1986.

Fed Chairman Powell will speak at 2:30 today. We do not expect to hear much new from him, given he testified to Congress on Tuesday and was interviewed by 60 Minutes on Sunday night.

Daily, the media and Wall Street try to diagnose why the market was up or down. Some days the explanations make sense. Other times it seems they are fishing for a rationale to explain price action.  Yesterday Tom DeMarco, from Fidelity, avoided providing his readers a rationale and spoke the truth:

Once again there is no good explanation behind the rally other than the same tired themes – reopening, positive linearity, drug/vaccine hopes, earnings rebound, stimulus, and super-cap tech.”

The market over the last few weeks is very reminiscent of 2019 when the U.S. and China were engaged in trade talks. Positive commentary, Tweets, and even specific words from the administration would trigger sharp moves higher and lower. At the time, the market had poor liquidity, which allowed algorithmic programs (algos) to easily move the markets with trades that keyed on various words from news feeds. Today’s markets seem very similar,  but the algos are focused heavily on words related to reopening and vaccines. While the markets may seem stable, poor liquidity coupled with an unprecedented economic environment will result in violent moves up or down. Given the many unknowns about the virus, we suggest you stay vigilant.

The chart below is a fascinating result of our changing habits due to COVID. Per Bespoke: “As of last Wednesday, for the first time the market cap of ZM actually surpassed the total market cap of those nine major airlines as shown in the chart below.”

 

May 20, 2020

Monday’s explosive rally was led in large part by the announcement of positive vaccine test results from Moderna. Those hopes were tempered yesterday as the company said its vaccine trial is not working as well as expected. Making this odd sequence of events even fishier, Moderna raised $1.34 billion in a stock offering on Monday night. The offering was at $76 per share, $10 a share above where it closed on Friday. The stock fell over 10% yesterday to close at $71.67 after the bad news.

One of our biggest challenges going forward is correctly forecasting the tug of war between inflation and deflation. Currently, deflation is raging as demand dropped sharply and suppliers can not slow production fast enough. This was highlighted with oil prices when they went negative last month. While we have all seen some instances of higher prices, especially for food items and paper goods, inflation is not a story for today.

Tomorrow is a different story.  In fact, an interesting divergence has emerged between investors view of future inflation versus consumers. The chart below compares the sharp divergence in expectations from the University of Michigan 1 year inflation survey versus the implied inflation from the TIPS market. The current 2.16% gap is more than twice the average differential of the last three years.

The graph below from job search agent Indeed provides some cause for optimism in the labor market. While the number of job postings is still well off the pace of a year ago, it has recently begun to trend higher. Over the past two weeks it improved from -39.3 to -37.2%.

The equity put-call ratio indicator compares put volume to call volume. The ratio tends to be a good sentiment indicator. When the ratio is high, it signals that investors are bearish as they are buying more puts than calls. Puts are often used as a hedging tool. Conversely, when it is low investors are bullish. Extreme readings can be signs of a pending market reversal.

Currently, the ratio is very bullish.  Since 2004, the current level of .47 or less has only been met on 74 trading days or less than five times a year on average. The last time the ratio was below the current level is the standing record high set on 2/19/2020 when it hit .45. While very telling about the degree of bullish or bearish sentiment in the market, the ratio is not always a reliable indicator of an imminent change of direction, so take the current reading with a grain of salt.

May 19, 2020

A “buying panic” on Monday morning resulted in a record opening tick reading with 2049 stocks on the NYSE opening with positive upticks. As shown, that is unprecedented in at least the last 20 years. The combination of Jerome Powell saying the Fed has a lot more room for monetary policy along with positive reports that Moderna has positive test results for a COVID vaccine drove the record opening.

This week should be quiet on the economic data front. The Fed will be active with Jerome Powell speaking to Congress today at 10am, numerous Fed Presidents will speak throughout the week, and the Fed will release its minutes from the last FOMC meeting on Wednesday.

The June crude oil contract rose over 10% yesterday to $32.74 a barrel. The recent surge in price, especially the price action of the front month contracts has flattened the pricing curve. A few weeks ago, we talked about the unprecedented difference between the front contract and those 3-6 months out. That gap has completely filled with the front month contract standing only $1 less than the October contract.  To put context around the change in the curve, the January 2021 contract is unchanged from a month ago (4/17/2020), while the June 2020 contract is up over 50% over the same period. Fingers crossed, but it appears the storage problem has improved.

In a 60 Minutes interview on Sunday night, Jerome Powell mentioned that the Fed can still do a lot more monetary stimulus. Actually, the amount is unlimited except for one crucial regulator that could slow or even halt their actions. The Fed has three mandates, one of which is stable prices. In deflationary times, such as today, the mandate gives them plenty of cover to print money to boost inflation.

As shown below, the money supply is up over 25% in just the last two months.

The economic environment is still overwhelmed by deflationary forces, and therefore, the Fed can print a lot of money. However, as the economy reopens, the combination of surging money supply and increased monetary velocity along with higher energy and food prices, could quickly push traditional measures of inflation higher. The Fed has mentioned on many occasions they prefer market-based inflation expectations to assess future inflation. The Five-year Breakeven Inflation rate (implied inflation from TIPS) has recovered from near zero to .84%, but it is still well below the 1.5-2.0% running rate of the prior years.  This indicator may be the most important signal that inflation is a concern for the Fed and they may have to curtail QE. The Five-year Breakeven Inflation rate can be followed daily on the St. Louis Federal Reserve FRED site

 

 

May 18, 2020

Stocks surged in overnight trading on comments from Jerome Powell on 60 Minutes in which he stated:

Powell to CBS: “There is no limit to what we can do under these emergency powers.”

CBS: “Where does the money come from?”

Powell: “We print it digitally.”

April Retail Sales were worse than expected at -16.4% versus the consensus estimate of -11.2%. More surprising, sales excluding gas and autos declined by a similar amount -16.2% versus forecasts of -7.6%. The only sector that saw an increase was non-store retailers like Amazon.

With the latest data, the Atlanta Fed lowered its GDP forecast for the second quarter to -42.8% from -34.8%. The estimate is based solely on released data. As such, it is probably overestimating the quarterly decline as economic activity will pick up as the economy reopens. Currently, the consensus of Wall Street economists ranges from -22% to -40%. These forecasts estimate activity for May and June.

Saber rattling with China continued on Friday. Per CNBC:

  • The Trump administration moved to block shipments of semiconductors to Huawei Technologies from global chip makers
  • The U.S. Commerce Department said it was amending an export rule to “strategically target Huawei’s acquisition of semiconductors that are the direct product of certain U.S. software and technology.”

Huawei is a leader in 5G technology and the world’s second largest smartphone maker. Huawei was a pawn in the first round of trade negotiations, so it’s not surprising to see this company once again in the spotlight. We would not be surprised to see the Chinese threaten companies like Apple or Intel.

Last week, the Fed bought $305 million of corporate bond ETF’s on its first foray into the secondary corporate bond market. They are approved to buy up to $750 billion. When the program was first announced the yield spreads between corporate bonds and Treasury bonds compressed meaningfully. Essentially, Wall Street bought at much lower prices to ultimately sold to the Fed at higher prices.

Over the last two weeks as Wall Street prepped for the Fed’s entrance, spreads have widened slightly. The graph below shows the ratios of the popular Investment Grade ETF (LQD) and High Yield ETF (HYG) to the 7-10 year UST ETF (IEF). In both cases, the corporate ETF’s outperformed after the program was announced in late March, but since mid-April have slightly underperformed.

One of the more prominent trends of the past two months has been the strong performance of momentum stocks like the FANMGs (FB, AAPL, NFLX, MSFT, and GOOG) as compared to the weak performance of value stocks. The chart below shows that the divergence between the two has reached an extreme not seen in at least the last 15 years.

 

May 15, 2020

Initial Jobless Claims were worse than expected at 2.981mm versus 2.5mm expected. Continuing claims surpassed 25 million, or 13% of the workforce.

More deflationary warnings came from the BLS in its Import and Export Prices report. The data measures the prices of nonmilitary goods and services traded between the U.S. and the rest of the world. The year over year change in imports and exports are -6.8% and -7.0% respectively.

Retails Sales, released at 8:30 this morning, is expected to fall by 11.2%. Prior to last month’s 8.2% decline, the largest monthly decline in the last 30 years plus was 2.92%.

The University of Michigan Consumer Sentiment report is expected to come in at 66, well off the recent February high of 100, but above the 57.7 low reached during the 2008/09 recession.

Despite the recovery of the major stock market indexes, the banking sector is not following. The graph below shows that the nation’s four largest banks, JP Morgan, Citi, Bank of America, and Wells Fargo, are all trading near the lows of March. Given that marginal growth in the economy is largely driven by debt and the ability of banks to issue new debt, this is a troubling sign for future economic growth.

The next graph shows the price ratio of the banking sector ETF (XLF) t0 the S&P 500 (SPY). As shown, the ratio is back to the lowest levels of the Financial Crisis.

As rates across the maturity curve compress towards the zero bounds, banks’ profit margins, aka net interest margin, are also compressing. Couple, reduced profit potential with surging delinquencies/defaults on consumer debt and the outlook is not great. As Europe and Japan can attest, negative rates are a big problem for banks. If the Fed Funds futures markets continue to imply negative rates, it should be tough for the banking sector to rebound meaningfully.

May 14, 2020

Producer Prices (PPI) were weaker than expected, declining 1.3% versus expectations for a .5% decline. The year over year rate is now -1.2%.

The consensus expectation for initial jobless claims, released at 8:30 am, is for an additional 2.5mm people to join the ranks of the unemployed. That is less than the 3.169mm from last week, but still almost 3x the largest weekly increase prior to this episode.

Fed Charmian Powell confirmed what other Fed Presidents have recently been saying about negative interest rates. To wit, he repeated a line from a prior FOMC meeting statement- “All participants judged that negative interest rates currently did not appear to be an attractive monetary policy tool in the United States.”  He did call for more fiscal spending, which indirectly entails more monetary stimulus (QE) to help ensure rates do not rise as the supply of debt in the market is increased.

GE fell 3.5% to a price last seen during the depths of the Financial crisis of 2008. At that time, investors were concerned that GE was a bankruptcy risk. That rumor is once again circulating.

For all of the fundamental reasons to be bearish the stock market, investor sentiment is providing a reason for some bullishness. Bearish US investor sentiment, at 52.6%, is the highest it has been since January 2013. The S&P 500 rose 30% that year. As they say, markets like to climb a wall of worry.

Speaking of a wall of worry, famed investor Stanley Drunkenmiller stated the following on Tuesday: “The risk-reward for stocks is as bad as I’ve seen.” Within hours of Drunkenmiller’s comment, CNBC reported: “Young investors pile into stocks, seeing ‘generational-buying moment’ instead of risk.”

The following article from Bloomberg, Tax-Averse Nashville Goes Where Few other Cash-Poor Cities Dare,  discusses the impact that COVID is having on Nashville’s finances and the tough decisions it is being forced to make. While the article is generally focused on the city of Nashville, it rings true for many states, counties, and cities throughout the United States. Given the dire situation these municipalities face and an election coming in months, we suspect a large second round of federal stimulus will ultimately be approved to help bailout out some of these entities. From the article:

“Congress has earmarked $150 billion for states and local governments — Nashville is slated to receive $122 million but the money must be spent on public health and can’t be used to fill budget holes.

State and local governments are in “uncharted territory” and will have to start making serious cuts if they don’t get more help, said Richard Auxier, a senior policy associate in the Urban-Brookings Tax Policy Center.”

 

May 13, 2020

The winds of a trade war with China are picking up. Yesterday, President Trump ordered that Federal retirement funds invested in Chinese equities should be liquidated. It will be interesting to see if China reacts as they are the second largest foreign holder of U.S. Treasury securities coming in at just above $1 trillion. The complete listing by country and one-year holdings history is found HERE. It is unclear how much in U.S. equities is held by the Chinese government and its citizens and corporations.

Adding to the pressure is legislation from Senator Ted Cruz that seeks to end reliance on China for rare earth metals. The bill is part of a larger push by Congress to reduce U.S. dependency on goods of national interest from China. Apple piled on yesterday when they announced they are working to shift “a significant portion of its production to India from China.”

April CPI fell 0.8%, reducing the year over year rate from 1.5% to 0.3%. Despite the broad based deflationary pressures, the BLS reported that the price for “food at home” aka groceries, rose by 2.6% in April, the largest increase in 45 years.

The degree or amount of monetary stimulus is often judged by real rates or the level of interest rates less the rate of inflation. With the sharp decline in CPI yesterday, real rates spiked higher, despite nominal rates falling over the last few months. For instance, the 10-year Treasury real rate in April was -.64%. With the latest CPI print, the real rate is now +.30%, a nearly 1% increase in real rates.  Many economists argue that current monetary policy, despite massive stimulus, has actually tightened. Higher real rates is likely what is driving Fed Funds future below zero.

The problem of higher real rates is not lost on the President. On Twitter yesterday Trump stated: “As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the “GIFT”. Big numbers!

The following Reuters headline quickly followed the President’s Tweet :FED’S KASHKARI SAYS FED POLICYMAKERS HAVE BEEN ‘PRETTY UNANIMOUS’ IN OPPOSING NEGATIVE INTEREST RATES.

In addition to Kashkari, a few other Fed speakers were out yesterday and discussed a need for fiscal responsibility when the crisis is over and limits on how much monetary stimulus can be used. Chairman Powell will speak today at 9 am, and we shall see if he continues on these same themes.

The market traded sharply lower in the last hour of trading yesterday on a report that Los Angeles is likely to extend the stay at home order for at least three more months.

The Treasury announced that April’s budget deficit was $737.9 billion. Since at least 1980, there was only one other deficit in the month of April, and that was $82 billion. April tends to be a surplus month due to tax revenue.

Speculative short positioning of the 30yr U.S. Treasury Bond futures contract hit a record level. This class of investors represent hedge funds, CTA’s and other institutions trading for profits and not as a hedging activity. Frequently, when speculative positioning in futures is extreme, the market will reverse its recent trend. The chart below makes the case for bond prices to rise and yields fall. We are watching the situation closely as we would like to add to our bond exposure.

 

May 12, 2020

Saudi Arabia will reduce its oil production by 1 million barrels per day starting in June. It is unclear if other OPEC or non-OPEC nations will join them. Even with recent reductions, it is still believed supply is firmly outstripping weak demand, and with limited storage facilities, the pricing problems of April are likely to resurface. The June contract goes to settlement on May 19th, so pricing volatility will likely erupt later this week and early next week if that is, in fact, the case.

Per the Global Times: “China officials may consider invalidating Phase One of the trade deal and negotiating a new deal to tilt the scales more to the Chinese side.” The Trump administration countered by saying renegotiation of the deal is unlikely.

Chairman Powell will speak on Wednesday at 9am. The speech is not a planned appearance and its substance is unknown.

On the economic data front this week, inflation figures will be of the most importance. Currently, there is a significant lack of demand and, at the same numerous supply line problems. While we think the aggregate effect is deflationary, predicting CPI and PPI will be very difficult as there are certain products whose prices are rising rapidly, as many others fall. CPI, released at 8:30 this morning, is expected to decline -.8% month over month, bringing the annual number down to +.5%. A large part of the decline is due to oil prices. On the other hand, food prices are providing some upward pressure. The annual CPI excluding food and energy is expected to be +1.8%.

PPI, released on Wednesday, is also expected to decline. We expect PPI to show more deflationary tendencies than CPI as the prices are based on raw commodities, which have fallen sharply in price. The graph below courtesy of Thompson Reuters shows the 30%+ decline in the CRB index in 2020.

The other interesting economic data release this week will be Retail Sales on Friday. The current expectation is for an 11.2% decline, following last month’s 8.7% drop. Personal consumption is nearly 70% of GDP, so this number weighs large in GDP forecasts.

The chart below shows each date the national debt eclipsed the rounded $1 trillion level. Note the top three bars are all from 2020 and the year is not even halfway over. There will likely be at least two more bars added to the graph before yearend.

May 11, 2020

The BLS reported that 20.5 million jobs were lost in April, bringing the unemployment rate to 14.7%, the highest level since the Great Depression. The big question going forward is how many of these job losses will become permanent. The BLS commented on the topic: “The number of unemployed persons who reported being on temporary layoff increased about ten-fold to 18.1M in April. The number of permanent job losers increased by 544,000 to 2.0M.

The employment to population ratio fell by 8.7% to 51.3%, which is the lowest rate since at least 1948 when records were first kept by the BLS.

The U6 unemployment rate rose to 22.8% from 8.7%. The 14.1% increase in the U6, was much more than the 10.3% increase in the often quoted U3 rate. The U6 is those included in the U3, plus discouraged workers no longer seeking jobs and part-time workers seeking full-time employment.

The average hourly earnings data is skewed as the majority of those getting laid off are lower paid employees. The labor force participation rate fell to the same levels of 1973.

To put some context around Friday’s jobs data, aggregate job losses from the last nine recessions, dating back to 1958, total 20.5 million jobs. Also, consider that two months ago we had the lowest unemployment rate in over 50 years and today we have the highest rate in over 80 years.

After the jobs report, the Atlanta Fed released its revised annualized GDP forecast as follows: “The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2020 is -34.9 percent on May 8, down from -17.6 percent on May 5. After this morning’s releases of the employment report by the U.S. Bureau of Labor Statistics and the wholesale trade report from the U.S. Census Bureau”  It is worth noting the number is scarier than it looks. For one, it is annualized. Secondly, it assumes that May and June will be like April. Odds are they should improve as the economy opens up.

These times are truly unprecedented indeed! Data covering quarterly earnings calls from large corporations shows the word “unprecedented” is being used to describe business conditions about 50% more often than during the Financial Crisis of 2008/09. As we wrote last week in Extraordinarily Uncertain Indeed, those in the media and on social media with predictions of a “V” shaped recovery and a prompt return to normal, are clearly not recognizing the unprecedented nature of what is occurring. While we certainly hope they are correct, we must also prepare for a wide range of potential outcomes. Managing wealth is not about hope, it is about properly assessing risk, especially in times like these.

May 8, 2020

Initial Jobless Claims rose by 3.169 million last week down from 3.846 million in the prior week. Continuing claims are now 22.6 million, which is over three times the 6.6 million peak of the previous recession.

As shown below, in aggregate consumers paid down their credit cards at an unprecedented rate last month. There is $1.066 trillion of revolving consumer debt, so even though the net amount of the paydown is large, it is still a rather small percentage of the debt outstanding.

December 2020 Fed Funds futures contracts and those further out in maturity, fell below zero yesterday. The market is implying the Fed reduces rates into negative territory by yearend and stays at or below zero until the spring of 2022.

Despite the eye-popping equity rally of the last month or so, investor sentiment remains extremely bearish. As shown below, those that characterize themselves as bearish are now at the highest level since 2013. The percentage of investors considering themselves bullish remains at the lows for the year, but, unlike bearish sentiment, is not quite at extreme levels. Taken on its own, this survey paints a bullish picture for the weeks ahead.

The Turkish Lira has been depreciating rapidly versus the U.S. dollar over the last few weeks, pointing to an acute dollar shortage in Turkey. On Thursday, Turkey banned three large international banks from partaking in currency transactions in a bid to slow the depreciation. The Fed has yet to offer Turkey currency swap lines to help alleviate the situation. Likely, any relief from the Fed will be in coordination with some sort of political favor from Turkey. The graph below shows the long term depreciation of the Lira and the recent collapse. Turkey’s situation is just another example of a second order effect that is difficult to predict, but carries with it the potential to create meaningful economic and geopolitical impacts.

May 7, 2020

The ADP report was slightly worse than expected, showing a loss of 20,236,000 jobs in April. Over six million of the losses came from small businesses that employ less than 50 people. Further data on job losses by industry and company size is found HERE. The million dollar question going forward is how many of these job losses become permanent.

Our model is forecasting a loss of 18,125,000 jobs in Friday’s jobs report.

Yesterday we highlighted that Treasury yields are backing up do to supply. A reader asked us if they may also be rising in sympathy with inflation concerns. The graph below shows that implied inflation expectations, calculated from nominal and inflation-protected Treasury yields, show no indication of a recent change in inflation expectations. Again, this move seems to be corporate and U.S. Treasury supply related.

To wit, the U.S. Treasury announced that the amount of debt outstanding rose by $1 trillion last month to over $25 trillion outstanding. The Federal debt to GDP ratio shot higher to 117% from 106% at the end of 2019. Given the stimulus spending plans for the remainder of the year and the inevitable decline in GDP, this ratio will continue to higher.

Since April 20th, the front month Crude Oil futures contract traded as low as -$40 per barrel and recently has risen to over $25. As we have discussed, this massive price volatility of the front contract(s) are largely the result of excessive supply, weak demand, and a lack of storage facilities. Without sufficient storage, producers must dump oil on the market and accept whatever price can be had.

On April 22nd, we shared the first graph below to highlight the divergence between the front month contract and longer term contracts. It is updated as of May 6th to show that the spread remains wide but is back to more normal levels. The second graph below shows how the price of each monthly contract has changed since April 20th. All of the price improvement in the crude oil complex is occurring in the first three contracts. In fact, prices have declined slightly for months five and six over the period. If the storage problem is solved, the curve should remain relatively flat. If not, expect the front month contracts to fall victim again to extreme volatility. From an economic and investment perspective, we should primarily focus on the out month contracts for a truer economic price of oil.

May 6, 2020

Upward pressure on Treasury bond yields in recent days is partially attributable to “rate locking” for expected corporate debt issuance. Banks and Broker/Dealers, on behalf of corporate issuers, will short U.S. Treasury securities to help lock in an interest rate for upcoming bond issuance. This week alone, we have seen Apple ($8.5bn), Amgen ($4bn), Starbucks ($3bn), Altria ($2bn), Schlumberger ($1.5bn), and Kraft Heinz ($1.35bn) come to market with large issuance. When the deals price and the hedges are lifted (shorts covered), bonds may see improvement, all else being equal.

In an interesting twist of events, Germany’s constitutional court in Karlsruhe, found that the EU overstepped its powers when it backed the legality of the ECB’s QE operations. The court is giving the ECB three months to change the rules of operation.

The most important data point of the week will be Friday’s BLS jobs report. The stunning consensus estimate for job losses and the unemployment rate, as well as the extremely wide band of estimates, are shown below. As a point of reference, the highest unemployment rate since 1948 was 10.8% in 1982, and the largest monthly drop in non-farm payrolls was 1.959 million, right after WWII. This morning’s ADP report is expected to show a 20 million decline in jobs last month, somewhat in line with expectations for Friday.

The good news is that the latest data from the TSA shows that air travel is slowly improving. The bad news is that air travel is still well below 90% of normal.

 

May 5, 2020

President Trump is ratcheting up pressure on China as a result of the economic fallout from the virus. For now, they are just words, but outside of the Corona Virus and its economic impact, his words and possible actions may be the most critical geopolitical factors to follow. Per Fox Business Network- MNUCHIN SAYS HE EXPECTS CHINA TO MAKE GOOD ON ITS TRADE AGREEMENT WITH U.S., WILL BE VERY SIGNIFICANT CONSEQUENCES IF THEY DON’T.

Accordingly, we will closely watch the Chinese Yuan versus the dollar to see if the Chinese are depreciating their currency. If so, it means they are taking action to cheapen their exports and at the same time make the import of U.S. goods more expensive.  Currently, the yuan sits at 7.06 per dollar. It is widely believed part of the original trade agreement involves China keeping the yuan at 7 or lower. A move above 7.10-7.15 would be concerning.

Much was made of the annual Berkshire Hathaway (BRK/A) annual meeting this past weekend. To summarize, Warren Buffet is very concerned about the markets and economy. Of particular note, he sold his entire holdings of U.S. airlines. BRK/A is sitting on at least $128 billion in cash. His actions are a clear indication that one of history’s most astute investors is not buying into the recent rally.

Employee withholding federal tax receipts were down 14.61% in April. That provides a rough indication of what this Friday’s employment report may look like.

The following LINK from TD Securities provides a comprehensive listing of all of the fiscal and monetary measures being taken by the G10 countries.

The biggest question for investors is when economy will open up and, once opened, how quickly will economic activity returns to normal. The graph below provides some guidance in that regard. Per Open Table reservation data, people had sharply cut back on eating out a week or so before mandated so by state lockdowns and closures. We suspect that regardless of state actions to open commerce, consumers will be slow to resume normal activities. This is undoubtedly due to a fear of catching the virus but also increasingly a result of reduced economic means.

If you are an investor of REITs or considering buying into the REIT sector, the chart below provides some guidance as to how various real estate sectors are faring.

May 4, 2020

The Fed will slow its balance sheet growth further in the coming week to $40 billion. Last week, the Fed’s balance sheet grew by $83 billion (Wednesday to Wednesday), continuing the trend downwards in recent weeks. In the week prior to last week, the balance sheet grew by $206 billion, which is also down significantly from the $557 billion growth for the week ending March 1. Make no mistake, they are still very aggressive, buying $5 billion per day, but it is now more comparable to prior QE.

The Citi Economic Surprise Index fell to an all-time low. This index measures the divergence between the consensus of economists estimates for incoming economic data versus the data itself. A negative number, as it stands today, tells us that forecasts have been overly optimistic versus the actual economic conditions. In other words, economic data has been surprising to the downside. This index, like many other economic data points, is not as valuable as they were due to the inability to assess how rolling lockdowns throughout March affected economic activity. We suspect the accuracy of consensus forecasts will improve when April data is released throughout May.

Phil LeBeau of CNBC provided a first look at April economic data as follows: “April auto sales plunge 48% with April ‘20 sales rate was 8.6 Million units versus 16.52 million units last April according to the research firm AutoData

We recently read that regulations prohibit certain types of foods that are destined for restaurants to be sold in supermarkets. Like we have written about meat, pork, and poultry, the amount of food is not necessarily a problem, but the ability to get the food to our supermarkets is a big problem. A lot of food is being wasted due to numerous constraints.

According to Neilsen: In the past week, prices have risen for fresh meat by 8%, eggs by 31%, cheese by 11% and cow milk by 10% versus this time last year. The graph below from Neilsen provides an interesting perspective on how our dining habits have radically changed since Covid19. Follow @nielsen on Twitter for many other unique consumer statistics.

 

May 1, 2020

Initial Jobless Claims rose by 3.839 million, down from 4.442 million last week, but still running at over five times the prior weekly record (1982 -680k). To put the data into a more modern context, the high point in the 2008/09 crisis was in March of 2009 at 661k.

The Personal Savings Rate surged to 13.1% from 8.4%. The predominant driver is a lack of consumption and therefore, “forced” savings. The rate is the highest since the early 1980s, however, at that time, there was incentive to save with interest rates over 10%.

The Fed expanded the scope and eligibility of its Main Street Lending Program (LINK) to include riskier firms with higher levels of debt. This program involves the Fed and Treasury lending up to $600 billion to small and medium-sized businesses. Like other Fed/Treasury programs, this one is set up as an SPV.  The Treasury puts up the initial funding for the vehicle and retains a small percentage of default risk. The Fed then leverages the Treasury’s funding up to ten times and retains the remainder of the risk.

J. Crew will file for bankruptcy this weekend. In its wings are bankruptcy rumors from fellow retailers, The Gap, Neiman Marcus, and JC Penny.

On Wednesday, we wrote about the inflation/deflation problem that is simultaneously resulting from the closure of meat processing plants. Today we further the discussion with two graphs showing the extreme divergence between retail beef prices (USDA) and Live Cattle prices on the Chicago Mercantile Exchange (CME). The first graph shows that Live Cattle futures are trading at ten year lows. At the same time, as shown in the second graph, wholesale beef prices spiked to ten plus year highs. High meat prices and reduced inventory should become very noticeable at your local butcher in the coming days and weeks. In theory, prices should converge as the supply of cattle will decline when processing plants re-open and some animals are culled. At the same time, demand will drop due to higher retail prices. However, like negative oil prices, who knows what this market oddity will bring us.

April 30, 2020

Yesterday’s FOMC statement (LINK) is essentially a pledge to keep the Fed Funds rate at zero, maintain QE to “support smooth market functioning“, and support/provide other stimulus as needed until the economy is back on track to achieve the Fed’s price and employment goals. Based on the fact that there were no dissenting votes, it appears the idea of cutting rates into negative territory was not seriously discussed. The Fed did not provide forward guidance as they typically do, but based on the following statement they are not on board the “V” shaped recovery bandwagon: The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.

A few takeaways from Chairman Powell’s press conference:

  • SPV programs that buy corporate and municipal credit are unlimited in size.
  • He reiterated that they would use their tools “forcibly and confidently” until the U.S. is on the road to recovery.
  • He mentioned risks to the outlook that the Fed is keyed on. 1) The spreading of the virus, new outbreaks, and the development of vaccines and drugs. 2) Lasting damage to the productive capacity due to extended unemployment and small and medium-sized business failures. 3) “global dimension” – how global economic activity affects the U.S. economy.
  • We are going to see data for Q2 that’s worse than anything we’ve seen
  • He seems to believe that inflation is guided by inflation expectations. As long as inflation expectations remain anchored, he does not expect to see deflation.
  • We won’t run out of money.

First Quarter Real GDP was worse than expected at -4.8%. The slowdown was led by a sharper than expected 7.6% decline in consumer spending, the largest drop in 40 years. Consumer spending was only expected to fall by 1.5%. Bear in mind, the GDP report only captured a few weeks of the shutdowns, with over two-thirds of the reporting period having occurred during a relatively healthy economic environment. Interestingly, the price index was stable from last month at 1.3%.

GDP data will likely be revised significantly in the coming months and even years, as we have seen with prior recessions. Page 8 of the GDP report (LINK) provides the contribution of the components making up GDP. The graph below shows the breakdown by major sector groupings.

Despite the GDP data, stocks surged on optimism from Gilead that its Remdesivir Corona Virus treatment showed positive results. Dr. Fauci also spoke with optimism-“what it has proven is that a drug can block this virus … This drug happens to be blocking an enzyme that the virus uses.

Jobless Claims will be released at 8:30 with expectations of 3.5 million new claims being filed. Chicago PMI will also be released with a consensus of 37.9 and wide range of estimates from 29.8 to 42. National PMI and ISM manufacturing surveys will follow on Friday. All of these corporate surveys, which used to provide economists dependable forward guidance, will be impossible to make sense of. Investors and economists will likely put little weight on their results.

 

April 29, 2020

GDP will be released at 8:30. The consensus expectation is for a decline of 3.7% ,with estimates ranging from 0 to -10%. The Fed will release the minutes from its FOMC meeting at 2:00 and follow up with Jerome Powell’s press conference at 2:30. Fed Funds futures are priced at 8bps, implying an 18% chance rates are cut into negative territory. The Fed Funds curve is flat through at least October 2021, meaning there are no additional expectations for further decreases or any increases for a long while.

As expected, Consumer Confidence fell sharply in April to 86.9, down from 120 in March. The drop was led by the present conditions sub-component, which fell from 164 to 76.4.

On CNBC’s Squawk Box Treasury Security Mnuchin stated “I would say that’s highly unlikely” in regards to the Fed buying stocks. We have little doubt this statement will prove false if the market tumbles back toward March lows.

In an optimistic sign of improvement in the credit markets, LIBOR spreads to Treasuries continue to compress. The current 3-month spread is 38.5bps down from nearly 100bps. LIBOR indicates the rate that banks can borrow from each other. The tighter the spreads, the better condition banks are in.

One of our concerns about the sustainability of the current equity rally is the two week divergence between junk bonds and stocks. When the Fed announced they will buy junk-rated debt, the popular junk ETF (HYG), spiked higher. However, since then, it has retraced all of the gains. Over the same period, the S&P 500 has continued to grind higher. The correlation between junk bonds and stocks tend to be strong over time, so this divergence bears watching closely.

The most common theme from earnings announcements this quarter has been the withdraw of 2020 forecasts and guidance. Making sense of Q1 earnings is already a difficult task, but trying to assess how the virus will impact certain companies in the coming quarters is now nearly impossible without the qualitative and quantitative input from corporate executives.

Tesla’s valuation summed up in one picture-  (TTM Rev. = Trailing 12 months of revenue)

April 28, 2020

This week will be important for corporate earnings. Some of the more important corporate earnings announcements by day are as follows:

  • Tuesday- Pfizer, Merck, 3M, Google, Caterpillar, and Pepsi
  • Wednesday- Boeing, Humana, Tesla, Facebook, Microsoft, and MasterCard
  • Thursday- American Airlines, Apple, Twitter, McDonalds, Amazon, Visa, and United
  • Friday- Exxon, Chevron, Clorox, and Honeywell

Given the record concentration of the five largest stocks in the S&P 500, all of which report this week, earnings may amplify volatility in the markets. Potentially further stoking volatility will be the Fed’s FOMC meeting statement and Powell’s press conference on Wednesday, along with GDP also being released on Wednesday.

Diamond Offshore (DO), a large offshore oil driller, filed for bankruptcy protection over the weekend. Continental Resources (CLR), the largest shale producer in the Bakken region is shutting in most of its production. CLR was producing over 200k barrels per day. Headlines like these will likely become more common as many small to mid-size energy producers are unprofitable at current oil prices and saddled with tremendous debt loads. As we discussed last week, there will be a lot of assets for sale at deep discounts, and the larger energy companies with strong balance sheets, diversified products, and the ability to withstand sub $20 oil prices for a while will benefit.

Crude oil fell almost $4 a barrel or 23%. Continued fears about a lack of storage and overproduction continue to haunt the price.

GM will suspend dividends and cancel buybacks. Delta Airlines is suspending contributions to it pension fund. Boeing’s CEO said it would take “years” before they start paying dividends again. Headlines like these will be common themes going forward as companies take necessary action to preserve cash. It is worth considering that reinvested dividends and share buybacks were the key drivers of stock prices for the last decade.

Fox News said that a negative payroll tax is on the table. Negative interest rates, oil prices, and now possibly taxes. Economics is being turned on its head.

The Fed expanded its $500 billion municipal lending facility to include smaller cities and counties. Click this LINK for the press release.

April 27, 2020

The Fed will further reduce QE purchases this week to $10 billion per day, down from $15 billion last week.

On Tuesday and Wednesday, the Fed will conduct their regularly scheduled monetary policy meeting. The market is not expecting much in terms of additional actions. Still it is worth noting that ex-Fed President Kocherlakta penned an editorial urging the Fed to consider dropping rates into negative territory at this week’s meeting. The BLS employment number will not be out until next Friday, but the Fed will have a decent estimate of that much anticipated number and may opine on it.

