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We are replacing the running Commentary with Daily Market Commentary. Daily Market Commentary provides the same market-related information you are accustomed to, as well as more technical guidance and a preview of what to watch for in the day ahead. Here is today’s Commentary.
December 9, 2021
**Due to technical difficulties, there will be no 3 Minutes on Markets today.
Jobless Claims at 50-year Lows
Initial Jobless Claims fell to 184k this past week, hitting its lowest level since 1969. In 1969, the U.S. population was 203 million. Today it’s 332 million. If you adjust for the population increase, jobless claims are well beyond the prior record low of the late 60s.
Between last Friday’s employment report, JOLTs data, and initial claims, the Fed will likely continue to shift toward inflation-biased policy. Such logic entails the Fed will be more aggressive in reducing QE. Asset prices and the current high-risk tolerance among many investors are largely supported by the Fed’s liquidity. While markets may ignore the circumstances for a while, we mustn’t forget the Fed regime is changing. We think the change in monetary policy will be an important theme driving investment results in 2022. Stay tuned!
How Big Is Apple?
Apple’s stock is up over 10% in the last five trading days. In the last month, its market cap increased $400 billion and is now approaching $3 trillion. To put that in context consider the $400 billion gain in market cap over just the last month is more than the total market cap of the world’s 20th largest company, Walmart ($380 billion). The two bar charts below compare Apple versus the total size of the top ten nations ranked by their respective aggregate stock market capitalization and nominal GDP. As shown, Apple is bigger than all but six nations in terms of stock market size and is bigger than the GDP of all but seven nations.
The graph below from Home Equity Insights, by Core Logic, sheds more light on recent home equity gains which directly boosts the amount of credit available to consumers via mortgage refinancing. Core Logic estimates homeowners with mortgages saw their equity increase by $2.9 trillion over the past year, an increase of nearly 30%. The map below breaks down the average equity gains by state. The amount of credit card debt has recently picked up back to normal levels. Further, savings rates have fallen to pre-Covid levels. While both of those data points argue that consumers do not have much money beyond their paychecks to spend, the sharp increase in home equity is a potential source to fund new spending. Assuming house prices stay stable or increase, we should expect consumers to tap equity to finance consumption and lessen the burden of inflation.
December 8, 2021
The BLS JOLTs report once again confirmed there is a severe shortage of labor. JOLTs data lags the employment report by a month, but it shows there are 11.033 million job openings, 400k more than last month. This data along with recent productivity and labor costs adds to the mounting evidence that corporate profit margins will come under pressure in the coming month. Simply, job seekers and current employees have more bargaining power today than in decades.
The first table below puts context to how outsized the current number of job openings are versus the last 20 years. The second table breaks down the number of job openings by industry.
Apple’s Nightmare Before Christmas
Nikkei Asia published Apple’s Nightmare Before Christmas this morning, detailing how chip shortages and energy restrictions are cutting down on Apple’s ability to produce iPhones. Despite the bad news, it is not denting investor enthusiasm. Apple’s stock price has been on a tear recently, rising 22% since early October. Our equity model holds a 3.75% position in Apple.
“Due to limited components and chips, it made no sense to work overtime on holidays and give extra pay for front-line workers,” a supply chain manager involved told Nikkei Asia. “That has never happened before. The Chinese golden holiday in the past was always the most hustling time when all of the assemblers were gearing up for production.”
After launching the iPhone 13 range and new iPads in September, Apple is falling millions of units short of its production goals and missing out on billions of dollars of revenue. In many countries, it is now too late for consumers to buy some Apple products in time to give as holiday gifts.
Is The Short Term Rally Here To Stay?
Consumer Credit is Finally Slowing Down
Consumer Credit rose by $16.9 billion in October almost half of an expected $30 billion increase. It also marks a sharp slowdown from September’s $27.8 billion growth. As stimulus checks were wound down, consumers started relying more on credit card debt and mortgage refinancings to meet their needs and compensate for inflation. One month does not make a trend, but this new data point along with weak consumer spending data for Black Friday and Cyber Monday argues consumer activity may be slowing.
U.S. Multiple Expansion vs. The World
The graph below, courtesy of Top-Down Charts, shows that since the Financial Crisis the CAPE P/E ratio has expanded 3x in the United States versus staying relatively flat in developed and emerging foreign markets. One reason to partially explain the outperformance is that the U.S. equity indexes are more highly dominated by higher growth tech companies which tend to command higher P/E’s. That said, when it comes to paying the piper and valuations normalize in the U.S., foreign markets may offer a little protection.
December 7, 2021
Profit Margin Pressures Are Coming
Unit labor costs rose 9.6%, year over year, in part due to productivity, which fell 5.2% over the same period. Hourly compensation rose 3.9%. While wage growth is higher than average, it is well below the rate of inflation. The decline in productivity is the largest since 1960. Surging labor costs and falling productivity is a recipe for profit margin compression for many corporations. Given margins are at historically high levels, a decline should not be a surprise.
Easy Money- “Buying The 50”
The graph below shows how the S&P 500 (SPY) has repeatedly bounced off its 50dma in 2021. The black bars quantify the 20-day returns from each trading day SPY was below its 50 dma. As we show, buying below the 50 dma and holding for 20 days has been easy money. On December 1st, as circled, SPY fell below its 50 dma. It has since rebounded 3.5% from that day. “Buying the 50” is a great trade and may continue to work well, however, there will come a time SPY breaks below the 50 dma and fails to recover quickly. That could be a signal the market environment is turning.
The black line below charts the difference between implied volatility (VIX) and realized volatility. We use this measure to help us quantify how risk tolerances are changing for the market in aggregate. The difference between implied and realized volatility is frequently above zero, so we prefer to key on the variance around its trend line to assess. When implied volatility spikes above the trend line, it signals that investors are becoming more risk-averse as they bid up options. This is what happened last week as the difference rose to 8-month highs. The large difference has since come down but remains elevated. Also of note, the trend for the differential is gently rising, meaning investor risk-averseness is slowly increasing with the market. Given high valuations and the Fed pivot, the upward trend makes sense.
Bonds vs. Stocks
Based on the hoopla surrounding the bullish stock market one would think bonds would have been a bad place to be invested. Contrary to popular opinion, long-duration Treasury bonds (TLT) have kept up with the S&P 500 since April. The graph below shows the price ratio between TLT and SPY. The recent increase in the price of TLT and the decline of SPY have brought the ratio back to April’s levels.
December 6, 2021
The Fed Pivots
As is quite common, the Fed likes to signal changes in policy via the media. Today, the Wall Street Journal published an article entitled, High Inflation, Falling Unemployment Prompted Powell’s Fed Pivot. The article confirms some of Chairman Powell’s testimony to Congress from last week. The bottom line per the article: “Officials are making plans to accelerate the process at their policy meeting next week, ending it by March instead.” The article clearly articulates that inflation, not employment, is now the Fed’s primary concern. While the Fed thinks high inflation rates will come down next year, they “can’t act as though we’re sure of that.” The Fed often gets economic data prior to their release. Is it possible this Friday’s CPI report is concerning?
In last Friday’s Relative Value Scorecard report for RIAPro subscribers, we noted the communications sector is performing incredibly poorly on a relative basis versus the S&P 500. To wit: “The standout on the relative charts is the incredibly oversold condition of the communications sector. Its score is -12.41 out of a possible -13.5.” While a bounce versus the market is likely we caution the sector is very top-heavy. As such, over half of its weighting is in three stocks- FB, GOOG, and NFLX. The fortunes of those companies, especially FB and GOOG are likely to drive the sector. The graph below, courtesy of Charles Schwab, further highlights how poorly the communications sector is trading. Every member of the sector is below its respective 50dma and 81% are below their 200dma (not shown).
The Week Ahead
There are not many relevant economic data releases but what data is coming out is important to better assess what the Fed may do at their FOMC meeting next week. Wednesday’s JOLTs report is expected to show the number of job openings continues at or near record-high levels, meaning the labor market is robust. Job Quits, another indicator of the jobs market is also supposed to be high, signaling employee confidence in their ability to quit and find a better or higher-paying job. On Friday the BLS will report on CPI. After last month’s shocking 6.2% print, economists are expecting another bump higher to 6.8%. Such a number will put further pressure on Powell and the Fed to speed up the taper process and start thinking about the timing of interest rate hikes.
On Wednesday and Thursday, the Treasury will auction 10 and 30-year bonds respectively. Typically the auctions can weigh on bond prices in the days prior. The Fed will enter its self-imposed media blackout window this week with the FOMC meeting next Wednesday.
December 3, 2021
Are Value Stocks in Vogue?
The Finviz heat map below shows there is a clear divide between the winners and losers. The winners in green, are companies and sectors that have been lagging the market. Many of these companies are considered value stocks, due to their relatively low valuations. Many of the companies in red are stocks that have done very well this year. In many cases, they are trading at or near record-high valuations. The last few days have been a rare instance of outperformance by the value sectors. It’s way too early to call it a trend but it is worth following closely.
Five Stocks for Friday uses stock screens to give readers five stocks that we expect to outperform if a particular investment theme plays out in the future. Investment themes may be relevant to the current or expected market, industry and/or economic trends. Check out our inaugural picks.
First Impressions can be Deceiving
Stocks initially rose on the employment data as the weak jobs print might mean the Fed would step down from recent hawkish tones. St. Louis Fed President Bullard, quickly put an end to such wishful thinking and took the wind out of the sails of the stock market. He said the Fed could consider raising rates before they finish tapering. Almost all investors were under the impression the Fed would finish tapering before raising rates. Such implies no rate hikes until July unless the Fed speeds up its taper schedule. The May Fed Funds Futures Contract now implies a 65% chance the Fed tightens before June. The market is betting that Bullard is on to something.
The BLS Employment Report- Good or Bad?
CNBC says “Job Growth Disappoints“. CNN Money writes “The U.S. economy added 210,000 jobs in November, far fewer than expected.” The headline number, +210k new jobs, is well off expectations for a gain of 545k jobs, thereby justifying the concerning headlines. However, the underlying employment data was robust. The unemployment rate fell from 4.5% to 4.2%. Maybe the most crucial data point persuading the Fed’s assessment of the labor markets is the labor participation rate which rose .2% to 61.8%. Chairman Powell repeatedly uses the low participation rate as an excuse to remove monetary accommodation at a very slow pace. Might the pick-up in labor participation further support his recent hawkish tone regarding combatting inflation? The market is reacting positively to the report, signaling it thinks weak job growth will impede the Fed from speeding up the pace of tapering at the December FOMC meeting.
Our graph below shows that professional and business services accounted for nearly half of the job gains. Curiously, retail lost 20k jobs in November, which is one of the biggest shopping periods. We suspect the seasonal adjustments and Covid-related anomalies make reporting an accurate number difficult for that sector.
The graph below shows that the risk/reward equation for the S&P 500 becomes much more skewed when the VIX is between 31 and 100. The VIX has been hovering near 30 recently. The green shaded area shows that S&P 500 returns tend to follow a relatively normal distribution curve with a skew toward positive returns. The black bars highlight the non-normal distribution of returns when the VIX is elevated. During such periods, returns tend to be better than average but the risk of a 10-20% drawdown is also much higher than when the VIX is below 31.
The graph below courtesy of Zero Hedge and Goldman Sachs shows the amount of stranded containership tonnage at U.S. ports is abating. Per Goldman Sachs: “While the amount of stranded tonnage is still historically elevated, a further decline in congestion could boost supply and ease inflation pressures for consumer goods and manufactured products in early- or mid-2022”. It is also worth noting that as we pass the holiday season the demand for many goods will lessen appreciably which should further relieve pressure at the ports.
December 2, 2021
OPEC is Threatening to Curtail Planned Output Increases
Oil prices opened the day 5% weaker as OPEC decided to go ahead with a planned output hike of 400k barrels for January. The news was a bit of a disappointment as there were expectations they might curtail the increase to 200k or even less. Oil prices came storming back, however, as OPEC said they may revisit the potential to reduce their planned output increases at the January 4th meeting.
The tweet and graph below show the bullish percent index on the S&P 500 has dipped below 50%. The last six times that occurred it proved to be a good buying opportunity. However, as shown, the first dip below 50% on the graph was a false signal. Do you feel lucky? The index is a measure of breadth that simply counts the percentage of stocks with a point & figure buy signal.
In yesterday’s commentary, we note that heavy short interest in Treasury note futures could propel bond prices higher (yields lower) if those with shorts are forced to cover their positions. The graph below provides a little technical context for what might cause them to do so. As shown, the price of TLT (20 year UST ETF) has bumped up against $152 numerous times since July. Each time it was repelled but to increasingly higher lows. If bonds can break through the current wedge pattern, the 2020 highs may be in sight. Many technical traders’ that are short bonds are likely watching how this plays out closely.
Will Inflation Heat Up More?
The first graph below shows the inverse correlation between rental vacancy rates and owners’ equivalent rent. Not surprisingly, a lower vacancy rental rate tends to result in higher rental prices. With the Fed seemingly getting more serious about inflation, rental prices and owners’ equivalent rent (OER), which account for nearly a third of CPI, become very important data points to follow more closely.
Rental vacancy rates are back to 30+ year lows which is pushing rents higher. Adding to the pressure on rents and ultimately CPI is surging home prices. The second graph, courtesy of Fannie Mae, shows their model based on home prices predicts a big jump in OER in 2022. Per the article: “On a year-over-year basis, house price gains historically lead to changes in the CPI shelter cost measures by about 5 quarters.” Home prices started spiking in September of 2020, about 5 quarters ago. If CPI continues higher, the Fed is more apt to remove liquidity quicker. As we discuss in Is a Stock Market Crash Like 2000 Possible, liquidity via QE and zero rates are the lifeline of excessive stock valuations.
December 1, 2021
National Manufacturing Surveys
The PMI manufacturing survey was weaker than expectations at 58.3 versus 59.1. Per the report- “November PMITM data from IHS Markit signaled the second-weakest rise in production recorded over the past 14 months as producers reported further near-record supply delays and a slowing of new order inflows to the softest so far this year. Jobs growth also waned amid difficulties filling vacancies.” Further- “While average selling price inflation eased as firms sought to win customers, the rate of input cost inflation hit a new high, hinting at a squeeze on margins.”
The ISM survey came in at expectations of 61.1. While below levels from earlier this year, the survey remains near 20-year highs. The much-followed prices paid index fell slightly. Supply line disruptions remain a big problem. Over half of the respondents report slower delivery times. The normal range is 10-20%. The table below annotated by Zero Hedge shows six of the ten ISM components were lower this month.
The chart below provides fodder for oil bulls and bears. The price of oil tends to rally strongly following periods when the OVX (oil volatility index) is above 65. Currently, the index is at 75. While the reading entails oil may rise in price once volatility declines, we must consider the volatility index can stay elevated resulting in further declines. For example, the index was above 65 from October 2008 to March 2009. In 2020, the index was above 65 from early March until late May. Currently, the index is only on its third day above 65. Bulls are waiting on a sub-65 reading and bears are hoping volatility remains elevated. We do caution, the index can fall slightly below 65 for a day or two before rising back above 65. In such prior cases, the price of oil continued lower.
The second graph below compares the price of the popular energy sector ETF, XLE, to the OVX index. As shown, like oil prices, XLE tends to do well once the index falls back below 65. However, XLE bucked the trend in 2020 as it rose when the index was above 65 and fell once it dropped back below 65.
Everyone Hates Bonds- Is That Bullish?
Per Reuters, the net bearish bets on U.S. Treasury ten-year note futures is now the largest since February 2020. In January and February 2020, bond prices were rising and yields falling as the economy was slowing and the Fed had begun cutting rates late in 2019. The advent of Covid in early March sent bond prices soaring, fueled in part by traders forced to cover their short bets. Today, like then, net shorts are extreme and some traders are starting to buy to cover their shorts as the new Covid variant and hawkish tones from Powell pressure stocks. History may not repeat itself, but it often rhymes.
Cyber Monday Disappoints
According to Adobe Analytics, sales for Cyber Monday were disappointing. Online sales for last Monday totaled $10.7 billion, a 1.4% decline from last year. While it is the first decline for Cyber Monday, one must factor that last year’s data was an anomaly due to Covid and consumers’ reluctance to go to stores. To wit, foot traffic is up 48% versus last year, but it is still down 28% from pre-pandemic years. Personal consumption accounts for approximately two-thirds of GDP. As such, holiday spending is an important component of growth. This year we must be careful reading too much into retail sales data. Inflation and shortages of many goods are resulting in timing and spending behaviors that are not comparable to years prior.
November 30, 2021
Consumer Confidence Continues to Weaken
The Conference Boards Consumer Confidence Index fell to 109.5, down from 111.6. Both the present situation index and the expectations index were lower. Driving consumers’ moods are concerns about rising prices and income prospects.
The Chicago PMI, a precursor to national manufacturing surveys, fell more than expected to 61.8 from 68.4. After hitting a high of 75 in April, the index has been trending lower. The slowing of new orders and employment were partially responsible for this month’s decline. The ISM and PMI manufacturing surveys will be released tomorrow. Both are expected to show slight increases from last month.
Sounding The Inflation Alarms
Chairman Powell was vocal about inflation and is finally backing off using the word “transitory” to describe it. Per his testimony to the Senate: “time to retire the term”transitory” regarding inflation.” He followed, “the risk of persistently higher inflation has increased. We will use our tools to make sure higher inflation does not become entrenched.” The inflation comments are an upgrade to his recent descriptions of inflation. However, he countered the discussion by mentioning the weak labor participation rate and covid related factors affecting economic growth. On balance, his statement was a little more hawkish than usual.
Chairman Powell spoke late on Monday. While his economic assessment was generally in line with other recent speeches, he did offer pause about the new Omicron variant.
The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation. Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.
Buckle Up – The Debt Ceiling is Upon us Again
The last debt ceiling debate ended with an extension to mid-December. December starts tomorrow, and the debt ceiling headlines are starting back up. For instance, Bloomberg reports that Congress needs to pass a stopgap funding bill to keep the government open beyond this week. The graph below, courtesy of Zero Hedge, shows that Treasury Bills maturing in mid and late December are now trading about 4bps higher than where they should. Such a kink in the curve is due to investors requiring a premium to take the risk that principal payments on maturing bills are delayed.
A Bull Market For the Ages
The chart below, courtesy of Fidelity, shows all of the cyclical bull markets since 1920. The rally starting in 1932, following the crash of 1929 and subsequent 89% drawdown, is the only rally that is steeper than the current post-March 2020 rally.
November 29, 2021
Twitter’s stock jumped almost 10% at the market open on news that CEO Jack Dorsey will be stepping down. The gains were short-lived as shown in the graph below. Twitter has become a large social media brand but its stock price is basically flat since IPO’ing in 2013. After the initial rush of enthusiasm, it appears investors are concerned that promoting a long-time Twitter veteran (current CTO – Parag Agrawal) to replace Dorsey will not result in the types of changes investors are asking for.
The graph below compares two widely followed foreign stock ETFs and the S&P 500, from the beginning of the Covid outbreak through today. EEM holds emerging market stocks, and EFA developed market stocks. As shown, all three ETFs performed similarly during the decline in early 2020 and the recovery afterward. However, starting in the spring of 2021, the foreign market ETFs peaked while the S&P 500 continued to new highs. Over the last nine months emerging markets (EEM)s have given up about 25% of their post-Covid gains, while developed markets (EFA) have essentially flatlined. The following factors help account for some of the U.S. equity outperformance:
Since June 2021, the USD index is up about 8%.
The economic recovery in the U.S. has been stronger than in most nations.
The Fed is slightly more hawkish than other central banks.
China’s economic activity has slowed significantly, weighing heavily on many emerging markets.
The week’s significant events will be the ADP employment report on Wednesday and the BLS report on Friday. Currently, the forecast is for a gain of 550k jobs in the November BLS jobs report. Investors are likely to focus on the labor participation rate as Fed Chairman Powell claims the lower rate is a sign of labor weakness. The current estimate is for the participation rate to uptick 0.1% to 61.7%.
Investors will also watch the ISM manufacturing and services surveys on Wednesday and Friday, respectively. Current indications are that both numbers will remain at their current levels. We will follow the price gauges in both surveys closely.
The next Fed meeting will be in two weeks on the 15th of December. Assuming the new covid variant does not become problematic for global economic activity, we might see some Fed members encouraging a faster tapering pace in speeches and comments this week. Voting Fed members go into their self-imposed media blackout period next week, so this week may be their last chance to speak up publically before the meeting.
November 26, 2021
**The equity markets will close at 1 pm ET today
Green in a Sea of Red
The Finviz heat map below shows many stocks are down 2-3% on the day, but there are a few bucking the trend. In most cases, the green on the map is in businesses that benefit from the lockdowns. In addition to the obvious winners in the healthcare industry, are Verizon, NetFlix, and Clorox. Moderna and Pfizer are up significantly. The restaurant and travel business are faring the worst. In the upper right corner, notice losses approaching 10% for Marriot, Las Vegas Sands, and Booking.com.
Stocks are declining worldwide due to a new variant of covid detected in South Africa. Per CNBC:
“South African scientist Tulio de Oliveira said in a media briefing held by the South Africa Department of Health on Thursday that the variant contains a “unique constellation” of more than 30 mutations to the spike protein, the component of the virus that binds to cells. This is significantly more than those of the delta variant.
Many of these mutations are linked to increased antibody resistance, which may affect how the virus behaves with regard to vaccines, treatments and transmissibility, health officials have said.”
The bond market is assuming the new strain will force the Fed into a more dovish policy stance. 2-year yields are down 12 bps this morning, essentially taking out half of a 25bps Fed rate hike over the next two years.
Many traders are out for the holiday, so liquidity will be poor and trading may likely be volatile.
The Dollar is on Fire
The dollar rose in light trading on Wednesday. The impetus behind the dollar continues to be economic data that the market believes will push the Fed to become more hawkish. It is worth noting many corporate and sovereign borrowers that borrow in dollars for use in their home country are exposed to currency risk. Essentially, a stronger dollar increases their net borrowing costs as they have to convert to dollars at a higher rate to pay interest and principal. As such, a strong dollar tightens liquidity for the rest of the world and will inhibit global economic growth if the dollar continues upwards. The graph below shows the dollar index is up over 7% year to date.
Defining “Prolonged” and “Substantially Exceeds”
The Fed recently informally updated its price stability policy. Under the new inflation averaging regime, they will allow inflation to run higher than 2% for short periods, to compensate for periods when it was below average. The graph below shows the three-year average inflation rate is now 2.7%. Further, the annual inflation rate is 6.2%. Fed members are increasingly getting nervous that inflation is running hot for a prolonged period and the current rate substantially exceeds the Fed’s target on both a short-term and longer-term averaging basis. We expect to see various Fed members discussing their thoughts on how to adjust monetary policy to better manage inflation.
November 24, 2021
**The stock and bond markets will be closed tomorrow. Trading volumes should be light this afternoon.
The Team at RIAPro wishes you and yours a very happy Thanksgiving holiday.
A Plethora of Economic Data
Jobless Claims fell to 199k in the latest week, marking a low going back to November 1969. Keep in mind that the population is 65% larger today than in 1969, so today’s number is off the charts on a population-adjusted basis. This is yet another piece of data that affirms the labor market is robust. Having an inflation problem and strong labor market is more evidence the Fed needs to speed up tapering QE and start contemplating rate hikes.
Durable Goods fell 0.5% versus expectations for a 0.3% gain and a prior month reading of -0.4%. Excluding transportation, the number was positive at 0.5%. Accounting for the difference is the auto sector, which struggles to produce cars due to the chip shortage.
Wholesale inventories rose 2.2% versus 1.4% last month. This is a positive sign that supply line problems and shortages are abating. However, Retail Inventories only increased by 0.1% versus falling 0.2% last month. Either retailers are not fully stocking up on goods to help justify higher prices, or trucking problems are making it difficult to deliver goods. It is likely a combination of both factors.
Are Junk Bonds Sending Us A Warning?
The graph below shows the strong correlation between JNK and the S&P 500. JNK is a popular junk bond ETF. JNK just hit lows going back to July, while the S&P is nearly 10% above its July levels. JNK is also back to its 200dma, something the S&P hasn’t done since it broke through the 200dma in June 2020. Higher yields for junk bond issuers can lead to financial hardship and bankruptcy in some cases as they tend to be overleveraged. Are inflation and the possibility of the Fed raising rates finally concerning JNK investors? Maybe the better question is, is the recent price action of JNK foreshadowing problems for the equity markets?
More Details on the SPR Oil Release
Of the 50 million barrels being released from the Strategic Petroleum Reserve, 32 million will be under the exchange program. Companies that successfully bid to receive oil under the program must pay it back and with interest, so to speak. The winning bidders can take delivery starting December 16th from one of four sites. They will then have to return the oil plus a premium in the future. Each site has a different premium and date range requirement regarding the return of the oil. For example, Bryan Mound will offer 10 million barrels. The oil has three return dates, with the first starting January 2023. If the oil is returned at that time, the winning bidder must return an additional 3.9% of oil. The premium increases to 5.3% and 8.6% if they choose the second or third delivery dates, respectively. In the short run, the release will add supply to the market but reduce it starting in July of 2022.
The graph below, courtesy of Bianco Research, provides context for the size of the SPR and recent withdrawals from the reserves.
President Biden is ordering the Department of Energy to release 50 million barrels of oil from the Strategic Petroleum Reserve. The action is in unison with China, India, Japan, Korea, and the U.K. Per the announcement:
“The President stands ready to take additional action, if needed, and is prepared to use his full authorities working in coordination with the rest of the world to maintain adequate supply as we exit the pandemic.”
What’s Wrong With Gold?
A reader asked us why gold fell over $40 an ounce on Monday. While some media outlets ascribe it to Powell’s nomination, the real answer lies in the two charts below. The first chart, from our article The Fed’s Ever Growing Footprint, shows the strong correlation between the price of gold and real interest rates (nominal interest rates less the implied inflation rate). Gold prices often rise when real rates fall and vice versa. The second graph, courtesy of Zero Hedge, shows real rates (green) have risen about 20bps (from -1.20% to -1.00%) from midday Friday through Monday. The sharp increase is due to the 10-year break-even inflation rate (red) falling and bond yields rising.
Will Bond Bears Be Proven Wrong, Again?
Short interest in bond futures is currently at or near record highs. Given the inflation outlook and the Fed’s lethargic response to combatting inflation, shorting bonds may seem like a nice trade. It may be, but context is valuable in this case. The graph below from Jim Bianco shows that professional forecasters have been consistently wrong in predicting the path of bond yields since 2002. Those short bond futures better hope this time is different.
Reminiscent of 1999
We stumbled upon the table below highlighting market performance by sector in the months leading to the Tech crash in 2000. It looks awfully familiar to the poor breadth of the last few days of trading.
November 22, 2021
Rivian Is Out of Favor
Last week’s favorite EV automobile company, Rivian (RIVN), is taking it on the chin. Today shares are down more than 10% as plans to develop cars jointly with Ford (F) have been canceled. The stock has lost a third of its value in the last few days, yet is still up 10% since its November 11th IPO. Ford is up over 5% on the news. Also helping Ford are rumors they may break off their electric car division.
U.S. Federal Reserve Chair Jerome Powell is being renominated by President Biden for a second four-year term. The runner-up for the seat, Lael Brainard, is the new Vice-Chair. The initial reaction from the stock futures market is bullish. The asset markets and betting markets had high odds for his renomination.
