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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.

 Home Equity

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

Jobs Aplenty

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.

Market Rebound Continues

What is Volatility Telling Us?

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?

Time For Value?

The Communications Sector (XLC) is Struggling

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 To Buy If Santa Comes to Town – New Weekly Report

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.

Technical Value Scorecard

More Risk and Reward When Volatility is Elevated

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.

Stranded Containerships

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.

Cartography Corner

Do you Feel Lucky?

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.

Is There More Selling To Be Done?

Is TLT Ready to Run?

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.

Is the Sell-Off Over?

Have Oil Prices and Energy Stocks Bottomed?

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.

End In Sight?

Powell is Warning About Omicron

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 Rollercoaster

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.

Omicron Variant Shakes Wall Street

What’s Wrong with Foreign Stocks?

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.

Gamma Band Update

The Week Ahead

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.

Technical Value Scorecard

B.1.1.529 Variant is Roiling Markets

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.

November 23, 2021

Is A Jerome Powell Second Term A Bad Thing For Markets?

The War on Oil Prices

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.

Is There Any Upside Left?

Powell Renominated

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.

Gamma Band Update

Leverage At The Largest Pension Fund

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.”

Leverage Galore

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.

Faster Taper

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.

Technical Value Scorecard

Buybacks > Investments

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%.

Are We Due For A Santa Claus Rally?

Stocks are Expensive

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.”

Stocks or Bonds?

 

7% Risk-free Yields

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.

Trading The Bull

Bitcoin Correction or Just an Average Move?

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.

Options Expire

Gamma Band Update

A Shortage of Turkeys – RIA Pro PSA

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.

Technical Value Scorecard

Buybacks Gone Bad

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.

Will Markets Further Correct?

CPI En Fuego

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.

PPI

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- Inflation

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.

Fear Gauge is Up- Should You Resize Your Portfolio?

Small Businesses Are Not Very Optimistic

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.

18 Days?

Gamma Band Update

Earnings Growth Fading

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.

November 6, 2021

Trading Desk Notes for November 6, 2021 – by Victor Adair

November 5, 2021

Duke Energy (DUK) Earnings

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.

Trading COVID

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.

Technical Value Scorecard

Record-Setting Streak

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.

November 4, 2021

Albemarle Corp (ALB) Earnings

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.

After the Fed’s Announcement, What The Fed is Thinking

Options Fever

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 Health (CVS) Earnings

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.

Speculation Returns

ADP Jobs

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.

Public Storage (PSA) Earnings

PSA reported 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.

Market Winners and Losers

Another Feat for the Bull Market

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.

Bullish Bears

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.

Cartography Corner

Three Minutes on Markets & Money is Back!!

Markets Continue To Rally, Despite Weak Internals

The Yield Curve is Inverting

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.

Gamma Band Update

The Week Ahead

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.

October 30, 2021

Trading Desk Notes for October 30, 2021 – The Trading Desk Notes by Victor Adair

October 29, 2021

NFT Mania

The Non-Fungible Token (NFT) market continues to amaze. Crypto Punks, shown below, sold for $532,414,877.01. It is also now for sale at $1.11 billion.

AbbVie (ABBV) Earnings

ABBV reported 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.

Exxon Mobil (XOM) Earnings

XOM reported 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.

Technical Value Scorecard

The BOC Shocks the Market

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.

GDP

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.

More Tesla

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.

Gamma Band Update

The Week Ahead

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.

October 22, 2021

Trading Desk Notes for October 23, 2021 – The Trading Desk Notes by Victor Adair


Jerome Powell

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.

Technical Value Scorecard

Credit Card Spending Compensating For Inflation

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.

Powell Speaks

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.

Philly Fed

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.

Third Quarter Earnings Pageant Continues

$BITO is Not Perfect

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.

Why Stocks and Bonds Do Not Agree

Paltry Growth Forecast

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.

Industrial Production

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

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.

Stocks to Watch as the Earnings Parade Continues

The Crash of 1987

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

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

Will Higher Oil Prices Become The Norm?

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

Per the article:

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

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

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

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

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

Labor Market

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

October 18, 2021

Top 10-Buys and Sells From TPA Research

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 


Gamma Band Update

China Economic Growth is Slowing Rapidly

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

Will You Trade The First Bitcoin ETF?

Bond Market Warning

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.

Vacant Offices

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

October 15, 2021

Trading Desk Notes for October 16, 2021 – The Trading Desk Notes by Victor Adair

Goldman Sachs Earnings

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.

Technical Value Scorecard

Cleveland Fed Trimmed Mean Inflation

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

EPS and Returns

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

October 14, 2021

Economic Data

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.

Markets Sustain Key Support, as Banks Soldier On

$15 Billion is the Benchmark

The latest Fed minutes show that tapering of QE purchases is likely to begin in November. It appears they will reduce purchases by $15 billion a month which should eliminate this round of QE by July 2022. $15 billion now serves as a benchmark. Any changes to that amount will help us gauge if they are becoming more aggressive or conservative. 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.”

#FedGrammarMatters

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 Earnings

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.

Will The Fed Taper Sooner and Harder?

CPI Hotter than Expected

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

JOLTs

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

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

Can Markets Maintain Support?

Is The 50DMA Trying To Tell Us Something?

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

Used Car Prices En Fuego

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

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

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%.

Gamma Band Update

The Real Impact of $80 Oil

A Big Week Ahead

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

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

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

Dividends over Oil Production

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

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

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

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

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

 

October 9, 2021

The Real Investment Report: Is The Great “Bear Market” Of 2021 Finally Over?

Technical Gauge remains oversold

Fear / Greed Index remains in the neutral zone.

Risk/Reward Measures show Energy and Financials stretched.

October 8, 2021

Payrolls Report

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

Technical Value Scorecard

The Danger of Fighting the “Last War”

Bill Dudley, President of the New York Fed from 2009 to 2018, in a Bloomberg editorial, voices concern the Fed is too worried about deflation, or as he says, the “last war.”  He argues the Fed should be concerned inflationary pressures are more than transitory. He prefers the Fed take on a more hawkish tack sooner rather than later. Per Dudley: “This dovishness increases the risk of a major policy error. If the economic outlook evolves in unexpected ways, Fed officials will almost certainly be slow to respond…” “Hence, if inflation proves more persistent than anticipated and even accelerates as the economy pushes beyond full employment, they’ll have to tighten much more aggressively than they expect.”  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.

Jobless Claims

Following yesterday’s strong ADP report, the labor market showed more improvement.  Weekly Initial Jobless Claims fell back toward a post-covid low of 326K. This was below expectations of 348k and well below last week’s 364k.

Market Rise On Debt Ceiling Increase

St. Louis Fed Expects an Ugly Jobs Report While JPM is Optimistic

Per Market News (MNI), the St. Louis Federal Reserve expects to see an 818k decline in tomorrow’s BLS payrolls report. St. Louis Fed economist Max Dvorkin states: “There’s still “a lot of uncertainty around these figures,” but the model has tracked actual CPS employment “quite well” through the summer, he said.” He blames the recent uptick in Covid cases and the impact on global supply lines. The current forecast is for a gain of 410k jobs. If the Fed’s forecast is proven correct the Fed might delay what appears to be a tapering announcement in early November.

On the other hand, JP Morgan is optimistic “we are looking for a 575,000 gain in jobs and a drop in the US unemployment rate to 5%. The driver for an above-consensus forecast is the expected rebound in the leisure and hospitality sectors.”

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.

Markets Rocky Start to Q4

Atlanta Fed GDPNow Tumbles, Again

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.

Can Markets Rally Post Manic Monday?

Perspective

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.

Gamma Matters

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

Market  Update

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.

Gamma Band Update

Will The 50DMA Hold For a 12th Time?

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.

Where The Buys Are

Week Ahead

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.

October 1, 2021

Trading Desk Notes for October 2, 2021 – The Trading Desk Notes by Victor Adair

Atlanta Fed GDPNow

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.”

Daily Market Commentary

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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!

Cartography Corner

Technical Value Scorecard

Global Monetary Tightening is Beginning

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.

Lost Productivity

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.

How to Play the Dodging Debt Game

Claims on the Rise

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.

Dollar Breakout?

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.

Rates Spike and Stocks Decline

Is Powell On His Way Out?

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.

How To Spot Bond Buying Opportunities

Ford on a Roll

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.

Gamma Band Update

Is Resistance Futile?

Higher Fuel Prices are a Vote Killer

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.

September 25, 2021

Trading Desk Notes for September 25, 2021 – by Victor Adair

September 24, 2021

New Home Sales

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?

Technical Value Scorecard

Costco Earnings

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.

Fed Speakers

Starting today and through next week, Fed members will make their thoughts known through a plethora of speaking engagements.

September 23, 2021

PMI

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.

Is Now the Time to Buy Stocks?

Fed Rate Projections

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.

June

September

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.

FOMC Pre-Taper Market Review

Adobe Q3 Earnings

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.

 

September 21, 2021

Follow Up to Monday Market Mayhem

Easy Lending Standards

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.”

September 20, 2021

Gamma Band Update

There is Much More To The Evergrande Story

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.

Top 10-Buys and Sells From TPA Research

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 


What To Do With Markets In Turmoil

Market Support

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.

September 18, 2021

Trading Desk Notes for September 18, 2021 – The Trading Desk Notes by Victor Adair

September 17, 2021

University of Michigan Survey

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.

Three Hot Stocks We Are Watching

Evergrande is Sinking

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.

Michael Pettis (China Property Slowdown Deepens as Evergrande Hurts Outlook) provides great coverage on the problems in China’s property markets driving Evergrande’s potential default.

Rising Labor Costs

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.

Can “Buy The Dippers” Drive Markets Higher?

Praseodymium and Neodymium Prices are Soaring

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.

Peaking Delta?

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

Median CPI

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.

9 out of 10 Bears Say Market Correction Coming

CPI Review

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.

Market Drawdowns

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.

Gamma Band Update

Markets In Turmoil

Bracing for CPI

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.

Rental Inflation

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.”

September 11, 2021

Trading Desk Notes By Victor Adair – Week Of September 11, 2021

September 10, 2021

Sour Apple

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.

PPI

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.

Technical Value Scorecard

Dow Theory

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.”

Cleveland: “Staff levels increased modestly amid intense labor shortages.”

Richmond: “many firms faced shortages and higher costs for both labor and non-labor inputs.”

Atlanta: “wage pressures became more widespread.”

Chicago: “Wages and prices increased strongly while financial conditions slightly improved”

St. Louis: “Contacts continued to report that labor and material shortages.”

Minneapolis: “hiring demand continued to outstrip labor response by a wide margin.”

Kansas City: “Wages grew at a robust pace, but labor shortages persist.”

Dallas: “Wage and price growth remained elevated amid widespread labor and supply chain shortages.”

San Francisco: “Hiring activity intensified further, as did upward pressures on wages and inflation.”

How To Prepare For A Market Correction

Jobless Claims Continue to Fall

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.

Inflation Expectations

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

Strong Auction

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.

Rule #5

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.

The Problem With El Salvador’s Bitcoin

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.”

Markets Continuous Climb

Bond Yields Opening Higher

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.

Gamma Band Update

Unloved Bonds

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.

Week Ahead

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.

September 3, 2021

Victor Adair’s Trading Desk Notes For – September 3rd.

Employment In Perspective

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.

Technical Value Scorecard

Will the mid-month VIX pattern hold yet again?

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.

Deteriorating Optimism

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.

Stocks On The Move

Natural Gas In Deficit

Commodity investors Goehring & Rozencwajg share their research on natural gas. Per North American Gas Markets Now in Deficit:

  • “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.

Valuation Re-examined

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).

Cartography Corner

Major Market Review

A Weak Precursor to Friday’s Employment Report

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.

TIPS

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

Plunging Confidence

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

More Divergence

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:

  • Pent-up demand is fading quickly
  • Inflation concerns are dampening consumption
  • Stimulus is running out quickly.
  • Weakening consumer confidence

First Signs of Market Correction

Gamma Band Update

Earnings Yield Warning

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

Ambiguity

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.

PCE

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.

Technical Value Scorecard

Continuing Supply Line Problems

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.

Taper Temptation or Low Liquidity

Jackson Hole Appetizer

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

Fading Delta

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.

Return of Meme Stocks

Biden’s Approval Rating

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?

Which ‘Flation?

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.

2000 Redux

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.

Richmond Fed

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.

Pfizer Jabs Markets

Tis the Season of Volatility

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.

IPO Frenzy

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.


Gamma Band Update


Investors Buy Market Dip


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.

August 21, 2021

Trading Desk Notes for August 21, 2021 –  by Victor Adair


August 20, 2021

Technical Value Scorecard


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.


Market Shock From Taper Talk


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.


Hot Stocks We’re Watching


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.


Risky Business


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.

August 16, 2021

Is Kabul the Catalyst for Markets to Fall?


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.”

Gamma Band Update

“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.

Financial Insyghts – Confidence Diversification


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.


Technical Value Scorecard


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.


Why Markets Aren’t Making Progress


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:

Doug Kass – Is It All A Ponzi?


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.


Market Sector Winners and Losers


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.


Markets Are Primed for Correction


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.”

August 9, 2021

Top 10-Buys and Sells From TPA Research

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 


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.


Gamma Band Update


What’s Wrong With Gold?


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.

August 6, 2021

Victor Adair’s Trading Desk Notes – August 7, 2021


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.


Technical Value Scorecard


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.


Why You Should Watch These Stocks Today


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.”


What Happens After The Bounce?


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.


Why The Fed Is In A Box


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.


Why August Holds Danger for Investors


Gamma Band Update


Cartography Corner is published


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.

July 30, 2021

Victor Adair’s Trading Desk Notes: July 30th, 2021


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).


Technical Value Scorecard is published


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. .


Why Q2 Earnings Matter


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 Dichotomy of the Indexes


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.


Market’s Minsky Moment


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.


How Long Will The Rally Last?


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.


Gamma Band Update is published


10 year real yields are now trading at an all-time low as shown below in the Bloomberg graph. The real yield is calculated by subtracting the 10 year UST yield from the rate of expected inflation over the next ten years. At a real yield of negative 1.12%, investors will need to see the 10-year UST yield fall by about 15 bps. to approximately 1.10% to earn a 0% real return due to the gain in the price on the bond. This condition, in part, helps explain why investors are willing to pay outlandish valuations for equities despite poor expected returns.


There is a lot of information for the markets to digest this week. For starters, the Fed meets on Tuesday and Wednesday, followed by the updated policy statement and Jerome Powell’s press conference. We suspect there will be few changes to their current policy stance or economic outlook. However, we will not rule out a shift of QE from mortgages to U.S. Treasuries. The other thing to be on the lookout for is any hint at policy changes they might announce at the late August Jackson Hole conference. They have made big some big announcements in previous conferences.

More housing data comes this week with new home sales today, the Case Shiller Home Price Index tomorrow, and pending home sales data on Thursday. Personal income and spending and the monthly PCE price index will be released on Friday along with the Chicago PMI report.

Earnings will be lively this week with many S&P 500 companies reporting as shown below.

July 24, 2021

Victor Adair’s Trading Desk Notes For July 24, 2021

July 23, 2021

Despite most equity markets, foreign and domestic, rallying over the past few days, emerging markets remain the odd man out. As shown below, the popular emerging markets ETF, EEM, is touching its 200 dma today. The index is down 1.75% at noon today, while the S&P and developed foreign markets (EFA) are up .75%. Many emerging markets are heavily concentrated in commodity production. The second graph below shows similar weakness in the commodity-centric energy and materials sectors as compared to the S&P 500.


Rental prices have been rising as of late, which is leading to concerns that CPI will stay elevated as higher rent prices offset stabilizing and declining prices of goods that already had marked inflation. Rent constitutes about 7% of the CPI Index.

Zillow, in a report published earlier this week, had the following to say about rental prices: “Rent growth maintained widespread momentum in June, with the Zillow Observed Rent Index (ZORI) up 1.8% month over month, pushing typical U.S. rents to $1,799/month in June. A strong recovery in the rental market over the past few months pushed year-over-year rent growth up 7.1% — the largest annual increase in the series’ history reaching back to 2015. Even discounting a weakened market last year, rents have risen 5.1% since March, the fastest quarterly growth in Zillow’s data.”


Technical Value Scorecard


Yesterday the National Association of Realtors (NAR) released data on home sales and prices for June. Per NAR: “The median existing-home price for all housing types in June was $363,300, up 23.4% from June 2020 ($294,400), as every region recorded price jumps.” The graph below, courtesy Lohman Econometrics, helps break down the sharp rise in house prices and the results are stunning. The more expensive houses rose much more in price than lower-priced houses. While lower prices for starter homes may be good for first-time buyers, which did account for almost a third of June’s home sales, the beneficial wealth effect is clearly going to those with large real estate investments and in many cases above-average levels of wealth.

 

July 22, 2021

This morning, Lance and Michael discussed the recent PBS Frontline episode, The Power of the Fed, and shared 10 important clips from the video. If you haven’t watched the video, today’s Real Investment Show podcast provides a nice summary of the show and important commentary expanding on thoughts aired by industry leaders and ex-Fed members.


Per Bloomberg: *POWELL HAS BROAD SUPPORT AMONG TOP BIDEN AIDES FOR NEW FED TERM.

His term expires early next year. A continuation of his term will likely be perceived as market-friendly as investors have green accustomed to his easy money policies and might fret about a potential change in policy if someone else were to take the position.


Economic data was a little weaker than expected this morning. The Chicago Fed National Activity Index which measures 85 economic data points fell to 0.09 from 0.29. A zero value denotes the economy is growing at its historical growth trend. Their inflation measure now points to subdued inflation after rising above their threshold for “sustained increasing inflation” last month. This data set has been volatile for the last 6 months, so take today’s release with a grain of salt.

Jobless Claims which had been trending lower popped up to 419k from 360k last week. Non-seasonally adjusted Claims have now risen for 3 weeks in a row.


Hedging The Risk Of Deeper Declines


Why The World is Short of Computer Chips, and Why it Matters– Bloomberg

Bloomberg’s article linked above does an excellent job explaining why there are shortages of so many products that rely on semiconductors, aka chips. The article discusses the factors behind the shortage, who is most affected, and importantly from an investment view, a long discussion of chip manufacturers, the industry, and what the future holds for chip production. The graph below, from the article, shows time from ordering a chip to delivery is about 50% longer than it was before the pandemic.


Per Bloomberg: of the Q2 earnings reported thus far, 85% have beat expectations as compared to the average of 71%. It is important to note that only 10% of S&P 500 companies have reported of which many are banks. Banks had a profit boost last quarter as many banks lowered their loss reserves. 87% of the companies which reported earnings mentioned “inflation” in their earnings commentary.

July 21, 2021

Per Ned Davis Research, individual investors own more stock as a percentage of their assets than at any other time in the last 70 years. We remind you of one of Bob Farrell’s 10 investment rules: “The public buys the most at the top and the least at the bottom.”


Where is the Most Risk?


The price to sales ratio (P/S) of the S&P 500 is now double that of global equity markets. It’s important to note a couple of things. First, the composition of the S&P 500 is more tech-laden than global equity indexes. Given the higher growth rates of tech companies, investors are often willing to pay higher valuations for the S&P 500. That said, the S&P P/S ratio has well surpassed the all-time highs of the late 1990s while the global index is sitting at its highs. The takeaway: The ratio of the P/S ratio for the U.S. versus the world appears extended even considering compositional differences.

For more context of U.S. valuations versus the rest of the world, we present a comparison of CAPE (10) ratios by country/region.


Yesterday we showed how the price of crude oil was sitting on important support and being closely followed by the bond markets because of the strong correlation between crude oil and CPI. The two graphs below help further highlight the important correlation. The first scatter plot shows the relatively strong relationship between the year-over-year change in CPI and Crude oil. The second chart shows the annual changes but in a different format. Important in the second chart, the year-over-year price in crude has fallen sharply recently. Will CPI follow? If the price of crude oil stays around $75, the red line should flatten out near current levels until November at which point it will fall.

July 20, 2021

The graph below shows the decent correlation between rising inflation expectations and the S&P 500. Both measures of inflation expectations have stopped increasing and are gradually declining. It appears the equity markets might just be noticing.


Market Correction: More to Come


As shown below, the price of crude oil fell to critical support yesterday. At this point, its risk and reward are fairly even. If it bounces from the recent support line and the longer support line from May 2020, it may go test $75, the prior high. A break of the two support lines may result in a test of the 200 dma at $56. The bond market is likely paying close attention to crude prices as it has a high correlation with CPI.


Gamma Band Update is published.   We apologize for the delay.


The graph below, courtesy of the Daily Shot, shows housing inventory is finally rebounding and back to levels last seen in 2019. The combination of higher prices and more inventory should quell further large increases in house prices. Will it be enough to push them lower?


The chart below, courtesy Lohman Econometrics, shows margin debt has only been more than 2 standard deviations above its trend two other times since 1997, before the current instance. As shown, the reversal back to and below trend in those two instances was accompanied by a 50%+ decline in the S&P 500.


The graph below, courtesy of Brett Freeze, shows the correlation between real earnings yield and future returns. The earnings yield is the opposite of P/E, or earnings divided by price. Real earnings yield subtracts the current inflation rate from the yield. As he shows, at current real earnings yields, we should expect a one-year forward return of close to -20%. The R-squared is strong at .50, but there is significant variance around the trend line.

July 19, 2021

The graph below shows Bitcoin (BTC) is sitting on key support at 30,000. BTC has been a good barometer of the risk trade in equities, so the support line may be of importance for not just crypto investors.


Today’s equity sell-off and big decline in bond yields are being blamed on OPEC for increasing supply and the spreading of the Delta Variant. In regards to oil, lower oil prices are beneficial for bonds as it lowers the inflation rate. Lower yields and oil prices are also good for the economy, which should help stocks. Of note, the major airlines are down between three and five percent thus far today, despite being a beneficiary of lower oil prices. The decline is likely growing concern over new restrictions due to the Delta variant. The good news is that, thus far, hospitalizations and fatalities are not following the number of new cases related to the variant.


Markets Test 50-DMA


Crude oil is trading nearly 3% lower and below $70/barrel this morning as OPEC agreed to boost supply by 400k barrels a day each month starting August. The monthly increases will continue until the output is back to pre-pandemic levels. Equally important for OPEC, Per Bloomberg: “It also puts an end to a diplomatic spat that unnerved traders, as the fight between the two long-time allies (Saudi Arabia and UAE) risked unraveling the broader accord between the Organization of Petroleum Exporting Countries and its allies that has underpinned the recovery in crude prices.”


Housing data takes center stage this week. Today, the NAHB Housing Market Index will be released, followed by housing starts and permits on Tuesday, and existing home sales on Thursday. New home sales will come next Monday.

There will be a limited number of Fed speakers this week as they enter their blackout period before next week’s FOMC meeting.

There are a slew of earnings reports this week as shown below.


The following article by Lacy Hunt at Hoisington (LINK) is a little heady but well worth a read. The simple takeaway is fiscal stimulus will help boost aggregate demand and GDP today but reduces it below where it would have been tomorrow. From his summary- “More debt does not cure a subpar economy mired in a debt trap.”


Last week we discussed the prominent role used car prices played in the CPI report. We follow up with the graph below courtesy of BofA which helps explain the supply/demand mismatch driving new car prices higher. With so few new cars being produced there are fewer trade-ins which, in turn, reduces the availability of used cars.

July 16, 2021

Victor Adair’s Trading Desk Notes For July 17th

The University of Michigan consumer confidence survey declined from last month. The index fell to 80.8 from 85.5. It appears inflation is playing a role in eroding confidence. Inflation expectations rose sharply from 4.2% to 4.8%. Partially as a consequence, consumers expect their real (inflation-adjusted) income to fall 3.2%. The graph below also shows that many of those surveyed think now is the worst time in recent history, by a long shot, to buy a house.


Retail Sales were better than expectations at +.6% versus expectations of a .4% decline. Last month’s data was revised lower by .4% to -1.7%. Not surprisingly food services/drinking and gasoline stations accounted for almost 80% of the gain. Given the shortage of new and used cars, motor vehicles and parts reduced .4% from the number. The control group, which feeds GDP, rose 1.1% but May was revised lower by .7%.

Per Zero Hedge and Bank America, Today’s strong report may be fleeting in July. Per their report- “According to BAC aggregated debit and credit card spending data, after a strong June, consumers hit the brakes, and total card spending slowed to only up 13% over a 2-year period or 12% over a 1-year for the 7-days ending July 10th. This will mark the slowest 1-year increase since the covid crisis began.”


Technical Value Scorecard is published


The Bank of England (BOE) is under pressure by Parliament to explain QE and justify its risks. Per the report: “The Economic Affairs Committee publishes its report ‘Quantitative easing: a dangerous addiction?’, which urges the Bank of England to explain in more detail why it believes rising inflation will be a short-term phenomenon, and why continuing with its quantitative easing programme until the end of 2021 is the right course of action.”

The Fed is also seeing some backlash against QE and the resulting financial bubbles. This pressure however is from the media, not the government. Frontline recently published a damming episode, called An Epic Mistake? on the Fed and QE. Of particular note, they interview Peter Fisher who was the NY Fed President for over a decade. Mr. Fisher has some choice words to say about financial instability and the risks the Fed is taking in their pandemic-related massive QE efforts.

Peter Fisher has been a lone voice of reason since leaving the Fed in 2001. Two years we wrote, The Wisdom of Peter Fisher, which discusses his concerns about QE. It’s worth giving it a quick read before watching the Frontline Video.


The graph below charts market expectations for the Fed Funds rate going out to March of 2023. The orange line shows the market currently expects about 30bps in Fed tightening between now and then. Said differently, they expect a 100% of one 25bps rate hike and a 20% chance of two by March 2023. The graph also shows that current levels are near the highs for each monthly contract. The blue line extends the current effective Fed Funds rate out until March 2023.

July 15, 2021

Quarterly Guide to Sector Performance


Lumber is down 7% this morning and, after the big surge in price earlier this year, has now corrected back into the pre-pandemic range.


One more tidbit on inflation. The graph below shows the difference between CPI and PPI. PPI, which measures commodity prices and other manufacturing inputs tends to rise before CPI in an inflationary environment. CPI follows PPI as manufacturers and retailers try to push input price increases on to consumers. That is exactly what happened over the last year. At one point CPI was 6% higher than PPI on a year-over-year basis. Currently, CPI is 4% less than PPI. CPI will catch back up to PPI as is typical. If prices can be pushed to consumers without losing too much demand, PPI will drive CPI. If consumers are unwilling to pay higher prices, corporate margins suffer, which usually leads to less demand for input goods and ultimately lower prices.


Used car prices only represent about 3% of the CPI Index but contributed to about a third of its recent increase. As such, used car prices have become an important factor to watch for gauging inflation. The Manheim Used Vehicle Value Index below shows the sharp increase in prices since the pandemic. The only positive takeaway from the latest data from Manheim is it shows that price increases may be abating. June prices show a monthly decline of 1.3% from the prior month. That said, the index is still up 34.3% from a year ago.


Movie theaters are being left behind in the economic recovery. This year’s big blockbuster, Black Widow, just pulled in $80 million in revenue in its best weekend. In 2019, Avengers: Endgame had the biggest grossing weekend at over four times the revenue- $357 million. The graph below shows that ticket sales are running grossly behind levels from before the pandemic. The data for 2021 is through June so you can essentially double the $2.5 billion in box office sales to $5 billion and compare it to the nearly $12.5 billion in sales pre-pandemic.

July 14, 2021

Stocks, bonds, and gold are off to the races this morning as Powell’s prepared remarks before his testimony later today was released. He essentially quelled concerns that taper might be coming soon. He continues to base that judgment on the slow improvement in the labor markets.

“While reaching the standard of “substantial further progress” is still a ways off, participants expect that progress will continue. We will continue these discussions in coming meetings. As we have said, we will provide advance notice before announcing any decision to make changes to our purchases.”


Like CPI yesterday, year over year Producer Prices (PPI) came in about .5% above expectations. PPI rose 7.3% and core PPI rose 5.6%. Monthly PPI rose 1% versus 0.8% last month and expectations of +.6%.


Sector by Sector Wednesday


The following chart, courtesy of Macrobond, shows if you strip out food, energy, and goods that have been directly affected by the economic reopening, inflation is relatively tame. Over the coming months, we will closely track the individual components of inflation to best assess its future path. In this realm, watching sticky prices versus flexible prices will be important. Sticky prices are those that tend to trend, like housing. Inflation in sticky sectors is more likely to be permanent. Flexible prices tend to oscillate over time. These include energy and used cars for example.


Fed Chair Jerome Powell is scheduled to present testimony on monetary policy and the economy to Congress today and tomorrow. We suspect he will continue to walk the fine line between talking about tapering and wanting to wait for an improvement in the labor markets before tapering. It is increasingly likely that senators and representatives will grill him on yesterday’s inflation data and the widening wealth inequality gap. As we wrote in Two Pins Threatening Asset Bubbles, such pressure could force the Fed to taper sooner than they would like.

To wit:  If the prices of food, shelter, and other necessities continue to surge higher without equivalent wage growth, wealth inequality will worsen. This problem represents a coming dilemma for the Fed.

When the media and politicians take notice, they will pressure the Fed on their inflation stance.


U.S. bond yields have been declining as the market buys into the Fed’s view of transitory inflation and declining economic growth. Bloomberg recently wrote an article providing more evidence for such an outlook. In China’s Slowing V-Shaped Economic Recovery Sends Global Warning, the author warns China’s economy may be providing the recovery road map for the global post-pandemic economic recovery. They were the first to experience COVID and the first to recover from it. We noted a few weeks ago the sharp slowdown in credit creation as a signal of decelerating growth in China. The outlook was emphasized last Friday when their central bank cut the reserve ratio requirement for banks, essentially making lending easier. In regards to inflation that we import from China, the article quoted the following: “China’s growth slowdown should mean near-term disinflation pressures globally, particularly on demand for industrial metals and capital goods,” said Wei Yao, chief economist for the Asia Pacific at Societe Generale SA.

China has long been the marginal driver of global economic growth as they are the second-largest economy and, prior to the pandemic, growing at twice the rate of almost all developed nations’ economies.

 

July 13, 2021

The initial market reaction to the strong CPI print was a decent rally in bond prices (lower yields). Some may wonder why yields are falling if inflation was much stronger than expected. The answer likely lies in the reasons CPI rose. The table below shows the contributions by sector to the monthly and annual CPI Index. Energy and Transportation prices were both up sharply. In aggregate they contribute 63% and 80% to the monthly and annual number respectively. Both are considered to have flexible pricing meaning they can fall in price as easily as they rise. As a result, bond investors seem to remain comfortable with the idea that the recent inflationary surge will be transitory. The Fed will also likely use this reasoning to brush off today’s data.


Dow 35,000. How Significant is it Really?


As shown below, CPI came in .4% higher than expectations on a monthly and year over year basis. Troubling for the markets will be that the monthly rate of inflation accelerated after having declined last month. Markets tend to focus more on the rate of change as it provides guidance about future trends. That said, the monthly rate of inflation on an annualized basis is nearly 11% and that will no doubt make headlines.

Per the BLS“The index for used cars and trucks continued to rise sharply, increasing 10.5 percent in June. This increase accounted for more than one-third of the seasonally adjusted all items increase.”  

The good news is that used car prices are not likely permanent as they are the result of severe shortages and strong demand which are both temporary. The bad news is that housing prices (OER) continue to tick up. These prices are considered more “sticky” and constitute a much larger proportion of the CPI number.


One of the recent market themes we have been discussing is the growing divergences between certain sectors and markets. Last week, for instance, we wrote:  “The generals are leading the way higher but the troops are not necessarily following.” The graph below, courtesy Lohman Econometrics, shows that 1-year rolling correlations between many indexes have broken down to levels, that in eight of the nine cases haven’t been witnessed in 20 years. These graphs and other related data do not mean the market will crash but they do represent a change in market dynamics that bears close watching and caution.

July 12, 2021

Per Bloomberg: “The U.S. central bank’s purchases of Treasury and mortgage-backed securities are both contributing to lower housing costs, New York Fed President John Williams says”

The unfortunate reality, as shown below, is that housing is now more unaffordable than any time in at least the last 20 years.


Real Investment Report- Yields Plunge. Dollar Surges. The Reflation Trade Unravels.  


Gamma Band Update


Is Market Exuberance Justified?


Top 10-Buys and Sells From TPA Research

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 


Massive intervention by the Fed and other central banks is significantly reducing investors’ perceptions of risk. For example, many equity valuations sit at or near levels recorded in 1999 and 1929, despite economic growth rates that are declining and lower than those periods. The graph below highlights another manifestation of risk complacency. It shows the standard deviations of UST yield spreads for each credit rating of corporate bonds. As shown, the deviation escalates as the bonds’ riskiness increases. Junk-rated bonds, especially the worst in class (CCC or lower) are now over four standard deviations from their average.  Investors in these bonds only require an additional 5.81% of yield versus UST notes. The average is nearly 12% since 1997.


Our first glimpse of inflation data for June comes Tuesday with CPI. The current expectation is for a decline in the monthly growth rate from +0.7% to +0.4%. On a year-over-year basis, a slight decline from 5% to 4.9% is expected. PPI will be released on Wednesday and a slight decline from May is also expected. We are more concerned with the rate of change of inflation than the rate itself. If the monthly rate declines for the second month in a row it provides some level of confidence that inflation might be peaking. Given the highly unusual supply line shortages and insatiable demand for some goods, we must understand that forecasting inflation will continue to be extremely difficult and likely humbling.

On Friday, we will learn more about the health of the consumer with Retail Sales. Economists expect it to fall -.5%, following last months -1.3% decline. We will also keep an eye on various surveys throughout the week to see if they continue to rise to record or near-record levels or begin to stabilize.

Earnings will start this week with the following key releases shown below. Of note will be the large banks with JPM and GS on Tuesday, followed by BAC and WFC on Wednesday.

July 10, 2021

Victor Adair’s Trading Desk Notes – For July 10, 2021

July 9, 2021

The graph below helps to further highlight the underlying weakness in the markets. It shows the S&P 500 continuing to set record highs on a seemingly daily basis, yet the percentage of S&P stocks above their 50 dma continues to decline. Currently, half the stocks in the index are below their 50 dma!  We also noticed that only 33% of stocks are one standard deviation or more above their 200 dma and that percentage has been steadily falling. For reference, it stood at 55% at the start of June and 70% in January and February.


The most recent data on inventories shows that some of the shortage problems may be lessening. Wholesale inventories rose 1.3% last month, slightly more than expectations of 1.1%. At the same time, wholesale sales only rose 0.8%, meaning the inventory to sales ratio at the wholesale level upticked. The ratio for retailers will be released next week. As shown below, it has been in a free fall since the early days of the Pandemic. If the ratio starts to stabilize or turn higher, inflationary pressures should alleviate on the margin.


A special Friday edition of Three Minutes on Markets & Money – Yields Send Economic Warning


Technical Value Scorecard


The latest Consumer Credit data, released yesterday afternoon, shows consumer credit rose by $35.3 billion in May, almost double expectations. Non-revolving credit (auto and school loans) increased by $26.1 bn, the most on record. Revolving credit, mainly credit cards, rose $9.2 bn after falling last month. With the unexpected increase, consumer credit is running about 2% above January 2020 levels. The growth rate prior to the pandemic was in the 4-5% range.


The graph below, courtesy of Brett Freeze, shows how the returns between the S&P 500 and 16 year-zero coupon treasuries tend to oscillate over time. In March, the year-over-year outperformance of equities over Treasuries hit an extreme. Based on the previous two times this occurred, we should expect Treasuries to outperform the S&P 500 over the coming months.

 

July 8, 2021

The New York Fed announced they will start selling their holdings of corporate bonds on July 12th. While the amount they own is minimal, it does represent a normalization of monetary policy. This announcement was widely expected and should have minimal impact on the corporate bond market.


What’s NOT Working In The Markets


The minutes from the last Fed meeting were released yesterday afternoon. Bottom line: the Fed has begun discussions about reducing QE purchases and the likelihood of tapering mortgage purchases is likely sooner rather than later. We suspect such an announcement regarding mortgage purchases could come at the late July meeting or at their annual Jackson Hole retreat in late August.

  • “Several participants highlighted, however, that low-interest rates were contributing to elevated house prices and that valuation pressures in housing markets might pose financial stability risks.”
  • “Various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of in-coming data.”
  • “Several participants saw benefits to reducing the pace of these purchases more quickly or earlier than Treasury purchases in light of valuation pressures in housing markets.”

Owners Equivalent Rent constitutes nearly one-third of the CPI Index. As such, trends in rent prices are important to factor into inflation forecasts. Rents fell during COVID but have been recovering with the economy. The following paragraph and graph are from an in-depth report from Apartment List.

  • “Our national index increased by 2.3 percent in June, continuing the trend of rapid price growth since the start of the year. So far in 2021, rental prices have grown a staggering 9.2 percent. To put that in context, in previous years growth from January to June is usually just 2 to 3 percent. After this month’s spike, rents have been pushed well above our expectations of where they would have been had the pandemic not disrupted the market.”

While rental prices are recovering nicely we must put the gains into context. Rents are still below 2019 levels in many major cities. The ten cities hardest hit by the pandemic are shown below. That said there are many smaller cities seeing double-digit annual increases in rent. Boise and Spokane lead the way at +39% and +31% respectively.

 

July 7, 2021

Wolf Richter of Wolf Street shines a light on evidence the housing market is weakening quickly.

The evidence has been piling up for months in bits and pieces: While investors still have the hots for this housing market, potential buyers that need a mortgage and those who want to live in the home they’re thinking of buying are getting second thoughts, as evidenced by sharply dropping sales of existing homes and new houses even as inventories for sale have now risen for the third month in a row and new listings are coming out of the woodwork.

So here’s the latest piece of evidence: Demand from buyers who need a mortgage to fund the purchase of a home has been declining for months and in the week ended July 2 fell further and is now down 14% from the same week in 2020 and down 8% from the same week in 2019, according to the Mortgage Bankers Association this morning. Mortgage applications are now at the low end of the range in 2019. The entire Pandemic boom has now been worked off, plus some.


Per the BLS JOLTs report, the number of job openings declined slightly versus last month but remains near a record high at 9.2mm. New hires were also similar to last month at 5.9mm. Basically, the labor market remains tight despite the high unemployment rate. The quit rate fell but remains at 20 year+ highs at 2.5%. Typically employees that quit do so because they have confidence in finding another job and often one that is higher paying. Given the perceived leverage of those that quit over employers, there has been a strong correlation between wage growth and the quit rate. As shown below, the correlation broke down in 2017 and has been irrelevant during the pandemic. If the correlation normalizes we should expect an uptick in wages.


What Treasury Yields are Foretelling


A WSJ article entitled Supermarkets are Stockpiling Inventory as Food Costs Rise discusses how grocery stores are stockpiling food inventories in anticipation of price increases. This is not the type of action grocers would take if they thought recent price inflation was transitory.  “When you have a uniquely inflationary period like now, it’s a feeding frenzy,” said Tony Sarsam, chief executive officer of SpartanNash Co. The Grand Rapids, Mich.-based retailer and distributor is stockpiling about 20% to 25% more groceries such as frozen meat and boxed foods after more than 100 suppliers notified SpartanNash that they would raise prices, he said.

As grocers stockpile inventory, their actions fuel more inflation as demand further exceeds supply and supply line-related delivery problems. Such actions, especially if carried out by consumers and a large number of retailers, can create a repeatable cycle of higher prices.


The graph below, courtesy of the Cleveland Fed, suggests the surge in headline/core inflation is concentrated in a limited number of items. Per the Fed: PCE inflation jumped to 3.9% in May. But median PCE inflation, which excludes outlier components and focuses on the middle of the distribution, was steady at 2% for the third month in a row.

The data may provide some level of confidence for the Fed that the recent bump in inflation is transitory.

 

July 6, 2021

Per SentimenTrader:

The Nasdaq Composite closed at a 52-week high today, something it’s done 1,080 times since 1984. On those days, an average of 50% of stocks on the Nasdaq advanced on the day. Today, 31% of stocks on the exchange advanced. That’s the lowest out of all those 1,080 days.