Also, GDP will be released on Wednesday. The current estimate is for a 3.3% decline. Q1 has the potential to vary significantly from the estimate as various local and state lockdowns occurred at different times throughout March. We also have to consider that economic activity in February and March was boosted by corporate and consumer stockpiling.

One of last week’s themes in the daily commentary was the extraordinary oil price volatility resulting from the supply/demand imbalance. Today we shift focus to meat products that are facing an odd set of supply/demand imbalances. Per a Bloomberg article, “about a quarter of American pork production and 10% of beef output has now been shuttered.” The closures are due to employees and meat inspectors that have contracted the corona virus and the risks to other employees. The article states that 100 USDA inspectors have tested positive for the virus and at least one inspector has died. These inspectors travel from plant to plant and can quickly spread the virus. Since the processing plants are closing, the growing supply of animals is also becoming a problem. The article notes, “Minnesota farmers may have to kill 200,000 pigs in the next few weeks.” There also reports that 2 million chickens are being “depopulated” in Maryland and Delaware.

As a result of supply chain impediments, the prices of certain finished meat goods may rise sharply at grocery stores and restaurants while the prices of raw products in the futures market trade near the lows of the year. Essentially, there is downstream inflation for consumers of processed meat products and, at the same time, deflation for farmers selling the animals. You can track futures pricing for cattle, hogs, and a host of other commodities at Finviz.com.  Supply chains around the world are fracturing and resulting in imbalances that can be inflationary, deflationary, or both.

The graph below shows that the annualized number of new fracking operations in the Permian, Eagle Ford, and Bakken basins has fallen by about 75%. Today, the lack of demand is dwarfing the supply cuts, but as the economy recovers production cuts, coupled with increased demand should provide a substantial boost to the price of oil.

Per Bloomberg News- “U.S. homeowners seeking to delay mortgage payments topped 3.4 million, up 17% from a week earlier, according to Black Knight. About 6.4% of mortgage borrowers have entered forbearance.”

April 24, 2020

Initial Jobless Claims rose by 4.427mm, bringing the total for the last five weeks to 26.5mm. The unprecedented nature of job losses is shown below.

The ECB joined the Fed and will now purchase junk-rated corporate debt under certain conditions. Rumor has it the ECB will also accept junk-rated debt as collateral for loans to banks. The BOJ joined the party by removing limits on the amount they can buy under existing QE programs. Further, they will double their purchases of corporate debt.

Yesterday we added positions in Exxon (XOM), Chevron (CVX), and the SPDR Energy ETF (XLE) to our portfolios. We believed the companies offered significant value before the crisis and offer even more today despite the sell-off in oil. Based on our discounted cash flow model for XOM and CVX, we think that both stocks are about 25% undervalued. The model assumes very conservative earnings projections for the next three years and a low earnings growth rate thereafter. In addition to trading at a good discount, we think their strong balance sheets put these companies in a prime position to purchase sharply discounted energy assets in the months ahead. These stocks and the sector will be volatile for a while, but our intention is to add to these positions in the future and potentially hold them for a long time.

The graph below shows that the stimulus checks to individuals will have limited economic stimulative benefits. Over 50% of the funds will go towards savings or paying down debt. Typically a much higher portion would go towards expenditures and contribute to economic activity.

Throughout the week we have written about the massive imbalance in the supply and demand for oil and how it is killing oil prices. Now we take a macroeconomic view and consider how weakened demand for oil might affect U.S. GDP. To quantify the relationship, we share two graphs below. The first one is a scatter plot, with each dot representing the annual intersection of the change in economic activity with the change in energy consumption (data since 1977). As shown, the relationship is statistically solid with an R-squared of .55. The next graph compares GDP to a forecast based on the regression analysis from the scatter plot. Again, it visually shows the strong relationship between the two factors.

Based on the analysis above, if we assume total energy consumption will be down 25% for the entire year, then the estimated annual GDP should decline by 8.68% for 2020.

April 23, 2020

Jobless Claims will be released at 8:30. The current estimate is for 4.250mm new claims, a decline from 5.245mm last week. On Friday, the University of Michigan will release its revision to last week’s April Consumer Sentiment reading. Last week the index was 71.0 down from 89.1 in March and 97.2 in April of 2019. The current estimate is 68.0.

Per Lisa Abramowicz/Bloomberg- “Total hedge fund capital fell by $366 billion in Q1 to $2.96 trillion, falling below $3 trillion for the first time since 2016: HFR data. Investor outflows totaled about $33 billion in Q1, the 4th largest in industry history & the biggest quarterly outflow since 2009.”

Congress approved an additional $320bn allotment for PPP loans for small businesses. Given the backlog of requests, it is widely expected the funds will be exhausted by the weekend.

It is troubling to think about, but with the price of oil so low, we must consider the possibility of conflict in the Middle East as a way to help boost prices. To that end, President Trump tweeted the following: “I have instructed the United States Navy to shoot down and destroy any and all Iranian gunboats if they harass our ships at sea.” Iran followed up with a call to the U.S. to “remove forces from the region and end bullying.” Given the recent volatility in oil it is hard to pin the exchange of barbs for yesterday’s 21% gain in crude oil. Crude oil is up another 10% this morning to $15.30.

According to FactSet, Q1 S&P 500 profit margins are expected to decline to 9.4%, which is about 2% lower than the running rate of 2019. It is also the lowest level in over four years. Given the economic headwinds that will emerge after this crisis, we must now consider that lower profit margins may not be a crisis-related, one-off instance, but a trend. Supply lines have been damaged, and in some cases, those changes are permanent. We believe that many countries will become less dependent on China as the lowest-cost producer. Having witnessed economic vulnerabilities, they will likely mandate that a larger percentage of domestic production for goods deemed essential. Globalization improved margins in the past and de-globalization will deduct from margins in the future.

Second, given the unprecedented monetary and fiscal efforts of the central banks and governments, inflation is a distinct possibility in the future. Will corporations be able to pass on higher costs to consumers? The answer to the question is clouded by what will likely be a slow recovery in employment, wages, and hours worked. Add to the equation, more debt at the federal, municipal, corporate, and consumer level, which will further impede consumption.  These considerations will no doubt play a role in the way we assess stocks for our portfolios.

April 22, 2020

With the May crude oil contract now expired, June becomes the new front month contract. Unfortunately, June is following in May’s path. The June contract fell 36% to $12.90. Unlike Monday, where the energy complex, as a whole, held up much better than the front crude contract, yesterday’s bearish action was much more encompassing. Brent Crude Oil was down 22%, gasoline down 20%, and heating oil down 16%.  The commodity complex also got hit hard, as most metals, precious metals, meats, and grains were lower. As shown below, the Thompson Reuters CRB commodity index was down over 10% yesterday and has fallen 55% year to date. Over the last week, the ten-year breakeven implied inflation rate is 0.35% lower to 0.94%, in sympathy with commodity prices.

Based on our discussion of oil spot and futures prices in yesterday’s commentary, we provide some  context to the historical spreads. The graph below compares the rolling front month contract (within 30 days of expiration) to the rolling 3 month and 6 month future contracts. The contracts that expire 3 and 6 months from today are priced about $20 more per barrel than the front contract. Typically they are within $5 of each other.

The graph shows that at times the futures contracts trade above the current price of oil and other times below it. In futures trading parlance, the difference is called contango when the future price is higher than the current price and backwardation when the current price is higher than the futures prices. There is no question, given the current instance of severe contango (current prices < futures prices), that the demand and supply for oil are grossly misaligned.

USO, the largest crude oil ETF, with $2.6 billion of assets, has seen its shares fall precipitously with the price of oil. It has been estimated that the ETF owns approximately a quarter to a third of the open interest in June crude oil contracts. If the ETF were forced to unwind, as we have witnessed with other ETFs during bouts of severe volatility, the fund’s managers would likely have to sell those contracts, which would add further pressure to oil prices in the short run.

China experienced the virus and the shutdown months before the U.S. was stricken. As such, we can see how effectively China is “opening up.” The graph below tracks auto traffic congestion in Beijing. The general takeaway is that traffic is back to normal for the morning weekday commute, but the afternoon commute is not as congested. This is probably the result of people working less than a full day. Second, as highlighted in yellow and evident on the weekend days, there is no congestion outside of workers commuting to and from their jobs. Until there is a viable treatment or vaccine, we think similar patterns will play out in the U.S. and Europe. Workers will return to work if possible, but most people will avoid non-essential activities. Such behaviors bode poorly for travel, retail, food, and the entertainment industries. To that end, Bloomberg posted an article titled-“Wuhan’s 11 Million People Are Free to Dine Out. Yet They Aren’t.

April 21, 2020

The Chicago Fed National Activity Index fell to -4.19, which is near the lows of 2008. The only difference is that in 2008 the index deteriorated for more than a year until it reached its trough. This time the decline took one month. The 85 economic indicators that comprise the index are computed as a standard deviation from the norm. A four standard deviation event, as it now registers, should occur once every 83 years!

Spot oil, oil for delivery in May, plummeted to an intra-day low of -$40 a barrel on Monday, yes negative! We thought the price action was so unbelievable that we provided a picture below of oil from 2:30pm, when it was trading at -$13.98.

At the same time, next month’s oil contract, for settlement in late May and delivery in June, traded down 15% to $21.09 per barrel. This morning the June contract is down a further 20% to $16.40. We received many questions voicing confusion about which is the “real” price of oil. To help answer the questions, we share an article we presented last week which discussed the difference between the S&P 500 and S&P 500 futures –How To Use S&P 500 Futures to Indicate the Market Open.

As defined in the article, cash and carry is equally applicable to the oil market. The difference between today’s oil price and the price of oil in the future, is a function of the amount of time, borrowing costs, delivery costs, and, most importantly today, storage costs. The big difference between the S&P and oil is that holding the S&P benefits the holder with dividend income, whereas holding oil results in a storage cost. Currently, the lack of demand and overproduction of oil has filled up storage facilities. With no storage remaining, producers are now being forced to have to pay someone to take their oil.  You can find the price of the monthly crude oil futures at the CME. For more on the storage problem, Reuters had an informative piece out yesterday on the glut of oil stored at sea- LINK

Please note we have removed the Chart of the Day. Recently, we have been adding pertinent/timely charts to the Daily Dashboard and will continue to do so going forward. The Chart of the Day has been replaced with News about your portfolio holdings and alerts, which you can set for your portfolio holdings. The alerts, when triggered, will send you an email alert.

April 20, 2020

The Conference Board’s Leading Economic Indicators plummeted from -.2% in February to -6.7% in March. That was by far the largest decline in the index’s 60-year history. The biggest reason for the deterioration was the recent surge of initial jobless claims.

The Fed continues to slow down the pace of QE. On Friday, they further reduced the daily pace of purchases to $15 bn, down from $30 bn in the prior week, and $75 bn at the peak. Even at $15bn per day, the pace of purchases is still larger than the peak pacing of QE1. Given the massive issuance expected by the Treasury, we will closely follow yields on longer duration Treasury bonds to see if these reductions have a negative effect on yields.

Per Barry Diller on CNBC– “At Expedia we spend $5B a year on advertising. We won’t spend $1B in advertising probably this year. You just rip that across everything. There you are.” Facebook, Google, and a host of other social media outfits are advertising companies. To wit, we wrote the following two years ago- “Facebook (FB) and Google (GOOG), two of the hottest tech stocks in the market, are simply advertising companies. Based on current financial reports, 95% and 88% of revenue from FB and GOOG respectively come from advertising. These companies and others like them are the new Mad Men.”  While there may be more eyes on the sites and users as everyone is bored at home, Diller makes it clear that profits from advertising for the social media sector could be cut significantly.

The graph below shows the ratio of the financial sector (XLF) to the S&P 500 (SPY).  XLF is grossly underperforming the market, and, the ratio is hitting new lows despite the broader markets run higher.  This underperformance is occurring despite the Fed providing the sector with massive liquidity and quite frankly generous handouts. During the last financial crisis, the ratio fell from .21 in 2007 to a low of .07 in March of 2009. It was at the ratio’s lowest point when the broad market finally bottomed and turned upward. The global economic model is massively dependent on growing debt levels and banks to issue and administer debt. This is what makes XLF a sector to watch to assess macroeconomic conditions.

April 17, 2020

China’s Q1 GDP declined 6.8% year over year. Considering China was afflicted with the virus and related economic shutdowns throughout the quarter, the GDP official number is likely better than reality.

Jobless Claims rose by 5.245 million people through April 11th, bringing the four week total to over 22 million. The prior record for cumulative claims over a four week period was 2.6 million in 1982. All of the new jobs created since the last recession have now been erased.

The point in sharing horrific data and putting it in historical context is to help you understand that the structural damage being done, even if somewhat temporary, is unprecedented. Recovery in a “V” shaped fashion, as the media and Wall Street are hyping, is nice to think about, but is it really possible?

The following comes from frequent RIA author Mish Shedlock:

More than 1 million people – over a quarter of Michigan’s workforce – have filed for unemployment during the COVID-19 pandemic, the state’s top labor official said Monday.

Last week, Michigan reported more than 828,800 unemployment claims filed in the state from March 8 to April 4. Michigan’s pre-coronavirus record for new unemployment claims occurred during the Great Recession in January 2009, when there were 77,000 claims in a week.

Keep in mind that Michigan was hit hard during the 2008/09 recession as GM and Chrysler filed for bankruptcy and Ford was close.

Conoco is slashing North American output and further reducing capital spending. Per Reuters, “North American oil producers have so far announced 550k in production cuts for the year.”  That number will undoubtedly grow over the coming weeks. In the long run production cuts and reduced capital spending are bullish for oil prices. However, in the short run, the massive drop in demand is thwarting efforts to stabilize the balance between supply and demand and, ultimately prices.

On CNN, Los Angeles mayor Eric Garcetti said it is likely that he will not allow any concerts, sporting events, or anything where thousands of people gather, until 2021

The graph below shows Moody’s default rates on high yield corporate debt (junk) as well as a range of forecasts for default rates next year. Despite the Fed’s actions to help the sector, Moody’s believes that defaults will be on par with those of the last recession. The Fed’s corporate bond buying operations have driven spreads, that in most cases, are not commensurate with the risk. Buyer beware!!

We are not sure how reliable data going back over 300 years is, but the graph below is stunning none the less.

April 16, 2020

March Retail Sales fell 8.7% versus expectations for a 7.3% decline. The monthly decline is more than twice the worst monthly change during the 2008/09 recession (-4.0%).  This is even worse considering the full brunt of the shutdowns did not occur until the second and third week of March in many places.  The hardest hit sectors and their changes versus March 2019 are as follows:

  • Clothing/Accessories  -50.7%
  • Furniture  -24.6%
  • Department Stores  -23.9%
  • Restaurants/Bars -23%

On the positive side, grocery stores saw sales grew by 29.3% and non-store retailers registered a gain of 9.7%.

The Empire Manufacturing Survey (New York State) fell to -78.2, a stunning reading as it is more than double the lowest reading at the trough of the 2008 recession.

Today’s Chart of the Day highlights the strong correlation between inflation expectations and the price of oil. Note that in recent days the price of oil has fallen sharply while inflation expectations are still on the rise. If oil continues to trade near recent lows, there is a good chance that inflation expectations will decline and re-correlate with oil. This was another factor in our decision to temporarily sell our holdings of inflation protected bonds.

One of our recent points of discussion is the probability that the current liquidity crisis morphs into a solvency crisis. Per Atlanta Fed President Bostic via Reuters, we are not only one with this concern- “Bostic- BUSINESS CONTACTS TELLING HIM THAT MAY IS “LOOMING” AS A MONTH WHERE LIQUIDITY PROBLEMS COULD EVOLVE INTO SOLVENCY PROBLEMS.” 

In case you missed it, Lance and Michael explained the difference between liquidity and solvency in the Real Investment Show from April 9th. Click HERE to watch.

The graph below shows how the virus has impacted revenue for small businesses. Some of these businesses will qualify for PPP loans and hopefully weather the storm. Many others can not or will not apply for the loans. Small business accounts for about two-thirds of employment and consumer spending accounts for nearly 70% of GDP. As you consider media and Wall Street forecasts for a “V” shaped economic recovery and a swift return to normalcy once shutdowns are lifted, just consider the damage already done to individuals and small businesses. Currently, the PPP program is set to run out of funds with the next day or two. Negotiations in Congress are ongoing to increase funding for the program.

April 15, 2020

Two weeks ago crude oil bottomed at just below $20 a barrel and then proceeded to climb nearly 50% to just shy of $30. The risk-on markets followed suit, especially those assets that were hardest hit in the prior few weeks. Oil prices, despite a huge reduction in production from OPEC, have now completely given up the entire gain of the last two weeks. Oil stocks which have risen in equally impressive fashion have thus far held onto their gains. The recent divergence between oil stocks and oil, as well as between oil and the risk markets in general bears paying attention to.

JP Morgan (JPM) released its Q1 earnings yesterday. Of note, they built loss reserves by $6.8bn in the prior quarter, which equates to $1.66 per share.  The amount of new reserves brings total reserves close to the $8.29bn that they now have provisioned for credit losses. This amount, which will surely grow, is just shy of their peak provisions from the financial crisis ($8.6bn). Building reserves brought their EPS down to 78 cents and well below the estimate. We expect all banks to aggressively build reserves in the first quarter and more in the second quarter. JPM released the table below showing various financial factors that greatly affect their financial statement. This table also provides us a glimpse of what is happening to the economy and the credit markets.

Yesterday we sold our 5% holding of STIP. We originally bought the security because we thought future inflation rates, implied by inflation-protected securities, were too low, as shown below. Since then, implied inflation rates have risen sharply. We still harbor concerns that the monetary stimulus being supplied by the Fed is inflationary in the long run, but in the meantime, we think implied inflation is back to close to fair value. We also would not rule out another decline in expectations if the market falls again signaling weaker economic activity and another burst of deflationary pressures.

Annie Lowery of The Atlantic published a stunning article entitled Millennials Don’t Stand a Chance. The article highlights how the economic downturn is impacting the millennial generation. She writes:  “In a new report, Data for Progress found that a staggering 52 percent of people under the age of 45 have lost a job, been put on leave, or had their hours reduced due to the pandemic, compared with 26 percent of people over the age of 45. Nearly half said that the cash payments the federal government is sending to lower- and middle-income individuals would cover just a week or two of expenses, compared with a third of older adults. This means skipped meals, scuppered start-ups, and lost homes. It means Great Depression–type precarity for prime-age workers in the richest country on earth.”

A link to her source for the article, Data For Progress, can be found in the article.  The link has stunning graphs showing how the impact of the virus is affecting different demographic groupings.

April 14, 2020

The mayor of Vancouver Canada projects that the city will lose nearly $200 million in tax revenue and claims it is “at risk of going bankrupt.” He stated that approximately one in four homeowners are unable to pay their property taxes. What Vancouver is experiencing is likely being felt by almost all municipalities in the U.S. and many other nations. We have little doubt that the national governments and central banks will add to their stimulus packages to help these municipalities/local governments avoid bankruptcy, but municipal spending on non-essential items will be sharply curtailed. As an example, from the Washington Post- Maryland Governor Larry Hogan “froze all non-coronavirus state spending after a new analysis shows the pandemic could reduce the state’s tax revenue by $2.8 billion over the next three months.”

First quarter earnings releases will start up in earnest this week, with the bulk of the reports coming from the banking and airline sectors. Today’s highlights will be JPM, Wells Fargo, United Airlines, and J&J. Bank earnings will be especially unpredictable as they are likely to add significantly to their loss reserves in advance of Q2 and Q3 credit losses. On the economic data front retail sales, will be released Wednesday and are currently expected to decline 7%. Like many March reports, this one will be tough to decipher and may vary widely from expectations.  Of interest will be the breakdown of sales across the various industries. Jobless Claims will be released Thursday, with an additional 5.5 million expected to join the ranks of the unemployed. If there is a silver lining, it is that if the expectations hold, it would be the second straight decline in the number of new unemployment filings.

President Trump is claiming that OPEC may come back to the negotiating table and further cut production to 20mm barrels a day from the just negotiated 9.7mm reduction. Also helping to stabilize the price of oil are discussions that many countries will soon fill their emergency oil reserves. Countering those actions, it is estimated that the demand destruction from the virus is possibly as high as 35mm barrels a day. Oil closed slightly lower yesterday as Trump’s claims, in addition to the deal agreed to on Sunday, still fall short in the market’s eyes of what is needed.

JP Morgan announced that new mortgage originations now require a FICO credit score higher than 700 and 20% down. At a time when banks are getting bailed out and the Fed is buying debt of junk-rated corporations, JP Morgan’s ratcheting up of credit on the public will not sit well. One of our concerns is that at some point, the inequality of the stimulus and bailouts will result in political angst and protests.

The graph below shows the stunning decline in the newly introduced New York Fed Weekly Economic Indicator. Index components are found in the fine print.

April 13, 2020

The UK is the first large country to officially embrace MMT, even if only “temporary and short term.” The Bank of England (BOE) will print money to directly finance the government’s financing needs during the crisis on an as-needed basis. This move allows the government to use the BOE’s printing press to regulate the amount of debt issued. For instance, when the amount of debt issuance is determined too large for the market to digest in an orderly fashion, the BOE will supply the excess funds to the government. While such a plan may sound prudent, the consequence, if enough money is printed, will be a surge in inflation. The Fed and other central banks do not have the same ability to print money directly into the economy yet. They purchase assets from the market in exchange for reserves at banks. Those reserves can then be used to create money via new debt. This two-step process is not as effective, as it relies on the willingness of banks to increase their lending.

The Fed enhanced its corporate bond buying program to include newly downgraded junk-rated debt and junk-rated debt ETF’s. This enhancement doesn’t include individual bonds that were rated junk prior to March 20th, however, it indirectly includes all junk debt as they can buy junk-rated ETF’s. Click to enlarge the paragraph below from the Fed’s revised term sheet.

The full press release can be found HERE with the term sheet for corporate debt towards the bottom. Treasury Secretary Mnuchin followed the press release with a subtle reminder that the Fed buying stocks is a possibility- “MNUCHIN SAYS NO TALKS RIGHT NOW ABOUT POTENTIAL TO HAVE FED BUY STOCKS.”

Jerome Powell spoke after Thursday’s Fed actions and stated, One thing I don’t worry about right now is inflation.” He is correct that deflation is the greater worry in the short run, but when the economy recovers, inflation will be a substantial risk unless the Fed is willing and able to reverse their crisis related actions quickly. To that end, we have some concern the Fed may not be quick enough to remove stimulus- Per Powell “Fed Will Only Pull Back Support When Economy Is Well On Its Way To Recovery.”

A stunning 6.6 million more Americans filed for unemployment claims last week, bringing continuing claims over the previous three weeks to nearly 22 million, or about 15% of the 151 million person workforce. CPI fell 0.4%, which is the first monthly decline in a decade.

As expected, OPEC finally agreed on a 9.7mm a day production cut. Crude oil is only 20 cents higher this morning after an extremely volatile last Thursday in which it spiked over 10% in the morning to $28.25 a barrel but then fell sharply to close the day at $23.54. Either the market thinks the cut is not enough given the massive decline in demand or that participating countries will not adhere to their commitments.

Over the last few weeks we have received many questions asking how S&P 500 futures trading at night or early morning determine how the market will open. To help answer these questions and provide the calculation necessary to make sense of after hours trading we provide you with the following article. CLICK TO READ IT

April 9, 2020

Jobless Claims will be released at 8:30 this morning. The current estimate is for another 5 mm people to join the approximate 10mm of newly unemployed from the prior two weeks. Also of interest, PPI will be released today and CPI tomorrow. Both inflation figures are expected to be down by 0.3%, but like all other data, the results may stray far from expectations. Jerome Powell will speak at 10 am. We suspect he will remind us once again that the Fed will do whatever it takes to stimulate the economy and stabilize the markets.

OPEC will hold an emergency meeting at 10 am. The rumor is that they will announce an output reduction of up to 10 million barrels per day. Crude oil rose over 10% and stocks zoomed higher as the rumor circulated yesterday.

Stock and bond markets will be closed on Friday for Good Friday.

The Fed released its minutes from their March 2nd and March 15th emergency Fed meetings. We share a tweet from Wall Street Journal Fed reporter Nick Timiraos that sums up the Fed’s concerns- Wednesday’s FOMC minutes use the adverb “sharply” 18 times to describe changing economic and financial conditions. Some form of the word “deteriorate” and “severe” appears 14 and eight times, respectively.”

The VIX has steadily declined from over 75 to its current reading in the low 40s. While still very high, the reduced volatility is becoming more noticeable with daily and even hourly market gyrations having calmed down a bit.

We recently increased our exposure to gold and gold miners and bought a new position in STIP, a short term inflation-protected Treasury bond ETF. These additions are, in part, due to a growing concern we harbor that the Fed’s massive and unprecedented efforts to manage markets and minimize the economic impact of the virus will be inflationary when the economy normalizes. Because of this concern, we have been looking at commodity producers that may benefit from higher prices. In our opinion, it is still early to start buying but time to start making a shopping list. The graph below charts how various commodities have fared year to date.

April 8, 2020

Per the Mortgage Bankers Association (MBA), the percentage of mortgages not making payments (in forbearance) has risen from .25% to 2.66% as of April 1. Mark Zandi of Moody’s Analytics thinks that number could rise as high as 30%.

Moody’s recently published a list of B3 Negative and Lower (Junk or soon to be junk-rated) corporate debt ratings and it is now at its highest level. Currently, 311 companies are on the list, beating its prior peak of 291 companies from 2008 financial crisis.

Based on an FT article, dividend futures contracts imply that dividends will not return to 2019 levels until 2028. To put that into context, it only took three years for dividends to fully recover from the 2008 crisis, but nearly 20 years to get back to even after the Great Depression started.

As of Tuesday morning, Gold futures were trading about $25 above spot gold. In other words, gold purchased for settlement and delivery in the future is trading more than gold for current settlement and delivery. Such an anomaly has not occurred since 1979. This condition is very odd as banks, dealers, central banks, and investors can buy gold for spot settlement, sell the futures contract at the same time, and earn a rewarding risk-free return. The possible explanation is that physical gold is not available in enough size to obtain the risk free arbitrage.  If we learn more we will pass it on.

On a positive note, New York City has admitted less Corona Virus patients than they discharged for four straight days. Today’s Chart of the Day shows that many countries are experiencing a similar drop off in cases as they pass their peak. Tempering the good news, other big cities like Washington, Chicago, and Los Angeles are concerned that they are still ramping up to their peaks.

April 7, 2020

Stocks shot out of the gates on Sunday night, added to the gains throughout Monday and again through last night. Unlike the stock rallies of last week which were based on Saudi Arabia and Russia agreeing to production cuts, this one came with a deal looking less promising and oil trading lower. Bond yields are up slightly but not as much as one would have expected given the stock rally. Also of interest, the dollar was relatively flat and gold closed above $1700, reaching an eight year high.

The Fed created another new facility. This one offers financing to the banks and other investors that own the new small business loans (PPP) guaranteed by the SBA. This will enable the banks to borrow using the loans as collateral, which should allow them further liquidity to create new PPP loans. These loans are guaranteed by the SBA. At some point, the SBA will require a bailout as many of these loans will not be paid in full.  Fed Chair Powell will speak at 10 am on Thursday, presumably on a broad range of monetary policy and economic topics.

Rumors are circulating that a potential suspension or reduction of the long term capital gains tax is a possibility.

Since the market sell-off began in February, the S&P 500 has fallen nearly 900 points (through last Friday). The chart below shows that only 27% of the losses have occurred during the day trading hours, with 73% occurring during the futures overnight sessions. For most investors, the inability to manage risk during the more volatile overnight trading hours makes trading in this environment even more difficult.

The chart below shows that year to date, share prices of some of the nation’s largest department stores are down 65-75%. JC Penny (JCP) stock is trading at 27 cents a share and is on bankruptcy’s doorstep. It does not take a leap of faith to suspect that the others are not far behind if the shutdowns continue longer than are expected.

As we ponder the fate of these stores, there is an equally troubling problem to consider. Large department stores like the ones shown above are the cornerstones for malls. Through low interest rates, leverage, and insatiable investor demand for yield, shopping mall REIT’s like SPG, SKT, and TCO, developed what in hindsight may have been an excessive amount of mall square footage. Per Statista, the mall square footage per capita (23.5) in the U.S. is about 5x greater than the U.K., Italy, and Japan. The only two countries that come close to the U.S. are Canada (16.2) and Australia (11.8). Despite sharply discounted share prices, economically sensitive shopping mall REITs are leveraged and heavily reliant on shutdowns ending and a healthy consumer coming to the rescue. Needless to say, we urge extreme caution and be careful not to get fooled by double-digit dividend yields, as dividends will be reduced.

The calls for allowing the Fed the power to buy stocks got louder yesterday when Janet Yellen promoted the idea on CNBC. To wit:

“It would be a substantial change to allow the Federal Reserve to buy stock,” Yellen told CNBC’s Sara Eisen on “Squawk on the Street.” “I frankly don’t think it’s necessary at this point. I think intervention to support the credit markets is more important, but longer term it wouldn’t be a bad thing for Congress to reconsider the powers that the Fed has with respect to assets it can own.”

 

April 6, 2020

The employment report was much worse than expected as 701k jobs were lost and the unemployment rate rose to 4.4% from 3.9%.

Of the 701k  jobs lost, over half (417k) came from the restaurant industry. It is estimated that the industry employs over 15 million people, so unfortunately, Friday’s number may have just been the tip of the iceberg. The graph below puts the losses into context with prior recession experiences.

The data used for the Friday employment report was based on surveys up to March 12th. Bloomberg says that the early consensus for the April report, which will capture the rest of March and the full impact of the economic shutdown, is around -20mm with a 15% unemployment rate. As if that forecast was not bad enough, we need to factor in that many employees that still have jobs will have their hours and salaries reduced.

As we have mentioned, the value of the dollar can tell us a lot about the acuteness of the global dollar shortage. This past week the dollar index rose about 3% and with it concerns are rising about liquidity.

Crude oil rose sharply again on Friday as it appears Russia and Saudi Arabia are discussing production cuts. Assuming those two countries can agree, a deal may be contingent on some sort of reductions to U.S. supply. Given that the government does not control U.S. oil production, nor does the government own oil companies, this seems like a tall order. Further, many shale producers are independent and not owned by the majors. That said, given the dire situation, the big oil companies may be able to come to some agreement and appease Russian and Saudi requests.

Credit Suisse announced that its once-popular 3x leveraged inverse crude oil ETF (DWTIF), which was a victim of the sharp rally in oil the last few days, will be delisted as its value went to zero on Thursday. This ETF once had over $1 billion in assets. We suspect that the SEC will outlaw 3x leveraged ETFs as they cannot stand up to extreme volatility.  It would also not be surprising to see leveraged ETF’s also banned at some point.

Per The Numbers, the number one grossing movie on Thursday, March 19th was Disney’s Onward. It grossed $33,296. The Invisible Man came in second at $21,800. Since then, the situation has worsened. Total box office sales last week were only $5,179.

April 3, 2020

The number of new Jobless Claims for the past week was 6.6 million. To put that into perspective, the highest weekly claims number during the 2008 crisis was 665,000, and the total number of jobs lost during the crisis was about 9 million. Continuing claims from just last week and this week are now at 10 million.

Crude oil rose nearly 25% as China announced it would add oil to their reserves. Also helping the price are rumors that Russia and Saudi Arabia are discussing production cuts.

The Fed’s balance sheet for the week ending Wednesday increased by $586bn, which is about $30bn more than the entire QE2 operation which lasted about 8 months. Since March 4th it has risen by slightly over $1 trillion.

From April 1st through April 8th, the U.S. Treasury will issue $486 billion in new debt. Despite being only one week into April, that is half of the total for April 2019 and 75% of the issuance for all of April 2018. Stimulus spending and falling tax revenue have the potential to generate a $3-4 trillion deficit this year. There is no doubt that QE will be used to monetize this massive surge in debt.

The helpful table below from Bank America summarizes credit card spending by day and category. This is a good tool to help with stock/sector selection.

The following Tweet from David Schawel is very telling of the disillusion that many investors had going into this crisis. Over the last month, as shown below, the yield on Macy’s 4-year debt rose from 2.9% to 15%. David’s tweet and other messages of his imply that a 15% yield is too high. Instead, David should consider that the 2.9% yield that existed before the crisis was too low. Macy’s was slowly going out of business before the crisis hit. Their stock (M) fell from 52 in 2015 to 15 prior to the crisis, and it currently sits below 5. 15% is a fair yield for a company that has a good chance of filing for bankruptcy. Had Macy’s been properly priced at 8% or 10% before the crisis, the current yield would seem appropriate and may not be as shocking to most market participants.

Barbara Corcoran of CNBC’s Shark Tank was recently interviewed about the state of her small business investments. Of the over 70 small businesses/partnerships she is invested, she believes they have reduced staffing by 25-30%. More concerning, she stated that a majority of her investments will not survive. Further, all of her entrepreneurs are applying for Federal help and many of them are having trouble with the first step of the process, applying for help from the SBA. She did not seem optimistic Federal aid will help many of these companies.

April 2, 2020

The ADP Employment Report was lower by 27k jobs versus an estimated loss of 180k jobs. The report is clearly not capturing the bulk of the layoffs that have occurred over the last two weeks.

All economic data lags and some of it by up to a few months. Because of the delay, we and most other market participants are putting little stock in the current round economic data. In 2-3 weeks, corporations will begin posting Q1 results. The results will be mixed as January and February should have shown decent activity, especially for domestic companies. In most cases, we will look past the profits and losses and focus on forward guidance. Ideally, we would like to hear some optimism about a pickup of activity in Asia, as they are a month or two ahead of us in terms of dealing with the impact of the virus.

The table below shows the consensus of economist expectations for Friday’s March BLS Employment Report. Our model estimates a loss of 56k jobs. Because of current circumstances, we have no faith in our model’s predictive ability. For what its worth, Citi is predicting job losses of 10mm in the April report due out in early May. The worst monthly number during the Financial Crisis of 2008 was -800k jobs.

Financials, Real-Estate, and Utilities were the worst performing sectors yesterday as they are credit intensive industries, and despite the Fed’s efforts, there remains a lot of stress in the credit markets.