As we write below, the use of leverage by retail investors is up sharply. Similar behaviors are occurring by many institutional investors, including the more conservative types. The following comes from David Robertson and Almost Daily Grant’s
“Facing a high bar to generate necessary returns within the confines of public markets, the largest pension fund in the United States tweaks its own strategy in the opposite direction. The California Public Employees Retirement System (Calpers) voted in a board meeting yesterday to upsize its allocation to private equity holdings to 13% from 8% and bump private credit holdings to 5% from less than 1%, while adding $25 billion in leverage (equivalent to just over 5% of assets) to help juice returns. Without those changes, Calpers estimates that its portfolio would generate a 20-year return of 6.2% annually, lagging the 6.8% annual bogey established this summer, which was itself lowered from 7%.”
David’s summation- “To sum up, the largest pension fund in the country is not only increasing allocations to the riskiest assets at the most expensive valuations in history, but it is also taking on debt to boost returns even more.”
The graph from Top Down Charts below shows that investors’ participation in leveraged long ETFs has tripled since the pandemic. Due to zero interest rates, the cost of leverage has never been cheaper for the ETF managers and ultimately the investors. However, if the Fed gets closer to raising interest rates the cost of leverage will rise in anticipation. This may be a fly in the bull market’s ointment, but likely a story for next year, not this year.
The Week Ahead
Despite the Thanksgiving holiday, it will be a busy week for economic data releases. Of note are Existing and New Home Sales, PMI Manufacturing Survey, Durable Goods, GDP Price Index, and Personal Income and Spending. The Fed will also release the minutes from its November meeting on Wednesday.
November 19, 2021
More Bad Breadth
The graph below shows that despite the NASDAQ hitting new highs, the number of new lows is now the highest since March of 2020.
The more hawkish Fed members are finally expressing their views and it seems they want to speed up tapering. For instance, Fed President Chris Waller said “The rapid improvement in the labor market and the deteriorating inflation data have pushed me towards favoring a faster pace of tapering and a more rapid removal of accommodation in 2022.” A “more rapid removal of accommodation” implies raising interest rates. He also mentions the Fed should consider “contracting its balance sheet“, aka selling bonds.
What’s Ailing Europe?
As we note below, Covid infections are on the rise in Europe and we are now learning Austria is going on a full lockdown. We suspect other European nations may follow their lead. The Euro has traded poorly over the last week, in part due to the rising number of infections and their economic implications. As we show below, the Euro/USD is down about 4% since the start of the month. More importantly, it has fallen about 10% versus the dollar since early June. Europe’s economy is not rebounding as strongly as the U.S. which helps explain part of the underperformance. As a result, the ECB has been more dovish (if that’s possible) than the Fed.
This morning ECB President Christine Lagarde essentially ruled out rate hikes in 2022. Per her speech- “conditions to raise rates are very unlikely to be satisfied next year.” Currently, the Fed’s “dot plots” call for one rate hike next year, and the markets see as many as three hikes.
The Bloomberg graph below shows that the stocks spending the most on buybacks (orange) are outperforming the S&P 500 (white). The chart also shows that companies investing the most in R&D and Capex are considerably lagging the market. Investors should be concerned that the companies investing the most into their future are essentially being punished. Slowing productivity growth is a big factor limiting future economic growth. This chart highlights the personal incentive for most executives with equity-based salaries to buy back stock instead of engaging in productive investments.
Covid Infections are Spiking Again in Europe
The graph below from Longview Economics shows that Covid infections in many European countries are rising rapidly and in some cases at the highest levels since the pandemic began. The sharply increasing number of cases will likely result in lockdowns in Europe, which will stunt economic activity in Europe and to a much lesser degree worldwide. The big question for U.S. investors is will the high rate of infections spread across the Atlantic? Further, the euro versus the dollar has been declining rapidly. If the high rate of infections continues and European economic growth suffers, will the dollar continue to appreciate versus the euro?
November 18, 2021
NVIDIA (NVDA) Earnings
NVDA reported third-quarter earnings yesterday after the close. GAAP EPS of $0.97 easily topped the consensus estimate of $0.86, thanks to strong demand and favorable product mix. Gross margin increased +2.6% YoY to reach 65.2% in the third quarter. Revenue of $7.1B (+50.1% YoY) modestly beat expectations of $6.8B, driven by record sales in the Gaming (+42% YoY) and Data Center (+55% YoY) segments.
Management set guidance for Q4 revenue at $7.4B plus or minus 2%, which sits above expectations of $6.9B. In addition, they guided for gross margin to remain steady at 65.3% plus or minus 50 bps. The positive momentum and strong guidance are being well received by the market, as the stock is trading +10% this morning. We hold a 1.75% position in the Equity Model.
Higher Prices in Philly
The Philadelphia Fed Economic Survey, showing current economic conditions in the mid-Atlantic, points to robust activity. The index rose to 39, its highest level since April. Prices also continue to rise with the prices paid index rising to 80, just a hair below 80.7 in June, which was a 42 year high. A score of 80 means that 80% of those surveyed witnessed higher prices in November than October. Price received rose as well to its highest reading since 1974. The bottom line is companies are paying more for input goods but are able to pass the higher costs to consumers.
The most important part of this survey is this month’s special question. Per the Fed: In this month’s special questions, the firms were asked to forecast the changes in the prices of their own products and for U.S. consumers over the next four quarters. The results, as shown below, are clear that firms are bracing for more inflation in the prices of goods they sell as well as higher wage expenses. More telling, their longer-term inflation forecast rose by half a percent to 3.5%.
The chart below from the Leuthold Group shows that stocks are extremely expensive by all measures except those that compare valuations to interest rates. The Fed model and the two equity risk premium valuations are relatively cheap because interest rates are so low. The problem we have with those models is that interest rates are so low in part because future economic growth and therefore earnings growth are also trending lower.
Infrastructure Spending Forecasts
The graph below from Moody’s shows net spending from the recently passed infrastructure bill and the current proposal for the social infrastructure bill. Currently, nominal GDP is over $23 trillion. If we assume the social bill passes, as it is currently written, additional government spending from both bills will peak in 2025 at about $150 billion. That amount would add approximately .60% to GDP. While somewhat meaningful, we must also consider net government spending from the two bills in aggregate decline in the years 2028 and beyond.
November 17, 2021
The Next Big Shock
Fed’s Mester Says Improving Treasury-Market Resilience Is Top Priority
Fed’s Williams says: “We Must Think About How To Shore Up The Treasury Market So It Can Better Endure The Next Big Shock “
The two comments/headlines came out on the same day. The Fed owns 25% of all U.S. Treasury securities outstanding and north of 50% of the available float. Despite their holdings, and the significant effect it has on yields, they appeared worried that volatility could destabilize the bond markets. Do they see an event on the horizon that could significantly shock interest rates much higher or lower? The only obvious events we can think of are a quickened pace of tapering or the coming debt ceiling debate in Congress.
Powell or Brainard?
President Biden says he will choose the next Fed Chair in the coming days. The market is betting that Powell gets renominated, but some believe Lael Brainard has a chance. “Who Will Be The Next Fed Chair?” a Baron’s article, compares and contrasts the two candidates. While they certainly have differences, Brainard is likely to be equally as dovish as Powell if she were to get the nomination. However, from the market’s perspective change may be viewed poorly. To wit, Danielle DiMartino Booth is quoted in the article as follows:
“Moreover, a shift away from the continuity at the Fed that Powell represents would like roil the markets, which is the last thing Biden needs now, she adds in an interview.”
Mark Hulbert from MarketWatch shares a little-known secret about earning 7% yields in U.S. Treasury securities. In his article, Hidden In Plain Sight Is A U.S. Treasury Yielding More Than 7%, Mark walks through Treasury I bonds and the benefits of owning them in a higher inflation environment such as today. With the 6.2% inflation CPI print last week, the new coupon rate on I-bonds is set at 7.12% for the next six months. Because I-bonds reflect the current inflation rate, they are a viable alternative to TIPs for investors looking to retain their purchasing power. As a comparison, the real yield (nominal yield less expected inflation rates) on the 5-year Treasury note is -1.66%. The graph below compares nominal yields for I-bonds versus the Treasury curve.
Job Quitters are Driving Up Wages
The Job Quit rate is up to 3%, the highest level since they started tracking it twenty years ago. People typically “quit” or voluntarily leave jobs in search of higher-paying jobs. The graph below confirms a strong correlation between the quit rate and wages for those switching jobs. Given the record number of job quitters, we suspect wages will continue higher, putting further pressure on corporate profit margins and, more importantly, increasing the risk of a wage-price inflation spiral.
November 16, 2021
Stronger Than Expected Retail Sales
Despite weakening confidence, consumers spent a lot of money last month. Retail Sales rose 1.7%, up from 0.7% last month and well above the 1.0% consensus. While the number was great, there are a couple of factors that may be overstating it. First, Retail Sales is nominal, meaning it doesn’t capture inflation. As such, consumers may be buying a similar number of goods but paying more for them. Second, we believe many people are ordering Christmas gifts early due to concerns about supply lines and shortages. If this is the case, sales for November and especially December may end up being weaker than expectations. One last point, Hanukah starts on the Sunday after Thanksgiving this year, which is also driving earlier than normal demand.
As the first graph shows Bitcoin is down about 11% over the last few days. While a double-digit percentage move is quite often significant for most assets, it is fairly commonplace for Bitcoin. In fact, the five-day average price range using the high and the low for each five-day period since 2014, is 11.65%. The second graph circles the recent five-day range, highlighting just how average it is.
Lofty Earnings Expectations
“The attractive P/E to LTG ratio, or ‘PEG ratio’, of the S&P 500 is due to lofty growth expectations, not low valuations… LTG rates are better contrary than positive indicators… today’s level would suggest losses of -20% over the next 12 months” – BofA
Bottom line- implied long-term earnings growth of nearly 20% is well above any level witnessed since 1986, including 1999. It’s also more than double any actual growth rate over the period. Now consider, profit margins will be under pressure due to rising prices and wages, the Fed is removing accommodations, and economic growth will normalize. Given these headwinds, the implied growth forecast seems like pie in the sky. An adjustment of growth expectations is likely to make investing much more difficult in 2022 than this year.
Diversification Ain’t What it Used to Be
The graph below, courtesy of Jim Bianco, shows the diversification benefits of a passive portfolio are rapidly fading as the five largest stocks now garner nearly 25% of the contribution to the S&P 500. While many investors may think they are diversified because they indirectly own 500+ stocks, such is not mathematically accurate. Yes, they own a piece of 500+ stocks, but the returns are heavily based on five stocks.
November 15, 2021
Lofty Expectations for Interest Rate Hikes
The graph below shows the implied Fed Funds rate based on Fed Funds futures pricing. The blue bars represent the expected dates at which a 100% chance of a rate increase will occur. For example, the market assigns a 100% chance of a rate increase by August 2022 and a 100% chance of a second increase by November 2022. As we show, the market expects the Fed to increase rates five times to 1.25%, by the end of 2023.
There is definitely not a shortage of turkeys on Wall Street, but if you are planning on serving turkey for Thanksgiving you may want to buy one soon. As the graph shows, the volume of birds in storage is running at about half the normal rate for this time of the year.
Slumping Confidence and Political Ramifications
Last week we reported the University of Michigan Consumer Sentiment Survey fell more than expected and now sits at 10-year lows. After digging deeper into the report we discovered something interesting that will likely gain importance as we near next year’s mid-term elections. First, the divide in sentiment between Democrats and Republicans is massive at 90.8 and 53.1 respectively. More telling, confidence among those considering themselves independents fell sharply to 69.2. It is likely independents, along with moderate Democrats and Republicans that will decide the balance of power in the House and Senate. If the confidence of independents continues to fall, the Democrats are more likely to lose the House, Senate, or possibly both.
The Week Ahead
The economic calendar starts in earnest on Tuesday with Retail Sales and Industrial Production. Given the recent drop in consumer confidence, we would expect retail consumption to slump. However, retail sales do not account for inflation, thus forecasts are for an increase of 0.5%. The week will be relatively quiet on the economic front after Tuesday.
We expect to see numerous Fed speakers this week. With the recent barrage of employment and inflation data, a few speakers may call on the Fed to increase the pace of tapering and move up the timeline for interest rate increases.
Options expiration is on Thursday. As David Robertson points out below, options market volume has been extreme. Such high volumes and open interest along with generally low stock volume can lead to large price swings.
Retail is extremely active, and they love punting options. Below are a few stunning facts via Goldman’s Scott Rubner:
1. single stock option notional (140%) now exceeds single stock shares notional
2. over 70% of options traded have an expiry of two weeks or less (more in the 2,3,4 day range)
3. $904bn (Thursday stock option notional). This is largest single stock option notional traded of all time.
November 12, 2021
It’s Transitory They Say
Consumer Sentiment and JOLTs
The University of Michigan Consumer Sentiment Survey fell more than expected to 62.8. The one-year inflation expectation ticked up from 4.8% to 4.9%. The report states: “Consumer sentiment fell in early November to its lowest level in a decade due to an escalating inflation rate and the growing belief among consumers that no effective policies have yet been developed to reduce the damage from surging inflation.”
The BLS reports there are now 10.438 million job openings, slightly better than forecasts of 10.30 million. The two graphs below show the extreme imbalance between the number of job openings and the unemployment rate. The ratio of the two in the bottom graph is at 20-year highs. The “quits” rate rose from 2.9% to 3%, another sign of a robust labor market. Our latest article, What a Rate Hike in 2022 Might Mean for “Stonks“, discusses how the labor market is much healthier than the Fed believes.
Rivian vs Ford and Gm
Rivian (RIVN) is the latest company to benefit from the electric vehicle stock craze. Its stock went public on Wednesday and now has a market cap of over $100 billion. We thought it would be helpful to compare RIVN to Ford and GM for proper context. Keep in mind, both Ford and GM, have numerous electric vehicles already being distributed and more models in the pipeline.
Ford has a market cap of approximately $80 billion and GM is at $90 billion.
Rivian has revenue that is expected to range between zero and $1 million this quarter. Ford and GM have revenue of approximately $135 billion each.
Ford has EBITDA of over $12 billion for the last 12 months and GM is nearly double Ford at $23.8 billion. RIVN lost over $1.5 billion.
Speculative investors are putting the cart well ahead of the horse. They appear enamored with new entrants without contemplating established automakers with extensive financial and manufacturing means competitive electric vehicles for sale.
JNJ is Splitting Into Two
JNJ will split into two companies, separating consumer health goods from its medical devices and prescription drug businesses. The split is expected to occur within the next two years. Shares of JNJ are up about 5% on the news. We currently hold a 1.5% of JNJ in the Equity Model.
The chart below, courtesy of Charlie Bilello, compares IBM’s market cap to its buybacks and declining shares outstanding. Over the last 20 years, IBM has repurchased $132 billion worth of its shares. Its current market cap is now only $113 billion. Simply, they threw away a lot of money. Imagine what its market cap would be had they invested the $132 billion into other companies or projects that would boost earnings?
Yield Curves Are Starting to Invert
An inversion in the 2-year/10-year U.S. Treasury yield curve is frequently a precursor for a recession and accordingly well followed by investors. Other parts of the yield curve are not followed as closely but can give us hints about the future shape of the 2-year/10-year curve. For instance, the graph below shows the 20-year/30-year yield curve. It is currently inverted by about five basis points, having flattened by nearly 30bps in the last year. While not a precursor for a recession necessarily, it does warn the entire curve is flattening. The last time the 20-year/30-year curve was inverted was in the period leading up to and during the financial crisis.
November 11, 2021
Are Semiconductor Sales Peaking?
Semiconductor stocks have been on a tear lately as chip demand is incredibly strong. At the same, semiconductor manufacturers can’t produce enough chips which give them significant pricing power. SMH, a well-followed semiconductor ETF, is up 17% over the last month and 51% for the last year. The graph below warns the exuberance for the industry may be overstated. As shown, courtesy of Stouff Capital, semiconductor sales have a strong correlation with credit growth in China. Given China produces a large number of goods using chips, the relationship makes sense. Recently, China has clamped down on credit creation resulting in negative credit growth and, not surprisingly, weak economic growth. If the semi-credit relationship holds up, the graph portends semiconductor sales may appreciably underperform sales estimates for 2022. That said, the shortage of chips and demand for products using chips, such as cars, provides a decent base of demand for future sales.
Inflation, Inflation, and More Inflation!
The Dollar and Commodities Are Not Behaving Like Normal
The first graph below charts the dollar in orange and the CRB commodities index in blue. Typically a strong dollar results in weak commodity prices and vice versa. Throughout 2021, commodity prices and the dollar have a positive correlation, as circled. The second graph highlights the abnormal correlation a little better. In the Bloomberg graph, the dollar index (white) is plotted on an inverse scale to the left and Bloomberg’s commodity index to the right. The positive correlation is likely because commodity prices are increasing due to supply line factors and not traditional economic factors.
More CPI Worries
The graph below foreshadows that inflation may continue rising. It tracks the median CPI, measuring the breadth of inflation. As discussed in recent articles and commentary, the headline CPI figure everyone follows can be swayed by a few items. For instance, “shelter” represents nearly 30% of CPI. The median figure helps assess how the prices of many goods are behaving. As the graph shows, median CPI is now at highs last seen in 2008. More problematic, the 3-month change is running at levels more significant than any seen since at least 1984.
November 10, 2021
Ugly Bond Auction
Stocks and bond markets are under pressure as the Treasury Department’s 30-year auction went poorly. In the minutes prior to the auction, the bonds were trading at a yield of 1.888%. The auction went off at 1.940%, over .05% higher than expected. It appears the CPI data spooked traders causing them to back up their bids.
The Fixed Income Derivative Markets Imply Persistent Inflation
The graph below courtesy of Arbor Research shows the derivatives markets are increasingly pricing greater odds that inflation runs 3% or greater. Currently, the market implies odds of 88% that inflation will persist above 3% for two years. Even longer time periods, such as five and ten-year terms, have good odds of greater than 3% inflation for those respective periods.
CPI ran much higher than expectations as shown below. The 6.2% annual rate of inflation is the highest since October 1990. The core rate, excluding food and energy, is also higher than expected. The Fed favors, excluding volatile food and energy prices when assessing inflation. CPI, and yesterday’s PPI, will add to the pressure on the Fed to speed up the pace of taper and raise rates. Some of the pressure may come from the White House which is increasingly vocal about inflation.
Yesterday the BLS reported PPI is running at 8.6%, insinuating the prices of goods used to produce final products are rising rapidly. PPI data from China confirms the data, showing inflation for manufacturers is running hot. Since China is a massive exporter of goods, they are likely to pass some of the inflation our way. China’s PPI rose 13.5% year over year, the highest pace in over 25 years.
Is Gold a Buy?
The Fidelity graph below shows the strong correlation between real interest rates and the price of gold. 5 and 10-year real rates (inflation-adjusted) are on the bottom with an inverse y-axis on the right side. Per Jurrien Timmer (Director of Global Macro- Fidelity) -“If the Fed is ultimately forced to accept higher inflation as the cost of financial repression, then real rates could fall further, much like they did during the 1940s. This creates an opportunity for gold and silver, not to mention Bitcoin.”
Party Like Its 1999
The graph below, courtesy of the Leuthold Group, shows there are many stocks trading at extreme valuations. At 73 S&P 500 stocks, there are almost twice as many companies trading at greater than 10x sales than in 1999. The current median price to sales ratio is 3.5x versus 2x in 1999. By almost all historical valuation standards 1999 is considered the peak. Recently more and more valuation measures have been surpassing those levels.
November 9, 2021
PPI rose 0.6% in October, rising to 8.6% year over year. Both readings met expectations. Over half of the gain came from energy prices. As shown below, PPI is running at over 3x the pre-pandemic rate. From an investment perspective, the question we face is whether or not companies can pass the rising costs on to consumers. So far, it appears they have been able to, but as stimulus dries up, and savings revert to normal, it seems less likely going forward, barring higher wages.
The NFIB small business optimism index fell to 98.2, the lowest level since March. More concerning is the forward outlook of those surveyed, in the second table below. Per the NFIB: “The NFIB Uncertainty Index decreased 7 points to 67. Owners expecting better business conditions over the next six months decreased 4 points to a net negative 37 percent. Owners have grown pessimistic about future economic conditions as this indicator has declined 17 points over the past three months to its lowest reading since November 2012.”
The survey acknowledges there is still a shortage of workers, but the survey results “hint at an easing of conditions in the labor market.” In regards to inflation, “price raising activity has reached levels not seen since the early 1980s, when prices were rising at double-digit rates.”
The first table below shows economic conditions and the political climate are primarily responsible for the poor outlook among small business owners. Per the SBA, small businesses account for nearly 65% of the private sector workforce, making this survey an essential part of our economic outlook.
Bond Auctions Today and Tomorrow
The U.S. Treasury will auction $39 billion of ten-year notes this afternoon, followed by $25 billion of 30-year bonds tomorrow. Dealers tend to be net sellers/hedgers of bonds going into auctions. As such, the prices of longer maturity bonds may be under pressure until Wednesday’s auction.
Baltic Dry is Plummeting
As shown below, the Baltic Dry Index is down 12 days in a row. The decline in the shipping price index of dry bulk ocean vessels is hopefully a harbinger that supply line disruptions are abating.
Powell Pressured to Act
Chairman Powell is up for renomination, and it does not appear to be a slam dunk as other Chairs were in the past. Rick Scott, a senator from Florida, penned a letter to Powell pressuring him to significantly change monetary policy if he wants the senator’s renomination vote. We suspect congressional pressure for the Fed to fight inflation will become more vocal as the 2022 Congressional elections near.
“Without a significant and demonstrable change in course, I will not be able to support your continued service as Chair of the Board of Governors of the Federal Reserve System beyond your current term ending February 2022. American families cannot continue down this dangerous path of rising inflation, broken supply chains, and continued workforce challenges.”
November 8, 2021
AMD Lands Meta Platforms Chip Deal
Shares of AMD are up roughly 11% in mid-day trading after announcing that Meta Platforms (Facebook) will use AMD’s Epyc processors in its data centers. According to Bloomberg, “The addition of Meta, the world’s largest social media company, to AMD’s customer list means it now supplies all the top operators of the giant computing networks that run the internet.” In addition, AMD announced its MI200 Instinct processor that will provide better competition against NVDA as AMD aims to gain market share in graphics processors. We hold a 2% position in AMD in the Equity Model.
Richard Clarida Speaks
Fed Vice Chair Richard Clarida largely mimicked Powell’s comments from last week. In regards to raising interest rates, he states: “While we are clearly a ways away from considering raising interest rates, if outlooks for inflation & unemployment turn out to be the actual outcomes… then I believe that these 3 necessary conditions for raising fed funds rate will have been met by year-end 2022″
His comments were generally dovish as widely expected. Jerome Powell spoke today but not on the topic of monetary policy. The Fed speaker schedule will be packed this week and we anticipate a wide range of thoughts on how to advance monetary policy in the near future. Some of these speakers will discuss raising rates much sooner than year-end 2022.
The graph below from Bank of America shows earnings growth is likely to decline quickly in the coming quarters. Given valuations, this is an important topic which we have been discussing. To wit, in 2022 Earnings Estimates Still Too Bullish we wrote:
“The “sugar high” of economic growth seen in the first two quarters of 2021 resulted from a massive deficit spending surge. While those activities create the “illusion” of growth by pulling forward “future” consumption, it isn’t sustainable, and profit margins will follow suit quickly.
The point here is simple, before falling victim to the “buy the market because it’s cheap based on forward-estimates” line, make sure you understand the “what” you are paying for.
Wall Street analysts are always exuberant, hoping for a continued surge in earnings in the months ahead. But such has always been the case.”
Valuations Are Soaring
As shown below, the Shiller PE ratio is now above 40, a milestone only seen for a few months in late 1999. The prior high was witnessed during the speculative markets leading to the crash of 1929. From a fundamental perspective, the risks are palatable but cash continues to flow into markets driving prices higher. Close attention to technical analysis is warranted to help establish proper risk strategies.
The Week Ahead
With the self-imposed public speaking blackout over, we look forward to hearing the thoughts of Fed members. Many members are more hawkish than Chairman Powell. As such, we expect some of them to voice concern over inflationary pressures and discuss their desire to speed up tapering and possibly start to raise rates. The strong employment report last Friday will further encourage some members to disagree with Powell regarding the timing of rate hikes. Chairman Powell will be speaking on Monday and Tuesday. We do not expect to hear anything new from him.
The market gets its next dose of inflation information, with PPI on Tuesday and CPI Wednesday. A consensus of economists expects CPI to uptick another 0.4% to 5.8% annually. JOLTS – job openings data comes out on Friday. The forecast is for a slight decline, but still at levels well above historical norms. Bond markets will be closed on Thursday for the Veterans Day Holiday.
DUK reported third-quarter earnings yesterday before the open. GAAP EPS of $1.79 was in line with expectations, while revenue of $6.95B (+3.4% YoY) missed the consensus of $7.46B. Management reported that the results were driven by continued strength in the Electric Utilities and Infrastructure segment. Leadership narrowed its FY21 adjusted EPS guidance to $5.15-$5.30, which compares favorably to the consensus of $5.21. In addition, it maintained guidance for a long-term adjusted EPS growth rate of 5%-7% through 2025. The market’s reaction is quiet so far; the stock has lost 0.5% since Wednesday’s close. We hold a 2% position in the Equity Model.
Pfizer (PFE) stock is surging on news its experimental anti-viral pill for COVID reduces the odds of hospitalization or death by 89% for adults in a trial. The results are better than Merck’s new anti-viral pill. Assuming these new medications prove effective, the use of vaccines will diminish rapidly. Moderna (MRNA) is paying the price down over 20% on today’s news and 30% on the week.
The BLS Employment Report
As foreshadowed by Wednesday’s ADP report, the BLS payrolls report was strong. 531k jobs were added in October, bringing the unemployment rate down to 4.6% from 4.8%. The prior two months were revised higher by 235k jobs. Monthly average hourly earnings slipped from +0.6% to +.04%, but year-over-year earnings rose 4.9% versus 4.6%. The average workweek declined by a tenth of an hour, which is surprising given the strong demand for labor. Jerome Powell’s key figure, the labor participation rate, was unchanged from last month despite the strong job growth. During his post FOMC press conference, he mentioned on numerous occasions that he would like to see the participation rate rise before entertaining rate hikes.
The graph below shows October’s employment gains or losses by industry. As shown, leisure and hospitality added 164k jobs to the economy, accounting for almost a third of the new jobs. The government sector was the only sector to lose jobs.
As shown below, the S&P 500 has only been down in 2 of the last 17 days, a feat only accomplished one other time since 2000. If the market closes green today, it will mark the only time in 20 years it has gone 18 days with only two losing days.
Ripples In Still Water
On the surface yesterday, the most followed stock indexes gave the appearance of just another healthy market rise. The S&P was up 20 points and the NASDAQ up 1.25%. The tech sector carried the weight with semiconductor stocks, notably being the best performers. Beneath the surface, there are ripples. The heat map below shows over half the stocks in the S&P 500 were down on the day. Also of concern, the VIX volatility index rose 5%, bond yields fell sharply, and gold was up 1.75%. Divergences and poor breadth bear watching as they can signal a change in direction. Our models are alerting us to overbought conditions, so a drawdown would not be surprising.