The Citi Economic Surprise Index, measuring economists’ expectations versus actual data, has been positive for 274 of the past 275 trading days. It currently sits slightly above zero and is trending lower. It appears economists’ predictions have finally caught up with reality. Markets now run the risk that economic data going forward will fall short of expectations. However, if investors perceive bad news as good news, as it keeps the Fed from tapering, then a run of negative readings may be a good thing and the risk of weak data minimal. Such is the distorted environment we must invest in.


Gamma Band Update


The graph below shows the market’s breadth is diverging from prices. The orange line (S&P 500) has been steadily climbing despite the number of NYSE stocks sitting above their respective 50 dma’s falling. Looking back over the last four years you can see a similar divergence occurred in 2018. The S&P ultimately fell by about 20% as the Fed was reducing its balance sheet at the time. QE Taper is on the horizon, might that ultimately determine how this divergence ends?


Taking Advantage of Market Strengths & Weaknesses


Economic data will be relatively light during this holiday-shortened week. Of importance will be the FOMC minutes from the last meeting. We will be interested to see how much discussion there was around the timing of tapering. ISM non-manufacturing PMI is due out tomorrow. Expectations are for a slight decline, but the prices component should rise to a very high reading of 81. The BLS will release JOLTS job openings on Wednesday.


Over the weekend a few subscribers asked us to explain the Feds reverse repo program that is approaching $1 trillion daily and could rise to $2 trillion over the coming months. In particular, they want to understand how it is different from the repo program the Fed initiated in the fall of 2019 that lead to interest rate cuts and QE of T-bills. Our answer can be found at the 27:40 minute mark of last Thursday’s daily podcast- The Real Investment Show.

The daily shows can be watched via our Real Investment Advice website or our YouTube channel.


 

 

July 3, 2021

Victor Adair’s Trading Desk Notes For July 3, 2021

July 2, 2021

Despite the strong performance by the indexes today, the underlying breadth of the market remains poor. As shown below, 5 of the 11 sectors posted meager to negative returns, and only two sectors, Tech and Communication, beat the S&P. The generals are leading the way higher but the troops are not necessarily following.


Sharply rising prices at the pump are helping further stoke inflationary concerns among individuals. As shown, the price of gasoline futures are now at levels last seen in 2014.


As shown below, the headline number from the BLS jobs report was strong at 850k net new jobs added in June. However, the unemployment rate rose from 5.8% to 5.9% and the labor participation rate fell by a tenth of a percent to 61.6%. Also of concern, hourly wages and the average workweek were slightly lower than expectations. Earnings are tricky to make sense of as an increase does not necessarily denote increased wages. The mix of jobs is equally important and hard to gauge. For instance, many service jobs are low-paying and reduce earnings. This past month 343k jobs were added in the leisure and hospitality sectors and teachers accounted for 269k of the new jobs.


Technical Value Scorecard


As we have noted recently, we expect the Fed will begin to taper purchases of mortgages, possibly as soon as the late July FOMC meeting. With mortgage rates just above all-time record lows of earlier this year and house prices rising at a double-digit pace, it’s hard for the Fed to deny some culpability in spurring a housing bubble. The graph below, courtesy of Jim Bianco, shows the Fed now owns about a third of all mortgages used in Barclay’s MBS index.


Markets will be closed on Monday, July 5th for Independence Day.


The series of graphs below show that almost half of the investors surveyed in the poll are taking on leverage to invest. Generation Z leads the pack with nearly 80% of respondents saying they are taking on debt to invest. Not surprisingly only 9% of the more conservative Baby Boomers are leveraging their assets. The second and third graphs show the types of loans and types of investments favored by personal investors. While the data is telling about the state of speculation in today’s market, we would like to see it compared to years past to put it into proper context.

July 1, 2021

The PMI Survey on manufacturing conditions, which has been rising sharply, is showing signs of peaking. The index came in at 62.1 versus expectations of 62.6 and the prior month’s reading of 62.1. However, input prices continue to rise and sit at a new record high. Per the increased price pressures Chris Williamson, Chief Economist for IHS Markit (survey producer) commented: “Supplier delivery times lengthened to the greatest extent yet recorded as suppliers struggled to keep pace with demand and transport delays hindered the availability of inputs. Factories were increasingly prepared, or forced, to pay more to secure sufficient supplies of key raw materials, resulting in the largest jump in costs yet recorded.

“Strong customer demand in turn meant producers were often able to pass these higher costs on to customers, pushing prices charged for goods up at a rate unbeaten in at least 14 years.”

China’s PMI continues to slowly weaken and their prices index is down from 59.8 in March to 51.4 in June. China is the driver of marginal global economic growth so their pronounced relative weakness versus the United States bears watching. Eurozone and UK PMI’s inched higher and are at similarly high levels as the U.S.


Cartography Corner July 2021 is published.


July 1 Market Preview


With the first 6 months of the year in the rearview mirror, it’s worth looking at how markets finished the year after a strong first half. The table below, from LPL, shows that in the 16 previous times since 1950 the S&P was up more than 12.5% in the first 6 months, the next 6 months were positive 12 times, with an average return of 7.1%. The S&P is up over 14% already this year so the statistics books tell us that +20% is a reasonable expectation.


One of the key factors driving inflation higher is supply line problems. The graphs below from Goldman Sachs show that supplier delivery times are now over 4 standard deviations above their norm of the last 20 years. Maybe more concerning, businesses expect the problem to abate somewhat in 6 months but they still expect the largest supplier delays in 20 years.


The graph below highlights the difficulty in trading modern equity markets. As shown, if you bought the S&P 500 at the market open and sold the close since 1993 you would have not made a dime other than dividends. Conversely, if you bought the market at the close and sold at the open you would have captured all of the market gains of the last 28 years.

June 30, 2021

Major Market Wednesday


The ADP jobs report came in nearly 100k jobs stronger than expected at 692k net jobs added in June but off the 978k pace from last month. Not surprisingly, leisure and hospitality jobs account for nearly half of the gain as shown below.

The full report can be read HERE.


Liz Ann Sonders from Charles Schwab posted the commentary below on Twitter which rebukes the commonly held thought that enhanced unemployment benefits are keeping people from finding jobs.

  • Job postings on ⁦@indeed in states that have ended enhanced unemployment benefits early have been climbing right in line with openings throughout the country, supporting ⁦@CapEconomics view that added insurance isn’t that strong a factor in holding back employment.

When extended benefits end nationwide over the next few months, we will better understand why job openings are at a record at the same time the unemployment rate is elevated from pre-pandemic levels.


In the aftermath of the last FOMC meeting and numerous Fed speeches, it is clear that unemployment is the main factor holding the Fed back from tapering QE and raising rates. As such, today’s ADP report and Friday’s BLS labor report will be important in regards to estimating the timing of Fed actions. ADP is expected to show a gain of 533k jobs, a historically strong pace but well off last month’s 978k. Friday’s BLS report is expected to show a pick-up of 675k jobs, compared to 559k last month. Equally important will be the participation rate, unemployment rate, and wages and hours in Friday’s report.


The graph below, courtesy of the Brookings Institution, shows the massive amount of fiscal stimulus of the last year is waning. Going forward, the sharp decline in spending will detract from GDP growth. This graph does not obviously take into account unknown future stimulus spending bills.

June 29, 2021

The chart below highlights an important issue for markets and one hotly debated by market prognosticators. Does the amount (stock) of monetary stimulus or the change (flow) in the amount of stimulus matter more? The graph below, on the left, from JP Morgan, shows the size of the major central bank balance sheets has doubled since the pandemic started. At the same time, the 12-month change in balances just peaked at over $8 trillion and is heading sharply lower. We believe the flow or annual change of the stimulus matters more. Accordingly, we think caution is warranted as the correlation between QE and asset prices is strong as shown in the second graph.


Home prices remain red hot. The Case Shiller 20 City home price index rose 1.6% on a monthly basis and 14.9% annually. The FHFA (regulator of Fannie Mae and Freddie Mac) home price index confirmed Case Shiller by rising 15.7% annually.

Also of note on the economic front, consumer confidence was much better than expected at 127.3 versus 117.2 last month. It now stands only about 5 points below pre-pandemic levels. While market expectations for inflation have leveled out in recent months around 2.5%, consumer expectations, via the confidence survey, just hit a 10 year high at close to 7%. Keep in mind consumers tend to believe there is more inflation than reported by the government, ergo they have higher expectations for inflation than the market. The lowest levels of the last ten years occurred between 2016-2019 where they ranged between 4.5% and 5%.


Dressing the Windows to Close out the Month


The graph on the left shows the shape of the crude oil futures curve. Specifically, the black line is the price difference between the front-month contract and the forward contract settling a year in the future. As shown by comparing the curve to the price of crude oil (right graph), when the curve peaks (oil futures are in backwardation), oil prices tend to peak.

 

June 28, 2021

The graph below updates inflation expectations. As shown, both 5yr and 10yr expectations have stabilized for the last three months after rising sharply for almost a year. The other takeaway is the difference between 5yr and 10yr expectations. Typically 5yr expectations are lower than 10yr. Since late 2020 they have been higher. This can be interpreted as the market believing the Fed in that inflation will run “hot” but will be transitory. The difference between them is shown in gray. Recently it has been slightly declining, furthering the transitory view.


Gamma Band Update


As shown below, B and CCC-rated junk bonds are now trading at 20+ year record low yields. As a spread versus U.S. Treasuries, both sets of bonds are close to levels seen in 1999 and 2007. With little upside and significant downside, we urge caution in the junk bond sector. Simply, the additional yield offered by junk bonds versus safer bonds is not worth the additional risk.


How Markets are Setting up for the Summer


Top 10-Buys and Sells From TPA Research

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 


The S&P 500 is showing signs of weakness lately as it grinds higher at a seemingly slowing pace. This chart from Bloomberg points out the narrow breadth seen as the index made a record high last week. Only 46% of index members were trading above their 50-dma when the market closed on Thursday.

The following chart from SentimenTrader provides ominous historical context to the situation. The last time we saw the market making new highs with a similar lack of breadth was in 1999. Moreover, most other instances prior to 1999 preceded significant corrections or bear markets. This is not to say a large correction is imminent, rather keep an eye on signs of market weakness as the effects of fiscal stimulus fade.


The economic calendar will be busy this week. The Case-Shiller Home Price Index and Consumer Confidence Index will be released tomorrow, followed by the ADP Employment Report on Wednesday and the ISM Manufacturing Index on Thursday. Perhaps most important, Nonfarm Payrolls will be released Friday. Considering recent inflation prints, unemployment continues to grow in importance with regard to the Fed’s decision to taper asset purchases.

After last week’s barrage of Fed speakers, this week will be relatively light. We will hear from NY Fed President John Williams today.

June 26, 2021

Victor Adair’s Trading Desk Notes – June 26th

June 25, 2021

Boston Fed President Eric Rosengren voiced some concerns regarding financial stability today. He commented that we should to consider some of the side effects of a “low for long” interest rate plan, and that the Fed needs to have a less ad hoc approach to crises. He continued by stating that monetary policy may not be as accommodative for as long if financial stability risks are not addressed. Regarding inflation, he largely stuck to the script reiterated many times this week by Fed members.

Rosengren also discussed a need to monitor the speed of increases in housing prices, noting that in several markets, prices are now higher than they were prior to the financial crisis. He suggested that the Federal Reserve consider tapering treasury and MBS purchases by the same amount when the time comes. Tapering of MBS purchases has become a hot topic with Fed officials lately, signaling this could be the first area of action when the time comes.


The University of Michigan’s Consumer Sentiment Index was 85.5 for the month of June, which measures below the estimate of 86.5. The index fell from the preliminary reading of 86.4 earlier this month, however, it represents an improvement from May’s value of 82.9.


Personal Income fell -2% in May versus expectations of -2.6%, while Personal Consumption Expenditures were unchanged on a monthly basis, missing the consensus of +0.6%. On a YoY basis, the PCE Price Index matched expectations of +3.9%. This represents a slight increase over the +3.6% seen in April.

The Core PCE Price Index, the Fed’s preferred measure of inflation, rose +0.5% on a monthly basis and +3.4% YoY in May. Both timeframes came in below expectations and compare to April’s readings of +0.7% MoM and +3.1% YoY. The Federal Reserve will likely stick to its story of transitory inflation caused by a strong reopening and supply chain pressures which will moderate going forward.


The Technical Value Scorecard is published.


Lumber futures continue to retreat this morning as home builders wait out high input costs, buyers are increasingly priced out of the market, and saw mills begin catching up with demand.


The following chart from Julien Bittel shows that since 1990, every time the 30-Year T-Bond yield rose more than 1% over a 12-month period, it declined over the subsequent 12 months. The YoY change in yield reached 1.3% on March 8, 2021, and the rate has fallen over 21 basis points since. Thus, the data suggests we may have seen a local peak in long-term yields.

June 24, 2021

The bipartisan infrastructure agreement includes $579B of proposed new spending. According to President Biden, funding sources will not include a gas tax increase or fees for electric vehicles. The President also said he expects a vote on the bill before the fiscal-year ends.


President Biden’s Latest Tweet:

“We’ve struck a deal. A group of senators – five Democrats and five Republicans – has come together and forged an infrastructure agreement that will create millions of American jobs.”


Weekly jobless claims came in higher than expected this morning, at 411K versus a consensus estimate of 380K. Initial claims fell by 7K, a slight improvement over last week’s data but still higher than the print two weeks ago. As we alluded to last week, the employment situation going forward will be an important factor in the timing of the Fed’s decision to begin tapering asset purchases.


Sell Signal Science


A bipartisan group of Senators will meet with President Biden today at 11:45 AM EST to discuss plans for an infrastructure proposal totaling nearly $1 trillion. According to Senator Jon Tester, the group has reached a general framework for the deal but there are still some components that need to be fleshed out.


Yesterday Treasury Secretary Janet Yellen urged Congress to increase the government’s debt limit to avoid potential default on Treasury debt this year. The Wall Street Journal noted:

“Without congressional action to suspend or raise the limit after July 31, the government could begin to miss payments on its obligations, triggering a default on government debt, which Ms. Yellen called unthinkable.

‘Failing to increase the debt limit would have absolutely catastrophic economic consequences,’ she said, noting that the U.S. has never defaulted on its legal obligations. ‘I believe it would precipitate a financial crisis. It would threaten the jobs and savings of Americans at a time when we’re still recovering from the Covid pandemic.’”

It is highly unlikely that Congress would allow this to happen, but as Yellen stated, “We can’t tolerate any chance of defaulting on the government’s debt.”


The chart below compares the shape of the 2yr-30yr UST yield curve (orange) to the ratio of the S&P 500 Growth to Value indexes. As shown, the correlation has been strong since the start of the year. Growth has outperformed recently as the yield flattened. This chart falls in line with a lot of other trends which help define the inflation-deflation trade.

June 23, 2021

Following the hawkish stance from Bostic, the Fed’s Kaplan made some comments that inspired modest selling into the close.

“The U.S. economy will likely meet the Federal Reserve’s threshold for tapering its asset purchases sooner than people think, said Dallas Fed President Robert Kaplan, who has penciled in an interest-rate increase next year.

‘As we make substantial further progress, which I think will happen sooner than people expect — sooner rather than later — and we’re weathering the pandemic, I think we’d be far better off, from a risk-management point of view, beginning to adjust these purchases of Treasuries and mortgage-backed securities,’ Kaplan said Wednesday in an interview with Bloomberg News.”

Like Bostic, Kaplan said he expects an initial rate hike in 2022.


The Atlanta Fed President, Raphael Bostic, said today he now expects a rate hike in late 2022 with two additional rate hikes in 2023. He also expressed his belief that the economy is close to fulfilling the “substantial further progress” needed to begin tapering bond purchases and commented that a tapering decision could be made in 3-4 months. The S&P 500 briefly dipped into negative territory following his comments but returned to positive territory shortly thereafter.


Following yesterday’s stronger than expected Existing Home Sales report, New Home Sales fell 5.9% to 769K in May, missing expectations by a wide margin. The median sales price rose to a record high $374,400 (+18.1% YoY) as supply side constraints contributed to rising prices.


Behind the Money Flow Signals


The median sales price of existing homes in the US rose to $350,300 last month, up 23.6% year over year. This chart from Bloomberg highlights the clear link between declining inventory and surging home prices. Meanwhile, the Federal Reserve continues its purchases of $40B per month in MBS despite fueling a supply-demand imbalance that is driving home prices out of reach for many first-time home buyers.


The graph below shows the absurdity of how low junk bond yields have gotten. Assuming no defaults, which is historically impossible, the Barclays junk bond index will return a yield slightly below the rate of inflation. Typically the real, post-inflation, yield is north of 4% to provide a cushion against defaults. Just to hit home with the stunning graph, in a better than best-case scenario, junk bond investors should expect to lose purchasing power.

June 22, 2021

The semiconductor chip shortage worsened yet again last month, according to an article published by Bloomberg earlier today.

“Chip-starved industries from automakers to consumer electronics will need to wait a bit longer for components, as delays in filling orders continue to get worse.

Chip lead times, the gap between ordering a semiconductor and taking delivery, increased by seven days to 18 weeks in May from the previous month, an indication that chipmakers’ struggles to keep up with demand are worsening, according to research by Susquehanna Financial Group.”

The chart below shows the drastic increase in lead times for semiconductor chips as the economy continues to reopen.


Per Live Squawk:

– Fed’s Daly: Appropriate To Debate Taper But We Are Not There Yet

– Could Reach Threshold For Taper Late 2021, Early 2022

– Looking To Autumn To Get More Clarity On Economy


Existing home sales for May came in above expectations at 5.8M versus the consensus of 5.72M. This represents a decline of 2.7% from the April level. The lack of supply of existing homes continues to pose a problem for the market, but it’s worth noting that inventory rose 7% month over month.


Markets Really Rally


At 2 pm ET Chairman Powell will testify to Congress on Pandemic emergency lending and supporting economic recovery. This will be the first chance for Congress to pressure Powell on rising inflation and the problems it creates for the lower and middle class. This will also Powell’s first comments since the Fed meeting last week.

This excerpt from his prepared remarks echoes a familiar tone:

“Inflation has increased notably in recent months. This reflects, in part, the very low readings from early in the pandemic falling out of the calculation; the pass-through of past increases in oil prices to consumer energy prices; the rebound in spending as the economy continues to reopen; and the exacerbating factor of supply bottlenecks, which have limited how quickly production in some sectors can respond in the near term. As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”

June 21, 2021

New York Fed President John Williams said today that he believes recent inflation data is mostly due to rapid reopening of the economy and supply chain disruptions.

“I expect that as price reversals and short-run imbalances from the economy reopening play out, inflation will come down from around 3 percent this year to close to 2 percent next year and in 2023.”

Regarding the Fed’s policy, he went on to explain:

“It’s clear that the economy is improving at a rapid rate, and the medium-term outlook is very good. But the data and conditions have not progressed enough for the FOMC to shift its monetary policy stance of strong support for the economic recovery.”


Following some hawkish comments on Friday, the St. Louis Fed’s Jim Bullard appears to have dialed it back this morning:

  • BULLARD SAYS NO ONE REALLY KNOWS HOW THIS IS GOING TO UNFOLD BUT NEED TO BE READY FOR UPSIDE RISKS TO INFLATION
  • BULLARD SAYS THE COMMITTEE IS ONLY NOW STARTING TO TALK ABOUT TAPERING AND IT WILL TAKE SOME TIME TO GET THAT UP AND RUNNING
  • BULLARD SAYS LOW INTEREST RATE AND LOW INFLATION RATE ERA IS NOT ENDING ANY TIME SOON
  • Bullard: There Are Legitimate Questions About Fed Buying Mortgage Bonds

Rally Likely Today


Gamma Band Update


This upcoming week will be relatively light on the economic data front but should be chock full of Fed speakers. Jobless claims on Thursday bear watching to see if the recent downward trend continues. Friday will feature the PCE price index for May. This is the Fed’s preferred measure of inflation.

Given the Fed’s change in tone last Wednesday, we will closely follow Fed speakers. Many Fed members were already calling for the Fed to taper sooner than Powell was alluding to. Inflation is clearly becoming a concern of the Fed. As such, we will see if their calls for taper become more urgent. If Bullard’s recent comments that we shared are any indication, the market may be volatile.


Owners Equivalent Rent (OER), a proxy for housing costs, accounts for about a quarter of the CPI number. Rents are on the rise as discussed in a CNBC article entitled- Rents for single-family homes just saw the largest gains in nearly 15 years.  While housing prices were rising double digits, rental costs were not following. Recent data, some of which is included in this article, shows that rental prices may finally be playing catch up. If so, they will provide a further boost to CPI levels.

Per the article: “Single-family rents were up 5.3% year over year in April, rising from a 2.4% increase in April 2020, according to CoreLogic. That is the largest gain in nearly 15 years.”

June 19, 2021

Victor Adair’s Trading Desk Notes For June 19, 2021

June 18, 2021

Fed member Jim Bullard made some pretty hawkish comments this morning on CNBC:

  • Per Live Sqwuak: Fed’s Bullard: Sees Strong Inflation Of 2.5% To 3% Inflation Through 2022, Meeting Framework Goals, Justifying Rate Increase
  • BULLARD: CHAIR POWELL OFFICIALLY OPENED TAPER DISCUSSION AT LAST MEETING, MORE IN DEPTH DISCUSSION TO FOLLOW
  • Fed’s Bullard: Inflation More Intense Than Expected – CNBC
  • “I’m leaning a little bit toward the idea that maybe we don’t need to be in mortgage-backed securities with a booming housing market.”

The Technical Value Scorecard is published.


At Wednesday’s FOMC press conference Powell used the word “transitory” twice, compared to 9 times at the prior meeting in late April. He also voiced concern that inflation might be “persistent”. While parsing what we think the Fed is thinking is difficult, both examples suggest the Fed is much more concerned about inflation today than a month or two ago.


The market action since Wednesday’s Fed meeting has taken a decidedly deflationary bias. Since Wednesday afternoon, the 30 year UST yield has fallen from 2.23% to 2.10%. Commodity prices like copper and oil are off 5% and 3%, respectively over the same period. The NASDAQ rose 1.25% yesterday while the commodity heavy Dow fell by 0.60%.

Gold and silver were closely tied to bond yields and deflationary sectors over the prior month or so. Days in which inflation expectations fell and technology rose gold tended to do well. That has not been the case the last two days. We are keeping a close watch on precious metals to see if the correlation of the last month is breaking down. The dollar index is up nearly 2% over the last two days, which also helps explain gold’s weakness.


Should we prepare for a sneaker shortage now? Get ready, folks…”  That was the last line of a great Business Insider article entitled Why the World Is In a Shipping Crisis. We recommend reading it as it details problems in the transocean shipping industry that are driving shortages of many popular goods. One factor the author mentions is the surging price of shipping containers. The graph below, courtesy of Arbor Research, shows the dramatic price increase of containers since the start of the year.


The graph below, courtesy of Arbor Research, shows the tremendous inflows of money into ETFs that benefit from higher levels of inflation.

June 17, 2021

The graph below, courtesy of Arbor Research, shows the sharp drop in inflation expectations following yesterday’s Fed meeting. Market activity across many asset classes concurs, pointing to expectations for a more hawkish Fed going forward.


Market Response To A More Hawkish Fed


With the Fed boosting their inflation forecast it seems the only factor preventing the Fed from tapering sooner rather than later is the employment situation. As such, weekly jobless claims, in addition to the monthly BLS/ADP reports are important to keep a close eye on. If claims continue to decline, as they have done for the last three months, it will support yesterday’s shift in the Fed’s outlook about tapering. Initial jobless claims rose from 375k to 412k this past week. Prior to the Pandemic, claims were running in the low 200k’s per week. If the downward trend continues, claims will pierce 300k in one or two months and possibly normalize in the fall. Keep in mind the trend is predicated on continued economic recovery which may become trickier as the various forms of fiscal stimulus wane.


Tomorrow is quadruple witching day, one of four days each year in which index futures, options futures, stock options, and stock futures expire on the same day. Often, the confluence of expirations can lead to increased volatility as investors unwind their futures and/or options positions before contracts expire.


The popular narrative helping explain why Treasury yields are falling revolves around investors buying into the Fed’s belief that the recent bout of inflation is transitory. While it has merits, it’s also worth understanding the supply and demand dynamics in the U.S. Treasury market. Since January 1st, Treasury debt balances have risen by $271bn. At the same time, the Fed has purchased, $441bn of U.S. Treasury bills, notes, and bonds. Despite large deficits, the amount of debt outstanding in the markets has actually shrunk. Foreign holdings of U.S. Treasury securities also rose by approximately $60bn over the period. Simply, the supply/demand equation for U.S. Treasuries has resulted in lower yields. As we have mentioned, Treasury issuance has been lighter than normal over the past few months as they draw down their account at the Fed (TGA). Currently, their account balance is $730bn, down by over $1trln from last year’s highs. It will likely come down another $400bn by October, which should further keep net issuance after Fed purchases flat to negative.

June 16, 2021

Key comments and some commentary from Jerome Powell’s press conference:

  • Inflation has risen significantly in recent months”
  • “Inflation could turn out to be higher and more persistent than we expect
  • Even after liftoff (tapering), policy will remain highly accommodative
  • “Before adjusting asset purchases, the Fed would give advance notice”
  • Over the summer, prepare to see a lot of job growth”
  • “Take the dot plots (Fed expectations) with a grain of salt”
  • He mentioned employment a lot in his opening speech. Given strong economic growth and rapidly rising inflation, employment is the only thing holding the Fed back from tapering QE and raising rates. If he is correct about strong summer job growth, taper could come as early as this fall.
  • This is an extraordinarily unusual time. We really don’t have a template or any experience of a situation like this. I think we have to be humble about our ability to understand the data.” – This was his most important line- we are in unchartered territory and neither the Fed nor any “expert” should have full confidence in their economic or market expectations.
  • *POWELL: THIS WAS A `TALKING ABOUT TALKING ABOUT’ MEETING-  In other words, they are now thinking about tapering. Prior to today, even “thinking about, thinking about”, tapering was off the table. He confirmed that with- “Near term discussions that will begin is about the path of asset purchases”

Powell left little doubt that the Fed is now strategizing about when and how to taper.


Bottom line: the Fed’s statement was little changed but the more optimistic changes in their economic projections are hawkish as it implies the Fed will taper and increase rates sooner than expected.

The Fed raised their core PCE inflation forecast for 2021 to 3.0% from 2.2% and the all-inclusive CPI from 2.4% to 3.4%. Further, the consensus of Fed members now expects to increase rates twice in mid-2023. The Fed did not taper mortgage purchases as we suspected they might do. The “dot plot” graph on the left shows the level of Fed Funds that each Fed member expects by year. There are now 7 Fed members that think the Fed will hike rates as soon as next year. There were only 4 in March.  The Fed statement barely changed from the last meeting six weeks ago as shown in the second graphic.

 


Fed Day Preview


The ten-day moving average of the S&P 500 put-call ratio is now at its lowest levels since those seen before the tech crash in 2000. The ratio is the volume of put options divided by the volume on call options. A low ratio, as we have now, denotes there is significantly more interest in making upside bets than taking on downside protection.


Last Friday’s University of Michigan Consumer Sentiment survey shared results for home-buying conditions as seen by buyers and home builders. The first graph below, courtesy of Lohman Econometrics, shows that consumers believe now may be the worst time to buy a home in at least 35 years. The second graph shows the massive divergence between the optimistic view of home builders and their potential customers.  As an aside, buying conditions for automobiles also registered the lowest reading going back to the 1980s.


 

June 15, 2021

Rule #9 by Bob Farrell states: “When all the experts and forecasts agree – something else is going to happen.” Only 2% of those surveyed by Bank of America expect a bear market during the remainder of the year. We caution you, complacency is most often seen at tops, not bottoms.


Where The Action Is


Bank of America got it right, Retail Sales fell 1.35%. The table below from Brett Freeze breaks down its major components to show how each sector contributed to the data (column on the right). As shown, motor vehicle sales account for -.81% of the decline and building materials -.38%. Auto and home sales are the two hottest sectors over the last few months. Higher prices may finally be having a negative effect on sales. Not surprisingly, food services and drinking were the leading contributors as the economy reopens and people get comfortable going out again.

Producer Prices (PPI) were above expectations. Year over year prices rose 6.6% versus expectations for 6.2%. Core PPI was +5.3% versus expectations of 5.1%.


Retail sales are due out at 8:30 am ET this morning. Expectations are for a 0.4% decline. Bank of America, using its proprietary credit card spending data, suggests the number could be a full 1% weaker than expectations at -1.4%. Retail sales underwhelmed expectations last month as correctly predicted by Bank of America’s spending tracker.


As we wrote last week, we think it is possible for the Fed to reduce QE purchases of MBS as early as tomorrow’s FOMC meeting. Further fueling our speculation is comments from Andy Haldine, Chief Economist of the Bank of England. He states: “As things stand the housing market is on fire.” “There is a significant imbalance between incipient demand and available supply of houses, and because the laws of economic gravity have not been suspended, the result is pretty punchy rises in house prices.” Further, he tied the remarks to widening wealth inequality. Sound Familiar?

In part II of Two Pins Threatening Multiple Asset Bubbles we commented “Who benefits more from rising home prices, the wealthy or the poor? Who tends to rent more, the wealthy or the poor? Fed policy directly supports the housing market, and its benefits are overwhelmingly bestowed upon the wealthy.” The combination of surging housing prices and growing wealth inequality is certainly enough fodder for the Fed to reduce purchases of MBS sooner rather than later.

 

June 14, 2021

In last Friday’s Technical Value Scorecard, we wrote: “Note also that financials and materials are now both slightly oversold after being decently overbought last week and for many months prior. Both sectors underperformed the S&P by about 2.5%.”  The graph below shows the recent weakness in the ratio of financial stocks (XLF) to the S&P 500 (SPY). Since last November, the ratio has bounced off the red support line three different times after dipping below the 50dma. Currently, the ratio is trading below its 50 dma, but it is still above the trendline. A break of the trendline may likely signal further relative weakness for financials and may prove to be another sign that the reflationary trade is coming undone.


Gamma Band Update


The Evolution of Buy Signals


Retail Sales and PPI will be released on Tuesday. PPI tends to lead CPI, so we will watch closely to see if rising producer prices start to ease. Housing Starts and Permits on Wednesday are expected to rise slightly. Recent MBA mortgage data shows their purchase index weakening. We shall see if weakening demand translates to less construction of new homes.

Most important this week will be the Fed’s FOMC meeting on Wednesday. We will again be on the lookout for signals the Fed is thinking about tapering. Equally important to Powell’s press conference following the meeting, will be the speeches following from various Fed members. Many have become increasingly outspoken about the need to start considering tapering QE purchases.


In the past, we mentioned that the Treasury accumulated a lot of cash from the stimulus relief bills that were not immediately spent. The excess cash balance sitting at the Fed’s Treasury General Account (TGA) must be reduced significantly by October. The Treasury, with the surplus cash, must significantly lessen its borrowing needs, specifically with short-term Treasury Bills, to meet its mandate.

Banks, hedge funds, and other leveraged investors are highly dependent on said bills as they are used for collateral for many trading opportunities. Further, money market investors are also facing problems finding positive yielding short-term paper as cash balances by retail and corporate investors are running high. As a result of the relative dearth of T-bills and strong demand, banks and money market funds are actively engaging in reverse repurchase (RRP) transactions with the Fed. The graph below shows the daily overnight repo balances at the Fed now account for over 50% of the decline in TGA balances. As we approach the Fed meeting next week, we need to consider if the Fed will take actions to combat short-term interest rates trading below their target. Fed Funds are trading between 5-6 bps versus 10 bps prior to the reduction in TGA balances.

 

June 12, 2021

Victor Adair’s Trading Desk Notes For June 12, 2021

June 11, 2021

Today’s University of Michigan Consumer Sentiment survey has interesting inflation results. The broad sentiment index increased over the past month with current conditions falling slightly but future expectations rising decently. Of particular interest, 1-year inflation expectations were only 4% versus expectations for 4.7%. 5-10 year expectations were also below expectations at 2.8% versus 3%. Might the consumer also be buying into the Fed’s expectation that inflation will be transitory?

The table below breaks down sentiment by political affiliation. The results show the stunning change in sentiment over the past year based on the change in political power.


The graph below, courtesy of Fundstrat, shows the strong correlation between the change in ten-year UST yields and the change in the ratio of financials to technology. Financials tend to outperform technology as yields rise and vice versa. As we have been writing about on many occasions, financials are part of the inflationary trade and technology along with Treasury bonds part of the deflationary trade. In the technical value scorecard below, we wrote: “One of the key themes this past week is the increasing investor buy-in to the Fed’s expectation that inflation will be transitory. Despite a 5% annual inflation print Thursday, bond yields fell and the deflationary sectors outperformed inflationary sectors.”

It’s too early to see if the market transition to a more deflationary regime will be lasting, but watching yields and the sector rotations, as the graph shows, will be an important and powerful tool.


Technical Value Scorecard


Next Tuesday and Wednesday, the Fed’s FOMC meets to discuss monetary policy. Due to soaring home prices, we think, it is possible the Fed announces it will begin to reduce its $40bn/month of MBS purchases. If that were to occur, it’s likely to be matched with increased purchases of UST securities. If not, any net reduction of QE would go against the Fed’s forward guidance that they “are not even thinking about, thinking about tapering. The last thing the Fed wants to do is cause investor confusion and potentially harm investors’ confidence in the Fed.

As we wrote in Taper is Coming: Got Bonds?, tapering of QE has actually been good for bond prices in the prior instances. The graph below, from the article, shows that periods of QE – highlighted in gray- were followed by lower 10-year UST yields.

June 10, 2021

Early today we offered caution as the recent bout of low volatility might be a precursor to a move lower. LPL Research takes the other side. As shown below, when stocks are sitting near all-time highs “dull markets” offer decent average returns over the next six months.


Major Market Mania


CPI was stronger than expected with a monthly increase of 0.6% and year over year rate of 5%. Core CPI rose 0.7% monthly and is running 3.8% year over year, the highest since 1992.  As we showed earlier today, used car prices are having a significant influence on inflation data. In today’s report, used car prices rose 7.3%, on top of last month’s 10%. Bond yields are up slightly on the report but equities seem comfortable thus far, posting a slight gain. The graph below shows that CPI, using a two-year annualized rate, is back to pre-pandemic norms.


The sleepy market is potentially a warning signal. The lower graph shows the average true range (ATR) using 10 day periods on SPY. It confirms the recent bout of lackluster trading we are witnessing. More often than not over the last few years, a low ATR resulted in a sell-off of sorts. One problem with relying on a low ATR is that it can drift at low levels for quite a while. It’s worth adding, our proprietary cash flow models are getting ready to turn bearish and the Fed is meeting next week. As such, the potential for a pick-up in volatility is increasing.


The Manheim Used Car Index continues to soar as shown to the left below. The index is up approximately 43% since January of 2020 while the used cars and trucks sub-index of CPI is only up 21%. The second graph compares the Manheim index to the CPI-used car index. Currently used cars only account for 2.57% of CPI, yet despite its low relative importance, substituting Manheim for the BLS data would result in a CPI number that is .57% higher than reported.


The graph on the left below, courtesy of Arbor Research and Trading, shows 10-year sovereign yields, worldwide, are the least volatile they have been in at least 25 years. Essentially, the chart quantifies that bond traders are complacent. Frequently, periods of low volatility are followed by more extreme volatility. The 10-year UST yield graph on the right highlights the latest four low volatility readings as shown on the first graph. The data warns of a big move coming, but not in which direction. With U.S. ten-year yields sitting on support at 1.50%, a break below could introduce the meaningful potential for a push to 1.25-1.00%. Trade carefully.

June 09, 2021

The graph below shows, based on expectations for tomorrow’s CPI data, CPI and Core CPI should peak at 4.65% and 3.41% respectively tomorrow. Thereafter, assuming a 2.5% annual rate of inflation, which is 1% higher than the previous five years, annual rates of CPI will fall throughout the next 12 months. Conversely, Core CPI, the Fed’s preferred method for assessing inflation, will stay at current levels until February 2022 before falling. Assuming a slightly higher 3% rate of inflation going forward, CPI will linger at slightly above 4% this year, while Core CPI will rise to 4% before peaking in early 2022. The Fed is likely following monthly data versus year over year data due to the skewed base effects.


Sector by Sector Wednesday


The yield on the 10-year Treasury note broke below 1.50% this morning, down nearly .30% from its highs in March. As shown below, 1.50% has been technical support for yields. If it holds, we suspect yields will rise to about 1.60% where it will test the recent downward sloped resistance line and its 50 dma. A break lower in yield, possibly due to a weaker than expected CPI number tomorrow or hawkish language from the Fed next week, could result in yields falling as far as the 200 dma (1.15%). It’s worth adding, 5-year break-even inflation expectations have fallen from 2.72% in mid-May to 2.47%. Both indicators are currently opining that despite a spike in inflation that may last a few more months, inflation will ultimately be transitory and gravitate back to trend.


The graph below, courtesy of BofA Global Research, shows the power of the massive stimulus payments given directly to citizens. As shown, retail sales are nearly 20% above pre-pandemic levels despite employment which remains almost 10 million jobs below pre-pandemic levels. Had the government not infused massive stimulus, paid directly to individuals, retail sales would look a lot like the employment graph. Mind you, personal consumption accounts for about two-thirds of GDP. As such, GDP would also look like the employment graph. Going forward, with less fiscal stimulus likely, the economy will become heavily dependent on employment making a swift recovery and bolstering jobs and wages back to trend levels.

June 08, 2021

The JOLTS (job layoffs and turnovers) report from the BLS showed the number of new job openings reached another record high at 9.3mm. Despite the number of openings, the number of hires was little changed at 6.1mm. In a positive sign for job growth, the number of separations (quits) increased to 5.8mm, a series high. Workers tend to quit jobs when they are confident in their ability to easily find a better job. Click HERE for the full report. The updated Beveridge Curve below shows the job opening rate is near twice the rate it should be based on historical unemployment data. The conundrum continues: why are businesses not hiring given there are so many unemployed and why are people not taking jobs that are apparently abundant?


Market Risk Is On The Rise


The series of charts below, courtesy of @robinbrooksiif, provides a rough profit margin proxy for manufacturers by country. Output prices (vertical) are what firms charge their customers, while input prices (horizontal) are what they pay for goods to produce their products. The dots shifting toward the right and away from the red line over the three-month period is an indication that producers are able to mark up their prices and more than offset the increasing cost of goods used to produce their goods. This is a positive sign for manufacturing profit margins.


The graph below, courtesy of Black Knight, helps partially explain why home prices are soaring. As shown, the number of active sale listings is running at less than half of the average running rate before 2020. Despite higher prices, the number of new listings still lags the average by about 25%. Further, new listings account for more than 75% of listings in April. This is because most homes are selling quickly and not lingering on the market, meaning new listings are largely the only listings.  To wit: “Data from our Collateral Analytics group showed there was two months’ worth of single-family inventory nationwide in March, the lowest share on record and trending downward.”  The second graph shows the rise in home prices has been relatively equally distributed across the country. LINK to the full report which also includes interesting data on delinquency and foreclosure activity.

Coupled with the lack of supply noted above is relatively strong demand resulting in higher home prices. However, a recent survey by Fannie Mae points to weakening demand which may help counter low supply and provide a headwind to further home price inflation. Per Reuters: “The percentage of consumers who said it is a good time to buy a home declined in May to 35% from 47%, Fannie Mae said in its monthly survey of the U.S. housing market. This reading, the lowest since Fannie Mae began the survey about a decade ago, marked the second straight monthly decline and represented a drop of 18 percentage points since March.”

 

June 07, 2021

Gamma Band Update


Has Economic Activity Peaked?


Top 10 Buys & Sells

From TPA Research (Click Here to add TPA Research to your subscription.)

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Treasury Secretary Janet Yellen, during a weekend speech, made the following comment: “Higher interest rates would be a plus for the U.S. and the Fed.” We are unsure of what to make of her comment, but assume she is looking forward to a time the Fed can raise rates because the economy and jobs market is fully recovered.