UK and European banks are canceling and/or deferring all dividends and buybacks, with some minor exceptions. Are the U.S. banks next?  While many smaller banks may take those necessary steps, we believe the larger banks will stop buybacks, if they haven’t already, but will try to keep dividends intact. European banks started the crisis in a much worse financial situation, so their actions may not reflect on the domestic banks. We also think that dividends signal financial health, and in times like today they care dearly about appearances. Also consider, the Fed will do whatever it takes to avoid bank failures.

April 1, 2020

Macy’s recently furloughed 125k workers, and The Gap and Kohl’s furloughed about 80k workers each. These actions are in line with similar measures from many large retailers. At 8 am this morning, ADP will release their employment report. There is no estimate at this time. Jobless Claims will follow on Thursday (est. 4mm vs. 3.28mm last week), and the BLS jobs report on Friday. Currently, we cannot find a BLS payrolls estimate, but we will share one if we do.

It is worth noting that when an employee is laid off, they receive COBRA insurance, but in most cases will have to pay the full health insurance premium and not just the co-pay. As if losing income is not bad enough, healthcare will be an additional financial burden on many households. These and other mounting financial problems for individuals is one reason we sold Visa (V) yesterday. Unless jobs are recovered quickly, or stimulus is increased rapidly, the discretionary and financial sectors will disproportionately suffer.

The Fed has been very aggressive in their purchases of mortgage-backed securities (MBS). Over the past week, the spread, or yield difference, between MBS and comparable maturity U.S. Treasuries has shrunk from 2% to just 0.67%, which puts current coupon MBS at or near the lowest spread ever. While this is undoubtedly welcome news for those looking to refinance or buy a new home, the fact of the matter is that in many cases, the individuals’ employment situation or outlook may likely preclude them from taking either action.

The graph below shows BBB-rated corporate yields on a nominal basis (green) as well as a spread to U.S. Treasuries (black). Note that nominal yields have only risen to the prior peak levels of the post-2008 era. The spread to Treasuries is higher, having eclipsed peaks over the past decade, but it is still well below the levels of 2008.  One possible takeaway is that corporate yields and spreads can increase a good amount more. That view, however, should be tempered by the fact that the Fed can actively buy corporate bonds, an action they were never able to do in the past.

March 31, 2020

Despite the strong rally, the daily volume on SPY, the popular S&P ETF, has been declining rapidly over the past few days. Weakening volume is a clue that buying power is exhausting.

Crude oil fell over 5% and broke below $20 a barrel for the first time in this selloff. The demand destruction has left many oil storage facilities full, resulting in oil being dumped onto the markets.

Nearly $200 billion of stock buybacks have been suspended over the last few weeks as companies shore up their cash balances. Despite lower share prices, we expect the number of buybacks to decrease sharply from the prior few years. Keep in mind buybacks were a big driver of the bull market.

Goldman Sachs revised their economic outlook as follows:

  • Q1 GDP -9% (Q/Q annualized)
  • Q2 GDP -34% (Q/Q annualized)
  • 2020 GDP -6.2%
  • Unemployment 15% by mid-year

As we have been postulating, QE for stocks may be the next trick in the Fed’s hat. The new SPV partnership with the Treasury allows the Fed to buy corporate bonds and related ETFs and ,therefore, a mechanism that seems to get around the Federal Reserve Act regulating the Fed’s activities. As an aside, the Act prohibits purchasing corporate bonds and stocks. Frequently the Fed will leak policy ideas to gauge the market’s response. Might a recent article from CNBC- “Nothing is out of the question: What it would take for the Fed to start buying stocks” – be a leak from the Fed? Another angle to consider is that the Fed would prefer not to use SPV’s to buy equities, but may hang it out there to help support equity prices.

CNBC had an interesting article yesterday entitled- Mortgage bankers warn Fed mortgage purchases unbalanced market, forcing margin calls. Essentially, the article states that the massive mortgage purchases by the Fed created incredible volatility which crippled many mortgage bankers due to their rate hedges. Expect to see many unintended consequences from the Fed unprecedented activities.

The table below shows how severe the lack of liquidity has been in ETF space. All ETFs have a natural arbitrage mechanism that helps ensure the ETF trades very close to their respective net asset values (aggregate value of underlying securities). Any variance between the ETF and NAV is a risk-free profit arbitrage opportunity for any dealer able to transact in the underlying securities and the ETF. As shown, the variance at times has been exceptionally large, meaning dealers are forgoing outsized profits. Clearly liquidity is grossly lacking as the spreads below should never happened otherwise.

March 30, 2020

Late Friday afternoon, the Fed announced they would scale back QE next week from $125bn to $100bn a day. The market sold off sharply on the unexpected news. Our best guess at this point is the Fed is concerned that Treasury and Mortgage securities, often used as collateral for margin and derivative trades, is becoming scarce.

During the last week of quarter ends, portfolio managers tend to aggressively rebalance their portfolios back to their desired/mandated allocations. Due to the substantial change in asset prices over the past month, rebalancing actions will be much more impactful than normal. For example, if an investor started the year with a simple stock/bond portfolio comprised of 75% SPY and 25% IEF, the portfolio allocation would have changed to 68%/32% over the prior quarter. If the portfolio manager wishes to return to the original 75/25 allocation, they would have to buy about 7% of SPY and sell 7% of IEF. These investment flows tend to occur in the last week of the month, but in many instances are completed a day or two prior to the end of the month.

QE, zero interest rates, repo, and many, but not all, Fed liquidity programs rely on the member banks to re-offer the Fed’s liquidity to counterparties in need. The big question for the next few weeks is whether or not the banks will take the baton from the Fed, lend the money, and take on additional counterparty risk. Thus far, it appears the banks are taking a very conservative stance. To wit, on Friday morning, at the Fed’s repo window, banks only submitted and received a total of $6.75bn in overnight repo and had zero demand for a 3-month repo offering.

The stimulus bill has a provision allowing affected homeowners to postpone mortgage payments for up to a year. While that will help struggling individuals, the onus will be put on banks who will miss those payments. Further, in the case of securitized mortgages, banks, loan servicers, and the agencies (Fannie/Freddie) will be on the hook to make the missing payments to mortgage security holders.

Treasury Bill yields continue to fall deeper into negative territory. On Friday, the yields on both the 1 and 3 month T-bills were below -.20%.

As we have noted over the past few days, the volatility index (VIX) has not confirmed the recent rally. Typically the VIX will decline as the market rises and vice versa. The red trend line in the graph below shows the relationship well. Interestingly, and as shown with the orange dot, for the five days ended last Thursday the market was up nearly 15% and the VIX was about 5% higher. Based on the statistical relationship (r2=.5019), the VIX should have been down 25-50% or even more. The instance is an anomaly and likely signaling that either the VIX or the S&P are wrong.

The following Tweet caught our attention. We hope they are right but are skeptical as bear markets do not often end so quickly or with optimism.

March 27, 2020

Weekly Initial Jobless Claims were shocking, coming at 3.283 million new claims versus a 1.7 million estimate. The graph below shows the claims number is simply beyond compare versus any print over the last 50+ years. The number is roughly 2% of the entire civilian workforce. We suspect initial claims will continue to rise by the millions for the coming weeks, which in turn will cause continuing claims to skyrocket as well.

Today’s Chart of the Day shows that small firms do not have adequate cash buffers to survive an extended lockdown. 25% of all small businesses hold less than two weeks of cash, meaning a good number of them will have to borrow money if possible or take drastic financial and employment actions to stay in business. We remind you small business accounts for about two-thirds of new jobs in the U.S.

In a positive sign that global demand for dollars is weakening, the dollar index is now down to 99.54, about 3 points lower on the week. A weakening dollar points to less stress in foreign dollar funding markets.

Boeing (BA) is up 89% this week through Thursday. While dreams of instant riches are fueling sentiment that a bottom is in, and easy money to be made, it is worth reminding you that BA is still down 39% for the month.  Percentages can often tell a misleading story.

Per Yahoo Finance: “S&P has cut more than 280 long-term ratings so far this quarter, also on pace to be the most since the crisis, the data show. Of them, over 170 have come this month alone. Roughly 75 companies have been upgraded in 2020. Moody’s has downgraded more than 180 companies, including about 20 investment-grade firms and 160 junk-rated borrowers. Fitch Ratings has cut over 100 ratings against just 14 upgrades year-to-date.”   Currently, companies already rated junk are the ones predominately getting cut. That will probably change and include a large swath of investment-grade companies if a “V” shaped recovery doesn’t take hold quickly.

The following chart shows the 21% gain over the last three days is the second largest on record. During the Great Depression, there was a slew of massive gains, unfortunately, they were accompanied by a large number of sharp declines, of which both the gains and losses were all part of a bearish trend.

March 26, 2020

The Senate passed the COVID19 economic stimulus and bailout legislation unanimously. Upon passage of the bill by the house, expected Friday, both houses will adjourn until April 20th.

Despite another strong rally, the VIX volatility index gave up little ground. Essentially, there are still many investors clamoring to buy insurance via the options markets. Also helping the VIX maintain such historic levels is likely a lack of investors willing to write, or sell, put options to investors. Writing a put option has immense downside if the market continues to fall, but limited upside.

The Fed Funds futures curve is telling an interesting story. By December of 2020, Fed Funds futures contracts imply a 15% chance the Fed cuts rates by 25bps to below zero. Fast forward a year to December of 2021, and futures imply a 40% chance of a 25bp tightening from current levels. This forecast seems out of touch with the “V” shaped economic recovery that is expected to occur later this year after the virus runs its course. If the economy can recover quickly and the Fed does not remove stimulus, as the market is betting on, the consequence might be a spurt of inflation well above the 2% target.

Almost all financial derivatives are partially backed with collateral, typically consisting of U.S. Treasuries or cash. As volatility in the prices of derivatives increase, banks require more collateral. They are also likely to increase collateral requirements if they have credit concerns with a counterparty. The derivatives market in aggregate is over $600 trillion, but approximately $12 trillion when all trades are netted out. Bloomberg wrote an article entitled: We’re Looking at a System-Wide Margin Call, which helps put context to how the derivatives market is putting additional strains on the financial markets.

The impact of the virus on air travel is truly startling as revealed by Deutsche Bank’s Torsten Slok:  “The TSA counts number of passengers originating trips from US airports, i.e. No. of people who show their boarding pass to a TSA agent at TSA checkpoints. On a normal March day over 2M people travel by air in US. Yesterday number was 279,018″

Edmunds expects that March automobile sales will be down 35% from March of last year.

Jobless Claims will be released at 8:30. The consensus of economists expect an increase of 1 million people, other analysts think the number could be much higher. The higher water mark in the last recession was 665k.

March 25, 2020

On Monday night, with the equity markets limit up, the volatility index (VIX) fell from 60 to 52 as would be expected. However, when the cash markets opened Tuesday, the VIX rallied throughout the day and regained the entire loss from the night before.

The dollar index fell by 1%, and there was a slew of investment-grade bond issuance. Both are positive signs.

With the price of gasoline so low, Phillips 66 announced: “WE ARE NEARING MINIMUM CRUDE RATES IN MANY OF OUR REFINERIES TODAY.” In other words, refinery profit margins are approaching zero. As a result, they will have to limit the production of gas and other distillates going forward. In regards to future gas prices, will the reduced supply be enough to offset the significant decline in demand?

Invesco’s mortgage REIT (IVR) announced that they could not meet margin calls. The REIT fell 50% and now sits below $3 a share as compared to near $20 before the crisis started. There are rumors of other mortgage REIT failures as well.

Delta was cut to junk by S&P. We expect Delta will be the first of many new entrants into the junk sector. As we have written in the past (LINK), the implications of such a large number of downgrades to junk status are troublesome given the distinct bifurcation of junk and investment-grade investors. Also, bear in mind, the Fed’s new programs only apply to investment-grade paper.

The graph puts historical context to the stunning decline in GDP expectations. The graph below and others showing unemployment rate and jobless claims expectations come courtesy of Sebastian Sienkiewicz (@Amdalleq). Article Link

March 24, 2020

Early Monday morning, the Fed announced unlimited QE. To kick it off, they plan on buying $125 billion of Treasury and mortgage-backed securities (MBS) each day this week. At that pace, they will easily eclipse prior QE operations within two weeks. They also are adding a $300bn lending program for Main Street businesses and the Term Asset-Backed Loan Facility implemented during the financial crisis. Part of the allocation to mortgage-backed securities purchases will also be spent on commercial MBS. The Fed is also creating a special purpose vehicle (SPV) that allows the Fed to buy investment-grade corporate debt from the secondary markets. The SPV was funded with a $10 billion investment from the U.S. Treasury, and it appears that it can be leveraged up ten times, meaning they can buy $100 billion of corporate debt.  The facility can also purchase corporate bond ETF’s. This construct might be the “legal” structure allowing the Fed to circumvent the Federal Reserve Act and buy equities.

The market, which was limit down when the market opened Sunday night, popped higher on the news and then fell back to near the lows of the day. It did manage to rally off the lows, but political wrangling in Congress is certainly weighing on the market. Gold, on the other hand, was up $80, the largest one-day dollar gain in recent history. This morning the gains in stocks and gold continue. Stocks are currently limit up 5% and gold added another $85 to yesterday’s gains.

Last week it was rumored that the Fed, via their latest round of QE, was buying Mortgage-backed securities (MBS) with settlement dates of two days from the trade date. While two-day settle is normal in most bond markets, the MBS market works on a singular monthly settlement date in which almost all trades are settled. After hearing that rumor we assumed that a large mutual fund, REIT, or hedge fund was in trouble and the Fed was rescuing them with immediate cash settlement versus the entity having to wait until the April settlement date.  Yesterday, per Yahoo Finance, we found out there is at least one big bond fund that required a bailout from the Fed. While on the topic of problems in the fixed income markets, here is a great note from WolfStreet.Com on distress in the leveraged loan market.

As we watch the market concern based on fiscal stimulus from Congress, we are reminded how this played out in the Crisis of 2008. The graph below shows the market rallied when the Senate rejected the first version of the bailout bill and conversely sold off after the passing of the bill.

RBOB Gasoline futures on the CME exchange traded to near 40 cents a gallon yesterday. Retail prices should be falling sharply in the days ahead.

 

March 23, 2020

It is rumored that the size of the heavily debated fiscal stimulus may be $2 trillion or higher. The debate in Congress is being waged over support for corporations versus support for individuals.  Given the upward pressure this deficit would have on debt outstanding and ultimately interest rates, it is quite likely the Fed will also increase the size of QE.

Ohio reported that jobless claims jumped to 139k from 5k a week ago. To put that into perspective, jobless claims for the entire country were 281k last week and were running in the low 200s for months prior to that. Goldman posited that next week’s number could be 2.25 million. Based on Ohio, that number seems low.

Goldman Sachs revised their economic outlook as follows: we are now forecasting a -24% quarterly annualized growth pace (from -5% previously). A decline of this magnitude would be nearly two-and-a-half times the size of the largest quarterly decline in the history of the modern GDP.On the bright side, their forecast has a 22% recovery in the following two quarters.

Another day another new Fed program. The latest program, announced Friday morning, allows the Fed to help indirectly fund the municipal bond market:

“Through the Money Market Mutual Fund Liquidity Facility, or MMLF, the Federal Reserve Bank of Boston will now be able to make loans available to eligible financial institutions secured by certain high-quality assets purchased from single state and other tax-exempt municipal money market mutual funds.”

Funding to the municipal markets may become more direct in the days ahead. Per Bloomberg: (Bloomberg) “A Senate bill introduced Friday would allow the Federal Reserve to purchase municipal debt, in an effort to ease the economic strain of the coronavirus pandemic on state and local governments.”

We leave you with a bit of humor to lighten up your day.

March 20, 2020

Today is a quadruple witching day, meaning quarterly market index and stock futures, along with market index and stock options expire. Some investors will need to replace expiring positions or re-hedge existing positions and, in doing so, can produce more volatility than average.

Jobless Claims jumped to 281k from 211k. JPM now expects the unemployment rate to rise to 6.5%. While it’s tough to judge at this point, we fear that estimate may be undershooting the rapid deterioration in payrolls.

The Fed extended dollar swap lines to Australia, Brazil, Denmark, Korea, Mexico, Norway, New Zealand, Singapore, and Sweden. This is in addition to the swap lines just initiated with larger economies earlier in the week. This operation allows for countries to swap their domestic currency for U.S. dollars directly with the Fed. In doing so, the transaction occurs off the market and helps limit dollar appreciation.

In mid-February, the ten-year U.S. Treasury yield was 1.60%. By March 9th, as market concern grew over the economic impact of the virus the yield dropped to a low of .38%. Since then it has risen by nearly 1% in less than two weeks. The initial decline in yield was due to a flight to quality as investors sold risky assets and purchased safe Treasury bonds. Also pushing yield lower was rapidly increasing deflationary pressures as demand for goods and services cratered. At the lows in yield the Fed and the U.S. government rolled up their sleeves and got to work. The Fed dropped rates to zero and introduced a smorgasbord of liquidity programs, all of which are driven by the printing presses. The government has floated numerous proposals for bailouts and economic stimulus. From a ten-year investors horizon point of view one must consider the current deflationary impulse. They must also assess the inevitable massive supply of debt that must be issued and the eventual inflationary impulse when demand recovers. Assessing the tug of war between deflation today and inflation tomorrow will be a big task and, one that if played right, can prove very beneficial for investors of all asset classes. Stay tuned.

Day after day the Fed has introduced new liquidity plans, and day after day liquidity in the equity and credit markets has worsened. We believe the banks are deeply concerned with counterparty risk and not passing on Fed liquidity to those in need. Given the situation, the Fed must be seeking ways to get liquidity directly into the hands of those in need. The idea of the Fed buying corporate stocks and/or bonds is becoming more likely by the day. To that end, Former Fed Chairs Ben Bernanke and Janet Yellen publicly called for the Fed to ask Congress for the ability to buy corporate bonds. The corporate bond market is currently under significant stress, and while such a Fed operation would likely relieve some stress, it raises many questions about the Fed’s role in investing in corporations. The Bank of England and ECB already allow the purchase of corporate debt.

Ford suspended their dividend to bolster, or at least maintain, their cash balances. As respective dividend payment dates come near, we expect many companies that are being heavily impacted by the crisis to reduce or suspend dividend payments. Do not be fooled by high dividend yields.

REITs have gotten hit hard over the last few days. One of the reasons for the sharp sell-off is that UBS announced a mandatory redemption of two leveraged REIT ETFs. The redemption resulted in forced selling at a time when liquidity conditions in the equity markets were awful to begin with.

March 19, 2020

At 1:00 in the morning their time, the ECB  announced 750 billion euro of QE. Not to be outdone, the Fed followed up at 8:30 pm with yet another new program. This one will help ensure money market funds have enough liquidity to meet client demands. The timing of both actions is odd, to say the least, and points to the severity of the freeze up in the credit markets.

Across the credit risk spectrum, from risk-free Treasury bonds to risky corporate junk bonds, bond yields rose sharply as it is becoming evident that large and likely forced liquidations are occurring in all asset markets. Yesterday we sold two of our high-quality bond funds, tilting even further towards cash. Our rationale is that the yields are small, upside price potential limited, and the downside is substantial. Further, given our much reduced equity exposure, our need to hedge equity risk is minimal.

The 30-year U.S. Treasury bond hit a yield of 1.85% yesterday after trading below .50% on March 9th. The 2yr/10yr yield curve is now at 70 basis points. Just as stunning as the yield declines were a couple of weeks ago, these recent increases are equally remarkable. Undoubtedly, severe bond volatility may also be the reason that many suspect a large hedge fund(s) has blown up and is being liquidated. Cash is king as evidenced by the 3-month U.S. Treasury bill which traded with a negative yield yesterday.

The dollar soared yesterday to 101.38. The dollar index is now up over 6% since March 9th, the day yields hit their lows. 6% may not seem like a lot, but in the world of currencies that is a massive move. We will have more on the whats driving the dollar in a short article coming later today.

Detroit’s big three automakers have agreed to shut all U.S. factories.

JPM announced their quarterly GDP forecasts for the year as follows:

  • Q1 -4%
  • Q2 -14%
  • Q3 +8%
  • Q4 +4%

Per the FT, one of the U.K.s largest private pension funds, Universities Superannuation Scheme (USS), serving university and other higher education employees, has reported itself to the regulator after plunging stock markets triggered a breach of a critical funding measure. Trustees will now consider whether contributions from employers and hundreds of thousands of members need to increase. 

Expect to hear more news like this from U.S. pensions funds over the coming weeks.

 

March 18, 2020

The Fed continues to throw the kitchen sink at the credit markets. Yesterday morning they announced $1 trillion in additional overnight repo operations that will occur through the week and a new Commercial Paper Funding Facility (CPFF). The CPFF will allow the Fed to purchase commercial paper and asset-backed commercial paper directly from eligible companies. The Treasury is backing the Fed with $10 billion in credit protection against any losses the program encounters.  Later, at 6 pm that night, the Fed introduced the Primary Dealer Credit Facility (PDCF). This facility will offer repo funding backed by a wider range of asset classes, including commercial paper, municipal bonds, and a “broad range of equity securities.”  The rollout of this program hints at the likelihood that  one or more massive hedge funds is failing. The goal of the program would be to fund the hedge fund so they do not have to sell liquidate onto an already weak market.

Yesterday morning we asked dealers for bids on four high-grade municipal bonds. The dealers would not provide bids on three of the four bonds. The fourth bond came back with a bid, but it was about four points below what we believe is a fair price. This is an example of the freeze occurring in the credit markets.

Italy, Spain, and France are now banning short sales on certain stocks. If the U.S. stock market keeps declining, we expect this could be the next action to help stem losses and protect companies most affected by the virus. The SEC took similar action in 2008/09 with banking and financial stocks.

The flight to quality has fully taken hold in the dollar. The rally is the result of a surge in demand for dollars, as dollars are the world’s reserve currency and much needed around the world. A strong dollar will temporarily boost deflationary pressures. The Fed is currently engaged in a massive currency swap program with other countries. This allows for large currency swaps to occur without further driving up the dollar.

Lost in the overwhelming market and virus news is deteriorating relations with China. China announced they will expel all U.S. reporters for the Wall Street Journal, New York Times, and Washington Post. They are not allowed to work in Hong Kong either.

February Retail Sales fell by 0.5% versus an expectation of a 0.2% increase. It’s hard to know whether or not consumers were starting to hunker down in February as news of the virus spreading throughout Asia and into Europe occurred. Industrial Production was positive and better than expectations. Data, in general, will largely be ignored for the time being.

The U.S. government will postpone the April 15 tax-payment deadline giving Americans an extra 90 days to pay their 2019 income-tax bills.

March 17, 2020

Not only were double-digit losses very troubling yesterday, but of more concern was that the decline started immediately following the Fed’s commitment to providing unprecedented amounts of liquidity to markets. Throughout Monday, intra-day rallies were consistently sold, telling us there is still a steady supply of shares for sale overhead. This was evident in the VIX (volatility index) which peaked in the lower 80s yesterday, slightly surpassing levels last seen in the worst days of the Financial Crisis.

Interestingly the $1.5 trillion in repo offered by the Fed is mostly going unused. Yesterday, dealers only asked for $18.45bn of a possible $500 billion available. $78 billion and $41 billion of $1 trillion total was taken on Thursday and Friday of last week. This weak demand tells us banks are uncomfortable with counterparty/collateral risk if they were to reoffer the repo. As for using it to meet their own needs, they must not have enough collateral to post to the Fed. The circumstance points to troubles in the money markets, as is evident in LIBOR and commercial paper spreads to Treasuries.

Lost in Sunday night’s fireworks was a major change in banking regulations. The Fed abolished the fractional reserve system. Per their statement: “In light of the shift to an ample reserves regime, the Board has reduced reserve requirement ratios to zero percent effective on March 26, the beginning of the next reserve maintenance period. This action eliminates reserve requirements for thousands of depository institutions and will help to support lending to households and businesses.” 

Historically banks were required to hold a small percentage of every deposit to ensure they had enough cash in the event of a bank run. Banks then would loan out the remainder of the unreserved deposit and as a result the money supply increased, but it was limited as determined by the reserve requirements. This is what is called the fractional reserve system. Until last night, the supply of money that banks could create was limited by the Fed’s reserve requirement.

This was a significant change that was swept under the rug. As for immediate effects, it is meaningless as banks are already sitting on excess reserves with more coming from the Fed via QE. However, the supply of money is now unconstrained by the Fed. In the future, this can be very inflationary.

We finally got economic data reflecting the realities of the current economic situation. The March Empire Manufacturing Index, covering New York state, fell sharply to lows last seen in 2009.

Economic data will be incredibly hard to assess over the coming weeks as it will begin to incorporate the economic downturn. Surveys such as the regional Fed surveys, University of Michigan Consumer Sentiment, ISM, and PMI will be the first to show the downturn. The monthly jobs number, on the other hand, may take a month or even longer to reflect today’s events. For example, retail sales due out tomorrow are expected to rise 0.2%, and jobless claims are only supposed to increase marginally by 9k jobs.  Both of these statistics will be vastly different over the coming few months.

March 16, 2020

If last weeks Fed action was a bazooka, then Sunday night’s was a nuclear bomb. The Fed cut the Fed Funds rate to zero and committed to buy $500 billion of Treasury bonds and $200 billion of mortgage backed securities. The stunning and unprecedented move was clearly planned for just prior to the open of futures market trading at 6pm est. In lieu of this action the Fed canceled this week’s FOMC meeting.

Treasury yields are 15-20 basis points lower as rates across the Treasury curve head to zero. In fact, the 1-month T-Bill actually traded with a negative yield last night.  Stocks, commodities, and the dollar are falling sharply as the Fed sparked fears around the world due to the abruptness of their action. The question on every trader’s mind is who are they bailing out?  Gold is also falling, likely the result of margin calls and the need for liquidity.

Given the markets poor response to the Fed, we suspect the next course of action could be a suspension of trading for a week or two.

Sunday’s surprise follows Friday in which the Fed announced they would buy $37 billion in various Treasury maturities due to “temporary disruptions in the market for Treasury securities.” Per the press release, the purchases are not additional QE, but part of the planned $60 billion per month that has been occurring since last fall. The highly unusual announcement with predetermined sizes per specific maturity, was in hindsight a tip that the Fed is very concerned with credit markets freezing up.

The University of Michigan Consumer Sentiment survey fell from 101 to 95.9. Quite frankly we expected a bigger decline, but keep in mind the survey period started February 26th so many of the early results were before the market rout and virus related shutdowns.

We update a graph we showed two weeks ago. While the recent volatility seems unprecedented, the difference between the high and the low for each trading session has been extreme, but not as extreme as the financial crisis. Also note the extended duration of volatility during the 2008-09 bear market.

March 13, 2020

Last night we published our latest thoughts on markets and our portfolio management process for the days ahead. Click to read.

The Fed shot their bazooka yesterday. They (Fed Link) are offering three sets of $500 billion repo with terms of one to three months. The first $500 billion operation occurred yesterday with the other two coming today and Monday. Further they altered their current QE program to include longer maturities, TIPs, and mortgage-backed securities. The repo operations will increase the Fed’s balance sheet by $1.5 trillion or 38%. The suddenness and sheer size of the move reek of fear over falling stock prices and possibly a problem brewing in the credit markets. To put $1.5 trillion of repo in context, QE1 totaled $1.320 trillion, QE2 $557 billion, and QE3 was $1.570 trillion.

The graph below shows how $1.5 trillion (orange bars) stacks up against prior QE.

The market spiked on the announcement and then proceeded to give back all of the gains and then some. There is clearly heavy selling pressure that is more than offsetting the liquidity injection. However, the market is up over 5% last night, which puts it near yesterday’s post-Fed announcement spike level.

The European Central Bank (ECB) committed to providing an additional 125 billion euro of QE through the remainder of the year. However, they disappointed the markets buy not reducing rates.

Not helping matters is fighting within Congress. To wit, Mitch McConnell spoke to the differences between the parties- The Speaker and House Democrats chose to produce an ideological wish list that was not tailored closely to the circumstances. … Certainly, this is disappointing.”  As we have discussed, political jockeying in front of an election is a risk few are considering.  However, it is worth remembering that in 2008 Congress initially rejected TARP and the market fell 7%, then the bill quickly passed. That occurred within a month or so of a Presidential election.

PPI was down 0.6% versus expectations for producer prices to remain flat for the month. This is a result of plummeting commodity prices. As the lower price of oil filters into other areas of the economy, we should see CPI follow PPI lower.

Yesterday we discussed the coming volatility in inflation data and how hard it will be for the Fed to assess inflation. As an example, the price of jet fuel (graphed below) has been cut in half since the end of the year. At the same time, airlines are grappling with a significant drop in demand. In this case we should expect to see declines in airfare and some great deals. However, some airlines are facing massive losses and possibly bankruptcy if travel bans and weak demand continue. These airlines may cut the number of flights, increase pricing, and try to operate flights profitably, which might be inflationary. Similar examples hold in most industries.

March 12, 2020

The World Health Organization (WHO) officially declared Covid-19 a pandemic.

The Bank of England (BOE) cut rates from 0.75% to 0.25%, and the government followed with 30 billion pounds of fiscal stimulus.

JP Morgan expects the Fed to lower rates 100 basis points at next week’s FOMC meeting.

The Fed boosts the limit for overnight repo to 175bn.

The NCAA basketball tournament will be played without fans, and the NBA suspended its season.

Trump bans travel from Europe.

Headlines like those above and many others are taking their toll on global markets.

Boeing, Hilton, and other companies are aggressively drawing down lines of credit and in many cases on a precautionary basis. These lines of credit are pre-approved loans that often go untapped. Companies frequently pay for these credit lines to ensure they have access to liquidity when credit markets freeze up and/or they are struggling and cannot borrow at reasonable rates. As the lines are drawn down, banks must come up with liquidity to make the loans. Banks likely sold Treasuries to help free up cash, which may help explain why Treasuries sold off yesterday. This also helps explain why the Fed is increasing the size of repo operations and may likely reintroduce QE for bonds.

CPI inflation data came in as expected with a 0.1% monthly increase, which results in a 2.3% year over year change. Inflation data could be volatile over the coming months as inflationary supply line problems are met with deflationary weaker demand. The Fed will likely view any upticks in inflation as transitory, therefore it will not affect their policy decisions.

In Monday’s commentary, we mentioned the Fed was possibly in a bind if they try to provide stimulus via QE due to near zero interest rates. Yesterday morning, Danielle DiMartino Booth also raised the topic in a Bloomberg article entitled The Fed Can’t Let Bond Yields Fall To Zero. Needless to say, Fed stimulus via traditional QE and/or lower interest rates is not as easy as it was over the last decade.

Today’s Chart of the Day puts context towards the recent volatility in Treasury yields. Per the graph from James Bianco, the two-day price return on the 30 year Treasury bond was +8.50% for March 6th and 9th. That was the largest two-day return in the modern history of 30-year issuance. Amazingly, that was immediately followed by a record low two-day price return of -6.66%.

 

March 11, 2020

Yesterday’s rally started on rumors that the Bank of Japan (BOJ) is considering an expansion of their ETF purchases. The BOJ already owns over 75% of the Japanese ETF market, so their actions are not only limited but detrimental to pension funds and other investors which must hold equity investments.

U.S. markets were nearly 5% higher in part due to proposed fiscal stimulus and bailouts in numerous industries that are being signifcantly impacted by the virus. We believe the bounce was more technical in nature, but regardless, we should consider how stimulus might benefit the markets and the economy. The million dollar question is how much fiscal stimulus can Trump issue via executive order without Congressional approval? We doubt the Democrats will do Trump any favors with only months to go until the election. As such, any fiscal stimulus outside of direct Presidential actions will likely be limited to directly helping with the virus itself and not so much on economic consequences.

Lost in last weekend’s news was a downward revision to Japan’s Q4 GDP from -6.3% to -7.1%. The substantial decline is mainly due to a new sales tax put in place late last year. However, given their already fragile economy and reliance on foreign trade, the impact of the Corona Virus all but guarantees a negative first quarter GDP, which will put Japan in a recession.

The Bloomberg High Yield (Junk Bond) Energy Index rose sharply over the past two weeks to over 14%. To put that in context, it traded around 4% for much of 2017 and 2018, and between 5% and 8% for 2019. In 2008, the yield peaked at 18%. The price of crude oil is currently slightly below the lows of 2008.

As shown below, financial conditions have tightened considerably over the last two weeks, but the decline pales in comparison to 2008.

 

 

March 10, 2020

We start with a timely quote from Warren Buffet- “Only when the tide goes out do you discover who’s been swimming naked.” We suspect that over the coming weeks we will see some skinny dippers.

There is finally some good news regarding the virus. China and South Korea are both reporting that the situation appears to be improving. Hopefully, the news indicates that precautionary measures are slowing the spreading of the virus and maybe even that the virus is running its course. Some scientists believe that warmer weather will also help slow down the virus. That said, the impact is just beginning in the U.S. We expect school closing announcements and cancellations of all sorts to intensify over the coming weeks.

The Fed did not cut rates this morning as some suspected, but they did increase the size of their repo programs. The quantity offered in Overnight repos increased from $100B to $150B  and term repo from $20B to $45B. As we have witnessed over the past few months these actions are being used to fill short term liquidity gaps until QE (bills) and possibly new QE can make up for the slack.

Saudi Arabia’s decision to produce more oil introduced a new and complicated geopolitical problem into the investing equation. Essentially, the Saudi’s declared economic war against Iran, Russia, and U.S. shale. This situation can resolve itself quickly if Russia comes back to the negotiating table and agrees with OPEC on production cuts. However, many experts think its possible they hold their ground. In fact, Rosneft, Russia’s largest oil producer, plans on following the Saudi lead and increasing production. Like Saudi Arabia, Russia also produces cheap oil and can withstand lower prices better than most producers. The other wild card is Iran’s reaction. Iran was already in dire economic circumstances due to the U.S. imposed sanctions before the price of oil tumbled. $30 oil or less, will inevitably make their economic woes much worse.  Saudi actions also put severe pressure on highly leveraged U.S. shale producers of which many cannot profitably produce oil at current prices. As shown in Today’s Chart of the Day the banking sector, which has loaned energy companies considerable funds is also at risk.

The economic data front will be quiet this week except for inflation figures (CPI on Wednesday and PPI on Thursday). We will also pay close attention to Jobless Claims, which will be released on Thursday. The Fed is now entering its pre-FOMC meeting blackout period, meaning that Fed voting members are not allowed to speak publicly. That said, if the Fed takes action between now and then, Chairman Powell is likely to hold a press conference and/or release a statement.