ALB reported third-quarter earnings yesterday after the close. Adjusted EPS of $1.05 smashed expectations of $0.77, but GAAP EPS of -$3.36 missed the consensus of $0.75. Revenue of $830.6M (+11.2% YoY) beat the consensus of $764.6M, driven by a 35% YoY increase in lithium sales. The GAAP EPS miss was related to a $657.4M charge from an arbitration decision in a dispute that ALB inherited in 2015 when it acquired Rockwood Holdings. ALB plans to appeal the decision.
Management guided to FY21 revenue of $3.3B-$3.4B, well above the consensus of $3.24B, noting that it expects higher lithium pricing because of tightening market conditions. In addition, ALB raised FY21 adjusted EPS guidance to $3.85-$4.15 versus analyst expectations of $3.61. The stock is trading 4.9% higher mid-day following the strong guidance. We hold a 3% position in the Equity Model.
Profit Margin Pressure Ahead
Worker productivity fell 5%, well below estimates for a 1.5% annual decline and the largest decline since 1981. The surprising move is largely the result of sharply increasing unit labor costs which rose 8.3% annually. This data set bodes poorly for corporate profit margins unless companies can continue to pass on higher input costs and wages to their end consumers. Large declines in labor productivity often result in more inflation and vice versa. This is certainly occurring today.
OPEC Is Ignoring Biden
Despite President Biden’s request to increase oil production, OPEC will not abide. OPEC will stick to its original plan and increase production by 400k barrels a day in December. According to Bloomberg, the administration was asking for an increase of up to 800k barrels a day. The price of oil initially rose on the news but has since given back a big chunk of the gains.
The options market and necessary options hedging by dealers are driving stocks like Tesla much higher than warranted by recent news or fundamentals. Essentially, dealers that write options must purchase the underlying stock to hedge their position. The combination of aggressive call purchases, and higher prices, adds fuel to the fire as dealers must buy more and more stock to hedge.
The graph below from Sentimentrader shows net long options exposure is about 15% of total NYSE volume. Net options volume is now about 5-7x the norm before 2020. Per Sentimentrader: “Last week, the smallest traders spent 51% of their volume on buying call options to open. The largest traders tend to be more conservative, but even they focused 43% of their volume on call buying. Both are in the top 2% of all weeks since the year 2000.”
Why Are Yields Blind to Inflation?
Some investors are questioning why bond yields are not higher given inflation is running hot. The graph below, courtesy of the Leuthold Group, shows that it is quite frequent to have yields remain relatively constant with rising inflation. Inflation rates have spiked on numerous occasions, and in most cases, those instances proved transitory. The oddball is the 1970s and 1980s, where greater than 4% inflation rates were the norm.
November 3, 2021
Jerome Powell’s Press Conference
Below are some key points from Powell’s press conference-
*POWELL: FOCUS AT MEETING WAS TAPERING, NOT RAISING RATES
“Our focus is not on raising rates at this time.” He essentially danced around questions regarding future rate hikes.
Fed members see something different from traders but are flexible to adapt & change course if incoming data challenge their thesis
“The inflation that we’re seeing is really not due to tight labor markets. It’s due to bottlenecks.” He is pushing back on the idea that wage pressures are driving inflation.
Powell acknowledges language shift around “transitory” was intentional because they’re basically less sure it will be transitory
“The level of inflation we have right now is not at all consistent with price stability“
In a nutshell, the press conference was dovish. Powell will delay raising rates solely due to the employment picture. He is willing to overlook high inflation and the Fed’s “price stability” mandate to keep policy easy to meet their full employment mandate.
FOMC Statement – Taper has Begun
As is widely expected the Fed will begin to taper asset purchases this month to the tune of $15 billion a month. LINK to the statement. The redlined statement below shows the changes made to the last FOMC statement. Of note, in the second paragraph, they appear to be fading their transitory inflation point of view. They changed transitory factors to factors that are expected to be transitory. There were no Fed members dissenting support of the statement.
CVS reported third-quarter earnings this morning before the open. GAAP EPS of $1.20 missed the mark versus expectations of $1.40, but adjusted EPS of $1.97 beat expectations of $1.79. Revenue of $73.8B (+10% YoY) beat the consensus of $70.5B on the back of growth across all segments.
Leadership raised FY21 adjusted EPS guidance from the prior range of $7.70-$7.80 to $7.90-$8.00, which compares to analyst expectations of $7.79. However, they revised FY21 GAAP EPS guidance lower to $6.13-$6.23 from its prior range of $6.35-$6.45. In addition, CVS boosted FY21 revenue guidance to $286.5B-$290.3B as it noted that management expects recent strength to continue throughout the fourth quarter. The stock is up 5.6% in mid-day trading, seemingly in response to the updated guidance. We hold a 3.5% position in the Equity Model.
The Service Sector is on Fire
The ISM services survey rose to 66.7, the high water market dating back to at least the late 90s, as shown below. Prices rose to 82.9, which is also the highest level in over 20 years. The only negative in the report is the employment sub-component fell from 53 to 51.6. The graph on the right shows the recent disconnect between the index and the employment component.
Per ADP, 571k jobs were added last month, similar to the 523k added in September. The Fed has continually noted that weakness in the labor is the primary reason they are waiting to taper QE. It seems that is no longer the case. With inflation running hot and the jobs market seemingly back to normal, we suspect the Fed might be more hawkish than expected today.
Atlanta Fed Q4 Forecast
Despite a minimal amount of data, the Atlanta Fed’s fourth-quarter GDPNow forecast is out. Currently, they expect growth of 8.2%, well above last quarter’s 2% growth. We caution the prediction is based solely on limited data for the quarter and not estimates of upcoming data points. The forecast will most likely come down over the next few weeks as October data is released. Wall Street’s 4.7% consensus forecast is lower, albeit high, compared to last quarter.
Watch out for the Whales
The graph below shows one risk of holding Bitcoin or Etherium. Less than one percent of the investors own over 90% of the respective crypto coins available. If one of these “whales” were to aggressively sell, they would potentially affect the price meaningfully. However, some of the addresses in the largest 1% are holding on behalf of many individuals or entities.
November 2, 2021
Hertz and Avis Follow Tesla
Joining the surge higher in Tesla are Hertz (HTZZ) and Avis (CAR). As of noon on Tuesday, Avis is up nearly 100% on the day. Prior to Tuesday, it was already up 50% since October 1, 2021. Hertz, who is supposedly buying Tesla’s cars has doubled since late September. We say “supposedly” because of the tweet from Elon Musk below. It is worth noting two things in his tweet. First, there is no contract yet between Hertz and Tesla. Second, Hertz will be paying retail prices for the cars, not discounted prices as is customary.
PSAreported third-quarter earnings yesterday after the close. Funds From Operations (FFO) of $3.42 beat expectations of $3.22 thanks to a 20.8% YoY increase in net operating income. Revenue of $894.9M (+21.8% YoY) also beat the consensus of $858.8M. A 14% increase in same-store sales combined with a 6.2% decrease in same-store direct operating costs drove the positive results.
PSA entered an agreement during the quarter to purchase an All Storage portfolio for $1.5B. Of 56 properties acquired, 52 are in the high-growth Dallas-Fort Worth market. Management expects the acquisition to be immediately accretive to FFO/share with acceleration through 2025. The stock is trading 2% higher today following the upbeat earnings announcement. We hold a 2% position in the Equity Model.
The LPL graph below shows, thus far in 2021, the S&P 500 hit a new record high each month. If it can register another high in December it will join 2014, as the only year since at least 1928 to have all 12 months set a record high.
The market is so bullish that even the bears are bullish. The graph and commentary below show that, per the NAAIM survey of active investment professionals, bearish managers have about 50% exposure to stocks on average. That figure is tied for the largest allocation since the pandemic started.
Manufacturing and Yields
The graph below, courtesy of Brett Freeze, shows the nominal adjusted ISM manufacturing index is highly correlated with the change in 10-year Treasury yields. The ISM index tends to oscillate, portending yields are likely to fall from current levels when the ISM index trends lower. That said, if inflationary pressures remain persistent, the nominal index may stay elevated even if the ISM index declines. If so, yields are likely to stay at current levels.
November 1, 2021
Manufacturing Growth Slowing
The ISM and Markit’s PMI Manufacturing surveys fell slightly as manufacturing growth continues to moderate. The more followed ISM index, shows price pressures continue, with the prices sub-index rising from 81.2 to 85.7. Inventories rose while new orders dropped considerably from 66.7 to 59.8, in a sign that output is set to slow in the months ahead. Along the same lines, ISM output expectations are now at a 12 month low. PMI notes, “the pace of new order growth is the slowest for ten months.” In regards to inflation, they state “the latest increase was the fastest since data collection began in May 2007.”
The graph below courtesy of Nordea Markets highlights that the drop in new orders and increase in inventories portends ISM could turn below 50, signaling that a contraction in the manufacturing sector might occur in the next few months.
The yield curve is starting to invert, albeit not in a well-followed part of the curve. Currently, the 30-year yield is 1.98%, below that of the 20-year yield (2.015%). Historically, as shown below, an inversion between the 2yr and 10yr maturities (blue line is negative) signals a recession is coming in the next six months to a year. The current 20-yr/30-yr inversion is only a start. We will watch to see if more well-followed curve inversions start occurring. The most followed, 2-yr/10-yr curve still has over 100 bps before it inverts.
The event of the week will be the Fed’s FOMC policy meeting on Wednesday. It is widely expected the Fed will announce a $15 billion reduction in its schedule of asset purchases. Assuming they follow through, the market will be intently focused to see if continued inflationary pressures are moving them to speed up the taper schedule and/or begin discussions on raising interest rates sooner than expected. A taper reduction of greater than $15 billion per month will be a surprise for the markets.
The ISM manufacturing survey on Monday and Markit PMI survey on Wednesday will provide further light on manufacturing sentiment. In addition to the headline numbers, traders will be focused on the inflation, deliveries, inventories, and employment subcomponents of the surveys. On Wednesday, ADP will release their employment report followed on Friday by the BLS. While still important data, employment may now be taking a back seat to inflation in regards to the path of monetary policy.
Europe May Have To Tighten Too
Euro-area inflation rose to 4.1% the highest level in ten years, and above estimates for a gain of 3.7%. This comes as ECB President, Christine Lagarde, stated that she did not think the ECB would have to raise rates next year. Traders seem to feel differently as they are now pricing in a rate increase for later next year. Per Bloomberg: “Based on market pricing, investors are expecting the ECB to raise borrowing costs for the first time in more than a decade to bring the deposit rate to minus 0.3% within a year.” Keep in mind, rates are negative and still will be even after a rate hike.
ABBVreported third-quarter earnings this morning before the open. GAAP EPS of $1.78 came in below expectations of $2.00, but adjusted EPS of $3.33 beat expectations of $3.22. Revenue of $14.34B (+11.2% YoY) inched above expectations of $14.30B, driven by strength across the board.
Management raised FY21 GAAP EPS guidance to $6.29-$6.33 from a previous range of $6.04-$6.14. Management also raised guidance for adjusted EPS to $12.63-$12.67, which tops the consensus of $12.57. Finally, ABBV raised its quarterly dividend by 8.5% to $1.41/share, implying a forward yield of 5.14%. The stock is trading +4.1% higher mid-morning following the release. We hold a 4% position in the Equity Model.
XOMreported third-quarter earnings this morning before the open. GAAP EPS came in above estimates at $1.57 versus the consensus of $1.50. Revenue of $73.8B (+59% YoY) also beat the consensus estimate of $72.1B thanks to surging oil & gas prices.
Management expects future capital investments of $20B-$25B annually with a four-fold increase in low-carbon spending. In addition, the board authorized a share repurchase plan to start in 2022 with a ceiling of $10B in buybacks over the next one to two years. The market’s reaction is muted amidst a slight pullback in crude prices, as XOM is trading 0.6% higher mid-morning. We hold a 2% position in the Equity Model.
Consumers are in an Inflationary Bind
The quarterly Employment Cost Index rose 1.3% versus expectations for a gain of 0.9%. On a year-over-year basis, the index is up 3.7%. While the data is a little old, it points to profit margin pressures for corporations.
Personal Income fell 1% in September. Personal Consumption Expenditures rose 0.6%. It appears expenditures are rising because of inflation, not because consumers are buying more goods. This data also helps explain the recent uptick in credit card spending.
The Fed’s preferred method for gauging inflation, the PCE Price Index, rose 4.4% over the last year, the highest rate of inflation since the early 90s.
The graph below courtesy of Eric Basmajian, shows Real Disposable Income per Capita is back below the 1.8% trendline growth of 2009-2020. Simply, the stimulus is gone.
The Bank of Canada (BOC) surprised markets by ending QE abruptly and predicting they might increase interest rates as soon as April. LINK to the press release. Further, they expect a total of four rate hikes next year. Their rationale appears to be a concern that price pressures “now appear to be stronger and more persistent than expected.”
Since the announcement, Canada’s 2-year notes are up 20bps, while its 10-year notes are slightly lower in yield. The Canadian 2/10 yield curve is now 50bps, down from nearly 100bps a month ago. The BOC’s actions and large effect on its yields and yield curves seem to be partially responsible for similar trading with U.S. Treasury yields and curves. On October 8th, the UST 2/10 yield curve was 130bps. Today it stands at 108bps. Both the U.S. and Canadian yield curves appear to be warning the respective central banks may be tightening policy right into an economic slowdown. With the Fed meeting next week, equities investors should be prepared for a statement that is more hawkish than expected. This may include a quicker taper timetable and or a more specific discussion on raising rates.
House Price Increases Are Slowing
According to Case-Shiller Home Price Index, the surge in house prices may finally be slowing down. As shown below, the monthly gain in the index was only 0.08%. That compares to the last 12 months which saw gains of around 1% or higher each month. The annual gain in the index is 19.8%.
October 28, 2021
Starbucks (SBUX) Earnings
SBUX reported its fiscal fourth-quarter earnings today after the close. GAAP EPS of $1.49 beat the consensus of $0.98; however, revenue of $8.15B (+31.5% YoY) fell short of expectations of $8.2B. Global comparable store sales increased 17% versus expectations of 19%, driven mainly by the North American region where comparable sales increased 22%. International comparable sales increased 3%, but China comparable sales fell by 7% during the quarter. The stock is trading 2.9% lower in the after-hours session. We hold a 1% position in the Equity Model.
Apple (AAPL) Earnings
AAPL reported its fiscal fourth-quarter earnings today after the close. GAAP EPS of $1.24 arrived in-line with expectations, while revenue of $83.4B (+28.9% YoY) missed expectations of $84.99B. Products revenue of $65.1B missed the consensus of $68.7B, largely due to iPhone sales of $38.9B versus expectations of $41.6B. The CEO told CNBC that supply constraints would likely intensify in its fiscal first quarter, but he expects “very solid” revenue growth. The stock is down -3.9% in the after-hours trading session. We hold a 3.5% position in the Equity Model.
Amazon (AMZN) Earnings
AMZN reported third-quarter earnings today after the close. GAAP EPS of $6.12 came in well below the consensus estimate of $8.93. Revenue of $110.8B (+15.3% YoY) also missed expectations of $111.66B, with AWS sales of $11.6B missing expectations of $15.4B. In addition, operating income decreased to $4.9B versus $6.2B in the third quarter of 2020.
Management guided to sales between $130B-$140B and operating income between $0-$3B in the fourth quarter. This stacks up against operating income of $6.9B in the fourth quarter of 2020. The CEO, Andy Jassy, warned that AMZN expects to incur several billion dollars of additional costs throughout the holiday season. “It’ll be expensive for us in the short term, but it’s the right prioritization for our customers and partners”. The stock is down -4.5% in the after-hours session. We hold a 3% position in the Equity Model.
Earnings Yield Warning
The graph below, courtesy of Nautilus Capital, shows that earnings yields on the S&P 500 are at the lowest levels since the early 1980s. The lower graph and table break historical readings of the earnings yield into quadrants. As the table shows, the lowest quadrant produces minimal positive returns versus double-digit returns for the other three quadrants.
Ford (F) Earnings
F reported earnings for the third quarter of 2021 yesterday after the close. GAAP EPS of $0.45 smashed the consensus estimate of $0.21, driven by “significant increases in semiconductor availability and wholesale vehicle shipments from Q2”. Automotive revenue came in slightly above consensus at $33.2B (-4.3% YoY) versus expectations of $32.8B. Notably, F saw its North America EBIT margin improve to 10.1% from 7.6% in 3Q20.
Management increased guidance for FY21 adjusted EBIT to a range of $10.5B-$11.5B from the previous $9B-$10B. FY21 adjusted free cash flow guidance remains unchanged at $4B-$5B. F also announced that it reinstated its quarterly dividend at $0.10/share after suspending it in 2020, implying a forward yield of roughly 2.5%. The stock is trading 8.7% higher this morning following the upbeat earnings. We hold a 3% position in the Equity Model.
The good news is Q3 GDP, at 2%, is much higher than the Atlanta Fed’s 0.2% forecast. The bad news, it is decently below the consensus of economists forecast of 2.7%. Of concern, inventories added 2.1% growth to GDP. Without inventories, which in the long run contribute zero growth to GDP, GDP was flat. GDP was boosted by personal consumption expenditures (PCE) which rose 1.6%. We suspect GDP will be revised lower as PCE is likely overstating consumer economic activity. Durable goods and auto sales weighed heavily on GDP, primarily due to shortages and transportation problems. As these problems resolve themselves, GDP should benefit.
An Odd Divergence
Economists have been racking their brains for the last nine months trying to pinpoint why there are still shortages of many goods. Yesterday’s inventory data and the graph below provide a clue. Retailer inventories fell 0.2% while wholesaler inventories jumped 1.1%. The graph shows this is not just a one-month divergence but a trend existing for over a year. The most logical explanation is there are not enough truckers to deliver the goods from the wholesalers to the retailers. If this is the case we should expect wholesale inventories to stabilize, resulting in fewer orders to manufacturers. The other explanation is that retailers are purposely ordering less, keeping shelves semi-stocked, thus allowing them to charge more and pass higher costs and wages on to consumers.
Q3 GDP Report Warning From the Atlanta Fed
A consensus of Wall Street economists expects today’s third-quarter GDP to increase by +2.7%. The Atlanta Fed’s most recent forecast is well shy of that at +0.2%. One of the main reasons for the Atlanta Fed’s weak forecast is Real Final Sales. The Atlanta Fed expects this large contributor to GDP to drop 1.6%. As the graph shows, every time Real Final Sales has fallen below zero since the early 1950s, a recession has occurred.
October 27, 2021
Visa (V) Earnings
V reported its fiscal fourth-quarter earnings yesterday after the close. GAAP EPS of $1.65 easily beat the consensus of $1.55. Revenue of $6.56B (+28.6% YoY) came in slightly above the consensus of $6.51B. Payments volume growth also topped estimates, coming in at +17% YoY versus expectations of +15% YoY. Cross-border payments volume rose +38% YoY versus expectations of +31.7% YoY; however, management’s outlook is not as rosy.
The CFO noted that revenue growth significantly depends on the pace of cross-border travel recovery, and V does not expect cross-border travel to reach 2019 levels until mid-2023. The outlook is weighing on performance as the stock is down 5.2% in mid-day trading. We hold a 1% position in the Equity Model.
Advanced Micro Devices (AMD) Earnings
AMD reported third-quarter earnings yesterday after the close. GAAP EPS of $0.75 beat the consensus of $0.61. Revenue also came in above consensus at $4.3B (+53.9% YoY) compared to expectations of $4.1B. According to the CEO, the growth is being driven by server chips, with data center sales more than doubling YoY.
Guidance for Q4 revenue was set to $4.4B-$4.6B, which blows analyst forecasts out of the water. As a result, management increased guidance for FY21 revenue growth to 65% from 60%. The stock is up 1.2% in mid-day trading. We hold a 2% position in the Equity Model.
The Yield Curve is Flattening
The table below shows the mid-day change in U.S. Treasury yields. Note the distinct flattening of the yield curve as short-term yields rise while long-term yields fall. For instance, 30-year bonds are down nearly 7 bps, while the 3-year note is up 3.5bps. Bond traders are pricing in future Fed rate hikes, while at the same time understanding that tapering QE and rate hikes will slow growth and inflation, to the benefit of longer maturity bonds. The 20/30 year curve will most likely be the first part of the curve to invert. The yield difference between those two maturities is only 1.7bps.
Microsoft (MSFT) Earnings
MSFT reported its fiscal first-quarter earnings yesterday after the close. GAAP EPS was $2.71, which beat the consensus of $2.07. Revenue also came in above consensus, at $45.3B (+21.8% YoY) versus an expected $44B. The beat was driven by a 50% YoY increase in Azure and other cloud revenue.
Management offered guidance for Q2 revenue above the consensus at $50.15B-$51.05B versus estimates of $48.92B. The stock is trading 1.7% higher in the pre-market session following the results. We hold a 2.5% position in the Equity Model.
Google (GOOG) Earnings
GOOG reported third-quarter earnings yesterday after the close. GAAP EPS of $27.99 topped the consensus of $23.32. Revenue of $65.1B (+41% YoY) also beat estimates of $63.2B thanks to impressive advertising revenues. This was GOOG’s largest quarterly revenue gain in 14 years, and the growth led to an operating margin increase of 8%.
Management included a caveat with the impressive results, noting: “Given the gradual recovery in results through the back half of 2020, the benefit from lapping prior year performance diminished in Q3 versus Q2 and will diminish further in Q4”. The market’s reaction to the release is muted thus far. We hold a 2.5% position in the Equity Model.
Labor Market Tightness
Per Goldman Sachs: The Conference Board’s labor differential — the “difference between the percent of respondents saying jobs are plentiful and those saying jobs are hard to get— increased by 1.5pt to 45.0, the highest level since 2000.”
This data provides even more evidence there are more job openings than those looking for jobs. Again, another sign of a healthy labor market. A shortage of candidates provides employees leverage to demand higher wages. This doesn’t bode well for the profit margins of companies that rely on large labor forces.
XLE is Neglected
The commentary and graphs below show that both ESG investors and traditional investors are underweighting the energy sector. Since January, XLE (energy) is up 58%, almost triple the S&P 500 which is up 21%. If such outperformance continues, we suspect investors will eventually gravitate toward the energy sector and try to capture the outperformance. The graph and commentary is courtesy of Callum Thomas and @mikezaccardi
October 26, 2021
Waste Management (WM) Earnings
WM reported third quarter GAAP EPS just short of the consensus at $1.28 versus an expected $1.33. Revenue of $4.7B (+21% YoY) topped expectations of $4.55B, driven by volume growth and increased yield. Management raised guidance for FY21 revenue growth to 17%-17.5% from 15.5%-16% previously. The new guidance is above the consensus of 16% YoY. Accelerating cost inflation was mentioned as a headwind, but the company remains on track to meet its full year targets according to the CEO. The stock is down 1.7% this morning following the release. We hold a 1% position in the Equity Model.
Raytheon Technologies (RTX) Earnings
RTX reported third quarter GAAP EPS of $0.93, which inched above the consensus of $0.91. Revenue of $16.2B (+8.1% YoY) came in short of expectations of $16.36B. Guidance for FY21 revenue was set at $64.5B from a prior range of $64.4B-$65.4B. This is slightly below the consensus of $65.2B. Guidance for FY21 adjusted EPS was raised to $4.10-$4.20 from $3.85-$4.00 previously; the consensus is $4.06. Management commented that a rebound in air travel was the impetus for raising earnings guidance. Despite the upbeat guidance, the stock is trading 2.5% lower this morning due to gloomy forecasts from its competitor, Lockheed Martin (LMT). We hold a 1.5% position in the Equity Model.
Yesterday we noted that Tesla’s market cap increased by approximately $100 billion. To put the gain in context, consider yesterday’s increase in market cap is worth about 1.5x the total value of Ford and about half of the entire domestic auto industry. Also interesting, Elon Musk added nearly $30 billion of personal wealth yesterday. He is now supposedly worth more than Exxon.
The graph below shows Tesla is valued at 42% of the entire auto industry despite having a very small fraction of total sales/revenue. Ford and GM recently reported annual sales of $137 and $139 billion respectively. Tesla’s latest report shows $46 billion in sales. Simply, the market is betting heavily that TSLA will be the dominant leader in auto sales over the next five to ten years. Anything short of 50% market share will likely be a disappointment for shareholders. If you do not buy into the prospects we offer caution. Tesla is one of the hottest stocks in the market, so selling or shorting the company may be painful in the short run.
Consumers Are Fretting
The Langer Consumer Comfort Index is a high-frequency confidence index. While lesser followed than the University of Michigan survey or the Conference Board’s consumer survey, it provides another data set to assess consumer attitudes. Given personal consumption traditionally accounts for two-thirds of economic growth, this measure is essential to follow.
In its most recent October 21st report, Langer notes: “Consumer sentiment continued down this week, dropping to nearly a seven-month low as Americans’ assessments of their personal finances and the buying climate extended their largest declines since early in the coronavirus pandemic.”
At 49.7, the Index is well above its March 2020 lows of 35 but a ways off its pre-pandemic highs near 70. For context, the Langer Index looks similar to the Conference Board Survey, sitting between post-pandemic highs and lows. On the other hand, the University of Michigan Sentiment Index is now at its lowest level since the pandemic and the lowest level in ten years. The importance of consumer confidence is not just economic. As their graph below shows, there is a strong correlation between the changes in stocks prices and consumers’ sentiment. Recently, stocks have soared despite weakening confidence.
October 25, 2021
*** There will be no Three Minutes on Markets Videos this week as we are refurbishing our recording studio. We expect to be back next Monday.
Tesla Surpassing Facebook
Tesla, rising over 10% this morning, overtook Facebook, becoming the ninth-largest company by market cap. The news propelling it to a market cap of just under $1 trillion is that hertz will buy 100k cars. The order is worth over $4 billion. Tesla’s market cap is up approximately $60 billion on the order. To put that in context, Ford’s market cap is $63 billion.
What If Inflation Isn’t Transitory?
It seems over the past few weeks more and more in the media are asking what happens if inflation becomes isn’t transitory. What if it is persistent. Mohamed El-Erian has been among the most outspoken on the topic. This morning he writes a concerning editorial in Bloomberg warning that underestimating inflation carries dire risks. To wit: “The longer this persists, the greater the risk of a historic policy error whose negative implications could last for years and extend well beyond the U.S.”
Oil In Backwardation
The table below shows the CME futures prices for crude oil. Typically the future contract prices of oil increase over time. Such a price curve is called contango. Currently, the front contract December is trading at $84.81 and the prices decline through next year. This somewhat unique circumstance for oil is called backwardation. It is a signal that there is strong demand for crude oil today but traders do not expect demand to be as heavy in the future. This indicator portends the supply/demand imbalance for crude oil will normalize over the next six to nine months.
A host of regional manufacturing indexes this week provide a first look at economic activity in October. Also of interest will be Thursday’s GDP report. Current estimates are for 2.5% growth in the third quarter. As we noted earlier this week, the Atlanta Fed forecasts 0.5% growth. Also on Thursday will be PCE prices, the Fed’s favorite gauge of inflation expectations.
The Fed meets on Tuesday and Wednesday of next week. Accordingly, they should be relatively quiet this week as they enter their self-imposed media blackout period.
Earnings will continue to dominate the news wires. As the first table below, from RIAPro, shows, ten of the companies we hold in the Equity model report earnings this week.
Less Stimulus, More Borrowing
The graph below, courtesy of Arbor Research, shows that consumer interest in borrowing is increasing. Some of the interest is likely from borrowers needing extra funds to replace the multiple stimulus programs from the last year and a half. It is also worth noting that consumers are also likely being pinched by higher prices and some are needing to borrow to make ends meet.