Economic data will be in short supply this week. On Tuesday, the BLS will release the JOLTs report. On the heels of last week’s employment reports, it will be interesting to see if the job openings rate remains at record highs. Thursday will feature the all-important CPI report.

Fed members will go into a media blackout this week in advance of the next FOMC meeting on June 16th.


A couple more concerning tidbits from Friday’s employment report. Service producing jobs produced 556k of the 559k new jobs. These tend to be lower-paying jobs. Secondly, the graph on the right, courtesy of Brett Freeze, shows temporary help service growth has stopped increasing on a quarterly basis. Temporary help and GDP growth are well correlated as shown in the graph on the left.

 


Bloomberg recently published a great article highlighting the surge in the price of materials used to build houses. In their article, Building a home in the U.S. has never been more expensive, they open the financial books of a Boise Idaho based construction company and break down the cost increases of products used to build a new house. Based on this one builder, the cost to construct a new home has risen 58% from the pre-pandemic period. The following are a few of the examples the article shares:

  • Foundation/concrete slab prices up 104%
  • Trusses up 146%
  • Plumbing, HVAC and Electrical up 49%
  • Paint up 68%

June 5, 2021

Victor Adair’s Trading Desk Notes For The Week Of June 5th


June 04, 2021

The graph below, courtesy of the Peterson Institute, provides context for the jobs recovery and the 10 million job shortfall from the pre-pandemic trend. This is the key statistic that concerns the Fed and keeps them from tapering QE and or raising rates.


The newly formatted Technical Value Scorecard is published


The BLS employment numbers were underwhelming. Payrolls grew by 559k versus expectations of 650k. More importantly, following the strong ADP report, many market prognosticators thought the number of new jobs could approach 1 million. Possibly more concerning is the monthly change in hourly earnings only rose by 0.5%. Expectations were for a gain of 0.7%. Wages are not keeping up with the spike in inflation, especially for necessities like food, energy, and shelter. The labor participation rate continues to languish, coming in at 61.6%, 0.1% lower than last month. The U-6 which is the broadest measure of unemployment was 10.2%, down from 10.4%. Jerome Powell has mentioned that this indicator is a truer measure of unemployment. As we look forward it is worth noting Thursday’s Challenger report showed job openings were at the lowest level in a year.


Glenn Kelman, CEO of Redfin (@glennkelman), posted a series of Tweets about the state of the housing market. We share a few of the most interesting comments, but urge you to read the entire thread as it is very telling about the state of the real estate market.

  • It has been hard to convey, through anecdotes or data, how bizarre the U.S. housing market has become. For example, a Bethesda, Maryland homebuyer working with @Redfin included in her written offer a pledge to name her first-born child after the seller. She lost.
  • There are now more Realtors than listings.
  • Inventory is down 37% year over year to a record low. The typical home sells in 17 days, a record low. Home prices are up a record amount, 24% year over year, to a record high. And still homes sell on average for 1.7% higher than the asking price, another record.
  • In 2020, new-construction permits were *down* 13% in DC and New York, 40% in LA, 48% in Chicago, 50% in Seattle, 79% in San Francisco. Permits were *up* 25% in Miami, 56% in Vegas, 96% in Greenville, 122% in Detroit, 246% in Knoxville.
  • In Redfin’s annual survey of nearly 2,000 homebuyers, 63% reported having bid on a home they hadn’t seen in person.
  • For low-tax states, 4 people move in for every 1 who leaves. For Texas, this ratio is 5:1; for Florida, 7:1. Cites & states have no leverage to raise taxes, after many promised new money for social justice; the federal government will have to fund long-term investments.
  • The average housing budget for out-of-towners moving to Nashville was $720K, ~50% higher than locals’ $485K budget. It used to be coastal elites who worried that every adult in the family had to win a career lottery, just to afford a home. Now that feeling may spread.
  • it’s not just income that’s k-shaped, but mobility. 90% of people earning $100,000+ per year expect to be able to work virtually, compared to 10% of those earning $40,000 or less per year. The folks who need low-cost housing the most have the least flexibility to move.

 

 

June 03, 2021

Macro Market Review


The ADP jobs report came in much stronger than expectations at 978k versus 650k expected. Last month’s figure was revised lower by nearly 100k to 654k. The current estimate for tomorrow’s BLS report is +645k jobs. While the ADP data is a great sign for economic recovery, the improving employment market also signals an end to excessive monetary policy. Further improvement may be a case where good news is bad news for the markets.


Yesterday we discussed how the Momentum (MTUM) ETF has switched from growth stocks to value stocks. The same is occurring in other factor-based ETFs. For instance, the two top holdings of IWN, the iShares Russell 2000 Value ETF, are GameStop (GME) and AMC Entertainment (AMC). Both stocks have risen considerably to valuations that are extreme. They are about as far from value as one can imagine. The scatter plot below shows that AMC’s valuation is now approximately 10x its historical valuation based on revenue. One can easily argue the number is even higher as the movie theater industry will likely not fully recover from the Pandemic due to the growing popularity of streaming services.


Last night, the Federal Reserve said they will shortly announce plans to wind down their Secondary Market Corporate Credit Facility (SMCC). The announcement is a far cry from tapering QE, but it is another reversal of pandemic-related actions. The facility only owns $13.8 billion of corporate bonds and ETFs.


The graph below is yet another way to assess inflation expectations. The Citi Inflation Surprise Index measures economists’ consensus forecasts for inflation versus actual inflation readings. The higher the level, the more the economists underestimated inflation. Conversely, negative readings mean they overestimated inflation.  As shown, they are currently underestimating inflation by the largest amount since at least 1998.


The scatter plot below compares each monthly instance of 5 year UST yields with the Core PCE inflation index. As shown, the relationship over the last 30 years has been statistically significant. The orange dot shows today’s instance is straying far from the historical relationship. Either, the market thinks inflation is transitory and not pricing it into bond yields or the Fed, via massive liquidity injections, is artificially suppressing yields by about 4%.

 

June 02, 2021

In last Friday’s Technical Value Scorecard, we noted the popular ETF MTUM, which holds momentum stocks, has been shifting from a growth orientation to value, as sectors benefiting from inflation were showing the most momentum. To wit: “It is important to note that MTUM shifts its holdings based on individual stock momentum readings. In March TSLA, MSFT, AAPL, AMZN, and NVDA were the top five holdings. Today Tesla remains the top holding, but JPM, BRK/B, DIS, and BAC make up the remaining four. The index is more biased toward inflationary sectors versus disinflationary than it was 3 months ago.”  The graph below, courtesy of Lohman Econometrics, shows that purely as a result of the shift of stocks comprising momentum indexes becoming more value-oriented, the forward P/E ratios are collapsing.


Quarterly Sector Round-up


Our equity allocation decisions to different sectors and companies have been heavily focused on those most affected by the question of whether or not the recent bout of inflation is transitory.  The graph below, courtesy of @jsblokland, shows the strong correlation between the price of oil and inflation expectations. The price of crude oil has not been able to break above $70 since 2019. It is once again closing in on $70. A break above $70 will provide further warning that the inflationary trade may have more room to climb and with it, Value, energy, financials, and materials may continue to outperform.


The Fed has repeatedly said they will not consider tapering QE or raising rates until they meet their 2% inflation objective. Over the past year, they switched their inflation target from monthly indications of inflation to its average over time, although they have not been specific about the time frame in which to average inflation.

Regardless, the table below shows the Fed’s preferred inflation gauge Core PCE (excluding food and energy) and the widely followed Core CPI. As shown, both indicators, over most time frames, are near or above 2%. Note the 6-month data is annualized.  Given they are likely comfortable with their inflation target, the focus will be on employment data for signs the Fed may be ready to taper QE or raise rates.

 

June 1, 2021

Top 10 Buys & Sells

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On Friday we noted that the Chicago PMI report was strong except for the labor component. Today, the ISM manufacturing report was slightly better than expected but shows similar weakness in employment. The employment sub-index fell from 55.1 to 50.9, a six-month low, and is now barely in expansion territory.

The graph below from Brett Freeze shows the statistically significant correlation between the ISM index and the year-over-year change in ten-year UST yields. If the ISM is topping, as is probable, yields are likely to fall.


Setting Up Risk Profiles For Summer


Over the weekend, China’s central bank (PBOC) took steps to reduce the value of their currency which has been surging versus the U.S. dollar. Specifically, they are forcing their banks to hold an additional 2% of their foreign exchange in reserves. In theory, this will reduce the supply of dollars in China and likely weaken their currency. From the U.S. perspective, the action should help temper inflation. America imports more goods from China than any other country. The strengthening yuan was making Chinese imports more expensive. From China’s perspective, it was making Chinese goods less competitive from a pricing perspective. The graph below shows the significant appreciation of the yuan versus the dollar since the Pandemic started. (a lower yuan/$, as shown below, denotes strength of the yuan as it takes less yuan to buy a dollar) Please click HERE for a Bloomberg article with more on the topic.


Gamma Band Update


Cartography Corner June 2021


After last Friday’s strong Chicago PMI report, we get more manufacturing data today with ISM and Dallas Fed Manufacturing. The prices sub-index in the ISM report is expected to rise to 90, a level that was last recorded over 12 years ago. This week we will also get an update on the labor markets with ADP on Thursday and the BLS report on Friday. Economists are forecasting a 600k increase in payroll in the ADP report and 610k in the BLS report. Last month the BLS report was much weaker than expectations at +266k. Another weak report would be concerning as it signals job growth may be slowing at a faster pace than assumed by most economists.


Bloomberg reports that gold stored at the Bank of England has been selling for a premium. The implication, per the article, is the central banks, via the Bank of International Settlements (BIS), are buying gold. If true, their actions should provide a bullish tailwind for the price of gold. For more read BOE Gold Commands High Premium, Signals Central Bank Buying.

May 28, 2021

The Chicago PMI, measuring economic activity in the midwest, rose to its highest level in nearly 50 years. As noted in the report and shown below, all of the sub-indexes rose except employment. While the report is historically strong, it points to current supply line constraints and importantly a lack of confidence in the future. If confidence were stronger we would expect employment to rise. Simply, employers are not fully committing resources, likely under the assumption that current levels of activity are not sustainable.

“Chicago Business Barometer™ Pushed On To 75.2 in May The Chicago Business BarometerTM, produced with MNI, jumped to 75.2 in May, the highest level since November 1973. Demand provided a boost to business activity, but supply chain constraints remain. Among the main five indicators, New Orders and Order Backlogs saw the largest gains, while Employment recorded the only decline.


Personal Income and Consumption data, shown below, remains extremely volatile due to the rounds of stimulus checks. Most important in this data series are the price indexes (PCE price index). April’s PCE was +0.6% monthly and +3.6% versus last year. Core PCE, excluding food and energy, rose from 0.4% in March to 0.7% in April. The Fed will pay close attention to that Core PCE trend to assess how transitory inflation is.


Technical Value Scorecard


President Biden will propose a $6 trillion dollar budget for 2022 over the coming days. Per the administration, the deficit would remain around $1 trillion. To help assess the reality of their assessment, consider for the last 5 years, prior to the pandemic, tax spending average $4 trillion, while tax receipts averaged around $2 trillion per year. Taxes are expected to rise, but not likely enough to cover the additional deficit resulting from the increased spending. From an investment perspective, this matters because the Fed will have little choice but to support spending via very low-interest rates and more QE.


Yesterday we mentioned that Fed taper chatter is increasing. We follow up with an article from Zoltan Pozsar, Credit Suisse’s Fed analyst. Like us, he believes the Fed will taper QE in the coming months. The problem facing the Fed is the potential negative effect of tapering on asset prices. Zoltan offers a way for the Fed to reduce asset purchases with the help of Wells Fargo. As background, currently, Wells Fargo has a regulatory cap on asset purchases.

Per Zoltan: “While lifting Wells Fargo’s asset growth ban now would do more harm than good, it could come in handy when the Fed commences taper later this year or next. The market assumes that taper will lead to a sell-off in rates, like in the past–but that need not be the case. The Fed could announce its plans to taper, while at the same time announcing the end of Wells Fargo’s asset growth ban, so that fewer purchases by the Fed would be offset by more purchases by Wells.

Less buying by the Fed and more buying by Wells Fargo…”


The latest chatter on taper from Fed Vice Chair Randy Quarles:

“If my expectations about economic growth, employment, and inflation over the coming months are borne out, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings…”

 

May 27, 2021

Pending home sales fell 4.4% monthly versus expectations for a small gain. With the recent decline in new home sales, it appears the housing market is finally starting to cool off a bit.

Initial Jobless Claims continued to fall, reaching 406k this past week. Other than the past year, one has to look back to 2011 to find a higher number of new claimants. While the trend lower in claims is great, it is still confounding that such a large number of people are losing jobs on a weekly basis.


Market Crash or Correction?


It seems with each passing day the volume of media discussion about the Fed tapering its QE purchases increases. Yesterday we published, Taper Is Coming: Got Bonds? to help our readers assess how bond yields and related interest-rate sensitive equities perform during QE and afterward.

To wit: “Currently, yields are close to their cycle highs. If we believe the Fed is nearing tapering, yields could be peaking. Based on prior QE taper experiences, a yield decline of 1% or even more may be in store for the next six months to a year if the Fed is, in fact, on the doorsteps of tapering.”


The graph below shows that 5yr, 10yr, and 30yr UST bonds are in multi-month consolidation patterns following a spike higher in yield. From a technical perspective, these patterns resemble bullish flags. Based solely on the pattern, we would expect them to break out higher in yield by about the size of the “flag pole.” In the case of the ten-year (orange) that would entail a .75bps increase to approximately 2.25%. The opposite of a bullish flag, a bearish flag, can be found in the 3 bonds during the fourth quarter of 2019.

While cognizant of the pattern and the potential for higher yields, we believe bonds may be ready to break lower in yield due to the potential for a sooner than expected Fed taper of QE. A break below the flag support lines would provide some confirmation. We recently added a very small position of TLT, but remain well underweight bond duration in our benchmark. We are closely watching and ready to react in either direction, as the charts are signaling the potential for a large move.

May 26, 2021

Typically inventories of crude oil and its byproducts increase going into the summer months. As shown below, courtesy of TFA, inventories for all products declined in an atypical fashion last week. If oil usage reverts back to levels of 2019 and prior, and inventories do not pick up, we run the risk of higher short-term oil prices.


Setting-up For A Summer Sell-off


Yesterday we noted the record surge in two home price indexes. Housing makes up almost one-third of the CPI Index, yet despite surging home prices, the housing component of CPI is relatively docile. The graph below, courtesy of Macrobond, highlights the discrepancy between the FHFA price index and CPI-shelter. In 2019 we wrote an article on MMT and discussed flaws in inflation reporting. In regards to home prices, we wrote: “The BLS replaced an index based on actual home prices with what is now called owner’s equivalent rent (OER). OER is a rental equivalence that calculates the price at which an owned house would rent. It is important to note that rents were then and continue to be a part of the CPI calculation.”

The next graph updates analysis from the aforementioned article to show that CPI would 2.58% higher if the CPI calculation used the Case-Shiller Home Price Index instead of its OER calculation.

May 25, 2021

Consumer Confidence in May fell slightly to 117.2 from 117.5.  The present situation index rose sharply to 144.3 from 131.9 while the future expectations index dropped to 99.1 from 107.9. Such a divergence will likely be a headwind for larger consumer purchases. Personal Consumption makes up about 2/3rds of GDP, therefore consumer confidence is an important factor drive economic growth.


Both the FHFA and the Case-Shiller Home Price Index beat expectations. On a year-over-year basis, the FHFA index is now up 13.9% while Case-Shiller is up 13.3%. The FHFA’s 13.9% increase is the fifth straight record in the series dating back 30 years. The Case-Shiller number is the strongest since late 2005. Strong housing data provides the Fed a reason to reduce MBS QE purchases. Currently, they are buying $40bn a month.


How We Read Opportunity In This Market


The graph below from the Atlanta Fed provides more clues about the potential future path of inflation. The Atlanta Fed breaks all goods and services included in the CPI calculation into 2 categories, sticky and flexible. Sticky are those goods and services whose prices do not change often. Per the Fed: “Because these goods and services change price relatively infrequently, they are thought to incorporate expectations about future inflation to a greater degree than prices that change on a more frequent basis.” The r-squared between the core sticky price index and core CPI is .97, denoting a strong statistical correlation. The core index removes volatile food and energy prices.

Sticky prices are recovering but still below levels preceding the pandemic. The sticky price data series does not point to lingering inflation. On the other hand, the year-over-year change in the flexible pricing index is at ten-year highs. The flexible core index is at its highest level since the 1980s.


@not_jim_cramer offers a series of graphs below showing eight market gauges that should be of concern for investors. Seven of the eight graphs use red dots to compare current levels to prior similar levels. The graph without dots (left side, third from the top) compares the Fed’s balance sheet to forward P/E’s. The takeaway from this series of graphs is to buy stocks when the Fed is buying, but heed the warnings from the other seven graphs when the Fed stops.

May 24, 2021

Electric vehicle (EV) lithium-ion batteries rely on five critical metals: cobalt, graphite, lithium, manganese, and nickel. Per The Elements Newsletter, China is currently the number one ranked country based on their resource, mining, and refining capacity of the aforementioned metals. They are expected to maintain a dominant position until at least 2025. The United States currently ranks 15th and is expected to move up to 13th by 2025.


Top 10 Buys & Sells

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The Chicago Fed National Activity Index is the latest economic indicator to fall short of economists’ forecasts and the prior month reading. The Index comprised of 85 national economic indicators rose 0.24 versus a prior reading of 1.71 and expectations for a 1.2% increase. Production and Income accounted for about 2/3rds of the increase. Employment indicators rose slightly while personal consumption and housing fell slightly. Based on recent data, it is looking likely that the greatest effects of the latest round of fiscal stimulus are behind us and the economy is beginning to slow.


Markets Try, Try Again


Gamma Band Update


Economic data will be light heading into next Monday’s Memorial Day holiday. On Tuesday we get FHFA and Case-Shiller data on home prices. Both are expected to slow slightly from last month’s pace but are still running at very high rates. On Friday The BEA will release personal spending, personal income, and the PCE price index. These are key components of GDP and should help economic forecasters hone in on second-quarter economic growth. Also on Friday is the University of Michigan Consumer Expectations Survey. Again we will focus on the inflation expectations sub-index.


For what it’s worth, the Cleveland Fed sees little inflation on the horizon. The graph below shows their expected one and two inflation rates. We added a third line (Red) that computes, based on the one and two-year expectations, what the one-year inflation rate expectation is for one year from now (1×1). As shown, the forward rate is well below the Fed’s 2% target and less than pre-pandemic expectations.

 

May 21, 2021

The graph below, courtesy of Arbor, uses interest rate derivative markets to arrive at market odds for inflation over the next five years. The markets assign a 99% chance of greater than 1% inflation and 40% odds inflation runs greater than 3%. As we noted in Foreseeing The “Flation” Knuckleball, “However, we do not think markets are ready for a resumption of deflationary forces or a more pronounced outbreak of inflation. It is these two outliers where a fat pitch may lie.”  The graph backs up the statement as the markets are not betting on deflation or stronger inflation. Also, note the big shift in expectations from September 2019 to today.


Technical Value Scorecard


The graph below, courtesy of The Market Ear, shows the strong correlation between Tesla and Bitcoin. The author notes the two “assets” remain the number one emotional trades.” Not only are many investors of each asset emotional, but they are, to some degree, driving investor behaviors of the broader risk markets. As such, watch the “generals.” Quite often their price action leads markets. Both Bitcoin and Tesla were due healthy corrections. We now watch to see if they resume their uptrends or we must contemplate what comes next if they are indeed in bubbles as some investors believe.


Yesterday afternoon Jerome Powell and the Fed announced they will release a paper this summer exploring digital payments, with a focus on the possibility of issuing a U.S. central bank digital currency (CBDC). His short speech can be watched HERE.


A subscriber asked our thoughts on the graph below from ZeroHedge. Specifically, she noted that overnight reverse repo transactions transacted by the Fed just passed last March’s highs. Should we be concerned?

The Fed offers overnight reverse repo transactions (RRP) in which they lend securities in exchange for money. From the perspective of the counterparty, a bank or money market fund, they are making an overnight investment. The reason for today’s popularity is different than a year ago. In March of 2020, some money market investors wanted to reduce their credit risk and opted to invest with the Fed over weaker counterparties. At the time they were willing to accept a lower rate for the security offered by the Fed. Today, some overnight investment options have negative yields while the Fed’s RRP program has a floor of 0%. As such, investors are simply choosing a higher-yielding option in RRP.

The uptake in RRP usage is not a sign of a healthy funding market as it points to a shortage of collateral. Collateral is needed to create leverage. Many asset markets have been bolstered by extreme amounts of leverage. As such the situation bears watching.

 

May 20, 2021

The Philadelphia Fed Manufacturing Index fell sharply to 31.5, but still indicates a strong expansion. The Future Expectations Index also fell by a similar rate. The decline occurred despite the Price Index hitting the highest level since 1980. Also of note, the number of employees fell from 30.8 to 19.3. The index and all sub-indexes are all still in expansion mode but slowing. The special question of the month involved the outlook for prices the firm will receive and consumers will pay. The table below shares the inflation outlook.


Initial Jobless Claims fell to 444k in the prior week and continue to decline at a decent rate. Total continuing claims is also falling but still stands at a high number, just under 16 million. Continuing claims are more difficult to assess as it’s likely a portion of these claimants are seeing their claims period expire but are still jobless. It is also unclear how many “gig-economy” workers are included.


Bonds Foretell A Weaker Economy


The chart below, courtesy of All Star Charts, shows the economic surprise index has been positive for a record 240 consecutive days. The index measures economic forecasts versus actual economic data. A positive number, as we have had, means economic forecasters have underestimated the pace of economic activity. It appears that after two-thirds of a year, forecasters finally have a better grip on what’s driving economic activity. With that comes the risk they begin to overestimate data, and as such, investors find economic activity disappointing. The recent labor and retail sales reports are two such examples.


The chart below shows margin debt as compared to the S&P 500 as well as the annual change in margin debt in the lower graph. Margin debt can be called from the borrower by the lender if markets become volatile. They can also be paid back by the borrower if they deem conditions too risky and want to reduce risk exposure. Margin debt growth can continue to propel markets higher but at the same time, it increasingly becomes a potential hazard if it declines.


On Monday we shared how Bitcoin, Tesla, and other market leaders have recently been falling sharply. If the correlation between Bitcoin and equities holds up, and Bitcoin continues lower, caution is warranted, as shown below.

 

 

May 19, 2021

Today’s FOMC minutes show there are some Fed members that are near ready to taper. To wit: “A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.” On the other hand, the minutes also said: “It would likely take some time before significant change is made.”  The Jekyll and Hyde opinions within the Fed are likely a way for the Fed to prepare the market’s for tapering, yet have the excuse to delay tapering for much longer.


The following headline hit the wires this morning.  BULLARD: U.S. MAY BE “GETTING CLOSE” TO POINT WHERE PANDEMIC IS OVER, THEN ATTENTION COULD TURN TO POST-PANDEMIC MONETARY POLICY

St. Louis Fed President Bullard is one of the more dovish Fed members. As such, his comment alluding to “getting close” to tapering (post-pandemic policy), is another sign the Fed is inching closer to tapering despite its official statements.


The Slop & Chop Continues


As shown below, courtesy of Investing.com, many cryptocurrencies are having a rough morning and, for that matter, week. Double-digit percentage gains or losses are somewhat commonplace for cryptocurrencies, so the recent downtrend may not be a concern for crypto investors. For the rest of us, they are worth watching as crypto and other more traditional risk assets have become somewhat correlated. To wit, equities are currently down over 1% this morning, and as shown in the FINVIZ heat map below, almost every other asset class except the dollar is trading weaker.


The graph below, courtesy of Ally Invest, goes a long way in explaining why there are shortages of so many consumer goods and resulting inflation. As we showed last week, retail sales are now 15% above the trend of the last decade. At the same time, retailers did not anticipate such a surge in demand and did not stock up their inventories appropriately. It is highly likely retail sales will fall back to the trend unless there are more stimulus packages that directly aid citizens. Inflationary pressures should subside if retails sales retreat to the trend. On the other hand, if retail sales maintain at current levels, retailers will have to bulk up their inventories which will further pressure prices to the upside. Essentially, the graph below is saying that retailers do not have much confidence in the sustainability of stimulus-induced spending.


The graph below, courtesy of Nordea, shows Chinese credit growth is shrinking rapidly after ramping up during the pandemic. Given China is the world’s largest importer of commodities, the relationship between credit growth and commodity prices has been relatively strong. Note, the credit impulse is pulled ahead by a year in the graph to show the one-year lag between commodity prices and Chinese credit. Might the recent downturn in credit growth be a harbinger for much slower growth in commodity prices shortly? Nordea helps answer the question: “the clear roll-over in the Chinese credit data could be the canary watch.”

 

May 18, 2021

Housing Starts were much weaker than expected, falling by 9.5% versus expectations of -2%. The decline was led by single-family home starts which fell by 13.4%. Building permits grew by +0.3%, slightly less than expectations and below the last month’s 1.7% pace.  We have mentioned higher mortgage rates along with surging house prices and commodity prices would dampen new housing construction. We should add, the record cold snap in the midwest and Texas and the effect it had on home construction is still resulting in quirky data.


Anticipating Money Flow Signals


The dollar index is opening down 35 cents this morning and trading below 90. It is now within 30 cents of the low for this recent downward trend of 89.40 on April 1, 2021. Prior to that, the dollar had not traded below 90 since early 2018. The catalyst appears to be the Fed which seems to have no intentions of raising rates or tapering QE.

The graph below provides historical context for its current level as well as technical guidance. As shown, the dollar is sitting on the lower support line of a 10+ year wedge pattern as well as a horizontal line of resistance that turned into support. Both levels of support argue for a stronger dollar or at least a bounce. However, if support doesn’t hold, the dollar could tumble from current levels. A weaker dollar would provide further tailwinds for higher commodity prices and other imports.


The key to successful investing these days is to properly forecast the current and future path of inflation. A large part of the analysis is gauging how much longer supply line-related shortages will continue. Bloomberg published The World Economy Is Suddenly Running Low on Everything yesterday which helps explain why these shortages are occurring. The article also gives a concerning forecast as highlighted below.

“For anyone who thinks it’s all going to end in a few months, consider the somewhat obscure U.S. economic indicator known as the Logistics Managers’ Index. The gauge is built on a monthly survey of corporate supply chiefs that asks where they see inventory, transportation and warehouse expenses — the three key components of managing supply chains — now and in 12 months. The current index is at its second-highest level in records dating back to 2016, and the future gauge shows little respite a year from now. The index has proven unnervingly accurate in the past, matching up with actual costs about 90% of the time.”

 

May 17, 2021

It is worth adding to the prior comment that three other market leaders of the past few months are also struggling. Bitcoin is now down over 30% from recent highs to 42,000 while Tesla and ARKK (Cathie Woods ARK innovation ETF) are both down nearly 40% from their respective February highs. Bitcoin is resting just above its 200-day ma, while TSLA and ARKK have broken below it.


From March of 2020 until about a week ago, the price of lumber rose over 600%. While still greatly elevated from last year and years prior, its price is finally showing weakness. The graph below shows that lumber is down nearly 25% in the last 6 trading sessions. From a technical perspective, the prior two weeks of trading formed a bearish engulfing pattern, whereas the high and low last week exceeded the highs and lows from the prior week. Continued weakness would confirm the pattern represented a top. Further downside, along with weakness in other essential commodities, might alleviate some broader inflationary fears.


The New York- Empire State Manufacturing Index dipped slightly but remains at a very high level. However, prices paid and prices received surged higher to their highest levels since at least 2000.


Gamma Band Update


The Importance of Watching the Stock/Bond Ratio


Economic data this week will largely be focused on the housing sector. Today, the NAHB will release their Housing Market Index, followed by Housing Starts and Building Permits on Tuesday. Existing Home Sales will be released on Friday. Both Housing Starts and Permits are expected to decline from the torrid pace set earlier this year. Higher mortgage rates and surging prices for copper, lumber, and other commodities used to make homes are certainly a growing concern for homebuilders.


In recent months we have relied heavily on implied inflation expectations to help guide our allocation decisions. Periods where expectations were rising led to a clear outperformance of materials, energy, and financial companies. Tech, staples, and utilities tended to benefit when inflation expectations stabilized. What makes this analysis very difficult is that “market-based” inflation expectations are not really market-based anymore. The graph below shows the Fed has bought significant amounts of TIPs and Notes and Bonds, which can lead to distortions in these markets, and therefore skewed implied inflation calculations.

 

May 15, 2021

Victor Adair’s Trading Desk Notes – May 15th


May 14, 2021

The University of Michigan Consumer Sentiment Survey data was decidedly weak as shown below. Interestingly weakness was equal for both current conditions and future conditions. Driving the weakness is likely inflationary concerns. The long-term inflation expectations rose to 3.1% from 2.7% last month.


As if supply lines were not fractured enough, the Mississippi River is closed to barge traffic near Memphis due to concerns over a bridge. Currently, there are 771 barges awaiting passage. Per CNBC– “The shutdown fueled concerns about shipping U.S. grain and soy to export markets at a time when global inventories are slim and prices are near eight-year highs.


Retail Sales were much weaker than expected as shown below. The control group, which feeds GDP, was down 1.5% versus an expected slight increase. On the plus side, last month’s data was revised higher. The markets seem to be taking the data in stride with stocks and bonds at similar levels as prior to the release.


The Technical Value Scorecard is published


April Retail Sales are due at 8:30 ET this morning. Expectations are for a 1% increase, following last month’s 9.8% gain. March retail sales greatly benefited from stimulus checks. It would not be surprising to see a big deviation today from expectations as the timing of the stimulus checks and when/how they were spent is very difficult to forecast. Based on their credit card spending trends, Bank of America expects a decline in retail sales.


As we have discussed, base effects (comparison versus last year’s data) make price inflation appear much higher than it actually is. The graph below puts the CPI indexes in context with their trends of the last five years. Currently, the broad CPI index is only .011% above its trend. Core CPI, which excludes food and energy, is running 1.06% above its trend. If the inflationary impulse is in fact transitory and dies out over the next few months, inflation data will end up close to where it would have been had there never been a pandemic.


Almost a year ago Tim Duy wrote a powerful editorial for Bloomberg about how expects the Fed to maintain ultra-easy policy going forward. With inflation running hot and the recovery maturing, it is worth reviewing the summary paragraph of his article as we consider how the Fed might react to high inflation.

“The implication for financial markets is that the Fed expects to hold policy very easy for a very long time. They will reinforce this stance with enhanced-forward guidance and, eventually, yield-curve control. As long as inflation remains below 2%, the Fed will push back on any ideas that they will tighten policy anytime soon. And even inflation above 2% wouldn’t guarantee tighter policy if the Fed concluded the overshoot was transitory. Don’t doubt the Fed’s resolve to keep policy accommodative. They will keep reminding you if you forget.”

 

 

May 13, 2021

The charts below show that many of the grain futures have given up some of their recent gains. Crude oil is down over sharply today as well. While not a trend yet, a continued sell-off in these commodities and others will help relieve recent inflationary pressures.


Inflation? This, too, shall pass


PPI came in hotter than expectations, but much less so than yesterday’s CPI report. Of note, monthly PPI rose 0.6% which was more than expectations of 0.3%, however, last month’s gain in PPI prices was 1%, meaning the rate of increase is slowing. The year-over-year gain of 6.2% was above expectations for 5.9%. Based on the initial market reaction, the higher than expected PPI figures were priced in.

Jobless Claims continue to forge lower, coming in at 473k versus 498k last week.


Cryptocurrencies are opening up down 10-15% after Elon Musk said Tesla would suspend accepting Bitcoin for new purchases due to the excessive energy use required to mine Bitcoin. Prior to the announcement, Tesla bought and held a sizeable chunk of Bitcoin for “liquidity purposes” and Musk was a self-professed fan/promoter of Dogecoin. Given the wasteful energy use was a widely known fact, the announcement seems odd and we are left to wonder if there is more to the announcement.


On the heels of yesterday’s hot CPI report, PPI is due out at 8:30. The consensus estimate actually points to slower producer price growth on a monthly basis. The monthly PPI core (excluding food and energy) is expected to climb 0.4%, versus 0.7% last month. On a year over year basis, it is expected to rise 3.7% from 3.1%.

The graph below shows the difference between CPI and Fed Funds. The last time the difference was as large as it is was June of 1980. The Fed is making a big bet that inflation is transitory.


The graph below, courtesy of Sven Henrich, is a unique way to show the bubble environment. Wealth should stay relatively proportionate with the output of a nation. As shown, it currently sits well above what has been historically normal since at least 1950 and above two prior peaks. The last two times the ratio spiked higher (dot com bust and financial crisis) were followed by significant drawdowns in many asset markets. This time is not likely to be different, however, timing the eventual reversion to the mean is very difficult.

 

 

May 12, 2021

A subscriber commented to us that they thought the five-point increase in the VIX (as of 3 pm ET) was excessive given the S&P was only down by 1.6%. The scatter plot below charts daily changes of the VIX and S&P over the last five years. The orange dot shows that the relationship today is in line with the historical correlation.


Is the NASDAQ the Place to be?


CPI was much higher than expectations on a monthly and annual basis as shown below. The core CPI data (excluding food and energy) rose +.09% versus expectations of 0.3%. At 3% YoY, core CPI is now running at the highest annual rate since the mid-1990s. A big portion of the increase came from used cars. Per Zerohedge- “the index for used cars and trucks rose 10% in April. This was the largest 1-month increase since the series began in 1953. It accounted for a third of the seasonally adjusted all items increase.” The gain in used car prices is temporary as its a function of the low supply of new and used cars at the same time fiscal stimulus is flowing through the economy. Supply line problems and chip shortages will abate and stimulus will run its course, leading to a normalization of supply/demand. The Fed will find some comfort in this and likely discount today’s data.

Stocks initially fell on CPI but have been climbing back to near where they were before the release. Interestingly, bond yields are only slightly higher on the news. Bonds appear priced for the expected surge in inflation and maybe looking ahead to the Fed more actively discussing tapering QE. The dollar initially surged but has given back a big chunk of those gains.


In yesterday’s commentary, we provided a link to CNBC’s interview with Stanley Druckenmiller. As we shared, he commented- “I can’t find any period in history where monetary and fiscal policy were this out of step with the economic circumstances, not one.”  To stress his point he presented a graph of retail sales. To his point and shown below, retail sales are now 15% above the pre-pandemic trend or about 5 years’ worth of growth. If retail sales were simply to revert to trend, it would have to decline more than in the 2008/09 recession. This is but one example of economic activity propped up by massive fiscal stimulus. As the benefits of stimulus fade, and with less new stimulus on the horizon, economic activity will suffer. That is the fiscal cliff we will be dealing with in late summer and fall.


Yesterday’s BLS JOLTs report showed that the number of job openings in March surged to 8.12mm from 7.53mm in February. The graph below is the Beveridge Curve, which compares the number of job openings as a percent of the labor force to the unemployment rate. As shown, historically we would expect a job opening rate in the 2-4% range, not at nearly 5.5%. Further, the rate of job openings is the highest on record since the BLS started tracking it in 2000. Extended and enhanced unemployment benefits are partially responsible for the gap between what we are seeing and what we should expect. The full JOLTs report can be read HERE.

May 11, 2021

On CNBC, famed investor Stanley Druckenmiller warned about the current pace of fiscal and monetary policy. Given his stature and extremely successful career, we think it’s worth your time to listen to today’s CNBC Interview.

“I can’t find any period in history where monetary and fiscal policy were this out of step with the economic circumstances, not one.”


In today’s 3 Minutes on Markets & Money (linked below) Lance Roberts mentions that the NASDAQ is relatively oversold versus the S&P and DJIA. The graph below helps provide some risk levels on the NASDAQ (QQQ). Since the market rout last March, QQQ has fallen below its 50 day moving average three times as labeled in the top graph below. Currently, the NASDAQ is down about 2% this morning. It would not be surprising to see it decline to the range of the prior episodes (another 2-4%). The second graph shows its deviation from the 200 day ma. It is still about 10% above the average. Falling to the 200-day moving average might be strong support, but a significant break of the moving average would be concerning. As Lance mentioned, the NASDAQ is over-sold on a short-term basis but not a long-term basis. There is a potential opportunity here but it entails a good eye on risk management.


The Long & The Short of NASDAQ


The NFIB Small Business Optimism Index rose in April to 99.8. The Index has recovered about 2/3rds of its losses from pre-pandemic levels. The survey was quick to point out “42% of owners reported job openings that could not be filled, a record high reading. Owners continue to have difficulty finding qualified workers to fill jobs as they compete with increased unemployment benefits and the pandemic keeping some workers out of the labor force.” The three graphs below highlight the disconnect between hiring workers and being able to find workers to hire.

The survey respondents also appear to be sounding inflation warnings. Per the report: “The net percent of owners raising average selling prices increased 10 points to a net 36% (seasonally adjusted), the highest reading since April 1981 when it was 43%. The highest was 67% in October 1974 when inflation reached double digit rates.” The graph below highlights the sharp increase in prices.


The recent uptick in inflation expectations is resulting in the outperformance of inflationary sectors like materials, financials, and energy. At the same time technology, communications, and cyclical stocks are underperforming. Yesterday for instance the Dow Jones Industrial Average was down by only 0.09% while the NASDAQ fell 2.63%.  The tables below courtesy of Finviz show the significant divergence over the last week and month  Last week’s Technical Value Scorecard highlighted these divergences in more detail as well.


The graph below, courtesy of CoStar, shows a large majority of workers are still working from home. Longer-term estimates forecast that the work from home trend is viable.  Per forecasts, the numbers below are likely to only get back to about 80%. If that forecast holds true, there will be a sizable surplus of office space in big city markets.

 

May 10, 2021

The dollar, shown below, was showing signs of a bottoming process but it has recently turned more bearish. Recent weakness has taken it below the rising support line which started at the beginning of this year. A break below the early March and January lows would confirm more dollar weakness ahead. The MACD is currently oversold, but not at levels that might indicate a bottom is in place. The only bullish factor in the graph is the 50-day ma is about to rise above the 200-day ma.

The second graph compares the dollar to inflation expectations. As shown, they tend to have an inverse relationship. The current bout of dollar weakness is likely associated with the recent pick-up in inflation expectations.


S&P Breakout: Can It Hold?


The Gamma Band Update is published


CPI, PPI, and Retail Sales data will be released this week. CPI, due out Wednesday, is forecast to increase 0.4% monthly, and 3.8% year over year. The year-over-year data is skewed because of last year’s low inflation. As such most economists will focus on trends in the monthly data.

There will be a slew of Fed speakers this week. We are on the lookout for Fed members that are more inclined to see the Fed taper sooner rather than later. Given last week’s poor employment report, those in favor of tapering may not be as vocal about it in the coming weeks as they might have been if it were a stronger report.


Rumors have been circulating this past week about a potential merger between Chevron (CVX) and Exxon (XOM). While they may be serious, it is worth noting the two companies have been in discussions for the better part of the last five years. Interestingly, both companies were spun off of Standard Oil when it was broken up 110 years ago due to antitrust concerns.


Gary Gensler, the new SEC Chairman, sent a few warning shots toward the crypto markets last week. Some headlines as follows:

  • GENSLER SAYS WE NEED GREATER INVESTOR PROTECTIONS REGARDING CRYPTO TOKENS -CNBC
  • *GENSLER SEES GAPS IN OVERSIGHT FOR BITCOIN TRADING ON EXCHANGES
  • *GENSLER: BITCOIN TRADING ON LARGE EXCHANGES NOT PROTECTED
  • SEC CHAIR GENSLER: IF CONGRESS DECIDES TO ACT ON CRYPTO TOKENS, WE WILL COLLABORATE WITH THEM.

 

May 8, 2021

Victor Adair’s Trading Desk Notes – May 8, 2021

 

May 7, 2021

The graph below, courtesy of the WSJ, provides good context for the pace of the labor market recovery and how many jobs are needed before a full recovery.