The following is from Jim Bianco:

The all-time high was February 19th, 13 trading days ago.

(we are now) just a little more than 1% away from a media defined bear market (<20%)

Fastest for the S&P 500 from an all-time high to <20%

  • September/October 1929 = 42 days
  • August to October 1987 = 55 days
  • July to October 1990 = 87 days

 

March 9, 2020

On Sunday, Saudi Arabia reversed course out of frustrations with Russia to agree upon oil production cuts. They came out Sunday and announced that they would increase production and flood the markets with oil. After falling 10% on Friday, crude oil is down an additional 23% to $32/barrel. The combination of lower oil prices and quickly rising virus concerns pushed stock futures to their limits. S&P futures have been down 5% (CME limit) for most of the night. Global markets are also down in similar fashion. Bond yields fell sharply as it appears inevitable the Fed will take action to calm global markets. The 30-year bond yield fell 35 bps to 0.86% and the 10-year note now sits at 0.43%. Fed Funds are pricing in a cut to 0.25% by the end of March and to the zero bound by June. We would not be surprised to see another emergency Fed action as early as this morning.

The BLS Employment report was stronger than expected at 273k, almost 100k more than consensus. The prior month was revised up by 50k. We caution once again, this number is not factoring in the impact of the virus.

As to be expected, inflation expectations are falling rapidly with Treasury yields. As of Friday, the 10-year breakeven inflation rate sits at 1.31%, down from 1.80% at the start of the year. This level is no doubt of concern to the Fed, which has been begging for more inflation for the last nine months.

As we consider the Fed’s options and, in particular, whether or not they will initiate more QE, plummeting Treasury yields enter into that equation. If the Fed were to buy Treasury bonds, it could add to the downward pressure on yields and make matters worse. The Fed could also buy mortgages, but again, as we discussed last Friday, such an action would translate into a run on longer maturity Treasury securities. Might the Fed try to buy some other asset class, perhaps stocks? Currently, they are not allowed to, but we have little doubt that if the market problems become grave enough Congress might grant them “emergency powers” that supersede the Federal Reserve Act. The wild card is the upcoming election and the Democrat’s willingness to help the President.

Boston Fed President Eric Rosengren was on the news wires yesterday and stated the following: “(The Fed) should consider widening the type of assets the Fed can buy.”

On Thursday we ran a poll on Twitter and 76% responded yes to Does the Fed introduce QE 5 this month? Reminder- QE4 with Bills is already occurring”  We bet that number would be close to 100% today.

An important note on credit ratings:

“What (credit) ratings describe isn’t the borrower’s ability to repay principal, but its ability to make interest payments and refinance principal.”– Howard Marks 7/2011

The ability to refinance principal, also known as rolling over debt, is dependent on two factors: interest rates and credit availability. When credit markets freeze up, interest rates rise, and liquidity in the credit markets declines. Under those conditions, companies have a hard time refinancing principal and while the respective companies expected financial situation might not change their credit rating might. Given that over 50% of corporate debt is perched at BBB, one downgrade from a junk bond rating, credit rating criteria are now more critical in the light of current market conditions than at any other time. For more on the situation in the corporate credit markets, we link our article The Corporate Maginot Line.  

The quote above finishes as follows: “So ultimately the security of capital providers stems not from the borrower, but from the continued willingness of other capital providers to roll debts in the future.”

The TED spread (Eurodollars less Treasury yields) is a measure of perceived credit risk in the credit markets. As shown below, the spread has recently gapped higher. While still at a relatively low level, a further widening of the spread could prove ugly for corporate bond issuers and investors and problematic for the stock market.

March 6, 2020

Led by the 30 year Treasury Bond, yields plummeted last night.  The 30-year yield fell over 25 basis points to a low of 1.30% before rising over the last few hours. The ten-year yield hit .70% and currently stands at .76%. It appears as if there may be a domestic credit problem brewing. The dollar is off a full point, which provides a clue that this event is not a flight to safety from foreigners. A second factor to consider is that banks, which are the largest holders of mortgages, are being forced to “buy duration” (longer-term bonds) in order to offset the declining duration of their mortgage books as mortgages refinance. The existing loans are funded, so banks must replace the mortgage assets as they prepay to prevent a mismatch between their liabilities and mortgage assets.

Jobless Claims show no impact from the virus. There were 216k new jobless claims last week, which is 3k less than the prior week. At 8:30 this morning the BLS will release the monthly employment report. Expectations are for a gain of 177k jobs and an unemployment rate of 3.6%.

There are six Fed speakers on the docket today. Last week every Fed speaker claimed the Fed would not cut rates unless the economic impact from the virus increased substantially. It turns out those claims were false. As such, be careful not to read much into their new words of wisdom.

Fed Funds are now priced for a 100% chance of 50 bps cut at the March 18th meeting. An additional 25bps is priced in for June, and by the fourth quarter the market implies the Fed will hit the zero bound.  As such, we cannot rule out an expansion of QE4 and repo as soon as the March 18th meeting.

“100 is the new 10.” Before the recent spate of volatility, a ten-point up or down move in the S&P 500 seemed standard. Today, the market is moving up and down by ten points in minutes and sometimes seconds. Since February 24, the average difference between the high and the low of the day is 106 points. In January and for all of 2019, the average was about 25 points. The important takeaway, given what is transpiring, is that having a process including stop losses and trading contingencies, bullish or bearish, is vitally important. The market can move away from you quickly; a process will help take the emotions out of critical decision making. Risk happens quickly, be prepared!

The graphs below put perspective on recent stock market volatility. The first graph shows the daily percentage difference between the high and low points on each trading day. The second graph shows the 5-day running average of the same data. As highlighted by the red dotted lines, bouts of volatility, as we have seen over the last week, have only occurred five other times since the 2008 financial crisis. Click to enlarge

March 5, 2020

***We are back up and operating as normal!! Thank you for your patience.

As shown in today’s Chart of the Day, based on the rationale for prior emergency rate cuts, the Fed must be very concerned about how the virus will impact the markets and the economy.

A few weeks ago we commented on the sharp decline in January auto sales in China. The combination of the Lunar New Year Holiday and the virus caused sales to drop over 20% that month. February, turned out much worse despite what is usually a bounce back month. As shown below car sales in China fell by 80% in February.

The Global Business Travel Association said the virus could cost the industry $47 billion a month, with more than half coming from airline ticket sales. To add to the impact from the virus, Bloomberg reports “The James Bond sequel “No Time to Die,” due for release next month, will be pushed back until November as Hollywood scrambles to cope with the global coronavirus outbreak.” Needless to say the costs of the virus are ramping up and will be felt in economic data in the coming weeks.

ADP reported that employment for February increased by 183k jobs versus 209k in the prior month. If you recall, last month’s print was originally 291k but was revised lower in yesterday’s report to 209k. Seasonal quirks were the culprit. The consensus of economist expectations for Friday’s BLS Labor report are currently at 177k new jobs and a 3.6% unemployment rate.

Repo offered by the Fed was in high demand for a second straight day. Yesterday $111 billion in bids were submitted and $100 billion accepted. Keep in mind that this recent heightened demand for repo comes as the Fed is winding down its repo operations.

OPEC, backed strongly by Saudi Arabia, is working to cut oil production by up to 1 million barrels per day. Russia is fighting this action as they are looking for more time to better judge the impact of the virus.

On the heels of Joe Biden’s comeback on Super Tuesday and diminished prospects for Bernie Sanders, health care stocks soared. The broad health care sector represented by XLV was up 5.76% and more impressively the health care sub index- managed health care rose over 12%. The index is solely comprised of United Health Care, Centene, Anthem, and Humana which were all up at least 10%.

March 4, 2020

The Fed cut rates by 50 basis points immediately following a conference call, which included Jerome Powell, Treasury Secretary Mnuchin, and other central bankers. While the cut was surprising, the Fed Funds futures market was fully priced for such a move. We remind you of an article we wrote last June, Investors are Grossly Underestimating the Fed. It showed how the Fed Funds futures markets tend to underestimate future Fed moves.  In the article we wrote- “If the Fed initiates rate cuts and if the data in the graphs prove prescient, then current estimates for a Fed Funds rate of 1.50% to 1.75% in the spring of 2020 may be well above what we ultimately see.”  We now enter Spring in a few weeks and Fed Funds are now between 1.00%-1.25% and are forecasted to fall another 25-50 basis points.  Currently, the market implies that Fed Funds will be .50% at yearend. Based on history, Fed Funds will likely be zero by then.

The Markets did not show much confidence over the Fed’s action. Almost immediately following the cut, the S&P 500 fell nearly 100 points and Gold soared by $40.  10-Year Treasury yields fell below 1% to an intraday low of 0.94%, setting another record low. The yield curve continues to steepen as the front end of the curve prices in aggressive easing by the Fed in the future. 30-year yields fell the least as investors are starting to show some inflationary concerns. The 2yr/10yr curve widened to 30 bps. Adding to inflationary concerns, OPEC is in talks to reduce supply.

In addition to the virus roiling the markets, the rising odds of a Bernie Sanders nomination was also being blamed. With Biden’s strong showing last night, the markets are breathing a sigh of relief. S&P futures are set to open up 60 points.

The Fed accepted $120 billion in repo versus demand for $178 billion. Both figures are a sharp uptick from the prior week in which the total amount bid and accepted was below $50 billion per day.

March 3, 2020

Expectations for a rate cut by the Fed are high. It is also widely expected that any Fed actions will be coordinated with the ECB, BOJ and possibly other central banks. A conference call of the G7 Central Bankers is scheduled for tomorrow. The Bank of Japan bought a record 101 billion yen of ETF’s yesterday and vowed to do all it can to help stabilize markets. The ECB stated the following: “We stand ready to take appropriate and targeted measures, as necessary and commensurate with the underlying risks.”

The hope for rate cuts from the Fed may keep the risk markets bid for the time being, but if hopes diminish, the markets may resort to selling off again, and the pressure on the Fed to react will grow. This is the tug of war as we mentioned last week.

The S&P soared yesterday by 136 points (4.6%) and is now about 50 points above its 200 day moving average. The dollar fell by half a percent yesterday and is at one month lows. After a sharp drop in yields overnight to new all time lows (1.04%), the Ten-year Treasury reversed course and closed at (1.15%).

Some important pieces of economic data will be released this week but it will be tough to evaluate, as we do not know to what degree the virus is impacting the data. Yesterday, ISM Manufacturing fell from 50.9 to 50.1. Based on the same data from China, this survey could fall sharply next month. ADP Employment will be released on Wednesday and the BLS jobs report on Friday. On Thursday the timeliest indicator of the labor market, Jobless Claims, will be reported.

There are a few Fed speakers scheduled to speak this week. We suspect they will have very similar scripts and will reveal little as to their latest thoughts on using policy to stem the impact of the virus.

March 2, 2020

The futures markets were extremely volatile last night. S&P futures opened down 75 points, rallied over 100 points, and fell back towards the lows. As of 7:15 am futures are down 30 points.  Gold is currently up nearly 40 points, erasing much of Friday’s loss, and Treasury yields have again fallen sharply. The 10-year yield is approaching 1%.

The Fed Funds Futures markets are now expecting a 50bps rate cut from the Fed. Based on pricing, the cut could come as early as this morning. The market is now priced for 100 bps by year end. We suspect the stock market will be very disappointed if the Fed does not take action shortly. If they do cut, we will likely see a relief rally, but then things will get interesting.

On Friday night, after markets were closed, China released horrendous PMI data. The manufacturing index fell from 50 to 35.7, well below expectations for 45. The services index fell to 28.9 from 54.1 last month. Both are record lows (inclusive of 2008). The decline was certainly expected, but not expected was the severity of the decline. Given China’s propensity to manage economic data, the true level for these indicators is likely even lower than what was reported.

The Fed’s preferred price index (PCE) rose 0.1% to 1.7% in January and now sits only 0.3% below the Fed’s inflation target. Hampered supply lines may put upward pressure on this number in the coming months. Rising inflation pressures may help explain why the Fed has not been in a hurry to heed the market’s call to cut interest rates. As a reminder, CPI (yoy) is now at 2.5% and has been steadily climbing over the last year.

Chicago PMI was stronger than expected at 49 versus a prior reading of 42.9. Consumer Sentiment also held up. Both results beg the question of when the surveys were conducted in relation to the virus news.

On Friday, Robert Kaplan, President of the Dallas Fed, and James Bullard of the St. Louis Fed repeated what we have consistently heard from other Fed members; a near term rate cut is not likely. However, Chairman Powell followed later in the day with the statement below. Now we are left to wonder whether the market will find solace in his statement. With the markets expecting imminent actions, are words enough, or will Mr. Powell and the Fed need to reduce rates and/or do more QE?

The ChiNext Index tracks 100 of the largest and most liquid stocks on the Shenzhen Stock Exchange in China. It is sort of an S&P 500 for the Chinese stock market as the index is well-diversified among many industries. Prior to the Corona outbreak and Chinese Lunar New year the index traded at 1993. On the first day of trading after the holiday and state-imposed trading suspension the index fell sharply to 1795. It currently stands at 2071, up 15% from the post-holiday lows and up 4% from before the break. Year to the date, the index is up over 20%. This confounding performance is a testimony to the massive liquidity being supplied to the market by China’s central bank (PBoC), as well as trading restrictions and newly instituted internet firewalls that likely make trading/selling difficult. Clearly, the Chinese government is trying to send a “stay calm and carry on” type message via stocks.

February 28, 2020

The graph below shows that the S&P 500 is now sitting just below its 200 day moving average. Over the past two years, this moving average has provided a backstop for the market. At times, as circled, the moving average arrested the downward price action. In late 2018, shown by the square,  it provided a range in which the market consolidated before breaking lower. Investors will be watching this level closely.

Fed Funds Futures are now pricing in a 70% chance of a rate cut at the March 18th FOMC meeting and a total of at least three, 25bps rate cuts by January. In just the last three days, the market has priced in one more 25 bps rate cut in the second half of the year.

Gold was down slightly yesterday but gold miners fell by over 5%. This is potentially a warning that margin calls are starting to force leveraged investors to liquidate holdings.

Despite declining slightly (-0.2%), Durable Goods orders were stronger than expectations (-1.2%) in February. If we strip out the volatile transportation sector, the data was more robust at +0.9%.  It’s likely the impact of the virus has yet to be felt in this data set. On the other hand, weekly Jobless Claims rose by 219k from 210k last week. While still a very small number of claims, the data is much more timely and reflective of current employment trends. Due to its weekly reporting this will continue to be a key data point to follow. Similarly, The University of Michigan Consumer Sentiment survey due out at 10 am this morning is timely and may begin to reflect concern by the consumer.

Japan closed all schools, including colleges, until at least spring (March 21st). We have little doubt this all but assures Japan a negative GDP print for the second quarter and, given their sharp 6.3% decline in first-quarter growth, will put them in a technical recession.

 

February 27, 2020

On Wednesday morning, the S&P 500 jumped over 75 points from its lows established at 4 am; however, by noon those gains started leaking and shortly after the market close, the market had given up the 75 points and then some. The culprit again seems to be the Corona Virus. After the close Microsoft joined a long and growing list of companies that are warning earnings will be hurt this quarter due to the virus.

The market seems to be in a tug of war between the virus and the Fed. As long as the virus keeps spreading, especially if it picks up speed in the U.S., and the Fed remains firm about not lowering rates, the virus will weigh on the market. This was a similar construct witnessed in the fourth quarter of 2018. At the time, the market fell nearly 20% because of the burgeoning trade war and the Fed’s refusal to back down from planned rate hikes and QT. Once the Fed said they would stop hiking rates and stop QT, the market soared. Replace the trade war with a virus, and late 2018 might be a good analog for the current situation. It is worth adding a caveat that the growing threat of a Bernie Sanders nomination is not a positive for the market. Super Tuesday, next week, will shine more light on his probability of winning the Democratic nomination.

Today’s Chart of the Day shows that over the last week there have been massive outflows (investor redemption) from HYG, the popular junk bond ETF. Because it is an ETF, an outflow means that banks and dealers are returning HYG stock to the ETF manager in exchange for the underlying securities. This could be a sign that dealers think the sell-off in equities has run its course and are using the underlying bonds to cover their short junk positions, which they used to hedge stock market exposure. It may also be because liquidity in HYG is much better than the underlying securities, which has created an arbitrage trade for the dealers, whereas they exchange what is rich and liquid (HYG) and receive what is cheap but illiquid (specific junk bonds). We follow this ETF closely as a proxy for the junk bond sector, which can become highly illiquid during volatile periods in the stock markets. Given the popularity and extremely rich pricing in the junk sector, HYG may provide an early warning that junk bonds are in trouble.

The following quote from Warren Buffet caught our attention yesterday: People, because they can make decisions every second in stocks, whereas they can’t with farms, they think an investment in stocks is different than an investment in a business or an investment in a farm or investment in an apartment house but it isn’t.”  His quote is another way of warning that valuations matter.

February 26, 2020

The S&P fell 95 points yesterday and the three-day selloff has now erased nearly three months of gains. Yesterday’s decline was worsened by the following headlines from the Center for Disease Control (CDC):

  • U.S. CDC SAYS WANTS TO PREPARE AMERICAN PUBLIC FOR POSSIBILITY THAT THEIR LIVES WILL BE DISRUPTED AS CORONAVIRUS SPREADS IN U.S. – TELEBRIEFING
  • U.S. CDC SAYS NOW IS THE TIME FOR BUSINESSES, HOPSTIALS, COMMUNITIES AND SCHOOLS TO BEGIN PREPARING TO RESPOND TO CORONAVIRUS – TELEBRIEFING
  • US CDC: “VERY STRONG CHANCE OF AN EXTREMELY SERIOUS OUTBREAK OF THE CORONAVIRUS HERE IN THE UNITED STATES.”

We must also consider that a vaccine may not come quickly. Per the NIH: a virus candidate could be ready in six weeks, but the first trials will take 3-4 months and then the second round another six months. Then it will take some time to produce and distribute it.

The markets are now beginning to discount the probability of a sustained economic impact from the virus.

Yesterday’s price action was interesting in part because the dollar and gold also fell sharply, however, bonds were still well bid with yields on 10’s and 30’s once again setting new all-time lows .

Stocks are now very oversold based on short term analysis and some indexes are closing in on their 200-day moving averages. The Dow Jones Industrial Average is sitting on its 200-day ma, while the S&P still has about 3% to go. The NASDAQ is still 9% above its 200-day ma.

In a speech Monday night, Cleveland Fed President Loretta Mester said: “I don’t have fear that we’ll be behind the curve” by not cutting rates again sooner.”

Yesterday, Vice Chair Clarida stated: But it’s too soon “to even speculate” about whether that (virus) will spur a material change in the outlook.

Every Fed speaker over the last few days has iterated a confident view about stable near term rate policy, which leads us to believe the Fed is no hurry to lower rates to counter any impact from the virus.

The amount of BBB-rated corporate bonds just eclipsed the $3 billion mark, and at the same time, the aggregate yield for these bonds is at all-time lows and the spread to Treasury bonds nears record lows. Corporate bond investors are chasing an increasing amount of risk and receiving far too little in return. During the last recession, BBB-rated corporate bonds traded as high as 8% over similar maturity Treasury yields. Assuming a 5 year duration and no movement in Treasury yields, a similar spread to Treasuries would result in a 32% loss for BBB bondholders today. That is a significant amount of risk for what in many cases is a sub-3% yield.

 

February 25, 2020

10-year and 30-year U.S. Treasury yields hit all-time record lows on Monday as yields fell sharply across the board. The 2/10s curve was flat on the day, but the 3mos/10s curve fell 10 basis points and is now inverted by 20 basis points. Credit spreads widened as investors sought safety.

Crude oil fell 4% on the day despite a slightly weaker dollar. Oil and other industrial commodities are pricing in a sharp manufacturing contraction over the coming months. Silver, which is a hybrid between a precious metal and industrial metal, was up on the day (+.48%) but not nearly as much as gold (.85%).

The S&P 500 fell 3.32% and the NASDAQ nearly 4%.  For the second day in a row, market leaders Apple and Microsoft declined more than the major indexes.  The S&P 500 is now flat for the year to date. The VIX (volatility index) rose 48% to 25.

At 10 am, the Conference Board will release Consumer Confidence. After a strong reading in January it will be very interesting to see if the Corona Virus is starting to weight on the positive consumer psyche. The consensus estimate is 132.5. Fed Vice Chairman Richard Clarida will speak this afternoon. Since he spoke last Thursday when he talked down the markets in regards to the Fed cutting rates over the next few months, the stock market has fallen sharply and the virus is spreading into Europe and hitting South Korea hard. His speech will provide a good indicator on whether the Fed may walk back recent statements about being firm with rates.

With Monday’s market strains, Fed Funds futures have ratcheted up the odds of rate hikes. Yesterday, the Fed Funds futures market reduced the implied Fed Funds rate by 8-10 basis points for June and beyond. As shown below, a full 25 bps rate cut is now priced into the June 10th meeting.

The Hong Kong dollar has been pegged to the U.S. dollar since the early 1980s. If the economic impact of the protests, Corona Virus, a weakened Chinese economy, and importantly the stronger U.S. dollar continue to harm Hong Kong’s economy, the central bank may be forced to break the peg as a means of stimulating the economy with a weaker currency. If that were to happen, there would be many consequences. The largest perhaps would be a massive movement from Hong Kong dollars into U.S. dollars. Such a currency flight would certainly benefit the U.S. dollar, U.S. Treasury market, and other U.S. assets to a lesser degree. On the other hand, the resulting stronger U.S. dollar would impede global growth and put more pressure on foreign borrowers of U.S. dollars, particularly in the emerging markets. A stronger dollar is also deflationary and tends to be negative for corporate earnings in aggregate.

February 24, 2020

***Please note the Dashboard has changed slightly. We moved the gauges to the top of the page and, in their place on the right side, added the rolling Twitter feeds of Michael Lebowitz and Lance Roberts.

The market fell sharply overnight following Friday’s losses based on growing concerns of the spreading and impact of the Corona Virus. Gold, bonds, and the dollar are soaring this morning.

Not helping matters on Friday was the Markit Flash PMI (49.6), which fell below 50 and now signals economic contraction.  The consensus estimate was 52.5. The Flash index is based on preliminary survey results and serves as a gauge for the final PMI reading due out in about two weeks. Interestingly, within the survey, the manufacturing sector was above 50, while services fell sharply from 53.3 to 49.4. Over the prior year, services led the way as manufacturing suffered due to the trade war with China. Total new orders fell below 50 for the first time in a decade. Markit claims that this new data is consistent with GDP growth of 0.6%. This index may be the first U.S. economic indicator feeling the impact of the Corona Virus.

China’s Passenger Car Association said automobile sales in the first 16 days of February were 4,909, which is only 8% of the auto sales that occurred in the same period last year. As the virus continues to negatively impact China’s economy, the effects will become more noticeable to U.S. companies. For example, in 2019, GM sold more cars to China than they did domestically. The graph below shows which industries are at the greatest risk if the virus continues to have a big impact on China’s manufacturing capabilities.

St. Louis Fed President James Bullard made the following comment on Friday- “Valuations look high but at this level of interest rates. I think we are OK for now.”  Bond yields are low for two reasons. First economic growth has been trending lower despite massive fiscal and monetary stimulus. Second, the Fed has removed a considerable supply of Treasury and Mortgage debt from the market, thus artificially reducing rates. The justification Bullard uses and is being used by many investors to justify sky-high valuations, makes little to no fundamental sense.

On Friday, James Bullard and Atlanta Fed President Raphael Bostic reiterated a common theme among the Fed speakers this past week- The Fed does not expect to do anything with rates in the near future. This may also be responsible for Friday’s negative price action.  We suspect they will act a lot quicker than they think if the stock market continues lower and the virus spreads as rapidly as it has been.

 

February 21, 2020

After trading slightly in the green by mid-morning, the stock market hit a tailspin around 11am with the S&P 500 falling nearly 40 points in less than a half-hour.  We have yet to see a good reason for the sudden and steep decline, so we provide you with a few of our guesses:

  • The dollar index continued its daily assent higher and now sits at 2.5 year highs. The dollar is already up about 4% for the year. A stronger dollar tends to be a headwind for corporate earnings.
  • The Fed minutes on Wednesday and Vice Chair Clarida’s comments (see below) yesterday may have been a bit more hawkish than expected
  • The virus is beginning to spread rapidly in Japan, South Korea, and Iran, which should create further negative impacts to supply lines and global economic growth
  • Asset rotation: Gold and bonds continued to perform well and value/small caps outperformed while growth/large caps lagged. Apple and Microsoft, the leaders of this years advance, noticeably unperformed the market.

As has become the norm, the S&P 500 rallied back throughout the day and cut the losses in half. We take yesterday’s action as a reminder that the markets are technically very overbought and a correction can happen much quicker than expected.

The Philadelphia Fed Business Outlook Survey soared to 36.7 from 17, returning it to levels that were consistent prior to the China-U.S. trade war. The only downside in the report is a further decline in the employment index, as shown below.  This report and a handful of other employment readings continue to go against the data in the unemployment and jobless claims reports.

Jobless claims edged higher to 210k and the Leading Economic Indicators (LEI) jumped 0.8% versus expectations of +0.3. The gains in LEI were driven by the decline in unemployment claims, and strength in housing permits and consumer confidence.

Fed Vice Chairman Richard Clarida, in an interview yesterday, talked down the notion that the Fed would lower rates in the near future.  The Fed Funds futures markets are implying a full 25bps rate cut by late summer and a 50% chance of a cut by June.

The combination of falling Treasury yields and rising inflation has resulted in negative real yields across the entire Treasury curve (from Fed Funds to 30-year bonds). As shown below, this has only occurred one other time (2016) in at least the last 60 years. This provides yet another sign that yields are too low and the Fed is providing an excessive amount of stimulus.

CNBC had an interesting article out yesterday titled: A huge driver of stock prices got off to it’s worst start in 7 years, but that could change. The article points out that in January, corporations bought back their stock at the slowest pace since 2013. The author notes, however, February has seen an uptick. Record breaking amount of stock buybacks have been a large driver of higher stock prices over the last few years. As such, we need to follow this data closely to understand whether January was an anomaly or a sign that corporations are not able to continue at the prior pace. It is worth pointing out that debt has funded many buybacks and some companies are increasingly finding it difficult to keep borrowing without negative consequences to their credit ratings.

 

February 20, 2020

After two straight months where producer prices were soft, yesterday’s January PPI report showed a sharp increase in input prices for corporations. The monthly change was +0.5% versus a consensus estimate of +0.1%. The sharp jump in prices during January increases the year over year figure to 2.1%, above the Fed’s 2% inflation mandate. PPI excluding food and energy also showed sharp gains.  The increases may be partially the result of the Corona Virus and the negative impact on supply chains. In a growing number of instances, manufacturers seeking parts and products from Chinese producers must source more expensive alternatives to meet production needs. As the virus festers, we expect to see smaller companies lacking the ability to source alternatives for Chinese parts to reduce or suspend production and lay off employees. The jobless claims data would likely be the first economic data signaling such activity.

Yesterday, the Fed released the minutes from January’s meeting. As expected, the minutes showed a strong consensus that rates should be kept on hold until a significant change in the outlook occurred. The minutes also said that term repo operations would be “phased out after April.” Further, they said the Fed’s balance sheet was approaching “durably ample levels,” and that “such operations could be gradually scaled back and phased out.” Before thinking the meeting had a hawkish tilt, consider that there was more chatter about a standing repo facility. The facility would provide repo on demand at all times, allowing the Fed to eliminate scheduled and limited repo operations as they do today.

The Fed minutes are essentially modified minutes that allow the Fed to incorporate their latest thoughts into the public announcement. To that end, the Fed’s thinking on valuations may have changed over the last few weeks. Following the January meeting, Powell said “We do see asset valuations as being somewhat elevated.” The minutes released yesterday stated “(the) staff saw asset valuations had increased to elevated levels.”

 

February 19, 2020

This week is short on economic data but will feature plenty of Fed speakers. On the economic data front, we are most interested in Jobless Claims and Leading Economic Indicators, both are released on Thursday. Leading Indicators, which has historically been a strong barometer of the economy, is expected to rise 0.3% after declining four of the last five months. Jobless Claims continue to skirt near all-time lows and is expected to do the same this week, rising marginally to 211k.

About the slew of Fed members speaking this week, we are on the lookout for indications that the Fed is starting to shift towards the market’s expectations for two rate cuts in 2020. Prior to this week, Fed members have largely been on the same page with each other and the Chairman in being content with current policy and taking a wait and see approach toward future policy. We suspect the growing impact from the Corona Virus might push some of this week’s scheduled speakers to reduce their growth outlook and possibly take on a more dovish stance. If that is to occur, we would expect Neel Kashkari and Lael Brainard to lead the charge.

Macy’s (M) was downgraded to junk status affecting almost $5 billion in debt. The ratings action follows on the heels of $30 billion of Kraft Heinz (KHC) debt that was downgraded last week. The two instances are not necessarily the start of a trend, but we are very concerned by the record amount of BBB debt and the repercussions if a portion of it were to be downgraded. We touch on this concern in today’s Real Investment Advice article Digging for Value in a Pile of Manure which includes graphs and a link to an older article, The Corporate Maginot Line, that went deeper into the topic.

While the equity markets held up reasonably well yesterday despite the downgrade of revenue and earnings guidance from Apple, gold and bonds sense trouble. Gold rallied over 1% yesterday and now sits at a 7 year high despite a strong dollar as of late. Since the start of the year, the USD index is up over 3% and gold has risen over 5%. 30 year yields have dropped from 2.40% at the start of the year to just over 2% today.

February 18, 2020

Yesterday afternoon Apple cut revenue guidance due to virus related production delays and weak demand from China. We suspect that more companies will make similar changes to their earnings and revenue guidance in the coming weeks. Apple represents 5% of the S&P 500, 7.5% of the DJIA, and 11.5% of the NASDAQ.

The U.S. China trade war and a new sales tax caused Japan’s 4th quarter GDP to fall by 6.3% annualized, much worse than the expected 3.4% decline. The sharp reduction of growth was fueled by an 11.1% decline in consumer spending and a 14.1% fall in capital spending. It is now likely that slowing global growth coupled with the impact of the Corona Virus will result in a negative Q1 2020 report and put Japan in a recession. Japan’s GDP is currently at the same level as it was in the mid-1990s.

Retail Sales came in as expected at 0.3%. The only fly in the ointment was the control group, which was flat versus an expected gain of 0.3%. The control group is the sales classifications used for computing personal consumption within the GDP report. The New York Fed’s Nowcast estimate of Q1 GDP fell from 1.67% to 1.39% last week, and sits well below the 2.4% estimate from the Atlanta Fed.

In the last commentary we showed the wide and growing divergence between new jobs (JOLTS) and retail sales. Today, we share a similar graph comparing an equally wide divergence between the S&P 500 (with a four month lead) and new jobs. Either the stock market is very confident that new jobs will spike in the next four months or the liquidity from QE and repo have negated fundamental analysis. As we keep harping, liquidity is the driver of these markets, trumping negligible corporate earnings growth, slowing global growth, the Corona Virus, and a host of other geopolitical concerns. Recognizing the disconnect is important for risk management, but we must also respect the effect that excess liquidity and perceptions have on financial markets.

 

February 14, 2020

Retail Sales will be released at 8:30 this morning. The current consensus of economists is for an increase of 0.3% for both the main index and the core index, which excludes gas and autos. The graph below shows the strong correlation between the annual change in Job Openings (JOLTS data) and Retail Sales. The current divergence between these two factors portends a sharp decline in retail sales or a surge in job openings over the coming months.

Chinese automobile sales slumped 22% in January, which was the biggest decline in history in the month of January. The China Passenger Car Association warned that February could be even worse.  January auto sales in China tend to be weak due to the week-long Lunar New Year holiday. This year, the coincidence of the holiday with the virus made sales much worse. As we have been warning, the impact of the virus will be felt in the U.S. As an example, approximately over a third of GM sales in 2019 were to China. In addition to declining auto sales from all manufacturers to China, China also accounts for 25% of global auto production.

CPI showed inflation was tame and largely in line with expectations and prior month levels. The core reading rose .01% versus expectations of +.02% however, the year over year change was 2.5% versus expectations of 2.4% and 2.3% in the prior month.The Fed prefers inflation as measured by PCE which remains under their 2% bogey.

Jobless claims continue to hover at historic lows with an increase of only 205k in the latest week.

Yesterday afternoon the Fed announced they would further reduce the maximum size for 14-day term repo auctions from $30 to $25 billion throughout the remainder of February and then drop it another $5 billion to $20 billion for March. They also reduced the maximum size of overnight repo operations from $120 billion to $100 billion. Keep in mind the Fed is still buying $60 billion in Treasury bills a month, which should offset the decline in repo liquidity.

Stock and bond markets will be closed on Monday for the Presidents Day Holiday.

We leave you with some weekend reading. The CNBC article linked below summarizes a telling interview with Warren Buffet’s partner, Charlie Munger. Munger’s bearish outlook helps explain why their company, Berkshire Hathaway, is sitting on a growing stockpile of cash, currently valued at $128 billion.

Charlie Munger warns there are ‘lots of troubles coming’ because of ‘too much wretched excess’

 

February 13, 2020

In his second day of Congressional testimony, Chairman Powell said “low rates are not a choice anymore.” In other words, higher rates will do too much harm to the economy and therefore, the Fed must do whatever they can to ensure rates stay low. This explains the increased chatter from various Fed members about rate fixing. Rate fixing is when the Fed puts a cap on interest rates and has a permanent buy program in place to ensure rates do not exceed the cap. This was done as an emergency measure during and after WWII to control interest rates as debt soared to pay for war costs. Incidentally, the Fed just put out a research piece on these operations. The link is HERE.

Powell also provided the stock market a boost when he said the Fed would be willing to use QE “aggressively” if the economy hit a slump.

Today’s Chart of the Day is courtesy of Brett Freeze. His telling graph shows that private investment has dropped precipitously over the last few quarters and to the degree that has not been witnessed since the early 1970s. As shown, sharp declines, such as the current one, have occurred 13 times since 1951, excluding today’s instance. Of those, 10 or 76% have been a result of or attributed to a recession.