In a speech this morning, Jerome Powell said “its time to taper” but not raise rates. He expects to complete tapering by mid-2022. Powell now views “higher inflation” as the biggest risk. Equity markets are trading weaker as he finally acknowledges inflation is more persistent than “transitory.” Bond yields are falling as he implies the Fed should be more hawkish if inflation does not abate.
Flattening Yield Curve
5-year implied inflation expectations are up over 40 basis points (bps) since October 1st. They now stand at a 15+ year high of 2.94%. While inflation expectations rise, the yield curve is flattening. In this case, short maturity bonds are rising in yield much more than longer maturity bonds. The graphs below show what has happened to bond yields since the inflation expectations last peaked on May 18th. As we show the 30-year bond is 26 bps lower since then, while the 2-year note is 26 bps higher. As a result, the 2/30 yield curve has flattened 52 bps over the period.
Our portfolios are set up for the yield curve flattening. The portfolio’s largest bond holding is TLT with a duration of 20 years. The benchmark, AGG, has a duration of 8 years. The models are also not fully vested in the fixed income sleeves to further protect against higher yields.
The graph below, courtesy of Bank of America, shows a recent uptick in credit card spending among those making $50,000 a year or less. It appears consumers, especially those at the lower end of the income scale, are increasingly relying on credit to make ends meet as inflation rises quicker than earnings.
Quantifying The Cost of BITO
Yesterday we pointed out the new Bitcoin ETF, $BITO must roll futures contracts from month to month. We estimate the annual cost based on the current roll from October to November is 15% or even greater. The problem with our estimate is that it does not take into account how the futures curve may change. The graph below, courtesy of J.P. Morgan, provides some historical context to assess the roll cost. It shows the annual cost of rolling the first month to the second-month contract, as well as the second month to the fourth month. As the graph shows the average cost is around 10% annualized, but as the curve shifts the cost or benefit can vary significantly. The cost of rolling futures, ultimately paid by the ETF holder, is not a reason to avoid BITO, but it is a factor worth considering especially if you are planning to hold it for a long period.
Fed Chairman Jerome Powell is expected to speak at 11:00 am ET today. He has been quiet on the topic of tapering QE so it will be interesting to see if he uses the opportunity to lay out his thoughts on the topic. In particular, will he affirm the $15bln/month pace of reduction that was laid out in the recent FOMC minutes, or push for something either more aggressive or conservative? Also, will he discuss the possibility of increasing interest rates next year?
October 21, 2021
Federal Reserve Trading Policy
With the cat out of the bag, and many high-ranking Fed officials caught actively trading the markets with inside knowledge of what the Fed would say and/or do, the Fed is finally taking action. Per the press release below, Fed members are now subject to a number of strict rules that will greatly limit their ability to trade markets.
The Philadelphia Fed Manufacturing index came in below expectations at 23.8 down from 30.7 in October. That said, the details were not as bad as the headline. Employment, new orders, and the 6-month outlook for capital spending all rose.
The index is composed of indicators that tend to lag economic activity and ones that lead economic activity. The graph below, courtesy of Nordea, shows how the difference between the leading and lagging indicators leads the broader index by about 10 months. As shown, the leading-lagging differential portends the index will fall back into economic contraction in the coming months. This chart affirms the sharp deceleration in growth currently being forecasted by the Atlanta Fed GDPNow.
A few subscribers have asked our thoughts on trading the new Bitcoin ETF (BITO) as a substitute for Bitcoin. The biggest drawback in our opinion is the cost structure of the ETF is not as friendly as owning Bitcoin for two reasons. First, the ETF’s management fee is 0.95%. Second, and this is a flaw with many commodity ETFs, holders pay to “roll” contracts. BITO is currently fully invested in the October Bitcoin futures contract priced at 67,500. At some point soon they will have to buy the November contract and sell October. Currently, the November contract is trading at a premium of 1.27% to the October price. If the futures curve remains steep, holders of BITO will pay 15% or more over the course of the year to roll contracts. Including the management fee, BITO could underperform Bitcoin by nearly 20%. Obviously, that estimate will change based on the shape of the futures curve. Click HERE for Bitcoin futures prices for current and out months.
Oil CAPEX Declining
On Tuesday we shared a WSJ article that discusses the lack of investment in energy exploration (capex). We just stumbled upon the graph below which shows the problem has been brewing for about five years. Political and economic incentives favor green energy, leading us to believe that unless oil prices stay at current levels or higher and can sustain such levels, there is little reason to expect investment to pick up.
October 20, 2021
Verizon (VZ) Earnings
VZ reported third-quarter GAAP EPS well above consensus at $1.55 versus expectations of $1.35. Revenue was $32.9B (+4.4% YoY), which missed estimates of $33.2B. Wireless retail net adds surprised to the upside with 699K net adds versus 566K expected.
Guidance for FY21 adjusted EPS was raised to $5.35-$5.40 from $5.25-$5.35. The new range is well above the consensus estimate of $5.29. Management also narrowed FY21 guidance to a 4% increase in total wireless revenue from the previous range of 3.5%-4%. VZ is trading 2.1% higher this morning following the results. We hold a 1.5% position in the Equity Model.
NextEra Energy (NEE) Earnings
NEE reported third-quarter GAAP EPS of $0.23, which missed analyst estimates of $0.71. Adjusted EPS did beat estimates, however, at $0.71 versus expectations of $0.67. Revenue came in short of consensus at $4.4B (-8.8% YoY) versus expectations of $5.4B.
Guidance for FY21 adjusted EPS remains unchanged at $2.40-$2.54, with the mid-point slightly below the consensus of $2.52. NEE expects adjusted EPS growth of 6%-8% from FY21 in 2022 and 2023. NEE is trading 2.3% higher this morning after the release. We hold a 2% position in the Equity Model.
Abbott Labs (ABT) Earnings
ABT reported third-quarter GAAP EPS of $1.17, which beat analyst estimates of $0.67. Revenue of $10.9B (+22.8% YoY) also beat the consensus of $9.56B. Revenue growth was driven, in part, by strong results in COVID-19 testing products. Excluding COVID-19 related testing products, organic sales grew 11.7% versus the third quarter of 2019.
Guidance for FY21 GAAP EPS was set to $3.55-$3.65, while FY21 adjusted EPS guidance was boosted to $5.00-$5.10 from a prior range of $4.30-$4.50. This compares to a consensus estimate of $4.45. Following the positive results and guidance, the stock is trading 3.9% higher this morning. We hold a 2% position in the Equity Model.
The Atlanta Fed GDPNow forecast for Q3 economic growth was revised lower to 0.5%, down from 1.2%. The chart below shows how each major subcomponent contributed to the forecast. Increasing private inventories, adding 2.1%, is keeping the GDP forecast above zero. Typically accounting for two-thirds of GDP, Consumer Spending is only contributing 0.31% to the forecast, well off the 2.70% rate in August.
In Monday’s Industrial Production report, Industrial Production fell 1.3%, and the lesser followed capacity utilization fell from 76.4% to 75.2%. The data is a little surprising given the shortage of goods available to the public. At first blush, one would think factories would be running at maximum capacity and production rising rapidly. Unfortunately, manufacturers face the same problem as their consumers, a shortage of goods needed to produce products. For example, it is well documented most auto manufacturers are cutting production due to a chip shortage. The graph below shows capacity utilization for the auto industry is at recession levels of 55%. It was running between 70-80% before the pandemic and had prior peaks over 90%. Auto manufacturing contributes about 3% to GDP.
October 19, 2021
Netflix (NFLX) Earnings
NFLX reported third quarter earnings today after the close. GAAP EPS came in above consensus at $3.19 versus $2.56 expected. Revenue of $7.5B (+16.1% YoY) was in line with expectations. Global streaming paid net additions blew management expectations out of the water, coming in at 4.38M versus guidance of 1.54M.
Management offered guidance for 4Q21 revenue of $7.71B, slightly above the consensus of $7.68B. Guidance for EPS was less positive, however, at $0.80 versus expectations of $1.13. Finally, management offered above-consensus guidance for Q4 global streaming paid net additions of 8.5M versus 8.3M expected. We hold a 2% position in the Equity Model.
Johnson & Johnson (JNJ) Earnings
JNJ reported third quarter earnings today before the open. GAAP EPS of $1.37 missed the consensus estimate of $2.17. However, non-GAAP EPS of $2.60 beat expectations of $2.35. Revenue of $23.3B (+10.7% YoY) missed the consensus of $23.7B. According to the CFO, the revenue miss was just a matter of timing of shipments in the COVID vaccine and medical devices businesses. That revenue should be made up for in Q4 results.
JNJ increased guidance for FY21 revenue at the low end to a range of $92.8B-$93.3B from $92.5B-$93.3B, but guidance remains below the consensus estimate of $93.97B. Guidance was also boosted for FY21 adjusted EPS to $9.77-$9.82 from $9.50-$9.60 previously. This is well above the consensus estimate of $9.64. The stock is trading 2.6% higher on the results. We hold a 1.5% position in the Equity Model.
Proctor & Gamble (PG) Earnings
PG reported third quarter earnings this morning before the open. GAAP EPS came in slightly above expectations, at $1.61 (-1% YoY) versus the consensus of $1.59. Revenue of $20.3B (+5.3% YoY) also beat expectations of $19.9B. Organic sales growth of +4% YoY was driven by increased volume (+2%), increased pricing (+1%), and positive sales mix (+1%). Gross margin, however, decreased by 3.7% YoY due to increased commodity and transportation costs as well as less profitable sales mix.
PG is planning to raise prices on certain beauty, oral care, and grooming products to offset increasing costs. According to the Wall Street Journal, “‘We do not anticipate any easing of costs,’ P&G Finance Chief Andre Schulten said in an interview. ‘We continue to see increases week after week, though at a slower pace’”. The article continues, “Despite the higher expenses, P&G maintained its sales and profit outlooks for the year, saying increased revenue and cost reductions will enable the company to stay on track”. The stock is trading roughly 2% lower this morning in light of the margin concerns. We hold a 2% position in the Equity Model.
For more on how cost pressures are affecting PG and many other companies, check out this article from the Washington Post.
“Despite varying perceptions, there were clear fundamental and technical warnings preceding the crash that were detected by a few investors. For the rest, the market euphoria raging at the time blinded them to what in hindsight seemed obvious.”
The quote comes from an article we wrote on the stock market crash of 1987. Today, being the 34th anniversary of the crash of 1987, we revisit some important lessons from that era. Read The Article.
Will Higher Oil Prices Become The Norm?
The Wall Street Journal ran an article discussing a growing investment deficiency into traditional and renewable energy sources. As a result oil prices may stay high until the industry closes the gap.
Per the article:
“Global oil and gas exploration spending, excluding shale, averaged about $100 billion a year from 2010 to 2015, but dropped to an average of around $50 billion in the years that followed after a crash in crude prices, according to Rystad Energy. Total global oil and gas investment this year will be down about 26% from pre-pandemic levels to $356 billion, the IEA said Wednesday.”
Green investments are not growing quickly enough to offset reduced CAPEX in the energy industry. Per the article:
To meet global energy demand, as well as climate aspirations, investments in clean energy would need to grow from around $1.1 trillion this year to $3.4 trillion a year until 2030, the Paris-based agency found. Investment would advance technology, transmission, and storage, among other things.
The bottom line: “The world isn’t investing enough to meet its future energy needs, and uncertainties over policies and demand trajectories create a strong risk of a volatile period ahead for energy markets,” the IEA report said.
Equity Model Earnings Announcements
Q3 earnings announcements for the RIA Pro equity model start this morning and continue on Wednesday as follows:
Tuesday (October 19th)
JNJ – Before Open
NFLX – After Close
PG – Before Open
Wednesday (October 20th)
ABT – Before Open
NEE – Before Open
VZ – Before Open
Over the last six months, the Fed has been dragging its feet and delaying the inevitable tapering of QE due to perceived weakness in the labor market. The graph below shows the unemployment rate less those labeled “quitters” is near 20-year lows. Quitters are those that left their jobs voluntarily and, in theory, are in search of better or higher-paying jobs. The current quit rate at 2.9% is the highest in its 20-year history. A high quit rate is a signal of labor market strength. Between 5.4% inflation and the graph below, is it any wonder the market is starting to think the Fed is behind the eight ball in tightening?
As shown below China’s economic growth rate for the third quarter was negligible at +0.2%, bringing the annual growth rate to just 4.9%. While still high, the annual rate is down from 7.9% last quarter. China’s economic slowdown bears watching as they are the marginal driver of global economic growth.
Equities are recently showing a little hesitation as investors gear up for QE in November. The bond market has been a lot more vocal about more hawkish Fed policy and the implications for growth. Over the last 5 months, as shown below, the Treasury yield curve (30yr-5yr) has collapsed by three-quarters of a percent. Over the last week or two, the rate of flattening picked up markedly.
A yield curve flattening trade should not be surprising. In Taper is Coming, Got Bonds? we wrote: “The yield curve and yield graphs look similar. Short-term yields were relatively constant during QE while long-term yields rose. In all three QE examples, the yield curve quickly flattened after QE ended.” The graph below, from the article, shows how the 10yr-2yr yield curve fell rapidly after the three prior episodes of QE ended.
The Week Ahead
We take a bit of a break this week after last week’s full calendar of important economic data. On the docket is Industrial Production on Monday, Housing and Building Permits on Tuesday, and Jobless Claims on Thursday.
More important for the markets this week will be Fed speeches and earnings. Recently Fed members have become increasingly vocal about their concern for the recent rise in inflation overstaying its welcome. Last week Bostic led the charge saying “inflation is broadening, not transitory.” If others use similar rhetoric, we will see the market continue to price in a quicker pace of QE tapering and rate hikes coming sooner than previously expected.
This is will be the first of a few important weeks for corporate earnings as shown below.
The graph below, courtesy of Jim Bianco, shows that a majority of employees in eight major cities are still not going back to their offices. While the number of employees going back to their offices will rise we think it’s likely the number falls well short of pre-pandemic levels. Per Jim Bianco “What a year at home did was open our eyes to what we are were capable of outside the office and what it was really like in the office. Few were ready to do this pre-pandemic.”
GS reported earnings for the third quarter of 2021 this morning. GAAP EPS of $14.93 (+66% YoY) easily topped the consensus of $10.04, driven by impressive revenue growth across segments. Revenue came in well above consensus at $13.6B (+26.3% YoY) versus expectations of $11.6B for the quarter. The stock is up +2.6% mid-day on the back of the strong results. We hold a 2% position in the Equity Model.
Inflation Concerns Weigh on Sentiment
The October University of Michigan consumer sentiment survey came in weak at 71.4 versus a consensus estimate of 74. The result, which fell from 72.8 in September, registered as the second-lowest outcome since 2011. The chart below, courtesy of Bloomberg, shows year-ahead inflation expectations based on the survey have risen to 4.8%, their highest point in 2021.
Retail Sales Surprise
September retail sales surprised to the upside this morning at +0.7% MoM versus estimates of -0.1%. Retail sales ex-vehicles grew +0.8% MoM versus +0.4% expected, and ex-vehicles and gas rose in line with expectations of +0.7%.
Incorporating Wednesday’s September CPI release, real growth in retail sales for September was only +0.3% MoM. Thus, over half of the nominal growth in September came from rising prices. Treasury yields are moving higher following the release, reflecting the market’s increasing expectations for taper.
On a monthly basis, the Cleveland Fed puts out the 16% trimmed mean inflation rate. Their modified inflation rate trims price change outliers, both high and low, from CPI. Currently, as shown below, the index is just short of the 2008 highs. At that time oil was nearly $150 a barrel and up well over 100% from where it was a year earlier. Take away that short burst higher and the trimmed measure is at its highest level since the late ’80s. The takeaway from this inflation gauge is that the number of goods driving higher inflation is broadening and not just confined anymore to a few extremes like used cars and gasoline.
EPS and Returns
The graph below, courtesy of Fidelity, shows the correlation between S&P earnings growth (EPS – X-axis) and price performance on the Y-axis. The EPS data is broken into 8 tiers and color-coded. Each color, or specific range of EPS, has a trend line drawn through it. In general returns and EPS are positively correlated as should be expected. There are exceptions. In particular, there seems to be no correlation when EPS is very strong -on the right side of the graph. This is likely due to strong but unsustainable earnings growth coming out of recessions. Conversely, the red circles on the far left are likely periods at market bottoms where prices rose in expectations of a rebound in EPS.
October 14, 2021
Initial Jobless Claims had another nice decline and now sits at +293k, the lowest level since the Pandemic began. The last two weekly claims reports bode well for the upcoming unemployment report. Unlike CPI, PPI was generally weaker than expectations. The headline number rose 0.5% versus +.07% last month. However, the year-over-year number was +8.6%, lower than expectations for +8.7% but above last month’s +8.3%. Core PPI, excluding food and energy, rose 6.8% on an annual basis.
The latest Fed minutes show that tapering of QE purchases is likely to begin in November. It appears they will reduce purchases by $15 billion a month which should eliminate this round of QE by July 2022. $15 billion now serves as a benchmark. Any changes to that amount will help us gauge if they are becoming more aggressive or conservative. There are some members that prefer a faster pace. Per the minutes- “Several participants indicated that they preferred to proceed with a more rapid moderation of purchases than described in the illustrative examples.”
We often note how the Fed uses language at times to complicate matters and put an understanding of their policies and forecasts beyond the reach of many non-economics or finance professionals. Fed members also use vague terminology, allowing them to be technically correct through a wide range of outcomes. In our latest article, What Causes “Transitory” Inflation to Become “Persistent”? we write: “Transitory is a vague term. It can mean minutes or hours or infer years or even decades. 400+ economics Ph. D.s are not dumb. They likely chose the word because it has no clear-cut definition.”
The Fed itself supports our notion of the high-level language they use. In a recent article, the Fed states: “Hernández-Murillo and Shell (2014) showed that the complexity of the language used in the FOMC statement increased towards the end of Bernanke’s tenure to a reading grade level of 20 to 21, equivalent to a least a doctoral degree level of education. The circles in Figure 2 illustrate that since then the Flesch-Kincaid grade level for the FOMC statement language gradually declined under Yellen and has averaged between grades 16-17 thus far under Chair Powell, equivalent to a bachelor’s or master’s degree level of education.“
The following graph accompanies the article. In short, Fed communications remain technical. Unless you hold a college degree or possibly a master’s, Fed communication may be going over your head. In normal times this may not matter. With inflation running hot and the word stagflation being used regularly, the Fed may want to simplify their language or risk creating even more confusion, fear, and behaviors that can foster even more inflation.
October 13, 2021
JPM reported earnings for the third quarter of 2021 this morning. GAAP EPS of $3.74 came in well above the consensus of $3.00, boosted by a $2.1B release of loan loss reserves. Revenue of $29.6B (+1.7% YoY) was in line with estimates, and guidance FY21 for interest income was unchanged at $52.5B. Average loans fell 2% YoY in the Consumer & Community Banking segment and 7% YoY in the Commercial Banking segment; however, they rose 5% YoY on a firm-wide basis, driven by the Assets & Wealth Management segment. The stock is trading 1.7% lower this morning following the earnings release. We hold a 2% position in the Equity Model.
The Market Thinks They Will Raise Rates Sooner
Over the last few weeks, Fed Funds futures have been pricing in greater odds of a rate hike coming sooner than was previously expected. For instance, the June 2022 contract now implies about a 25% chance of a tightening by June. The odds were near zero in mid-September. The December 2022 contract implies a 100% chance of a 25bps rate hike and a 50% chance of a second hike by the end of the year.
CPI came in slightly higher than expectations. The monthly rate of price increases was 0.4%, 0.1% higher than last month. The year-over-year rate, at 5.4%, is also a tad above expectations. The core monthly and annual rates, excluding food and energy, were in line with consensus.
It is important to note that some inflation is the result of deflation or lower prices this time last year. While “base effects” are rapidly lessening, they are still in play. Per Ben Casselman of the N.Y. Times- “Base effects” — the impact of the drop in prices earlier in the pandemic — are still playing some role in lifting year-over-year inflation. If prices had kept rising at their pre-Covid rate last year, September inflation would have been 5% instead of 5.4%.”
Chaikin is Providing a Warning
The graph below shows the S&P 500 with the Chaikin Money Flow indicator below it. The indicator looks back over 20 days and multiplies the daily volume with where the market closes within each day’s trading range. The multiplier is positive when the S&P closes in the upper half of a day’s trading range. Where the market closes in relation to the high or low is multiplied by the volume. High volume and a close at the high or low for the day will produce a strong signal.
Technical analysts use the indicator to help determine if institutions are accumulating or distributing. A green reading (above zero) signals accumulation as it is believed institutions tend to buy late in days. The strength of the recent string of red days signals early strength is followed by late-day weakness. This is a sign of institutional distribution (selling). The Chaikin indicator has not been this deeply negative since 2018.
“Broadening, Not Transitory”
Atlanta Fed President Bostic went where no Fed member has gone since the Pandemic. He stated, “U.S. inflation is broadening, not transitory.” This appears to be the first time a Fed member is voicing concern that higher inflation is no longer transitory. If other Fed members join him in this view, it might speed up the tapering process and bring forward the date of the first rate hike.
Humorously, he started his speech with disdain for the use of “transitory” to describe the recent bout of inflation. To wit: “You’ll notice I brought a prop to the lectern. It’s a jar with the word “transitory” written on it. This has become a swear word to my staff and me over the past few months. Say “transitory” and you have to put a dollar in the jar.”
October 12, 2021
Per the JOLTs report, the number of job openings fell for the first time since April. The number of openings in August was 10.43 million versus expectations of over 11 million. This may be a signal the labor market is getting better, or at least less bad, at matching workers with openings. The quits rate rose to a record 2.9% of the workforce. Typically workers quit jobs when they have confidence in finding a better, higher-paying job. Prior to Covid, the quit rate was around 2.2%.
As shown below the number of openings is still well above normal levels. The second graph below, the Beveridge Curve, highlights the anomaly. At the current unemployment rate of 5.2%, we should expect a job openings rate of about half of what it is. The million-dollar question is whether employers truly have as many job openings as advertised or are there too many unemployed workers either not trained for certain jobs or not willing to accept offered wages.
As we show below circled in red, the 50dma is turning lower for only the second time since the market rebounded in April of 2020. In late October and early November of last year, the 50dma turned lower for six days on a relatively steep 7.5% decline. The current market decline causing the 50dma to fall is only a 4% decline but its duration is almost twice as long as the prior one.
Used Car Prices En Fuego
After a brief rest bit, used car prices rose again in September back to all-time highs as shown in the Manheim Used Vehicle Value Index below. The accompanying report notes: “According to Cox Automotive estimates, total used vehicle sales were down 13% year-over-year in September.” Prices rising with sales falling clearly points to a lack of supply.
Per the report: “Using a rolling seven-day estimate of used retail days’ supply based on vAuto data, we see that used retail supply peaked at 114 days on April 8, 2020. Normal used retail supply is about 44 days’ supply. It ended September at 37 days, which is below normal levels. We estimate that wholesale supply peaked at 149 days on April 9, 2020, when normal supply is 23. It ended September at 18 days.”
October 11, 2021
Staples Getting Historically Cheap
In last Friday’s Technical Value Scorecard in RIA Pro we discussed how cheap the consumer staples sector was getting. To wit: “However, staples are nearly three standard deviations below its 50dma, arguing for a bounce in the coming days.”
SentimentTrader follows up our work with a much longer-term view. As shown below, staples, at about 6% of the S&P 500, have the lowest weighting in the S&P 500 since the tech boom in late 1999. In the year 2000 when that bubble popped, staples (XLP) ended the year up 42%. The S&P was down 10% and the technology sector (XLK) was down over 40%.
Buckle up! This is a big week for key economic data. The JOLTs report on Tuesday will provide more color on the labor market and specifically if job openings continue to at record levels. Wednesday features CPI and the Fed minutes from their September meeting. Given the importance of inflation to the Fed, CPI will help them further hone in on how to taper QE, in regards to amounts and timing. More inflation data follows Thursday with PPI. Retail Sales and the University of Michigan Consumer Sentiment Survey come out on Friday.
Also on tap are the 10 and 30-year Treasury auctions on Tuesday and Wednesday respectively. It will be interesting to see if demand is strong given the recent backup in yields.
If you crave more information, have no fear, earnings for the major banks start on Wednesday with JPM. Many of the largest banks follow them on Thursday. Most other companies will release earnings over the coming six weeks. Beyond earnings and revenues, investors will be paying close attention to forward guidance, in particular how inflation is affecting their bottom line.
Dividends over Oil Production
Last Friday we wrote how oil rig counts were rising slower than is typical considering the current price of oil. Another consideration is the transition to cleaner forms of energy. As Reuters writes below, companies like Occidental are not clamoring to increase production.
(Reuters) – U.S. oil and gas producer Occidental (OXY.N) wants to raise margins and re-establish dividend payments for its shareholders rather than focus on growing its production volumes, Chief Executive Vicki A. Hollub said on Thursday.
Oil companies can best contribute to the energy transition by producing just enough oil to meet demand in a way that is more efficient and produces fewer emissions, the CEO said.
“We don’t see that in 2022 and beyond that we need to grow significantly,” Hollub said at an online event by the Energy Intelligence Forum.
“Our growth in the period, and maybe over the next ten years, will more be to reestablish dividend and grow that dividend”.
Risk/Reward Measures show Energy and Financials stretched.
October 8, 2021
The BLS Jobs report was weaker than expected, with job growth of 194k. Expectations were for a gain of between 475k and 500k jobs. The BLS revised the prior month higher to 366k from 235k. The unemployment rate did fall from 5.1 to 4.8%, however, it was in part due to people dropping out of the workforce. 183k people left the workforce causing the participation rate to fall from 61.7 to 61.6%. With the number of job openings so high and jobless benefits ending we find it surprising people are leaving the workforce. Also interesting was temporary help fell slightly. With so many job openings one would expect many companies to hire temporary workers to fill gaps until they can hire permanent workers. The graph below from True Insights shows payroll growth is starting to fall back in line with pre-pandemic rates of 150-200k per month.
Bill Dudley, President of the New York Fed from 2009 to 2018, in a Bloomberg editorial, voices concern the Fed is too worried about deflation, or as he says, the “last war.” He argues the Fed should be concerned inflationary pressures are more than transitory. He prefers the Fed take on a more hawkish tack sooner rather than later. Per Dudley: “This dovishness increases the risk of a major policy error. If the economic outlook evolves in unexpected ways, Fed officials will almost certainly be slow to respond…” “Hence, if inflation proves more persistent than anticipated and even accelerates as the economy pushes beyond full employment, they’ll have to tighten much more aggressively than they expect.” Further, “A faster pace of tightening would come as a shock for financial markets and could risk tipping the economy back into recession. That’s the danger of fighting the wrong war.”
Oil Prices and Rig Counts
The graph below compares oil prices to rig counts. After falling to recent lows, rig counts are rising. However, they are still well less than should be expected given current oil prices. Why are oil producers not adding rigs and producing more oil to take advantage of higher prices? There are a few reasons. First, OPEC is increasing production and will get more aggressive if prices keep rising. Second, oil producers realize the current economic boom and spike in economic activity, and demand for oil is temporary. It is the result of short-term fiscal stimulus and economic normalization. Lastly, President Biden is threatening to release oil from the strategic oil reserves. If the government indiscriminately caps the price of oil via rhetoric and action, the incentive to produce and add rigs is lessened.