The BLS jobs report fell far short of expectations at +266k versus a consensus estimate of nearly +1 million. The unemployment rate rose to 6.1%, which was +.3% above expectations. The average workweek rose to 35 hours from 34.9 and average hourly earnings rose .7% versus last month. On the wage front, hourly earnings are only up 0.3% versus a year ago. This is concerning given the denominator in the year-over-year math is April of 2020, the trough of the employment crisis. CPI is running at +2.6% YoY, meaning workers, on average, have lost 2.3% in purchasing power over the last year. Government stimulus has thus far eased the situation.

Leisure and Hospitality jobs added 331k, which accounts for more than the total number of jobs added. Temporary help lost 111k jobs which is surprising given how often we hear companies can’t find employees.

The initial market reaction was friendly for the deflationary sectors like technology. Bonds and gold are also off to a strong start. The market will likely perceive today’s report as evidence the Fed is far away from tapering.

The graph below, courtesy of Brett Freeze, shows the strong correlation between temporary help and GDP.


Technical Value Scorecard is published


Goldman Sachs shines a light on its poor expectations for wage growth today and for the remainder of this year- “We expect that base effects will pull the year-on-year rate negative in this Friday’s employment report, and that the composition unwind will drag the average monthly growth well below +0.2% for the remainder of 2021”

Wage growth is important because inflation, without a boost in wages, will be crippling especially for the lower-income classes.

Expectations for the BLS Employment report due at 8:30 ET are as follows:


Last night Fed President Lael Brainard stated: “Vulnerabilities associated with elevated risk appetite are rising.” The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a repricing event.”

And therein lies the Fed trap they set for themselves. QE and low-interest rates elevate risk appetites which drive stretched valuations and high levels of indebtedness. Tapering QE and/or raising rates might very well “amplify the effects of a repricing event.” More simply: Fed stimulus is blowing bubbles that will pop if they stop blowing.

A day after the last Fed meeting, Fed President Kaplan said: “The Fed should start talking about tapering bond-buying soon.” This was due to his concerns about rising inflation. Brainard’s comments yesterday concern rising financial instability. We think her comments might represent a more cloaked effort to push the Fed closer to tapering and raising rates.

May 6, 2021

Jobless Claims continue to improve, crossing below 500k, to 498k, for the first time since the COVID lockdowns began. There are still over 16 million people receiving state or federal claims, a number the Fed would like to see drop meaningfully before they talk about removing stimulus.


Recovery vs. Expansion


Yesterday afternoon, Boston Fed President Rosengren said “the mortgage market probably doesn’t need as much support now.” Similar to hawkish comments from Dallas Fed President Kaplan, it seems Rosengren is indirectly pushing for a tapering of MBS-QE. Currently, the Fed is buying $40 billion mortgages a month.


Real (after inflation expectations) 10-year UST yields peaked at -.58 on March 21, since then they have fallen to -.91%. Treasury yields fell nearly 10bps over the period while inflation expectations have been on the rise as of late as shown below. As we have noted on numerous occasions, the price of gold is highly negatively correlated to real yields. Since mid-March, its price has gone from 1675 to near 1800. The question for gold investors is can Treasury yields remain rangebound while inflation expectations rise?  That is a tall order.


We are not sure of the reliability of the graph below from the Daily Shot, but if somewhat accurate, it shows that farm values are expected to rise sharply. We think some of the credit for the increase is due to speculation and the recent popularity of owing hard assets, including land to protect from inflation. The recent surge in agricultural prices certainly helps as well.


Last Sunday, 60 Minutes aired a segment on the shortage of semiconductor chips in the United States. The shortage is part of the reason supply lines for so many products reliant on chips are troubled. Ford, for example, recently cut their production in half for the second quarter as it can’t source enough chips. Based on the segment, it is likely these shortages are likely to continue, to some degree, for two more years. Also of note, only 12% of chips are made in the United States leaving the U.S. vulnerable to Asian suppliers who manufacture about 75% of them.  LINK to the video clip.

May 5, 2021

Earlier today we wrote: “Based on recent Fed comments, employment seems to be the key factor stopping the Fed from tapering QE.” Fed Vice Chair Clarida just said the economy needs to add 8 million jobs to get back pre-COVID levels. From the trough of the last recession to 2020 the economy formed 182k jobs a month. At double that rate it will still take two years to get back to pre-COVID levels.


What the Hell, Janet Yellen?


The ADP Labor report was weaker than expected, showing the economy gained 742k jobs versus expectations for 850k. We suspect the report will be perceived by investors as equity market-friendly. Based on recent Fed comments, employment seems to be the key factor stopping the Fed from tapering QE.


Yesterday we reported that Yellen sparked a little fear by mentioning interest rates might “somewhat” if the economy overheats. Apparently, she got a tap on the shoulder as those remarks were rescinded in a speech later that afternoon. In those later comments she said “I do not see the rescue package as overheating the economy” and “I am not predicting anything.”


The ISM Manufacturing survey is an important gauge used by economists to assess the manufacturing sector. While most investors and economists focus on the quantitative results of the surveys, ISM also shares some commentary from respondents that can be illuminating. We share a few of the more interesting comments below. The rest can be found on the ISM website.

  • “Steel prices are crazy high. The normal checks on the domestic steel mills are not functioning — imported steel is distorted by the Section 232 tariffs.” (Fabricated Metal Products)
  • “It’s getting much more difficult to supply production with materials that are made with copper or steel. Lots of work on the floor, but I am worried about getting the materials to support.” (Electrical Equipment, Appliances & Components)
  • “In 35 years of purchasing, I’ve never seen everything like these extended lead times and rising prices — from colors, film, corrugate to resins, they’re all up. The only thing plentiful at present, according to my spam filter, is personal protective equipment [PPE].” (Plastics & Rubber Products)
  • “Demand continues to be very strong. Supply chain delays hamper our availability and ability to sell more.” (Machinery)

Over the past few months, we have noted the amount of margin debt, or leverage being employed in the equity market, is approaching, or in some measures greater than we have ever seen in the past. The graph below, courtesy of Topdown Charts, shows another form of leverage that is not captured in the margin data. The green line shows that assets under management (AUM) of leveraged long ETFs have risen by about 150% in the last year and sits well above pre-COVID levels as well as anytime in the 15 years prior. Signs of euphoria are everywhere but that doesn’t mean a top is imminent. However, it does mean, we should exercise caution, understand the potential downside, and manage our risk carefully.

May 4, 2021

It may be that interest rates will have to rise somewhat to make sure our economy doesn’t overheat,” Yellen said in an interview with the Atlantic recorded Monday that was broadcast on the web on Tuesday. “It could cause some very modest increases in interest rates.” – Per Bloomberg

Take notice of this important comment from Treasury Secretary Janet Yellen. After largely agreeing with Jerome Powell that inflation will be transitory and there is no rush to raise interest rates/taper, she seems to be changing her tone. Given her current role and former role as Fed Chair, she might be tipping us off to coming changes in Fed policy.


Downside Risk Outweighs Upside Reward


Equities fell this morning, supposedly on the rumor of a Chinese aircraft entering Taiwan’s Air Defense Identification Zone (ADIZ). The ADIZ is not the same as Taiwan’s territorial airspace. This event is likely not the cause for the decline because similar incursions have been occurring and have been widely publicized. Further, as shown below in the map, China’s and Taiwan’s ADIZs overlap, making it a possible “legal incursion.” That said, the area is becoming more of a geopolitical hot spot and worth paying attention to.


Most recessions are cyclical events that occur when inventories are bloated and, as a result, manufacturers cut production, resulting in layoffs. As shown below, in the ISM report courtesy of Bloomberg, during the 2008/09 recession, inventories rose which resulted in order reductions, ergo fewer backlogs, for new goods. Today is quite different. Inventories are at the lowest levels in at least 14 years as customers are waiting on new orders to replenish their inventories and meet pent-up demand for many products. This graph argues supply line-related product shortages will continue to be problematic and result in reduced supply and upward price pressures. Over time we expect the situation to normalize but given the historic divergence, it may take longer than expected, and the resulting price pressures may last longer than expected. At some point, the markets may begin to question the Fed on the “transitory” nature of recent price increases.


One of the more notable aspects of this earnings season is that companies reporting good earnings and sales have not been rewarded as they have been in the past. Per BofA, “Companies beating on sales/EPS in 1Q have led by just 16bps the next day, vs. average +1%.” Their graph below provides historical context.

May 3, 2021

Similar to a graph we shared last week, this graph by Standard and Poors shows the percentage of firms in each industry feeling profit margin pressure.


The ISM Manufacturing Index was weaker than expected at 60.7 versus 64.7 last month. Noteworthy, employment fell 4.5 points to 55.1, and inventories fell below 50 and into economic contraction territory at 46.5. Prices paid were the only notable subcomponent rising on the month. It was 89.6 versus 85.6 last month. As shown below, it has only been above 90 twice, the 1970s and 2008. The combination of higher prices and slowing economic activity is not a good sign for corporate profits. That said, one month certainly does not make a trend.


Gamma Band Update is published


Market Seasonality: Welcome to May


Cartography Corner is published.


The economic calendar will be busy this week. ISM releases its manufacturing survey this morning followed by its service sector survey on Wednesday. The most important data points of the week will be Wednesday’s ADP labor report and Friday’s BLS employment report. With inflation and inflation expectations near the Fed’s 2% target, employment appears to be the only factor keeping the Fed from discussing tapering QE and raising rates. The market is expecting the BLS to report that nearly 1 million new jobs were created in April, which should bring the unemployment rate from 6% to 5.8%. While great news, it is still well above pre-COVID levels.

We expect an active Fed speaking calendar this week. Again, we will be on the lookout for any dissension in the ranks in regards to the timing of removing monetary stimulus.

The earnings calendar will be busy this week as follows:


As shown in the graph below, the sharp increase in the amount of margin debt outstanding is only rivaled by similar increases before the meltdowns of 2000 and 2008. The red dots show periods when the annual change in margin debt exceeded two standard deviations. While an ominous graph, we caution that the amount of margin debt a year ago was falling rapidly with the market. As such, a year over year comparison may not portray similar circumstances as those leading to 2000 and 2008.

April 30, 2021

Victor Adair’s Trading Desk Notes For May 1, 2021


And just one day after the FOMC meeting, Fed President Kaplan is the first dissenter. This morning he said, “The Fed should start talking about tapering bond-buying soon.” He also said rate hikes should start in 2022.


The Chicago PMI Survey rose to its highest level since 1983. The index was 72.1 versus 66.3 last month. The broader ISM Survey, due out on Monday, is expected to be 65. Like Chicago PMI, that would be the highest level in nearly 40 years.


Technical Value Scorecard is published


Earlier this year we discussed how the Treasury would draw down its $1.6 trln cash balance at the Fed which would result in less short-term debt issuance and lower rates. Yesterday the Fed auctioned $40 bn 1-month Treasury Bills at 0.00%. As a result of the Treasury’s actions, investors are clamoring for short-term paper with any positive yield.  In the same vein, the Fed has recently been conducting its reverse repo program due to strong demand. In reverse repo (RRP), the Fed borrows money from participants in exchange for Treasury securities as collateral. The Fed only allows repo at 0% or positive rates. It sounds crazy but 0% is better than secondary market repo rates, so money market funds have interest in lending/investing at 0%. Unfortunately, like M2 money supply, the Fed discontinued providing Treasury balances held at the Fed. As such, we do not know how much longer the situation may last.


Late yesterday afternoon Department of Labor Secretary Marty Walsh said “a lot of gig workers in the United States should be classified as employees.” If his wishes are granted, companies like Uber (UBER), LYFT (LYFT), and Door Dash (DASH), will be on the hook to provide benefits to their employees that they are currently not supplying. All three companies were down nearly 10% on the news.


The first graph below shows that the U.S. savings rate increased markedly during the COVID crisis. This was due in to a combination of stimulus benefits received by many people that remained employed as well as limited opportunities to spend money due to economic shut-downs. Interestingly, as shown in the second chart, courtesy of the Financial Times, savings rates around the world increased sharply over the last year. The big economic question going forward is whether or not a global consumer mindset favoring savings versus consumption is emerging. As shown, in the U.S., the savings rate has been relatively stable. Given this long track record, we assume until proven otherwise, the recent spike in savings is an anomaly and will revert to historical norms once economic activity normalizes.

April 28, 2021

Comments from Jerome Powell:

  • “The unemployment rate of 6% understates the shortfall in inflation”
  • Prices will continue to rise due to economic reopening, pent-up demand, and supply chain bottlenecks, but price increases are temporary. He stressed this numerous times
  • The Fed will aim to anchor inflation at 2%, but will temporarily tolerate inflation above the target to offset prior periods of lower inflation
  • He made it very clear that a significant reduction of the unemployment rate and 2%  inflation is needed before tapering QE or raising rates. Until those goals are met there will be no reduction in QE ($80bn UST and $40bn MBS)
  • Per Powell, it’s not time to even begin “thinking about thinking about” tapering
  • We are unlikely to see persistent inflation with slack in the labor markets- (ergo they think wages are the primary driver of inflation and do not see them rising up yet)
  • He does not see long-time “scarring” of workers, meaning he believes the job losses are not permanent as we saw after the financial crisis.
  • They are watching housing prices rise but do not characterize the situation as a bubble because they do not see financial stability problems like in 2005-2008. He thinks the primary driver of higher prices is the lack of supply.
  • “Some asset prices are high.” Powell also alluded that parts of the equity markets are “frothy”

As we expected, the Fed’s FOMC statement was little changed from the last one from March 17th. The red-lined version below, courtesy of Zero Hedge, compares the two statements. As shown, the only changes are a slight upgrade in their description of economic activity with credit given to policy support and vaccinations.


Major Market Review


The graph below, courtesy of Optuma, shows the strong correlation between the ratio of Copper to Gold and 10-year U.S. Treasury yields. Historically, the Copper/Gold ratio has proven a durable measure of inflation. As shown, on a technical basis, the ratio is breaking out of a brief period of consolidation, portending yields will potentially move up in lockstep.


Prices for many agricultural products on the futures exchanges have been on a tear over the last month as shown below. The price increases of these goods will have a larger effect on the poor and middle class than the wealthy. Given the Fed has been outspoken about the divergence of wealth, and the poor being left behind, it will be interesting to hear their comments today on rising prices. We must also keep a close eye on staples stocks and assess if they can fully pass on the price increases to consumers. If not, they will take other measures to cut costs to try to keep profit margins stable.

1 Month Performance:

  • Wheat +24%
  • Corn +23%
  • Soybean Oil +20%
  • Canola +20%
  • Sugar +13%
  • Coffee +12%
  • Soybeans +12%
  • Oats +11%

The graph below, courtesy of All Start Charts, shows the economic surprise index has been greater than zero for 225 days, the longest such streak since at least 2003. The index measures economists’ economic forecasts versus actual economic data. The gist is economists have been consistently underestimating the pace of the economic recovery.

April 27, 2021

The graph below and commentary are courtesy of Danielle DiMartino Booth:

“Risk premiums on CCC bonds dropped below 500bps late Monday, a level only seen twice in the last two decades — the years leading up to 2008 financial crisis & right before the dotcom bubble burst.” 

By “risk premium” she is referring to the spread or differential between the yields on CCC-rated bonds and like maturity Treasury bonds.


Fed Meeting Preview


The Fed’s two-day FOMC meeting concludes tomorrow at 2 pm with the FOMC monetary statement and the Powell press conference at 2:30. While we expect little to no change in the statement and no change to ongoing monetary operations, we do think they will pay more lip service to inflation than they have been. They are likely to acknowledge the recent uptick in prices, especially of food and energy, but we expect them to stick to their belief that the increases are transitory. The Fed conversation may become more interesting over the next week or two as Fed members will be back out on the speaking circuit.

Over the last year, Fed members have been in unison in regards to comments on monetary policy and their policy of allowing inflation to “run hot.” With the inevitable taper on the horizon and a recent uptick of inflation in consumer staples, which hurt the poor, it will be harder for Powell to keep the group in line. This may prove troubling for the markets in the coming months.


The graph below on the left, courtesy of Stifel, shows that almost all of the gains in the S&P 500 over the last decade occurred during periods when the year over year growth of the global money supply was increasing. The graph argues the rally may hit some headwinds in the coming months as the annual growth of the money supply will inevitably see a sharp decline. We are now a full year past the initial liquidity injections of 2020. As this occurs the denominator in the annual growth calculation will increase rapidly. The second graph quantifies this effect by showing how year over year U.S. M2 money supply growth will shrink despite the assumption that the Fed continues to add $120bn a month of QE.

April 26, 2021

While on the topic of the Fed’s possible trial balloons, Bloomberg released the following article this morning- Fed to Taper Bond Buying in Fourth Quarter, Economists Say.


What Are You Doing With All Of That Cash?


The Fed likes to use trial balloons to assess how potential changes to their operations might affect investor behaviors. Given that the economy is recovering nicely, vaccinations are giving a further boost to economic activity, and inflationary pressures are on the rise, we suspect the Fed may be closer than they allude, to begin “thinking about thinking about tapering.” To wit, this morning comes a potential trial balloon by the WSJ article entitled The Fed’s Next Test Is Breaking The Ice Over Policy Shift. There is nothing in the article that leads us to believe change is coming at this week’s FOMC meeting, but it does state the Fed is closing in on the time when they must start to reverse emergency stimulus measures. It wouldn’t surprise us if Chairman Powell makes a short statement this Wednesday saying as much. The question is, how will the markets react.


The Gamma Band Update is published.


The economic calendar is relatively light for a second week running. Of note this week will be personal income and spending and the PCE price index on Friday. The PCE index is the Fed’s preferred inflation gauge. Also on Friday will be the University of Michigan Consumer Survey and importantly their survey on inflation expectations, as well as the Chicago PMI report and their inflation sub-survey. After a weak durable goods report last month, economists are expecting a strong rebound to 2% when released at 8 am today.

The highlight of the week is likely to be the Fed’s FOMC meeting and Powell’s press conference on Wednesday. Similar to the last couple of meetings we suspect little will change in their statement that would lead us to believe they will be more or less aggressive with monetary policy. As such, any meaningful changes in QE or just in their tone or descriptions of economic/market activity may have an outsized effect on markets.

This will be a big week for Q1 earnings releases. The table below shows the more widely followed earnings release dates.

 


The graph below, courtesy of Goldman Sachs, shows that SPAC issuance has significantly slowed. Thus far in the second quarter, 6 SPACs have come to market. That compares to over 50 at the same point in the first quarter. Poor recent returns and heightened regulatory risks are largely to blame for the decreased issuance.

April 24, 2021

Victor Adair – Trading Desk Notes For 04/24/21

April 23, 2021

As shown below, the Baker Hughes Rig Count is still below pre-COVID levels despite the price of oil having fully recovered. Assuming the rig count does not spike higher as the economy continues to recover, this should limit supply and keep a bid under the price of oil. The wild card is OPEC, which has begun slowly increasing production levels.


The graph below, courtesy of the Daily Shot, shows that people are using mortgage refinancings and home equity lines to draw on their house’s equity. The extra money is providing homeowners additional funds to pay down other debts and spend. Recent trends in credit card debt lead us to believe that some people are using their home’s equity to pay down costly credit cards.


The Technical Value Scorecard is published.


On Tuesday Fortune published an interesting article on some of the risks with Bitcoin mining. The key takeaways included pollution and national security. On the pollution front the article stated:

  • “Overall, de Vries reckons that fossil fuels power around 70% of all Bitcoin mines worldwide, and that coal provides the vast majority of that share. “We now know for sure that one-third of all production runs on pure coal from a tiny place in China,”
  • “Miners are going to unusual places in search of the cheapest power that’s also reliable—and that’s almost always fossil fuels.

In regards to national security:

  • Finally, “It’s now clear that one-third of all the world’s Bitcoin-mining power masses in a single hotbed of our archrival, China. He fears that if tensions between the U.S. and China escalate, Beijing could use the equipment in Hutubi and the rest of China to paralyze the network, halting all transactions. That shutdown would wreak havoc with the hedge funds that hold Bitcoin and the corporations piling the coins into their treasuries.”
  • Since sanctions constrain Iran from exporting oil, Tehran is developing a new market inside the nation’s borders by luring Bitcoin miners with super-low energy costs. By some reports, Iran now accounts for 8% of the world’s Bitcoin production.

April 22, 2021

President Biden will propose boosting the long-term capital gains rate to as high as 43.4% for those with earnings of greater than $1 million. It is rumored the tax will be retroactive to include 2021 gains. Stocks are trading lower on the news.

To show how deep our fiscal deficit issues are we share a paragraph from Bloomberg on the tax increase: “The Tax Foundation estimates that increasing capital gains taxes in the fashion suggested by Biden would result in just $469.4 billion in revenue over 10 years. That may seem like a lot, but most of the forecasted tax revenue will be back-end loaded and is actually paltry when compared with projected total government outlays of $6.6 trillion in fiscal 2020 alone. Capital gains taxes account for about 5.2% of tax revenue on average.”


Initial Jobless Claims fell again to a one-year low of 547k. Despite the recent decline in state unemployment claims, the total number of unemployment benefits, including Federal programs, rose by 500k to 17.4 million. It has been hovering around this level for all of 2021.

Existing Home Sales were weaker than expected at 6.01mm annualized sales, down from 6.22mm last month. The monthly decline of 6.6% is due to higher mortgage rates, higher prices, and a limited supply of homes on the market. The report stated there were slightly over 1 million homes for sale in March. To stress how little supply is available on the market, that number is 28% less than last March, when the economy was reeling from COVID lockdowns. Even with the declines over the last two months, Existing Home Sales remain well above the rates of the prior ten years.


Where Is The Smart Money Going?


Yesterday we discussed how SPACs and Bitcoin can help us gauge the market’s desire to take on risk. We would be remiss if we did not mention Lumber. The price of Lumber futures is up nearly 300% from pre-COVID levels. While supply line shortages and heavy construction demand for lumber are driving its price higher, speculation is also playing a role. Add lumber to the list of “risk-on” assets to keep an eye on.


Per Bloomberg, Dogecoin (cryptocurrency) is now worth more than Ford and Kraft Heinz. Per Yakob Peterseil at Bloomberg:

“No one thinks these blue-chip stocks are all that comparable to Dogecoin, a fringe asset with no real purpose beyond being a joke on social media. But the similarity of their market values underscores the boom in cryptocurrencies that’s taken Wall Street by storm.”

April 21, 2021

Over the first two months of 2021, SPACs were all the rage. From January through February 17th, the IPOX SPAC Index rose 27%. Since then it gave up all of the gains and is down over 3% year to date. The quick rotations into and out of risky products have been a hallmark of the last year. As we noted with BTC below, following these trends can yield important clues about market sentiment.


Where Do We Go From Here?


The Bank of Canada (BOC) appears to be the first central bank to reduce COVID-related QE bond purchases. Partially driving the decision is a sharp rise in home prices. To wit: “We will continue to have an eye on the threats posed by the dramatic increase in home prices.” One has to wonder if the Fed is harboring similar thoughts.


The graph below is of Bitcoin’s (BTC) price for the last year. We follow it, in part, because the “risk-on” trade in some equity sectors has been well correlated with BTC. As shown the recent 5-6x increase in price from last fall had good support in its 50-day ma as well as the white support line. Over the last few days, it has broken below both. BTC is certainly extended and due for a pull-back. Given how much its risen in just months, a decline to the 200-day ma (34,123) should not be shocking. Equity investors in some of the high-flying stocks linked to BTC, like Tesla, Coinbase, Overstock, and Microstrategy, should pay close attention.


The following series of graphs, courtesy of Brett Freeze, shows bank lending growth contracted for the first time since 2010. At the same time, securities and cash held by the banks are rising rapidly. QE is designed to spur loan growth but, as shown, banks are using the Fed reserves to buy investment assets, not make loans. This is one reason QE has been a strong tailwind for asset prices but unable to help sustain economic growth.

The graph below, courtesy of Zero Hedge, further confirms Brett’s analysis. As shown, loan growth from the four largest banks has been flat since the 2008 financial crisis despite a doubling of bank deposits. Prior to 2008, banks used deposits to make loans, and accordingly, they tended to grow at very similar rates.

April 20, 2021

Coca-Cola is raising prices to help offset higher input costs. Per CNBC they “join a number of other consumer giants, such as Kimberly-Clark and J.M. Smucker, in hiking prices.” With the price of many commodities up significantly over the past few months, investors will be looking to see if they can raise prices to help stop profit margins from shrinking, yet, at the same time, not hurt demand for their respective products.


Why We Are Reducing Exposure to Markets


Last week we shared data from the BLS JOLTs report showing that despite a large number of unemployed people, employers are having a hard time hiring. To that end, we ran across a report from Business Insider which claims McDonald’s is paying people $50 just to interview for a job and “it’s still struggling to find applicants.”  The graph below tells a similar story for companies in search of truck drivers.


Julian Bittel, in his graph below, argues that the recent surge in equity valuations implies poor future 1-year returns. As such, the gray line, the equity to bond ratio, should fall sharply, meaning bonds will outperform stocks. If true this would represent a reversal of the last six months in which bond prices fell while stock prices rose.


The graph below, which was accompanied by a few tweets from Jim Bianco, shows the rolling annual Federal deficit in dollar terms at the top left, and as a percentage of GDP at the bottom left. Per Jim Bianco “As this chart shows, the last 12-months the deficit was hard to understand $4+ trillion. As a % of GDP it was equally hard to understand 19%.” The second chart shows that the only time the government went into as large a deficit, as a percentage of GDP, was during WWII. The financial crisis of 2008 and the Great Depression, pale in comparison to the current deficit.

April 19, 2021

Gamma Band Update is published.


Federal stimulus is not likely to spark long-term inflation, says Lisa Abramowicz in an opinion piece recently published to Bloomberg.

“The headline numbers seem huge: Americans have $1.8 trillion in extra savings over the pre-pandemic total, according to the latest estimates by Bloomberg Economics based on data through February. A lot of this stems from about $877 billion of checks sent to U.S. households in three rounds of stimulus payments during the pandemic, which has helped consumers pay down debt and save.

The question, though, is how much of that they can truly deploy in the coming months. While March retail sales surged 9.8%, the most in 10 months, according to data released on Thursday, the jump comes on the heels of stimulus checks that spurred shopping sprees.”

Abramowicz goes on to explain,

“On average, American households set aside about 26% of their stimulus checks to buy things in the relatively near future, with most of the funds going toward savings and debt payments, according to an April 7 New York Fed research report.”

She concludes by stating that it’s tough to see how “helicopter money” alone could lead to sustained inflationary pressures in the US.

 


Top 10 Buys & Sells

From TPA Research (Click Here to add TPA Research to your subscription.)

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Time to Take Profits?


The economic calendar will be quiet this week. Of note will be existing home sales on Thursday and new home sales on Friday. The next Fed FOMC meeting is scheduled for next Tuesday and Wednesday.  As such, speeches or comments from voting fed members will be sparse as they enter a self-imposed media blackout this week.


As shown below, the corporate earnings schedule will be much busier this week as we progress further into earnings season.


The graph below is a good tool to help define sectors according to Growth/Value and Defensive/Cyclical traits. As we have discussed sectors falling into the Cyclical/Value description were the best performing sectors when implied inflation was running higher in late 2020 and early 2021. Over the last month, with implied inflation values stalling out around 2.5%, Cyclical/Quality is taking back leadership. Generally speaking, the market has been keyed on value vs growth and seems to prefer cyclical over defensive sectors. You can map this to our weekly Technical Scorecard report to better evaluate sector rotations on a weekly basis. We are doing more work with this type of analysis that we hope to share soon.

April 17, 2021

Victor Adair Trading Desk Notes For April 17th, 2021

April 16, 2021

Housing Starts for March came in above expectations at 1.739M units annualized versus the consensus estimate of 1.620M and a prior month reading of 1.421M. Housing Permits were 1.766M— slightly above expectations of 1.750M and a prior month reading of 1.682M. This is somewhat surprising given higher mortgage rates and record lumber prices are starting to weigh on homebuilders. Six to nine months from now, these positive readings could help alleviate the supply shortage currently facing the housing market.


Earlier in the week, we discussed the role higher energy prices are playing in boosting CPI. The graph below, courtesy of Jim Bianco, shows how Used Car prices are rising at their fastest annual pace in at least 20 years.

In Used Car Prices Soar and The Sticker Shock May Get Worse, MarketWatch comments on the situation as follows:

“How come? It’s a classic case of low supply and high demand.

There’s just not as many used vehicles for sale, for one thing. The pandemic forced rental agencies to slash purchases of new cars after a steep decline in individuals leasing cars at airport and other locations. Those vehicles typically are sold to used-car lots after a year or less.

At the same time, demand rose for used vehicles as more people avoided public transportation or moved from the cities to the suburbs to escape the coronavirus. Cox Automotive estimated that demand for used vehicles has doubled since last March.

Many Americans preferred used vehicles to save money in a time of great economic uncertainty, especially with the cost of new cars and trucks at an all-time. Earlier this year the average cost of a new vehicle surpassed $40,000 for the first time, the auto-research firm Edmunds found.

The imbalance is unlikely to end anytime soon.”


The chart below, courtesy of Ned Davis Research, shows retail investors are “all-in” so to speak. Rising stock prices and pitiful bond yields are pushing investors to take their highest allocation to equities since the days preceding the dot com bubble crash. It is worth reminding you of Bob Farrell’s investment rule #5: the public buys the most at the top and the least at the bottom.

April 15, 2021

**We apologize, there will be no 3 Minutes on Markets & Money this morning due to technical difficulties.

This morning CitiBank warned that peak credit losses may not occur until 2022. While the market is bulled up on the banks and their prospects, some seem to be losing sight that many loans and mortgages are in forbearance. As the borrowers are forced to make regular payments plus make up for missed payments, we are likely to see a decent number of defaults. The question facing banks is how much of their loan loss reserves do they need to hold in anticipation of coming defaults. Yesterday JPM said it released $5.2 billion in loss reserves, leaving it with $25.4 billion. As a comparison, they had $18.6 billion prior to COVID.


The Technical Value Scorecard is published.


We start the day with much better-than-expected economic data. Initial Jobless Claims fell sharply to 576k versus expectations for a 700k increase. Retail Sales, with the help of newly minted stimulus checks, rose 9.8% on a monthly basis. Interestingly, despite the strong economic numbers, bond yields are falling this morning. The ten-year UST yield is currently down 4 basis points to 1.60%, about .15% below the highs from two weeks ago.


China has been a leading driver of global economic growth for the last decade-plus. Fueling the growth are exports, massive infrastructure projects, urbanization, and importantly, extreme leverage. U.S. economists pay close attention to their money supply or so-called “credit impulse” to gauge how much financial and economic leverage is being generated. As shown below, M1 has been growing at a relatively tepid rate despite the Pandemic. The PBOC (central bank) is making a concerted effort to limit further expansion of leverage in hopes of making economic growth more sustainable over the longer term. While prudent, it will weigh on short-term economic growth for not just China, but the U.S. and the rest of the world. The graph to the right shows Morgan Stanley’s expectation for reduced credit growth resulting from the PBOC’s actions to reduce leverage. As they note, commodity prices are likely to feel the sting as China is the world’s largest consumer of many commodities.


We have struggled over the last few months to reconcile the high and sustained rate of weekly jobless claims with the quickly recovering labor market. Zero Hedge recently published an article that seems to explain some of the divergences. Jobless Claims, as the title says, are claims for money, not actual payments. Just because one makes a claim for jobless benefits doesn’t mean they are given money. The graph below shows about 50% of claims, prior to COVID, resulted in payments. Currently, about 20-25% of jobless claims receive benefits. Assuming a quarter of claimants (versus historically half) actually receive benefits, the number of weekly claims is more in line with the unemployment rate.

April 14, 2021

The Coinbase (COIN – Crypto Exchange) IPO initially traded at $391, which is a market cap of just under $100 billion. For context consider Goldman Sachs has a market cap of $115 billion and Charles Schwab is $127 billion. Also, consider the largest stock exchange, prior to today’s offering, was the Hong Kong Exchange at $74 billion.


Following on the heels of CPI yesterday, we got more inflation data today. Import prices rose 1.2%, above the estimate of 0.9%, but 0.1% weaker than last month. Export prices rose 2.1% versus 1.6% last month and well above estimates of 0.9%. The Atlanta Fed released their Business Inflation Expectations at +2.5% annually versus +2.4% last month. Their reading is in line with CPI at +2.6% annually.


S&P Marches Forward Ahead of Earnings Season


Per the latest NFIB survey, the number of small companies having trouble filling jobs is the highest since at least the early 1980s, as shown below to the left. Last week JOLT’s report also reported a high number of job openings. The graph to the right is the Beveridge Curve. It compares the number of job openings as a percentage of the working population (y-axis) to the unemployment rate (x-axis). The orange dots and the line show the path of this data over the last 13 months. While the labor situation has improved markedly, it is confounding unemployment is over 2% higher than pre-COVID despite a record number of job openings. Also, worth noting, the curve shifted right (green to blue) after the last recession. In light of the massive amounts of stimulus, which will weigh on future economic growth, might current readings be an early warning of another shift to the right?


Along with record prices come record valuations. The graph below, courtesy Top Down Charts, shows that a composite valuation using CAPE10, P/E (TTM), and 1yr. forward P/E is nearing its peak of 1999. This indicator will decline in the coming weeks with improved Q1 earnings reports. If earnings were to stay constant, the S&P would need to rise about 5% to take out the 1999 highs. While valuations are concerning and should raise our risk radar, we also have to recognize stocks may have further to climb. As we wrote in Zen and the Art of Risk Management

“The market is grossly expensive, but as we stated valuations have poor predictive ability to help gauge what will happen in the next few weeks or months. Despite extreme valuations, we can ride the market higher with other greedy investors. However, unlike most investors, we are aware that the risk of significant losses is not minimal.”

“Quantifying downside risk allows us to have a plan in place to reduce or hedge risk when technical indicators and other signals alert us to potential changes.”

April 13, 2021

Prelude to the Dance Kicking Off Earnings Season


CPI was .1% higher than expectations on a monthly and annual basis as shown below. While slightly warmer than expectations it was not as hot as the PPI print last Friday. This non-confirmation may prove to be a temporary relief for the bond markets.


The graph below shows the market’s breadth, as measured by the percentage of S&P 500 stocks above their respective 200-day ma, is at its highest level in over five years. With a reading over 95%, this gauge serves as a warning as markets fell sharply when it peaked at slightly lower levels in early 2018 and 2020. That said, prior peaks such as in the first quarter of 2017, saw breadth deteriorate without a sharp drop in the S&P 500.


The graph below, courtesy of Brett Freeze, shows consumer credit trends. Noteworthy, the year-over-year change in revolving credit (credit cards- non-seasonally adjusted) is falling at the sharpest rate since at least 1994. Despite the housing boom, non-revolving consumer credit is also trending lower, albeit still exhibiting positive growth. Personal consumption typically accounts for about two-thirds of GDP. As such, consumer borrowing is an important driver of personal spending.


Below is the corporate earnings schedule for the week:

April 12, 2021

St. Louis Fed President Bullard made an interesting comment today as follows: Fed’s Bullard Says 75% Vaccinations Would Allow for Taper Debate. For now, we will treat this as a one-off statement and not necessarily representative of other Fed members. However, If we hear similar rhetoric from other Fed members, the equity markets will pay closer attention to vaccination data and likely fret as they rise.


Market Weaken With Extreme Exuberance


Gamma Band Update is published


This will be an important week for economic data with CPI at 8:30 am ET tomorrow, Fed Chair Powell speaking on Wednesday, and Retail Sales due out on Thursday. Also on the radar will be the University of Michigan Consumer survey on Friday and, in particular, its inflation gauges. With PPI rising well above expectations last Friday, investors will be looking for confirmation in other inflation indicators. More important, will be any indications pointing to whether this bout of inflation is transitory or longer-lasting.

Q1 corporate earnings start this week in earnest. The banks will lead the way with JPM and GS releasing earnings on Wednesday, followed by many other big banks on Thursday. We are expecting strong reports from the large banks as they are likely to significantly reduce loan loss reserves. Further, the steeper yield curve should have increased margins, and the active trading environment bolstered trading revenue.


In the upcoming Q1 earnings reports, investors are likely to focus on rising input inflation costs and how companies will try to maintain or boost profit margins. Our friend Eric Cinnamond at Palm Valley Capital wrote an interesting article on the topic (LINK) that is worth reading. Here are few noteworthy passages:

Recent quarterly results and commentary of the businesses on our 300-name possible buy list support my anecdotal observations. With declining inventories and rising costs, companies have been reducing promotions to protect gross margins and receive full price on their limited supply.

Another business we follow, Big Lots (BIG), also reported fewer promotions, stating, “As our inventory levels were sold through, we were able to navigate through the holiday period with fewer promotions than last year. This reduction in markdowns significantly mitigated the pressure felt from increased spot freight rates and higher supply chain charges we incurred.”

Nike (NKE) discussed how supply chain shortages are negatively impacting sales, saying, “Starting in late December, container shortages and West Coast port congestion began to increase the transit times of inventory supply by more than three weeks. The result was a lack of available supply, delayed shipments to wholesale partners and lower-than-expected quarterly revenue growth.” Management also commented on its improved gross margins, partially contributing them to “higher full-price product margins.”

April 10, 2021

Victor Adair’s Trading Desk Notes

April 9, 2021

Chairman Powell will appear on 60 Minutes Sunday night. We presume he will talk up the economic recovery, pledge to keep the stimulus coming, and try to allay any fears of sustained inflation.


Producer Prices (PPI) surprised to the upside, rising 1% in March and 4.2% on a year over year basis. Expectations were for a gain of half a percent and +3.8% year over year. The 4.2% increase is the largest since 2011. We remind you, year over year analysis involves a comparison to March of 2020 when the economy wash shut down. Core PPI, excluding food and energy, rose .6% versus expectations of a .2% gain. CPI will be released next Tuesday. It will be interesting to see how much of the increase in input prices (PPI) corporations are able to pass on to consumers. The current estimate for CPI is +.5% and +2.5% on a monthly and annual basis respectively.


The Technical Value Scorecard is published.


The graph below, courtesy of the Daily Shot, shows that 42% of stimulus checks are being saved and 34% are being used to pay down debt. While this bodes well for personal finances and helps explain the reduction in credit card balances, the stimulus is not stimulating the economy as much as politicians desired.


On April 29th the BEA will release the first-quarter GDP. The graph below shows the Atlanta Fed estimates growth will come in around 6%, while the consensus of economists is closer to 4%. The recent bump up in the Atlanta Fed forecast is primarily due to increased government spending forecasts and the robust housing market.


The chart below, courtesy of Macrocharts, shows that large gold outflows from the GLD ETF, as recently experienced, are typically followed by decent rallies. As shown 660k metric tons of gold were removed from the ETF in recent weeks, the second-largest withdrawal in the history of the ETF.  We added a 2.5% position of gold via IAU three days ago in both the Equity and Sector models. Our internal money flow models are turning bullish, signaling the recent downtrend may be ending. The second graph shows that when RSI and MACD are extremely oversold (vertical gold lines), gold tends to rally. Further, gold bounced off its support trend line (ascending purple line) and formed a double bottom. The double bottom and trend support line provides us two relatively low-risk areas to establish stop-loss limits. If gold continues to show signs of a trend reversal we may add another 2.5% bringing the total to 5%.

April 8, 2021

As of late February, investors had borrowed a record $814 billion against their portfolios… up 49% from one year earlier, the fastest annual increase since 2007… Before that, the last time investor borrowings had grown so rapidly was… in 1999.”Investors Big and Small Are Driving Stock Gains With Borrowed Dollars. -WSJ


The economic recovery will face some challenges in the months ahead. One of them is that Federal/state actions allowing renters and mortgagees to skip payments and making evictions illegal will shortly end. As this occurs, those the did not make payments will have less money to spend for general consumption as they will have to pay rent/mortgage payments or face eviction. To this end, the Texas Supreme Court is allowing the emergency forbearance order to expire and will not enforce federal orders to stop evictions. For more, NPR wrote the following article: Texas Courts Open Eviction Floodgates: “We Just Stepped Off A Cliff.”