The graph below by Ernie Tedeschi shows that over the last six years the number of people entering the workforce has been trending higher while payroll growth has generally been trending lower. They have now converged, meaning that any continuation of these trends should result in higher unemployment rates. That is not necessarily a bad thing, but the Fed may interpret a higher rate as a reason to be more aggressive with monetary policy.

February 12, 2020

Regardless of strong investor sentiment and new record highs, there is mounting evidence of economic damage to the U.S. and global economy as forewarned by recent press announcements. Here are a few that caught our eye yesterday:

  • China will not meet their purchase obligations of agriculture under the Phase one trade agreement
  • Apple sales in China could decline by up to 50%
  • Airbus sees no clear timeline to reopen the Tianjin final assembly plant
  • Singapore’s Tourism board expects a 25% decline in visitors in 2020.
  • Under Armour missed on sales and their outlook is weak. They partially blamed the Corona Virus outbreak.

Hedge fund giant Ray Dalio seems to disagree. In Bloomberg, he stated: the market impact of the Corona Virus outbreak has been exaggerated.” With no vaccine and the virus still spreading, coupled with U.S. stock markets at all-time highs, that is a bold statement from Mr. Dalio. We remind you that in January 2018 Dalio said: “if you are holding cash, you’re going to feel pretty stupid.” He made that statement days before the market embarked on a nearly 20% decline.

Job Openings in yesterday’s JOLTS report were much weaker than expectations at 6.423 million versus consensus of 6.775 million and a prior reading of 6.80 million. Despite other strong BLS reports, this data continues to point to a slowing of employment. As shown below, the decline over the last few months has been the sharpest since the last recession. In fact, the last time it declined this much on a year over year basis was September of 2008.

In testimony to Congress yesterday, Chairman Powell raised concerns about “disruptions in China that spill over to the rest of the global economy.” He also reiterated that the Fed intends to replace repo operations with more permanent QE of T-Bills. In general, his prepared comments were as expected, but during the questioning from representatives, he acknowledged that markets are misinterpreting the Fed’s actions and implied that asset valuations are getting ahead of themselves.

President Trump was not amused and followed with the following Tweet- “When Jerome Powell started his testimony today, the Dow was up 125, & heading higher. As he spoke it drifted steadily downward, as usual, and is now at -15. Germany & other countries get paid to borrow money. We are more prime, but Fed Rate is too high, Dollar tough on exports.

February 11, 2020

The S&P 500 rose .75%% to close at a record high on Monday. Market are not discounting the potential for any negative effects from the Corona Virus. Either investors believe the economic impact will be small and limited in duration, or they believe the Fed and China will continue to pump the markets with liquidity. We believe it’s the latter driving the markets and, as such, this run can continue despite extremely overbought technical conditions. This condition is best exemplified with Chinese stock indexes, which have been gaining in recent days despite worsening conditions and growing economic consequences. The Shanghai Index, for instance, initially fell 12% in early February but has since risen daily and recovered about two-thirds of the losses.

Jerome Powell will testify to the House and Senate today and Wednesday in regard to the state of the economy and monetary policy. We suspect that Elizabeth Warren and possibly others will use the question and answer sessions to grill the Chairman on repo/QE with the intent of exposing the real reason(s) the Fed has redeployed crisis-era monetary policy. Powell will likely warn about slowing global growth due to the virus. Will he mention asset valuations which have become even more extreme since his last press conference?

JOLTS will be released at 10 am this morning. Given the strong jobs and claims data from the BLS we are curious to see if the pace of job openings in the report continues to increase as it has been. On Thursday the BLS will report on CPI and Jobless Claims. The most important number of the week may likely be Retail Sales on Friday. With the holiday season behind us, this data point provides our first opportunity to see if the last three months of gains were due to seasonal shopping. Given positive readings in consumer sentiment, consumer credit usage, and recent BLS employment data, we suspect Retail Sales will show continued growth in January. We do not expect to see any effect from the Corona Virus.

As if China’s economy did not have enough to contend with, inflation is becoming problematic. On Sunday, it was reported the CPI grew by 5.4%, the highest level in nearly ten years. Of greater concern for the government, the increase is being led by food prices, which grew over 20% from the prior year. Shortages of pork alone accounted for nearly 3% of the increase in inflation. The closing of large manufacturing centers and the reduced ability to provide goods and services will add to inflation in the coming months.

February 10, 2020

The BLS jobs report was strong with payrolls increasing by 225k, about 65k more than estimates. The unemployment rate rose from 3.5% to 3.6%, but that was in part due to a rise in the participation rate from 63.2 to 63.4, a 6 year high. As more workers reenter the workforce, the unemployment rate should rise, but it is generally considered a good signal that jobs are plentiful and new workers are confident in their job prospects.

The BLS revised payrolls from March 2018 to March 2019, lower by 514k. The biggest downward revisions came from the following industries: Private service producing, retail trade, professional and business services, and leisure and hospitality. Average weekly hours were revised higher by 0.1% and average hourly earnings by 5 cents.

The first economic data to show an impact from the Corona Virus was reported by Taiwan last Friday. Exports fell 7.6% versus expectations for a gain of 1%. China accounts for almost a third of all Taiwanese exports. We expect that more economic slowing will start being reported in China and other Asian countries’ economic data in the coming week or two. U.S. economic growth and corporate profits will be negatively affected; however, it is too early to assess how much. Today’s Chart of the Day shows that over 6% of S&P 500 revenue is generated from China and Hong Kong. While a relatively small number, some industries such as semiconductors, technology hardware, and consumer services have much more revenue at stake. Conversely, utilities, and telecommunication services have almost no exposure.

February 7, 2020

Jobless Claims slipped to 202k, showing no signs of labor weakness. On the other hand, the Challenger Job-Cut Report surged to 67,735, the highest since last February. While some of the increase is seasonal, This January’s reading is up 28% more than last January’s total. Once again we are left trying to decipher between government labor reports, which are generally in great shape and deteriorating reports from private entities.

In addition to the closely followed employment report due out at 8:30 this morning, the BLS will also release revisions to data from March of 2018 to March of 2019. Last August, the BLS said that they expect that today’s revisions would reduce payrolls over that one year period by 501k. While the revision is large, it is also old and therefore we suspect it will be largely ignored by the markets. The graph below, courtesy of Dr. Julia Coronado, provides context to the revisions as currently expected.

Our estimate for January jobs growth is  +256k, but seasonal adjustments and recent volatility in the data could cause this number to be larger or a lot smaller than our estimate. Bottom line, large or small number, be careful reading too much into this data point.

Yesterday, the Fed’s repo facility was met with $57.25bn in bids from dealers and banks but the Fed only accepted $30bn. This was the second time this week the Fed did not meet demand. Might the Fed be trying to wean banks off of the repo facility?

February 6, 2020

The ADP payrolls report was much better than expected, almost doubling estimates of 154k. The gain of 291k jobs was the highest 1 month increase since May of 2015. With the ADP report in hand, our model is forecasting a gain of 256k in Friday’s BLS jobs report. We caution the variance between the BLS and ADP reports has been significant in recent months. To this point, BLS payrolls only need to grow by 154k to bring the 3 month average of both indexes in line with each other. The consensus estimate is currently 158k.

The ISM Services index slightly beat consensus at 55.5, up from 55.0 last month. While seemingly a good number, the year over year trend points to a gradual slowing of the index. The graph below by Brett Freeze shows the longer term trends in the index.  Also of note, the employment sub-index weakened but is still expansionary

Today’s Chart of the Day, courtesy of Axios, shows that consumer confidence is greater for older people than younger people and to an extent not seen in at least 40 years. Axios attributes the anomaly to the different debt and asset profiles of the two generations. We add that the graph may also help partially explain the younger generation’s rising interest in socialism and populism. The following section is from the Axios link.

November’s consumer confidence report showed the largest gap between the confidence of consumers under 35 and those over 55 in the history of the Conference Board’s report.

  • The chart above shows the result of subtracting the monthly confidence score of respondents over 55 from those under 35.
  • Younger people have typically had higher confidence scores, but that has changed in recent years, the data show.

What’s happening: That’s largely because older Americans have benefited much more from the current low interest rate environment and gains from the stock market, Nela Richardson, investment strategist at Edward Jones, tells Axios.

  • “People at different ages are experiencing the economy differently,” she says.
  • “If you’re under 35 you’re looking more likely at student loan debt and really high home prices, even if interest rates are low. If you’re older, you’re probably not as affected by student loan debt, and you’re probably not negatively affected by high home prices, though you might have a huge gain from home equity.”

The bottom line: Richardson also points out that younger people are less willing to take on risk assets like equities and have missed out on much of the bull market, in part because of their albatross of student debt.

  • “Whereas every other form of debt — from credit cards to mortgages — actually have this wealth effect that makes you want to invest more and be part of the economy, student loan debt makes young people more risk averse, and it makes them more risk averse precisely at the time you should be taking on more risk assets.”

February 5, 2020

Stock markets around the world surged on Tuesday because of _________.  We struggle to name a fundamental rationale to fill in the blank. However, we remind you liquidity is king and that is trumping the Corona Virus and weak earnings. Starting last Sunday night, China has injected massive amounts of liquidity into their financial markets to help stabilize them. Some of this money is certainly finding its way to markets outside of China. Further, banks’ demand for repo from the Fed increased yesterday, and the Fed is meeting those needs, hence more liquidity. On Tuesday, the Fed provided $96.5 billion in repo, which is about $30 billion more than the average over the last two weeks.

On Friday, the BLS will release its monthly update on the labor market. The current consensus estimate calls for data to be largely in line with last month, as shown below.  With this morning’s release of ADP, we will run our labor model and provide a forecast on payroll growth tomorrow.

Also of interest today will be the ISM non-Manufacturing Index at 10 am. Thus far, the services sectors, along with personal consumption, have more than offset weakness in manufacturing.

The Baltic Dry Index, a measure of global shipping rates and an indicator of global trade, has fallen sharply since last September. It now sits slightly above its all-time low recorded in 2016. Yesterday, the Wall Street Journal published an article entitled Shipping Bellwether Hits All-Time Low, which discusses the index but points out that one of the sub-components of the index, the Capsize Index, is now below zero. Per the WSJ: “Capesize vessels move products such as iron ore and coal from mines in Latin America and Australia to Europe and China. The index tracking then plunged from minus 21 points to an all-time low of minus 102 on Monday, a Baltic Exchange spokesperson said.”  Clearly world trade is hurting due to the Corona Virus outbreak, but it is important to understand both the gravity of the decline as well as the fact that it started well before the Virus took hold.

Yesterday afternoon we published RIA PRO- Quick Take: The Great TSLA Hysteria of 2020, a short article providing some context to the surge in the price of Tesla’s stock.

February 4, 2020

Stock markets will open sharply higher this morning as the World Health Organization stated that the world is not in a pandemic. With the rally, the S&P 500 is approaching the top of the range that it has traded in since the original sell-off from record highs.

January’s ISM Manufacturing Survey was much better than expected. The reading hopefully signals that the weak Chicago manufacturing survey from last week was an anomaly due to Boeing. ISM is 50.9 and back into expansionary territory. The new orders sub-component rose sharply to the highest level in 6 months (52 vs. 46.8 last month). The big concern within this survey is employment which was improved but remained under 50. David Rosenberg pointed out that only 44% of the industries surveyed reported growth. The chart below shows the current wide divergence between ISM and the performance of the S&P 500. If this relationship is to normalize, then we might expect ISM to continue to rise or the S&P 500 to correct.

 

 

 

 

Last week the CBO released its deficit forecast for the next decade. They now expect deficits to average $1.3 trillion per year. To put that into context, the largest deficit during the financial crisis was $1.4 trillion. The CBO’s forecast equates to 4.6% of GDP, meaning that if growth is slower than 4.6% the ratio of debt to GDP will continue to rise. It is crucial to understand the CBO is not forecasting a recession over the next ten years. A recession could easily result in a year or two where the deficit is at least double the current annual forecast.  One of the big drivers of the higher deficit projection is due to retirement and health spending as a result of the aging baby boomers. Michael Peterson of the Peter G. Peterson foundation summed up our thoughts on the deficits nicely as follows: “It would be one thing if we were running up deficits to fund investments in the future, but that’s not what’s happening,” he said, adding that investments only accounted for “a tiny fraction” of the spending in the budget.”

February 3, 2020

The stock market sold off sharply on Friday despite strong earnings results from Amazon. The S&P 500 has reversed January’s gain and is now down slightly on the year. The 30 year Treasury bond settled slightly below 2% on Friday and is now closing in on 1.95% the record low from last August. Investors finally appear to be focused on the spreading of the Corona Virus and the growing reality that it will impede economic growth.

China’s financial markets finally opened after the Lunar New Year and the extension due to the virus. Despite a massive liquidity injection and rules prohibiting most stock sales, the CSI is down almost 8%.

The Fed Funds futures market rallied sharply on Friday and is now pricing in a 25bps rate cut by July and another 25bps by the end of the year.

The Chicago PMI Manufacturing Index fell sharply to 42.9 versus expectations of 48.9. The index has been below 50 (signaling economic contraction) for 7 straight months. Such a streak has only happened during recessions. One factor adding to the sharp decline is Boeing’s production suspension of the 737 Max. Further, Boeing’s headquarters are in Chicago. Interestingly, the much less followed Milwaukee PMI index is now above 50 and at its highest level since June. Looking ahead, surveys such as these will become tougher to assess as they could be greatly affected by the Corona Virus.

Consumer sentiment continues to rise. The University of Michigan index rose from 99.1 to 99.8. Hopefully, high sentiment continues to result in consumption and offsets manufacturing weakness.

January 31, 2020

Q4 GDP matched consensus estimates of +2.1%. There are, however, a few items that concern us. First, the price index rose by just 1.4% versus 1.8% last quarter and an estimate of +2.0%. In regards to longer-term economic growth prospects, companies are reducing investment. After a short surge following the corporate tax cuts, corporate investment (non-residential investment) has fallen for three straight quarters. The last time that occurred the economy was already in a recession. Lastly, 1.3% of the GDP increase was due to trade. In particular imports of foreign goods fell sharply by 11.6%. This was in part due to tariffs, but it also points to a slowing of domestic consumption. To wit, personal consumption expenditures only contributed 1.2% to GDP, as compared to a running rate of 1.85% for the last three years. Healthcare accounted for over a quarter of personal expenditures.

Jobless Claims came in at 216k, providing little confirmation to private labor reports showing weakening.

BMW is halting auto production in China. Airlines are reducing and/or suspending flights to and from China. Apple is trying to move production from China.   These corporate actions and many others like it will impair corporate earnings and reduce economic growth for not just China but for the world.

Tesla rose over 10% on Thursday and now has a market cap equal to GM, Ford, and Chrysler Fiat combined!

One of our investment themes for 2020 is to remain cognizant that the market risks greatly outweigh the rewards. This is based in part on equity valuations that are stretched to levels previously seen before major drawdowns and the record length of the current economic expansion. Just because the risks outweigh the rewards doesn’t mean we need to hide in investment shelters and wait for the storm. However, it does mean we must pay close attention to the known risks and try to think outside of the box and understand the potential unknown risks.  To that end, we share a great article from Morgan Housel: Risk Is What You Don’t See.

January 30, 2020

The Fed left rates unchanged as expected, but they did raise the IOER rate by 5 basis points. IOER is the interest rate the Fed pays banks to retain excess reserves. By hiking the rate they will marginally reduce liquidity in the overnight markets and in doing should push the Fed Funds rate higher towards the mid-range of the Fed’s target. Other than changing the date and some members’ names, only two words were changed from the prior December meeting statement. Both changes were of little consequence. The Fed also extended repo operations through April, as was expected.

Here are a few takeaways from Chairman Powell’s press conference:

  • Jerome Powell mentioned the Fed is monitoring the spreading of the Corona Virus and related economic implications but seemed little phased at the prospect of slower economic growth due to the virus.
  • In regards to QE guidance, he stated: “We need reserves at all times to be no lower than they were in early September. I would say around $1.5 trillion… That will be the bottom end of the range.”  Currently, excess reserves sit just under $1.5 trillion.
  • Powell dodged Steve Liesman’s (CNBC) question about whether QE was driving stock market gains.
  • Powell was asked about inflation target averaging, whereby they would aim for a higher inflation rate after periods of lower inflation. Like the prior bullet point, he danced around the question and did not provide an answer.
  • The Fed believes global economic growth is rebounding as some uncertainties such as trade and BREXIT have been somewhat resolved.
  • He said that credit and stock asset valuations are “somewhat elevated” but not at extremes.  Based on many popular valuation techniques, “somewhat” must be a code word for “extremely.”

Despite a rapid increase in Corona Virus infections, the U.S. stock market seems willing to discount the possibility of any economic slowdown. In China, they are not as sanguine. The Chinese government said “(the) impact of Corona virus on China’s economy could be significantly bigger than that of SARS outbreak.” A Chinese government economist quantified the statement by saying that Q1 growth may fall below 5%. In the latest reported quarter, GDP grew at 6%.  Today’s Chart of the Day compares the S&P 500 performance during prior virus outbreaks. If this outbreak could be “significantly” bigger than SARS, the market may want to reconsider its stance. They may also want to consider that China is a much bigger economic power than when SARS hit in 2003. China’s GDP is now over 15% of the world’s economy as opposed to 4% in 2003.

January 29, 2020

Economic data on Tuesday was mixed. The headline Durable Goods number was strong but predominately due to a massive increase in defense aircraft new orders. Excluding transportation and military orders, the data was decidedly weak as shown by Core Capital Goods, which were down 0.9%. Consumer sentiment surged higher, as did the Richmond Fed Manufacturing Index. This is the first strong reading in a manufacturing index and possibly indicative of a rebound in the sector.

After yesterday’s close Apple released a strong earnings report. Both revenues and earnings easily surpassed estimates. They also upped their estimates for both sales and earnings for the next quarter. The stock is trading up 1.8% after hours, which is giving the S&P a boost as well.

The 3 month/10 year Treasury yield curve inverted for the first time since October. The Fed expressed concern over yield curve inversions last fall and helped drive their decision to do QE in addition to repo operations. The question for the Fed as they meet today is will they act upon inverting curves again. It is very unlikely they announce anything today, however, they may mention it in their statement and put the markets on warning about future policy actions.

As you may recall, we added AGNC, NLY, and REM to our portfolios in mid-2019 in anticipation of a steeper yield curve. The yield curve did steepen and we benefited with solid price gains and double-digit dividends. We recently sold half of AGNC as its price was over-extended. We do not have immediate plans to sell the remaining holdings as they have been holding up well despite the curve flattening. We are paying close attention as further yield curve inversions will harm their bottom lines.

In just the last few days copper has fallen nearly ten percent in reaction to the Corona Virus. China is world’s largest consumer of copper. The price is dropping in anticipation of reduced demand and slowing global economic growth. The CRB index (a basket of commodities) and crude oil are also down about ten percent over the same time frame due to similar concerns.

The corporate junk bond ETF HYG saw an outflow of $1.4 billion on Friday, accounting for almost eight percent of the fund. While we are not overly concerned, it’s worth following as junk debt and equities tend to be highly correlated.

January 28, 2020

China’s financial markets will extend their Lunar New Years holiday vacation by three more days to February the 3rd due to the Corona Virus. Since the outbreak, the Chinese Yuan (offshore) has depreciated from 6.85 to 6.98 versus the U.S. Dollar. The decline has now erased all of the gains that came on the heels of the Phase One trade agreement. Even if the virus is eradicated shortly, it will put a temporary clamp on its growth rate. Given that China is the driver of marginal global GDP growth, how will its slowdown affect the rest of the world’s economy?

In addition to the virus, there will be a good amount of economic data this week plus the Fed’s FOMC policy meeting on Wednesday to drive the markets. Today at 8:30, Durable goods will be released followed by Consumer Confidence at 10 am. On Thursday, the BEA will release Q4 GDP. The current estimate is for an increase of 2.1%, which would be in line with the prior quarter. The Atlanta Fed’s GDPNow currently forecasts +1.8% growth. Friday will see the releases of Chicago PMI and the University of Michigan Consumer Sentiment report. We think it is too early for the effects of the Corona Virus to alter any of the data this week or likely data released over the next few weeks. However we might see the Fed comment on it, and there is a possibility some corporations may provide warnings in their quarterly corporate earnings reports. In particular, we will pay attention to Apple’s earnings call on Wednesday, as they are doubly affected due to the manufacturing and consumption of their products in China. China accounts for nearly 20% of Apple’s revenue.

The following was from this past weekend’s Barrons: “.. the Fed’s balance sheet has stopped expanding since the beginning of the year and actually contracted by some $25B in the week ended on Wednesday. .. It’s probably coincidental that the stock market has stumbled, but it bears watching.” 

We doubt its coincidental.

January 27, 2020

The S&P 500 is currently down 45 points on rising concerns over the rapidly spreading Corona Virus. This follows a 0.87% decline on Friday, the largest one-day loss in almost two months. While the virus is a growing concern and may potentially impact economic growth, we also believe an important reason for the selloff is the grossly overbought conditions and run away investor sentiment. As we have written, the market is well overdue for a correction, it was just looking for a reason.

This will be the busiest week in terms of earnings reports. Of note are the two stocks driving the market higher, Apple and Microsoft. Apple will release earnings on Wednesday afternoon and Microsoft on Thursday.

For the most part, retail stocks have reported weaker than expected earnings and many have issued poor earnings guidance. Amazon’s earnings on Friday will help us better assess if retail is slumping because more sales are going online to Amazon and others, or if the consumer is slowing down.  On a quarterly basis, real, inflation-adjusted, retail sales are negative. This is only the second time this has occurred since the recession a decade ago.

If it appears that the recent rally is an anomaly, your thoughts do not deceive you. The graph below shows that recent returns divided by annualized volatility (risk) have been running higher than at any time since the financial crisis. This standard calculation of return per unit of risk is technically called the Sharpe Ratio. The ratio has been sitting around 2.0 for most of January. To put that into context, the current reading is about 4 sigmas (standard deviations) from the norm, an event that should statistically occur in one day out of every 43 years. Since January first, there have been 5 daily readings that were greater than 4 sigmas!

January 24, 2020

The Chicago Fed National Activity Index fell to -0.35 from +0.41 last month. This index is a weighted average of 85 measures of economic activity. A negative level means economic activity is below trend. A reading of +/- 1 corresponds to one standard deviation. Accordingly, we are only about a third of a standard deviation below trend, which is not concerning. This index tends to fluctuate from month to month, so we do not read too much into monthly data points. However, a reading below -1 would cause us to take notice. Since the mid-1960s all seven recessions were preceded or accompanied by a sub -1 reading. There were only three times the index went below -1, and a recession did not occur.

The Conference Board’s Leading Economic Indicators (LEI) fell by 0.3% versus last month despite the contribution of the surging stock market. On a year over year basis, it is only up 0.1%, the lowest level in over ten years.

Today’s Chart of the Day shows that maybe there are limits to the benefits of QE, at least as far in its ability to manipulate interest rates. The chart compares the yield on German 10-year Bunds, the most liquid of euro bonds, to the size of the ECB’s balance sheet.  The data appears to slope upwards, denoting that larger balance sheets drive rates lower. The problem occurs when rates get near and through zero, the correlation of rates and balance sheet seems to disappear.

The graph below shows that the Fed’s balance sheet has declined slightly in January.  The decline is due to repo balances (overnight and term) declining more than QE (T-Bills in red) can make up for.

January 23, 2020

Per Fox Business News, Trump said, “we are going to be doing a middle class tax cut, a very big one.” “We will be announcing that over the next 90 days.” While a tax cut would spur GDP growth as the corporate tax cut did, we must consider that he would need the support of the House, which given the upcoming election, seems unlikely to help the President in any way.

The Bank of Canada, which was the only of the major central banks with a hawkish tilt, reversed course yesterday.  They expressed concern about their economy, which has slowed in recent months. While they didn’t lower rates, they did drop language about the current interest rate being appropriate. The Canadian economy is much smaller than the U.S. economy ($1.7 trillion vs. $21 trillion), but the economies are well correlated. Canada is America’s second largest trade partner right behind China and ahead of Mexico.

Bob Prince, CEO of Bridgewater, the world’s largest hedge fund, declared that the economic boom/bust cycle is over. Unfortunately, we think Mr. Prince is grossly underestimating the effects of massive and unprecedented monetary and fiscal stimulus that is being employed to keep the economy stable.

January 22, 2020

It will be a quiet week in regard to economic data and Fed speakers. Of interest will be Jobless Claims and Leading Economic Indicators (LEI) on Thursday. Voting members of the Fed will not speak publicly for the next week and a half as they just entered a blackout period preceding the January 29th FOMC meeting.

Last week we discussed the surge of Tesla’s stock price in the Daily Commentary and presented a Chart Book showing similar trading patterns that were witnessed at the tail end of the 1999 dot-com boom. Tesla is not the only stock today that seems to have caught the fever and is rising purely based on momentum and short covering. Beyond Meat (BYND) rose 18% yesterday and is now up 82% in just the first 20 days of January. While it’s tempting to “gamble” on these stocks, we must keep in mind their behavior is not indicative of a healthy market and, importantly may be sending a strong message about the future.

The CDC announced the first U.S. case of the Chinese coronavirus that has killed 6. This is certainly not something to panic over, but we do suggest paying attention to it as rapid spreading of the virus in China and/or the U.S. could certainly alter economic activity.

Commodities have performed poorly versus a traditional stock/bond portfolio since the Financial Crisis. Recently we have discussed the potential for a weaker dollar and with that the potential to increase our exposure to commodities. As the graph below shows, other asset managers are slowly following suit. Currently, as circled, the percentage of managers who are “overweight” commodities is approaching 10% and sits at an 8 year high. It’s too early to say the commodity rout is over, but it is an encouraging sign for the commodity sector.

January 21, 2020

In Friday’s JOLTS report, the BLS stated that job openings fell sharply. The chart below shows the concerning trend in the year over change in job openings.

 

 

 

Housing starts surged 16.9% led by multifamily (5+ units) starts, which were up nearly 75% versus last year. This huge print appears to be a seasonal quirk and we caution not to read too much into this singular data point.

President Donald Trump will nominate Judy Shelton and Christopher Waller to the Federal Reserve Board. Judy Shelton is an MMT advocate and has publicly called for interest rates to be brought down to zero. When her name first came up last summer, the Washington Post quoted her as follows: “(I) would lower rates as fast, as efficiently, and as expeditiously as possible.”  For a more in-depth discussion of Shelton and the Fed, we share a link to Shelton, The Fed, & The Realization of a Liquidity Trap, an article we published in July 2019.

The graph below shows that global central bank balances are now at a new all-time high after rising steadily since September. The Fed has certainly played a large role in the increase. Since September, the Fed’s balance sheet has grown from $3.76 trillion to $4.15 trillion.

 

 

 

 

Strange fact of the day from Eddy Elfenbein (@EddyElfenbein)

“S&P 500 closed above 3,300 for the first time ever. If you’re into numerology, the index first broke 330 in 1987, meaning 33 years ago, and it first broke 33 in 1954 which was 33 years before that. I don’t know what it means, but that’s a lot of 3s.”

January 17, 2020

S&P futures are pointing to another gain this morning on the heels of yesterday’s 27 point rise. Interestingly the S&P is up over 50 points on the week, and yet the VIX (volatility index) is flat. While the index is historically low at 12, it did fall below 10 before the surge in January of 2018 and the subsequent sharp decline that followed. That period feels similar in many ways to the current market run. Recent stability despite the rising market, tells us some investors are bracing for a correction.

Economic data was relatively strong yesterday. Jobless Claims fell back to 204k from last month’s 214k. The Philadelphia Fed Business Outlook Survey soared to 17 from a prior level of 0.3 and an estimate of 3.0. Retail Sales met expectations growing .3% last month and in line with the prior month. More impressive, the core retail sales, excluding gas and automobile sales, rose .5% as compared to a decline of .2% last month.

As we have been writing about for months, private surveys of the job market continue to show a weakening in the labor market, but most of the official government data from the BLS fail to confirm these reports. Tomorrow the BLS will release JOLTS containing information on job turnover. This indicator tends to lead claims and payrolls data slightly.

Alphabet Inc (Google) saw its market cap surpass $1 trillion yesterday, joining Apple ($1.38t) and Microsoft (1.27t) as the only U.S. companies with trillion-dollar market caps.

 

January 16, 2020

On Tuesday, the Wall Street Journal ran a story called Hedge Funds Could Make One Potential Fed Repo-Market Fix Hard to Stomach.

Beneath the header it says, “Federal Reserve officials are considering a new tool to ease stresses in the repo market.” Our takeaway is that while the Fed acknowledges the risks of too much leverage, they also understand the potential market stresses if leverage to hedge funds is reduced. As such the Fed is looking into making repo trades directly with hedge funds.  It seems like a Catch-22 to us.

Details of the Phase One Trade Agreement with China are not being released but we do know that existing tariffs on billions of dollars of Chinese exports are expected to remain in place until after the November election unless a Phase Two agreement is signed. The odds of a second agreement seem small as more complicated and controversial issues like IP and human rights are slated for that deal.

We have overused the words “overbought” and “overextended” over the last few weeks in efforts to try to describe current market sentiment.  Today’s Chart of the Day shows that equity analysts appear to be upgrading stocks on the basis of price gains and not fundamentals.

There have been a large number of Fed members speaking over the last few weeks of which none have linked asset prices with the Fed’s balance sheet. Yesterday, Dallas Fed President Robert Kaplan bucked the trend. The following headlines provide us some hope that the Fed is aware that their balance sheet actions are causing distortions in the asset markets.

  • WORRIED ABOUT IMPACT OF FED POLICY ON ASSET PRICES”
  • “HOPE WE CAN FIND A PLAN TO TEMPER FED B/SHEET GROWTH

January 15, 2020

Both headline (0.2%) and core (0.1%- ex food/energy) CPI came in 0.1% below expectations. The lukewarm inflation data provides further justification for the Fed to keep rates stable.

NFIB (small business survey) continued to trend lower but it still remains near the higher end of the range for this expansion. The graph and table below show the survey’s long term history as well as a breakdown of the ten survey questions asked of small business owners. The decline in job openings and plans to increase employment are concerning as they confirm labor data from other corporate and personal surveys. Small businesses account for over 50% of employment in the U.S.

The Fed announced a slight change to its term repo schedule for February. Each auction will be for $30 billion instead of the current $35 billion. On its own, this action should reduce its balance sheet by about $20 billion.

A subscriber asked us why we keep taking profits and reducing our position in Apple (AAPL). The simple answer is that AAPL is a great company, but its share price is growing well beyond the rate at which earnings and sales are growing. As such, not only is the price technically overextended but it is fundamentally overextended.  We recently wrote an analysis of Coca Cola, whose stock is in a similar situation (Gimme Shelter).

Over the last year, Apple’s earnings per share (EPS) grew by 0.33% while its stock price has risen by 86%. Further, the slight gain in EPS is not due to earnings growth but because the number of shares fell by 9%. Over the last three years, the stock is up 153% and its EPS grew by 46%, but only 21% adjusted for share buybacks.  Due to the surging stock price and relative mediocre earnings growth, Apple’s price to earnings (ttm) has risen from 12 on January 1, 2018, to 26 today. Its P/E sits well above any reading since the Financial Crisis. Simply, Apple’s share price is grossly overextended. We are holding on to a reduced position in Apple solely due to its price momentum. We understand the precarious nature of the recent price action and will sell it entirely when its price falls below our risk limit.

January 14, 2020

Yesterday, it was reported that the U.S. Treasury will lift the currency manipulator tag on China before the signing the Phase One trade deal on Wednesday. As we suspected, currency manipulation on China’s part was part of trade the deal. Since the deal was announced, the Chinese yuan has strengthened versus the dollar which helps increase U.S. exports as U.S. goods become cheaper for the Chinese.

Since the U.S. assassinated Qasem Soleimani on January 4th, asset prices have been volatile. The following bullet points quantify the change in price/yield since the night he was assassinated through yesterday’s close.

  • S&P 500 +45
  • Crude Oil  -2.80
  • Gold -8.10
  • 10yr. Yield  +2.50

Tesla continues to surge, rising nearly ten pct on Monday. Its market cap now stands at $92 billion. To put that into context, the aggregate market cap of GM, Ford, and Chrysler is $111 billion.  Last month GM, Ford and Chrysler sold 640,000 vehicles, Tesla sold 19,000.

Today’s Chart of the Day shows that many S&P 500 companies are entering, or will soon begin, their earnings blackout period in which they can not buy back shares of their stock. Q4 earnings reporting kicks off this week in earnest as the big banks lead the way. Today, JPM, Citigroup, and Wells Fargo report Q4 earnings. Bank of America, Goldman Sachs, and a host of regional banks will follow them on Wednesday and through the remainder of the week. As shown on the graph, almost half of the S&P 500 companies will be unable to buy back shares from this Wednesday through month end due to self-imposed restrictions.

If you want to see when the stocks in your RIA Pro portfolio or our portfolios report earnings, click on the dividend tab to the right of the graph in the Portfolio page, select earnings, and sort as you wish.

 

January 13, 2020

December payrolls increased by 145k, 13k below the estimate of 158k. After last month’s surge in job growth, payrolls are back in line with the recent trend and ADP data. As such, we can confirm that last month’s gain of 256k jobs was an aberration largely due to seasonal adjustments. Weak earnings and average workweek data from Friday’s BLS report also confirm this. Average hourly earnings rose 0.1% monthly versus estimates of 0.3% and increased 2.9% year over year versus an estimate of 3.1%. The average workweek also fell short of the consensus estimate.

Next week a new round of inflation data (CPI and PPI) from the BLS will be released. Also of interest will the December Retail Sales data. Currently, expectations are for a 0.2% increase and 0.1% excluding auto sales. As we saw this past week, there will be a large number of Fed members speaking at various events. The next Fed meeting will be in two weeks on January 29th.

The graph below caught our attention. Based on CrossBorder Capital’s model, recent Fed repo and QE operations have resulted in the largest percentage change in liquidity since at least 1970. What’s mind-boggling about these actions is that the Fed has yet to rationally explain why they are supplying so much liquidity, especially since we are not in a recession.

January 10, 2020

In our quest to better appreciate the divergences in employment indicators and assess the health of the jobs market, jobless claims threw a curveball at us yesterday.  On the positive front, the BLS initial jobless claims number fell to 214k from 223k which reduced the four-week moving average back into the upper bound of its recent range. Of concern, as shown below, continued claims have been on the rise and now sit at levels last seen almost two years ago. The claims data tells us that workers are not getting laid off at a high rate, but those workers laid off are having more difficulty finding new jobs.