October 7, 2021
“Inflation” Coming Next Week
The graph below, courtesy of the Market Ear, shows how mentions of inflation are a hot topic for earnings calls. As we gear up for another round of earnings releases starting in earnest next week, there is little doubt the number of “inflation” mentions will increase further. The question facing shareholders is how well can companies deal with inflation? Can they take advantage of higher prices or will they negatively impact profit margins? Each company and industry has different factors to consider that will help answer those questions.
From a macro perspective, we will also learn a good deal about expectations for continued inflation in the coming quarters. The Fed speaks with executives at many large companies, so this information will also help us better assess our outlook on the potential pace at which the Fed tapers QE.
Following yesterday’s strong ADP report, the labor market showed more improvement. Weekly Initial Jobless Claims fell back toward a post-covid low of 326K. This was below expectations of 348k and well below last week’s 364k.
St. Louis Fed Expects an Ugly Jobs Report While JPM is Optimistic
Per Market News (MNI), the St. Louis Federal Reserve expects to see an 818k decline in tomorrow’s BLS payrolls report. St. Louis Fed economist Max Dvorkin states: “There’s still “a lot of uncertainty around these figures,” but the model has tracked actual CPS employment “quite well” through the summer, he said.” He blames the recent uptick in Covid cases and the impact on global supply lines. The current forecast is for a gain of 410k jobs. If the Fed’s forecast is proven correct the Fed might delay what appears to be a tapering announcement in early November.
On the other hand, JP Morgan is optimistic “we are looking for a 575,000 gain in jobs and a drop in the US unemployment rate to 5%. The driver for an above-consensus forecast is the expected rebound in the leisure and hospitality sectors.”
Retail Inventories are Low
Price pressures, especially on retail goods, will likely continue into the holiday season. The graph below shows the ratio of Retailers’ inventories to sales is at a 25+ year low and well below pre-pandemic levels. Given there appears to be little let-up in supply line problems, it’s becoming increasingly probably that many retailers will not be able to fully stock their shelves to meet the heavy demand for Christmas presents. With, the limited inventory we suspect many stores, both online and brick and mortar, will be able to raise prices over the next few months.
October 6, 2021
Delaying the Debt Cap Limit
Senator McConnell has supposedly told a closed-door meeting of Senate Republicans that he would offer a short-term debt ceiling extension today. Stocks recovered from their morning losses on the rumor.
ADP Jobs Report
The ADP Employment report shows strength in the jobs market during September. Per ADP, there was a net pick-up of 568k jobs in September versus 374k in August. The services sector accounted for about 80% of the gains with leisure/hospitality accounting for 226k jobs.
“Leisure and hospitality remain one of the biggest beneficiaries to the recovery, yet hiring is still heavily impacted by the trajectory of the pandemic, especially for small firms. Current bottlenecks in hiring should fade as the health conditions tied to the COVID-19 variant continue to improve, setting the stage for solid job gains in the coming months.” – Nela Richardson, chief economist, ADP.
The Atlanta Fed’s forecast for Q3 GDP growth fell again from 2.3% to 1.3%. The forecast was over 5% in early September. The worsening trade deficit and weaker than expected ISM Services Index are to blame for the latest revision.
Volatility Is Not Living Up To Hype
Watch a few minutes of CNBC and you would think recent daily market gyrations are extreme. In prior commentaries, we note that volatility and the put/call ratio are not signaling much concern. The reason is that the roller coaster the market has been on over the last week or two or is not that daunting. Dare we say it’s a kiddie ride. The graph below charts the absolute daily price change of the S&P 500. As circled, daily changes are running above 1% a day. While above-average, there is nothing too unusual about it.
Utilities vs. Energy
The bar chart below, courtesy of Charles Schwab, shows 100% of energy stocks in the S&P Energy sector are above their 50dma. Conversely, not one utility is above its 50dma. XLU, the utility sector ETF, is sitting on its 200dma while XLE (energy) is about 15% above its 200dma. The second graph shows XLU is resting on important support in both the 200dma (red) and a support line (lime) going back to June 2020. We added utilities to both RIA Pro portfolios over the last week, as we believe support will hold and a bounce is probable. However, caution is warranted as higher natural gas and coal prices may weigh on the sector, forcing it to break support.
October 5, 2021
ISM Services Weakening
The services sector is not showing nearly as much strength as manufacturing. Last week we noted the ISM Manufacturing Index rose to 61.1, which, while off recent highs, is still at levels commensurate with prior peaks over the last 20 years. ISM Services on the other hand fell to 54.9 today and is 15 points below recent highs of 5 months ago. It is now normalized with pre-pandemic levels.
Put/Call Ratio is not Fearful
In Monday’s commentary, we showed the VIX is higher but not rocketing to levels that would cause more concern. The put/call ratio, another indicator of investor stress, is elevated, but like the VIX, not at concerning levels. As shown, the ratio is still below levels seen in prior 2-5% declines over the last year. The current instance pales in comparison to the surge in March 2020.
The graph below, courtesy of Bianco Research, helps put the recent 7% sell-off in the NASDAQ into perspective. As shown, there have been four other declines which have been greater than the current one in just the last year. While recent price action may be concerning, the markets have not done anything overly concerning. That said, valuations are sky high and the Fed is about to embark on tapering QE, so we want to manage our risk closely.
Energy Defying the Market
Despite the S&P 500 falling by about 1.50% yesterday, the energy sector (XLE) rose by a similar 1.50%. As we have shown previously, crude oil ($77.70) is bumping up against long-time resistance of $76-78. A break above resistance could lead to a substantial rise in oil prices. Crude was up over 2% yesterday as rumors spread that OPEC will follow its plan and increase production by 400,000 barrels in November. Some traders were expecting a larger increase in an attempt to limit higher oil prices. Further helping many of the oil companies is a surge in the price of natural gas. Yesterday it rose over 2% to $5.75, more than double its price from spring.
In yesterday’s Gamma Band Update Erik Lytikainen wrote: “There have been three straight weeks that the SPX has failed to overtake the Gamma Flip level, which is currently near 4,440. Our risk-avoiding model currently has an allocation of 30% to SPX and 70% cash. If the market closes below what we call the “lower gamma level” (currently near 4,285), the model will reduce the SPX allocation to zero.”
Erik’s model is reducing exposure because options gamma has flipped negative. Simply, it is at a point where further moves lower in the S&P 500 result in increasingly more selling by options dealers. When prices are above the gamma flip traders need to buy to hedge their books. The graph below confirms his analysis, showing the Gamma Flip level just north of 4400. Given how large options volume has become this year and general market illiquidity, options hedging is a significant cause of price change and may result in more volatility.
October 4, 2021
We are about midway through the trading day and the equity markets are lower. The NASDAQ is leading the way down nearly 2%. The Dow is only down 1%, supported by energy stocks which are up over 2% today. Despite the decline, the VIX is not increasing as much as might be expected. As shown, the VIX is in the same range it has been for the past four days and below levels from the first leg lower on August 20th. A break out to higher highs in the VIX, in conjunction with lower prices, might force short volatility traders to cover, which would add further to downside pressure in the markets.
The graph below shows how well the 50DMA has supported the market since the swoon of March 2020. The bottom graph shows the difference between the S&P and the moving average. As highlighted it is currently 2-3% below the moving average, similar to dips in October and November of 2020. While the decline may not feel great, it has yet to show us something different from what we have witnessed over the past year and a half. A further breakdown, especially below the 100dma would be concerning. Conversely, if the S&P 500 re-takes the 50dma, it may likely head back to record highs. As we have been saying over the last few weeks, all eyes are on the 50dma.
This will be a quiet week for economic data, yet one of the most important of the month. ADP comes out Wednesday with expectations for a gain of 415k new jobs added. The BLS will release its payrolls report on Friday. Economists expect 475k new jobs versus a weak 235k last month in that report. If both data points come near or better than estimates we should assume the Fed will announce tapering QE at their next FOMC meeting (11/03).
Speaking of the Fed we expect they will remain quite vocal this week. As we saw last week, we expect them to continue to reflect concern about inflation and promoting taper soon. Vice-Chair Clarida joins other Fed members in being exposed for personal trading prior to important Fed statements. We suspect, as a result, Powell will not be renominated.
Earnings season kicks off this week but there are not any major companies set to report. The banks will effectively lead off Q3 reporting next week.
Banks Are Not Lending
The graph below from Brett Freeze is a very powerful summary showing why monetary velocity is not rising. As we have written, inflation is a function of money supply and monetary velocity. Fading velocity has offset a large chunk of the surge in the money supply. As his graph below shows, banks are investing in secondary securities, mainly U.S. Treasuries instead of lending money. The tradeoff between the two is normal but the current levels are somewhat extreme.
Today’s release of the Atlanta Fed’s GDP forecast took another big tick lower. As shown below, it now stands at 2.3% for the third quarter, down from 3.2%.
Farrell’s Rule #5 Continued
Yesterday we shared Bob Farrell’s rule #5- “The public buys the most at the top and the least at the bottom.”
Today we follow it up with evidence from Jim Colquitt at Armor Index ETFs. Jim’s graph below compares the average investor allocation to equities to S&P 500 future 10-year returns. As we see, the data is very well correlated lending credence to rule #5. Note the correlation statistics at the top left of the graph.
More importantly, current allocations to equities are more than two standard deviations above the norm. Per Jim- “Since 1952, we’ve only had 4 quarterly observations above the two standard deviation line. Each of which resulted in negative returns (CAGR) for the subsequent 10 years. We now have a 5th.”
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ISM Better Than Expected
The ISM national manufacturing survey was better than expected despite declines in many regional surveys. ISM Manufacturing rose to 61.1 versus estimates of 59.5 and 59.9 in the prior month. Employment bounced back into economic expansionary territory and inventories rose, hopefully signaling the supply side shortfalls may be getting better. Prices continue to reside at very high levels. The prices subcomponent is 81.2, up from 79.4.
Higher Prices, Weaker Income, and Strong Consumption
Today’s Personal Income and Outlays report was not welcome news for consumers. Personal Income only rose 0.2% versus 1.1% last month. Personal Consumption Expenditures (PCE) a direct feed to GDP was +0.8%, much better than last month’s revised -0.1%. Also, the price index and core price index were 0.1% above expectations and in line with last month. The PCE price index rising to 4.3% is the largest annual change since 1991. The PCE price index serves as the price deflator to calculate real GDP. The Fed’s term “Transitory” to describe the recent surge in inflation is starting to get long in the tooth!
The chart below, from MacroMarkets Daily, shows there are now 8 of 35 central banks increasing interest rates.
Bill Farrell Rule #5
The graph below, courtesy of the Daily Shot, serves as a good reminder of Bill Farrell’s rule #5. “The public buys the most at the top and the least at the bottom.”
Inflation Greater than 3%
The graph below, courtesy of Brett Freeze, shows the Minneapolis Federal Reserve’s implied probability for inflation running greater than 3% for the next five years. The probability is derived from derivative markets. Currently, the Fed puts the odds at approximately a one-third chance inflation runs at 3% or greater. The Fed’s long-term goal is 2%. Interestingly the President of the Minneapolis Fed, Neel Kashkari, remains the most dovish member on the board. Based on comments he expects inflation to run well below 3%.
September 30, 2021
QE is in the Budget Fray
As if the Democrats did not have enough trouble passing a budget deal, they have a new hurdle per the headline below. Fed independence continues to weaken as it is now a pawn in the budget battle.
MANCHIN TOLD SCHUMER HE WANTED THE FED TO END QE AS A CONDITION FOR A BUDGET DEAL
Chip Shortage for Autos
Want to know why production at most major auto manufacturers is being sharply reduced? The Bloomberg illustration below shows the average car uses 1,400 chips. Some estimates claim the chip shortage may not be fully resolved until 2023.
Yesterday we published China Plays The Long Game While The U.S. Blows Bubbles. The article discusses recent actions China is taking to boost productivity. Also in the article, we criticize the U.S. and other capitalistic countries for failing to prioritize productivity. For example: “For the better part of the last five years, S&P 500 companies have given back to investors via dividends and buybacks about 100% of their earnings. Why not? Executives are paid handsomely to boost share prices today, not to be more productive and profitable in the future.”
To further emphasize the point we share the Fidelity graph below which breaks down buybacks by industry. Since 2004, U.S. companies have spent $11 trillion to buy back their own shares. Instead, imagine if they invested $11 trillion into productive ventures. Corporate earnings, economic growth, and wages would certainly be higher today and more sustainable.
Initial Jobless Claims rose for a third week in a row to 362k. We are not overly concerned with the recent increase as there are seasonal aspects and hurricane Ida affecting hiring/firing patterns. However, we do not want to see the recovery in claims stop at this relatively high level. Prior to the pandemic, initial claims ran in the low 200k range.
The dollar was up over .60 cents yesterday and is now hitting formidable resistance as we show below. The dollar appears to be forming a head and shoulder bottom. Based on the pattern, a breakout above the red resistance line (neckline) might likely result in the dollar index moving up another $5. Commodities and possibly equities are at risk if that occurs.
Stocks and Bonds Travelling Together
Bonds typically fall in yield during measurable declines in the stock market, making them a great diversifier. The graph below shows that in each “sell-off” over the last ten years, except one, Treasuries had positive returns. That standout is occurring now. It’s early to claim bonds will not diversify equities if the decline continues but it bears watching.
September 29, 2021
Housing is Red Hot
Pending Home Sales rose 8.5% in August after two straight monthly declines. The change in year-over-year sales is still negative but the monthly trend is clearly on the rise again as shown below. Per the National Association of Realtors President, Lawrence Yun, “rising inventory and moderating price conditions are bringing buyers back to the market.”
His comment about moderating price conditions is debatable. Yesterday, the Case-Shiller 20-City Home Price Index rose another 1.5% monthly and is now up nearly 20% annually. Prior to the pandemic, the index rose approximately 3-6% a year. At the housing market’s peak in 2006, the Case-Shiller Index rose 15% annually.
Defense is not Working
As we discuss in our 3 Minutes on Markets video, bonds did not rally to help offset losses in stocks yesterday. While bonds and gold tend to historically provide diversification to an equity portfolio, such is not always the case. In fact, days like yesterday are recently becoming a little more common. The last 3 times the S&P fell by 2% or more in a day, the 10-year Treasury price, gold, and bitcoin also fell on the same day.
Extreme stock and bond market valuations are largely predicated on the Fed’s ability to provide excessive liquidity via low rates and QE. Given confidence in the Fed is paramount to valuations we offer some concern at recent disclosures implicating Fed members. In particular, are those of Dallas President Robert Kaplan. The quote below is from Wall Street On Parade.
Each of Kaplan’s financial disclosures forms dating back to when he first became Dallas Fed President on September 8, 2015 (which we obtained directly from the Dallas Fed), show that Kaplan was trading in and out of S&P 500 futures, a highly speculative form of trading used by hedge funds and day traders.
Given Kaplan had access to non-public information, including transcripts of potential market-moving speeches yet to be released from Fed Chairs, the allegations are serious. Over the coming days and weeks, we need to ascertain if investors care and further if Congress will take any action that might inhibit the Fed’s policy thought process.
Another consideration is whether or not the disclosures provide President Biden a reason to nominate Lael Brainard instead of granting Powell a second term. The graph below shows the odds favor Powell, but they have come down in recent days.
Will Yields Surprise To The Upside?
The graph below, courtesy of Ed Yardeni, shows the strong correlation between the Citi Economic Suprise Index and ten-year UST yield changes. The Citi index measures economic data estimates versus actual readings. Over time the index oscillates as economists move back and forth from overestimating economic activity to underestimating it. As shown below in red, economists have been over-optimistic recently but given this data series in the past, it is likely reaching a point where economists start under forecasting economic data. If this proves true, yields are likely to rise over the coming weeks.
September 28, 2021
Richmond Fed Goes Negative
The Richmond Fed Manufacturing Index now points to economic contraction at -3 versus estimates of 10 and a prior month reading of 9. The regional index is at its lowest level since May 2020. While most sub-indexes fell, the good news is that employment is still expanding. Yesterday, the Dallas Manufacturing Index fell from 9 to 4.6 but remains in expansion mode. The ISM National Manufacturing Index will be released on Friday. Expectations are for a minor decline but keeping it well within an expansionary mode.
Per CNBC: “Ford (F) – Ford is accelerating its push into electric vehicles, with plans for a new U.S. assembly plant and three battery factories. Ford and South Korean partner SK Innovation will invest more than $11 billion in the project. Ford shares rose 3.3% in premarket trading.” We hold a 3% in F in the 60/40 Equity Model.
Hawks are Fleeing The Fed
Dallas Fed President Kaplan is following Boston Fed’s Rosengren in retiring from the Fed. The announcements come in the wake of disclosures about their active trading activity. Both members were hawkish and outspoken about their desire to taper QE and ultimately raise rates.
Dow or NASDAQ?
In the aftermath of the last Fed meeting, value and cyclical stocks are edging out growth stocks. Given the recent jump in yields and outperformance of energy, materials, and industrials, the market may be voicing concern the Fed is late to stop inflation. We recently boosted allocations to cyclical and value sectors as their respective technical setups are enticing and the possible reflation rotation may be back on. To help us track a reflation rotation we can use the ratio of the more value-centric Dow Jones to the growth-led NASDAQ. The graph below shows the recent uptick in Dow versus the NASDAQ. Also, note that the MACD of the ratio is turning up and the RSI is above 50. If the reflation trade is on again, the relative upside of the Dow and value/cyclical sectors can be very rewarding. From February to June of 2021, during the last inflation scare, the Dow beat the NASDAQ by about 15%.
Inflation on the Mind
The graph below from Teddy Vallee shows that inflation concerns are top of mind in corporate earnings outlooks. In a couple of weeks, corporations will start announcing quarterly earnings. We suspect many companies will highlight how they are handling margin pressures due to higher wages and input costs. For companies that can push through said costs to consumers, the outlook should be better than for those that can’t.
September 27, 2021
Atlanta Fed GDPNow
The Atlanta Fed GDPNow forecast for Q3 GDP continues to fall. It now stands at 3.2%, down from 3.7% a week ago, and is now almost half of what it was in mid-August. As shown, the delayed forecast from economists is at 5% but following the GDPNow trend lower.
Northwestern University quantifies the effect of higher oil prices on a President’s approval rating. Per the Financial Times: “A study by researchers at Northwestern University in 2016 found that for every 10-cent rise in petrol prices, the approval rating of the incumbent president dropped by 0.6 percentage points, after controlling for other factors.”
With the mid-term elections a year away and oil prices on the verge of a breakout higher we may start to see the administration pressuring Chairman Powell to better control inflation. Powell is up for renomination as his term expires in February. Will political expediency push the Fed to tighten more aggressively than they might have otherwise?
Critical Technical Resistance For Crude
As we show below, crude oil is sitting just under $77 a barrel. Over the last ten years, that price has marked significant support and more recently resistance. A decent break above $77 and there is little resistance before possibly seeing triple-digit prices. Shortages in Britain are providing a tailwind to the price. Goldman Sachs is optimistic, raising their price target on Brent Crude oil to $90 for year-end.
The Week Ahead
This week will mark a quarter-end so expect a little more volatility as traders do a little window dressing.
There are a decent number of economic data points this week. We lead off today with Durable Goods Orders and the Dallas Fed Manufacturing Index. Later this week the Richmond Fed, ISM, and Chicago PMI will provide more updates on the state of manufacturing. Given heightened concerns over inflation, the reports’ prices sub-index and related comments will be important. On that same thought, the PCE price index for August will be released on Friday. The Fed prefers PCE over CPI. Current expectations are for a gain of 0.3% versus 0.4% last month.
There will be plenty of Fed speakers this week. Many of them will further clarify their thoughts and outlooks for monetary policy going forward. Keep an ear out for any comments on Evergrande and China, and their implications for economic growth and ultimately policy.
August new home sales came in above expectations at 740k (+1.5% MoM) versus a consensus of 708k. The median new home sales price grew to $390,900, which represents a massive increase of +20.1% YoY.
China Crackdown Continues
Cryptocurrencies are selling off following news that the PBOC has declared all cryptocurrency transactions illegal. According to ZeroHedge, “In a statement the People’s Bank of China said the latest notice was to further prevent the risks surrounding crypto trading and to maintain national security and social stability.” Prices have previously dipped and recovered from attempts by the CCP to squash digital currencies. Will this time be different?
COST reported earnings for its fourth fiscal quarter yesterday after the close. GAAP EPS of $3.76 comfortably beat expectations of $3.58. Fourth quarter revenue came in at $62.7B (+17.4% YoY) versus the consensus estimate of $61.5B. Sales growth was primarily driven by comparable store growth of 15.5% YoY, with double digit growth in all operating segments. We hold a 1.5% position in the Equity Model.
Bonds Get Routed
Bond yields rose significantly yesterday, following a decent performance after the Fed policy statement on Wednesday. While too early to tell if yesterday’s move is just technical, it may be an early warning from bond investors that the Fed is behind the curve in tapering. Market implied five-year inflation expectations rose from 2.41% to 2.48%, supporting our concern.
Today bonds are being punished further, with the 10-Y yield pushed up 4 bps to 1.45% by mid-morning. If the 10-Y yield remains elevated through the close, it will have reached its highest point quarter-to-date.
Did Ending Jobless Benefits Help?
The Wall Street Journal helps answer our question. Per their article, States That Cut Unemployment Benefits Saw Limited Impact on Job Growth, “States that ended enhanced federal unemployment benefits early have so far seen about the same job growth as states that continued offering the pandemic-related extra aid, according to a Wall Street Journal analysis and economists.” The graph below shows there is no discernable difference in job growth between states that ended benefits during the summer and the states in which they just expired.
Starting today and through next week, Fed members will make their thoughts known through a plethora of speaking engagements.
September 23, 2021
The PMI composite index fell slightly as growth is “hampered by severe supply chain hold-ups and capacity shortages.” Both manufacturing and services sectors continue to signal solid economic expansion. Inflation however remains a concern. The following paragraph from the report leads to concern the recent stabilization in headline inflation data may not be lasting: ”
On the price front, input costs rose at a sharper pace during September. The rate of cost inflation was the quickest for four months, and the second-highest on record, as supply chain disruptions and material shortages pushed prices and transportation costs up. Meanwhile, output charges continued to increase markedly, continuing to rise at a pace far outstripping anything seen in the survey’s history prior to May, as firms sought to pass on higher costs to clients where possible.
The Evergrande Saga
Evergrande is required to pay $83 million of interest on a dollar-denominated bond today. Per Newsquawk, they have a 30-day grace period as part of an existing agreement before the debt is classified as a default. It appears as if Evergrande may give a preference to paying off Yuan-denominated debt and obligations over foreign-held dollar-denominated debt. They have another $47.5 million dollar-denominated interest payment due next week.
The two graphs below are the “dot plots” from the Federal Reserve showing Fed member expectations for where the Fed Funds rate will be in the coming years. The graph on top is the set of projections from June. At the time only 5 members thought they would raise rates four times or more by the end of 2023. As shown on the bottom graph, with yesterday’s projections, that number stands at 9. There are also 2 more Fed members that think the Fed will hike rates in 2022 compared to three months ago.
All Ears on the Fed
With the Fed meeting behind us, Fed members can now speak publicly. We expect a deluge of speeches and interviews over the coming days as members try to clarify the Fed’s views as well as their personal opinions. We are on the lookout for dissension in the ranks by the members that are overly concerned with higher inflation. While Powell clearly set out a time frame for taper, the Fed might get cold feet if the equity markets turn lower. If that were to happen some of the hawks may become even more vocal about the need to taper and ultimately raise rates. In The Fed Speaks Loudly and Carries a Feather, we decompose the Fed members by their voting status and degree of influence. The chart below and the article provides some context for their latest thoughts on the economy and policy.
September 22, 2021
Powell Q&A Session: A More Hawkish Picture
Following a vague reference to taper in the FOMC statement, Jerome Powell made some hawkish comments during his press conference:
With respect to progress towards taper, Powell commented, “In my own thinking, the test is all but met”.
“I think if the economy continues to progress broadly in line with expectations and the overall situation is appropriate for this, we could easily move ahead [with taper] by next meeting, or not…”
Again, with respect to a decision for November taper, “I don’t need to see a good employment report next month; I just need to see a decent employment report”. Powell is clearly signaling that Fed is likely to announce taper in November barring an unexpected deterioration in economic conditions.
Powell commented that it may be appropriate for taper to conclude by mid-2022.
As expected, Powell is leaving a back door open in case taper doesn’t go over well. “If necessary, we can accelerate or decelerate the taper”.
Taper Talk Continues
Changes to the FOMC statement are highlighted below. Of note, the Fed signaled taper could be around the corner, but did not drop any hints in the statement with respect to timing. “Since then, the economy has made progress towards these goals, and if progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted”. However, in the FOMC press conference Q&A session, Powell noted that taper could come “as soon as the next meeting”.
The Fed reduced their projection for 2021 real GDP growth to 5.9% from 7%. Further, the Fed raised their core PCE inflation forecast for 2021 to 3.7% from 3.0%. The “dot plot” graph on the left shows the level of Fed Funds that each Fed member expects by year. There are now 9 FOMC members that think the Fed will hike rates as soon as next year, compared to only 7 in June. This represents an even split between members that see liftoff in 2022 and those who don’t, and could have implications for the pace of taper once initiated.
ADBE reported earnings for the 3rd quarter yesterday after the close. GAAP EPS of $2.52 easily beat the consensus estimate of $2.29. Similarly, revenue of $3.94B (+22% YoY) beat expectations of $3.54B, driven by a 24% increase in subscription revenue. Management guided to Q4 revenue of $4.07B- slightly above the consensus of $4.05B. Guidance for non-GAAP EPS is also above consensus, at $3.18 vs. an expected $3.09. ADBE is down ~4% in pre-market trading despite beating expectations across the board and guiding above consensus for Q4. We hold a 1.5% position in the Equity Model.
FedEx is Raising Prices
Federal Express announced that effective January 2022, FedEx Express, FedEx Ground, and FedEx Home Delivery shipping rates will increase by an average of 5.9%. FedEx Freight rates will increase by an average of 5.9% to 7.9%. We suspect UPS and other carriers will take similar action. Given a large number of goods are now ordered online, the increase in shipping costs will inevitably work its way into higher prices next year.
Cash on the Sidelines
The graph below from Sentimentrader compares the amount of cash in money market funds to corporate equity issuance. Per Sentimentrader:
“During the pandemic panic, the ratio neared 30 and was the highest in 30 years. In other words, there was 28 times more cash available than shares offered in supply. There are ways to quibble with the technicals, but it’s simply meant as a reflection of sentiment.
Over the past year, the ratio has declined steadily as supply ramped up. Corporations are “feeding the ducks,” as the saying goes. Even though money market assets haven’t been drained much, the skyrocketing supply has caused the ratio to drop below 10 for the first time since the year 2000.”
Declining Earnings Confidence
The graph below, courtesy of the Market Ear, shows declining sentiment towards earnings expectations. Each line representing the four major global equity markets shows the number of earnings upgrades less the number of downgrades, divided by the total number of estimates. Each line is approaching zero but still above it, denoting net confidence remains positive but if falling.
Employment and inflation tend to get the headlines as far as rationales for the Fed to take action. As we consider what the Fed may do tomorrow, we should also consider lending standards. The graph below shows the lending standards for large banks’ credit card customers are as easy as they have been in 20 years. On its own, very easy lending standards, as we have, push the Fed toward a more hawkish stance. Easy borrowing conditions incentivize personal consumption. More consumer activity, especially given current supply line problems, is likely to further agitate inflationary conditions.