Despite the blockbuster jobs report last week, Initial Jobless Claims continue to make very slow progress lower. This past week 744k new people filed for claims versus 728k the prior week. The number of federal and state continuing claims continues to hover around 18mm, the same level it has been stuck at for the last four months.


Consolidation Before Correction


Yesterday’s Fed minutes from the March FOMC meeting were as expected for the most part. Below are a few noteworthy sections:

  • “Participants noted that it would likely be some time until substantial further progress toward the Committee’s maximum-employment and price-stability goals would be realized and that, consistent with the Committee’s outcome-based guidance, asset purchases would continue at least at the current pace until then.”
  • Per CNBC -” Though inflation shows up 64 times in the minutes, Fed officials indicated little concern that it might become a problem anytime soon. One notion in the minutes said that inflation forecasts were right around where FOMC members expected.”
  • Disorderly conditions in the Treasury markets or a persistent rise in yields that could jeopardize progress toward the Committee’s goals were seen as cause for concern”

After the minutes were released, Lael Brainard essentially defined “Disorderly Conditions”: “I would be concerned to see disorderly conditions, like we saw Feb. 25.”  On February 25th, the ten-year UST yield increased 13 basis points which represents a 2.73 standard deviation move.  The graph below shows the daily standard deviation of changes in ten-year UST yields over the last ten years. A change of 2.73 or greater has occurred 41 times in the last ten years. In other words, the bar is set pretty low for the Fed to potentially take action to limit yields rising.


April 7, 2021

Per the headline below, some of the supply line-related problems are improving. Any inflationary pressures due to these temporary problems should abate with continued normalization.

* NATIONAL RETAIL FEDERATION – CONGESTION AT U.S. PORTS IS ABATING AS CONTAINER CARRIERS AND TERMINALS ADJUST TO NEW NORMAL


The graphs below show the MBA’s Purchase and Refi Indexes as compared to mortgage rates. We are watching them closely to see how higher mortgage rates affect both indexes and therefore the economy. In the first graph, showing the Purchase index versus the mortgage index, the index has not fallen significantly despite rates rising by about .60%. The correlation between home purchases and rates will likely be low for the time being due to the limited supply of houses on the market and rates that are still well below the 4.25% average for 2018/2019.  The Refi index, on the other hand, is much more sensitive to the change in rates. The Refi index is back to pre-COVID levels despite rates that are still .50% lower. New home purchases play a large role in economic activity and job growth. Refi activity is also economically important as it allows existing homeowners to reduce their mortgage payments, allowing them to spend more.

 


Long Term Market Outlook


Most economic data is reported on a year over year basis to help minimize seasonal effects. Data coming out over the next few weeks, for March of 2021, will be compared to March of 2020 when the economy was paralyzed. The graph below of credit card spending shows how the so-called “base effect” warps annual change (year over year) reporting. As shown, credit card spending is up an astonishing 64% versus a year ago. However, compared to more normal economic periods it is actually down 3.2%.


The two graphs below tell a similar story- Investors rooting for more inflation better be careful about what they wish for. The first graph, courtesy of Brett Freeze, shows that valuations have historically declined as the volatility of CPI increases. The second graph, from the Daily Shot, highlights that lower valuations are associated with higher levels of CPI.  The current CAPE is 35. As shown in the second chart, the maximum CAPE for any historical CPI reading greater than 3% is in the low 20s. A decline from 35 to 20, assuming no change in earnings, entails an approximate 40% price decline.

April 6, 2021

The Job Openings and Labor Turnover (JOLTs) report from the BLS pointed to more good news on the labor front. Per the report, the number of job openings rose by 286k to 7.37m, back above where it was before the pandemic. At the peak a year ago, there were 4.60 unemployed workers for every job opening. That ratio has shrunk significantly to 1.40 but it still has room to fall as it was below 1.00 for much of 2019.


The Best Surprise is No Suprise


The chart below shows ten-year UST yields (white) and Fed funds (yellow) since 1986. Overlayed on the chart is the regression line as well as one and two standard deviations from the line. As circled, each time the yields hit the +2 standard deviation line, yields quickly reversed lower. Currently, the line comes in slightly north of 2%, about .25-35 bps higher than today’s level. The only difference between today and the past is Fed Funds. In the past, the Fed increased Fed funds multiple times before 2 standard deviations were reached. Today, the Fed is nowhere close to raising Fed Funds. If yields break above the 2 standard deviation line, not only would it be unprecedented, but it may cause the Fed to consider options such as Operation Twist, to stem further yield increases. For more on Operation Twist- Its Time To Do The Twist Again.


Last week we discussed how the hedge fund Archegos used total return swaps and shared collateral to amass significant leverage in the equity markets. A reader asked us to better explain what total return equity swaps are, so here it goes: A total return swap (TRS) is a swap agreement (derivative) allowing one party to receive a payment based on a set rate, usually, LIBOR, while the other party receives payment based on a fixed or variable rate. With an equity TRS, the transaction typically involves the bank receiving LIBOR plus a fee, while the hedge fund/investor receives the total return (price and dividend) on a stock, a basket of stocks, or an index.  The benefit for the investor is they only need to put up collateral to back the trade and can therefore create leverage. Second, because they do not hold the stocks directly, they can avoid regulatory ownership rules.  In the case of Archego, they used the same collateral with 7 different banks, meaning they could employ 7x the leverage normally gained on TRS.  If you want to learn more, the WSJ has an excellent description of TRS including more color on how Archego used the swaps- LINK.

It is likely Archego is not the only fund to back TRS with shared collateral. As we saw with stocks used in Archego’s TRS, like VIAC and DISC, upward and downward volatility can be amplified due to the extreme leverage.

April 5, 2021

***We are having a data issue this morning on numerous pages. Please bear with us as we fix the problem.


Treasury Secretary Janet Yellen is pushing for a minimum global corporate tax rate. On the heels of Biden’s plans to retract Trump’s corporate tax rate cut, Yellen would like to see similar measures taken abroad. It appears she is concerned that higher taxes on U.S. corporations will impede their global competitiveness and incentivize companies to offshore operations. Per her speech:

“Together we can use a global minimum tax to make sure the global economy thrives based on a more level playing field in the taxation of multinational corporations and spurs innovation, growth, and prosperity,”


Today’s ISM Services survey, similar to last week’s manufacturing survey, was much stronger than expected, coming in at a record 63.7. The prices paid sub-component is now the highest since 2008.


Why We Increased Exposure To Risk


Gamma Band Update is published


This week should be relatively quiet on the economic front. Likely garnering the most attention will be PPI on Friday. Surveys and expectations continue to point to a surge in inflation, but PPI and CPI have yet to show the same. It is worth noting that PPI is for March, thus year-over-year data will show an uptick due to strong deflationary conditions last March. The current expectation for PPI yoy is +2.5%. The Fed’s minutes from the last FOMC meeting three weeks ago will be released on Wednesday.


In our ongoing quest to gauge inflation expectations, we present a new graph. The chart below shows the relatively strong correlation between the Australian dollar and U.S. 5-year inflation breakevens. The correlation is tight because Australia is a large commodities producer/exporter and almost all of their trade occurs in U.S. dollars. As such, the value of their currency is closely tied to inflation expectations. Since January 1, 2021, the AUD is unchanged while implied inflation is up by nearly .50%. Either the correlation may be temporarily breaking down, the AUD is signaling a weaker dollar, or the AUD is warning that U.S. bond traders may be pricing in too much inflation.

April 4, 2021

Trading Desk Notes – By Victor Adair

April 2, 2021

Markets are closed today for the Good Friday holiday!


The Technical Value Scorecard Report is published


The BLS Employment Report was stronger than expected at 916k versus 468k last month. The unemployment rate fell to 6% from 6.2%. Average hourly earnings fell, likely because many new hires are in the service industry which tends to be low-paying jobs. The sector accounting for the most jobs gained was the leisure and hospitality sectors with a pick up of 280k jobs. A summary of the report is below.

April 1, 2021

With today’s equity market rally, the VIX (volatility index) has fallen back to pre-COVID crisis levels. The dotted line shows the current sub-18 reading is fairly typical for the two years preceding the pandemic.


The ISM Manufacturing Survey came in at 64.7, the highest level since 1983! The Prices Paid sub-component rose further to 86 from an already high 82.10. The prices paid reading is in rarified territory. Since 1950, it has only been above 90 for a total of 18 months. Two of those months were in 2008, the remaining data all occurred before 1980.


Cartography Corner is published


How To Invest In The Strongest Month Of The Year


Weekly Jobless Claims rose by 61k to 719k. Through March 13th, there are still 18.2 million people receiving state or federal jobless aid. The volatility of the workforce in regards to the number of people being hired and fired is tremendous. Consider, the market is expecting the BLS to report that, in aggregate, 625k jobs were added last month. During the same month, almost 3mm people lost their jobs according to weekly jobless claims data.


The bond markets will close at noon ET today and the equity and bond markets will be closed tomorrow for the Good Friday holiday. Despite, market schedules, the BLS employment report will still be released tomorrow. Current estimates point to strong job growth in March, as shown below.


Welcome to April. The graph below, courtesy of Bank of America, shows that since 1928, the month of April has the second-best average monthly return (+1.37%), and posts positive returns nearly two-thirds of the time. Only December, at 74%, has a better win-loss percentage.


The graph below, courtesy of the Visual Capitalist, shows the problem the Fed faces as interest rates fall too much. The green dots show that household spending increase as interest rates decline. This occurs in falling rate environments as less interest earned on savings makes saving not as desirable. Further lower borrowing costs incentivize people and corporations to borrow and spend. However, the benefits of lower rates start reversing when the 10-year UST yield falls below 4%. The Fed tries to steer economic activity by manipulating interest rates. While their intent is to enhance economic activity with lower rates, they may have pushed rates too low and their actions are actually having the opposite effect. This is known as the Paradox of Thrift.

March 31, 2021

The NAR pending home sales data for February was weak. To blame is the cold snap in the midwest/south and rising mortgage rates. That said, the data comes with a grain of salt as the supply of houses is abnormally low. Per NAR President Lawrence Yun: “The demand for a home purchase is widespread, multiple offers prevalent, & days-on-market are swift but contracts are not clicking due to record-low inventory,”

The Chicago PMI manufacturing survey rose sharply to 66.3 versus 59.5 last month. The current reading is the highest since Q3-2018. The employment and priced paid sub-indexes continue to rise. The broad index is now within a couple of points of the prior peaks of the last 30 years.


Where Are The Best Buy Signals?


The ADP Jobs Report was slightly stronger than expected at +517k and well above last month’s +176k. Not surprisingly, approximately a third of the new jobs were in the leisure and hospitality industry.


This morning there is more troubling news on Archego leaking out. It is now rumored that the hedge fund used the same collateral to enter equity total return swap contracts with as many as seven banks.  Given there is already some leverage embedded within the swap structure, using the same collateral allowed them to amass at least 7x leverage. Assuming such leverage, a decline of 14% in the equities underlying the swaps would bankrupt the fund, leaving the banks on the hook for the equity exposure within the trades and no collateral to protect them. It is rumored that Goldman Sachs and Morgan Stanley were aware of this early and liquidated Archego’s swaps. They were likely to seize the collateral to help offset losses. Nomura, Credit Suisse, and other banks were left holding the bag.


Today, Joe Biden is expected to release an array of tax proposals to help fund his aggressive spending plans. The four biggest changes, based on what has been leaked, are highlighted below:

  • Raise the corporate tax from 21% to 28%
  • Impose a minimum tax on profits of foreign subsidiaries
  • Tax capital gains as regular income for high wealth/income classes and tax unrealized gains at death
  • Raise the top individual tax rate to 39.6% for those making $400k or more

With the quarter ending today, corporate earnings reports will hit the wires in the second half of April. Unlike any time over the last decade-plus, inflation will be a key topic in earnings commentary and management calls. Manufacturing surveys, such as ISM (Prices Paid) shown below, are reporting that a large percentage of companies are bemoaning higher prices for raw materials. As such, profit margins are at risk if higher input costs can not be passed on to the consumers of their respective goods. The Financial Times recently published an interesting article on the topic entitled U.S. companies sound inflation alarm.

March 30, 2021

Consumer Confidence jumped sharply from 90.4 to 109.7, the largest monthly increase since 2003. The surge in confidence is a good sign the economic recovery continues. Stimulus checks, vaccinations, and the reopening of the economy should help improve confidence going forward.


Who Gets Hurt By A Stronger Dollar?


The graphs below, courtesy of Brett Freeze, show the strong correlation between the price of gold and the combination of 10-year real yields and the Japanese Yen. Per the chart, the correlation of Brett’s model is significant with an R-squared of .88, denoting 88% of the price of gold is based on real yields and the yen. Gold is trading at $1680 this morning, slightly below its average premium to the model, but still about $30 above the model’s fair value.


The nine charts below show the large declines in stocks that are said to be part of the Archegos liquidation occurring Friday and yesterday. It is possible banks/dealers may still own sizeable shares of these companies as they are waiting for some price recovery or the new quarter to sell the rest. In other words, the selling pressure in these names may not be over. It is now rumored that Credit Suisse Bank is now looking at losses of $7 billion, up from estimates of $4 billion yesterday.


Yesterday afternoon Press Secretary Psaki announced that Biden is planning on rolling out another COVID stimulus relief bill in April, separate from this week’s forthcoming infrastructure plan. Bond yields rose, in part, on concerns of even greater federal spending.


ZeroHedge put out an interesting article in which they discussed a sharp uptick in corporate stock buybacks. The graph below from the article shows the four-week running average is now at a record high. Over 55% of the buybacks were in the technology sector, which is not surprising given many of the larger technology firms have large cash balances and shares that have been relatively depressed. Financials were second, accounting for about a quarter of the buybacks. Given many banks will be shedding loan loss reserves in the coming quarters we suspect they will continue to buy back shares.

March 29, 2021

On Wednesday President Biden will release details of his infrastructure plan as well as plans on how to fund it. The markets, thus far, have focused on spending and its stimulative effect, but at some point, it will also have to factor in likely increases in personal and corporate tax rates.


Risk & Rewards as April Approaches


Shares in Viacom (VIAC) started the year at $40, rose to nearly $100 by mid-March, and just over the last week fell back into the 40s. We learned this weekend the sharp losses in VIAC, along with DISC and a few other stocks is due to a large, heavily leveraged hedge fund (Archegos Capital) failing. Nomura and Credit Suisse Bank are said to be taking larges losses as a result. Other European banks are also at risk, but thus far no significant losses have been pinned on U.S. banks. For more on the story from Reuters- LINK


Gamma Band Update is published


The first quarter ends on Wednesday, which might induce some volatile price action due to portfolio rebalancing. Such trades may help bonds as many investors are likely under-allocated to bonds due to their steep price declines the past few months.

This week we get updates on the labor market with ADP on Wednesday and the BLS employment report on Friday. The current estimates point to a pick-up in job growth with a gain of 480k jobs and a 0.2% decline in the unemployment rate. Interestingly, we cannot trade on the BLS data as the markets will be closed for Good Friday.

Also this week, the Chicago PMI and ISM Manufacturing survey will provide us March readings. Investors will focus on the underlying prices data to better assess inflation expectations.


The graph below shows what Treasury bond and TIP yields imply about future inflation expectations. The graph shows the difference between implied inflation expectations for the five-year period starting five years from now versus that of the next five years. As shown, a year ago the markets were concerned that the lockdowns were temporarily deflationary. As such five-year inflation expectations rapidly fell about 1% more than those five years in the future. Since then the tide reversed. Market prices now imply inflation will run .38% lower in years 2026-2031 than the next five years. We can use this graph to help determine if the market believes the Fed in that inflation will be transitory. Currently, bond investors concur with the Fed. If the difference continues to decline it will represent further confirmation.

March 27, 2021

Trading Desk Notes From Victor Adair

March 26, 2021

The University of Michigan Consumer Sentiment Survey was strong for the month of March. The index was 84.9, up from 76.8 in February and above estimates of 83. 1-year inflation expectations were unchanged at 3.1%. The latest round of stimulus coupled with economic reopening and better than expected uptake of vaccinations is boosting consumer confidence. Interestingly, inflation-adjusted income expectations were 1.1%, the lowest since January 2017


The Technical Value Scorecard is published


Late Thursday afternoon the Fed announced, as of June 30th, they will remove restrictions on the ability of most banks to buy back their shares or increase dividends. The announcement should provide more upside impetus for the sector.


Mikael Sarwe of Nordea Markets recently published A Perfect Storm Brewing Part 2, in which he forecasts yields and inflation can increase significantly from current levels. The base of his argument is that the COVID-related recession will be short-lived and the amount of stimulus is unprecedented. To wit: “It is important to understand that the slump of 2020 was a disease-driven output shock and not a recession where economic imbalances got laid bare as central banks tightened policy by hiking rates. From a macro perspective, 2020 was nothing like the financial crisis, after which it took 10 years to close the output gaps created by the crisis. This time, as soon as the root cause of the output shock is cured, which will be very soon, the economies can be expected to get back to the starting point very quickly.”

In regards to CPI he wrote: “To me, there is a high likelihood of US core inflation spiking the coming months, falling back slightly over the summer but then reaching new highs in late 2021. Perhaps we will see the highest core CPI in almost 30 years?”

In his opinion, a strong recovery coupled with central bankers that will be slow to remove stimulus and aggressive fiscal stimulus is a recipe for more inflation and stronger growth. He does warn however that while his forecast may seem rosy for equity investors, there is a strong inverse correlation between the forward S&P P/E and the 5-year real yield. If real yields rise as he forecasts, forward P/E’s should decline, creating a headwind for stock prices.

The article is full of compelling graphs. We share two of them below.

 

 

 

March 25, 2021

What Sell Signals are Saying


Weekly Initial Jobless Claims fell to 684k. This marks the first week below 700k since the Pandemic started! The number of claims for Federal assistance also fell nicely from 284k to 241k. Continued improvement in the labor market should help reduce the number of continued state and federal claimants which remain near 19mm.


The Tweet and graph below from SentimenTrader show that “smart money” has been selling at a rate not seen in over 20 years. It is theorized that so-called “dumb money” buys or sells at the market opens on emotions, while “smart money” digests the day’s events and makes more calculated trading decisions later in the day. Click HERE to read more on the Smart Money Index.


The graph below shows that investor cash inflows on Tuesday into the Tech sector were the largest in nearly 20 years. The sector has recently fallen out of favor as interest rates have risen. Interest rates are now consolidating/declining and with that, it appears we are seeing investors rotate back toward the “safety” of technology from more risky sectors like energy, value, and small-caps.

The graph below came from a WSJ article entitled Everywhere You Look, The Global Supply Chain is a Mess. Shortages of raw and finished materials are causing inflationary pressures. Chairman Powell understands these problems are temporary and thus his belief that inflationary pressures are transitory. Per the article:

The long-term economic impact remains unclear. Federal Reserve Chairman Jerome Powell said at a press conference Wednesday that he expects supply chains to adjust as economic growth accelerates. “It’s very possible, let’s put it that way, that you will see bottlenecks emerge and then clear over time…. These are not permanent. It’s not like the supply side will be unable to adapt to these things. It will—the market will clear. It just may take some time.”

It is worth noting that yesterday’s weak Durable Goods data and forthcoming manufacturing data will be negatively skewed as manufacturers, in many cases, are unable to produce enough to meet demand.

March 24, 2021

The Federal Reserve of Dallas surveyed 92 energy firms to arrive at the chart below showing the break-even price of oil required for said firms to operate profitably. The line represents the average price per region and the tops and bottoms of each bar represent the survey’s high and low prices. WTIC is currently trading at $60, above the mean for each drilling area below.


Markets Trigger Sell Signals


Late yesterday afternoon, Fed Governor Lael Brainard echoed Powell’s and Yellen’s comments from earlier in the day. The headline is as follows: “FED’S BRAINARD: WE HAVE SEEN SOME CLASSES OF ASSETS IN THE HIGH END OF THEIR HISTORIC RANGES.

It is not a coincidence there are suddenly multiple comments on the topic of asset inflation. It serves as a warning, of sorts, the Fed will not be uber-reactionary to a small drop in stock prices. That said, a decline of 20% or more and they are likely to voice concern and possibly take action.


With inflation expectations on every investor’s mind, it’s worth remembering Goodhart’s Law. Charles Goodhart’s adage states when a measure becomes a target, it ceases to be a good measure.

The following paragraphs, Courtesy of Prometheus Capital, quantify how the Fed’s QE purchases have skewed the implied inflation markets higher by about .60% to .70%, limiting its value as a “measure” of potential inflation.

The Fed Stimulated The TIPS Market Disproportionately

Another strong market signal of inflation expectations is breakeven inflation. To calculate breakeven inflation, we subtract the yield on a TIPS bond from that of a nominal bond, giving us “what the market thinks” about inflation. Hence, there are two potential causes for higher breakevens, a higher nominal bond yield or a lower TIPS bond yield. Below, we show how we have seen more of the latter, i.e., lower TIPS yields:

Given that the TIPS rate is predominantly driving the breakeven rate, we think it makes sense to look at what is causing this move. In today’s treasury markets, the largest driver of market moves changes in the Fed’s share of an existing market. We show this for the TIPS market and nominal bond market below:

In response to the COVID-19 crisis, the Federal Reserve purchased large amounts of the outstanding treasury market. However, the distribution of these purchases was not entirely even. While the Fed initially both TIPS and nominal bonds at an equal rate relative to their market size, over time, the Fed ended up purchasing more of the TIPS market than the nominal bonds market. The divergence in these purchases has led to more downward pressure on TIPS bonds than on nominal bonds, i.e., it has driven breakeven inflation to higher levels. We can see this impact below:

In the above scatterplot, we are looking at the relationship between two items. The first is the relative change in the Fed’s market share of TIPS versus nominal bonds. We calculate this by taking the year-over-year change in the Fed’s share of the TIPS market, minus the year-over-year change in the Fed’s share of the nominal bond market. The second item is the year-over-year changes in breakeven inflation.

We observe that as the Fed increased its market share of TIPS faster than of nominal bonds, breakeven inflation rose. Hence, we don’t think the TIPS market is necessarily pointing to higher inflation; it is just telling us that there has been disproportionately more demand for the outstanding asset base.

 

 

 

 

 

 

March 23, 2021

Stocks weakened throughout the afternoon in part due to comments from Janet Yellen and Jerome Powell in which they said asset prices were elevated versus historical norms. While truthful, such statements are not typical from the head of the Fed and U.S. Treasury. The graphs below show the small/mid-caps, and the recent sectors outperforming the market took the brunt of the selling pressure.


Following yesterday’s weaker than expected existing home sales report, today’s new home sales data also struggled in February. Yesterday we mentioned weather as a factor along with higher mortgage rates and home prices. Interestingly, the weather story accounts for some weakness but prices and mortgage rates are also playing a big role.  New home sales in the midwest fell sharply, but they also did in the Northeast and the West, where February’s weather was not a problem. The supply of new homes measured in months rose from 3.8 to 4.8. As shown below, the seasonally adjusted annual rate of new home sales is back to pre-COVID levels.


Is The Value Trade Over?


The Tweet below provides a 30 year perspective on the lower progression of U.S. Treasury yields and the shape of the yield curve.


According to Julien Bittel there is “no shortage of bulls out there.” His graph below shows the strong correlation between the University of Michigan (UM) survey of participants expecting stocks to rise and the price ratio of stocks to bonds (SPY:TLT). The current UM level, 65% of the participants expecting stocks to rise in the next year, is near 20-year highs. Per Julien:Highest since Feb ‘20 & only 3 months in the last 20Y have we been higher.

We expand on the current state of extreme bullish sentiment with the graph below, courtesy of Goldman Sachs. The graph shows short interest is back to the record lows last seen prior to the tech crash of 2000. Neither graph dictates that a sharp decline is imminent, but they do serve as a warning that everyone is on the same side of the boat. We will continue to respect the move higher but are careful not to get complacent to historical levels of sentiment and valuations.

March 22, 2021

The combination of higher prices and mortgage rates is starting to weigh on the housing markets. Existing home sales are still elevated but fell 6.6% last month to a six-month low. Even with the decline, the number of home sales is running about 700k more per year than pre-COVID.

The Chicago Fed National Activity Index unexpectedly fell sharply to -1.09 from .75. This was the first decline in the index since March of 2020. Prior to 2020, the last time the index was this negative was during the financial crisis. We must be careful not to read too much into the report as it may be an anomaly due to the cold snap in February.


Three Minutes on Markets is back!


Last Friday we noted that the Fed’s SLR exemption, temporarily removing capital requirements on bank’s reserves and U.S. Treasury holdings, was not extended and will expire at the end of the month. The graph below, courtesy of Bloomberg, shows bank balance sheets are bloated with reserves (from QE) that will now require capital. To accommodate the reserves, banks can sell assets to free up capital or raise capital via equity offerings. Also, the banks may sharply reduce loan loss reserves in the current quarter which will increase profits, thereby increasing capital.


The Gamma Band Update is published.


Jerome Powell is taking to the media to clarify the Fed’s recent FOMC meeting and better justify continued aggressive monetary policy despite solid economic recovery. On Friday, the WSJ published an editorial by Powell in which he reviews his actions over the last year. He ends as follows: “But the recovery is far from complete, so at the Fed we will continue to provide the economy with the support that it needs for as long as it takes. I truly believe that we will emerge from this crisis stronger and better, as we have done so often before.”

Jerome Powell will also speak This morning, Tuesday, and Wednesday. With the Fed out of their self-imposed blackout period, Fed members will again be active on the speaking circuit.

Existing and New Home Sale data for February will be released today and Tuesday respectively. Other economic data due out this week include Personal Income and Spending, February PCE price index, and Durable Goods.


Despite all the hoopla about spending on clean energy, the growth of new investments in clean energy has not really increased over the last five years, as shown below courtesy of The Visual Capitalist.

March 20, 2021

Trading Desk Notes by Victor Adair

March 19, 2021

To some surprise, the Fed decided to let the Supplementary Leverage Ratio (SLR) expire on March 31. The SLR essentially allowed banks to avoid holding capital on reserves and Treasury bonds. We assume the banks knew of this ruling in advance and sold bonds. This may explain yesterday’s decline in bond prices. Stocks, led by the financial sector, are trading weaker this morning. Bond yields are up a few basis points, with the 10-year UST yield back to yesterday’s high of 1.75%.


The Technical Value Scorecard is published.


Today is quad-witching today in the options market, so expect some volatility, especially at the open.


The graph below of real GDP helps put context to the market’s trepidation around the Fed’s new economic forecasts and current monetary policy. The Fed now expects real GDP growth of 6.5% in 2021 but intends to keep interest rates at zero and QE humming for two more years. It has been about 35 years since the U.S. experienced such strong economic growth. Running the economy hot with massive monetary and fiscal stimulus is a recipe for inflation, of which the bond or stock market is not priced for.


From a sector allocation perspective, the question we continue to grapple with is whether we expose ourselves more toward the inflation/reflation trade or the deflationary trade. Recently, that translates into deciding between the Dow (DIA) and the Nasdaq (QQQ). The graph below is a ratio of the price of QQQ to the price of DIA. It shows the ratio has consolidated in a very wide range over the last 8 months and is forming a megaphone pattern. If the ratio breaks lower out of the pattern, the inflation trade may have legs to the benefit of the DIA. If the ratio respects the pattern, tech/growth (QQQ) may have a period of nice outperformance. The MACD and RSI are grossly oversold pointing to the likelihood the ratio bounces in the coming weeks. The gray area from 2016-2017 shows a period when both indicators were deeply oversold.


The graph below charts Peter Lynch’s popular rule of 20 valuation method. His rule deems a P/E of 20 less CPI to be fair value. As shown, the metric just surpassed the highs of the dot com bubble and sits at 65+ year highs. The current flaw in his model is that it uses trailing earnings that are highly depressed from the pandemic and not necessarily representative of the current earnings potential.

March 18, 2021

**Lance Roberts is taking a much-needed vacation this week. Three Minutes on Markets will resume next week**

Markets fell in part due to crude oil but also a new lockdown in Paris France. They just announced that all shops will close on Saturday and remain closed and residents are advised to stay indoors. This is expected to last for 4 weeks.

Crude Oil fell sharply today with futures closing at $60 per barrel down over 7% on the day and nearly 15% from its recent highs. If the decline is sustained in the coming weeks, it draws into question the inflationary mindset driving markets.


The Philadelphia Fed Business Outlook soared to 51 from 26, the highest level since 1973. Within the report, the Prices Paid Index rose to levels last seen in 1979. Despite the rosy report on the economic outlook and continued economic reopening across the country, Initial Jobless Claims continue to languish. Initial Claims for the week rose to 770k up from 725k last week.


After a slow reaction, the bond market appears to have heard yesterday’s Fed’s message loud and clear. The ten-year UST yield jumped to 1.75% this morning. Jerome Powell stated that the economy was improving more quickly than expected, resulting in an upgrade of the Fed’s GDP, employment, and inflation forecasts. Of concern, despite the improved outlook, the Fed appears to be locked into its current policy for two more years. The Fed Funds market is not buying it. Fed Funds futures in late 2022 are now priced for a 50% chance of rate increase before year-end 2022. Higher rates, which will depress economic activity, and increasing odds the Fed tightens sooner than expected are likely to continue weighing on equity prices.


Below are 5 & 10-year real UST yields. As shown, both have been moving higher recently, resulting in marginally tighter financial conditions. While both real yields remain deeply negative, the recent increase provides some ballast to the Fed’s aggressive monetary actions. Tighter financial conditions will counter some inflationary pressures providing leeway for the Fed to keep monetary policy aggressive. This dynamic might help explain why the Fed seems unconcerned with rates rising in an “orderly” fashion.


The graph below provides guidance on where commodity prices may be headed over the next year. The blue line is an average of commodity pricing curves. It shows that current (spot) prices are higher than futures prices by about 10% on average. In other words, producers of commodities are financially incentivized to bring as much product to the market today instead of waiting.  The black line shows spot commodity prices on a one-year lag. Not surprisingly there is a tight correlation of commodity prices to the shape of the futures curves from a year ago. If the correlation holds up over the next year we should see a steep decline in commodity prices as supply will ramp up quickly given the current price incentives and strong demand.

March 17, 2021

The Fed statement reads similarly to the last statement. The only difference of note is their forecasts for this year were increased. They see PCE inflation running at 2.4% for 2021, up from 1.8%. They believe it then falls to their target of 2.0% in 2022 and to 2.1% in 2023. They also upgraded 2021 GDP growth to 6.5% from 4.2%. 4 of 18 Fed members think they will hike rates in 2022, rising to 7 in 2023. The graphic below shows the Fed only made minor changes to the prior statement from January.

Stocks, oil, and gold are rallying on the statement, while bonds continue to sell-off and the dollar trades lower.


**Lance Roberts is taking a much-needed vacation this week. Three Minutes on Markets will resume next week**


Housing Starts were much weaker than expectations coming in at 1.42 mm units annualized versus expectations of 1.57 mm and a prior month reading of 1.584 mm. Starts hit a 14 year high in December at 1.677mm units.  New Home Permits are also showing weakness, coming in about 200k units below last month’s level. Higher mortgage rates and inflation in timber, copper, and other goods used in housing construction are starting to weigh on homebuilders’ incentives to build new homes.


Today, the Fed will conclude its Federal Open Market Committee (FOMC) meeting and update its monetary policy stance. The statement, due for release at 2:00 pm ET, is likely to be very similar to last month’s statement. Jerome Powell will follow it up with a press conference at 2:30 pm. Investors are looking for any signs the Fed is concerned with inflation or inflation expectations. We suspect, they will continue to view any inflationary pressures as transitory. It is likely the Fed views the recent uptick in rates as a financial tightening, which gives them further room to keep the monetary pedal to the metal.


The graph below compares Retail Sales data from the Census Bureau and First Merchant Services credit card spending data. The two data series were very well correlated before COVID. Since then, the correlation has faded. There are two curious things worth noting about the chart. One, there is a divergence between the last data points. This may be a one-off effect from cash spending due to the latest round of stimulus checks. Second, data from First Merchant has not recovered as Retail Sales have. This is surprising because online spending accelerated during COVID lockdowns, and said spending requires a credit or debit card. The counterargument comes from the CEO of Brinks via CNBC- “Cash usage is up in the U.S., despite the coronavirus pandemic’s impact on the economy, cash management company Brinks CEO Doug Pertz said Tuesday.”

March 16, 2021

Today’s weak Retail Sales and Industrial Production data pushed the Atlanta Fed GDPNow forecast lower from over 8% to just under 6%. 6% is still very strong but more in line with Wall Street estimates.


Just as a reminder of how far the markets have come in the last year, we share a screenshot from CNBC from March 16, 2020.


As shown below February Retail Sales were weaker than expected, however, last month’s data (January) was revised decently higher. This data is difficult to assess due to seasonal quirks and the timing of the last round of stimulus checks versus when the data was collected. Also, the cold snap through the midwest and south, along with numerous snow/ice events on the east coast also dampened activity.


Last weekend David Brooks wrote an editorial for the New York Times,  Joe Biden is a Transformational President, which is receiving a lot of attention. He basically applauds large federal spending packages designed to help the lower classes and shrink the wealth gap. Regardless of your politics, the paragraph below is worth reading closely to better understand the emerging mindset of economists and the Fed. Brooks essentially claims massive federal debts and aggressive Fed actions to “fund” the debt is not inflationary. In our opinion, this editorial is an important step toward acceptance of MMT (modern monetary theory). For more on MMT, we share a two-part article Lance Roberts wrote last year- The Theory Fall Flat When Faced With Reality.

“It was assumed, even only a decade ago, that the Fed could not just print money with abandon. It was assumed that the government could not rack up huge debt without spurring inflation and crippling debt payment costs. Both of these concerns have been thrown out the window by large numbers of thinkers. We’ve seen years of high debt and loose monetary policy, but inflation has not come.”

Will this time be different with “the restraints cast aside” as David Brooks puts it?


The graph below, comparing the Baker Hughes North American Rig Count to the price of crude oil, paints a bullish picture for the price of crude oil. As shown, oil is back to nearly $70 a barrel, similar to where it was in 2018 and 2019. Rig counts, on the other hand, are less than half the level they were at during those same periods. The combination of weak growth in the number of oil rigs employed and sharply growing demand for oil as lockdowns end argue for higher prices ahead.

March 15, 2021

SentimentTrader put out the following statistic this afternoon-This is only the 7th time since 1897 that the Dow Industrials set 4 record highs in a row, gaining at least 0.5% each day. 3 of those triggered before 1900.


With the $1.9 trillion stimulus deal signed, Biden is looking ahead to the next package. Unlike the prior bill which relies fully on debt to fund spending, the new deal is said to include funding via tax increases. Any tax increases will likely fall on the shoulders of the wealthy and corporations. The 2018 corporate tax cuts are set to expire in 2025, but it’s possible Biden reverses them sooner. Further chatter about corporate tax hikes is likely to provide a headwind for stocks, just as the tax cuts three years ago provided a boost to prices.


The Gamma Band Update is published.


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The graph below shows the surge in used car prices occurring over the last 9 months. The most recent jump in prices appears to be a result of the late 2020 stimulus checks. With another round of stimulus checks coming we should probably expect the index to keep rising. Used car prices are not a relatively important component in inflation calculations, accounting for only 2.53% of the BLS CPI model.


There will not be any Fed speakers until after the Fed’s FOMC meeting on Wednesday. However, by early next week, we will likely see a wave of Fed members clarifying the Fed’s latest monetary policy statement. On the heels of the meeting, investors will no doubt pay close attention to any mention of how higher interest rates might affect Fed operations or economic activity.

On Tuesday, the Census Bureau will release February’s Retail Sales. It is expected to decline following last month’s surprise 5.3% increase. The gains last month were in large part due to the stimulus checks released in late 2020. On Wednesday, Building Permits and Housing Start releases will be the first chance to see if higher interest rates are affecting plans to build new homes. The NAHB Housing Market Index on Tuesday is expected to decline slightly. Zero Hedge recently published an article in which they discussed how rising commodity prices are adding to the costs of building new homes. Since early 2020, before COVID ravaged the economy, Copper has risen 161% and Lumber by 216%.

March 13, 2021

Trading Desk Notes For March 13, 2021 – by Victor Adair


March 12, 2021

Like the CPI report on Wednesday, today’s PPI report was near consensus expectations. Year over year PPI is now running at 2.8% versus 1.7% last month. Annual data is starting to capture the initial price declines from the COVID shutdowns last February, which elevates the year-over-year change.

Consumer Sentiment rose nicely to 83 from 76.8. The recent round of stimulus checks,  another check coming, and vaccinations should help sentiment continue to improve through the spring months.


In the Tweet below, Jim Bianco asks and answers the most important question facing investors of all asset classes.

  • Q: “When does this stop?”
  • A: “When something breaks.”

His question and answer are based on Treasury yields from the last 40 years. Spurts higher in interest rates have more often than not resulted in financial and/or economic crises. Next Wednesday we will publish an article that quantifies how much more rates can rise before “something breaks.” The graph below the tweet shows relatively small increases in rates and the various crises associated with them.


The Technical Value Scorecard is published


Bond yields are rising sharply this morning despite relatively well bid 10 and 30-year auctions on Wednesday and Thursday.  The 10-year UST yield is back to 1.60%, the recent high from Monday. Given the wedge-like pattern forming in the 10-year, it is becoming more likely it will break higher over the coming days/weeks. The dollar is trading higher, gold lower and stocks are mixed. As we have been seeing, higher yields are pushing NASDAQ futures down 1.5%, while the Dow Jones is slightly higher and the S&P falling in between the two indexes.


Does value beat growth in a rising yield environment?

At first blush, we would answer with a resounding yes. Our justification is value companies tend to use less leverage making profits not as sensitive to higher interest rates.

To help answer the question, we assessed nearly 100 years of data courtesy of Dartmouth (French/Fama). We created several statistical models and found no significant correlation between the value/growth trade and yields.

It turns out the task was simpler than we thought. All we needed to do was compare a value/growth index versus 10-year yields. The answer: value consistently outperforms growth, regardless of the rate environment.

The red shaded area denotes the last environment with consistently higher yields. The green period highlights the yield decline over the previous forty years.  The second graph shows rolling five-year annualized returns of value versus growth.

Note- the last decade, in which growth has beaten value, is the anomaly, not the rule. Just as we started with a question, we leave you with one: are we entering a new paradigm?

March 11, 2021

The graph below helps answer a question that we have been asked numerous times over the past month- How do higher interest rates affect housing affordability? The graph compares mortgage rates in blue with the amount of home one can buy with a $3,000 monthly payment. Since January, mortgage rates have risen 41 basis points. During that period the amount of house which a $3,000 monthly payment could buy fell from $744k to $706k. Broadly speaking, for each 1% increase in mortgage rates affordability drops by 12%, and for each 1% decline in rates, a buyer can afford a 14% higher price.


Value Versus Growth In Uncertain Economic Times


The European Central Bank (ECB) surprised markets this morning by increasing its pace of QE “significantly.” To wit- “purchases under the PEPP over the next quarter to be conducted at a significantly higher pace than during the first months of this year.”  Bond yields in Europe are falling as is the Euro versus the dollar. U.S. bond yields are declining slightly in sympathy and equities are rallying on the news. It appears the recent uptick in European bond yields, even though still negative in many cases, was enough to spook the central bank. The German 10yr-Bund yield which peaked at -0.23% a week ago, is now trading at -0.34%.


The term SLR is likely to become popular over the coming weeks. The SLR or Statutory Liquidity Ratio is the Fed’s regulatory mandate to banks quantifying the amount of capital they must hold for each asset type. In March of 2020, the Fed allowed banks to hold U.S. Treasury securities without any capital. The temporary ruling allowed the banks to more easily absorb the massive supply of Treasury issuance. Now, a year later, and the temporary ruling is set to expire (March 31st). If the change does not get extended, the banks will likely need to sell U.S. Treasuries to meet the SLR.


The graph below shows the ratio of the price of crude oil to the price of IEF, the 7-10yr UST bond ETF. As shown, the ratio is hitting a trend line that has reliably proven to be of strong resistance in the past. The graph argues yields and crude oil prices may be peaking.