Today’s employment report will shed more light on the jobs market. Expectations are for payrolls to increase by 158k and the unemployment rate to stay at 3.5%. Our model predicts that payrolls will grow by 123k.

Fed Vice Chair Clarida stated, “the Fed will adjust details of repo operations as appropriate, though ongoing purchases may be needed at least through April.”  Since September, the Fed has added $424 billion to its balance sheet. $255 has been via repo operations and the remaining $169 is in Treasury Bills (QE). The Fed has committed to adding $60 bln per month in Bills to their balance sheet (QE) through April. Between today and late April/early May they will purchase about $240 billion in Bills which in theory will replace repo operations.  This is likely the math backing Clarida’s statement. The problem with that calculation is that if  repo is replaced by Bills (QE) then the Fed’s balance sheet will stay the same size for the next few months. Two questions come to mind with that prospect. First, is the funding issue that cropped up in September resolved or at least fixed enough so that the Fed does not need to increase its balance sheet? Second, will the stock market keep levitating if the Fed’s balance sheet stops growing?

A study from Deloitte (link) claims that “97% of CFOs say a downtown has either begun or will begin in 2020“.   This is somewhat confirmed in the latest quarterly Conference Board CEO Confidence Survey, which reported a weak bounce from Q3 2019. While the index is higher than the last quarter, the fourth quarter of 2019 is lower than any other quarter since the recession of 2008.

January 9, 2020

Yesterday, stocks took out the record highs which occurred prior to the Iranian assassination. Investors appear content that the skirmish with Iran is now in the rearview mirror. Two factors are supporting this view. First, it is widely believed that Iran purposely missed hitting the U.S. bases on Tuesday night. Second, Trump’s speech yesterday was very conciliatory and supportive of peace.  Fortunately, the situation has eased greatly, but we must be careful and not be too complacent, as it will not take much to strike up tensions again.

ADP reported that December payrolls increased by 202k, 45k more than estimates. The two month average, which evens out seasonal holiday quirks, is 134.5k, about 30k below the 2019 average.  Consensus expectations for Friday’s BLS Payrolls report are for a gain of 155k jobs, which would put the BLS two month average about 25k above the 2019 average. For what its worth, an increase of 100k would bring the two month average in line with the year to date average.  Our employment model based on ADP and the ASA temporary staffing index forecasts a 123k gain in payrolls for December.

Yesterday, we discussed using the rate of change over longer periods versus monthly changes to appreciate changing patterns better. Today’s Chart of the Day shows the sharp deterioration in the ADP report occurring in later 2018 and throughout 2019. It is worth adding the ADP job gains over the last 12 months are the lowest since 2010.

The repo situation is getting more interesting by the day. Yesterday, the NY Fed conducted an auction for $47 billion in overnight repo that was met with $120 billion in demand. This is a warning that the Fed is not meeting growing demand and repo rates may start rising again. Thus far rates have been stable.

The following quote from Lisa Shalett, CIO Morgan Stanley Wealth Management, caught our attention.

“This is a market looking through fundamental data, looking through corporate guidance and data points, looking through Fed guidance itself”… “It is a market that wants to go up in the short term. That is what makes it so profoundly dangerous.”

 

 

January 8, 2020

Another crazy night of trading is in the books. S&P futures fell over 40 points on Iranian missile attacks on two U.S. Army bases. After Trump tweeted “all is well” and reports that there were no casualties surfaced, the markets reversed course. Currently, futures are up 6 points. Bonds, gold and oil which were up significantly last night, gave back most of their gains.

The ISM Services Index rose to 55 from 53.9 as the service sectors continue to do well. Of concern, however, this data point is similar to Jobless Claims in that the absolute reading is relatively strong, but the rate of change is declining. The graph below, courtesy of Brett Freeze, shows that the decline on a year over year basis is approaching levels seen before the last two recessions. Using the rate of change over longer periods versus absolute comparisons over shorter periods can help spot trends that are not evident on the surface.

The last two daily Fed’s repo operations were oversubscribed with larger amounts being transacted than the prior few weeks. This bears watching to see if the Fed’s removal of the extra liquidity they provided over the turn of the year is starting to cause problems.

China appears to be dragging their feet to sign the Phase One trade agreement, which is scheduled for January 15th. It is unclear at this time if the activity in Iran/Iraq will provoke China to take a different stance.

We have been asked a few times about our thoughts on shorting Tesla (TSLA) stock. The answer is worth sharing with a broader audience.

The stock has doubled in price from 230 in early October to 470 today. This run-up is likely the result of a short squeeze driven by momentum traders. At today’s closing price, Tesla ($85bn) is worth more than Ford ($36bn), GM ($49bn), and BMW ($53bn) to name a few auto producers. In regards to shorting Tesla, our answer is a definitive NO! It certainly appears grossly overvalued but given market conditions and the rampant FOMO in certain stocks, the rally can continue. On the flip side, a large decline is also possible given its overextended technical and fundamental status.  Unless you have an iron stomach, this is one to follow from the sidelines.

 

 

January 7, 2020

Yesterday, the S&P 500 was down over 20 points in the morning on Iranian concerns yet rallied to close the day up 11 points. While fiery rhetoric continues from Iran and President Trump, the market seems to be discounting the odds of any significant military action. Since the assassination on Thursday, the S&P 500 is down less than 1%. Gold and Oil provided mixed messages on Monday. Oil fell over $2 a barrel from its highs to close down slightly while gold ended up over 1% on the day.

On the economic data front employment will take center stage. On Wednesday ADP will release their employment report, Jobless Claims will follow on Thursday, and the all-important BLS Labor Report will be released Friday. Last month there was a massive divergence between the ADP and the BLS reports. ADP reported a 67k increase in payrolls while BLS was well above expectations showing a gain of 266k. Seasonal adjustments due to Thanksgiving and Christmas likely played a big role in the large difference. We suspect the divergence will be normalized over the next month or two.  Also of interest this week will be today’s release of the ISM-Services Index and Factory Orders.

Last Saturday, Ben Bernanke gave a speech in which he discussed monetary policy and specifically how the tools used to fight the Financial Crisis might work in the next recession. In his opinion, the combination of QE, low rates, and forward guidance are effective to stymie a recession. He cautioned the Fed should not rule out the possibility of using negative interest rates in a recession, as is being done in Europe and Japan.

Of particular interest to us was the following: Monetary easing does work in part by increasing the propensity of investors and lenders to take risks.”

Bernanke is essentially saying that aggressive Fed policy works because it incentivizes those with capital to take risks. While true, he fails to recognize that much of the risk is in speculative financial assets and not in the real economy. As such, the markets boom while the productivity of the real economy suffers. Essentially he is arguing for a continuous feedback loop in which we sacrifice future economic growth for higher asset prices.

January 6, 2020

The ISM Manufacturing Index was weaker than expected at 47.2 versus the consensus estimate of 49, and a reading of 48.1 last month. All of the 60 estimates by leading economists predicted a higher number than the actual print. 47.2 is the lowest reading since June of 2009. Of concern, the employment sub-index slipped further from 46.6 to 45.1. The following table from ISM provides information and the current trends for each respective sub-index.

 

 

 

 

 

 

 

On Friday, the Fed released the minutes from their December 11th meeting. The minutes provided more color on the ongoing repo and QE programs. For starters, they finally acknowledged that QE could expand in scope and include purchasing longer-term assets. To wit: “the Federal Reserve could consider expanding the universe of securities purchased for reserve management purposes to include coupon-bearing Treasury securities with a short time to maturity.” A few Fed followers believe this QE instance is not QE because the Fed is buying short term Bills instead of longer term notes. Will this change their minds?

The Fed also alluded to transitioning away from repo operations starting in mid-January as QE will supply “a larger base of reserves.” The Fed didn’t say it, but they will likely have to do QE beyond April or they risk reducing liquidity in the markets.

Over the last few months, many investors bought stocks because history told them that they didn’t want to miss out on “easy” gains that accompany QE. Many of these “investors” are weak hands meaning they have little conviction and likely little threshold for losses. It is worth remembering this as any further escalation of the Iranian conflict has the potential to cause these investors to sell which could become problematic if it happens in a relatively short period.

January 3, 2020

Last night and this morning stocks gave up yesterday’s gains and then some on the assassination of Qasem Soleimani, head of the Iranian military wing Islamic Revolutionary Guards- Quds Force. Crude oil is up nearly 4% or $2.20 per barrel, ten year yields down 0.06%, and gold is $20 higher. Fear of retaliation and escalation will likely weigh on the stock market and keep a bid under oil, gold and bonds for the foreseeable future.

The S&P 500 rose sharply yesterday despite any news of consequence. The internals of yesterday’s move was odd, suggesting the rally was due to portfolio repositioning for the New Year. Likely, any positions that were sold in the prior few weeks for tax purposes, risk reduction, or window dressing were bought back yesterday. Small caps, large-cap value, and defensive sectors, in general, were lower despite the broader market surging nearly 1%. Four of the eleven S&P sectors were substantially lower. Over the next few days and weeks, we should learn if the move is one time in nature related to the New Year or if investors have a renewed hunger for growth and momentum stocks.

China started off the New Year with economic stimulus via a reduction in reserve requirements for banks. The action allows banks to hold fewer reserves per loan and therefore encourages banks to lend more.

Jobless Claims fell slightly from 224k to 222k. The four week moving average, however, continues to rise and now sits at a nearly two year high.

The ISM manufacturing survey will be released at 10 am this morning. Expectations are for the index to rise to 49 from 48.1. While an improvement, a reading below 50 signals economic contraction in the manufacturing sector. The lesser followed PMI Manufacturing Index continues to signal economic expansion, coming in at 52.4, versus expectations of 52.6. PMI is an outlier as many of the regional manufacturing surveys are pointing to contraction in the sector.

The Fed’s balance sheet should shrink in the coming weeks as the one-time year-end repo operations will roll off the books. In time, the decline should be reversed as the Fed is still expected to buy $60 billion of short term assets (QE) through April.

Today’s Chart of the Day removes the stock market from the Index of Leading Economic Indicators (LEI). As shown, the index, excluding stocks, just dipped below zero on a year over year basis. The last two times it fell below zero, a recession followed. Stocks are an important component of consumer and corporate confidence. As long as the market avoids a series downturn, the likelihood of a recession is reduced. We have little doubt that the Fed clearly understands this construct.

 

January 2, 2020

Buckle up, the stock market may see a big move today.  As shown below, since 1930, January 2nd has experienced the largest average absolute percentage price change of any day in the year.

On Tuesday, President Trump tweeted that Chairman Xi and he will sign Phase One of the China/U.S. trade agreement on January 15th. He also said that he would be traveling to China to kick off negotiations on Phase Two soon. As we have discussed, agreement on technology, IP, human rights and other important issues will be much more difficult than the relatively simple Phase One agreement which appears to be largely focused on agriculture and tariff relief. Regardless, we will monitor market reactions to any Tweets and statements from the administration and/or China as to the progress of the new discussions.

Consumer Confidence, as reported on Tuesday, dipped in November. Interestingly, the divergence between near term and future confidence continues to diverge. The present situation component rose and sits near recent highs, while the expectations index declined and is near three-year lows. With weak global growth and declining growth in the manufacturing sectors, the consumer remains the linchpin to economic growth.

In case you missed Monday’s Major Market Buy/Sell Review, we think it is worth highlighting our chart and commentary of the U.S. dollar. As we noted, the dollar appears to breaking lower from a rising two-year channel. Given the importance of the dollar on domestic and global economic activity and inflation, as well as the fact that price trends in the dollar tend to last for lengthy periods, we are assessing and preparing portfolios for the possibility of a prolonged dollar downtrend. In What We Are Not Being Told About The Trade Deal we wrote about the possibility that a weaker dollar is part of the U.S/China trade agreement. In the article, we touched on the correlation between the dollar and various asset classes.

December 31, 2019

The manufacturing industry continues to show weakness with the Chicago PMI report coming in at 48.9, which is above the consensus forecast of 48 and the previous reading was 46.3. Because it increased but stayed below 50, it entails that manufacturing is contracting but at less of a rate than the last reading.

After weeks of slowly melting up in what was expected to be a quiet week of trading, the S&P fell 18 points. Over the last two days, the VIX Volatility index has risen nearly 20%. Volume was very light so we caution not to read too much into yesterday’s decline and rise in volatility as they are likely the consequence of year-end maneuvers.

In the money markets, the night of December 31st is referred to as the “Turn.” This overnight period, starting in one year and ending in the next, is when banks square up their balance sheets to meet stringent year-end regulatory and capital requirements. The turn often sees huge swings in borrowing and lending rates. For instance, it is not uncommon to see Fed Funds and Repo rates collapse to near zero or soar well above normal levels. In fact, there have been years where both happen with the course of hours.

The graph below shows forward Fed Funds trading for this year’s turn. The Fed, through a massive supply of liquidity, seems to have managed an orderly turn. We do not anticipate problems today as the Fed is paying close attention and is willing and able to provide funds to alleviate any stress. CLICK TO ENLARGE

Just a reminder, the BLS will not release employment data on the first Friday of the month, as is customary. It is scheduled for next Friday on the 10th of January.

We wish you a happy and healthy 2020!

December 30, 2019

The low volume stock melt-up will likely continue this week. Of note, however, the VIX (volatility index) rose sharply on Friday and is up again this morning despite the market being slightly higher. It’s hard to tell if the activity is year end position squaring or investors hedging themselves early for potential downside in early 2020 when the Fed’s year-end liquidity programs are curtailed. Regardless, given the extreme overbought conditions and the seemingly steady rise throughout December, a pullback should be expected in January.

The China/U.S. trade deal boosted the price of oil as it hoped that relief of tensions helps resuscitate global trade and economic growth, both of which entail more energy usage. Crude is topping $62 a barrel this morning.

Economic data will be light this week, but of interest will be Chicago PMI on Tuesday and the ISM Manufacturing Index on Friday. Both data points will provide an update on the health of the struggling manufacturing sectors. Based on smaller regional indexes released over the last two weeks, the two indexes may remain below the crucial 50- economic contraction/expansion level.

December 27, 2019

Yesterday, the market closed sharply higher as the end of the year “melt up” continues. The main driver of that rally was the near 5% surge in Amazon (AMZN) on the back of stronger than expected online holiday sales. A couple of months ago we added AMZN to the Equity Portfolio and XLY to the ETF Portfolio in anticipation of this breakout in the stock, however, performance had been disappointing in both until yesterday.

With just three trading days left in the year, the S&P is now set to surpass the 29.6% full year return of 2013 at which point 2019 will be the best year in 22 years, since the 31% return posted in 1997. With the majority of humans out until after New Years, there is little impediment to the algos running the markets higher until the end of the decade.

While the media has continued to use the same strawman of trade optimism to justify the rally, the reality is whatever trade agreement there may actually be, it was priced in long ago. The reality is that the Fed’s $500 billion flush of liquidity into year end to meet short-term funding needs has been interpreted by the markets at “QE” and the rush to benchmark performance into year end is pushing equity allocations, and investor optimism, toward record highs. It is worth noting there could be “payback” after the beginning of the year when gains can be locked in with taxes deferred until 2021.

Speaking of optimism, and outright complacency, the difference (spread) between the high yield (junk debt) CDX index and U.S. Treasury yields has fallen back below 300 basis points. The index measures the cost of insuring high yield debt against default. This extremely low cost of insurance, especially this far into an economic expansion, reeks of complacency and a chase for extra yield as we are seeing in other asset markets.

While we are certainly enjoying the rally, just don’t forget “what goes up, eventually comes down.”

CLICK TO ENLARGE

December 26, 2019

Stocks are set to open slightly higher, based in part on reports from MasterCard of strong online retail holiday sales.

Jobless Claims, released at 8:30 are expected to normalize after a two week spike. The consensus of economists expects an increase of 223k.

Complacency as measured by volatility is not solely confined to the equity markets (as measured by VIX) but, as shown below, is rearing its head in the FX markets. Despite ongoing BREXIT discussions and the possibility of negative consequences for Europe, one year historical volatility in the Euro/USD is at the lowest levels since its formation.

December 24, 2019

Stock markets will close at 1pm and the bond markets at 2:00 today for Christmas.

Durable Goods fell 2% versus an expectation of a gain of 1.5%. Excluding transportation the index was down 0.2%.  Despite home builder optimism at 20 year highs, new home sales were weaker than expected. Both data points can be volatile so we caution reading too much into the data.

On Thursday morning the BLS will report on jobless claims, a data series that we are paying close attention to.

With no market to follow this afternoon, we provide you with an interesting article from Bloomberg on the quality of jobs in the labor market. The article helps better explain why wage growth has been weak despite the unemployment rate at 50 year lows. The Jobs Market Isn’t as Healthy as It Seems.

We wish you a Merry Christmas and happy holidays. We will be back on Thursday.

December 23, 2019

China announced they would reduce tariffs on over 850 goods. Markets are up slightly on the news as it was already rumored that tariff relief on U.S. imports to China would be part of the Phase One deal.

The Fed’s balance sheet increased by $43 billion last week (Thursday to Thursday) which annualized, is growing at a pace of $2.2 trillion a year, or a 50%+ increase in the balance sheet.

Consumer spending matched expectations, growing at +0.4% monthly, while Personal Income surprised to the upside (0.5% versus 0.3% expected).

The New York Fed’s GDP Nowcast, a forecast of Q4 GDP growth, increased from +0.69% to 1.32%.

Today’s Chart of the Day shows one of the reasons for the stress in the overnight funding markets. Commercial banks have had to help fund the massive surge in Treasury debt issuance which in turn, forced them to allocate less of their funds toward other loan products such as repo. To put Treasury issuance in context, over the last 12 months the amount of publicly traded Treasury securities has grown by $1.64 trillion. That compares to an average annual issuance of $600 billion during 2018.

Barring the emergence of a large buyer of U.S. Treasuries, this crowding out effect should continue until the Fed can permanently add reserves to bank balance sheets. This is why many, ourselves included, believe that the Fed will eventually buy longer term Treasury notes and bonds to replace maturing repos and short term bill purchases (QE4).

 

December 20, 2019

The Philadelphia Fed Manufacturing Index was weaker than expected at +0.3% versus an estimate of +8.0 and prior reading of +10.4. Due to the timing of this survey, following the Phase One trade agreement, it is not reflective of the current mindset of those executives that were surveyed.  Any benefits from the agreement should become evident in the January round of manufacturing surveys.

The Leading Economic Indicators Index was up 0.1% year over year. Since 1970, every time the indicator fell below zero, a recession followed. The index would probably have been below if not for the rising stock market, which is a key input.

Weekly Jobless Claims fell to 234k from last months elevated 252k. Due to the volatility of the weekly number, economists prefer to focus on the four week moving average. The four week moving average low for the current economic expansion was recorded in April at 201.5k.  Currently the average sits at the upper end of the range of the last two years. On a historical basis, the number is very low, but it is rising.

Today’s Chart of the Day shows that prior to last three recessions, the four week moving average of Jobless Claims spiked higher a month or two prior to a significant decline in payroll growth. As shown the recent increase is barely noticeable, but given the deterioration in non-BLS employment data this bears watching closely as a leading indicator.

At 10am Personal Income and Spending data will be released. This data will provide a good reading on the health of the consumer. Expectations are for income to be flat and spending to be up 0.3%. This implies that credit is being used to fill the gap.

December 19, 2019

The market looks to open flat following the House’s impeachment vote, as it is widely believed it will fail in the Senate.

The November Cass Freight Shipments Index was down 3.3% year over year and now lower for 12 consecutive months in a row. This provides further confirmation of weak global economic activity.

Boston Fed President Eric Rosengren, during a speech on Tuesday, made a statement about asset prices that is worth sharing. He stated: “If you look at the last two recessions, they were not situations where inflation got out of control. They were situations where asset prices went way up and then came way down. So if your goal is to avoid recessions, I think we need to be pretty focused on asset prices not just inflation.

It is widely surmised by investors that the Fed has their back. This statement provides all the more evidence supporting that feeling. We would just ask the Fed to pay more attention to periods like today when asset prices “went way up”, and well beyond normal valuations.

We have written a lot about inflation and how we believe it is underestimated. In this vein, we just stumbled across the Chapwood Index.  Chapwood provides inflation data broken down by each major city and based on the top 500 items that people spend money on in those cities. Based on the index, inflation is running at approximately 10% a year. This figure is in line with ShadowStats which calculates inflation the way the BLS calculated it in 1980. Given, approximately 3% wage growth on average, this discrepancy further helps explain the need for ever increasing amounts of debt and the poor situation many retirees find themselves in today.  Click on the link above to find the inflation rate in your city.

 

 

December 18, 2019

Following two bad monthly prints, Industrial Production rose by 1.1%, slightly above expectations. The GM strike played a large role in the fluctuations over the last three months so we will pay closer attention to this data over the next few months for a better indication of the health of manufacturing. We suspect the trend should be slightly higher due to the Phase One trade agreement, however with Boeing (BA) cutting production of the 737, there may be downward pressure on activity. Capital Economics forecasts that if the Boeing production cut continues through the first quarter, Q1 GDP could be reduced by 0.5%.

The JOLTS labor data showed some improvement with job openings (7.267 million vs estimate of 7.018 million) increasing 3.3% monthly, however they are still down over 4% year over year. We continue to be befuddled by jobs data. Some data has been very strong while other data has been weak. JOLTS is produced by the BLS which in general has produced the more bullish jobs data.

The yield curve continues to steepen, with the 2yr/10yr curve now at+25 basis points. With the Fed on hold, keeping short rates stable, and economic data coming in better than expected we expect the curve will continue to have a steepening bias.

Crude oil broke above the $60 barrier yesterday, however it remains well within its 2019 range ($44-$68). As shown below, from the Major Markets Review published on Monday, oil has cleared the downtrend resistance line from the $75 highs in October of 2018.  The case for crude is getting more bullish, which has inflationary implications.

 

December 17, 2019

Economic data this coming week will be relatively light, but there are a few items worth following. At 10:00 this morning, JOLTs data will provide more detail on the health of the labor market. Job openings have been trending lower in recent months. Just prior at 9:15, Industrial Production data will be released. Of key interest today will be a 12:30 speech by NY Fed President John Williams. The NY Fed manages repo and QE operations, so any information he can provide on the overnight funding stresses and year end operations will be helpful. Jobless Claims and Leading Indicators will be announced on Thursday and Consumer Sentiment on Friday.

As shown below, the European manufacturing sector continues to fall further into recessionary territory. The Eurozone Manufacturing PMI, shown below, has been below 50 for 11 straight months. Within the data set we learned that manufacturers cut jobs to the greatest extent since 2012. Fortunately, Eurozone Services PMI was higher and above 50, helping offset manufacturing woes. Japan and Australia also reported a contraction with PMI manufacturing data readings below 50. We are waiting to see if the Phase One trade agreement will help improve executive outlooks of the manufacturing companies and thereby result in improvement in the sector over the coming months.

CLICK TO ENLARGE

Today’s Chart of the Day shows the surge in the NASDAQ index, which occurred during the last few months of 1999. Most people attribute the massive gain to the final feverish pitch of the dot com bubble. We believe the real culprit was the Fed which added substantial amounts of repo liquidity to the banking sector due to concerns over Y2K and the potential for mass computer malfunctions. These repo funds designed as a buffer for the banking system worked their way to the financial markets. For more please read the following WSJ article from 1999- Federal Reserve Clears Loan Facility Linked To Y2K Computer Problems.

The graph below shows the 10x surge in repo funding during late 1999 and its quick removal shortly after the New Year. Note the recent surge, on the right side of the graph, dwarfs the 1999 experience and that is before an expected $500 billion spike in repo financing over the next week or two. Unlike 1999, we have our doubts as to how quickly the graph normalizes, as the Fed continues to underestimate the scope of the growing overnight funding issues. CLICK TO ENLARGE

To quote Yogi Berra “deja vu all over again.

 

 

 

December 16, 2019

The takeaway from the ongoing trade saga again is that Phase One appears to be finally agreed upon. As such, existing tariffs will remain in place and the new tariffs, expected to begin on December 15th, will be suspended. This seems to be predicated on China buying $40-50 billion of agriculture per year. As mentioned on Friday, the terms are not being announced, so we can only speculate as to what else might be included in the agreement. We have one opinion, that could greatly affect the asset markets, which we will share with you in a RIA Pro article coming shortly.

In case you are worried that the President will not be able to push the markets higher with daily trade related tweets now that Phase One appears to be done, he announced that negotiations on Phase Two with China will begin immediately.

Retail Sales were weaker than expectations coming in at 0.2% versus expectations for a 0.5% increase. More concerning, core retail sales (ex. autos and gas) were flat versus a +0.4% expectation.

We learned on Friday that for the first time since 2009, the number of people collecting unemployment insurance increased.

With Boris Johnson’s landslide victory in the UK elections it seems all but certain that Great Britain will leave the EU by January 31st. Terms remain to be negotiated, but based on the overwhelming support Johnson received, he has the backing of Parliament and the country to proceed.

December 13, 2019

Right after the stock market opened, President Trump tweeted the following: “Getting VERY close to a BIG DEAL with China. They want it, and so do we!”  And with that tweet stocks zoomed higher. The deal was confirmed later in the day, although it is being reported that no details will be released and there will be no signing ceremony. Rumors are China will buy up to $50 billion in agricultural goods in exchange for no increase in tariffs. The chart below shows that $50 billion is significantly more than China’s purchases of US agriculture over the last decade. CLICK TO ENLARGE

Long term bond yields rose sharply as a trade deal means further Fed stimulus is less likely as economic “uncertainty” will diminish. The yield curve steepened yesterday on the trade deal announcement and is further helped by the Fed’s new stance on inflation. Because the Fed is wanting for more inflation, the market  is pushing longer term yields higher, while short term yields remain tethered to the Fed’s Feds Funds Rate which is unlikely to rise or fall in the near term.

Lost in the trade news was weak economic data. Jobless Claims surged higher from 203k to 252k. It is worth reiterating that this data point is volatile and we should not make any presumptions based on one weekly reading. However, the increase is big enough to take notice, especially given signs of labor weakness in corporate and consumer surveys.

PPI, was weaker than expected, posting no change on a monthly basis and a 0.2% decline in the core (ex food and energy) reading of producer inflation. Retail Sales will be released at 8:30 this morning. The current estimate is for a gain of 0.5%, following last month’s 0.3% rise. This number is one of the key indicators used to assess the health of the consumer. As noted, personal consumption has largely offset weakness in other sectors of the economy. Consumption accounts for nearly 70% of GDP.

The Fed announced plans to provide an additional $365 billion of repo funding that will cover banks over year end. Typically year funding can be tight due to year end capital requirements. The Fed must concerned that this year end could be particularly troublesome.

 

December 12, 2019

Headline CPI came in one-tenth of a percent higher than expectations at +.3% monthly, and +2.1% year over year. Core CPI, excluding food and energy, was as expected at 2.1%. Given the Fed is taking a more pro-inflationary stance then what we have witnessed over the last few decades, this economic data point is less relevant than it had been. They will largely turn a blind eye to inflationary pressures that may arise, especially when inflation running below 2% as it is.

As expected the Fed left rates unchanged. They did make a few noteworthy changes that are worth mentioning. For one, the Fed removed the term “uncertainties” in regard to their outlook. Also of note 13 of the 17 Fed members predict no rate changes in 2020. Interestingly, the other four think the Fed will hike rates next year.

“We can sustain much lower levels of unemployment than had been thought and that’s a good thing because we don’t have to worry so much about inflation. The quote from Powell in his post meeting press conference provides further evidence that the Fed believes they can push on the economy harder without fear of employment causing inflation. Given that we are at 50 year lows in unemployment and inflation is scant tells us either unemployment isn’t as low as reported, or this time is different.  We doubt this time is different.

In general, Powell reiterated the minutes from the Fed meeting in stressing that the Fed is not concerned with the economic outlook. He also mentioned, that if needed, the Fed would purchase longer term Treasury securities making the current QE operation more permanent. The media avoided asking him tougher questions on the repo funding issues or QE4 operations and the questions they asked were largely swept under the rug by Powell.

The dollar was weaker while stocks, gold, and bond prices rose, telling us that the market interprets the press conference and meeting as dovish.

December 11, 2019

Zoltan Polzar, a well followed Fed and Banking analyst at Credit Suisse, is making headlines in regards to his thoughts on the Repo funding situation. He claims that reserves and regulatory constraints are “shaping up to be a severe binding constraint.” To paraphrase- The Fed’s repo and QE4 operations, as currently being administered, are papering over a much bigger problem. He thinks the Fed will be forced to do much more extensive QE before year end.

This morning we published our thoughts on the topic- When It Becomes Serious You Have To Lie – Update on the Repo Fiasco.

In part due to skyrocketing pork prices, food prices in China have risen 19.1% year over year. In addition to hurting consumers, inflation makes monetary stimulus harder for the Bank of China to administer as it is inflationary. From a trade perspective, consumer inflation will likely be one factor that pushes Chinese leaders to come to some sort of Phase One agreement. Not surprising, there were numerous press releases yesterday claiming that a delay of the December 15th tariffs is a strong possibility.

The Fed will report on monetary policy at 2pm, followed by Jerome Powell’s press conference at 2:30. Given the new attention to repo funding and QE, we will be on the look out for any changes to their daily repo/QE4 liquidity operations or proposals for how they might address the issues in the near future. We suspect the media will ask a lot of questions on this topic.

CPI will be released at 8:30 and the current estimate is for a 0.2% increase both in the core (ex food/energy) and the headline number.

 

December 10, 2019

The Bank of International Settlements (BIS) reported that the overnight repo problems of the last few months might stem from the reluctance of the four largest U.S. banks to lend to some of the largest hedge funds. The four banks are being forced to fund a massive surge in U.S. Treasury issuance and therefore reallocated funding from the hedge funds to the U.S. Treasury.  Per the Financial Times in Hedge Funds key in exacerbating repo market turmoil, says BIS: “High demand for secured (repo) funding from non-financial institutions, such as hedge funds heavily engaged in leveraging up relative value trades,” – was a key factor behind the chaos, said Claudio Borio, Head of the monetary and economic department at the BIS.

In the article, the BIS implies that the Fed is providing liquidity to banks so that banks, in turn, can provide the hedge funds funding to maintain their leverage. The Fed is worried that hedge funds will sell assets if liquidity is not available. Instead of forcing hedge funds to deal with a funding risk that they know about, they are effectively bailing them out from having to liquidate their holdings.

In addition to the Fed’s monetary policy meeting and press conference on Wednesday, UK elections on Thursday, and the 12/15 China tariff deadline, is a good amount of important economic data slated for release this week as follows:

  • Tuesday: NFIB Small Business Optimism Index- keep an eye on the labor component as discussed below
  • Wednesday: CPI
  • Thursday: PPI and Jobless Claims
  • Friday: Retail Sales

Last week we were amazed by the large gap between the ADP and BLS labor reports. After  some research we discovered that weakness in small business jobs growth is the predominant cause. Because ADP services many small businesses they are quicker and more accurate in reporting changes to small business payrolls than the BLS. The divergence of data is also supported by the NFIB’s (Natl. Federation of Independent Business) employment measure which is also weakening. While the effect on the overall BLS jobs number is not big as it is for ADP, the BLS does show weakness in small businesses. From January to November, the year over year growth in hiring at small employers (1-19 employees) has shrunk from 1.2% to 0.1% while hiring growth at large employers (1000+) has grown from 1.8% to 2.1%. The concern with this finding is that smaller business are more sensitive to business cycles and quicker to react to changes than larger, more bureaucratic companies.

 

December 9, 2019

The BLS employment report exceeded all expectations, registering a gain of 266k new jobs. Of the 50+ economist estimates that comprise the consensus forecast, the highest one called for a gain of 210k new jobs. Also positive, the unemployment rate fell from 3.6% to 3.5%, although that is partially the result of the participation rate dropping from 63.3% to 63.2%. The GM strike resolution added the 41k jobs that were taken away in the prior month.

This will be a busy week. On Wednesday the Federal Reserve meets to discuss monetary policy. No changes to interest rates or the balance sheet are expected but their comments on growth and implications for policy should be informative. On Thursday, Great Britain will go to polls to elect a prime minister. The biggest market mover may be the December 15th deadline on tariffs. We suspect this week will be filled with many official and unofficial comments as well as plenty of rumors. While it appears that some sort of deal is likely to be agreed upon, there is also a decent likelihood that no deal is reached and the trade war escalates rapidly.  Buckle up it should be a fun week.

In numerous commentaries we have discussed the role that the Fed Balance sheet (QE/repo operations) plays in pushing asset prices higher. The following graph puts the current balance sheet expansion into context with the prior episodes of QE. It is truly stunning to consider that QE4 is on the same pace as QE1. QE1 occurred during a recession and with the financial system melting down. At the time major banks and financial companies were in danger of failing. We still have yet to hear a viable rationale for why QE4 was abruptly started. We will have more on this topic in an article coming out on Wednesday.   CLICK TO ENLARGE

 

NEW PORTFOLIO UPDATE:

Due to many requests, we have now added the ability to ADD CASH to the TRANSACTION BASED portfolio.

This is found in the PORTFOLIO TAB / MYPORTFOLIO TRADING

Click To Enlarge Image

 

December 6, 2019

China is supposedly waiving some tariffs on soybeans and pork. This is hopefully a step in the right direction towards a resolution before U.S. tariffs go into effect on December 15th.

Yesterday we discussed the sharp decline and weakening trend in payrolls as reported by ADP.  Jobless Claims bucked the trend and fell sharply from 218k to 203k. The Claims report is making it difficult to figure out the labor market. Private labor market indications such as ADP, NFIB, and various independent surveys point to a definitive weakening trend that the BLS has not picked up on to any large degree. However, it is worth noting that BLS data tends to lag by a few months so we may have to continue to wait for another month or even more to assess which data source is correct. We also remind you that BLS data is sharply revised up and down years after it is first reported. For example, in August the BLS announced that they will revise 2018 payrolls down by 501,000 jobs.

Today BLS jobs report will be released at 8:30. The current expectation is for a gain of 180k jobs and an unemployment rate of 3.6%. That compares to last months readings of 128k and 3.6% respectively. Keep in mind payroll growth was reduced last month by over 40k jobs due the GM strike which has since been resolved. The data report should include the GM jobs which will boost the number by over 40k jobs. The two month total gain will compensate for this and should be correct. Our labor model estimates much weaker growth of 110k jobs.