Trading Game Plan for the S&P 500
The markets are trading well in overnight trading following yesterday’s late-day bounce. The sizeable bounce provides us with another set of levels, in addition to the 50, 100, and 200-dmas, to guide our trading. The graph below shows the Fibonacci retracements from the recent high to low. If this rally proves to be a bull trap, it is likely to give up between the 38% retracement (4395) and the 62% retracement (4451). There is also a gap between 4400 and 4430. It is common for such gaps to fill and then reverse direction. If the market surges higher through the gap and retracement levels, the outlook becomes more bullish. A rally above the 4451 retracement level and well through the 50dma (4436) will likely lead to new highs. Conversely, the 50 dma (4436) may prove to be resistance. The first line of support is yesterday’s lows and the 100dma (4328). A break of the recent low leaves a target of 4106, the 200dma.
Will They or Won’t They?
In addition to concerns with China, Evergrande, and possible contagion, the markets are also grappling with Wednesday’s Fed meeting. In what was likely a purposeful leak last week, the WSJ laid the groundwork for a taper announcement Wednesday and the reduction in asset purchases in November. With the U.S. and foreign markets skidding yesterday some are asking how the Fed might react. In a Bloomberg interview, ex-New York Fed President, Bill Dudley, warns “They’re not going to react to small market moves and defer the tapering on that basis. They have to change their economic forecast,” he said Monday during an interview on Bloomberg Television with Lisa Abramowicz, Tom Keene and Jonathan Ferro. “At this point, it’s really premature to reach that conclusion.”
There is a lot more to the failure of China’s Evergrande company than meets the eye. At $16 billion, (China’s GDP) is no longer that far from that of the U.S. ($22 billion) and nearly three times Japan, the world’s third-largest economy. What China does and how they do it matters a lot, not just to China but for the global economy. To help keep you better informed, we share a must-read commentary of the situation from @INArteCarloDoss.
With the S&P trading poorly this morning, we share an important graph to help you manage risk. As we show, the 50dma in blue has proven great support. However, the market is now trading more than 1% through that support this morning. The next level to watch is the 100dma, which was supportive in the fall of 2020. Breaking the 100dma may likely lead us to the 200dma at just over 4100.
60 Minutes Warned Us
In a memorable show, which aired eight years ago, 60 Minutes reported on China’s property bubble and ghost cities. The Evergrande Company, on the verge of default and mentioned in the clip, is just the tip of the iceberg. If you want to better understand the imploding bubble China faces watch the dated but poignant short episode- LINK.
The Week Ahead
The Fed’s FOMC meets on Tuesday and Wednesday. Investors will focus on the policy statement and press conference at 2:00 and 2:30 pm ET respectively. Some sort of taper announcement is widely expected with tapering likely to begin in November. The market will need to digest the pace at which they plan on tapering and what events or economic data may cause them to speed it up or slow it down. If they do not announce tapering, there is another factor that few investors are considering. As we wrote in The Fed Speaks Loudly and Carries a Big Feather, there is the possibility of dissension from some voting members. Per the article: Will they dissent? One or two dissents, while not frequent, are not uncommon either. The market reaction might be muted to a bit of friction. Where we offer caution is if the number of dissenting voters totals four or five or even more.”
The economic calendar is relatively light this week with a slew of housing data. Of interest will be the Thursday PMI survey. This will be the first national survey of manufacturing conditions for September. Recent regional manufacturing surveys have been better than expected over the last week, leading us to believe PMI may as well.
After last month’s plunge, the University of Michigan Consumer Survey was stable at 71.0, up slightly from last month. The index is well off the 110-120 rate it was running at for most of 2018 and 2019. Of focus, one year expected inflation seems to be stabilizing albeit at a high 4.7% rate. Longer-term 5-10 year expectations are 2.9%. Per the survey, inflation concerns are spreading to a broader chunk of the population. Consider the following quote: “over the past few months, complaints about rising prices have increased among younger, richer, and more educated households”
Excess Cash No More
On many occasions this year we noted how the Treasury is carrying excessive levels of cash. The graph below shows the spike in cash due to the massive pandemic-related debt issuance and slow-to-follow spending. Federal spending has caught up, and cash balances are back to normal. The result will be an increase in the supply of Treasury debt. This dynamic is occurring at the same time the Fed is contemplating buying fewer bonds. Over the last six months, Treasury supply has not been a concern for the market due to large Fed purchases and reduced issuance. The supply/demand equation will change in the months ahead possibly pressuring yields higher.
Shipping Costs Soar
Is it Time to Buy the Dow?
The ratio of the Dow Jones Industrial Average to the NASDAQ is approaching levels last seen at the peak of the Tech Bubble. Favoring the Dow over the NASDAQ paid handsome dividends from 2000 to 2003. Are we nearing a similar opportunity? The composition of the Dow has changed over the last 20 years. Unlike, the late 90s the Dow now has more tech exposure, like Microsoft at 5.7% of the index and SalesForce at 4.8%. It also holds Apple, albeit at a lesser weight. The Dow’s three top holdings, accounting for a fifth of the index, are UNH, GS, and HD. That compares to the NASDAQ’s top three holdings AAPL, MSFT, and AMZN account for nearly a third of the index. While the Dow has MSFT and other tech companies, a bet on the Dow is a bet against the world’s largest technology companies. Currently, the FAANG stocks driving the NASDAQ’s outperformance are considered both high growth and safety stocks. That narrative must change before the Dow has a fighting chance.
September 16, 2021
Junk Bonds in China
The graph below continues our discussion of Evergrande. Yields in China’s junk bond market have doubled since late May. The problems facing its property markets and economy, in general, are widespread. China’s junk bond yields are back to levels when COVID first roiled markets. As a comparison, BofA’s B-rated U.S. junk index is 4.41%, well below 12.50% from March 2020.
Retail Sales on Fire
U.S. Retail Sales unexpectedly rose 0.7% in August versus an expected .8% decline. However, last month’s data was revised from -1.1% to -1.8%. Excluding gas and autos, sales rose 2.0%. While the data is economically positive, the markets may not like it as it bolsters the rationale for tapering.
Jobless Claims rose last week to 332k. Louisiana reports the biggest increase in large part to Hurricane Ida. This is the first report after the federal pandemic unemployment benefits were rescinded on September 6th.
China’s largest real estate developer, Evergrande, is suspending trading in its bonds today but intends to resume trading tomorrow. The rumor is they will not pay interest or repay principal on any of its debt this week. Evergrande, with over $300 billion in debt, poses risks to the Chinese banking system and many foreign creditors. It is unclear whether the Chinese government will bail out its shareholders. With its stocks and bonds trading down significantly, investors are betting against it.
The table below, courtesy of Goldman Sachs, shows the sensitivity of each sector to rising labor costs. Industrials, which are typically labor-intensive businesses are not surprisingly, the most affected sector. It’s also worth noting, as shown at the bottom of the table, smaller companies have twice the EPS sensitivity to labor costs as larger companies.
Ferrari’s are Cheap
We finally found a valuation technique that claims stocks are cheap. The graph below compares the earnings yield of the S&P 500 to junk bond yields. To put this technique into context, it is like saying a Ferrari is cheap when compared to a Lamborghini. Junk bonds have never been more expensive. Currently, the B-rated, Bank Americal junk bond index yield is 4.44%, about 2% below its average from 2016-2019. It’s also worth noting this measure deems stocks as expensive at the market lows of 2001, 2009, and recently in March of 2020.
September 15, 2021
Trouble in China?
Stringent lockdowns in response to a delta variant outbreak are showing up in China’s economic data. YoY growth in retail sales fell to 2.5% in August versus the estimate of 7% from a Bloomberg survey of economists. Furthermore, construction investment is down 3.2% YTD following China’s new property restrictions, which is impacting global demand for commodities. For example, Chinese steel output reached a 17-month low in August according to Bloomberg. China’s government has avoided broad stimulus to support economic recovery, but some economists believe conditions will ease on the margin moving forward due to slowing growth.
You are probably asking why I should care about the prices of materials I have never heard of. These largely unknown metals and other are worsening supply delays and causing inflation in many popular technology goods. “Tech industry braces for skyrocketing rare earth prices” by NikkeiAsia, discusses why the prices of many rare earth materials are surging and the effect it’s having on tech manufacturers.
Per the article:“Praseodymium and neodymium belong to a category of metals known as rare-earth elements and are used to make neodymium-iron-boron (NdFeB) magnets. These permanent magnets, as they are known, are essential to a swath of tech gear — everything from speakers and electric vehicle motors to medical devices and precision munitions.”
Peaking Natural Gas Prices?
On Monday we pointed out natural gas prices are broaching the upper band of its ten-year range. Forex Live has interesting commentary arguing there may be more gains to come. They cite the TD Securities graph below showing that gas storage as compared to demand is at record lows (outside of the green band) and well below the recent five-year average. They think many analysts are focused on the supply of gas but not on increased demand. Per the article, demand has picked up for the following reasons: “What that ignores is that demand for natural gas has grown considerably in the past five years. The construction of many LNG facilities, the conversion of coal-fired power plants to natural gas and pipelines to Mexico all mean that larger inventories are needed.” Further: “What’s especially worrisome is that there are no signs of increased drilling.”
The Delta variant is mentioned by quite a few Fed members as a reason they should delay tapering. John Hussman’s model below expects fatalities from Delta to peak in the coming weeks. Assuming his model holds up, as it has, the number of fatalities should hopefully drop significantly into November and December and alleviate concerns from some Fed members.
September 14, 2021
While the CPI data was lower than expected, the breadth of the data was not as friendly. As shown below, the median CPI rose .33% month over month and, unlike CPI, is up for three months in a row.
CPI came in weaker than expected across the board. Of most importance to the Fed, the core CPI (excluding food and energy) only rose 0.1% for the month. As a result, the annual core rate fell from 4.3% to 4.0%. Accounting for about 30% of CPI, Shelter costs continue to rise. Owners Equivalent Rent (OER) is up .25% on the month, while rent rose .31%. Given their large contribution and sharply higher rental prices, it’s way too early to claim inflation has been tamed.
Is the Sell-off Over?
Yesterday we shared the recent dependable market pattern. The S&P declines for a few days mid-month with upward-sloping movement before and after the decline. Similarly, the graph below also shows a reliable pattern for the VIX. The VIX spikes with each mid-month decline. Each of the recent spikes has been above its Bollinger Band. The current upper band is 21.46 and VIX is at 19.37, after coming close to touching the band. A similar spike, as we have seen, implies a run to the 24-25 area.
The table below from The Market Ear shows the lack of any substantial drawdown this year. Through three quarters of the year, the largest drawdown is only 4.2%. Of the 94 instances in the table, only three years (2017, 1995, and 1964) have seen smaller intra-year drawdowns.
Value In Washed-out Japan?
David Robertson, an author for Real Investment Advice, shares interesting thoughts on potential value in Japanese stocks. He cites a Bloomberg article in which John Authers reviews how beaten up Japanese stocks are versus those in the U.S.
“John Authers provides some good background on Japan and its struggles over the years. After so many people have been burned so many times, it’s hard to seriously entertain the idea of investing in Japan. Perhaps that is exactly the type of washed-out situation that presents a value opportunity, however. Further, Japan’s epic underperformance started from the top of an epic bubble. What if the tables are turning? In a world of precious few cheap stocks or sectors, Japan is interesting.”
September 13, 2021
Nat Gas is on Fire!
As we show below, the price of Natural Gas is up sharply over the last few months sitting at the upper bound of its 10-year range. Will it break higher or fall back as it did in 2014 and late 2018 when it was at similar levels?
Inflation and Confidence
The New York Fed, via their latest Consumer Expectations Survey, shows the role that rising inflation expectations are having in declining confidence. The graph below shows expected inflation is now over 5% and rising. At the same time expected wage growth is 2.5% stable/falling. As a result, consumers expect to lose 2.64% (red line) in purchasing power over the next year.
Will the Market Bottom on September 21st?
The graph below shows the incredible regularity of the market over the last four months. As shown, every 20 days the S&P 500 tends to decline for a few days, bottom, and then rally back to prior highs. If the cycle plays out again this month we should expect a market bottom on 9/21. Monthly options expirations, which fall around the market troughs, are largely responsible. Liquidity is lacking, so options-related trades are driving direction on the days surrounding expirations.
CPI on Tuesday is the big market event of the week. Given the Fed is making substantial progress toward its employment goal, inflation concerns are moving front and center. While the Fed laid out a timeframe for taper in the WSJ last week, high CPI could speed that schedule up. Expectations for the monthly rate are 0.4%, slightly less than last month’s 0.5%. Also of importance this week is Thursday’s Retail Sales report. Will the recent plunge in confidence be felt by retailers? Speaking of confidence, the University of Michigan Consumer Survey will come out on Friday.
Next Tuesday and Wednesday is the next Fed meeting. Later this week most Fed members will enter the media blackout period.
30% of the CPI index is based on “Shelter” cost, i.e. real and imputed rental prices. The graph below should provide a warning that tomorrow’s CPI report can run hotter than expected. Luckily, the BLS uses questionable means to calculate rent. In BLS’ Housing Inflation Measure is Hypothetical Bull*** we analyze “Shelter” costs. Our conclusion: “If either OER or Rental prices show some correlation to reality, CPI could not only continue to run hot but could rise from elevated levels. That said, looking at historical BLS data, it appears Shelter prices will not change markedly from current levels.”
In the ongoing legal case between AAPL and Epic Games regarding app store payments, this morning a Federal Judge said that AAPL violated California’s laws against unfair competition. The judge ordered that AAPL can no longer require developers to use its payment system within their apps. The ruling could prove painful for AAPL’s top and bottom line if upheld, as AAPL currently receives commissions of up to 30% on some app sales, according to the New York Times. The order is set to take effect in 90 days, although appeals are expected from AAPL in the meantime. AAPL’s stock is down nearly 2.5% on the news.
The Fed Has Spoken
Often the Fed leaks policy changes or sends trial balloons via the media. They tend to have their favorite media outlets and authors in which to do it. Nick Timiraos from the Wall Street Journal is a current favorite. His latest article, Fed Officials Prepare For November Reduction in Bond Buying, lays out a timeline for the Fed to taper QE. While the article is not an official declaration, it will become the market assumption until we learn more at the September 22nd Fed meeting.
Per the article:
While they are unlikely to do so at their meeting on Sept. 21-22, Fed Chairman Jerome Powell could use that gathering to signal they are likely to start the process at their following session, on Nov. 2-3.
Under the plans taking shape, officials could reduce those purchases at a pace that allows them to conclude asset buying by the middle of next year.
The producer price index (PPI) is slightly higher than expectations. PPI, while not as well followed as PCE or CPI provides unique insights. First, PPI tends to lead CPI. Higher or lower input prices often eventually make their way to changes in the prices of goods companies sell, i.e. CPI. Second, other than labor, input costs are often the second largest expense for companies. Given rising wages and PPI, producers and other companies dependent on labor and commodities are likely to feel margin pressure.
Dow Theory, a once-popular way of evaluating the market, is well over 100 years. The theory follows that transportation stocks lead the broader markets. Per Business Insider: “The general idea is that both averages, over time, should move in tandem, given that the transportation average represents companies responsible for the movement of goods across the country. For that reason, it should serve as a leading indicator.” Many question the value of the theory today due to the tremendous technological progress. However, the fact of the matter is we still consume goods that must be shipped.
The graph below shows the Dow Transportation Index is down nearly 10% since May. At the same time, the broad market S&P 500 has steadily risen by 10%. For those following Dow Theory, this is a warning.
Will They Taper?
The chart below, courtesy of InTouch Capital Markets, breaks down the Federal Reserve Board by the degree to which they are policy hawks or doves. The graph also shows their respective voting eligibility by year. There are about twice as many hawks as doves, but three of the four most influential voters are dovish (Powell, Williams, and Brainard). The other, Vice-Chair, Richard Clarida, is neutral. Five of the six doves vote in 2021, while only four of the ten hawks vote in 2021. Despite the hawkish overtone from many Fed speakers, this chart points to a more dovish policy stance going forward. We will have much more on this graph and its implications in our next article this coming Wednesday.
September 9, 2021
Another Strong Auction
On the heels of yesterdays’ strong 10-yr auction, 30yr bonds were very well bid. The 1.91% yield on the bonds is nearly 2bps below where it was trading before the auction and the lowest auction yield in nine months. 30-year bond yields are down 10bps since peaking at 2% on Tuesday. Per Zero Hedge: “Dealers were left holding on to 13.1% of the auction, the lowest Dealer takedown on record!” Given there is little need for dealers to distribute what they own, selling pressure may be minimal in the days ahead. The bond is trading about 3bps lower in yield post-auction.
Fed’s Beige Book- Labor Shortages
The Fed’s Beige Book is a summary of economic conditions in the 12 Federal Reserve Districts. Before delving into each district’s report, the document starts with a one-paragraph highlight from each district. As shown below, all of the summaries include a statement on labor shortages and or wage pressures. The topic is clearly top of mind at the Fed, as it should be. If there are widespread job shortages and strong pressure to hire, as seen in the record number of job openings, wages may continue to rise and foster more inflation. Is it any wonder many Fed members are increasingly growing concerned with inflation?
Boston: “inability to get supplies and to hire workers.”
New York: “businesses reporting widespread labor shortages.”
Philadelphia: “while labor shortages and supply chain disruptions continued apace.”
Initial jobless claims fell to 310,000, a decline of 35,000 from last week. This is the lowest level for initial claims since March 14, 2020, when it was 256,000. In 2018 and 2019 jobless claims were steady in the low 200,000’s.
The graph below shows inflation expectations have stabilized after rising sharply in 2020. Expectations are probably more important than actual inflation figures like PCE, CPI, and PPI as the Fed tends to believe inflation follows expectations. Given the unprecedented supply line pressures along with pent-up demand, and massive fiscal stimulus, the Fed’s reliance on the markets might be a trap this time.
The equity markets are affirming stable inflation expectations. Cyclical sectors, that traditionally benefit from higher prices and strong economic growth, are lagging while more conservative, less economically sensitive sectors are leading the way. The sector performance map below points shows where money is flowing to and from. It appears investors are seeking shelter in more conservative, lower beta sectors like utilities, healthcare, and REITs. Large-cap technology and communication, like Apple, Microsoft, Facebook, and Google, have also done well as their earnings are thought to be minimally affected by slowing economic growth. The cyclical sectors like energy, materials and industrials are lagging as growth prospects decline.
September 8, 2021
The Treasury Department’s 10-year auction was met with strong demand for the second month in a row. The recent backup in yields seems to be eliciting demand. Today’s auction has a bid to cover ratio of 2.59, meaning there are 2.59 bids for every bond offered. That was the second-highest bid to cover in over a year. The highest was last month’s auction. 30-year bonds will be auctioned on Thursday.
Jobs Jobs Jobs!
The BLS JOLTs report shows the number of job openings surged from 10.2 million to 10.9 million, blowing away estimates of 10 million. There are now over 2 million more job openings than the 8+ million the BLS says are unemployed. The data is for July when over 7 million were still receiving unemployment claims. It is widely expected the number of openings will fall in the coming months as the pandemic-related jobless benefits expired last week.
Bob Farrell’s rule #5 states: “The public buys the most at the top and least at the bottom.” The graph below from Longview Economics speaks volumes for where the equity markets are in the investment cycle based on Bob’s logic.
Goldman Joins, Morgan Stanley, and the Atlanta Fed
Last week we noted that Morgan Stanley and the Atlanta Fed sharply reduced their estimates for Q3 GDP. Goldman Sachs is now joining them. Per Goldman: “.. we have long highlighted that the fiscal impulse will fade sharply .. it might take a while for spending to recover in still-depressed categories .. we have lowered our forecast for 2021Q4 consumption growth by 2.5pp to 3.5% … We now expect GDP growth of 3.5% in Q3″
In mid-August Goldman Sachs was expecting Q3 GDP growth of over 8%! The effects of 7+million losing unemployment benefits and the removal of the moratorium on evictions have yet to be felt. Both actions will likely further complicate forecasting going forward and weigh on economic growth.
Volatile Auto Sales
The graph below shows the recent volatility in auto sales over the past year and a half. After plummeting to 40-year lows at the onset of the pandemic, auto sales roared back to 15-year highs. Since then they have fallen nearly 30%, sitting at levels consistent with previous recessions. There are a few factors wreaking havoc on this data including pent-up demand, massive fiscal stimulus, and car/truck shortages. It is being said chip shortages for auto could last well into 2022 and possibly 2023. Given the shocks to demand and supply of autos, we caution not to read too much into this chart. That said, the industry is important as it accounts for about 3-3.5% of GDP and about 4.5% of jobs.
September 7, 2021
Ready for a SnapBack?
Michael Queenan (@mjqueenan) provides yet another reminder the S&P 500 is extremely stretched from its trend. Per his tweet: “For anyone tracking, this is now the second-longest the $SPX has gone without touching the daily 200 EMA. April 1958 to June 1959 (289 bars) is the longest. We are currently up to 213 bars.”
Bond yields are about 4-5 bps higher this morning despite little market news or movement in the equity markets. Some of the sell-off may be attributable to dealers setting up for the upcoming 10 and 30-year Treasury auctions. Tomorrow the U.S. Treasury will auction $38 billion 10-year notes. They will follow it up on Thursday with $24 billion in 30-year bonds. Since Wall Street banks and brokers are the prime distributors of the auctions, they tend to sell or short bonds in the day(s) preceding auctions and buy them back at auction. This can work to their advantage as bond prices often weaken prior to auctions allowing them to purchase bonds at lower prices than they sold them. While the pattern doesn’t always play out as described, some investors seeking to make some trading profits will mimic dealer behaviors.
According to Bank of America, with $3.2 trillion of assets held by private clients, allocations to bonds are at an all-time low of 17.7%. At the same time, stock holdings are at an all-time high of 65.2%. Assuming the data is representative of most individual accounts throughout the banking /brokerage system, which seems plausible, there is a lot of fodder for a bond rally at the expense of stock prices.
This holiday-shortened week will be light on economic data. On the heels of the employment report, the BLS JOLTs report on Wednesday will tell us if the record number of job openings continues to increase to new records or are they starting to get filled. With over 7 million people losing benefits we suspect the demand for jobs will increase. Of importance, on Friday the BLS will release Producer Prices (PPI). We believe the market and many Fed members are increasingly worried inflationary pressures are overstaying their “transitory” welcome. PPI will also shed light on rising input costs for manufacturers. CPI will be released a week from today.
So, was the gain of 235k jobs normal? The graph below compares the monthly change in jobs as a percentage of the workforce to the median percentage over the last 70 years. As we highlight below, 235k job growth is perfectly normal.
Taxing Stock Buybacks
An idea floating around Democrat circles in Washington is taxing stock buybacks or treating them as taxable dividends. Is it likely? Probably not, given the massive lobbying efforts of corporate America. However, if they are able to pass such legislation, a key driver of stock prices may have a limited effect going forward. While we think the odds of passage are low, this bears watching closely.
Underwhelming Jobs Report
The BLS Employment Report fell short of expectations with only 235k jobs added versus estimates of 750k. Despite the relatively minimal number of jobs added, the unemployment rate fell from 5.4% to 5.2%. The participation rate is unchanged at 61.7%. Hourly earnings were higher than expected at +0.6% versus +.04% last month. While positive for employees, higher wages, if sustained, will pressure corporate earnings and can put further upward pressure on prices.
So what does this report mean for the prospects of tapering? Chair Powell has repeatedly said taper will come with significant improvement in the jobs market. While the August number was well below expectations, the unemployment rate fell by 0.2%. Further, the average gain for the last three months, including today’s data, is +750k. That is about 3x the rate of pre-pandemic levels. We should also keep in mind, there are a lot of seasonal factors in August. In an odd year like this one, the seasonal adjustments can wreak havoc on the data. Today’s report may cause Powell to pause, but we suspect many other Fed members are concerned about inflation. The strong wage growth will only further their concern that inflation may be more than transitory.
Our guess is the market will push out expectations for tapering QE to a November-January time frame. Despite the poor data, bonds are trading poorly this morning which affirms our taper forecast.
The chart below from the BLS provides some context for the pace of jobs recovery by industry.
The graph of the VIX (volatility) below highlights a fairly reliable pattern that has been occurring mid-month for the last year. As shown, VIX tends to decline into the middle part of most months, rally sharply for a few days, and head lower again. The pattern has been especially pronounced the last three months. One likely cause is the combination of mid-month options expiration and low volumes. The volume of trades needed to cover and roll options contracts may be enough to push volatility higher at these times.
September is thus far looking to repeat the pattern. A nice short-term trade may again occur if VIX approaches the 16.00-16.50 range later next week. 16 has been the recent floor so if you do get long the VIX and try to take advantage of the pattern, keep risk targets in place below 16.
Shown below, courtesy of the Daily Shot, the Citi Economic Surprise Index continues to decline. Any reading below zero denotes economists’ forecasts are too optimistic. The recent string of weaker economic data has caught them off guard. Despite the implications of weakening economic growth, the positive correlation between the graph and stock prices has significantly deteriorated over the last year.
September 2, 2021
GDP Guesstimates Falling Rapidly
The Atlanta Fed’s estimate of third-quarter economic growth fell sharply for the second time in a week. To blame were Factory Orders coming in at +0.4% versus +1.5% last month and a change in real net exports. As shown below, their estimate is now at 3.7%, down from over 6% about a week ago. The consensus remains at 6.5%.
It appears Morgan Stanley is in agreement with the Atlanta Fed. Per Zero Hedge: But if Goldman was a surprise, what Morgan Stanley did this morning – when the bank slashed its Q3 GDP from 6.5% to just 2.9% – was shocking.
“Tightness in the US natural gas market is beginning to manifest itself in low inventory levels. After having started the year at a 200 bcf surplus to the five-year seasonal average, US inventories now stand at nearly a 200 bcf deficit. Given the current trajectory, our models suggest we could end the injection season at 3.2 tcf of gas representing a 400 bcf deficit, or 700 bn cubic feet lower than the same time last year. If we are correct, inventories run the risk of starting the withdrawal season at the second-lowest level in fifteen years. At that point, any bout of cold weather this coming winter would likely lead to a price spike.”
As shown below, the price of Natural gas is up significantly in recent months. Assuming the deficit of gas persists, a colder winter might briefly push its price to the highs of 2019, 2014, or possibly higher. It’s worth noting the price of natural gas doesn’t always rise in the winter. Of the 10 years shown, over half saw stable or falling prices during the winter months.
In Valuations Are Extreme Even With Rose Tinted Glasses, we take a new approach to calculating stock valuations. We forget history and assume “this time is different” has merit. Accordingly, we throw out scary graphs like the first three below which compare current valuations to past periods. Instead, we only compare valuations to valuations in the same ten-year period. The math is different, but the overvaluation story is not. The last graph shows that even with rose-tinted comparisons this time is not different. Valuations are extreme no matter your logic.
September 1, 2021
ISM Bucks The Trend
Unlike weakening manufacturing surveys from other countries and various regional surveys within the U.S., the ISM manufacturing survey is slightly higher versus last month (59.9 vs 59.5). In a sign shortages are abating, inventories rose to their highest level since 2018. The only concern in the report is employment fell back to contractionary levels at 49. The broad ISM index, while off the peak from earlier this year, is still near the highs of the last 20+ years. The lesser followed PMI Manufacturing survey is slightly higher than ISM, but lower versus last month (61.1 vs 63.4).