March 10, 2021

The Game Stop games are happening again. GME closed last Friday at $137. This morning it rose $100 to touch $350. Within 15 minutes of hitting $350, the stock tumbled to $200. For a few minutes, GME was the largest stock in the Russell 2000 Index. GME is not for the faint of heart!


Two Things That Can Stymie Markets Rally


CPI came right on the screws as shown below. Helping moderate prices is the way the BLS calculates home prices. The BLS uses an implied rent model, which is currently at 10-year lows on a year over year basis. Case-Shiller and other respectable home price indexes are up over 10% the last year.

  • US CPI 0.4%, Exp. 0.4%
  • CPI Core 0.1%, Exp. 0.2%
  • CPI YoY 1.7%, Exp. 1.7%
  • CPI Core YoY 1.3%, Exp. 1.4%

The Fed has a 70 percent limit in regards to how much of any Treasury issue they are allowed to own. The quote and table below show the Fed, despite ongoing massive QE operations, has plenty of ability to keep buying. The declaration not only includes the $80bn a month in Treasury purchases via QE, but flexibility, as well, if they are to invoke Operation Twist. This morning we wrote on Operation Twist and what it may mean for markets – It’s Time To Do The Twist Again!

Per Danielle DiMartino Booth and Bloomberg: “The Fed “has >$1.3T of firepower left in securities w/> 7 years to maturity, w/$725B in 20-30-year sector. Looking at TIPS market, the Fed has $600B left before owning 70% of it (1-30 years)”


The graph below highlights how investors continue to rotate into and out of inflation/deflation sectors at a fierce pace. Yesterday, Technology was up over 4% and is still down 3.4% for the last 5 days. Conversely, Energy was down 1.29% yesterday and is up 4.48% for the last five days.

CPI will be released at 8:30 this morning. Yesterday, we suggested CPI Y/Y could rise 2.3% based purely on the price of crude oil. It is worth noting, our model uses month-end prices while the BLS takes an average of prices during the month. Given the sharp decline in oil prices in February, our model is likely to project a higher CPI Y/Y than the BLS.

March 9, 2021

One of the biggest storylines of the last few weeks is the strong correlation between bond yields and the NASDAQ. The graph below shows the running 20-day correlation between ten-year UST yields and QQQ. Note the current correlation is -0.92, meaning 92% of the price change in QQQ can be explained by yields. Today’s reading is the strongest bout of negative correlation in at least the last decade. Interestingly, the current 20-day correlation between the Dow Jones Industrial Average and bond yields is slightly positive, as energy and financials, which are more heavily weighted in the Dow, benefit to some degree from higher yields and rising inflation.


Is The Bull Market On Shaky Ground?


As shown below, the NFIB Small Business Optimism Index upticked last month but still remains at somewhat depressed levels. The table of the components helps better assess the employment situation for small businesses, which account for more than 50% of employment in the U.S. As shown, Plans to Increase Employment remain low at 18% (% planning to increase less % planning to decrease) but current job openings rose nicely to 40%. As economic reopening speeds up, small businesses will hopefully see a marked improvement in hiring plans.


The scatter plot below highlights the strong correlation between the annual change in crude oil prices and the annual change in CPI. The r-squared is statistically significant at .54. The orange dots show where the next four months of CPI should print based on the current price of oil and the model’s regression formula. The model’s estimate for tomorrow’s CPI year-over-year change is +2.3%. The estimate rises sharply to 4.8% in March and peaks at 8.9% when April’s data is released in May.

Driving the large inflation forecast are the plummeting oil prices from last spring and the resulting annual change. The coming huge percentage changes in many CPI components is one of the reasons the Fed has been very outspoken that the current bump in inflation is transitory.

March 8, 2021

Last week we wrote on negative repo rates and how it implied large short positions in ten-year Treasury notes. The chart below confirms our suspicions.


In an MSNBC interview, Janet Yellen parrot’s recent Fed member comments on inflation being transitory. Per Bloomberg- “I really don’t think that’s going to happen,” Yellen said in an interview with MSNBC Monday, when asked about concerns that consumer-price pressures could surge as a result of deploying the stimulus despite the economy already gathering pace. Inflation before the pandemic “was too low rather than too high,” she noted.

This is important because Janet Yellen has Biden’s ear. As such, he will be more likely to support the Fed letting inflation run hot.


Market Response to More Stimmie Checks: “Meh…”


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Weekly Gamma Band Update


The economic spotlight will be on inflation this week. CPI will be released on Wednesday followed by PPI on Friday. The data is for February. Because of the very weak economic activity last February it is likely annual inflation measures will spike.

On Wednesday the Treasury will issue ten-year notes and on Thursday 30-year bonds. Everything else equal, these auctions will weigh on the bond market as banks hedge themselves in anticipation of buying a lot of this debt. The Fed should be relatively quiet as they enter their pre-FOMC blackout period. The next Fed meeting is March 16-17th.


We have been outspoken about equity valuations, so instead of beating on the same drum, we thought it might be helpful to share a message from our friend Eric Cinnamond, small-cap equity portfolio manager and owner of Palm Valley Capital Management (PVCMX). Per his note:

“Small cap stocks have been on a wild ride over the past year. We’ve been managing small cap portfolios for nearly three decades, and frankly, we’ve never seen anything like it. After declining 40% from its early 2020 highs, the Russell 2000 has increased 130% from March 2020 to February 2021! Based on current valuations, we believe our opportunity set has never been more expensive and risks never this elevated. Therefore, finding value in the current small cap market has become extremely challenging.”

March 6, 2021

Trading Desk Notes for March 6, 2021 – by Victor Adair

March 5, 2021

January Consumer credit data released this afternoon continues to show declining credit card balances (revolving debt) and increasing non-revolving debt such as student loans and auto loans. Total consumer credit is slightly lower than last year. Non-revolving debt makes up about 75% of total consumer credit, yet a nearly 3.75% gain was not enough to counter an 11.60% decline in revolving debt. Seemingly, like most other economic data, trends are unlike what we were accustomed to prior to COVID.


The BLS Employment report was much stronger than expected at +379k jobs versus 49k last month and a consensus estimate of +175k. The U3 Unemployment Rate fell from 6.3% to 6.2%. Hourly earnings were up 0.2%, up from 0.1% last month. The only concerning piece of data in the report was hours worked fell from 35 hours per week to 34.6.

Stocks are rallying on the good news but bonds are selling off. The 10-year yield is back up to 1.60%, its high point from last week.

The graph below, courtesy of Brett Freeze, marries hours worked, the number of employed persons, and hourly earnings to produce an aggregate estimation of total income. As shown, the index fell for the first time since the recovery started. One month does not make a trend but his estimate bears watching.


The Technical Value Scorecard is published


Per the chart below from Gavekal, stock investors betting on inflation may want to rethink their strategy if inflation is truly to take hold. If you fall into this camp you should consider concentrating bets in sectors that benefit from rising prices and avoid most other sectors. Passive/Index investing strategies are likely to disappoint if inflation is not transitory.


Overnight repo rates on ten-year Treasury notes have been trading in negative territory. Essentially, the repo market is where those holders of bonds can lend bonds overnight to those that are short bonds. This them to make good on their short and deliver bonds to the entities they shorted bonds to. When a repo rate trades negative it means the supply of bonds being lent in the repo markets is scarce. The combination of aggressive Fed buying and aggressive short selling by investors is a key contributor to this problem.

The issue can resolve itself in a number of ways as listed below:

  • Similar to GameStop, the shorts get squeezed by onerous overnight borrowing rates and cover their shorts.
  • Treasury yields start falling and short investors cover their positions. Given a large number of short positions outstanding, this could cause a sharp move lower in yields.
  • The Treasury will auction new ten-year notes next Wednesday which will should help alleviate the supply problem.
  • The Fed can lend their ten-year notes to the repo markets and normalize the lending rate.
  • The Fed shows concern for higher interest rates, which they have yet to do. This would result in short traders covering their positions on concerns the Fed will do “Operation Twist” or commit to buying more longer-term bonds.

March 4, 2021

Jerome Powell spoke and the bond market wasn’t thrilled. The ten-year UST is now trading back above 1.50%. Bond investors were hoping for some discussion on Operation Twist or at least heightened concern about rising rates. Instead, it appears he is comfortable with rising rates to some degree, as long as they rise in an orderly fashion. Stocks reversed gains and are trading weaker in sympathy with bonds.

  • “The rise in rates caught my attention”
  • “I would be concerned by disorderly conditions or a persistent tightening in conditions that threatens our goals”
  • “If we do see a transitory increase in inflation I expect we will be patient”

Crude Oil is trading over 5% higher this morning at just under $65/barrel on news leaks that OPEC will not boost production by 500,000bpd in April as was widely expected. It is also rumored that Russia will be granted an exception allowing them to increase production by 130kbpd. The price of oil has fully recovered from the losses of the past year. As of noon, XLE is leading the market higher, up 3.5% on the day.


The number of weekly job layoffs remains high. Initial Jobless Claims for the week were +745k, up slightly from 736k last week. The Challenger Job-Cut report, measuring mass corporate layoffs was only 34.5k, down from 79k last month. Based on the recent trends in these two data sets it appears that smaller businesses account for the large chunk of weekly layoffs.

The graph below shows the number of weekly state and Federal jobless claims show no improvement since last Fall.


Will Operation Twist Get Another Turn?


Fed Chairman Powell will speak at noon ET today. It’s likely that he will reiterate recent comments made by Fed Governor Lael Brainard. On Tuesday she said the recent surge in bond yields is being monitored and that she would be concerned by disorderly conditions in the bond market. She also said the Fed is not close to reaching its employment and inflation goals. To that point, she quoted the U6 unemployment rate of nearly 10%, not the more popular U3 rate at 6.3%. She also reminded us that inflation has been running below its target for nearly a decade.

We have little doubt Powell will once again say current inflationary pressures are temporary and he wants to see inflation above target for a period of time before the Fed even talks about changes to monetary policy. We think the odds of Operation Twist are increasing and will be on the lookout for any mention of it in his speech. We will share more on the Twist and what it may mean for bond and stock markets in an article next week.

March 3, 2021

After consolidating for a few days, bond yields are heading higher once again. Of concern to the equity markets are the 5, 7, and 10-year sectors. These sectors, most affecting the economy, are leading today’s charge higher. 10-year notes eclipsed the 1.50% yield on February 25th but quickly fell back below that level. This morning they are again approaching that level. Sustained trading above 1.50%, points to 1.75% as the next line of resistance.


Experience is the Best Teacher


The ADP employment report was weaker than expectations at +117k, versus expectations of +165k and a prior month reading of +174k. The report will put some downward pressure on expectations for Friday’s BLS employment reports.

The MBA mortgage purchase and refi indexes stabilized this past week, after falling sharply with higher yields over the prior few weeks.


Fed Governor Lael Brainard acknowledged the Fed is paying attention to the recent volatility in the interest rate markets. Per the New York Times: “I am paying close attention to market developments — some of those moves last week and the speed of those moves caught my eye,” Ms. Brainard said, speaking at a Council on Foreign Relations webcast. “I would be concerned if I saw disorderly conditions or persistent tightening in financial conditions that could slow progress toward our goal.”


Materials and energy have been the hottest sectors over the last few months as investors’ concern for inflation rises. The graph below, courtesy of Jim Bianco, shows that the Goldman Sachs Commodity Index (GSCI) is already up over 16% this year and the second-best start to year since at least 1973. The highest annual return over this period was 50%, so if the inflation theme holds up throughout the year, the trend may have a ways to go.

March 2, 2021

Per Fox News, Democrats are pushing Biden to make stimulus payments to individuals recurring. If the proposal gains in popularity, we might see the dollar fall and bond yields head north. Turning one-time stimulus into what essentially is universal basic income (UBI) would not only add further to the massive deficit but produce more inflationary pressures.


The graph below, courtesy of Axios Markets, shows the battle between clean energy stocks (ICLN -ETF) and oil producers (XOP – ETF). While the divergence in performance over the two periods is stark, the reality is that many companies in the XOP ETF are investing massive amounts of money in clean energy. Either, XOP is catching up to clean energy as the market finally recognizes their investments, or it considers them direct competitors and the higher price of oil is winning 2021 for now.


After The Surge: The Markets Next Steps


The graph below, courtesy from an American Banker article entitled CRE lenders’ growing fear: Office workers won’t come back, shows the huge decline in net office space usage. This should not be surprising given the shutdowns due to COVID. The big question when looking forward, in regards to the health of commercial real estate, is how predominant will the shift to “work from home” be?


Yesterday, the ISM (manufacturing) Prices Paid Index hit a ten-plus year high of 86. As shown below, the index has a strong correlation with CPI and tends to lead it by 3 months. If CPI follows ISM’s lead we may be looking at CPI running over 3% this spring. One of the drivers of higher prices is order backlogs. The Backlogs Index, within ISM, is at its highest level since 2004. Further opening of the economy should help alleviate the backlogs (supply line problems) and in theory, reduce pricing pressures.


The graph below, courtesy of the New York Times, shows that the number of houses for sale is running less than half of what has been normal. Coupling the limited supply with sharply lower mortgage rates makes the double-digit increase in house prices more understandable. If mortgage rates keep rising and higher prices bring more supply to the market some of the recent price increases may moderate or possibly decline slightly.

March 1, 2021

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Is A Market Rally Likely This Week?


The Cartography Corner is published


The Reserve Bank of Australia (RBA) was the first central bank to show concern about steeply rising interest rates. Last night they bought $4 billion of longer-term maturity bonds. The amount was more than double the amount they had been buying. The yield on their 10-year bond fell 27 basis points as a result. In a Bloomberg Article, Eric Robertson (Chief Strategist- Standard Chartered Bank) summed up the problem facing the world’s central bankers well. To wit- “The RBA is in the same camp as every major central bank — they want their economies to recover but they’re more and more dependent on low-interest rates.”


The Gamma Band Update is published.


On Friday, the Chicago Area Purchasing Managers report showed continued expansion in the manufacturing sector but at a slightly slower rate than in January. This week, the ISM survey is expected to show a similar decline in the manufacturing sector’s expansion from 59.2 to 58.5. The prices sub-component, which will garner a lot of attention, is expected to fall from 82.1 to 75. If that holds up, it means there are fewer of those surveyed seeing rising input prices than those surveyed last month.

Importantly this week will be key for employment data. On Wednesday, ADP is expected to show tepid job growth of +155k jobs as compared to +174k last month. The BLS jobs report will be released on Friday. We will have a summary of expectations before then.


Currently, the yield spread between high-yield corporate bonds and Treasury bonds is at its lowest levels since 1989. Typically such low levels occur 3-4 years after a recession when economic growth tends to peak. Given we are achieving these levels in the midst of a recession and yields rising rapidly, we offer caution for those holding high yield bonds.

February 27, 2021

Victor Adair’s Trading Desk Notes For The Week Of February 27th.

February 26, 2021

As shown below, Personal Income was up 10% last month. The increase is entirely due to the latest round of stimulus checks. The graph to the right shows that Personal Income actually fell 2% last month when transfer payments (government checks) are excluded. The PCE price index is the preferred inflation index for the Fed. As shown in the table there is little reason for concern.


The Technical Value Scorecard is published.


  • 2/25/2021  Fed’s Bullard: “The rise in bond yields is a good sign so far.”
  • Fed’s Esther George “LONG-TERM YIELD RISE DOESN’T WARRANT MONETARY RESPONSE”
  • *FED’S BOSTIC SAYS `I AM NOT WORRIED’ ABOUT MOVE IN YIELDS
  • *BOSTIC: FED DOESN’T NEED TO RESPOND TO YIELDS AT THIS POINT

Jerome Powell, Jim Bullard, Esther George, Raphael Bostic, and other Fed members are steadfast in their determination to use an excessive amount of monetary stimulus to promote inflation and growth. The reflationary trade and weak dollar over the last few months are confirmation that investors believe the Fed is making headway toward its goals.

The problem is that bond investors also believe they are making progress.  On Tuesday and Wednesday, Jerome Powell said, in no uncertain terms, he is not concerned about inflation and will keep the monetary pedal to the metal. The quotes above show a level of comfort with rising interest rates as well. These are all good reasons for bond investors to keep selling.

Selling in the bond market became problematic this week as yields in the economically sensitive 5 and 7-year sectors rose precipitously, as shown below. Prior to this week, it was 10 and 30-year bonds taking the brunt of selling activity. The shorter, intermediate sectors largely determine mortgage, corporate, and auto borrowing rates.  They steer economic activity. While the Fed is running uber-easy monetary policy, the market is increasingly imposing tighter monetary conditions.

The Fed has a choice, they can watch bond yields rise, to the detriment of economic growth and ultimately inflation, or they can walk back monetary policy. Doing so requires them to taper QE or talk about raising rates. Either action can pose problems for the equity markets which rose to record valuations on the tailwind of easy monetary policy.

To put it bluntly, the Fed is walking into a trap where, at some point, they will be forced to decide between rescuing the bond market or the stock market.

February 25, 2021

The sell-off in bonds is worsening as it appears the Fed is comfortable with yields rising. At the peak of the decline today, the yield on the 5 year UST was up .25%.

2/25/2021  11:55am – Fed’s Bullard: “The rise in bond yields is a good sign so far.”

2/25/2021  Fed’s Esther George “LONG-TERM YIELD RISE DOESN’T WARRANT MONETARY RESPONSE”


Today’s sell-off in bonds is a little more problematic than we have seen, as yields are rising the most in the intermediate maturities (5-7 years). These maturity sectors have the largest effect on economic activity. We will have a complete write-up on this and what it may mean for the Fed in the morning.


Economic data was strong this morning. Initial Jobless Claims fell sharply to 730k versus estimates for 845k. The previous week saw 841k new people file for claims. Claims data has been volatile the last few weeks. Durable goods orders were also better than expected at +3.4% growth, more than triple expectations for 1.1% growth. The gains came largely from defense and airplanes. Excluding those two sectors, durable goods rose 0.5% versus expectations for a gain of 0.8%. Durable goods are now back to pre-COVID highs.


The Grind Continues


The total return on the 30-year U.S. Treasury bond has only started a year worse than 2021 twice, 1980 and 2009. 2009, like today, marked a period with massive fiscal and monetary stimulus and economic recovery. At that time, many investors were concerned that QE, new at the time, was inflationary. If 2009 is the correct analog for bonds, we may only be in the mid-innings of the current bond rout.


As shown below, rising interest rates are not just a U.S. phenomenon. It will be interesting to see which central bank flinches first about higher interest rates.


One of the biggest macro questions facing the equity markets is how much more can it increase alongside rising bond yields. The 10-year yield graph below helps put some context to the question. The gray shaded area represents a likely answer. The problem, however, is the band is wide- it ranges from current levels of 1.40% to 2.00%. The vertical dotted lines represent the last three times that yields were as overbought (RSI and MACD) as today. In two of the three instances, yields fell. In the 2018 period, yields consolidated for six months, and then rose before triggering another strong signal in which yields fell from 3.20% to .40%. The equity market seems increasingly nervous with each tick higher in bond yields. Might a round number like 1.50% or 1.75% be the yield that reverses the trend in equities?

February 24, 2021

Just when you thought the GME saga was over it reappeared. GME closed at $91.71 up 104% on the day and another 50% to $137 after-hours. Call option volume was massive.  We shall see if AMC, BBBY, and others caught in the prior short squeezes follow suit.


The chart below of the Dow Jones, annotated by Sven Henrich, affirms our view and the market’s view that Powell is comfortable with more inflation. The Dow has more exposure to companies that benefit from inflation, than the S&P and NASDAQ. Accordingly, it has done well after his two speeches to Congress this week.


A few notable quotes from Chairman Powell at today’s Congressional testimony:

  • “Could Take More Than Three Years To Achieve Inflation Goal”
  • “Some Asset Prices Appear Elevated”
  • *POWELL SAYS THIS WILL BE THE YEAR IN WHICH THE FED ENGAGES WITH PUBLIC ON DIGITAL DOLLAR
  • *POWELL: U.S. HAS 10 MLN FEWER PEOPLE WORKING THAN A YEAR AGO

Like yesterday, the Chairman appears to believe there is no significant inflation pressure and the jobs market is worse than is commonly believed. As such, he remains intent on continuing monetary stimulus at its current pace until jobs and inflation are closer to their objectives.


One of the bright spots in the recovery has been housing. To wit, new home sales, reported this morning, was 923k, well above expectations for 855k. That compares to 700k before the recession and a low of 570k last spring. If rates keep moving higher the housing party may come to an end. On a weekly basis, the Mortgage Bankers Association (MBA) puts out a gauge on mortgage activity. As shown below, higher rates are resulting in a decent drop in both new purchase activity as well as refinancings.


St. Jerome Saves The Day


A few subscribers asked why the possibility of inflation has begun to weigh on the Tech sector. The answer is two-fold. First, many tech companies are heavily leveraged and dependent on debt to develop new products and achieve their growth targets. As inflation increases so do interest rates. With it, their cost of borrowing increases and effectively reduces their financial leverage.

Second, higher rates of inflation reduce the expected real (after inflation) returns on new investments. For more on this concept, we lean on a Warren Buffett article from 40 years ago. As you read it, keep in mind, inflation today versus 1980 is much lower. But, in some people’s opinions, it could break through the upper range of the last decade and become more problematic. The Buffett quote below comes from a tweet from Michael Burry. Burry was made famous for his role in the movie/book The Big Short. He has recently been vocal about the potential for hyperinflation.

 

February 23, 2021

**POWELL SAYS DOES NOT SEEM LIKELY THAT INCREASE IN SPENDING WOULD LEAD TO LARGE OR PERSISTENT INFLATION

The Fed continues to believe a boost in economic activity will not lead to inflation. The interest rate markets and, more recently, the stock market are getting increasingly nervous that the Fed is wrong.


Does NASDAQ Lead Markets Downward?


Yesterday the Dow Jones was slightly higher while the S&P and NASDAQ sold off decently. Those trends, as shown below, are continuing in the overnight session. Also of note, crude oil was up sharply yesterday and trading higher again today. Gold and silver also traded well. Based on the winners and losers, the rotational trade appears to be inflation-based, therefore the Dow, with more exposure to energy, materials, and financials outperformed. The second chart shows yesterday’s gains and losses by sector.


As interest rates rise and inflation perks up, the market is anxiously following the Fed for any signals they might start to lean toward a more hawkish policy stance. The graph below charts Fed Funds futures over the next three years. As implied by the market, traders believe there is only a 66% chance the Fed raises rates 25 basis points by the end of 2023. The odds of a rate hike do not even begin to increase until early next year. For now, the Fed has made it clear they will let inflation run hot and higher rates are not bothersome to them. Changes to this graph over the coming weeks and months will allow us to monitor if the market continues to believe the Fed or starts to call their bluff. Fed Funds futures data can be found at the CME.


Typically investors buy gold mining stocks because they think the price of gold will increase, and miners are effectively a leveraged play on gold. Gold miners are businesses and regardless of the price of gold or its prospects, we must always consider valuations. The graph below shows that even though gold miners and the price of gold have risen nicely over the last year, gold miner valuations are well below any point in the last 7 years. Even if the price of gold declines marginally, miners still offer value.

February 22, 2021

As Bitcoin surges it is grabbing the attention of central bankers and governments. For instance, Treasury Secretary Janet Yellen was interviewed by CNBC this morning and stated: “To the extent it is used I fear it’s often for illicit finance. It’s an extremely inefficient way of conducting transactions, and the amount of energy that’s consumed in processing those transactions is staggering.” We expect more government officials to come out against BTC as it represents competition to fiat currency. If governments can not control their currency they can not conduct monetary or fiscal stimulus effectively, thus BTC or some other crypto-currency reduces their power.


Top 10 Buys And Sells

From TPA Research (Click on RIAPro+ today to add TPA Research to your subscription.) 

Click To Enlarge


Money Flow Signals Weaken- Three Minutes on Markets & Money


Gamma Band Update is published.


As shown below, rising interest rates are not just confined to the U.S.  Over the last few months, the amount of negative-yielding debt worldwide, mainly in Europe and Japan, has fallen by over $4 trillion.


The Fed takes center stage this week with Jerome Powell testifying to Congress on Tuesday and Wednesday. We presume he will push for more fiscal stimulus and promise to keep monetary stimulus flowing. As we have been doing, we will continue to look for signals he is concerned about higher interest rates or inflationary pressures. Based on his comments and those from other Fed speakers we are not expecting any surprises. There are a host of other Fed speakers this week including Vice Chair Clarida on Wednesday.

On Tuesday Case-Shiller and FHFA will release their home price indexes. Both reports should show annual gains in the 10% area. On Friday the BEA will report Personal Income and Spending, as well as the PCE price index. This inflation gauge, used in the GDP report, is the Fed’s preferred source for monitoring inflation. The index is expected to rise 1.5% versus 1.3% last month. While higher, it would not be worrisome for the Fed or confirm inflationary pressures as we are witnessing in consumer and manufacturing surveys as well as in commodity prices.

February 20, 2021

Trading Desk Notes for February 20, 2021 by Victor Adair


February 19, 2021

The chart below quantifies how sharp the recent interest rate increase has been. Weekly TLT prices, representing 20-year UST bonds, are shown in blue and its 20-week rate of change (ROC) overlays it in orange. Over the last 20 weeks, the price of TLT has fallen by 13%. We highlight five other periods with similar declines over the last 15 years with blue dotted lines. Excluding the instance in 2009, the four other periods, with similar negative ROCs, resulted in higher prices shortly after the indicator troughed. We believe that will be the case this time as well, but the million-dollar question is when/where will the ROC trough.


The real estate market continues to do very well with Existing Home Sales growing 0.6% last month and over 23% versus January of 2020. With little supply on the market, home builders are very active. Housing Start Permits, released yesterday, were 1.881 million units (annualized), about 200k more than expectations. The prices of raw commodities used in housing, particularly lumber and copper, have been soaring. It will be interesting to see if the housing market stays hot enough through the spring and summer, allowing home builders to fully pass on these costs.


The Technical Value Scorecard is published.


“No matter how risky I find sentiment/valuation indicators and how certain I am that I am “right” about this longer-term, I believe in trying to make money that one must follow the weight of all the indicator evidence.” -Ned Davis

The quote from Ned Davis appropriately describes our current portfolio management psyche. We fully understand that equity valuations, as we frequently show, are at or beyond the record levels of 1929 and 1999. When looking out over longer time frames periods, high valuations are always met with long periods of low or even negative returns. However, we also know that valuations are a poor market-timing tool.

There are many factors that account for the market’s ascent higher.  Whether we think they are valid or not is irrelevant. As such, we must understand and quantify these factors and make them a part of our analysis. Currently, have a quick trigger finger as the long-term risk/reward is poorly skewed, but at the same time hold positions for the short term that we expect to do well under the current regime.

February 18, 2021

Initial Jobless Claims popped back up to 861k from 848k last week. If you recall the number of claims dropped sharply to 793k last week. It was revised in today’s report to 848k. On the positive side, the number of claimants for Federal assistance fell from 7.9mm to 7.7mm.


The merits of Bitcoin as a currency are hotly debated in financial social media outlets. To be a legitimate currency, a currency must be able to be a medium of exchange. The following comments, from Eric Holthaus, provide context to the question of whether it’s possible for Bitcoin to become a widely used currency.

“Bitcoin uses 0.5% of the world’s electricity on just 350,000 daily transactions. At that rate, Bitcoin would require 14x of the world’s electricity to replace all daily credit card transactions. Bitcoin is not just inefficient, it’s actively anti-efficient.


Yesterday, in no uncertain terms, the Fed minutes claimed that the recent increase in prices is transitory. The chart below, from Julien Bittel at Pictet Asset Management, adds some historical credence to their logic. As he shows, the annual change in the Bloomberg Commodity price index tends to closely follow the change in the ISM Prices Paid Index. The ISM Prices Paid index is currently at 82, which is not far off from its recent 15-year high. The Index is a survey that quantifies what percentage of purchasing managers saw prices rise in the current month versus last month. Julian points out that the index hit 90 in 2008 and tumbled. Commodity prices followed, falling 53% in the next 6 months. The dotted green line projects what that may look if the spike in the survey proves again to be short-lived.


With interest rates ticking up it’s worth revisiting the relationship between mortgage rates and home affordability. To quantify the relationship we turn to an article we wrote in 2018- The Headwind Facing Housing.

When we wrote the article, interest rates were moving higher, resulting in higher mortgage payments for new homeowners and weaker home sales. 30-year mortgage rates were 4.50% at the time. As shown below, a 4.50% mortgage affords a buyer a $500,000 house with a mortgage payment of $2,333.

With current mortgage rates at 2.50%, the same $2,333 payment allows a buyer to purchase a home worth $641,000, 28% higher. The recent 10% increase in home prices is predominately due to the substantial decline in mortgage rates. The problem facing the housing markets today is mortgage rates have a limited ability to decline and spur house price increases. Further, any sustained increase in mortgage rates has the reverse effect on affordability and will weigh on home prices and sales.

February 17, 2021

**Due to the blackouts in Houston, we aren’t able to record Three Minutes on Markets & Money. We hope to be up and running shortly.


The following quote, from today’s release of the FOMC’s minutes from the January meeting, tells us in no uncertain terms that the Fed is not worried about inflation and considers any uptick inflation to be transitory.

“Many participants stressed the importance of distinguishing between such one-time changes in relative prices and changes in the underlying trend for inflation, noting that changes in relative prices could temporarily raise measured inflation but would be unlikely to have a lasting effect.”


The Atlanta Fed revised their Q1 GDP forecast higher from 4.5% growth to 9.5% annualized growth as shown in the first graph. Personal Consumption accounts for about two-thirds of GDP, so with today’s great retail sales data, the upward revision should not be surprising. The bulk of the increase came from consumer spending as shown below in the Fed’s supplemental bar chart showing changes to the forecast.


Retail Sales blew the doors off of expectations rising 5.3% versus expectations of a 1.1% gain. Excluding auto and gas sales they rose 6.1%. PPI was also much higher than expectations at +1.3% versus +0.4%.

Both releases point to an increase in economic activity and reflation. Stocks are slightly lower on the news, in part because it signals the Fed may be closer than they acknowledge to tapping on the monetary brakes. Again, we will listen closely to the Fed speakers this week for any signs that they are concerned about higher rates or inflation.

The FOMC minutes from the Fed meeting 3 weeks ago come out at 2 pm. It will be interesting to see how they edit minutes to reflect recent data.


This is a follow-up to yesterday’s discussion on the recent increase in intermediate-term yields. The graph below compares the popular investment-grade corporate ETF (LQD) versus the S&P. They closely followed each other through the February swoon and recovery over the last year. However, as circled in blue, the two are beginning to diverge. This divergence will become increasingly important to watch if yields keep on rising. We suspect higher intermediate and long-term yields will begin to hamper the upward momentum of the stock market.


The latest chart to show extreme market conditions comes courtesy of All-Star Charts. As shown, the number of new (record) highs on the NASDAQ and S&P 500 is well above the prior market peaks of 1999 and 2007.

 

February 16, 2021

Stocks gave up large gains this morning as bond yields continue to climb. Longer maturity yields have been rising for a while, but we are starting to see intermediate-term yields rise as well. Mortgages and corporate debt tend to be heavily concentrated with durations of 3 to 7 years. As such, further increases in intermediate yields will begin to dampen the economic recovery. It’s likely the market will continue to push on the bond market until the Fed cries uncle or the recovery shows signs of faltering.


The record cold snap, crippling Texas and the Plains states is causing a spike in energy usage resulting in rolling blackouts in many parts of Texas. As a result, natural gas is opening this morning up 6% from Friday’s close and is about 30% higher than late January levels. The unusual cold is also forcing some refineries to shut down which will result in less refined products, like gasoline. Gas is set to open up 4% this morning to $1.71 a gallon. It started the month at $1.56.


The Gamma Band Update is published


Tomorrow is shaping up to be a busy day on the economic front, with PPI and Retail Sales due out at 8:30. Retail Sales are expected to grow following three straight months of declines. Like CPI last week, PPI is expected to be in line with last month’s figures which do not point to inflationary pressures. Given PPI measures raw commodities and input prices for manufacturers, we should expect PPI to uptick before CPI takes hold.

Later in the day, the Fed will release the minutes from their January meeting. The Fed may take this opportunity to clarify or stress its stance on inflation, the labor market, higher interest rates, or monetary policy. We will also look for any mention of the drawdown of Treasury’s cash balances and the effect it will have on short term yields. For more please read our latest Can The Fed Both Tap On The Brakes And Floor The Gas? There are numerous Fed speakers throughout the week that may also shine a light on the Fed’s current thinking.

A slew of housing data will be released Thursday and Friday.

February 13, 2021

Trading Desk Notes For The Week by Victor Adair


February 12, 2021

**U.S. Markets will be closed on Monday in observance of Presidents Day


The graph below shows investors’ recent preference for risk. Relatively safe S&P volumes sit near four-year lows, while much risker options and penny stock volumes are multiples of prior norms.


The graph below shows that 5-year UST yields have risen from .36% to .45% since January first. Over the same period inflation expectations rose 36 basis points from 1.95% to 2.31%. As a result, 5-year real yields fell 27 basis points and stand at -1.86%.


The University of Michigan Consumer Survey points to continued weakness in sentiment, falling from 79 to 76.2. Consumers may be worrying about their purchasing power get squeezed due to inflation. Inflation expectations rose from 3 to 3.3%. Inflation expectations are now at the highest level since 2014.


The Technical Value Scorecard is published.


In February 2019 we wrote MMT and its Fictional Discipline. The intent was to show how inflation, the regulator for MMT spending, is a flawed indicator and easily manipulated. In the article, we provide housing inflation as one example. To wit: “In 1998, the Bureau of Labor Statistics (BLS) changed the way they calculated real estate prices within CPI. The BLS replaced an index based on actual home prices with what is now called owner’s equivalent rent (OER). OER is a rental equivalence that calculates the price at which an owned house would rent.”

Since 2019, OER has risen 5.12% while the Case-Shiller Home Price Index (CS) is up 13.73%. OER comprises nearly a quarter of the CPI calculation. The graph below replaces OER with the CS Index in the CPI calculation to show how inflation is understated due to the sharp divergence between actual home prices and the BLS methodology to impute home prices. Per the graph, CPI would be 2.62% and rising, versus .96% and trending lower. The low CPI reading provides cover for the Fed to keep printing, but at what cost?

February 11, 2021

We constructed the graph below to impress upon you the horrific weekly initial jobless claims data. As shown in red, instances of more than 600k people losing their jobs in any week are few and far between. In five weeks we will more than likely have a full year of weekly job losses north of 600k.


Markets Signal A Coming Correction


Weekly Initial Jobless Claims continue to show little improvement. Last week, 793k new people filed for jobless claims, down slightly from 812k (revised higher since last week) and 33k above the expectation of 760k. Including Federal unemployment programs, the number is over 1 million.  It’s hard to see how we get much improvement in the monthly BLS employment data with this weekly indicator of the job market stuck at current levels.


Bill Dudley, ex-New York Fed President, wrote an editorial in Bloomberg in which he appears to side with Lawrence Summers in offering caution to Jerome Powell. Importantly, he is concerned the Fed will continue to keep monetary stimulus running at full blast while inflation runs hotter than the Fed expects. To wit: “…the Fed, despite its desire to be accommodative and boost employment, might have to pull back on stimulus sooner and with greater force than anticipated to keep inflation in check.”


To say interest in equity trading has upticked over the last year is a gross understatement. The graph below, courtesy of Crescat, shows share volume on the NASDAQ exchange is over four times greater than what was normal over the prior 25 years.


After showing the speculative excesses in the junk bond market yesterday we thought we would pile on today with SPACs and small-cap stocks.

The data below, courtesy of Charlie Bilello, shows that SPAC (Special Purpose Acquisition Companies) issuance is off the charts. These risky investments, also known as blank check companies, are essentially public investments in investment managers seeking to buy non-public companies. Former sports stars Alex Rodriguez and Shaquille O’Neal are now issuing SPACs if that tells you anything about the burgeoning demand for SPACs.

US SPACs- IPO capital raised…

  • 2013: $1 billion
  • 2014: $2 billion
  • 2015: $4 billion
  • 2016: $3 billion
  • 2017: $11 billion
  • 2018: $9 billion
  • 2019: $13 billion
  • 2020: $83 billion
  • 2021 YTD: $38 billion (a billion a day)

Since March 23, 2020, the small-cap Russell 2000 Index has been on a tear, up over 130%. As shown below, the index now sits 36% above its Pre-Covid highs and at a 40% premium to its 200-day moving average. The Index may certainly keep defying historical norms, but we urge caution as it severely deviates from its 200-day moving average.

The next graph shows that the surge in the Russell 2000 occurred despite a fundamental basis. Accordingly, current valuations using the measure below are now well above prior highs.

February 10, 2021

Based on today’s speech at the New York Economic Club, Jerome Powell has no intentions of easing up on monetary policy. Here are two takeaways that lead us to that assumption:

“After rising to 14.8 percent in April of last year, the published unemployment rate has fallen relatively swiftly, reaching 6.3 percent in January. But published unemployment rates during COVID have dramatically understated the deterioration in the labor market. Most importantly, the pandemic has led to the largest 12-month decline in labor force participation since at least 1948.”

“Our January postmeeting statement on monetary policy implements this new framework. In particular, we expect that it will be appropriate to maintain the current accommodative target range of the federal funds rate until labor market conditions have reached levels consistent with maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”


Are We In The Biggest Bubble Ever?


As shown below, CPI was at or slightly below consensus expectations as well as last month’s readings. Also of note, China reported its CPI fell 0.3% year over year. This is a deflationary pressure on the U.S. given the large number of goods we import from China.


Yesterday we noted that Barclay’s junk bond index fell below 4%. Last night Zerohedge put out an excellent article – Never Seen Anything Like This – on the “buying spree” in the high yield arena. The chart below, in particular, caught our attention. It shows the spread of the junk bond index to U.S. Treasuries is near its lowest levels in at least the last 25 years. At the same time, the amount of leverage/debt being taken on by the underlying companies is soaring. Simply, the ability to pay off the debt is becoming troublesome, yet, investors are settling for less yield.

Dear Mr. Powell, this is another of many market dislocations signaling that a zero interest rate policy warps investor mindsets.


Jerome Powell will speak and take questions at the New York Economics Club this afternoon. It will be interesting to hear his take on rising inflation expectations and the recent speculative antics pushing markets higher. In particular, we are on the lookout for any discussion around the coming reduction in Treasury cash balances. For more on the Fed’s coming dilemma, this morning we published Can The Fed Both Tap On The Brakes & Floor The Gas?

Yesterday, we wrote about Lawrence Summer’s concerns over a consumption-driven, stimulus plan. Will Powell opine on his preferences for fiscal stimulus? Keep in mind, Powell and the Fed will have to reduce QE and possibly raise rates if a big stimulus plan generates too much inflation, per Summer’s warning.

February 9, 2021

The Barclays U.S. Corporate High Yield (junk bonds) Index dipped to 3.96% after six straight days of yield declines and it now sits below 4% for the first time ever.


The Impact Of The Stimulus: Inflation On The Rise


January’s NFIB Small Business Optimism Index fell to 95 versus 95.9 in December. Despite other surveys of larger companies pointing to optimism, an important sub-component of the NFIB survey shows that expectations for better business conditions hit their lowest level since 2013. 8% of the employers surveyed think now is a good time to expand and only 17% anticipate job creation. This jibes with the Paychex small business employment report we showed on February 5th and recent consumer sentiment surveys.


Biden’s fiscal stimulus plan is getting pushback from within his own party. Lawrence Summers, a strong voice in the party, is arguing that Biden needs to be thoughtful in assessing the size of the fiscal stimulus package but equally importantly, how the money is spent. In a recent Washington Post Editorial, Summers argues that Biden’s current proposal, which is not only massive in dollars but focused heavily on current consumption, carries big risks that may cause more harm than good. To wit:

“First, while there are enormous uncertainties, there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.”


The corporate earnings calendar is slowing down but there are still quite a few earnings announcements slated for this week.