German Industrial Production fell 1.7% last month and now stands at -5.3% year over year. While some global manufacturing data has turned higher this is not a good sign for global trade.

As shown in Today’s Chart of the Day, the year over year change in both exports and imports is declining. The trade deficit declined from -$51.1 billion to -$47.2 billion as a result of imports declining more than exports.

December 5, 2019

The ADP Employment report was much weaker than expectations coming in at 67,000 versus an estimate of 156,000. That compares to the consensus estimate for the Friday BLS report of 180,000. Our model based on ADP and temporary hiring, estimates the BLS will report payrolls growth of 110,000. For what its worth our model has been within 25,000 of the BLS number on average for the last six months. Even if our estimate is low by 25,000, the jobs number will still be  disappointing. To reiterate a big theme of ours, economic growth has been largely supported by the consumer. Any weakness, or perceived weakness in job growth, is likely to spill over into consumption trends and could be problematic for economic growth. Today’s Chart of the Day provides perspective on the slower employment growth trend from the ADP report.

The ISM non-manufacturing survey also disappointed coming at 53.9 versus 54.7 last month and expectations of 54.5. The index is now at a ten year low after being at a 15 year high only 9 months ago. For a different perspective, the following graph, courtesy Brett Freeze, shows that the year over year change in this survey has fallen to levels seen during the prior two recessions.  CLICK TO ENLARGE

Despite the weak economic data stocks had a good day, fueled by rumors from an anonymous source that trade talks were progressing. The volatility over the past few days highlight how trade talks are a double edged sword for investors. We think it is important to not overly focus on press reports, government statements, and even rumors, but at the same time be aware that many traders and algorithms are keying on these statements and they can have a big impact on the markets.

December 4, 2019

Fox reported that the administration is planning on moving ahead with tariffs on December 15th. The combination of Trump’s admission that a deal may be postponed until after the election along with the December 15th tariffs caused the S&P 500 to fall by over 40 points. By the end of the day the losses were cut in half, closing the day at 3093.  To put the recent decline and current price level in context, the S&P closed at 2938 the night before Phase One of the trade deal was announced.

This morning an unnamed source said the trade talks were going well and with that, the S&P 500 is set to open 15 points higher. Rinse-wash-repeat…

Since last Friday, the VIX volatility index has increased from 11.50 to an intraday high of 17.50. It is approaching the range (18-25) where it has stalled and reversed numerous times over the past 9 months. We will watch VIX trading closely for signs that either the sell-off is abating or that it may break higher. A break above 25, especially if sustained, would be concerning.

The ADP jobs report will be released at 8:15am. The consensus is for an increase of 156k jobs which is about 25k higher than last month. Keep in mind however, last month was reduced by 42k due to the GM strike which has since been resolved. With this number in hand we will run our model and provide a prediction for Friday’s important BLS jobs report.

Following the weak ISM Manufacturing Survey on Monday, all eyes will be on the ISM Non-manufacturing Survey. Current estimates call for a small decline from 54.7 to 54.5. A sharper decline, getting the index closer to 50, would cause concern as ISM has a strong track record in signaling economic activity.

 

 

December 3, 2019

This morning the following headline hit the wire: TRUMP SAYS I HAVE NO DEADLINE ON CHINA DEAL AND IT MIGHT BE BETTER TO WAIT UNTIL AFTER NOVEMBER 2020 ELECTION. We will now wait and see what happens on December 15th, when the suspension of tariffs is scheduled to end.  The S&P 500 looks to open about 10 points on weaker on the news, following a 1% decline over the prior two sessions as such a result was becoming more likely.

The U.S. ISM manufacturing survey was disappointing on Monday, coming in at 48.1 versus expectations of 49.2 and a prior reading of 48.3. This follows the encouraging PMI manufacturing survey which rose last Wednesday and better manufacturing surveys from other nations. The employment component within the ISM report dropped further signaling the potential for weakness in Friday’s employment report. The new orders component has dropped and is now at its lowest level since June 2012.

China’s Caixin manufacturing survey rose above 50 and into economic expansionary territory (50.2 from 49.3), while the non-manufacturing survey is showing robust readings at 54.4 vs 52.8 last month.  Given China drives about a third of global GDP growth, this is an encouraging sign for a turnaround in weakening global growth. The only potential drawback is that the improvement of China’s economy allows the government to take a harder stance on trade which could re-introduce more tariff threats and/or actions.

Trump raised the prospect of steel tariffs on Argentina and Brazil. Last Tuesday Brazil signed an agreement with China allowing them to export  soy products to China. This is the first time they have been able to sell agricultural products to China in decades. Argentina signed a similar deal in September. These tariffs are likely a warning to those countries. China has been trying to diversify other products in addition to agriculture. Our friend Mike “Mish” Shedlock recently wrote about similar actions that China is taking in regards to the production of cell phones- China No Longer Needs U.S. Parts in its Phones.

The Fed is considering allowing inflation to run above its target of 2%. In an article released yesterday by the Financial Times, (LINK) the Fed’s review of monetary policy is likely to include a rule that allows them to overshoot their inflation target after a period of undershooting. As we mentioned after the last FOMC meeting, the Fed is making it abundantly clear they want more inflation and will not raise rates if inflation picks up. Bond yields rose on the news.

 

December 2, 2019

The ISM PMI manufacturing survey will be released at 10am this morning. Expectations are for the survey to remain in economic contraction territory (<50) but rise from 48.3 to 49.1. The ISM non-manufacturing (services) survey will be released on Wednesday. Also of note this week will be the ADP jobs report on Wednesday and the important BLS employment report on Friday.

Currently there is a near zero percent chance of a rate cut at the December Fed meeting and only a 25% chance of a 25bp cut by April.

In September, the 2yr/10yr Treasury yield curve went from -5bps to +27bps. Since then, it has flattened back to +15bps. We believe it can flatten further, but with the Fed currently doing QE and having reduced rates by 75bps, we think the market will be quick to price in further rate cuts if economic data weakens or the China/US trade deals falls apart. As such, we continue to think any inversion will be limited and that over the longer term the curve will steepen significantly.

The Atlanta Fed GDPNow forecast for Q4 GDP has risen sharply from 0.4% in mid-November to 1.7% as of last Wednesday due to the encouraging economic data released over the past week.

 

November 29, 2019

Economic data on Wednesday was better than expected but with some important caveats as follows:

  • Durable Goods rose 0.6% which is much better than an expected decline of 0.7%. Last month was revised lower from -1.1% to -1.4%. While October’s data was better, the year over year change in durable goods, excluding aircraft and defense, is still negative. These two sectors are commonly excluded as they are very volatile month to month.
  • GDP was revised higher to 2.1% from 1.9%, of which .17% of the .2% increase was due to a revision of inventory data.
  • Jobless Claims fell to 213k versus expectations of 218k. As we have been discussing this measure of labor is showing no sign of weakening. That said, due to seasonal adjustments and the Thanksgiving holiday falling a little later than last year, we must take today’s number with a grain of salt. To this point, the non-seasonally adjusted number posted its largest year over year increase since 2010.
  • Chicago Purchasing Managers Index (PMI) continues to show improvement rising from 43.2 to 46.3. This is potentially a good sign that the slump in manufacturing is abating. We will look for confirmation in the more followed ISM surveys.
  • Personal Income was flat versus expectations of a 0.3% increase. This did not effect consumer spending which rose by 0.3%.

President Trump signed the Hong Kong Bill of Rights and Democracy Act on Wednesday night. The Chinese quickly responded with strong rhetoric denouncing the bill which call trade talks into question. Despite Trump’s actions, the S&P 500 is only slated to open down 6 points. Trump had a week to discuss the bill with China so it is possible that any harm has been largely resolved. That said, we should not rule out that the signing will be a huge impediment to trade talks. For consideration- China knows how much Trump cares about the stock market and it therefore raises the possibility that they take actions when the markets are open and liquid today or even next week.

November 27, 2019

Dallas Fed President Robert Kaplan conveyed some noteworthy concerns about debt and leverage in an interview on CNBC. Here are a few quotes from the interview:

  • “The thing I am worried about is if you get two or three BBB credit downgrades to BB or B, that could lead to a rapid widening in credit spreads, which could then lead to a rapid tightening in financial conditions,”
  • “We’re got a record level of corporate and to be specific BBB debt has tripled over the last 10 years,”
  • “Leveraged loans as well as BB and B debt have grown dramatically.”
  • “The problem with ’08-’09 was that the lenders were overleveraged. Right now, we have an issue where the borrowers are highly leveraged,” Kaplan added. “My concern is if you have a downturn where we grow more slowly it means that this amount of debt could be an amplifier.”

Kaplan’s discussion about BBB-rated bond downgrades is potentially a big problem, and one which we believe is greatly underappreciated. We raised the issue in May with our article The Corporate Maginot Line. To wit: “If 50% of BBB-rated bonds were to get downgraded, it would entail a shift of $1.30 trillion bonds to junk status. To put that into perspective, the entire junk market today is less than $1.25 trillion, and the subprime mortgage market that caused so many problems in 2008 peaked at $1.30 trillion.”

Consumer Confidence was slightly weaker than expectations at 125.5 vs 126.9. While the decline is not worrisome, of concern is that consumers continue to see worsening labor conditions. Per Econoday: “those saying jobs are “plentiful” decreased from 47.7 percent to 44.8 percent, while those claiming jobs are “hard to get” increased from 11.6 percent to 12.7 percent.” We suspect this slow, but steady deterioration in the two job survey questions will eventually result in higher jobless claims.

Due to the holiday on Thursday, Jobless Claims will be released this morning. The current expectation is for a decline from 227k to 218k. The 4-week moving average is 221k.

Durable Goods, due for release at 8:30, is expected to decline by 0.7%, following a 1.1% decline last month.

November 26, 2019

The Dallas Fed manufacturing index dropped from +4.5 to -2.4 and has turned negative for the time first time in three years. The regional index is a good barometer of the energy sector.  The last time it was negative, crude oil traded below $30 a barrel. As we discuss below, CCC bond yields are rising of which a good chunk of the increase is due to the energy sector.

Over the past 6 months yields on CCC-rated bonds have been rising while those of other junk rated bonds (B and BB) have been stable. Some in the media believe this divergence to be a signal of brewing corporate credit problems that will soon show up in B and BB rated debt. Over the last 6 months the yield spread, or difference, of CCC rated debt to U.S. Treasuries has increased by 2.63%. At the same time those spreads for BB and B rated debt slightly declined. Such a divergence may seem extreme, but when historical data comparing these spreads is examined, as you can see in Today’s Chart of the Day, the differential is not statistically significant.  The current intersection of CCC and B rated yields is represented by the orange dot. Based on the strong regression (R2=.85), B spreads would need to rise by 0.29% to normalize to the historical relationship. BB spreads would need to increase by 0.74%. Neither move would be overly concerning.

What is more interesting is divergence between the S&P 500 and CCC rated spreads as shown below. CLICK TO ENLARGE.

Of note on the economic calendar is Consumer Confidence at 10am, Durable Goods and Jobless Claims on Wednesday and Chicago PMI on Friday. The stock markets will be closed on Thursday and close early at 1pm on Friday.

November 25, 2019

Of Friday we published an Update to our RIA Pro article- UPDATE: To Buy Or Not To Buy- An Investors Guide To QE4 in which we discussed the possibility that QE4 could be modified or curtailed.

Based on the recent speeches of Jerome Powell and other Fed members, we sensed a growing concern for increased Federal and corporate debt levels along with higher stock valuations. Prior to Friday, there were only a few of us voicing such concerns. On Friday this changed, as CNN published The $4 trillion force propelling US stocks to record highs. The fact that such a broadly followed non-financial media outlet made this insinuation, linking QE to stock market prices, will certainly catch the Fed’s attention. As we posited in our updated article, the Fed may unexpectedly alter QE4 to the chagrin of the market.

The Consumer Sentiment index improved again and is back to the same levels of mid-summer. Expectations led the improvement in the index while the current conditions component was down.

Jerome Powell will speak at 7pm tonight. We are interested on his thoughts about QE and repo as well as the Fed’s newfound concern with downside economic risks as mentioned in Thursday’s Commentary.

November 22, 2019

Weekly jobless claims registered at 227k, 10k above estimates and at the same slightly elevated level as the upwardly revised number from last month. This is a historically small number of jobless claims, but it has been rising recently. While the number of new claims is small, what concerns us is the rate of change. The chart below shows that the year over year change in continued claims (new and old claims), turned positive for the first time in this economic expansion. Positive readings have preceded all prior recessions since at least 1970, but it’s not a full-proof indicator as there have  been a number of false signals.  CLICK TO ENLARGE

The Philadelphia Fed survey on manufacturing conditions rose in a possible sign that manufacturing in the Mid-Atlantic region is recovering.

Leading Economic Indicators rose 0.3% year over year, which is the slowest rate of growth in a decade. The last 5 times the index went from positive to negative growth on a year over year basis resulted in four recessions (2008, 2001, 1990, and 1981) and one false signal (1996). On a monthly the basis the indicator was negative for the third month in a row. Since the data was first calculated in 1959, three consecutive monthly declines occurred 11 times and 7 of those 11, were followed by a recession within 6 months. Needless to say, this indicator is flashing a warning sign.

There are a couple of leading indicators that are not widely followed which have caught our attention recently. The daily Baltic Dry Index, which measures dry bulk shipping costs, has fallen sharply since the beginning of the fourth quarter. The index was rising throughout the first three quarters of the year. Lower shipping costs are in part the result of weakened demand for shipping as global trade is weak. The pickup in the first few quarters was likely a function of inventory stocking to front run potential tariffs or other trade restriction.

The other indicator is the Citi Economic Surprise Index. This measure quantifies whether economic data is coming in better or worse than a consensus of Wall Street economists. During the third quarter the index rose sharply, meaning economists were underestimating the pace economic activity. However, over the last month or so, it has fallen back below zero, a sign that economic data is in general coming in weaker than expectations. For the last few weeks we have heard many in the media claim the Fed has successfully avoided a recession or economic slowdown. Might they have spoken a little too soon?

Per the South China Morning Post- “China Watching Donald Trump’s Response To US Hong Kong Bill As It Threatens To Become New Barrier To Trade Deal.”

November 21, 2019

According to Reuters, Phase One of the China/US trade deal is unlikely to be signed this year. The market sold off sharply on the news but regained more than half of the losses by the close. As discussed yesterday, the passing of the Hong Kong Human Rights and Democracy Act is probably making difficult negotiations even more trying. Indications are that the President will sign the act. As we are publishing this a rumor is circulating that China invited the U.S. to Beijing for trade talks.

On Wednesday afternoon, the Fed released the minutes from the October 30th FOMC meeting. Of note, the minutes stated “many Fed officials view downside risks as elevated.” This was clearly a departure from the language used in the FOMC statement as well as the words of Jerome Powell following the October meeting. In both instances, we were lead to believe that the balance of risks was even and in fact, downside risks had been reduced over the prior month or so.

We believe that the meeting between Powell and Trump was probably a heads up to Powell to let him know the China trade deal is running into problems. The change in the Fed’s tone gives them leeway to provide even more stimulus if need be.

Target and Lowes reported strong earnings on Wednesday. Contrary to Home Depot, Lowes increased their sales forecast for the coming quarters. Unlike Kohls and Home Depot, today’s earnings news paints a healthy picture of the consumer.

 

November 20, 2019

Home Depot (HD) traded 5.50% lower on a weak quarterly earnings report. While earnings exceeded expectations, sales and same store growth missed expectations. Further the company revised Q4 earnings lower.  Sales for HD are highly dependent on personal consumption. As such this provides a clue that all may not be well with the consumer. Contrary to this data, home builders seem to believe consumers are able and willing to buy. Housing building permits are now at 12 year highs. Kohls (KSS) also cut their outlook in another warning about the health of the consumer. KSS fell by almost 20% yesterday.

The equity markets were largely unaffected by the news from HD and KSS as QE and FOMO appear in charge for the time being.

According to the American Staffing Association, the Temporary Staffing Index has declined sharply throughout this year and now stands at its lowest level in ten years. Reductions in temp staffing tends to be a first step employers take to reduce costs when they anticipate a slowdown. This index, at times, is a leading indicator of changes in payrolls and the unemployment rate.

Yesterday, the Senate passed the Hong Kong Human Rights and Democracy Act by unanimous consent following the House which had already passed it by unanimous consent. Given the veto-proof majority, Trump will have to sign the deal, which supports the protestors. This could greatly complicate trade talks.

The Treasury announced that foreign holdings of U.S. Treasury securities declined by 1.2% in September. As we have discussed foreign accounts used to account for about a third of Treasury securities purchases, making debt sales easier. Today, they are net sellers and, at the same time, the supply of debt has risen sharply. You can read about this troubling situation in our article Who Is Funding Uncle Sam?

November 19, 2019

As the riots and protests escalate in Hong Kong, it worth reminding you Hong Kong is the world’s third largest financial center, only behind New York and London. The increasing possibility of major disruptions to the flow of funds in and out of Hong Kong will have an impact on global markets and trade. Another thing to consider with Hong Kong is that any U.S. support for Hong Kong is problematic for the Chinese. If the U.S. officially starts siding with Hong Kong and openly provides support to the protesters, we expect trade negotiations will suffer greatly with any trade talk failures likely resulting in increased tariffs. Not surprisingly, on Monday morning, after two days of a well publicized standoff at a University,  it was “leaked” that Chinese government officials are pessimistic about a trade deal. Further, they are considering postponing any discussions until the U.S. election occurs.

President Trump, Treasury Secretary Mnuchin, and Fed Chair Jerome Powell unexpectedly met on Monday morning. The timing is interesting given a potential breakdown in trade talks.

The economic data front this week will be quiet. Of note is Jobless Claims, Philly Fed Outlook, and leading indicators on Thursday, followed by the PMI composite FLASH and Consumer Sentiment on Friday. There are not many speaking engagements scheduled for Fed members.

Over the past week we have warned that the major equity indexes are at grossly overbought levels. As shown in Today’s Chart of the Day, the S&P 500 has now reached MACD (moving average convergence/divergence) levels that have been hit seven times since 2018. The correction from each prior instance was at least 5%. We are now at the 8th instance and the only question in our mind is not if but when. Last Tuesday we hedged a portion of our equity exposure against such a sell off. We may add to the position on further market strength.

RIAPRO SITE UPDATE – NEW PORTFOLIO FEATURES

Do to popular request we have added a TRANSACTION BASED portfolio (MyPortfolio New) which now allows you to enter a starting cash balance and buy and sell positions for tracking purposes (same as the RIAPro Portfolios)

The previous portfolios (MyPortfolio Snapshot) remains for a simpler portfolio tracking system along with the Watchlist.

We have also added a new feature which allows you to enter MULTIPLE BUY/SELL Orders at one time when managing your portfolios.

We have lot’s of other new features coming from backtesting to Guru Portfolios so stay tuned for more updates.

November 18, 2019

Not surprisingly Hong Kong’s GDP fell by 3.2% in the third quarter and they officially entered a recession. While much of the weakness is due to the protests and the toll it takes on consumption and tourism, the China-U.S. trade war is also weighing on economic activity.

Retail Sales were slightly better than expectations (0.3% versus 0.2%) but the closely followed core data which excludes autos and gas, was only up 0.1% versus expectations for +0.3%. This number is important to follow as strength in personal consumption has thus far outweighed weakening in the manufacturing sectors and slow global growth. Signs of weakening consumer demand, especially if accompanied by a pickup in job layoffs, will increase the odds of a recession greatly.

Industrial production fell by 0.8% and the capacity utilization rate fell to 76.7% both much worse than expected and a further indication the manufacturing sector is struggling. Despite the increase in the price of oil, import and export prices declined 0.5% and 0.1% respectively. On an annual basis import prices are down 3% and export prices down 2.2%.

After Friday’s spate of weak economic data the Atlanta Fed reduced their Q4 GDP forecast from 1% to 0.3% in-line with the New York Fed at 0.4%. Despite the bad news and lower growth trajectory the markets rallied to even greater overbought levels. Clearly QE is in the drivers site while little else seems to matter.

 

November 15, 2019

Jobless claims jumped from 211k to 225k. One higher than expected weekly number certainly does not make a trend, but this data point is worth paying attention to in the weeks ahead. Unlike CPI, PPI was stronger than expectations but like CPI the year over year rate excluding food and energy was lower than the prior month. Core (ex food/energy) CPI and PPI is relied upon heavily by the Fed for inflation guidance.

On Thursday’s Real Investment Show podcast, Lance Roberts and Michael Lebowitz talked about inflation and the ways in which the government consistently modifies inflation calculations to help keep inflation readings lower than the real rise in prices. In particular Shadow Stats was mentioned. Shadow Stats simply recalculates CPI using the same exact price data in the BLS reports, but uses the formulas that were used in 1980. As shown in Today’s Chart of the Day, CPI using Shadow Stats logic is now running at about 10% a year versus the current CPI run rate of 1.5-2%. While inflation is impossible to calculate to a single number for a large population with diverse needs and demographics, we believe an approximation of inflation lies between the two calculations shown.

Beyond the current gap between the two lines, what we find to be very interesting is the trends of the two calculations. CPI (red) has been flat to declining, while the Shadow Stats figure (blue) has been flat to inclining. We tend to agree with Shadow Stats that prices in aggregate are rising, which helps explain why so many Americans find themselves in debt and living pay check to pay check.

Jim Bianco, of Bianco Research, recently presented the graph below. As shown, Fed Funds have been trading about 5-10bps below the mid point of the Fed Funds target range. Prior to the recent funding problems and liquidity operations by the Fed, Fed Funds traded 5-10 above the mid point. Jim’s takeaway is that maybe the Fed has supplied too many reserves to the market. If he is correct, Fed Funds should continue to trade at an increasingly greater distance below the midpoint. Might there be another purpose for QE?  CLICK TO ENLARGE

November 14, 2019

CPI was higher than expected by .10% on a monthly and annual basis. The increase was largely due to rising oil prices. The annual change in CPI less food and energy fell by .10% versus last month. MBA mortgage applications were strong last week. This is not necessarily an indication of a stronger real-estate market, but most likely buyers rushing to lock in mortgage rates on fears they will increase further. Such activity is typical when rates rise after a period of low rates.

Japan’s GDP rose 0.2%, well below expectations for 0.8% growth and last quarters 1.8% growth. Germany narrowly avoided a recession as their GDP climbed 0.1% versus an expected 0.2% decline.

The key line from Chairman Powell’s Congressional testimony yesterday was the following as reported by Reuters- “Powell repeated in his testimony that the Fed was unlikely to use its remaining capacity to cut rates unless there is a “material reassessment of our outlook.” 

In addition, Powell upgraded the Fed’s economic forecast, as they believe the odds of any further slowdown are diminished. The takeaway is that rates will not be reduced further, barring a sharp downturn in economic activity.  Currently, a full 25 basis point rate cut is not priced in until the fourth quarter of 2020. There is less than a 50% chance the Fed cuts by April 2020. Based on his statements about inflation and Fed policy from the prior FOMC meeting, the odds of rate hike are slim.

On the topic of Federal Deficits, Powell warned that rising debt levels could impair the government’s ability to boost economic activity during a recession. He also mentioned, correctly, that high government debt levels restrain private investment which has a negative effect on productivity and by default economic growth. This is an important topic that we have written numerous articles on.

Neel Kashkari, quite possibly the most dovish Fed member on the board, was quoted as saying he is “feeling better about the economy.” This is a good indication that those members who voted for more rate cuts than the Fed delivered are starting to coalesce with the Fed view that they are done cutting rates for the time being. If this continues it will make Powell’s job of forming a consensus at the Fed much easier.

November 13, 2019

The NFIB (small business optimism index survey) rose to 102.4 from 101.8, but remains down from the 106.7 average in 2018. There was good news on the small business employment front as there was an increase in the number of those that responded that they are increasing hiring plans and compensation. Small businesses are the largest employers in the U.S.

As we have discussed in prior articles and commentaries, QE has sparked a buying frenzy.  A recent Bank of America survey of fund managers “finds investors have traded fears of recession for the FOMO (fear of missing out).“- Per CNBC.  The question we need to stay on top of is- will improved confidence in the stock market translate to an uptick in economic confidence and ultimately economic activity?

Keep an ear out for Jerome Powell’s testimony to Congress today and tomorrow for more clues about monetary policy and the overnight funding situation. Also on today’s agenda is CPI. Current expectations are for a +0.3% m/m change and a +1.7 y/y change.

The market got a slight boost yesterday afternoon on a new proposal by Donald Trump to cut the middle class tax rate to 15%. The odds of such a proposal passing the Democrat led House are near zero, but we suspect similar types of tax cuts will also be proposed by Democratic presidential nominees.

Interesting fact- The Dow Jones Industrial Average was unchanged yesterday. The last time the index registered a zero change was in May 2007.

November 12, 2019

Britain’s GDP grew by 0.3% for the third quarter, and at the slowest annualized pace in almost ten years. No doubt concerns over a hard BREXIT and trade weighed on economic activity for the quarter. The market expects a weak, but positive GDP reading from Japan on Wednesday and the possibility of Germany posting a second straight negative GDP, meaning they will be in a recession.

Today’s Chart of the Day compares China’s Hang Seng Stock Index to the S&P 500. The two indexes have tended to be well correlated on a daily basis, yet the S&P is in an uptrend while the Hang Seng is trending lower. Note the Hang Seng has been making lower highs and lower lows since peaking in April, while the S&P 500 has done the opposite.  On Monday, the Hang Seng was down nearly 3% while the S&P was only down .25%. Will the S&P 500 follow the Hang Seng in the days to come?

Fed Member Neel Kashkari speaks tonight and again on Wednesday. He has been one of the more outspoken doves, pushing for aggressive rate cuts. Given the Fed’s new wait and see approach for further rate cuts, as relayed by Chairman Powell at the last FOMC meeting, it will be telling to see if Kashkari moderates his stance. If he does appear less dovish, it would a good sign that Powell may have corralled Fed members into a more united front.

On Monday, Bloomberg released an Odd-Lots Podcast interview with Zoltan Pozsar of Credit Suisse. The interview is worth a listen as it provides great insight into the recent surge in repo funding costs and the new QE operation.

 

November 11, 2019

Consumer Sentiment was on top of expectations and at a similar level as last month. Of note, those voicing concern over the pending impeachment were “virtually non-existent” while a quarter of those surveyed said tariffs were a concern.

Since early September, 10-year Treasury yields have risen by nearly 50 basis points. As a result of longer term bonds rising while shorter term bonds remain somewhat anchored to the Fed Funds rate, the yield curve has steepened. Currently the 2yr/10yr curve is +26 basis points, over 30 basis points steeper from the slight curve inversion experienced in late August.

Economic data this week will be sparse but meaningful. On Wednesday and Thursday the BLS will release CPI and PPI respectively. The current expectation for CPI is for a 0.1% increase while PPI is expected to fall by 0.3%. Following last month’s weak Retail Sales, expectations remain poor with retail sales expected to fall by 0.4%.

Chairman Powell will testify to Congress on the state of monetary policy and economy on Wednesday. We suspect he will face a lot of questions on the repo situation and the new round of QE. Elizabeth Warren has accused banks of creating liquidity problems in an effort to push for a relaxation of regulatory and capital measures. She and others are likely to revisit this charge with Mr. Powell on Wednesday.

The markets will most likely be quiet today as the bond markets are closed for Veterans Day. For all those who served, we thank you.

 

TRIAL USERS:

As referenced in our weekly newsletter, here is the referenced report on QE-4:

Click The Image To Read

November 8, 2019

Jobless Claims fell slightly to 211k from 219k, showing no signs of increased layoffs. We remain in limbo as to whether the survey data alerting us to labor concerns from employers and employees is a leading indicator of the jobs market or simply a false signal. It is worth noting that the jobless claims and the monthly employment data from the BLS tend to lag other indicators by 2-3 months. Thus far it appears that companies are hiring less. The decision to fire people is harder as  skilled workers are hard to find in many industries.

As we have harped on, personal consumption is providing a strong ballast for economic growth. As such, we are on alert for signs that consumption is being impeded by economic concerns or a change in financial conditions. Consumer sentiment, released at 10am today, will help us further asses the mindset of the consumer.

Markets rallied on Thursday morning on talk that China and the U.S. agreed on tariff rollbacks as a precondition to signing the Phase One Trade Agreement. Later that day we learned that there is strong opposition to tariff reductions from Trump’s chief negotiators. The market gave up most of the morning gains as the trade soap opera continues!

The stock market will be open on Monday for Veterans day but the bond markets are closed.

November 7, 2019

Labor productivity fell for the first time in four years due in large part to rising labor costs. An underappreciated culprit in falling productivity levels is the massive amount of share buybacks occurring over the last five years, which has come at the expense of investment. Had corporations invested more into their future earnings power, they would currently be more efficient and better able to offset rising wages. This data is having a direct impact on corporate margins which have been weakening after hitting record levels over the prior few years.

In December 2018 we published DIY Market Forecast, in which we quantified the positive impact on stock returns from rising profits margins (shown below). If profit margins are indeed falling and revenues are relatively flat, the expansion of valuations, which are already at record highs, is the last leg holding stock prices up.  CLICK TO ENLARGE

We elaborate further on labor costs and profit margins in Today’s Chart of the Day, courtesy of John Hussman. His graph shows that profits margins are very well correlated to the ratio of labor costs to prices (GDP price deflator). As labor costs rise faster than general prices, corporate profit margins tend to decline. Simply, labor costs are rising faster than corporations ability to pass on higher prices to consumers.

Ray Dalio who manages the world’s largest hedge fund just released a short, but very important, piece about the current stance of monetary and fiscal policy and its consequences. We urge you to give it a read-  The World Has Gone Mad And The System Is Broken.

Confidence in Phase one of the trade deal appears to be waning.  The signing ceremony for the deal is now being delayed until December as deal terms and a venue/date are being negotiated. That said it appears that Trump is willing to phase out tariffs, which is a key sticking point for the Chinese.

November 6, 2019

In yesterday’s Chart of the Day we showed that there is currently a record number of short positions in VIX futures, attesting to the zealousness in which traders are piling into the stock market.  Today’s chart of the day, highlighting the put/call ratio provides more evidence. These charts, and other data we follow, provide a strong signal that a short term correction is overdue.

Yesterday, the Fed transacted $31 billion of overnight repo. The amount of daily repo being used by the banks has been declining recently. The reduced daily amounts are not necessarily a sign that the funding issues have been resolved, but likely due to the fact that new QE operations are increasingly replacing the overnight repo liquidity.

The trade deficit declined in September in part because of reduced trade with China. The U.S. exported more oil than it imported, representing the first surplus in this category since data was first collected over 40 years ago.

ISM-services beat expectations as the service sector continues to remain in economic expansion and, along with personal consumption, is more than offsetting the decline in manufacturing. The lesser followed PMI services index was also above 50, but, unlike the ISM survey, came in slightly below expectations. Within the report was an interesting comment from Chris Williamson, Markit Chief Business Economist-

“With inflows of new work drying up, firms are relying on previously-placed orders to sustain current output growth, meaning the rate of expansion could weaken further in coming months if demand doesn’t revive. Hence we’re seeing jobs being cut at an increased rate among surveyed companies, with employment falling for a second successive month and to a degree not seen since 2009. Such a weakening of the survey’s employment index will likely feed through to the official jobs numbers as we move toward the end of the year.”

JOLTs data is also pointing to a slowing in the labor markets. Per Econoday:

“Hiring has been keeping pace but job openings, in a possible warning sign of slowing for the labor market, have been on the decline. Job openings fell 3.8 percent in September to 7.024 million, which is the lowest total since March last year and is down 5.0 percent from September last year.

Hirings rose 0.8 percent in the month to 5.934 million and, compared to September last year, were up 4.7 percent. The spread between hirings and openings, at 1.090 million, is the narrowest since February last year.

In a further sign of slowing in the labor market, quits fell a sharp 2.9 percent in the month to 3.498 million which hints at less worker mobility and less pressure on wage growth.”

 

November 5, 2019

After the barrage of economic data last week we get a few more important figures this week. Today, ISM services sector will be released at 10:00 am. The services sector has offset manufacturing weakness thus far. Expectations are for a increase from 52.6 to 53.5. JOLTS (Job openings and labor turnover survey) will also be released at 10:00 am. We will look to see if recent weakening trends in employment surveys continue. If so, it is potentially an early signal to labor weakness not found in last Friday’s BLS report.  On Thursday, jobless claims and consumer credit will be released, followed by consumer sentiment on Friday.

With the Fed meeting conducted last week, voting Fed members are now allowed to speak to the public.  We look forward to hearing their views on future rate changes, QE, Repo, and the general state of the economy.

Rising equity markets are starting to have the old QE feel to them. Stocks have been rising steadily while volatility has fallen back to historically low levels. At the same time bonds and gold are losing some luster. Within the equity markets, the defensive sectors have taken a back seat to the small and mid cap indexes as well as the higher beta stocks. Today’s Chart of the Day shows that shorts on VIX (equity volatility) futures are at record levels, implying the investors are betting heavily on a rally. This and other indicators of extreme sentiment make us think a correction is due.

From an investment perspective this round of QE is playing out as prior QE episodes did. For more on this please read To Buy Or Not To Buy- An Investors Guide to QE.

 

November 4, 2019

Payrolls rose by 128,000 in October and the unemployment rate increased from 3.5 to 3.6%. After taking into account the GM strike which reduced payrolls by 42,000, the data was in line with prior months and close to our estimate of 156,000.  Hourly earnings and hours worked met expectations. The only concern within the report is that temporary help service jobs were negative for the first time in nearly three years. Frequently, business owners will stop hiring temp workers or let them go before making decisions on permanent employees. At times it can be a leading indicator.

ISM was weaker than expected at 48.3 but slightly better than last month’s reading. Interestingly, new export orders improved, however employment, new orders, and order backlogs remain at economic contraction levels. Of concern in this report is that the import index is now at its lowest level since 2008. The divergence between GDP and the important index is wide. Are imports being dragged down by the trade war and not a meaningful sign of the economy? Conversely, is the sharp decline in the import index a harbinger of weak GDP readings in the quarters ahead? The graph below shows the widening gap. CLICK TO ENLARGE

Despite the good employment data, the Atlanta Fed cut their Q4 GDP forecast to 1.1% from 1.5%. The revision is more in line with the NY Fed which currently forecasts 0.8% growth in the fourth quarter.