The ADP report is well short of expectations at +374k jobs versus expectations for over +600k. The coming BLS report and ADP have not been well correlated over the last year, so do not read too much into this report. However, the timetable for taper hinges in part on continued substantial improvement in the labor market. A corresponding weak number in the Friday BLS data will likely push back market expectations for the start of tapering QE.
Over the last year, we have gotten a lot of questions on TIPS. In particular, readers want to better understand how they can protect themselves from inflation. Lyn Alden has an excellent paper describing how TIPS work as well as their pros and cons. CLICK HERE to read it.
In the article, she stresses that while TIPS can provide some protection when inflation is greater than expectations for inflation, they are still likely to result in a decline in purchasing power. One reason is the BLS CPI Index does not accurately capture inflation. Two, the yields on all TIPS are now negative. Negative carry offsets some of the bond’s inflationary benefits.
Negative Real Yields In Germany
The graph below compares the German central bank main rate (similar to Fed Funds) versus year-over-year inflation. Like the U.S., its lending rate is at zero and CPI is soaring. The last time their CPI was at its current level in the early 1990s, the lending rate was about 6%. Not shown, German 10-year bonds yield -0.40%, resulting in a real yield of -4.40%. Absurdly low-interest rates and rising inflation is a global phenomenon and one that could prove dangerous if the recent rise in inflation is not transitory.
August 31, 2021
Consumer Confidence affirms the University of Michigan survey that consumer confidence is falling quickly. The Conference Board’s Confidence reading was 113.8 versus expectations of 123, and a prior reading of 129.1. Both the present situation and expectations components fell by approximately 10 points. The clue as to why confidence is fading lies in the survey’s inflation expectations reading. One year inflation expectations rose from 6.6% to 6.8%. also in the report, the number of consumers saying jobs are plentiful fell slightly. Those answering jobs are hard to get rose slightly.
Another Weak Survey With Inflationary Implications
Over the last week, regional manufacturing surveys have been weaker than expectations. Today, the most followed of the regional surveys, Chicago PMI, fell to 66.8 from 73.4. Unlike China, the deterioration in these indexes appears supply-related. Order backlogs, for instance, have the largest increase. In fact, it is at its highest level since 1951! At the same time, production has the largest decline. The good news is inventories rose, but at 48.8 they still signal contraction. Prices paid rose to 93.9 a 40+ year high. New orders fell which is potentially a signal that demand is weakening from its torrid pace. Overall the report leads us to believe inflationary pressures are continuing.
The report has an interesting question as follows: “With enhanced Unemployment Insurance benefits set to expire in September, are you forecasting an increase in your staffing levels?” The answer: “The majority said they were not.”
Markets Extend Winning Record
Worrisome Signs From China
China continues to show signs of slower economic growth ahead. Its PMI Manufacturing Survey is clinging to expansionary territory at 50.1 vs expectations of 50.2. Both the Non-Manufacturing (47.5) and the Composite Survey (48.8) fell below 50, signaling economic contraction. In addition to the negative effect of Delta variant, China is also to blame for the weaker surveys as they are steadily imposing new regulatory laws limiting certain types of businesses and activities. The actions are meant to improve their economy in the long run, but in the short run, they will come at a cost. The latest round of legislation imposes more control over private equity funds and limits public stock offerings from these funds. Other recent laws including limiting the time children can play video games, curbing capital expansion in entertainment, and more closely enforcing IP violations.
Inflationary Headlines are Fading
Despite the highest inflation rates in decades, the scary “Brace For Inflation” headlines are fading. The interesting graph below, courtesy of Arbor Research, compares the ratio of articles saying inflation will rise versus it falling.
August 30, 2021
In the aftermath of Powell’s speech last Friday, investors are clearly favoring large-cap growth. The S&P and NASDAQ closed up by .44% and 1.13% respectively, while the Dow is slightly lower and Russell 2000 off by .50%. Given Powell’s dovish tone, we wrongly suspected cyclical sectors and small caps would trade better. Market breadth remains poor as the generals are leading the way higher. Apple is up 3% and Facebook and Amazon are up over 2%. There were more declining stocks on the NYSE than advancers.
Atlanta Fed-GDP Now
The Atlanta Fed revised its GDP-Now forecast from 5.7% to 5.1% in large part due to slowing personal consumption. The Delta variant is resulting in weaker dining and hotel spending but that is not the only problem. The recent torrid pace of spending is unsustainable and normalization is inevitable. The economic headwinds in addition to Delta, in our opinion, are as follows:
The graph below from Tavi Costa, charts the ratio of earnings over price. As he shows, investors are paying quite a premium for earnings. Most likely in the future, either earnings grow sharply or prices correct. As Tavi shows, the last four instances with similar yields were not market-friendly. Maybe this time will be different?
Watching The Paint Dry
Normally those Wall Street traders not sunning in the Hamptons watch the paint dry in trading rooms during the week preceding labor day. With the Fed providing more clarity on taper, that should be the case this year as well. However, the ADP and BLS employment reports come out Wednesday and Friday respectively. Given many Fed speakers are making it clear continued improvement in employment is the key to start tapering, we might see some fireworks this week. After a relatively weak report last month, ADP is expected to rise from 330k to 500k. Economists expect the BLS to show 650k more jobs in the workforce. With many unemployed people losing federal and state unemployment benefits, the incentive to find a job is higher which may lead to larger than expected additions to the workforce.
Also of interest this week will be the reaction of Fed speakers to Powell’s vague comments involving a taper timetable. We suspect dissension in the ranks will become more vocal over the coming weeks.
August 27, 2021
Investors were fretting the Jackson Hole symposium would result in a firm timetable for an aggressive tightening campaign beginning as early as September. As seen in Powell’s comments below, what it got was more ambiguity around timing and amounts. After Powell’s speech, Fed Governor Harker continued on with vagueness around taper as follows: “The Fed has reached an agreement that tapering will begin this year.”
The Oracle Speaks
Chairman Powell’s much-awaited speech is being met with optimism in the markets. In particular, the following line is assuring investors the Fed will not be aggressive with tapering QE. In regards to premature tightening he says: “Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful.”
Below are two key segments from his speech:
We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the “substantial further progress” test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.
The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time.
The Fed’s preferred inflation index, PCE, met expectations rising 0.4% in July. The level was 0.1% below the June reading. The year-over-year rate is 4.2%, which is more than double the Fed’s 2% inflation target.
The Fed is somewhat complacent on fighting inflation as they believe it’s transitory. They factor in the temporary impediments to the production and shipping of goods but think these problems will resolve relatively quickly. Bloomberg has an interesting article out which leads one to believe the supply problems may last longer than the Fed believes: The World Economy’s Supply Chain Problem Keeps Getting Worse. Here are a few noteworthy lines and a graph:
China’s determination to stamp out Covid has meant even a small number of cases can cause major disruptions to trade. This month the government temporarily closed part of the world’s third-busiest container port at Ningbo for two weeks after a single dockworker was found to have the delta variant.
“Port congestion and a shortage of container shipping capacity may last into the fourth quarter or even mid-2022,” said Hsieh Huey-chuan, president of Taiwan-based Evergreen Marine Corp., the world’s seventh-biggest container liner, at an investor briefing on Aug. 20. “If the pandemic cannot be effectively contained, port congestion may become a new normal.”
The cost of sending a container from Asia to Europe is about 10 times higher than in May 2020, while the cost from Shanghai to Los Angeles has grown more than sixfold, according to the Drewry World Container Index.
August 26, 2021
How Much Confidence Should We Have In Confidence Readings?
The graph below, courtesy of Rennassacience Macro Research presents quite the quandary. As we discussed last week, the widely followed Uof M Consumer Confidence fell sharply to levels below any seen in 2020. The lesser followed Langer confidence index continues upward. It’s difficult to fully understand why they are diverging, but we should note Langer rose steadily in 2019 and 2020 while the UofM indicator was flat. Other than that period preceding the pandemic, the two indicators are well correlated, including periods before the financial crisis and tech crash.
A day before Powell kicks off the Jackson Hole Conference, the host of the symposium, Esther George of the Kansas City Fed, is clear she wants to start tapering soon. Per her interview on CNBC:
“The U.S. economy has hit the necessary benchmark of “substantial” progress needed to start to slow down its $120 billion per month of asset purchases”
“My own view on that is that we have made substantial further progress and we can begin to talk to talk about backing off some of that accommodation”
“I would be ready to talk about tapering sooner rather than later”
She alludes that the timetable and amount of tapering will be on the agenda at the upcoming September 21-22 FOMC meeting.
Rinse Wash Repeat
The graph below from Northman Trader shows the predictable pattern the S&P 500 has fallen into over the last several months. The market grinds higher, hits an air pocket around the 15th of each month, and then sharply recovers and grinds higher again. The dips and surges all occur between the 14th and 19th of each month, corresponding with options expiration dates. Liquidity is poor as witnessed by light trading volumes, so heavier than usual options-related trade activity is driving price action on those days.
Bad Market Breadth
The Tweet below from Bespoke Investment provides yet more evidence the market is increasingly being driven higher by fewer stocks. Bad breadth is often an indicator of a coming market retracement.
August 25, 2021
When the Fed announced the coming Jackson Hole Conference would be virtual markets jumped. The assumption being the Fed is worried about the variant and therefore likely to downplay taper given new vulnerabilities to the economy. The reality is that new Delta cases appear to be falling. The graphs below from IHME/University of Washington show confirmed infections are stabilizing or declining and IHME’s estimates are also moving lower.
The graph below, highlighting President Biden’s declining approval rating, is an important macro factor emerging on the horizon. There are two points in regards to his ratings worth keeping an eye on.
First, Biden will try to improve his ratings. Will he push legislation for even more fiscal stimulus or other economic boosting measures to win approval? In a similar vein, will he back off on tax increases?
Second, will some Democratic Senators and Representatives, especially those facing tight reelection campaigns in a year, start to shy away from the President? If so, winning their votes for infrastructure, the budget, or anything else will become tougher.
Savings Rate Normalizing
The savings rate spiked early in the pandemic due to the abundance of fiscal stimulus sent directly to individuals along with less consumption as important segments of the retail economy were shut down. Since then, additional savings and further rounds of stimulus boosted consumption and nominal economic growth to levels last seen in the 1950s. Both sources of economic activity are coming to an end which helps partially explain why consumer confidence fell sharply last month and retail sales have been weak. The economy is slowly but surely being left to stand on its own legs. Will the Fed hold of tapering QE as economic reality emerges?
The graph below from Arbor Research provides a clue for the recent decline in consumer confidence. Based on Google search data, the term stagflation is now the leading ‘flation search word. Stagflation entails weak economic activity coupled with inflation. Stagflation results in higher unemployment and negative real wage growth.
August 24, 2021
More Pressure on Powell
Add Bloomberg to the list of people and groups asking Powell to taper sooner rather than later. The powerful message from Bloomberg’s editorial board states the following:
He ought to nudge expectations in the direction suggested lately by some other top Fed officials. Short of making a formal announcement, he should say he’d prefer tapering to start soon and be completed by the spring.
It isn’t the right tool for current conditions, and leaving the program in place serves to narrow the Fed’s options as conditions change.
Asset prices have surged and the risk of bubbles and financial instability is growing. All this suggests it’s past time to start dialing back the Fed’s commitment to maximum stimulus.
It is not just equity valuations that are near or have already exceeded levels from 2000. The graph below, courtesy of the Daily Shot, shows that investor willingness to bet against the market is also at levels last seen 20 years ago.
While a lesser followed manufacturing survey, the Richmond Fed confirms the slowdown that other similar surveys are relaying. Per the Richmond Fed: “The composite index declined from 27 in July to 9 in August but remained in expansionary territory, as all three component indexes — shipments, new orders, and employment — decreased but remained positive. However, several manufacturers reported deteriorating local business conditions.” There was some good news. The wage index hit a record high which should help those workers offset inflation and possibly boost consumption down the road.
As Market Ear’s graph below shows, the season of higher volatility is upon us. Their seasonality graph jibes well with others that show markets tend to have their worst few months of the year during September and October.
A Bigger Short
It has been revealed that Michael Burry, portrayed in the book and movie The Big Short, has a large short position in U.S. Treasury bonds. His stance is not surprising given he has been vocal about inflationary concerns. Burry’s expectations are largely in line with Wall Street. Per a Bloomberg article on this topic: The median forecast in a Bloomberg survey is for the 10-year yield to end the year at 1.60%…”
Bill Farrell rule #9- “When all the experts and forecasts agree — something else is going to happen”
Office Space Trouble?
The graph below, courtesy of Jim Bianco and Kastle, shows that well over half of the office space in major cities is being underutilized. Per Kastle’s data, nationwide only a third of office space is being used and no major city is above 50%. If the trends do not revert to normal over the coming year or two, the amount of vacant office space will become problematic, especially in the larger cities.
The following graph and commentary from GMO, show that over the last year corporations have been taking advantage of higher share prices. Interestingly, IPO issuance is currently running at the same pace as the market peak in 2000. Massive issuance from existing stocks is largely responsible for the big difference between total issuance today versus 2000.
August 23, 2021
The heat map below, from the RIA Pro Dashboard, is a good way to monitor the breadth of the market. Despite the Nasdaq rising nearly 1.50% and the S&P .85%, the map shows there were a good number of stocks lower in the more conservative, lower beta sectors such as utilities, healthcare, consumer goods, real estate, and consumer cyclical sectors. Despite weakness in the aforementioned sectors bonds were flat on the day.
The August PMI Flash Composite Economic Survey fell to 55.4 from 59.9, an eight-month low. The bulk of the decline was attributable to the services industry. Many other nations and regions saw declines in their PMI reports. Australia was the most pronounced, falling from 56.9 to 51.7. The combination of weaker growth from China and Covid related lockdowns is weighing on their economy. Japan fell deeper into contraction (below 50) with a composite reading of 45.9 versus 48.8 in July. Europe held up well, only falling to 59.5 from 60.2.
Unlike the PMI reading, the Chicago Fed’s National Activity Index rose to +.53 from +.09. As the graph below shows, it continues to oscillate around trend.
The big event this week is Chairman Powell’s speech at the Fed’s Jackson Hole conference on Friday at 10 am. Investors will be looking for any signs Powell is moving closer toward tapering in the coming months. It is possible he shares little, instead preferring to wait until the September 22 FOMC meeting. At that point, the Fed will have another round of employment and inflation data in hand.
On the economic calendar existing and new home sales will be released on Monday and Tuesday respectively. Durable Goods come out on Wednesday, followed by Personal Income and Spending on Friday. Also on Friday, the PCE price index for July will be released. PCE is the Fed’s preferred measure of inflation. In June PCE rose 0.5%. It is expected to rise 0.4% in July.
After rising rapidly in late 2020, new home sales are back to pre-pandemic levels as shown by the blue line in the graph below. Despite normalizing sales, shares of homebuilders D.R. Horton (DHI) and Lennar (LEN) are 61% and 59% respectively above pre-pandemic levels. This chart is just one of many examples where share prices are not reflective of underlying trends.
The graph below shows the small-cap- IWM (Russell 2000) index is now below its 200 dma for the first time since rising above it nearly a year ago. The S&P 500 is still 10% above its 200 dma, while the NASDAQ is nearly 15% above its. As we have pointed out on numerous occasions, this is another warning that markets may be on the cusp of a downtrade.
Dallas Fed President Robert Kaplan, a strong proponent of tapering in the coming months, put the markets on alert that taper may not be as inevitable as many investors believe. Per Reuters: “any economic impact from the Delta variant of the coronavirus and he might need to adjust his views on policy “somewhat” should it slow economic growth materially.”
The problem with his statement is in trying to discern why economic activity is slowing. Delta is certainly playing a role, but fading stimulus, reduced consumer confidence, inflation, China, and a sharp reduction in pent-up demand are also weighing on the economy. Delta may be a convenient excuse for the Fed to delay tapering until next year. The initial market reaction to his comments was positive.
As we have noted China’s economic activity is weakening. The message is not lost on its equity markets. Hong Kong’s Hang Seng Index is now officially in bear territory, down 20% from its February peak. The S&P 500 is up 10%+ over the same period.
Zero Hedge put out an interesting piece titled Morgan Stanley Spots a Flashing Red Market Risk warning about option gamma flip points. Morgan Stanley says gamma “flips to short below 4250. That is where we could hit an air pocket.” On Monday, in our Gamma Band Update, Erik Lytikainen pegged the S&P 500 gamma flip level at 4205. The gamma flip point is where dealers, on average, have to sell stocks versus buying them to hedge their options books. Given the increased volume in options, and call options, in particular, these flip points provide a level where the recent bout of selling could accelerate. In addition to key moving averages which have served investors well recently, gamma flip points another level of technical guidance worth following closely.
After a relentless grind higher, some key manufacturing metals such as copper and iron ore have begun to fall in price. Copper for instance is trading at $4.00, down from a high of $4.80 in early May. Iron ore is down 30+% over the same period. Not surprisingly the Australian dollar is also trading weaker as it is a large exporter of metals and minerals. China, whose economy has been slowing markedly, accounts for 42% of Australia’s exports. The second leading country they export to is Japan, constituting only 13%.
Despite the declines in some key industrial metals, the well-followed CRB commodity index, shown below, has yet to break its uptrend. The index is weighted 41% to agricultural products, 39% to energy, 13% to industrial metals, and 7% to precious metals.
August 19, 2021
The graph below is 30-year UST yields with its 50 and 200 dma’s. The vertical lines highlight the last five times, 30 year yields have witnessed its 50 dma falling below its 200 dma, also known as a “death cross.” In 3 of the last 4 death cross instances yields fell appreciably and reached record lows. The only time they didn’t was in 2017 (red vertical line). At that time yields consolidated to negate the death cross. As shown, on Monday 30-year yields witnessed a death cross.
Ford, Toyota, and Volkswagen are trading lower on plans to cut production in September due to the ongoing chip shortage. The Delta variant will only further complicate existing shortages.
Per Barons: Production woes have hit Infineon, a German chip maker and major supplier to the car industry, which said earlier this week that plant shutdowns in Texas and Malaysia have caused deliveries to core auto clients to fall, according to reports.
Ford’s decision to shutter the Kansas City plant was rooted in shortages related to the pandemic in Malaysia, according to the Reuters report.
The “Buy the Dip” (BTD) graph below from the Daily Shot, shows each consecutive market drawdown since the pandemic has fallen less than the prior one. Consequently, the VIX volatility index (graph on right) has a similar pattern. Investors and algorithms are increasingly quicker to buy dips and short volatility as such behavior has been rewarded with profits. The risk going forward occurs if the market keeps falling despite dip-buying, forcing traders to cover leveraged positions and unleashing new behaviors detrimental to prices. Until then, BTD!
Volatility experts at Spot Gamma had this to say about the graph- “The longer volatility is suppressed the more it’s going to pop.”
An increasing number of companies are hopping on the crypto bandwagon and allowing their customers to use crypto on their sites. Software company Palantir recently reported, that in addition to crypto, they will now accept gold. Further, they bought about $51 million dollars worth of gold. Per Bloomberg, COO Shyam Sankar said: “Accepting nontraditional currencies “reflects more of a worldview,” Shyam Sankar, the chief operating officer, said in an interview. “You have to be prepared for a future with more black swan events.”
August 18, 2021
The Fed shed little new light in the FOMC minutes in regards to the schedule and pace of Fed taper. While some Fed members seem eager to start tapering as soon as September, others voiced concern about downward inflation pressure and how the market may perceive tapering. We look to the Jackson Hole Fed conference late next week for more guidance.
Highlights from the Fed minutes from the July 28th FOMC meeting:
“Most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year.”
“They are worried that accelerating plans to wind down the asset purchases could lead investors to question whether the Fed is in a hurry to raise rates or less committed to achieving lower unemployment.”
SOME PARTICIPANTS REMAINED CONCERNED ABOUT THE MEDIUM-TERM INFLATION FORECAST AND THE PROSPECT OF MAJOR DOWNWARD PRESSURE ON INFLATION RESURFACING.
“Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year”
“Most participants remarked that they saw benefits in reducing the pace of net purchases of Treasury securities and agency MBS proportionally in order to end both sets of purchases at the same time.”
“The staff provided an update on its assessments of the stability of the financial system and, on balance, characterized the financial vulnerabilities of the U.S. financial system as notable. The staff judged that asset valuation pressures were elevated. In particular, the forward price-to-earnings ratio for the S&P 500 index stood at the upper end of its historical distribution; high-yield corporate bond spreads tightened further and were near the low end of their historical range; and house prices continued to increase rapidly, leaving valuation measures stretched.”
The Fed’s Reverse Repurchase Repo program set another new high at $1.116 trillion. The increasing trend points to the large and growing amount of cash being held at banks and money market funds. These massive balances are a green light of sorts for the Fed to taper. The large amount of cash on the sidelines will help offset the Fed buying less.
Housing Starts were weaker than expectations at 1.534 million annualized versus 1.643 million last month. Higher input prices and a growing reluctance to buy homes are likely causing home builders to scale back. Building permits were up slightly to 1.635 million. Given the increasing supply of existing homes, higher home prices, and weakening consumer sentiment we might find that some builders will reconsider and delay using the permits to build.
Since February, the Russell 2000 (IWM), tracking small-cap stocks, is little changed. Over the same period, the S&P 500 has risen by over 20%. The smaller graph below shows the underperformance of small caps to the S&P via the IWM: S&P price ratio. Many small-cap companies are feeling the negative effects of higher prices and are not able to offset inflation with lower interest rates to the degree large-cap companies can. Stripping the S&P 500 of the FANMG stocks and a few other leaders would leave the S&P 500 looking a lot like the Russell Index. This serves as a reminder of Bob Farrell’s investment rule #7: Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
The graph below, courtesy of Goldman Sachs, shows the strong negative correlation between the price of gold to 10-year UST real rates. Recently, the correlation has failed. If the correlation regains its prior strength, the graph implies gold is underpriced by nearly $300, real rates are about to rise, or some combination of both. Real rates increase if Treasury yields rise and/or inflation expectations decline. We suspect it will be the latter.
August 17, 2021
Chairman Powell, speaking to educators today, had little to say about the future path of monetary policy. It looks like we will have to wait for next week’s Jackson Hole conference to see if he agrees with many Fed members that taper is in the cards for this fall. The following headline is the only clue he left us:
THE FED IS IN THE PROCESS OF PUTTING AWAY ALL OF ITS TOOLS THAT WERE BUILT FOR TRUE CRISES.
Retail Sales can be a misleading data point as it doesn’t account for inflation. For instance, if inflation was 5% and retail sales grew by 5%, 100% of the growth in retail sales is due to price increases, not more consumption of goods. The graph below takes the inflation component of sales to give us a clearer reading of true sales. Core retail sales exclude vehicle and vehicle parts, gas stations, and building materials. At a 3.4% annualized growth rate, real core retails sales are back to near pre-pandemic levels.
July Retail Sales came in at -1.1%, versus expectations of -0.2% and +0.7% last month. Excluding autos and gas retails sales fell by 0.7% versus expectations of a 0.3% decline. The weaker than expected data should not be a total surprise as BofA and JPM credit card spending tracking data has shown a decent drop-off in credit card usage.
Per Arbor Research, the University of Michigan’s Consumer Survey reported that buying conditions for durable goods, homes, and vehicles are at the lowest levels since 1980.
Economic data from China continues to come in weaker than expectations. China is the world’s second-largest economy and has been an important driver of global economic growth. While many developed economies continue to post outsized growth, China is flashing warning signals. This past weekend China reported the following:
Industrial Production 6.4% versus expectations of 7.8% and prior month 8.3% Chinese Retail Sales 8.5% versus expectations of 11.5% and prior month 12.1% Chinese Fixed Assets Investment excluding rural 10.3% versus Expectations of 11.3% and prior month 12.6%
The graph below serves as another reminder that valuations are at extreme levels. However, despite the graph below and many other valuation techniques at or near records, the market can get more expensive. Pay close attention to technical indicators to help navigate the current environment.
Sunday marked the 50th anniversary of the “Nixon Shock.” On August 15, 1971, President Nixon eliminated the convertibility of U.S. dollars to gold and thus removed the U.S. off of the gold standard. 5 years ago we wrote on Nixon’s decision and importantly the consequences in The Fifteenth of August. From the summary:
“Now, seven years after the end of the financial crisis and recession, these consequences are in plain sight. The Fed finds themselves crippled under an imprudent zero interest rate policy and unable to raise interest rates due to fear of stoking another crisis. Worse, other central banks, in a similar quest to keep prior debt serviceable and generate even more debt-induced economic growth, have pushed beyond the realm of reality into negative interest rates. In fact, an astonishing $10 trillion worth of sovereign bonds now trade with a negative yield.”
“With the August monthly options expiration on deck for this Friday, we may be looking for an options expiration “pin” near 4,500 as long as price remains near the current levels above the gamma flip.”
Retail Sales will be the important economic data point for the week. On Tuesday it is expected to show a 0.3% decline, yet despite the decline is still expected to be +11.5% versus last year. Given last Friday’s weak consumer confidence data, Retail Sales could surprise to the downside. Recent real-time credit card tracking data points to such a recent drop-off in consumer spending.
Fed Chair Powell will speak Tuesday afternoon. Many Fed members have been increasingly outspoken about the need to taper sooner rather than later. The market will pay close attention to see if his comments shift toward a more definitive time frame for tapering. The Fed’s annual Jackson Hole conference is at the end of next week, so this speech can provide a good chance to warn the markets of a coming change in stance. The Fed’s minutes from their prior meeting in late July will be released Wednesday afternoon.
August 13, 2021
Peter Atwater, a leading expert in market sentiment, provides us with his recent Financial Insyghts subscriber-only article discussing how diversification is not just a function of the correlation between various assets in a portfolio, but equally important, as Peter writes, “a variety of feelings associated with those assets.”
The University of Michigan Consumer Sentiment Survey plummeted from 81.2 to 70.2, the lowest level since 2011. Inflation expectations for 1 year forward were unchanged at 4.6%. It’s not clear whether consumers are suddenly concerned because of higher prices or the Delta variant. Either way, the report paints a grim picture for personal consumption which represents about 2/3rds of GDP. We will pay close attention to near-real-time credit card spending data and other consumer surveys to see how accurately Michigan’s survey is tracking reality.
From an investment perspective, the big question facing many companies is whether or not they can pass on higher prices to consumers. While each industry is different, the graph below shows retailers are more confident than anytime in the last 15+ years they will be able to raise prices and protect their profit margins.
The graphs and tables below break down the 153 components of inflation to provide a broader analysis of the recent July CPI data compared to June. At the headline level, monthly CPI fell to 0.5% from 0.9%. The average price of the 153 goods comprising CPI fell from 0.63% to 0.42%. However, the median price rose by 0.20% to 0.50%. Further, nearly 70% of the goods saw percentage price increases less than the CPI rate in June. In July that number fell to just under 50%. Also note, the average and median increases in the year-over-year changes rose significantly from June to July. The headline CPI number is supportive of those in the transitory inflation camp, but the underlying data is not as clear. Yesterday’s PPI data provides further concern that inflation may not have peaked yet.
The series of graphs below from Brett Freeze show the demand for money is weak. As we wrote in Inflation: Making the Complex Simple, “To correctly anticipate inflation, we must look beyond the supply and demand for goods and services. The truth lies in the supply and the demand for money. Unfortunately, the supply of money gets the headlines, while its demand is an afterthought.” Over the last few months, inflationists have been dwelling on the surge in the supply of money. They fail to notice that velocity, or the demand for money, both consumer and commercial, has been weakening and largely offsetting the supply. The year-over-year growth of the supply of money has been declining and will continue barring an unexpected increase in the amount of QE or more massive fiscal spending packages. Will the demand for money increase and offset the declining money supply growth?