February 8, 2021

Dogecoin is the latest crypto craze, having doubled in price over the last few days as Elon Musk tweeted its name. The following LINK to a WSJ article discusses this particular currency. The article will help to appreciate some of the absurdity behind what is going on in the crypto markets.


30-year U.S. Treasury yields eclipsed 2% this morning before falling back, as 10-year implied inflation expectations rose to a seven-year high of 2.21% and Brent Oil popped above $60 a barrel. The big question for equity markets is how long will the Fed sit quietly by and ignore mounting inflationary pressures? Jerome Powell will speak on Wednesday and we will be on the lookout for any clues he mentions regarding inflation.


The Thrill is Gone (but the risk remains)


Gamma Update is published


From Tesla’s 10-K SEC filing “.. we invested an aggregate $1.50 billion in bitcoin under this policy and may acquire and hold digital assets from time to time or long-term. Moreover, we expect to begin accepting bitcoin as a form of payment for our products in the near future ..”


Inflation data takes center stage this week with the January CPI scheduled for Wednesday morning. Current expectations are for no change from December. Chairman Powell is scheduled to speak at 2 pm on Wednesday. The Treasury will auction $41 bn 10 year notes on Wednesday and $27 bn 30 year bonds on Thursday. Both auctions are the same size as the prior month. All else equal, the auctions will likely weigh on bond yields in the early part of the week.


We stumbled upon this interesting graph over the weekend. Neal Falkenberry, its creator, plots the popular valuation ratio of Enterprise Value to Earnings (EBITDA) in gray. The red line, corresponding to the inverted y-axis on the right side, shows what the following ten year annualized returns were for each instance of the valuation. For example, in 2000 the ratio peaked around 14, and the future returns over the next ten years were near zero. Currently, the valuation ratio is near 20. If the correlation holds up, the strong correlation portends horrendous returns for the next ten years. Valuation ratios are poor timing tools but over the longer term, they do a good job of predicting returns.

February 7, 2021

Trading Desk Notes for February 6, 2021 – by Victor Adair

February 5, 2021

The graph below, courtesy of Brett Freeze shows that consumer borrowing continues to decline, led by a sharp decline in revolving credit.


This morning the two-year U.S. Treasury yield matched its record low from March 2020 of .10%. The yield on the one-month Treasury bill is trading 4 bps lower to 0.03%. At the same time, longer-term yields continue to leak higher as shown below. As we have discussed, the U.S. Treasury will sharply reduce Treasury debt issuance over the coming months. The greatest effect should be in the Treasury Bill sectors. The implications for this coming wave of liquidity will have implications for the markets. We will have more on this in an upcoming article.


Technical Value Scorecard is published


The BLS employment report was a mixed bag. The headline number was right on consensus with a +49k gain in payrolls, however, last month was revised from -140k to -227k, and November was revised lower by 72k jobs. The unemployment rate fell nicely from 6.7% to 6.3%, but some of the gains were attributable to a smaller workforce as the participation rate fell from 61.5% to 61.4%. As a  point of reference, it was over 2% higher than before COVID. Average hourly earnings were concerning as they only rose 0.2% versus 1% last month. That said, the average workweek rose to 35.0 hours versus 34.7 last month.


In prior Januarys, the economy typically loses between 2.5 and 3 million jobs as temporary holiday workers are let go. The BLS employs seasonal adjustments to account for this. Given that the number of temporary holiday employees was much less than normal in 2020, the number of firings should also be much less than normal in January. If they do not adjust properly reduce the adjustment, we could see a large payroll number today, purely due to this seasonal adjustment quirk. The current expectation is for a gain of 50k jobs. The range of estimates is -250k to +400k.


Earlier in the week, we pointed out that employment seems to be picking up in large manufacturer businesses. As the chart below shows, courtesy of Paychex, smaller businesses that account for more than half of employment continue to struggle.

February 4, 2021

Are We At The End Of The Rally?


Initial Jobless Claims fell to 779k, which is the lowest level in nearly two months. The problem is that there are still nearly 18 million people collecting unemployment benefits as compared to 2 million pre-COVID.

There was a sharp 4.8% decline in fourth-quarter productivity which is the worst since 1981. At the same time, unit labor costs accelerated to +6.8%. The data points to sharp margin contractions for corporations, however, this economic data and most data remain volatile. The effects of COVID-related lockdowns and massive stimulus continue to make data difficult to assess.


Short squeezes are all the rage these days, but as shown below there is little fodder to keep the antics up. The median short-interest ratio is now at levels last seen in the days before the dot.com bubble popped.


The following headline hit the wires from a speech from Fed Governor Evans -*EVANS: CRITICAL FOR FED TO SEE THROUGH TEMPORARY PRICE INCREASE.

Essentially he states that price increases we are seeing today are temporary, related to warped supply lines, changing consumption habits, and the opening up of economies. He may be correct and the Fed would be best served to ignore them. However, if he is wrong and inflation proves not to be transitory, the Fed will be forced to aggressively remove stimulus. As a reminder, valuations sit at record highs. Gains over the last nine months are almost solely attributable to massive monetary and fiscal stimulus. Removal of said stimulus would likely have the opposite effect.


We present a piece of bullish technical analysis from Troy Bombardia as follows:

Breadth thrust: NASDAQ Up Issues Ratio exceeded 74% for 2 days in a row. Historically, this almost always led to more gains for stocks over the next 3-12 months. NASDAQ up an average of:

  • +5.5% 3 months later
  • +12% 6 months later
  • +15% 9 months later
  • +19.4% 12 months later

February 3, 2021

After a short break, longer-term Treasury yields are resuming their march higher. The 30 year UST bond, shown below, is quickly approaching 2%. Weighing on yields are rising inflation expectations, a heavy supply of new issuance coming, and prospects for significant deficit spending in 2021. The Fed has yet to balk at higher rates, so barring any significant changes to economic activity or stress in the financial markets we must respect the move higher. At some point, however, higher yields will drag on economic growth and the Fed will likely take actions to cap rates.


The ADP Employment report came in stronger than expected at +174k. This bodes well for Friday’s BLS employment report. The one caveat is December and January tend to have large seasonal adjustments due to the holidays so the data on a seasonally adjusted basis can be skewed. Given COVID-related lockdowns, that is even more true this year.


The graph below, courtesy of John Hussman, shows the median price to sales ratio for the S&P 500 broken down into ten deciles ranked on the price to sales ratio. While hard to see, all ten deciles are now at the highest levels since at least 1984. In the late ’90s the lower deciles were not trading at records as the upper deciles were. As such, the takeaway is that value, even in the “cheapest” S&P 500 companies, unlike 2000, is hard to find.


The ADP jobs report, due at 8:30 am, is expected to show a net gain of 50k jobs. While Monday’s ISM Manufacturing report was slightly below expectations, the jobs component rose nicely, signaling continued manufacturing jobs growth.

Also worth noting in the ISM report, it was the first time since 1978 that every firm surveyed saw an increase in prices. Commodity prices are rising, but we do not know whether it is temporary due to supply lines and speculative trading in some commodity futures.

February 2, 2021

Per Sentimentrader- “There may be cash sitting somewhere on the sidelines, but it’s not in the hands of investment managers. Mutual fund managers have less than a 2% cash cushion for the first time in history. Pension fund managers have 2.6% in cash, lowest ever.”


Can Markets Continue Bullish Trend?


Almost half of the SP 500 companies have reported Q4 earnings. Based on the data thus far, sales are lower by -.54% and net earnings are up +3.4%. Margins have expanded decently as companies, in general, have reduced their workforce, other expenses, and capital investment to prop up earnings. Without stronger growth in sales, it will be hard for the nation’s employment situation to improve rapidly.


The U.S. Treasury has an estimated $1.5 trillion of cash held at the Federal Reserve. The surplus represents funds raised for various CARES Act programs that were not fully used. Due to the excess cash, the Treasury expects to borrow $853 billion less than they had expected in November 2020. The cash balance at the Fed should fall to about $500 billion, which is high but not extreme.

As a result, the Treasury will issue less debt, particularly in the Treasury Bill sectors. This might lead to some problems. The combination of greater collateral needs related to recent equity trading (typically T-bills are used as collateral) and lower issuance might push short-term rates, including Fed Funds, negative. If so, will the Fed take action to get Fed Funds back to its target range? Actions might include a reduction of QE or, more likely, a heavier focus on purchasing longer-term securities and possibly selling shorter-term securities, aka Operation Twist.

As shown below, the 1-month Treasury Bill has been trading slightly below its range of the last 6 months. Thus far it is not indicating much stress.

As we noted yesterday, expectations for tomorrow’s ADP report and Friday’s BLS data are weak. Initial jobless claims data over the last four weeks points to over 3 million people that lost jobs in January (seasonally adjusted). The chart below, courtesy of Arbor, provides another clue that this week’s labor reports may live up to their poor consensus expectations.

 

February 1, 2021

Silver, and in particular the $SLV ETF, is the squeeze du jour. It is important to understand that the dynamics behind squeezing SLV is different than GME or other short stock squeezes. SLV is an ETF, meaning that large dealers can create shares easily. Such makes it more difficult to squeeze. However, in order to create shares, the dealer must deliver silver in exchange for the new shares. While GME and others, by and large, only affect the longs and shorts of those stocks, SLV is affecting the price of silver itself. If this continues, it will brighten the outlook for silver miners but also raise input costs for manufacturers that use silver in their production process. Silver is required to produce many high tech goods. The graph below courtesy of the Financial Times shows the creation of SLV shares recently is massive.


Will February Follow January’s Fall


February’s Cartography Corner is published


Gamma Band Update is published


Per Dow Jones: DTCC THE MAIN U.S CLEARINGHOUSE FOR U.S STOCK TRADES RAISED THE CAPITAL REQUIREMENTS INDUSTRYWIDE TO $33.5B FROM $26B THURS, A 30% INCREASE

This action requires brokers to put up more capital and/or sell assets to abide by the increased margin requirements. It was likely responsible for Friday’s decline. It also explains why Robin Hood and others are limiting or excluding shares in which clients can purchase. Recent activity in GME and other popular short squeezes are a sign that margin debt was at its limits.


This week will provide fresh employment data. On Wednesday, ADP will release their jobs report. Expectations are for a gain of 40k jobs. While better than the -123k last month, it would point to very tepid growth in the labor market. Expectations for the BLS report on Friday are equally weak with a gain of 20k jobs expected.

The national manufacturing and service sector surveys will also come out this week. In general, manufacturing is expected to show slight increases, while services retreat. Both should remain well in expansionary mode.

Fed members are out of their media blackout periods. It will be interesting to hear their take on recent market volatility, weak inflationary data, and any discussion on why they ended the repo funding program. Earnings reports will continue this week, with larger companies shown below.

January 29, 2021

Victor Adair – Trading Desk Notes For The Week Of 01/29/21


We leave you for the weekend with a timely quote from Bernard Baruch:

The main purpose of the stock market is to make fools of as many as possible.”

9:30 am ET

REVISED. We had a bad data feed earlier this morning and deleted our prior commentary on personal income and spending. The correct data is as follows: Personal income rose .6% and Personal Spending only fell 0.2%.  The Employment Cost Index was +.9% versus +0.4% last month. This gives us hope that payrolls, reported next Friday, will be back on the upswing.


9:10 am ET

The Technical Value Scorecard is published.

8:10 am ET

Last week we published The Fed’s Inconvenient Truth- Inflation is M.I.A. The gist of the article is that while the money supply is soaring, the velocity, or turnover, of the money is plummeting. To wit: “Herein lies an inconvenient truth for the Fed. They are boosting the money supply, and it’s having an equally negative effect on velocity. As such, it’s hard to forecast much inflation given current Fed policies.”

With yesterday’s GDP data we now have fresh velocity data for the fourth quarter. The graph below is updated to show that velocity (orange) fell sharply once again and counteracted the sharp rise in the money supply. Not surprisingly, the GDP deflator (change in prices) fell short of estimates at 1.9% versus expectations of 2.5%.


7:15 am ET

The short squeezes that got crushed yesterday recovered strongly overnight. GME and AMC are up 100% and 50% respectively. Janet Yellen is scheduled to brief Joe Biden at 11 am ET today about the situation in the financial markets. It appears yesterday’s actions by the brokers to restrict trading was possibly the one thing Democrats and Republicans can agree on- Per The Street: Rep. Ocasio-Cortez (D-New York) called Robinhood’s trading restrictions ‘unacceptable.’ Sen. Cruz (R-Texas) responded: ‘Fully Agree.’

We start the day with a graph from Jeff Gundlach at Doubline. The chart below shows that passive investing and buying and holding, despite recent popularity, may not always be winning strategies. As shown, Japan’s Nikkei 225 Index peaked in 1990 and has yet to get back to that level. Europe’s STOXX 50 and the MSCI Emerging Markets Index peaked in 2000 and 2007 respectively and similarly have yet to return to said levels. This is not a dire warning that the U.S. markets are peaking but it should serve as notice that markets can go long periods without reaching new highs. Valuations do matter in the long run!

January 28, 2021

1:05 pm ET

Is the short squeeze game over? Interactive Brokers and other trading firms, including Robin Hood, are not allowing their clients access to trade some of the “hot” short squeeze stocks and, even worse, in some instances they are forcing them to sell. As a result, GME is down 50% from this morning’s high of $500.  Other “favorites” have similar losses. The broker’s trade limitations and forced liquidations expose their clients to massive risks. These actions may have lasting consequences.

“Interactive Brokers has put AMC, BB, EXPR, GME, and KOSS option trading into liquidation only due to the extraordinary volatility in the markets. In addition, long stock positions will require 100% margin and short stock positions will require 300% margin until further notice.

*ROBINHOOD RESTRICTING TRANSACTIONS FOR GME, AMC, BB, OTHERS – Bloomberg


9:35 am ET

GDP was slightly weaker than expected at +4.0% annualized growth for the fourth quarter. While the economy has recovered nicely, the 2020 growth rate declined by 3.5%, the worst since 1946. As a point of reference, the “great recession” of 2008/09 only saw GDP decline by 2.5%.

Personal Consumption, typically accounting for 2/3rds of GDP, only contributed 1.7%, down sharply from over 25% last quarter. Given the last two retail sales data points and the increase in COVID restrictions late last year, this should not be surprising.  Inflation is not showing to be problematic. The GDP deflator (implied price changes) rose 1.9%, versus a forecast of 2.4% and prior quarter reading of 3.7%.

Per Zero Hedge here are the main contributors to GDP:

  • Personal Spending added 1.7% to the bottom line in Q4, down from 25.44% in Q3
  • Fixed Investment added another 3.02%, also a drop from the 5.39% last quarter
  • Private Inventories contributed 1.04%, down from 6.57% in Q3
  • Net Trade subtracted -1.52% from the bottom line print, down from -3.21% in Q3
  • Government reduced GDP by -0.22%, vs -0.75% in Q3.

9:20 am ET

The Elephant In The Room


6:45 am ET

Fourth-quarter GDP, due out at 8:30 am, is expected to show an annualized 4.1% growth rate. The Atlanta Fed GDPNow forecast expects significantly more growth (+7.5%). Initial Jobless Claims, also due at 8:30 am, is expected to show 875k jobs were lost last week.

The graph below, courtesy of Jim Bianco and Goldman Sachs, speaks volumes about the last short squeeze fad on Wall Street. Many of the most shorted companies in this index, like Game Stop, AMC Theaters, and Bed Bath and Beyond are the most shorted for a reason- they are on the verge of bankruptcy.

January 27, 2021

2:10 pm ET

The Fed Statement was largely left intact from the last meeting 6 weeks ago. They did, however, alter their assessment of the recovery by saying the pace of recovery has moderated. Further, the Fed announced they are taking a first step in removing liquidity by ending overnight repo operations at the end of the month. The redlined text is shown below, courtesy ZeroHedge.


1:35 pm ET

We promise this is our last note about Game Stop (GME). The following headline just crossed the wires. *BIDEN TEAM IS ‘MONITORING THE SITUATION’ WITH GAMESTOP


11:15 am ET

China is the only developed nation to experience a full economic recovery from COVID. Given they are the second-largest economy in the world and their growth rate has been running well above other developed nations, they are, and have been, a tailwind for global economic growth.

Over the last week China’s short-term borrowing rates, a measure of supply and demand for cash, have spiked to five-year highs as shown below. The rate can be volatile at times so be careful reading too much into the recent action. That said, if this is truly signaling a cash crunch in China, the dollar may start rising which will bring with it negative side effects for many other asset markets. The dollar index is up .50 cents this morning and approaching a one month high. Technically it has stabilized from a 9-month downturn but has yet to fully signal the trend is broken.


10:30 am ET

The only decent explanation for this morning’s decline that we have seen is that some hedge funds are being forced to liquidate long positions to cover losses on the short side of their books. We wonder if some of the sell-off is also based on concerns for what the Fed may say regarding recent trading activity.  We will share more as we learn more. Stay Tuned!


9:00 am ET

Correction Day on Wall Street


8:05 am ET

Per CNBC- Mar 21, 2018 — Fed Chair Powell warns some asset prices are ‘elevated’ including stocks.

Per CNBC Dec 16, 2020 – Powell says that stock prices are not necessarily high.

Unfortunately, the data shown below, courtesy Macrobond and Nordea, argues that asset prices/valuations are much higher today versus his comments from 2018. Will Powell and the Fed change their stance at today’s meeting/press conference?


7:25 am ET

The Fed will conclude its two-day policy meeting at 2 pm ET with the FOMC statement and Jerome Powell press conference at 2:30. We do not expect much new in the statement; however, we will pay close attention to any changes in how they characterize rising inflation and inflation expectations. In recent weeks, they have backed off their “letting inflation run hot” mantra, instead of retreating to their standard 2% target.

The press conference could be a little more interesting, especially if Powell is asked about recent bouts of excessive risk-taking in the equity markets, higher interest rates, and/or details on how or when the Fed will taper in the post COVID economy.

Quick update on $GME: it is now trading at $250 a share this morning, up over $150 from where it was trading at noon yesterday.

January 26, 2021

2:10 pm ET

A little more perspective on today’s consumer confidence number.


11:00 am ET

Consumer Confidence rose from last month’s level (87.1 -revised) and slightly beat expectations (88.5) at 89.3. The combination of vaccines, the new round of stimulus checks, and rising home prices are brightening the mood of consumers.

The Richmond and Dallas Fed Manufacturing Indexes were both slightly lower on the month.

The Case-Shiller home price index rose 9.1% year over year. The graph below shows pricing trends in the 20 largest metropolitan regions.


9:30 am ET

Markets Struggle To Hold Support


8:20 am ET

As we have mentioned on a few occasions, SPACs (Special Purpose Acquisition Companies) have become very popular over the last year. These private equity-like public stocks raised over $21 billion in January alone. Compare that to $83 billion for all of 2020, and $9 billion for 2019. While the potential returns of these entities are large, the expenses and risks are outsized. Like record-breaking call buying, cryptocurrencies, short squeezes, SPACs help us quantify the massive risks investors are more than willing to take on.


7:20 am ET

A brief update on GME, which we discussed in yesterday’s comments. After opening up yesterday in the mid-90s (+40% from the prior close) it rose to 159. Within two hours it fell back to 62, before closing the day at 77. Melvin Capital, a $12.5 billion hedge fund is one of the short-sellers that suffered from the surge in GME. Per Bloomberg, Citadel and Point 72 Capital are investing $2.75 billion into Melvin to help it stay afloat. Melvin is purported to have lost 30% of its principal year to date.

Will the Fed finally generate inflation up to and beyond their 2% target rate?  That is the million-dollar question facing investors. Making answering the question tricky is so-called transitory inflation. Transitory inflation refers to temporary bouts of inflation that are likely not to be persistent. The Washington Post published a great article (Why the pandemic had driven global shipping costs to record highs) explaining how COVID and changes in consumption habits due to COVID have wreaked havoc on supply lines and shipping. The result is higher prices. We believe these cost increases are transitory but likely to persist until the vaccine is widely distributed worldwide. The Fed may have some comments on this topic at tomorrow’s FOMC meeting.

January 25, 2021

4:30 pm ET

Today provided further hints that the reflation trade may be fading. The graph below is a heat map, courtesy of FINVIZ, showing how S&P 500 sectors and individual stocks fared on the day. Note that Utilities, Real Estate, Consumer Staples had good days, while Financials, Industrials, Energy, and Materials were lower. Bond yields were also notably lower on the day. The recent activity does not necessarily mark the end of the reflation trade. It could easily be a healthy decline/consolidation before the reflation trade picks back up again.


12:00 pm ET

The Gamma Band Update is published


9:35 am ET

Why We Sold On Friday


8:00 am ET

On Friday, Game Stop (GME) rose over 50%. This morning it is trading up an additional 40%. What was a $5 stock last fall is now worth $100. The reason is not good earnings, a takeover, or even positive news. What appears to be driving GME higher, as well as some other notable stocks such as BBBY and DDD, is a short squeeze. Short interest in these stocks is huge as their fundamentals are poor and many investors are betting on lower prices if not bankruptcy in some cases. The first graph below shows that while companies like GME and BBBY may have poor outlooks, their price performance has been stellar.

What we are witnessing is the latest market craze. While some investors are short, other investors see the massive short interest and try to squeeze the shorts. They try to push the stock higher, which in turn creates losses and margin calls for the shorts. In turn, this forces many shorts to cover and can drive the price significantly higher in some cases. Investors on the long side are not buying fundamentally sound or cheap companies but simply playing them in hopes of squeezing short investors.

Making short squeezes even easier than in the past are Gamma Squeezes. For more on how traders are able to push GME higher, squeezing options traders, and then short traders we recommend the following article- Game Stop and the Dangerous Game of Gamma Squeezes.

 


7:15 am ET

This week is shaping up to be a busy one with a lot of economic data, the Fed meeting on Wednesday, and plenty of corporate earnings reports scheduled throughout the week.

On the economic docket, the health of the manufacturing sector via the Dallas and Richmond Fed surveys will be released on Tuesday, and the widely followed Chicago PMI on Friday. All three are expected to decline but remain in expansionary mode. Also of note, will be today’s release of the Chicago Fed NAI, a broad measure of economic activity, the Case Shiller Home Price Index on Tuesday, Durable Goods on Wednesday, Jobless Claims and GDP on Thursday, and Personal Income and Spending on Friday.

The Fed will meet on Tuesday and Wednesday, followed by the standard FOMC statement and press conference by Jerome Powell.

A large number of corporations announce Q4 earnings as shown below.

January 22, 2021

The Real Investment Report Is Out

10:15 am ET

Existing Home Sales were very strong once again rising to the highest level in nearly 15 years. The median selling price was up 13% on a year over year basis. While the housing market is on fire, the report had an interesting bearish comment that accompanied it. Per Lawrence Yun, Chief Economist for the National Association of Realtors, stated the following:  “Today’s market is unhealthy, people are making hurried decisions and prices are rising way above income growth,”


9:30 am ET

Today we introduce a lesser followed inflation expectation measure published by the Fed. The 5×5 Forward Inflation Expectation Rate compares 5yr and 10yr nominal and TIP bonds to arrive at an average implied inflation rate that covers the 5 year period starting 5 years from now. What we find interesting about the index, as shown below, is its high correlation to the price of crude oil. Crude oil is used directly and indirectly in many facets of the economy. It is therefore not surprising that energy prices play a large role in the market’s inflation expectations. As such, we recommend following the price of crude oil, along with bond yields, consumer/manufacturing inflation surveys, and implied breakeven inflation rates to help form opinions on the rate of inflation going forward.


9:15 am ET

The Technical Value Scorecard is published.


7:15 am ET

Yesterday, the 10-year implied inflation rate hit 2.18%, a level which was last seen in 2017 and 2018. As shown in the box below, the Fed was aggressively raising rates at that time. Today, despite similar implied inflation levels and an upward trajectory, the Fed insists on keeping rates at zero for a long time. With unemployment still high and a desire to run inflation hotter than their 2% target, this should not be surprising. The question, however, is how high do inflation expectations have to rise before the Fed reacts?

January 21, 2021

2:00 pm ET

We stumbled across this valuable table below on Twitter which serves as a good identifier of companies involved in the “green trade.”


10:00 am ET

The following commentary from Tom Demarco of Fidelity may help explain some of yesterday’s euphoria-

“Yellen’s Senate confirmation hearing received a lot of focus on Tuesday, but none of her remarks were surprising. That said, her commentary on taxes was a big relief for the market in my opinion. Yellen wants to “go big” on fiscal policy as low rates for a long time should mean the US has the capacity for such a program. She felt the initial focus should be on bolstering economic growth instead of raising taxes. Somewhat heretically for a Democrat, Yellen acknowledged the ’17 corporate tax cut helped improve the competitiveness of American business and she vowed to keep corporate rates below pre-2017 levels, although she repeated that companies and wealthy individuals pay their “fair share”.”


9:25 am ET

Initial Jobless claims fell from last week’s 926k (revised lower) to 900k. While the decline is good, the number of people being laid weekly remains stubbornly high.

Housing data remains strong. Housing starts grew 5.8% rate versus 0.8% expected. Building permits were also higher, denoting that builders are likely to continue to ramp up construction to offset a near record low supply of homes for sale.

Prices paid in the Philadelphia Fed Manufacturing Index rose sharply as did the overall index.


9:20 am ET

Markets Cue for Correction


6:45 am ET

While on the topic of inflation, investors are clearly betting on inflation as witnessed by the chart below courtesy of the Daily Shot.


6:30 am ET

It seems a day doesn’t go by in which we are asked if we are concerned about inflation. Often the question is prompted by a graph of the surging money supply. We fully acknowledge money supply plays a big role in price changes, but often forgotten and equally powerful is monetary velocity.  Yesterday we published The Fed’s Inconvenient Truth: Inflation is M.I.A. to help our readers understand the interaction between inflation, money supply, and velocity. The article provides a framework to watch the actions of the government, Federal Reserve, consumers, and corporations to better assess whether or not inflation is a risk.

January 20, 2021

2:00 pm ET

Earlier we showed how President Biden is entering office with record-high equity valuations. We add another headwind to his presidency, courtesy of the Peterson Foundation, as shown below. The ratio of public government debt to GDP is nearing in on the debt explosion and weak GDP that accompanied WWII. At that time, the spike in the ratio fell just as quickly as it rose as GDP flourished in the booming post-war economy.  Strong productivity growth, pent up demand, suburbanization, and positive demographic effects greatly accelerated economic growth. As the graph projects, the ratio will worsen this time as there are far fewer drivers of growth and large headwinds in the form of debt, demographics, and weak productivity growth.


1:00 pm ET

Interest rates declined over the last five years and corporate treasurers’ responded by issuing longer maturity bonds to take advantage of the situation. As a result, and shown below, the duration of corporate bonds in the market increased by nearly 50%. Duration is a measure of when investors can expect the average cash flow (coupon/principal) from a bond. Duration is also a measure of risk as it approximates how much a bond’s price will move for a given change in yield. Considering that duration is high and yields are low, the risk per unit of yield for corporate bonds is extreme.

8:20 am ET

As we welcome Joe Biden to the White House and think about what the next four years may bring stock investors, Sven Henrich provides important valuation data to put the discussion in proper context versus what each of the last 8 Presidents faced on their inauguration day.

“Total stock market capitalization vs GDP on inauguration day of a new president: Ford: 40% Carter: 47% Reagan: 43% Bush I: 53% Clinton: 64% Bush II: 117% Obama: 60% Trump: 125% Biden: 190%”


7:15 am ET

The graph below, courtesy of Advisor Perspectives, shows Tobin’s Q Ratio is now at its highest level in at least 120 years. The ratio is a proxy for the market value premium or discount to a company or index’s worth. Prior to the last 20 years, anything over 1.0 was considered a bubble.

January 19, 2021

Top 10 Buys And Sells

From TPA Research (Click on RIAPro+ today to add TPA Research to your subscription.) 

Click To Enlarge


Treasury Secretary nominee Janet Yellen was in Congress this morning for her confirmation testimony and questioning. The following headlines and quotes from the meeting caught our attention:

  • BIDEN ADMIN FOCUS WIlL BE ON MAIN STREET AND NOT WALL STREET
  • I would be very pleased to take a look” at issuing longer-term debt, including a 50-year Treasury bond
  • TREASURY NOMINEE YELLEN SAYS PREPARED TO USE FULL ARRAY OF TOOLS TO CHALLENGE CHINA’S ABUSIVE, UNFAIR AND ILLEGAL PRACTICES
  • Our focus should be Main Street, not Wall Street
  • TAXING UNREALIZED GAINS MAY POSE TECHNICAL CHALLENGES
  • We don’t seek a weaker dollar

10:35 am ET

No comments required.

.


10:15 am ET

The Real Cost of Free College


8:10 am ET

Corporate executives, those with the most knowledge of the workings of their respective companies, are not as optimistic about their company’s stock valuations as one would expect given the excessive sentiment exhibited by investors.


7:45 am ET

Gamma Band Update is Published


7:10 am ET

With employment, inflation, and retail sales data for December already released, the pace of economic data for the remainder of the month will slow. Of interest, this week will be weekly initial jobless claims and an assortment of housing data on Thursday.

The Fed is entering their self-imposed media blackout period for voting members in anticipation of the FOMC meeting next Wednesday. Non-voting members are allowed to speak publically, but their opinions tend to carry less weight in the markets.

The corporate earnings calendar will pick up in earnest this week, with banks and transportation companies predominately on the calendar.

This past weekend, Neil Irwin of the New York Times published an interesting article. He provides a better appreciation of the potential inflationary impacts based on how consumers might react to the vaccine, large stimulus, and high savings rates.

Is Inflation About To Take Off?  That’s The Wrong Question.

NEWSLETTER IS OUT!

Everyone Is In The Pool – More Buyers Needed

New Momentum Growth Stock Screen Included

January 15, 2021

**Markets will be closed on Monday for Martin Luther King’s birthday.


11:00 am ET

The quote of the day comes from Danielle DiMartino Booth in regards to the Fed tapering QE.

“I think investors are getting a little ahead of themselves, anticipating the Fed beginning to tighten when they are not even thinking about thinking of taking such measures.”


10:20 am ET

The Technical Value Scorecard is published.


9:10 am ET

Retail Sales and PPI came out at 8:30 as shown below. Retail Sales were much weaker than expected for a second month. Most noteworthy, the control group which feeds about 30% of GDP, was down -1.9% and last month’s figures were revised lower from -.5% to -1.1%. PPI was a mixed bag, but like CPI, is not showing concerning signs of inflation. PPI excluding food and energy fell from 1.4% to 1.2% on a year over year basis but was up .4% on a monthly basis versus .1% last month.

The graph below courtesy of Bespoke is very interesting. Per their tweet- “Third largest decline in Non-Store (Online) sales in the last 20+ years? During a pandemic when people are staying at home?”


7:30 am ET

Last night, Joe Biden released details of his $1.9 trillion stimulus program. A summary, courtesy of CRFB, is shown below. Of note, the stimulus will release about a third of the money in the next few months and delay the rest of the stimulus toward the latter half of the year. This should help even out economic growth through 2021.


7:15 am ET

We start the day with an interesting Bloomberg article which was focused on a survey conducted by the ECB. The survey asked 72 European non-financial companies the following question- “Focusing on your own business/sector, how would you assess the overall long-term effects of the Covid-19 pandemic on the following?” Based on the results below, it appears, in aggregate, they expect to be suffering from the pandemic well into the future. From a profit perspective, they are counting on enhanced productivity to offset lower prices and sales. Employment and wages may suffer as a result of a weaker business climate. Reduced sales and potentially higher input costs are a distinct possibility in the U.S. as well. As such, we presume many U.S. companies will try to boost margins in a similar fashion. Such a paradigm does not bode well for labor.

January 14, 2021

3:25 pm ET

For the most part, Jerome Powell continues to shy away from putting a timeline on when the tapering of QE purchases might begin. Today he said: “The Fed will communicate exit early and clearly when it is time.” That said, he did acknowledge the economy could be back to the pre-COVID peak “fairly soon“, which could imply the Fed might be tapering “fairly soon.”


12:45 pm ET

Yesterday we shared the absurdity of Door Dash’s (DASH) valuation. Today we share another. With a market cap of $110 billion, Airbnb now has a market cap higher than the 6 largest hotel chains combined– Marriott, Hilton, InterContentintal, Hyatt, Wyndham, & Choice).


11:30 am ET

New Report-  Real-Time Commentary Heat Maps

We recently found a series of charts in FINVIZ that help visualize valuations of S&P 500 companies and the current behavior of Wall Street analysts and investors. Instead of cluttering up the commentary space on RIA Pro, we thought you would better appreciate the charts and can share them more easily in an article format. Click on the heat map below to access the graphs.


10:05 am ET

Will Joe Biden’s Fiscal Policies Float?


10:00 am ET

Initial Weekly Jobless Claims were much higher than expected at +965k versus +784k last week. Of note, covered employment was reduced by 4.4m. These are jobs being permanently reduced. We do not know if this was a seasonal adjustment or year-end issue but if it’s real, it points to a weak jobs report next month.


6:45 am ET

After two strong Treasury Auctions of 10 and 30-year bonds on Tuesday and Wednesday, which helped push long-term yields lower by 10bps, Biden upset the trend with word that his new stimulus plan will be around $2 trillion. That is much more than the $800bn to $1.3tn range which was widely expected. The 10yr UST yield backed up to 1.11% overnight from 1.07% yesterday afternoon.  Stocks rose overnight on the news but have since given up their gains and look to open flat.

 

January 13, 2021

1:40 pm ET

Just when you think things can’t get crazier, Door Dash (DASH) is up another 6% today making it nearly 50% for the year to date. More startling, it now has the same market cap as FedEx (FDX).


1:15 pm ET

Yesterday’s 10-year UST auction and today’s 30-year auction were met with strong demand. As a result, the 10-year is down over 10bps from yesterday’s pre-auction high. It’s too early to know if bond yields peaked, but the strong demand for the auctions shows significant demand at current levels. This affirms what we have been watching with money flows as well.


1:00 pm ET

It appears the meteoric rise in cryptocurrency prices is on the central bankers’ radar. Reuters put out the following article this morning, ECB’s Largard calls for regulating Bitcoin’s “funny business”, in which ECB President Largard calls for regulations. Her concern appears to be money laundering but their regulatory authority will surely intensify if crypto continues to impinge on sovereign currencies. As we wrote two years ago in Salt, Wampum, Benjamins – Is Bitcoin Next? :

If BTC continues to gain in popularity there is little doubt in our opinion the government will seek control or at a minimum the personal data from the transactions. In fact the SEC has recently opined on the matter claiming that “tokens” such as BTC can be deemed securities and may need to be formally registered. This is just a first step but given the potential threat, we envision government will impose a way to remove the secrecy BTC offers, allowing taxation and legal supervision to occur.”


10:45 am ET

Are We In A New Bull Market?


9:25 am ET

CPI was slightly higher than last month, meeting expectations for a 0.4% monthly increase. The Fed tends to rely on CPI excluding Food and Energy, as they consider price changes in those goods transitory. CPI ex-food and energy was underwhelming with the monthly rate at +.1% below last month’s +.2%. Year over year it was +1.7% versus +1.6% last month. There is little in this report that warns of pending inflation. All eyes to Friday’s PPI report.


8:05 am ET

As shown below, courtesy FINVIZ, the price of grains has risen sharply over the last few months. As a result, many producers of food products using grains or those relying on grains have stumbled. Kelloggs (K) for instance is down nearly 20% and sits much closer to its March lows versus its recent July highs.  The price action of GIS, CAG, and HRL among others, looks similar to K (shown below). When the “reflation” trade ends these will likely be good purchases but we warn that might be a while longer.


7:10 am ET

CPI will be released at 8:30 am. The current expectation is for monthly inflation to uptick to .4% from .2% last month.  Year over year inflation is also expected to increase from 1.6% to 1.7%.

Fed members, Brainard, Bullard, and Vice Chair Clarida will speak today. Over the last couple of days, a few Fed members have mentioned the possibility of tapering QE by year’s end. We will closely follow upcoming Fed speeches to see if this becomes a more common theme. Here are a few examples:

  • Fed’s Kaplan: If Economy Goes As He Expects, We Should Be Having An Earnest Discussion About QE Taper Later This Year
  • Fed”s Evans: Fed could taper in late-2021 or early 2022 if the economy is better.
  • Bloomberg- Fed officials said that more fiscal support and vaccines could lead to a strong economic recovery in the second half, setting the stage for a discussion of tapering

January 12, 2021

1:45 pm ET

The graph below compares 10-year implied inflation rates (blue) to 10-year UST yields (red). The difference between the two is called the real yield. As shown, implied inflation has risen about 50bps more than UST yields over the last 7 months, therefore real yields have fallen. Fed purchases of TIPs drive the implied interest rate up and purchases of nominal USTs drive nominal yields down. In a normal market, without interference by the Fed, nominal yields would trade higher than inflation expectations. With Treasury debt levels at historical extremes, the Fed cannot tolerate UST yields over 2% as this graph implies. Expect this divergence to continue and likely widen if the Fed has their way.


1:00 pm ET

Over the last month or so, we have shown a good number of sentiment measures at extremes (including the one from first thing this morning), and in some cases at levels never been seen before. The table below, courtesy of  Crescat Capital, shows that a multitude of valuations measures also sit at record highs. The market can keep chugging higher but it worth reminding yourself that sentiment and valuations are in rarefied air.


10:15 am ET

Welcome to the USSA.


7:40 am ET

The NFIB small business optimism index took a hit falling 5.5 points to 95.9. Of the ten survey components respondents were asked about, nine were lower than the prior month. From an inflation perspective, the NFIB writes: “The net percent of owners raising average selling prices decreased 2 points to a net 16% (seasonally adjusted). Price hikes were the most frequent in retail (30% higher, 6% lower) and wholesale (26% higher, 13% lower). A net 22% are planning price hikes (seasonally adjusted).” This report jibes with other data pointing to no current inflation but the anticipation of inflation in the future.

Key findings from the NFIB are as follows:

 

  • The percent of owners thinking it’s a good time to expand decreased 4 points to 8%.
  • Sales expectations over the next three months declined 14 points to a net negative 4%.
  • Earnings trends over the past three months declined 7 points to a net negative 14% reporting higher earnings.

Small businesses account for over 60% of employment in America. This survey provides important data on the state of small business and what that may mean for inflation and employment trends.

 


7:00 am ET

The fourth-quarter earnings season kicks off this week with a handful of companies reporting earnings. Of note will be Delta Airlines and Blackrock on Thursday followed by a few large banks on Friday – JPM, Citi, and WellsFargo.

The following chart, courtesy of Citi, was making the rounds on Twitter yesterday. It shows that market sentiment is literally off the charts!

January 11, 2021

1:45 pm ET

Per BofA- Bitcoin “blows the door off prior bubbles.”  On the topic of bubbles, Tesla is up over 200% in less than two months. The only news of note was two Wall Street analyst reports which both set a price target lower than the current price.

1:30 pm ET

Weekly Gamma Band Update


Does Market Excuberence Match Reality?


7:10 am ET

The week ahead will be important as the BLS releases consumer and producer price data for December. The reports will provide some evidence as to whether higher inflation expectations are playing out in the economy. CPI, due out on Wednesday, is expected to rise at a year over year rate of 1.2%, the same as November. PPI, being reported on Friday, is also expected to be flat versus November at 1.4% annually. Also on Friday, the University of Michigan will release its consumer sentiment survey which has an inflation subcomponent. Retail Sales will also be released on Friday.

Fed members have an active speech schedule this week. Of note will be Fed Chair Powell on Thursday afternoon and Vice Chair Clarida on Wednesday.

It could be another volatile week for bond yields. The Treasury will conduct its 10-year auction on Tuesday and 30-year auction on Wednesday. Both auctions may exert further downward pressure on bond prices. Biden’s stimulus plan is expected to be released later in the week. Bond investors will pay attention to the size and composition of spending, as well as any details on potential tax increases.  Initial rumors of a spending package “in the trillions” pushed yields higher Friday afternoon.

January 9, 2021

Trading Desk Notes for January 9, 2021. -by Victor Adair

(Good comments on why we sold IAU and GDX yesterday.)