November 1, 2019

Chicago PMI was much weaker than expectations, coming in at 43.2 vs 47.1 last month. The range of estimates from 27 economists was 46.1-53. Today we will look for confirmation of further weakening in the manufacturing sectors when ISM is released at 10am. Expectations are 49.3, an increase from last months 47.8.

Also on the block today is the all important BLS labor report due out at 8:30am. The market is expecting a gain of 90k jobs which is 46k less than last month. The unemployment rate is also expected to uptick from 3.5% to 3.6%. The expected data is weaker than last month in part due to the GM strike which has since been resolved. According to Econoday, the strike reduced payrolls by 50k jobs.

Last week we compared Federal budget deficits to the net amount of debt held by foreigners. Our purpose in providing the data/graphs is to highlight the record funding demands currently being put upon domestic investors. We follow up today with an important point and chart that shows we underestimated the funding problem. Today’s Chart of the Day shows the stated Federal deficit versus the actual government funding needs. The black dotted line is the 3 year moving average which removes volatility to better highlight that the reported deficit has recently been undershooting the government’s true funding needs by $200-400 billion annually. As an example, the stated deficit for 2018 was $980 billion, however the increase in debt, or true funding need for the year was $1.2 trillion.

On the China/U.S. trade front we are getting mixed messages. On Wednesday night China said that they doubt a long term trade deal is possible while Trump is in office.  The next morning, Lawrence Kudlow declared that trade talks are “going smoothly.” With the election coming up in a year, we continue to believe that phase one of the deal is likely all that will be agreed upon. The risk to markets and the economy remains a flare up of tensions resulting in increased or expanded tariffs.

October 31, 2019

ADP came in at the consensus estimate of +125,000. Concernedly, job growth for small firms (1-19 employees) is only growing at .08%, far off the 1-2% growth rate of the last 8 years. Our forecast for the payrolls number on Friday is +156,000. It is worth noting however, that the GM strike will reduce an estimated 40-50k jobs, which when factored in moves our forecast closer to near 100,000 which is close to the consensus forecast of +90,000. Over the last 6 months, our model has missed estimates by 26k on an absolute basis and only 4k on an average basis.

GDP was slightly better than expected at +1.9% fully supported by the contribution of personal consumption expenditures of 1.93%. Simply, the consumer is keeping GDP afloat and that is why our focus is on personal consumption trends and data. Not surprising, business investment (non-residential) was down 3%, in part due to trade war anxieties as well as a focus on stock buybacks and dividends over investment.

As expected the Fed cut rates by 25 basis points to 1.50-1.75%. There were two Fed members that dissented on voting for the rate cut. As shown in the red lined version below, the only change of note is the removal of the phrase “act as appropriate” and new language describing what is motivating policy decisions. It appears they will be more dependent on incoming economic data over the coming months.
CLICK TO ENLARGE.

Chairman Powell, during his press conference, confirmed the view that the Fed is pausing and may be done with  rate cuts unless economic data weaken. In particular, jobless claims, payrolls, inflation expectations, and retail sales are key data points.  This new stance likely means that any economic data surprises will create market volatility.

The most important line of the press conference came when he addressed the possibility of raising rates. To wit: “I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.

Simply the Fed is not raising rates anytime soon.

Happy Halloween!!!

October 30, 2019

Today will be a busy day with the potential for economic data and/or the Fed to move markets.  ADP releases their employment report at 8:15 followed 15 minutes later by the BEA release of Q3 GDP. Expectations for GDP are for a 1.7% increase. Our focus will be on consumer spending with consensus expectations of +2.6% growth. While still a nice growth rate, the expectation is well below last quarters strong pace of +4.6%.

Later in the day at 2pm, the Fed will announce their policy stance followed by Jerome Powell’s press conference at 2:30. The market assigns a nearly 100% chance of a 25 basis point rate cut, and we agree that is the likely result. The bigger question relates to the Fed’s next move. For this, we should get guidance from the FOMC statement and the press conference. Given the Fed has lowered rates twice already, maybe three times after the meeting, and is now pumping the market with liquidity, we suspect they will ease off on projections for future rate cuts. Many Fed speakers, including Powell, have characterized the rate cuts as “mid cycle” and “insurance”, therefore if they continue to forecast more rate cuts it raises into question whether they are much more concerned about the economy than they should be if the economy were just hitting a mid-cycle speed bump. We suspect the media will think the meeting is more hawkish than expected.

As if that wasn’t enough, Apple will report earnings after the close.

Currently, the market is pricing in a 60% chance of another rate cut by the end of March 2020. We can follow changes in the March 2020 Fed Funds contract (current price – 98.54) to see how the market consensus changes following the meeting. Every .01 increase in the price represents a 4% increase in the odds of a cut. The opposite holds true for each .01 decline.

The Case-Shiller 20 city home price index fell last month for only the second time since 2012.

October 29, 2019

The market opened higher and rallied throughout the day. The S&P 500 closed at 3039, a record high. We are watching closely to see if this is a false breakout or if there is more upside to go. Based on prior QE one can easily argue there is another 5% or more upside, however economic and earnings fundamentals along with technical divergences leave us concerned. Regardless of fundamentals we remind you that liquidity is a powerful tool.

According to a survey conducted by the National Association of Business Managers (NABE) jobs gains fell to their lowest level since 2012. This is another survey pointing to weaker employment data. Keep in mind, other than slightly weaker growth in payrolls, we are not seeing weakness in jobless claims or the unemployment rate.  Friday’s employment report will be another chance to see if that remains true.

We are about halfway through earnings season and both operating and “as reported” earnings per share are down 3% as shown below. Comparison to the prior few quarters of double digit growth is difficult as earnings growth over the last year was boosted by reduced tax rates due to the changes to corporate tax laws. CLICK TO ENLARGE

The Chicago Fed National Activity Index was reported at -.45. The index has a strong correlation with GDP, which is not surprising as it is calculated with 85 measures of economic activity. Based on yesterday’s level, GDP should be at 2%. A reading of approximately -1.50 would correlate with zero GDP growth. The BEA will release Q3 GDP on Wednesday and the current expectation is for +1.7% growth.

There will be a heavy dose of economic data releases this week. Of the most importance will be the following:

  • Wednesday- ADP labor report and GDP
  • Thursday- Jobless claims, Personal Income and Outlays, and Chicago PMI
  • Friday- BLS jobs report, PMI and ISM manufacturing

October 28, 2019

The S&P 500 is trading higher by about 10 points which puts it in position to set an record high today.

Today’s Chart of the Day graphs the money supply, in particular the M1 -Money Stock. During episodes of QE the Fed did not print money to buy securities, instead they swapped bank reserves for the assets. This is why they pound the table and insist that they did not print money. However, what is left out of the story is that the newly created reserves are then used by the banks to create loans. Keep in mind that all debt is money as anyone who is owed money via a loan has a claim on dollars. The important takeaway, as we begin a new round of QE, is that QE does not create money but it does create the fodder to allow banks to print money. If you notice in the graph the slope of the line has just begun to increase from the prior pace.

As we have discussed personal consumption accounts for almost 70% of GDP. Therefore the odds of a recession in the coming months depends heavily on the state of consumption. We have stated concerns about various surveys and recession headlines but other than recent retail sales data, we have seen little hard evidence the consumer is slowing meaningfully. One area however that is catching our attention are rising credit problems, especially in the credit card and auto sectors. To wit, on Friday Moody’s said that sub-prime auto loans “are souring at the fastest rate since 2008, with more consumers than usual defaulting within the first few months of borrowing.” While subprime auto loans are a relatively small component of consumer lending it does tend to be a leading indicator of credit issues. Stay tuned.

The weekly GDP Nowcast, the New York Fed’s public GDP forecast now stands at +1.9% for the third quarter, reported on Wednesday, and +0.9% for the fourth quarter.

October 25, 2019

Phase one of the China/US trade deal largely rested on tariff relief and an increase of agricultural/hog purchases by China. Yesterday, China committed to purchasing $20 billion of agricultural products from the US. The good news is that the amount is almost double that which China has bought since the trade war started. The bad news is that it is actually slightly below the annual average which they bought from the US between 2014-2017. Needless to say, Phase one of the deal does little to advance trade between the countries.

Durable Goods Orders were weaker than expected, coming in at -1.1% versus consensus of -.7%. The ex-transportation and core numbers were also weaker than expectations. Jobless Claims continue to hum along showing no signs of labor weakness. The four week moving average dropped slightly to 215k.

Median Home Sale prices, shown below, have been declining despite lower interest rates. The Shiller 20 city home price index, while still rising, had dropped to its lowest growth rate in the last 5+ years. While lower mortgage rates have certainly boosted demand, these graphs show the marginal benefit of lower rates is much less than in years past. CLICK TO ENLARGE

October 24, 2019

Today’s Chart of the Day is probably one of the most important macro charts to understand, yet is so underappreciated. The chart highlights that net purchases of U.S. Treasury debt by foreign investors (central banks, governments, corporations, and citizens) have been negative over the last two years. This is occurring as deficits topple the $1 trillion mark. In other words, not only are trillion dollar deficits being entirely funded with domestic funds, but domestic funds must also absorb the foreign net selling. To better understand the implications of this new dynamic, we suggest reading an article we wrote in June titled Who is Funding Uncle Sam?

We believe the funding situation is one causes of the overnight funding issues and the sudden introduction of QE.

Speaking of which, the Fed announced that they will double the size of their overnight repo facility to $120 billion and two week term repos will increase from $30 to $45 billion.

There is a good amount of economic data coming out this morning. Of note is Durable Goods (expectation -.7%), Jobless Claims (+214k), and PMI (composite 50.9, manufacturing 50.5, and services 51.0).

WeWork, which was only a few days away from doing an IPO at a valuation of $47 billion a month ago, now says it would have run out cash next week had SoftBank not purchased it for only $8 billion. WeWork is a reminder that valuations in both the public and private markets are excessive, and in many case unjustifiable.

Later this morning we will release To Buy QE, or Not To Buy QE. The article provides a construct to help you think about the effect that QE 4 may have on asset prices. It uses quantitative measures to project returns based on prior QE, as well as qualitative commentary that points out the differences between today’s environment and those in the past.

 

October 23, 2019

The Fed conducted their third QE4 purchase yesterday and, like the two prior ones, it was met with huge demand from the major banks. The Fed bid for $7.5 billion of Treasury Bills and received offers to sell over $40bn, resulting in a nearly 6x over-subscription rate. The prior two operations were also over-subscribed by at least 5x, meaning that the banks are still hungry for reserves. Overnight repo continues to trade 10-20 basis points above where it should, which is also a warning that liquidity is lacking and/or a credit issue is looming.

Senator and Presidential Candidate Elizabeth Warren is asking Treasury Secretary Steven Mnuchin for more information on the recent overnight repo funding issues. Her concern appears to be that the banks created or magnified the problems in part to have regulations and capital limits lessened. Per Warren and CNBC- “These rules were designed to ensure that banks have enough cash on hand to meet their obligations in the event of another market crash,” Warren wrote in a letter dated Friday and released Tuesday. “Banks are reporting profits at record, levels, and it would be painfully ironic if unexplained chaos in a small corner of the banking market became an excuse to further loosen rules that protect the economy from these types of risks.”

This election could get interesting from a market perspective if other candidates start questioning what the Fed has done and what they are currently doing.

Poor earnings and earnings outlooks are pushing stocks lower this morning, in particular Texas Instruments (TXN), Caterpillar (CAT), and Chipotle (CMG). Boeing (BA) will report earnings this morning.

October 22, 2019

The administration continues to support the stock market with positive statements regarding trade talks with China. Yesterday morning Lawrence Kudlow told the media that there is a chance that the planned tariff hikes in December will get called off. The S&P 500 closed up 20 points to 3006, which is only 19 points below its all-time high set in July.

With BREXIT still up in the air, Today’s Chart of the Day provides a nice schematic with expected odds for all of the possibilities. Based on the illustration, the odds are clearly in favor of an orderly BREXIT.

CNBC ran an interesting article yesterday based on a letter that Goldman Sachs sent to clients. The article starts: “Corporate buybacks are “plummeting” as companies tighten their purse strings, and it could have a big impact on the market, Goldman Sachs warned.” There is no doubt that corporate buybacks have driven stock prices well beyond valuation norms. We have warned that at some point debt levels will preclude companies from continuing to buy back shares. Combine Goldman’s sentiment with a recent WSJ article accusing bond rating agencies for being lenient on heavily indebted corporate issuers and the tide on buybacks may be turning. The WSJ article is linked HERE.

Third quarter earnings will be a key driver of stocks over the next few weeks. To see what the calendar holds in store, click on the Research tab and then Dividends and Earnings. Then click on a date and below the calendar you will find a listing of companies reporting that day.

 

October 21, 2019

The BREXIT saga will most likely be extended until February 2020 as Parliament forced Boris Johnson to ask the EU for another deadline extension and the EU delivered. If Parliament cannot pass the deal Johnson struck with the EU over the coming days, a general election will be held.

Japanese and Korean import/export numbers were weak last night attesting to the poor shape of global trade.

Today’s Chart of the Day shows an interesting graph from Crescat Capital.  The difference between inflation (CPI) and inflation expectations has expanded to levels that have only been seen before or during recessions. If we are heading into a recession, we should expect CPI will fall and likely more than inflation expectations, as had happened the past three times the difference between the two was positive. It is important to caution however, inflation is the most underappreciated risk to the stock and bond markets. In an inflationary environment the Fed will need to raise rates and possibly reduce their balance sheet to stem inflation. Such monetary action would not bode well for risk assets that have risen appreciably on the back of ultra-easy Fed policy.

The following appeared in a WSJ article on Friday- “In an Oval Office meeting, there was consensus “the economy was really strong…and that what’s going to get him re-elected…,” said economist Stephen Moore.” The point is, and always has been, that a sitting President has much better reelection odds during a strong economy. We expect, Trump, like many prior Presidents, to do whatever is in his power to boost economic activity and push stocks higher. Whether he can do this or not is the million dollar question.

October 18, 2019

The weekly Jobless Claims data continue to show no signs of trouble in the labor market. The four week moving average increased slightly with new claims rising from 210k to 214k. We will not be concerned until the four week moving average markedly trends higher and new claims broach 250k. It is important to note that BLS employment data tends to be a lagging indicator.

There are five Fed members speaking tomorrow. Most important will be Vice Chair Richard Clarida at 11:30 am. Interestingly, he is speaking at a CFA conference entitled : Fixed Income Management 2019 Late Cycle Investing. Remember the Fed has characterized the recent rate cuts as “Mid-Cycle” adjustments/insurance.  In all 5 speeches close attention will be paid for clues as to the rate decision at the coming October 30th meeting and any more discussion of the overnight funding problems. This will be the last speech before the Fed’s self-imposed media blackout starts on Saturday and continues through the next Fed meeting.

The Wall Street Journal published an article this morning which basically makes the case for the Fed to cut rates by 25 basis points at the coming meeting and then put further rate cuts on hold. The Fed often uses the WSJ and in particular the author of the article, Nick Timiraos, to alert the market to what they are currently planning in regards to policy. The link to the article is HERE.

All eyes will be on the UK this weekend to see whether or not Parliament will accept the BREXIT terms that Johnson and the EU have agreed to.

China’s third quarter GDP fell to 6%, .2% below last quarter and .1% below expectations. The rate of growth is the lowest in over 20 years.

 

October 17, 2019

Based on news reports this morning it looks like the EU and UK have reached a BREXIT deal. It also appears that Boris Johnson, UK’s Prime Minister, may have enough support to get a BREXIT compromise through Parliament by Saturday. Saturday is a self-imposed deadline for the UK to reach internal agreement. Failing to reach agreement would likely lead to a vote of no confidence and make a BREXIT deal with the EU more difficult to reach before the October 31 deadline. Over the last five days the pound has risen sharply from 1.22 to 1.29 per USD in anticipation of a deal being reached.

The overnight repo markets are again showing some worrying signs. Yesterday, overnight borrowing rates traded 10-15bps higher than where they have been over the prior two weeks. Further, the Fed’s overnight repo operation was oversubscribed to ($80.35bn in bids versus an offering of only $75bn). Given the amount of temporary and permanent liquidity (QE) the Fed is supplying the system, the current increase may be tipping us off to a credit issue and not necessarily a liquidity issue as the Fed leads us to believe.

Retail Sales, a good barometer on personal consumption which accounts for nearly 70% of GDP, was well below consensus forecasts falling 0.3% versus an expected increase of 0.3%. The reading was below all of the 69 economist estimates. Core retail sales, less auto and gas, were flat versus expectations of +0.3% and a prior month gain of 0.4%. The market is clearly keying on incoming data such as Retail Sales for guidance on what the Fed may do. Prior to the data, Fed Funds futures were priced for about a 50/50 chance of a rate cut at the October 30 meeting. The odds rose to 80% after the Retail Sales data.

The Fed’s Beige Book which describes economic conditions across the Federal Reserve districts pointed to continued expansion in most areas. While it mentioned some layoffs in the manufacturing sector its overall assessment of the labor markets was strong.

October 16, 2019

The market surged yesterday on __________ (fill in the blank). It is pointless to search for catalysts or market moving headlines to fill in the blank. Equities opened with a panic bid on the basis of nothing and rallied throughout the day.

The price surge coincides with the first day of QE and that is as good a guess as any to explain yesterday’s rise. It was interesting that the defensive equity sectors, gold, and bonds that were market leaders, lagged yesterday. The price surge and sector rotation trade may be marking the beginning of a new risk-on trade higher as we saw during QE 1, 2, and 3. We will pay close attention to technical resistance levels to help confirm if this is the case so we can act appropriately.

If you are not satisfied with QE as the driver, here the biggest headlines, most of which are not market friendly:

JPM released earnings yesterday and the market focused on the solid overall income numbers yet glanced over disturbing credit news. To wit, Lisa Abromowicz of Bloomberg tweeted the following:

At JPMorgan, charge-offs surged 33% to $1.37 billion from $1.03 billion last year. I’m curious to hear how much this stemmed from either riskier loans or weakening consumer & corporate credit.”

In yesterday’s Chart of the Day we showed the growing divergence in yields within the junk bond sector. In particular, the lowest rated bonds, CCC, have increased in yield, while BB and B bonds have been relatively flat. In response to a subscriber asking us for more data on the topic, we expanded the graph and show it in today’s Chart of the Day. The graph includes the last two recessions as well as investment grade BBB bonds. A few points worth discussing:

  • Prior to the recession of 2001, CCC spreads started widening well in advance of the recession.
  • About a year before the great financial crisis, spreads of all corporate bonds widened in unison.
  • CCC rated bonds are much more volatile than BB and BBB-rated bonds and therefore frequently sends false signals.
  • There has been no uptick in yields in BB and BBB over the past year despite CCC bonds widening.

It is too early to tell if the rising CCC yields is a harbinger of things to come or a technical gyration due to specific bonds such as WeWork and/or those of energy companies which make up a decent amount of the CCC sector.

October 15, 2019

There were no economic data releases or Fed speakers yesterday due to Columbus Day. Of importance this week will be the release of Retail Sales data on Wednesday and Jobless Claims on Thursday. In both reports we are looking to see if worrying signs in various labor and sentiment surveys is showing up in hard data.  There are also a number of Fed speakers throughout the week so we will be on guard for more clues about the new round of QE and what it might mean for interest rate policy at the coming October 30th meeting.

Having a few days to digest the trade news we have a few thoughts worth sharing. The supposed Phase 1 deal is a good sign as it means the two sides are amicable and willing to talk. It signals a de-escalation of trade tensions which should relieve some anxiety of corporations and consumers. On the margin it should help economic activity as the threat of more tariffs is reduced, at least temporarily.

The problem however, is that the agreement is very limited in scope and fails to touch on the bigger picture items like IP and geopolitics. These items will be much more difficult to negotiate and may cause a re-escalation in tensions between the two countries when they are addressed. Given the difficult nature of reaching future agreements and the election coming up in a year, we would not be surprised to see trade negotiations tabled and slowly faded out of the news, leaving the status as it is today.

Trade activity between the U.S. and China is certainly being depressed in part because of the trade war. China reported that exports to the U.S. fell 10.7% and imports of U.S. goods dropped 26.4%. The results, reported by Reuters, cover January through September.

The third quarter earnings calendar is starting to heat up. On Wednesday 39 companies will release earnings including Netflix, Johnson & Johnson, and IBM. For the complete list of companies reporting, mouse over the Research Tab and click on Dividends and Earnings. A calendar will pop up. When you click on a specific date, the listing of either earnings or dividends for that day will display below the calendar. The dates can also be found in the Portfolio section for stocks in your customized portfolios and in the RIA Pro portfolios. Click on Dividend to the right of the portfolio graph and then select Earnings. The companies are sorted by date.

October 14, 2019

Trump announced phase one of a trade deal with China on Friday afternoon. This morning we are waking up to news that China wants more discussions before signing phase 1. The market sold off Friday after the deal was announced and a little lower this morning as well. While progress is being made, investors are signaling that the deal is not that different from prior statements in which China said they would buy agriculture in exchange for tariff relief.

The Fed surprised the market on Friday and announced that they will start buying $60 billion of Treasury Bills monthly starting next Tuesday. The purchases will continue into the second quarter, meaning the Fed plans on purchasing at least $320 billion of assets. The Fed will also continue with temporary repo operations. The suddenness of the announcement leaves us wondering. Why the urgency to announce the action on Friday, when there is a Fed meeting in less than three weeks in which such an announcement would have been more appropriate? When answering the question, keep in mind that the temporary repo facilities are working well to alleviate the funding problems. Might there be another reason for this sudden change? We believe there is a credit issue with a bank or numerous banks, most likely European.

As Powell alluded to earlier in the week, this operation is not QE. As we discussed in QE By Any Other Name, if it walks like a duck and quacks like a duck it is a….. The stock market soared on the news, albeit it was already doing well based on the probability of a trade agreement with China. The yield curve steepened as shorter maturity Treasuries were flat to lower while longer securities rose in yield. The 3m/10yr curve was 8bps stepper on Friday.

On a year over year basis import and export prices both fell by 1.6%, despite the rise in oil prices in early September. Along with CPI and PPI, Friday’s Import and Export Prices report paints the same picture of deflationary impulses at work.

 

October 11, 2019

Stocks are trading sharply higher this morning as a trade deal seems likely to emerge from this week’s trade meetings. At 3:30 today, Donald Trump will meet with a leading trade negotiator from China and it appears a deal could be announced following the meeting. While the market is giddy about the prospects of putting the uncertainty of trade talks behind it, we believe the terms of the deal and importantly how it will treat past and future tariffs are important to assess before betting on the market beyond the next few days. Daniel Lacalle, a frequent guest on the Lance Roberts podcast, has an interesting take in CNBC on what to expect from a trade deal. The link is here – A US-China Trade Deal May Not Be The Catalyst The Market Is Expecting.

Further helping sentiment this morning is renewed hopes of a BREXIT agreement before the coming October 31st deadline.

CPI was slightly weaker than expected showing no change month over month and 1.7% inflation year over year. Jobless claims were strong at 210k and not revealing the labor weakness we have seen in other reports and surveys.

The following quote, as reported by Market News International, caught our attention yesterday: “although we can reduce interest rates further, the side effects of monetary policy are becoming more and more evident and more and more tangible” – European Central Bank (ECB) Vice President de Guindos

This quote follows similar comments by officials from the Bank of Japan (BOJ). Essentially they are finally figuring out that excessive monetary policy, including negative rates and QE, has its limits and more importantly, consequences. As far as consequences, little to no economic growth for almost a decade, along with the slow death of European and Japanese banking systems is finally catching their attention. We hope the Fed is paying attention.

The University of Michigan Consumer Sentiment report will released at 10am. Current expectations are for a slight decline from 93.2 to 92.

October 10, 2019

Following unexpectedly lower inflation in Tuesday’s PPI report, we get CPI today, the more important gauge of prices. Current expectations are .1% and .2% increases month over month and year over year respectively.

In yesterday’s JOLTs report, job openings fell from 7.217 million to 7.051 million. The number is still historically high but has been fading for a year as shown below. Hires and quits also fell, tipping off further signs of labor weakness. While the overall data in the report is healthy, the report lines up with the latest  BLS employment report and numerous employment sentiment surveys that give us concern. We will watch today’s weekly jobless claims data for further confirmation. Jobless claims are expected to come in at 219k, about 7k greater than the running four week average. CLICK TO ENLARGE

Trade talks with China start today so expect heightened volatility based on a deal/no deal or even just rumors and Tweets. Last night was extremely volatility as rumors were flying around that the Chinese delegation would leave talks a day early. The story was refuted by the administration. We still believe there is a better than 50/50 chance a trade-lite deal being announced. If so, we will focus on whether or not there any changes to tariffs. The potential market’s reaction is hard to gauge. A deal with reduced tariffs may pacify the market and ease concerns about slowing growth. However, a partial deal, may leave investors with concerns that little was accomplished and the possibility for more tariffs and other actions in the future.

The Fed released the minutes from their September 18th meeting. In general there was a lot of different views on the future path of monetary policy. Some members want to end rate reductions while others think more cuts are needed. The topic of using the balance sheet to help the overnight funding issues arose but, based on the minutes, was not discussed at length. Overall, the minutes did not shine much new light on monetary policy.

October 9, 2019

Yesterday afternoon Chairman Powell said the Fed will increase its purchases of short term Treasury bonds. Within this speech he went out of his way to claim that such actions do not constitute QE. In particular, he stated the following: “I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.” He then stated: “In no sense is this QE.”  The Fed is trying to alleviate the overnight funding shortage via QE, but they want to do so without calling it QE. For more on this “sleight of hand” read our article published last week titled QE By Any Other Name.

Fed member, Neel Kashkari followed later in the day by saying “Fed policy makers now view Quantitative Easing (QE) as a tool in its tool kit.”

Shortly after Powell laid the ground work for a new round of “QE” the market started rallying. The gains were quickly given up as President Trump imposed visa bans on Chinese citizens involved in humans rights abuses. The market recovered some losses overnight on rumors that China would buy more soybeans from the U.S.  The bottom line is try to ignore the trade headlines. We suspect the market will continue to get whipsawed on headlines and tweets going into this week’s trade negotiations.

BREXIT negotiations are heating up with both sides publicly blaming each other for non-compromise on key issues. It is increasingly looking like the exit will be disorderly when the October 31st deal deadline comes. A no-deal exit will result in economic consternation in Europe and the UK. This comes at a time when Germany is likely already in a recession and other European nations are not far off. The economic effects will not be limited to the Euro region.

Producer Prices (PPI) surprised to the downside falling .3% versus expectations for a .1% increase. The year over year change also dropped to 2% from 2.3%. The market will pay closer attention to CPI tomorrow for confirmation. A lower CPI would provide the Fed with a better rationale to cut rates later this month.

October 8, 2019

As we noted in yesterday’s commentary and witnessed since then, the markets will be volatile as trade comments from the U.S. and China will be overly scrutinized for clues about the progress of this week’s talks. We urge you to resist trading on these comments as they are largely a public display meant to sway negotiations.  It is worth noting China appears adamant that IP and government subsidies are not on the table. These are the key items that Trump and Navarro have argued must be changed.

Trump understands that a trade “victory,” even if not a full deal, helps his reelection odds. We continue to believe there is a wide chasm between the two parties but we expect a deal, likely lacking in specifics and meaningful reform. If we are correct, will a “trade-lite” deal be enough for the markets and will it ease the worries of corporations that have been reducing output and investments?

There is not much economic data being released this week to take the markets mind off of trade. That said, the BLS will release PPI at 8:30 and CPI on Thursday. If the recent upticks in both data points continue, the Fed will find it more difficult to cut rates at the upcoming Fed meeting. The market is priced for a near 100% chance of a 25bps cut at the October 30th meeting.

The price of gold slipped 35 points over the last week. While gold was overbought and certainly technically due for a pullback, Zero Hedge leads us to believe that a lack of Chinese participation due to China’s week long Golden Week holiday also played a role. The following graph shows the performance of gold during Golden Week and in the week or two afterwards for the last 6 years. CLICK TO ENLARGE

October 7, 2019

Trade deal jitters are weighing on the market this morning. Last night China said they were reluctant to make a broader level deal. In particular they said they would not negotiate government subsidies and other bigger ticket items the U.S. wants included in a deal. Keep in mind, last week Trump and trade negotiator Peter Navarro made comments that they will only settle for a full deal, including the items China said are not negotiable at this time. This may seem grim but we caution, this may easily be negotiation tactics by both sides and not necessarily a breakdown of talks. The market will be volatile heading into the talks later this week.

The employment report was a mixed bag. Payrolls were slightly weaker than expectations, increasing by 136,000 in September versus a consensus estimate of 145,000 and a revised prior month of 168,000. On the positive side, the unemployment rate fell to 3.5% from 3.7%. Most concerning is that average hourly earnings were flat versus  a gain of .4% last month and estimates of +.3%.  The year over year change in hourly earnings fell to 2.9% from 3.3%. The BLS employment report tends to lag other labor data but the earnings data is another sign of cooling in the labor market.

The market popped higher on the employment data as it supports the notion of a weakening labor market which in turn provides the Fed more leeway to cut rates on October 30th. Further supporting the market on Friday were numerous headlines from Lawrence Kudlow and President Trump in relation to the possibility of a trade deal when China and the US meet Thursday and Friday.

The New York Fed announced they will continue “emergency” repo operations to November 4th including term repo options and overnight funding. As judged by the fact that the Fed’s balance sheet continue to rise, short term bank funding needs have not alleviated. Friday’s announcement makes it possible the Fed will announce some sort of permanent funding (QE) at the October 30th FOMC meeting. The date, November 4th, allows the short term, temporary measures to help banks get past month end balance sheet constraints and would give the Fed a few days to begin more permanent actions if they are announced on October 30th.

Jerome Powell will speak on Monday, Tuesday and Wednesday. The minutes from the prior Fed meeting will come out on Wednesday. In a speech on Friday, did not discuss the short term funding problems. He also didn’t provide much guidance as to his views on a rate cut. He did say the economy is “chugging along despite the headwinds it faces.”

October trading has been volatile thus far, with three of the four trading days having moves of greater than 1%.

October 4, 2019

The ISM- Service Sector Survey was weaker than expected at 52.6 versus 56.4. This is the lowest rate in three years and further confirms the weakness we are witnessing in the manufacturing surveys.

On Wednesday, the Conference Board CEO Confidence Survey reported that expectations of corporate executives for the next 6 months has fallen to levels last witnessed at the trough of the prior three recessions. On a year over year basis the confidence reading is the lowest since the late 1970’s. These two graphs can be found in today’s Chart of the Day.

Chairman Powell will speak at 2pm this afternoon. With Fed Funds futures back to pricing in a nearly 100% of a cut at the October 30th meeting it will be interesting to see if he goes along with the market or gives the market reason a for pause.

Jobless claims rose slightly to 219k, but have yet to reflect the employment concerns we have seen in consumer and corporate surveys. Today’s jobs report will shine more light on the employment picture. The table below, courtesy of Econoday, contains expectations for the 8:30 monthly employment report. CLICK TO ENLARGE.

October 3, 2019

Late yesterday afternoon, the U.S. announced they will put tariffs on European aircraft, agriculture, and other products.  The tariffs are effective on October 18th.

The ADP report showed a gain of 135k jobs in September which beat the consensus forecast of 125k. Last month’s report was revised lower by 48k from 195k to 147k. The average ADP jobs growth for the last 12 months is 177k, despite markedly slower growth recently. Today’s Chart of the Day shows that the six month average is hitting the lowest levels since the recovery from the Financial Crisis.

With ADP data in hand, our model estimates a gain of 162k jobs in Friday’s BLS employment report. Based on other employment data released over the last two weeks we believe there is a decent likelihood the number falls far short of our estimate and the streets estimate of 145k.

The S&P fell 1.74% yesterday which marked the first time the index had back to back declines of more than 1% this year.

While Europe has started back up QE and rumors abound about the Fed introducing a new round of QE, Japan is taking QE in a different direction. The BOJ announced they would trim their domestic bond purchases but boost buying of foreign bonds. This is partially due to the fact they own over 50% of Japan’s outstanding government bonds.

The BOJ has been much more aggressive with QE than Europe or the U.S. Currently the BOJ’s balance sheet stands at 102% of Japan’s annual GDP. That dwarfs the Fed’s balance sheet at 18% of GDP and the ECB’s at 39% of GDP.  Buying foreign bonds will provide a steady bid to U.S. Treasury bonds as they are the most abundant and liquid of sovereign bonds. Doing so would also be appreciated by President Trump and might curry them favor in any trade disputes. It should also help Japan’s exports as it will put pressure on the Yen.

Australia, feeling the effects of the slowdown in China and the trade war, cut their overnight interest rates to 0.75%, the lowest on record. Further, they said more rate cuts may be needed as well as other measures, which we assume means QE.

October 2, 2019

ISM Manufacturing fell to 47.8 and further into economic contraction. Today’s reading compares to 49.1 last month and expectations of 50. As we have been recently harping on, employment is showing signs of weakness across a few different indicators including ISM. The ISM Employment sub-component came in at 46.3 versus 47.4 last month.  Also of concern, as shown below, new export orders continue to decline and are now below any level since the 2008/09 recession. On the brighter side, the lesser followed PMI Manufacturing rose to 51.1 from 50.3, however, some of the commentary included weaker labor market signals.

The weak report immediately pushed the market lower and it slid throughout the day, with the S&P closing down 38 points to 2938. This weekend’s newsletter, “Trade Deal” Is Coming stated: “(S&P 500) support at the 50-dma, which coincides with the January 2018 top, but a break of that level will put the 200-dma into focus.”  The 50-dma is currently 2947, a level which has proven to be support and resistance since 2018. The 200-dma is over 100 points lower at 2835.

Today’s Chart of the Day by Teddy Vallee shows a huge divergence between the reliable relationship between ISM and annual changes in the S&P 500. if the relationship holds up and the stock market is right, ISM should rise to the upper 50s. If, however, the market is wrong the current 20% gains could quickly turn into double digit annual losses.

ISM in the Eurozone fell from 47 to 45.7 led by Germany 43.5 to 41.7. Italy, France and Spain were also lower with Italy and Spain in contraction, while France (50.1) barely clings to expansion.