August 12, 2021
As shown below Producer Prices (PPI) were stronger than expected. On a monthly basis, PPI and core PPI was the same as last month- +1.0%. The graph below shows PPI-commodities have been outpacing CPI since the recovery began. This is no doubt resulting in margin compression for many companies reliant on commodities to manufacture their final goods.
Yesterday Doug Kass shared a rant from his Real Money Pro subscription service on Twitter. He discusses the deleterious effects of excessive monetary and fiscal policy and joins the growing list of industry leaders imploring the Fed to stand down. We put his comments into the following link:
The Bloomberg graph below compares job openings from JOLTS and the NFIB small business survey. The NFIB confirms that there are plenty of jobs for the unemployed to fill. The question however is why are they not taking the jobs. Is it related to covid and related medical issues or are the generous unemployment benefits providing an incentive to stay at home? It might also be there are not enough qualified workers to fill the jobs? Either way, the situation is likely much more of a fiscal/legislative matter than one monetary policy can fix. This argues the Fed should commence tapering sooner rather than later.
As Nordea Bank shows, money supply growth is slowing which is resulting in a reduction of excess liquidity. The graph shows excess liquidity, with a 6 month lead time, has been well correlated with P/E ratios. If the correlation holds we should expect P/E compression in late 2021 and 2022.
August 11, 2021
Crude oil is trading 1.3% lower to $67.30 on a request from President Biden to OPEC. Per the WSJ- “The White House urged OPEC to boost oil production, saying recent planned increases are insufficient as countries around the world seek to emerge from the Covid-19 pandemic.”
After the last CPI report, we published “Just How Transitory is Inflation?” which provided a detailed analysis of what is driving the latest inflationary push. We showed how gasoline and used cars accounted for over half of the annual increase. In the latest report gasoline rose 2.4%, a tenth of a percent lower than last month. Used Car prices are finally cooling off. After rising 10.2% in June they only rose .2% in the July report. Other used car price indexes lead us to believe they will negatively contribute to CPI in next month’s report. It is important to note energy prices are delayed three months in the CPI report. Given the recent declines in crude and gasoline prices, we should expect energy to weigh less on CPI in upcoming reports. Of concern are rising rent and home prices as Shelter contributes almost 30% to the CPI index. The broad shelter category was up 0.4% last month versus 0.5% the prior month and is now up 2.8% on an annual basis. We expect an uptick in shelter prices following the end of the eviction moratoriums, but they should stabilize after that.
This report will help assuage inflationary fears as the largest contributors to inflation appear to be stabilizing or falling, as is the case with transportation services which are down 1.1% for the month, after rising by at least 1.5% in each of the last four months. We warn you, however, one month does not make a trend.
CPI came in slightly below expectations as shown below. The monthly inflation number was up 0.5%, the lowest increase since February and potentially a sign the inflationary surge in prices is abating. We will follow up with details later today as the BLS releases more underlying data.
Investor sentiment is showing signs of moderating as the timing of a Fed taper comes into question. Per Bloomberg, inflows into US buy-write funds of $1B in July were the most since 2012. Buy-write funds utilize an options trading strategy that profits most during periods with limited upside.
In the Bloomberg article linked above, Lu Wang wrote: “Call them cautious bulls — preparing for gloom, concerned about valuations, yet unwilling to completely bail. They’re hedging as growth slows and the Federal Reserve mulls rolling back monetary stimulus in a market that has gone nine months without a 5% pullback”.
The chart below from MKM Partners echoes the same tone. It shows bullish sentiment decreasing as the market recorded recent highs, a signpost of what MKM Partners describes as the “Reluctant Bull”.
“Risk-On” has been the mantra for the surge in the prices of risky assets since late March 2020. The graph below, courtesy of Nordea, shows an interesting divergence occurring between two “risk-on” favorites. The S&P continues to hit new highs yet junk bond yields are starting to rise (prices fall). Might junk bond investors be worried about the increasing odds of the Fed tapering, while stock investors brush it off?
August 10, 2021
What is full employment? The answer matters because the Fed warns they will taper when “significant progress” is made toward full employment. The Macrobond graph below, accompanied by the one we put out in yesterday’s commentary, argues we may be at or very close to full employment. In 2018 and 2019, when the Fed believed we were at full employment, there were more job openings than unemployed persons. With the recent round of JOLTS and employment data confirming a similar ratio, one may argue we are back to full employment despite the higher unemployment rate.
Mohamed El-Erian, former CIO at Pimco, wrote an editorial in the Washington Post imploring the Fed to end their “ultra-loose monetary policy” stance. The editorial follows Senator Manchin’s letter to the Fed in which he voices concern about their easy money policies and the hardships inflation can cause.
El-Erian’s article lays out five reasons the Fed’s overly aggressive policy might harm the economy over the next 12 months. They are as follows:
First, the Fed’s policy tools are ill-suited to address what is hampering the economy. The primary problem is widespread supply-side disruptions, from dislocated supply chains and higher input costs to transportation bottlenecks and difficulties in hiring workers.
Second, with both private and public demand already surging, the Fed’s policy stance risks fueling inflation.
Third, its continued massive intervention in markets has distorted the price signaling mechanism, encouraging all sorts of inefficient resource allocations that will eat away at the U.S. economy’s productivity and dynamism.
Fourth, the ample and predictable injection of cash into the system continues to encourage excessive risk-taking in financial markets while deepening the unhealthy conditioning among investors to always expect the Fed to boost asset prices.
Finally, the $40 billion of mortgages that the Fed insists on buying each month is contributing to a red-hot housing market that has been pricing out more and more Americans.
The chart below from Ned Davis Research compares the S&P 500 to a composite of three well-known market cycles: 1-year seasonal cycle, 4-year presidential cycle, and the 10-year decennial cycle. If the market follows these historical cycles, we should expect a weaker finish to the year. Note, the composite is in regards to trend and does not forecast the actual changes, ergo their note- “trend is more important than level.”
Per the headline below, Fed Governor Bostic affirmed what Chris Waller said last week in regards to employment and the timing of a potential taper. He also said he preferred a shorter taper period than prior episodes.
FED’S BOSTIC: THE FED COULD ACHIEVE ‘SUBSTANTIAL FURTHER PROGRESS’ ON EMPLOYMENT IF THERE ARE IS ANOTHER MONTH OR TWO OF STRONG JOBS GAINS
JOLTS data reported this morning shows there are now 10.07 million job openings a big jump from last month’s 9.3 million. The graph below puts the number of job openings and the number of jobs lost due to the pandemic in perspective. In April of 2020, the economy lost almost 20 million jobs. As of last Friday, it has regained about 14 million of those jobs and remains 6.5 million short. Job openings just eclipsed 10 million, meaning there are now 1.47 jobs per job loss since the pandemic. The Fed must be looking at this data and questioning if its monetary policy needs to stay uber aggressive.
Gold looks to open weak this morning but that is not even half the story. Last night, shortly after the futures markets opened, gold fell nearly $100. It bounced back quickly and has been slowly rising since. Silver also had a stunning decline and a huge recovery. It was down over 10% early last evening, yet is only down 1.5% this morning. Crude oil also had a rough night but not the same degree. Unlike the rebounding precious metals, it continues to leak lower. Crude oil now stands at $65.60 down nearly 4%.
Last week Fed Governor Waller said if the next two jobs reports come as strong as the June Report we can taper by September. Based on his opinion and last week’s strong July report, another good report on the first Friday in September may start the tapering process. With nearly 2 million new jobs added over the last two months, some Fed members are likely to join him this week in various speeches supporting the tapering QE.
All eyes this week will be on inflation data this week with CPI on Wednesday and PPI on Thursday. The current CPI expectation is for a small decline to 0.7% from 0.9% last month. Stronger than expected CPI and/or PPI data may further push Fed members to call for tapering QE. We will also keep an eye on JOLTs data on Monday for more evidence supporting strength in the labor market.
Joe Manchin, Democrat from West Virginia, wrote a letter to the Fed offering concern about their easy money policies and the hardships inflation can cause. Per the WSJ– “I am deeply concerned that the continuing stimulus put forth by the Fed, and proposal for additional fiscal stimulus, will lead to our economy overheating and to unavoidable inflation taxes that hard-working Americans cannot afford,” …. “He asked Mr. Powell and the Fed’s rate-setting committee “to immediately reassess our nation’s stance of monetary policy and begin to taper your emergency response immediately.”
We suspect other Congressional leaders, on both sides of the aisle, are harboring similar concerns. Given Powell’s term ends early next year and Congress must approve a new term, the pressure on Powell to reduce the pace of QE is mounting.
The BLS labor report was strong with the addition of 943k new jobs and a +88k revision to last month. The unemployment rate fell from 5.7% to 5.4%. Despite the strong growth, hourly earnings were unchanged from last month’s revised number as well as hours worked. It is worth noting that employment rose by 221k in local government education and 40k in private education. This is due to seasonal quirks due to the pandemic. Similar to the ADP report on Wednesday, leisure and hospitality were the main contributors adding 380k jobs, which also helps explain why wages are not increasing more. The initial reaction in the futures markets implies an inflationary bias with the Dow leading the way, S&P 500 flat, and the NASDAQ down. Bond yields are rising on the news. We suspect today’s report will spur further discussion about the Fed tapering as early as September or October.
In our article, Just How Transitory is Inflation, we showed which goods were largely responsible for driving CPI higher. While we acknowledge the difficulty of forecasting inflation in this environment, we came to the conclusion that most of the goods driving the recent price surge should fall in price in the coming months. To wit: “We think the current inflationary surge is temporary. When flexible prices, especially some of those mentioned, normalize, inflation is likely to follow suit.”
The graph below, courtesy of Arbor Research, provides some confidence for our expectations. It shows the prices of four key inflation contributors (two of which we detail in the article) and two pieces of inflation survey data finally appear to be peaking.
Apartment rent in metropolitan areas is increasing rapidly as workers return to cities, according to this report by the Wall Street Journal. Apartment List, a home search website, recently reported that median rent has risen over 10% in the last year. Camden Property Trust, a landlord in the Houston area, reported rent increases of 19% in July for new leases. A key factor contributing to rising rents is the state of the housing market as the economy reopens. Many individuals who would have otherwise purchased a home are being priced out of the market due to strong demand paired with lackluster supply, which is, in turn, bolstering demand for rentals. Investors appear to be exploiting this trend, as apartment REITs have outperformed the S&P 500 by almost 25% YTD.
August 5, 2021
As we noted in the Portfolio Trading Diary, Albermarle’s “GAAP EPS of $3.62 demolished the consensus estimate of $0.85.” The increasing demand for electric vehicles is driving lithium production and boosting ALB’s sales. If the chart below proves accurate, demand for lithium will continue to surge. ALB is the world’s largest lithium producer.
The graph below shows the historical correlation between the current ISM Manufacturing Prices index with 6 months forward S&P 500 returns and CPI changes. Currently, the ISM Prices index is at 85.7 and in the top decile, although slightly lower than last month. Based on the graph, stocks should be slightly lower over the next 6 months, and inflation running at 7.6% in March of 2022. Take this data with a grain of salt as the current supply/demand anomalies are unlike any of those in the past.
Initial Jobless Claims fell slightly to 385k this past week. The good news is new claims are down significantly from 800-900k at the beginning of the year. The bad news is they have been stuck at current levels for the last two months. As a comparison, the average weekly claims for 2019 were about 220k per week.
The new eviction moratorium extension will likely help keep a lid on core CPI through its expiration, as evidenced by the graph below from Andreas Steno Larsen. However, Primary & owners’ equivalent rent (OER/Rent), which makes up roughly 40% of core CPI, will likely push inflation readings higher when the moratorium is allowed to expire or if it is overturned by the Supreme Court.
On quite a few occasions we have talked about how the K-shaped recovery is benefitting wealthy individuals while other income classes are not benefitting to the same degree. As the Wall Street Journal writes in Heavyweight Companies Enjoy Outsize Rewards as Economy Rebounds, similar trends are occurring in the corporate world as well. The author provides a few examples of large companies thriving while smaller companies languish. We share the final paragraph, the story of a drone maker in Europe. Per the article: “Stefano Valentini, president of French manufacturer Drone Volt SA, said he is seeing strong demand for drones from large companies in Northern Europe and the U.S. in the wake of the pandemic, but little demand from Southern Europe, where small—and less capitalized—companies are the norm. For those companies, many of whom were slow to recover from the financial crisis, “Covid is the nail in the coffin,” he said.”
August 4, 2021
Fed Vice Chair Richard Clarida was nebulous in regard to his outlook for tapering QE. Per his speech today: “At our meeting last week, the Committee reviewed some considerations around how our asset purchases might be adjusted, including their pace and composition, once economic conditions warrant a change. Participants expect that the economy will continue to move toward our standard of “substantial further progress.” In coming meetings, the Committee will again assess the economy’s progress toward our goals. As we have said, we will provide advance notice before making any changes to our purchases.”
Fed Governor Bullard is following in Chris Waller’s steps saying the market is prepared for taper and does not expect a negative reaction when such an announcement is made. Further, he wants to move “earlier and faster on taper so the Fed could be in a better position to combat strong inflation.”
The ADP jobs report significantly missed expectations coming in at 330k versus expectations of 700k. Over the last year, ADP and this coming Friday’s BLS report have not had a great correlation. If the BLS report is similarly weak, recent talk of tapering QE as early as September may be pushed back toward the winter months. Of note in the ADP report, over a third of the net new jobs were in the leisure and hospitality industry which tend to be lower-paying. If the BLS shows a similar strong contribution, those jobs are likely to weigh on aggregate wages.
The graph below shows the two defensive sectors, staples (XLP) and utilities (XLU), are well correlated and both sitting at or near record highs. However, there is a noteworthy divergence occurring beneath the trading surface. 93% of the utility stocks in the ETF are above their respective 200 dma and that percentage has been steadily climbing for the last 2 months. Only 66% of staples stocks are above their respective 200 dma and the percentage has been steadily falling since May. The weakening breadth of XLP may result in relative weakness versus XLU, especially if inflation and inflation expectations remain high.
The stacked graphs on the left, courtesy of Arbor Research and the Daily Shot, show investors are clamoring for inflation insurance via the TIPs market. The top graph shows TIPs yields are trading at record low yields. The bottom graph shows TIPs have seen record inflows of cash while investment grade and Treasuries have seen large outflows. This helps explain why breakeven inflation rates have been rising. To recap, the yield on TIPs less the yield on a nominal Treasury equals the inflation break-even rate or rate where an investor is indifferent between either bond. As TIP yields fall more than UST yields, TIP investors are betting on more inflation. The third graph shows the growing divergence between 10-year TIPs and nominal bonds and the resulting rising breakeven rate.
August 3, 2021
The graph below, courtesy of Brett Freeze, shows the strong correlation of the ISM Manufacturing Survey with the year-over-year change in 10-year USTs. As we discussed yesterday, ISM remains at historically very high levels but is starting to decline. We expect it to decline further as fewer and fewer survey respondents will be able to continue to answer that manufacturing factors are again better in the current month than the prior month. If we are correct with ISM and the correlation holds up, a further decline in bond yields should be expected.
Yesterday we shared Fed’s Chris Waller’s hawkish stance on monetary policy. It is worth adding he has had a dovish stance similar to Powell up until that speech. While we doubt Powell will make such an abrupt turn in policy we will focus on Lael Brainard and Vice Chair Richard Clarida. Clarida speaks tomorrow. If he lays out similar goals and timelines as Waller, the speeches may be a coordinated trial balloon aimed at warning the market on the schedule of tapering QE.
Noah Smith, blogger and Bloomberg Opinion author, wrote a compelling article titled Why is China Smashing its Tech Industry. China has recently been punishing “tech” companies such as Alibaba, Ant Financial, Tencent, and Didi to name a few. At first blush, it may appear Chinese leadership harbors some of the same monopolistic concerns that are brewing in the United States. Noah thinks there is much more to the story. Per the article: “And so when China’s leaders look at what kind of technologies they want the country’s engineers and entrepreneurs to be spending their effort on, they probably don’t want them spending that effort on stuff that’s just for fun and convenience. They probably took a look at their consumer internet sector and decided that the link between that sector and geopolitical power had simply become too tenuous to keep throwing capital and high-skilled labor at it. And so, in classic CCP fashion, it was time to smash.”
Noah argues China is aiming for productivity growth, not profit growth, “fun, and convenience.” If true, China is playing the long macro-economic game which should greatly benefit their nation. While banning or even punishing ‘internet” companies is much less likely here, we should take notice of their desire for more productive growth.
August 2, 2021
Per the headlines below, Fed member Christopher Waller provided helpful guidance on the potential timing of tapering QE and what the Fed is looking for before tapering.
WALLER SAYS IF THE NEXT TWO JOBS REPORT COME IN AS STRONG AS THE LAST ONE, CAN TAPER BY SEPT; IF NOT, MAY NEED TO PUSH IT
WALLER SAYS ON TAPERING WE SHOULD BE EARLY, FAST, TO BE IN A POSITION TO RAISE RATES IN 2022 IF NEEDED
FED’S WALLER SAYS COULD MAKE AN ANNOUNCEMENT ON TAPER BY SEPT
I was in favor of tapering MBS first,” Waller says, adding, resignedly, that Chair Powell said in his press conference that it wasn’t an option.
The ISM Manufacturing Index fell to 59.5 versus expectations of 60.9 and last month’s 60.6 reading. Importantly, the prices paid sub-component fell to 85.7 from 92.1. Also of note, supplier delivery times fell 2.6 points. While early, it may mean supply line bottlenecks are easing. Employment rose to 52.9 versus 49.9. Employment is now in expansion mode as it’s above 50.
Fed President Lael Brainard indicates that the coming Jackson Hole meeting may lack any new indications about when the tapering of QE may begin. Per Lael; “I expect to be more confident in assessing the rate of progress once we have data in hand for September, when consumption, school, and work patterns should be settling into a post-pandemic normal.” She is an important voice at the Fed and is rumored to be in the running for the Chair job if Biden does not reappoint Jerome Powell for a new term.
The economic focus this week will be on the job market and the manufacturing sectors. The ISM manufacturing survey will be released this morning and the ISM services survey on Wednesday. We will keep a close eye on the inflation/prices and employment sub-components of the surveys. Wednesday will feature the ADP labor report followed on Friday by the all-important BLS jobs report. The consensus BLS forecast is for a gain of 900k jobs, following last month’s 850k.
Earnings reports will continue, but the pace should slow markedly versus last week. We expect a slew of Fed speakers this week further clarifying their individual thoughts around the economy, inflation, employment, and most important monetary policy. We will also be looking out for any possible policy changes announced at the late August Jackson Hole Fed meeting.
The excess savings racked up by Americans from trillions in stimulus payments is quickly waning. The chart below from Zero Hedge illustrates the effect of stimulus payments on personal savings over the past year and a half. Excess savings from the last round of stimulus is falling rather quickly, and as Zero Hedge notes, “… at the current rate that Americans are burning through savings, this means that the entire fiscal stimulus tailwind from Biden’s trillions will be gone by August… just in time for emergency unemployment benefits to end”. The upcoming fiscal cliff bears substantial risks to markets, especially as we move past the point of peak economic growth in this recovery.
The Chicago PMI surprised to the upside for July. It came in at 73.4 compared to expectations of 66.1 and a June reading of 66.1. The survey results suggest that, in July, business conditions improved more than expected in the Chicago area.
Personal income and outlays data were stronger than expected in June. Personal income increased 0.1% compared to a consensus estimate of -0.7%. Personal consumption expenditures increased 1% in June versus expectations of 0.6%.
The PCE price index increased 0.5% MoM (0.6% expected) and 4.0% YoY (4.1% expected). The core PCE price index, the Fed’s preferred measure of inflation, rose 0.4% MoM (0.5% expected) and 3.5% YoY (3.7% expected).
The toughest part of forecasting inflation is trying to properly assess the supply line problems and labor shortages. Wells Fargo put out a handy table recently, shown below, which tracks price pressures due to supply, inventory, shipping, and labor problems. Per Wells Fargo: “It suggests that bottlenecks are not yet easing in any widespread fashion, let alone close to being fully resolved”. The conclusions reached by Wells Fargo align with the reasons for missed expectations we saw in the second quarter GDP report yesterday.
Next week begins the weakest two months of the year for the markets, as shown below. While the graph below points to weakness, there have been plenty of prior Augusts and September’s that have produced positive returns.
July 29, 2021
NKLA founder, Trevor Milton, was charged with fraud this morning regarding lies to investors about breakthroughs and prototype vehicles. NKLA went public via SPAC in June 2020, thus Milton was not bound by the usual post-IPO restriction period on communication with investors. He quickly took to social media with the apparent intention of pumping the stock. According to MarketWatch:
“Prosecutors said in the initial period following Nikola starting to trade publicly, the value of Milton’s shares shot up by $7 billion”.
It doesn’t stop there.
“Prosecutors said that, in fact, the prototypes that had been unveiled didn’t function and were Frankenstein monsters cobbled together from parts from other vehicles. At public events, the vehicles were towed into position and were powered by plugs leading from hidden wall sockets”.
Milton has posted bail and proclaims his innocence. NKLA stock has sold off roughly 65% from its June 2020 highs.
Robinhood completed its IPO today and is trading under the ticker symbol HOOD. The stock opened in line with the IPO price at $38 per share after the indicated open fell from a high of $42 this morning. Based on the IPO price, HOOD is being valued at $32B.
Update: HOOD finished the day at $34.71 after retreating 8.7% from its open price. .
US GDP (initial) grew 6.5% in the second quarter versus expectations of 8%. This compares to first quarter GDP growth of 6.3%. PCE was above expectations at 11.8% versus the consensus of 11.4%. A key factor in the GDP miss was the decline in inventories, which highlights the supply-chain problems the economy is facing have yet to abate.
Initial jobless claims fell by 24k to 400k this week, slightly higher than expectations of 390k. Although weekly claims are falling, they remain elevated compared to levels you might expect to see in an improving economy.
The first estimate of second quarter GDP will be released this morning at 7:30 CT. This chart from The Daily Shot shows that economists’ estimates of GDP growth have been moderating in recent weeks.
The graph below charts the MBA’s mortgage purchase applications. These are the number of applications for mortgages, not the refinancing of existing mortgages. As shown, the number of applications has been steadily declining and now sits at pre-pandemic levels. The housing market is increasingly showing signs of normalizing. It is quite possible home prices will follow suit and begin to stabilize and possibly decline over the next few months.
The graph below, courtesy of Nautilus Investment Research, shows the current bull market rally, starting March 2020, is getting into rarefied territory. The market has gone 337 days without a 10% retracement. Of the 135 instances in the study, only ten bull market runs have been longer in duration, and of those, only two have gone up a higher percentage.
July 28, 2021
Changes to the FOMC statement are highlighted below. While most of the changes are inconsequential, they added the following to the section which discusses QE: ” Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings.”
We think this new statement, and its deliberate placement in the section describing asset purchases is a reminder they are closing in on their goals and a signal to the market to prepare for the tapering of QE and ultimately higher interest rates.
The Financial Times (LINK) put yesterday’s earnings from Google, Microsoft, and Apple into perspective.
“The three US tech groups brought in combined after-tax profits of almost $5bn a week during the latest quarter. At $56.8bn, the total was almost double the year before and 30 percent more than Wall Street had predicted. The figures were “absolutely stunning”, said Jim Tierney, a portfolio manager at AllianceBernstein, adding that “digital advertising is just on fire”, as advertisers race to follow audiences who have turned to online services in huge numbers.”
Since today is Fed day we thought we would share a quote about monetary policy from Jim Grant: “Persisting with the easiest policy in memory in the teeth of the fiercest inflation in a generation, the Fed reminds us of a diamond-handed Reddit bro pushing his last chips on to AMC Entertainment. He’d better not be wrong.”
Have trucking costs finally peaked? If the recent rise, as shown below courtesy of Arbor Research, is forming a peak, another factor pushing inflation higher may be abating. This would be welcome news for Amazon and other e-tailers.
The graph below compares the S&P 500 to the Shanghai Composite. As shown, the broad Chinese market did not perform nearly as badly as the S&P 500 during the early days of the pandemic but has since grossly underperformed the S&P. It is essentially flat over the last year. The tepid performance of their stock market along with signs China’s economic activity is slowing sends macro warning signs to the world. China has the second-largest GDP in the world and has been growing at twice the rate of most developed nations. Simply, Chinese economic activity contributes significantly to global GDP growth. We are also keeping an eye on the Chinese yuan for signs they devalue it versus the dollar to stimulate export growth.
July 27, 2021
Thinking of buying today’s dip? If so, you may be proven correct in a record short period of time as shown below.
Consumer Confidence rose to 129.1 versus 127.3 last month. Both the present and future indexes were up versus last month. Interestingly, inflation expectations are showing signs of stabilizing. The report shows 1-year inflation expectations at 6.6% versus 6.7% last month.
The Case-Shiller Home Price Index rose 1.8% monthly and 17% on a year-over-year basis. The data is for May so it will be interesting to see if the gains continue next month amidst poor home buyer sentiment and the very weak new home data released yesterday.
The table below shows the clear outperformance by sector, style, and factors of large-cap stocks versus mid and small caps.
The graphs below tell the story of the growth/cyclical rotations of the past 7 months. The graph on the left is the ratio of the equal-weighted S&P 500 (RSP) versus the weighted S&P 500 (SPY). When RSP outperforms SPY, the ratio increases and vice versa. RSP has a much higher percentage of cyclical stocks, including- value, energy, financials, and materials. The S&P 500 is heavily weighted with technology and growth-oriented stocks. The graphs on the right compare the correlation of the RSP/SPY ratio to the NASDAQ, S&P, and ten-year UST yields. With Tech and the S&P 500 recently outperforming RSP, the correlations versus the QQQ and SPY are strongly negative. Conversely, the correlation to yields is currently strong, meaning yields are falling as RSP underperforms. Simply, the market is rotating fiercely, and it is important to be on the right side if you want to keep up with the market. Currently, the growth rotation is in vogue.
Yesterday we wrote that 10 year real yields hit a new all-time low. The graphs below show that the price of gold and real yields have been well correlated over the last decade. In particular, the scatter plot on the right, shows a statistically significant correlation with an R squared of .82 between gold and real yields. The red square shows the current instance and the arrows direct your eyes to where a reversion to the mean would bring gold or real yields. Per the graph, either gold is underpriced by about $200 or real yields should increase to about -0.60% from -1.20%.
There are a lot of companies in our equity model reporting earnings today as shown below.
AAPL – After Close
GOOG – After Close
MSFT – After Close
RTX – Before Open
SBUX – After Close
UPS – Before Open
V – After Close
July 26, 2021
Since its recent lows in March, the NASDAQ has risen over 20%. At the same time, the volume of NASDAQ stocks trading higher each day is deteriorating. The graph below shows the 10 day moving average of up volume and the NASDAQ. This is another bad breadth indicator showing fewer stocks are leading the charge higher.
New Home Sales fell sharply from last month and were below expectations. June sales were down -6.6% versus an estimate of +3.7%. This marks the third straight monthly decline. New home sales are now down 20% year over year, at the lowest levels in a decade. The median price of new homes fell from $380,700 to $361,800. The supply of new homes is back to pre-pandemic levels.