January 8, 2021

1:00 pm ET

Earlier this week we showed the dollar on a long-term scale to show that the recent sell-off is well within historical norms. Today we share 10 year UST yields. As shown, yields have certainly risen over the last few months, but remain well below all instances on the graph going back to 1970. Simply, the recent increase is meaningless on a historical basis.

The problem however is that as the economy has become more dependent on debt and lower interest rates to service the debt, the threshold for economic pain due to higher rates has increased markedly. We find it highly unlikely that the 10-year yield could get back to even 2% without economic weakness and problems in the financial markets.


11:35 am ET

Fed Vice Chair Clarida put to rest the notion that the Fed might taper QE purchases this year, saying “can be quite some time before we think about tapering” & “my economic outlook is consistent with us keeping the current pace of purchases throughout the rest of this year.” He does expect an uptick in inflation in the months ahead but also believes it’s transitory. He also stated that he is not concerned with the 10-year Treasury yield above 1%.


10:00 am ET

The graph below, courtesy of Goldman Sachs, shows a large gap between actual volatility (light blue) and implied volatility (dark blue) which is what investors are pricing into options contracts. Will implied volatility fall back to the teens, where it was for the large majority of the post GFC era, or are VIX futures correct in implying a significant level of volatility lies ahead? It is worth noting that the surge in call option activity is providing a bid to the VIX and possibly distorting the historical relationship.


9:30 am ET

The Technical Value Scorecard is published.


9:00 am ET

Like the ADP report on Wednesday, the BLS employment report was weaker as the economy lost, in aggregate, 140k jobs. On a positive note, hourly earnings increased sharply. As we warned last month, December’s data has large seasonal adjustments which are likely greatly flawed due to irregular hiring patterns for the holidays. For example, earnings were probably higher solely because traditional brick and mortar retail and restaurants, which tend to pay low wages, did not staff up like prior years. To that end, food services and drinking establishments lost 372k jobs.


7:15 am ET

The consensus estimate for today’s BLS payrolls report (8:30 am ET) is +65k, with a wide range of projections (-50k to +302k). If the consensus is accurate, this will be the sixth month of decelerating payroll growth and the first increase in the unemployment rate since April.

January 7, 2021

1:30 pm ET

The graph below, courtesy of Arbor, compares 2yr and 10yr implied inflation levels. As they highlight with the dotted lines, a peak in inflation expectations occurred the last 7 times short term inflation expectations (2yr) equaled or rose above long term expectations (10yr). The chart argues that inflation expectations should decline rapidly in the near future or this time is different and inflation is truly taking hold.

10:10 am ET

Grantham’s Correct: It IS A Market Bubble 

Jeremy Grantham’s article, Waiting for the Last Dance, can be found HERE.


10:00 am ET

The following headline just hit the wires: “FED’S HARKER: COULD DISRUPT MARKETS IF WE TAPERED TOO SOON.” It’s clear from that comment the Fed knows QE is driving markets and the situation is hemming them into policies driven by markets, not economics.

Initial Jobless Claims last week were 787k versus 790k the prior week. Claims continue to stay at a stubbornly high level despite economic recovery. Just to reiterate prior comments, nearly 800k people were laid off just last week alone. Prior to the recent experience, the number had never been above 700k since at least 1967.


7:00 am ET

With a Democrat-led Congress and with it, projections for even greater deficit spending, the following WSJ editorial –Welcome to the Era of Non-Stop Stimulus is worth considering. The prospect of trillion-dollar deficits well into the future is high and with it comes benefits and consequences. In the short run, government spending drives the economy/ reduces recessionary impacts, but in the long run, it detracts from economic growth. Further, the Fed is all but forced to stay very active to help ensure the interest rate on the debt stays at very low levels. This is the macro trap facing our fiscal and monetary leaders. The graph below the quote from the editorial shows deficit spending has far outpaced the tax revenue, which in part highlights that the rate of spending is unsustainable without consistent help from the Fed.

But with President-elect Joe Biden now making it clear that the recent $900 billion stimulus will “at best only be a down payment” and the now $3.3 trillion of total stimulus spending “is just the beginning,” it sounds like America is headed into a program of permanent stimulus.

January 6, 2021

2:25 pm ET

The Fed minutes from their December meeting were largely as expected. They continue to worry about “considerable” risks to the economy due to COVID and have no intention of slowing up QE in the near term. That said they seem to be a little more comfortable with the longer-term outlook.  “The recent sharp resurgence in the pandemic suggested that the near-term risks had risen, while the recent favorable developments regarding vaccines pointed to some reduction in the downside risks over the medium term.”  The Fed is also showing some concern with rising long term interest rates- “a couple of participants indicated that they were open to weighting purchases of Treasury securities toward longer maturities.”


11:30 am ET

The table and graph below provide guidance on how 12 month forward P/E ratios for the S&P 500 and its sectors, compared to their respective averages of the last 20 years.


10:15 am ET

Bond yields are rising sharply this morning on concerns that a Democrat-led Congress will further increase fiscal spending, resulting in even more debt issuance. As shown below TLT, an ETF proxy for 20 year UST, was tightly wound and reaching the pinnacle of a pennant pattern. This morning it clearly broke lower out of the pattern. Fed minutes from their December meeting will be released this afternoon. While unlikely, it will be interesting to see if there are any concerns about rising interest rates.


9:15 am ET

Will Dem’s Put The Fed in a Box?


8:20 am ET

The ADP labor report showed a loss of 123k jobs in December versus expectations for a gain 130k of jobs and a prior addition of 307k jobs. The correlation between ADP and Friday’s BLS employment report has been historically strong, but over the last 9 months, it has weakened considerably. As such we must be careful not to read too much into today’s report.


7:25 am ET

The markets, with the exception of bond yields, are relatively calm following what appears to be a Democrat sweep in Georgia. 10-year U.S. Treasury yields are up 6.5 basis points last night to 1.02% as the market presumes more stimulus is likely with full Democrat control of Congress. Stocks are flat and the dollar is slightly lower.

Crude oil and the energy sector (XLE) were both up nearly 5% yesterday. XLE now sits at about 15% above its 50 dma and 200 dma. It is not quite at 2 standard deviations above each moving average so there is some more room to keep running.

Last night a subscriber asked us, per our commentary yesterday on the ISM prices index, how well correlated the index is to manufacturers’ input prices. As shown below, the correlation was relatively strong before 2017 but has tailed off over the last few years. We will pay close attention to next week’s PPI data to see if the survey truly reflects rising prices or just a “feeling” that prices are rising like in 2018. We remind you this survey simply asks the respondents to make a comparison versus last month and not to quantify the degree of change. The other factor to consider is whether or not price changes are due to temporary supply line constraints or more sustainable inflationary forces.

January 5, 2021

12:45 pm ET

Perspective Matters!

The graph below is a monthly graph of the U.S. dollar since 1990. As shown, the dollar is declining but it is well within its 30-year range. Reports saying the dollar is crashing are not apparent by looking at the chart.


10:05 am ET

The ISM Manufacturing Index rose nicely to 60.7 from 57.5 last month and 56.7 as expected. On the positive side, the employment sub-index rose back above 50 denoting an expansion of hiring. The fly in the ointment in the report is the Prices Paid sub-index rose sharply to 77.6 from 65. If manufacturers can not pass on higher production costs, profit margins will decline. If they can, we should see increases in CPI and other consumer inflation gauges.


9:50 am ET

Crude Oil is rocketing higher by nearly 4% and approaching $50 a barrel after Russia is ending its push for an increase in production for February. Per Investing.com – “Newswires reported that Russia’s deputy prime minister Alexander Novak had agreed to ‘roll over’ the current level of production for another month, in view of an expected shortfall in demand from key economies due to the resurgence of the Covid-19 virus and spreading lockdown measures to contain it.”


9:40 am ET

The Risk of Markets Trading at Historic Extremes is published.


8:15 am ET

It appears Atlanta Fed President Raphael Bostic floated a trial balloon by raising the prospect that the Fed could taper, or reduce its pace of QE purchases. Per Reuters:

  • “I am hopeful that in fairly short order we can start to recalibrate,” the $120 billion in U.S. Treasury and mortgage-backed securities that the U.S. central bank is currently buying each month, Bostic said in an interview with Reuters.
  • The Federal Reserve could begin to trim its monthly asset purchases this year if distribution of coronavirus vaccines boosts the economy as expected, Atlanta Fed President Raphael Bostic said on Monday in what amounted to a bullish outlook for the coming months.

7:35 am ET

Reading through market conjecture about why equities sold off yesterday, it appears some are blaming today’s Georgia Senate runoff. The thought is that a blue sweep would give the Democrats full control of Congress thus allowing for greater fiscal spending, which can be inflationary. To that end, 10-year implied inflation expectations hit 2% yesterday, a two-year high, and the materials and energy sector, as shown below courtesy of Finviz, rose despite large drops in the other sectors. Materials and energy stocks, and in particular producers of raw materials, should outperform in an inflationary environment.

While some inflation and a short-term economic surge may benefit stocks, the flip side is that more inflation will force the Fed to take their foot off the monetary pedal by reducing QE or even raising rates. The market has run well ahead of fundamentals, leaving QE and excessive monetary policy as key drivers of asset prices. As such the market will be increasingly sensitive to changes in monetary policy.

January 4, 2021

3:00 pm ET

As we noted last week, it is typical at year ends to see window dressing trades and tax-related buying and selling. Some of these trades tend to be reversed in the new year. We believe that helps explain today’s sell-off. However, a newly announced 6-week national COVID-related lockdown in England and jockeying ahead of the Georgia Senate runoff election are also playing roles.


12:40 pm ET

In a speech this morning, Chicago Fed President Evans downplayed the market’s inflation forecasts. The following headlines make it clear he thinks the Fed still has a lot of work to do in order to get inflation up to its goal:

  • “will take years to achieve average 2% inflation goal”
  • “important for the Fed to get inflation moving higher with momentum”
  • “Fed likely to continue with bond-buying for some time”
  • “monetary policy will be accommodative for a long time”

11:35 am ET

The chart below plots 2020 price returns for the most popular exchange-traded commodities. The data is in strong opposition to deflationary data from the BLS Producer Price – Commodities Sub-Index (PPI), which is actually down .4% for the year through November. Excluding gold, as it not used heavily in the production of goods, the average change in commodity prices shown below is  +12.6%. Energy products, excluding Natural Gas, were the only commodities lower on the year.


10:40 am ET

The Weekly Gamma Band Update Report is published.


9:15 am ET

Is Upside Start a Set-up for Classic Rug Pull?  Three Minutes on Markets & Money is published.


7:15 am ET

Cartography Corner January 2021 is published.


In this first week of the new year, ADP and the BLS will update the employment picture. ADP releases their employment index on Wednesday. Current expectations are for the addition of 170k jobs, following 307k in November, 404k in October, and 754k in September. Following last month’s weaker than expected reading, the BLS Employment report on Friday is forecast to show a gain of only 112k jobs in December. The unemployment rate is expected to tick up by .1% to 6.8%. As shown below, 22 million jobs were lost in March and April of which 12.3 million were recovered. The road back to full employment will be lengthy if payrolls only grow by 100-200k a month.

January 1, 2021

Happy new year!!

So Far, The Bulls Are Disappointed in Santa,

What You Missed This Past Week On RIA

December 31, 2020

The team at RIA Pro wishes you and yours a very happy and healthy new year. We look forward to navigating markets and sharing our insights in 2021.


10:15 am ET

The Technical Value Scorecard is published.


7:20 am ET

The next big risk event will be the January 5th run-off Senate election in Georgia. While the Republicans are expected to win and hold the Senate, a surprise victory by both Democrats could supercharge the equity markets and push yields higher as the prospects for a much larger stimulus deal in the months to come increases significantly.

If you are looking for things to worry about, the following survey provides a list of possible events that concern investors in the year ahead.

 

 

December 30, 2020

12:00 pm ET

This morning we published Plus ça change: A French Lesson in Monetary Debauchery which tells the story of monetary and fiscal failures that led to the French revolution. While there are many similarities to the current situation there are also important differences. “This story is not a forecast but a simple reminder of what has repeatedly happened in the past.”


11:20 am ET

Keep an eye on bonds. In particular, the price of TLT has been consolidating with slowly rising bottoms and surging money flows over the last two weeks. A breakout in TLT (falling rates) might be the surprise no one is expecting in January. We would like to see TLT (156.75) trade above its 20 dma (157.10) and 50 dma (157.92), before betting on a bounce higher.


10:00 am ET

It appears the ECB is finally showing some concern about a stronger euro versus the dollar. Per Ollie Rehn, Governor of the Bank of Finland-ECB Is Monitoring Euro Exchange Rate Very Closely.” A stronger euro is deflationary which poses problems for the region which already has a deflation problem and employs negative rates. We suspect that the eurozone will not tolerate much more dollar weakness.


7:30 am ET

Yesterday we ran across the following Bloomberg article – Treasury Market’s Inflation Gauge Nears 2%, Highest Since 2018. We ask, does the inflation gauge still have credence?

The Fed closely monitors and bases monetary policy on inflation expectations as measured by the TIPs market. This gauge used by the Fed and investors is becoming a questionable forecasting tool as the Fed now owns over 20% of the TIPs market. Due to massive QE, their outsized demand for TIPs over the last 6 months has pushed inflation expectations higher than that which would have been the case without their interference. The Fed can own up to 70% of any security, meaning they have plenty of room to buy more TIPs and further distort inflation expectations.

The graph below compares 5 year implied inflation data with actual CPI data occurring 5 years from that point. As shown implied inflation expectations have been a reliable gauge for the last four years. Unfortunately, the value of this important data point will lessen as the Fed, not the market, increasingly dictates inflation expectations.

December 29, 2020

11:40 am ET

The chart and commentary below from Siblis Research serve as yet another reminder that valuations, in many cases, are at or near record levels.


10:30 am ET

Next Tuesday Georgia will conduct run-off elections for both Senate seats. Given that a Democrat sweep can tip the Senate in the Democrat’s favor, this election has big implications. The polls below, courtesy 538,  show that both Republicans have slight leads in the most recent poll. However, based on their prior two polls, conducted before Christmas, the polls have fluctuated back and forth. From an economic/investing perspective, a Democrat sweep will likely mean more stimulus, but potentially higher taxes for the wealthy. It also makes a roll-back of the corporate tax cut of 2018 more likely.


10:15 am ET

Case Shiller’s 20 city home price index for October was up an annualized 7.95%, beating expectations by 1%, and showing the sharpest one-month increase in over 5 years.


8:10 am ET

The price of cryptocurrency Ripple fell below 20 cents last night, down nearly 70% over the month of December. The sharp decline is based on an SEC allegation that Ripple is a security. Ripple is not Bitcoin, but this action and the proposed legislation to regulate stablecoins raises our concern that regulatory actions can cause severe drawdowns in cryptocurrency space, including Bitcoin.

It is worth noting, as we consider potential potholes, Ripple is centralized (ie. controlled by an entity) and Bitcoin is decentralized (not controlled by anyone).


7:50 am ET

Top 10 Buys And Sells

From TPA Research (Click on RIAPro+ today to add TPA Research to your subscription.) 


7:30 am ET

The low volume equity melt-up continued overnight with further gains of half a percent. Yesterday’s nearly 1% gains were impressive, but there are some concerning factors under the hood. For one, the VIX and bond prices both ended higher on the day. Advancing NYSE stocks only beat out declining stocks by 53.5% to 44.5%. We would have expected a much larger margin/better breadth. Lastly, the Russell 2000, which has been leading the market over the past few weeks, fell by .37%. That being said, we are careful not to read too much into this week’s trading due to light volumes and year-end related trading pressures.

December 28, 2020

12:00 pm ET

One of our primary concerns of investing in cryptocurrency is the governments’ ability to regulate or even abolish it if the government deems it detracts from their ability to control monetary issuance and therefore manage the economy via their own currencies. To that end, a bill was introduced that would heavily regulate stable coins. Unlike the more popular bitcoin and other cryptocurrencies, stablecoins peg their market value to an external index such as the dollar or a commodity. This new bill would require stablecoin issuers to become banks with the approval of the Federal Reserve and FDIC.


10:10 am ET

Gamma Band Update is published


10:00 am ET

Per Troy Bombardia @bullmarketsco – “Something to watch out for in 2021: Margin Debt soared 50% in the past 8 months. In the past 30+ years, such investor euphoria happened exactly twice:

  • March 2000
  • June 2007
  • Now

On Sunday, the WSJ published an article on Margin that is worth reading- Investors Double Down on Stocks Pushing Margin Debt to Record High.

 


7:40 am ET

Equities are opening up strong this morning as President Trump signed off on the $900 bn stimulus deal including $600 checks to individuals. This morning the House will vote on Trump’s request for an increased $2,000 for each qualifying individual. Bonds are weaker and the dollar is flat. Gold was up over $25 last night but gave back most of those gains. Conversely, crude oil opened up down 2% and is now up over 1%.


7:25 am ET

This will be another quiet week for economic data. On Monday and Wednesday, we get our first look at December’s manufacturing surveys, as the Dallas Fed and Chicago PMI report data respectively. Both are expected to show declines but stay above 50, denoting expansion. Jobless Claims on Thursday are expected to uptick slightly from 803k to 815k. Markets will be closed on Friday for New Years Day.

December 25, 2020 – Merry Christmas

The REAL INVESTMENT REPORT is OUT! 

December 24, 2020

11:25 am ET

Freddie Mac reported 30 year and 15 year mortgage rates hit new record lows this week. As shown in the graph below, a conforming 30 year mortgage is now 2.66%, almost 1% lower than the lows set in 2012. In case you are wondering why mortgage rates are declining while longer-term Treasury yields are rising, the answer lies in the duration of a mortgage. Due to significant refi and purchase activity, the duration of a mortgage is now below five years. As such mortgages are priced off of 3 and 5 year Treasuries bonds which have seen stable to declining yields over the last month.


9:30 am ET

The Technical Value Scorecard is published.


7:20 am ET

Yesterday we showed how household income has risen sharply during the pandemic due to the Cares Act. Last night we stumbled upon the graph below, courtesy of @ernietedeschi, giving a much more detailed breakdown of the factors driving the increase in household incomes. Per Ernie, the average citizen has gained $5,439 of extra income due to government stimulus. This compares to what would have been a decline of $4,074 without said benefits.

Equity markets close at 1 pm and the bond market at 2 pm today.

December 23, 2020

10:00 am ET

Three Minutes on Markets & Money


9:50 am ET

The graph below shows Disposable Income surged on the original Cares Act and has now retreated to the prior running rate. The $2.2 trln increase in income was solely due to the $2.4 trln increase in government transfer payments (benefits to citizens). It should be no surprise with incomes back to normal and most Cares Act related spending used, the recovery is faltering. While the new stimulus bill will boost incomes and provide a spark for short term growth, it should be recognized that the natural organic rate of economic growth is low.


8:45 am ET

Initial Jobless Claims fell from 892k to 803k. Over 20 million people are receiving Federal and/or State unemployment aid. About two-thirds of those people will lose aid on December 26th if the lastest stimulus act is not finalized. That is a primary reason Congress is rushing the legislation.

Personal Income fell 1.1% versus expectations of a .3% decline, and a decline of .6% last month. Personal Consumption (spending) fell 0.4%. Bottom line is that fiscal stimulus is wearing off quickly. The new stimulus bill will boost income and spending but only on a temporary basis.


7:00 am ET

On a few recent occasions, we have warned that the dollar is very oversold technically as well as from a sentiment perspective. To wit:

“Let’s start with the dollar.  The dollar is so extremely oversold, with a very large net-short position against it, that any event which causes a flight to safety is going to lead to a sharp counter-trend rotation in the dollar. While there is not a tremendous move in the dollar to the upside, the ramifications of that move would ripple through the current “reflation bets” of emerging markets, international, energy, and commodity stocks.” -12/15/2020 Portfolio Trading Diary

The table shows why a dollar rally could prove problematic for the S&P 500, crude oil, and their related stocks. As circled below, crude oil and the S&P 500 are running at relatively strong negative correlations to the dollar. Over long periods (bottom line) little to no correlation exists between these pairs. If the dollar reverses course and the negative correlation holds, crude oil and the S&P will surely decline. A dollar rally might also spell trouble for Gold, which also has a strong negative correlation, albeit near historical averages. If the dollar turns upward in a meaningful way, the port in the storm could be U.S. Treasury bonds, as there is no correlation to speak of between Treasury yields and the dollar.

December 22, 2020

12:15 am ET

Top 10 Buys And Sells

From TPA Research (Click on RIAPro+ today to add TPA Research to your subscription.) 

10:40 am ET

Per Marketwatch: “The index of consumer confidence fell to 88.6 this month from a revised 92.9 in November, the Conference Board said Tuesday. Economists polled by MarketWatch had forecast confidence would rise to 96.7 in December. The index had hit 101.4 in October.”   Given personal consumption is over 60% of GDP, this latest confidence survey, and its recent trend, serve as a warning that the recovery is in jeopardy. The survey was taken before the latest round of stimulus, so we will see if confidence, and hopefully spending, improve in the next round of surveys.


10:30 am ET

Three Minutes on Markets & Money


9:20 am ET

Gamma Band Update is Published


8:30 am ET

With another round of stimulus checks to households on the way, we were curious to see how many of our Twitter followers think that checks to the public become the norm. As shown almost three-quarters of those that replied think they will become a new fiscal tool for fighting economic slowing.


7:30 am ET

Corporate yields rose marginally on Monday despite the stimulus bill which takes away the Fed’s ability to buy corporate bonds without new Congressional approval.

As shown below courtesy of Goldman Sachs, Investment Grade bonds now yield a paltry 1.80%. At the same time, their duration has soared to nearly 9 years. In combination, the two figures point to a significant increase in the amount of risk in the corporate bond markets. Duration measures the change in price for a given change in yield. If yields were to rise from 1.8% to 3.8%, bond prices in aggregate would fall approximately 18%. That compares to an approximate 13% decline in 2018 for a similar 2% increase in yields. Investors are clearly putting a lot of faith in the Fed to ensure yields don’t rise significantly. At the same time, they are betting against the Fed being able to deliver meaningful inflation which would push yields higher.

Doublethink- Doublethink is a process of indoctrination whereby the subject is expected to accept a clearly false statement as the truth, or to simultaneously accept two mutually contradictory beliefs as correct, often in contravention to one’s own memories or sense of reality.

December 21, 2020

12:15 pm ET

The graph below shows economic activity has overtaken pre-COVID levels in China, while the U.S. and Europe have not only failed to regain lost economic activity but are losing momentum over the last few months. The combination of waning stimulus, stricter lockdown rules, and a much slower organic economic growth rate are the primary culprits driving the divergence.


9:45 am ET

3 Minutes on Markets & Money


7:30 am ET

The passage of a $900 billion stimulus bill appears to be a buy the rumor/ sell the event trade. Most U.S. equity indexes are down sharply but have recovered somewhat since last night’s lows. The S&P for instance is down 1.6% but about over 1% higher from the lows. The dollar and bonds are rallying, precious metals are flat, and crude oil is down over 3%. Also weighing on the market is a new more potent strain of COVID breaking out in England. Bear in mind, as discussed below, TESLA related rebalancing is also responsible for some of this morning’s volatility.

While $900 billion was widely expected the market appears to be concerned with some restrictions that the bill puts on the Fed. Per Zero Hedge: “But the Fed wouldn’t be able to replicate programs identical to the ones it started in March at the beginning of the pandemic without the approval of Congress; in short if the Fed is to restart any of the 4 emergency 13(3) programs and lending programs that are set to expire on Dec 31 (shown in red below), it will have to get Congressional approval. These four programs are the market corporate credit facility, the secondary market corporate credit facility, the Main Street lending program and the municipal credit facility.”

The Fed will not be able to buy corporate bonds without Congressional approval. Without the Fed backstop, and with spreads and absolute yields sitting at or near record lows, we expect corporate yields to increase.


7:15 am ET

Starting today, Tesla (TSLA) is a member of the S&P 500. Tesla represents about 1.5% of the index and is the 7th largest contributor (behind Google and in front of Berkshire Hathaway). We suspect the index will see some volatility today as a result of index rebalancing by many investors and funds. The inclusion of Tesla pushes valuation measures on the index higher due to the extreme valuations of Tesla. Tesla has a P/E north of 1300, versus 37 for the S&P.

After the market closed on Friday, the Fed announced it will once again allow banks to resume stock buybacks. JPMorgan immediately announced $30 billion of share repurchases. One must ask why the Fed continues to pump in massive amounts of reserves to the banking system via QE and at the same essentially admitting the banks have excessive levels of capital.

This week’s economic calendar is light. Of note will be Personal Income and Spending on Wednesday, and Jobless Claims on Thursday. Given the holiday, there are not many Fed members scheduled to speak.

December 19, 2020

Trading Desk Notes for December 18, 2020 – by Victor Adair

Latest 3-Minutes On Markets And Money

(Note: We produce 3-minute Videos Mon-Thursday. To be notified immediately click here.)

December 18, 2020

4:15 pm ET

Tesla’s price action was crazy in the last few minutes of trading before becoming an S&P 500 member.


2:20 pm ET

Much ado has been made about extremely low put/call ratios. While it is a concern as it highlights extreme sentiment, it is also worth noting that the ratio can stay low for a while. As shown below, the ratio was actually lower than current levels for a few years preceding the tech bust of 2000.


11:30 am ET

The price of crude oil continues to rise on a seemingly daily basis and is quickly approaching $50. Despite the steady gains energy stocks (XLE) have begun to lag. As shown in the graph on the right, the ratio of XLE to crude oil has fallen by nearly 10% in the past 6 trading days. The graph on the left shows the price of XLE and crude. Note that the last two significant increases in crude oil were preceded by strength in XLE. XLE might be ahead of the curve and signaling future weakness in oil prices. That said, energy stocks are up well over 50% since early November and grossly overbought on all technical readings. As such, a consolidation or decline should not be surprising despite improving fundamentals.


9:15 am ET

The Technical Value Scorecard is published.


Stimulus negotiations are ongoing with a deal probable over the next few days. It is worth noting, that funding for the government lapses at midnight, and, as such, about 12 million people will lose their federal unemployment benefits in the coming week if a deal is not struck by Christmas.

Today is a quadruple witching day as a slew of stock and futures options expire. Per Goldman Sachs, almost 50% of all S&P options expire today. Goldman is not expecting fireworks as a good percentage of the options are well in the money.

 

December 17, 2020

10:50 am ET

A few weeks ago we shared the chart on the left which shows that when most investors expect a steepening yield, local highs in longer-term bond yields occur. We continue with the same yield curve expectations graph, but instead, compare it to gold prices over the last few years.  As shown, when a large majority of investors think the yield curve will steepen, gold tends to show local weakness. Following two of the three prior peaks in expectations, gold prices surged. As we think about the yield curve, we must remember the Fed will only tolerate so much yield curve steepening, as higher long term interest rates are damaging to the economy. Might we once again be on the precipice of lower yields and higher gold prices?

 


8:40 am ET

Initial Jobless Claims rose 32k from last week to 885k, versus an expectation for a sizeable decline to 806k. The Philadelphia Fed Manufacturing Index also points to employment problems as the employment subindex fell from 27.2 to 8.5. The overall index also fell sharply from 26.3 to 11.1. Expectations were for a decline to 20. Housing Starts and Building Permits were both stronger than expected as record-low mortgage rates continue to drive the housing markets.


6:45 am ET

The U.S. dollar is opening up considerably weaker this morning at $89.80 and precariously sitting on an important support line in a wedge pattern. The next level of key support should be the lows of the first few months of 2018 at $88.50. A break below those levels could portend serious weakness for the dollar and renewed inflationary pressures. The flip side of the argument is that the same pattern of 2017/2018 is playing out again and the dollar will break higher.

The consensus estimate for today’s Initial Jobless Claims (8:30 am ET) has been lowered to 806k versus last week’s reading of 853k.

While stocks traded in a narrow range yesterday, bond yields were volatile. The 30-year Treasury bond opened Wednesday morning 7 basis points higher than Tuesday’s close. It then spent most of the session declining back to flat on the day. Upon Jerome Powell’s statement that the Fed has no plans to expand their purchases of long term bonds, yields rose back to the day’s highs. The spike higher did not last long and was met with an equal decline in yields. This trading activity is noteworthy as there seems to be a big buyer of bonds on every dip. Whether it is enough to reverse the recent trend higher in yields, however, has yet to be seen.

December 16, 2020

3:15 pm ET

Jerome Powell’s Press Conference Notes:

  • Per the Fed’s new economic projections, they expect unemployment to fall to 5% at end of next year and 4% by the end of 2022. The current rate is 6.7% and the pre-COVID level was 3.5%.
  • Half of the Fed members still see downside risks to their 2% inflation goal.
  • Powell links the maturity of bonds they purchase via QE with economic performance. If the economic recovery falters and the Fed thinks it needs “stronger accommodation” the Fed may likely shift purchases to longer-term bonds versus shorter-term bonds. Currently, he seems content with the distribution of maturities in their purchases. This statement explains the sell-off in bonds this afternoon.
  • Powell strongly supports and welcomes fiscal support.
  • High-frequency data shows the recent surge in COVID cases is slowing economic activity.
  • He is hopeful that the vaccine will help the economy run “strongly” in the second half of 2021.
  • The bottom line per Powell- “NO ONE SHOULD DOUBT’ FED COMMITMENT TO AID ECONOMY”

2:10 pm ET

The only statement change of note in the FOMC minutes was the following in regards to sustaining the Fed’s $120 bn QE pace- “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.” Prior to today, the statement based QE operations on credit market functioning and financial stability. Needless to say, QE will be with us for a long time. The red-lined statement is below. Click to enlarge.


9:15 am ET

Per Politico- “Congressional negotiators are on the brink of a coronavirus rescue package that would include a second round of direct payments, but would likely leave out state and local funding and a liability shield, according to multiple sources involved with and briefed on talks.

This helps explain why stocks are maintaining their bid and bonds are trading weaker following the Retail Sales data.


9:05 am ET

Retail Sales were much weaker than expected as shown in the table below. With a consistent weakening theme emerging throughout the economy and higher interest rates, will the Fed discuss shifting more QE purchases to longer-term notes and bonds? Shifting purchases away from the Bill sector would also alleviate downward yield pressure on Treasury Bills as discussed in the comment below.


7:30 am ET

Chris Whalen, author of the Institutional Risk Analyst, put out an important article entitled Wag the Fed: Will the TGA Force Rates Negative. The gist of the article is that the Treasury pre-funded COVID relief efforts and end up borrowing more money than it spent. The Treasury now finds itself with a severely bloated account at the Fed (TGA) as shown below. The nearly $1.6 trillion cash balance should fall over time but will “remain well above historical norms.” Chris fears that if a sizeable stimulus bill can’t be agreed upon, the Treasury will reduce debt issuance and use the excess cash to fund expenditures. As a result of less debt issuance, primarily in the T-bill sectors, Fed Funds and short term rates could go negative.

In such a scenario, the Fed in its goal to manage Fed Funds within its 0-.25% target, would need to reduce QE to offset the Treasury’s reduced supply. This bizarre situation illustrates the fact that once the FOMC turned to the dark side by embracing QE, it essentially lost control of monetary policy. More than ever before, the Treasury is the fiscal policy dog and the Federal Reserve System is the increasingly superfluous tail.

It will be interesting to hear Jerome Powell’s response if he is asked about this problem at his 2:30 pm press conference.

 

December 15, 2020

2:20 pm ET

Stocks took a turn higher on stimulus optimism from Mitch McConnell. Per McConnell We’re not leaving here without a covid package. It’s not going to happen. .. no matter how long it takes, we’ll be here


1:53 pm ET

Top 10 Buys And Sells

From TPA Research (Click on RIAPro+ today to add TPA Research to your subscription.) 


11:20 am ET

It appears the best shot for passing a stimulus bill is a “lite” version of the $910bn bill that was in play last week. Currently, a $750bn spending bill is on the table with spending on more difficult aspects being put off until after the inauguration. Of the most noteworthy items are stimulus checks to individuals. It is likely a bill will contain more small business support, a continuation of unemployment programs, and possibly an extension of student loan forbearance and the housing eviction ban.

The market feels like it wants to run on a deal announcement but will a watered-down deal pass muster?


8:20 am ET

In the most recent December Oil Market Report, the International Energy Agency (IEA) downgraded its 2021 oil demand forecast by 170k barrels per day, in large part (80%) due to jet fuel and kerosene. Essentially the agency believes it will take longer than the market expects for the vaccines to bring normality to daily lives.

The understandable euphoria around the start of vaccination programmes partly explains higher (oil) prices but it will be several months before we reach a critical mass of vaccinated, economically active people and thus see an impact on oil demand. In the meantime, the end of year holiday season will soon be upon us with the risk of another surge in Covid-19 cases and the possibility of yet more confinement measures


7:30 am ET

With the December Federal Reserve Monetary Policy meeting kicking off today, an update on Fed Funds futures is worthwhile. Currently, the front contract, December 2020, trades at .08%, and the monthly contracts out through October of 2021 sit at the same level. Beginning in late 2021 the rate increase ever so slightly. By July 2022, the rate is .10% and about .14% by year end 2022. Essentially, the market is saying there will be no rate hikes in 2021 and an approximate 33% chance of a 25bps hike by the end of 2022. These prices can change rapidly, but for now, it appears the Fed has made it clear to traders they have no intent on raising rates anytime soon. As we will likely hear tomorrow, the odds a reduction in QE amounts in the near future are also very slim.

The chart below shows why a renewal of the stimulus CARES Act is so important. Per Liz Anne Sonders (Charles Schwab) -“When CARES Act protections run out, many landlords will have no choice but to evict some tenants

December 14, 2020

2:30 pm ET

The surge of housing prices in the suburbs is being partially offset with sharp declines in urban housing activity. The graph below shows rents in Manhattan have fallen by nearly a third and are now back to levels from ten years ago.


12:20 pm ET

A few subscribers have asked us for more information on SPACs. As such, we share the following short video from the Financial Times.

 


10:30 am ET

The Weekly Gamma Band Update is published.


10:10 am ET

As shown below, the Euro (versus the USD) has been in a downtrend for 12 years. Since 2008, the upper end of the trend is defined with a series of lower highs. Currently, the Euro is bumping up against a significant resistance trend line (gold line). If it can breach resistance and 1.25 to the dollar (red line), the prior high from 2018, significant dollar weakness may lie ahead. That said, the dollar is grossly oversold and bearish sentiment is extreme, so at least in the short run, we suspect resistance will hold.


8:00 am ET

19 IPO’s have doubled on their first trading day in 2020. There were a total of 25 IPO’s that did that from 2010-2019!!

Per the graph below, courtesy of Bloomberg, over 80% of IPOs issued this year have negative earnings. Despite questionable fundamentals, opening day trading returns on IPOs this year are the highest in 20 years. Bottom line: investors are chasing hope and promise with no regard for risk. The riskiest of assets have been the best performers as of late- IPO’s, SPACs, and zombies.


7:15 am ET

This week’s significant economic data will include Retail Sales on Wednesday, and Initial Jobless Claims Thursday. After a relative paltry gain of 0.3% last month, November Retail Sales are expected to decline by 0.3%. The forecast for Jobless Claims is also concerning, showing a further rise after last week’s large gap higher.

The Fed will meet Tuesday and Wednesday, with the FOMC statement of monetary policy and Powell press conference at 2:00 pm and 2:30 pm respectively. It is possible the Fed downgrades the current status of economic activity and possibly their 2021 growth forecast. The wild card will be whether the Fed discusses additional QE and/or other forms of monetary stimulus to counteract the slowing recovery and lack of additional fiscal stimulus.

December 12, 2020

The Trading Desk Notes by Victor Adair

December 11, 2020

2:30 pm ET

The Value Seeker Report (VMC) is published!

“Construction aggregates form the backbone of much of the infrastructure making up today’s world. Headquartered in Alabama, Vulcan Materials Company (VMC) is the leading producer of construction aggregates in North America, primarily dealing in crushed stone, gravel, and sand.”


12:30 pm ET

As shown in the Energy Information Administration (EIA) table below, this past week saw a sizeable build of oil inventories, predominately due to imported oil. Regardless of this recent trend, the price of crude oil continues to grind higher. In a nutshell, demand is not keeping pace with the increasing stocks of oil. We suspect the price of crude oil has limited upside unless demand picks up meaningfully.  Inventories are still down versus 2019 levels, but on a longer-term basis, they are running decently higher than average. Per the EIA’s weekly report:

  • “At 503.2 million barrels, U.S. crude oil inventories are about 11% above the five year average for this time of year.”
  • “Total motor gasoline inventories increased by 4.2 million barrels last week and are about 5% above the five year average for this time of year.”
  • “Distillate fuel inventories increased by 5.2 million barrels last week and are about 11% above the five year average for this time of year.”
  • Propane/propylene inventories decreased by 4.1 million barrels last week and are about 4% above the five year average for this time of year.”


10:30 am ET

University of Michigan Consumer sentiment rose but inflation expectations, both near term and long term, fell. With CPI, PPI, and now the Michigan consumer survey pointing to price stagnation, it may only be a matter of time before the inflationary stock market rotation comes to an end.


10:00 am ET

The Technical Value Scorecard is published.


9:30 am ET

PPI, like CPI, shows no signs of inflation pressures. Core PPI was +0.1%, matching consensus. Year over year the Producer Prices are only growing +.08%.


7:30 am ET

The chart below, courtesy of Bull Markets, shows that the ratio of insider buying versus insider selling is at or near record lows. Per the report- “There were only 8 other historical cases in which the S&P 500 Insider Buy/Sell ratio was this low. The S&P 500’s forward returns over the next 2-6 months were poor and usually faced pullbacks/corrections.”  Lastly- “Corporate insiders are incredibly good at trading their own stocks. They know their companies’ situation better than outsiders do, and thus can profit from this information-advantage. Corporate insiders have a consistent track record of buying their stocks near market bottoms and selling their stocks near market tops.

The yield on Portugal’s ten-year Notes and Australia’s Treasury Bills turned negative this past week, pushing the amount of global negative-yielding debt above $18 trillion, a new record. The increasing yield spread between most developed sovereign debt and U.S. Treasuries has the potential to create a surge in demand for U.S. Treasuries on any sign of economic weakness and/or the emergence of a stronger dollar trend. For foreign buyers of assets denominated in the dollar, a weaker dollar reduces their returns and can partially or fully negate the benefit of the higher yield. The opposite holds true when the dollar is stronger versus the investor’s home currency.

December 10, 2020

12:15 pm ET

In the latest sign of market exuberance, DoorDash (DASH) went public on Wednesday at $102 per share and closed the day at $188, leaving it with a market cap of approximately $60 billion. Today, Airbnb (ABNB) IPO’d at $68 and the stock is indicated to open later today at $145.  With a potential market cap of over $100 billion, Airbnb is now the world’s largest online travel company.


9:05 am ET

CPI was slightly higher than expected, increasing 0.2% last month versus 0.0% the prior month, and expectations for a .01% increase. Year over year CPI and CPI excluding food and energy were both unchanged at 1.2% and 1.6% respectively. Unlike what the equity markets seem to be pricing in, there are few signs of actual inflation. That said, official inflation data tends to lag, so we must also keep an eye on alternative price data.

Due to our large trade deficit with China, it is worth noting that China’s most recent CPI report was -0.5%, the first time it turned negative in over 10 years.

The charts below, courtesy of Brett Freeze, show that year over year inflation, broken down between commodities and services, is not showing an inflationary push.


9:00 am ET

Initial Jobless Claims rose sharply to 853k from 712k, and well above expectations of 724k. The increase brings the weekly number of newly unemployed back to levels from mid-September. The non-seasonally adjusted number was also much higher at 947k versus 718k last week. Of concern, continuing claims increased from 5.53k to 5.76k. The upward trend may continue in the coming weeks due to new COVID lockdowns.


8:00 am ET

As expected, the ECB increased the size of its Pandemic Emergency Purchase Program (PEPP), aka QE, by 500 billion euros through March of 2022. They will also re-purchase maturing bonds through 2023, effectively keeping the size of the program intact for three years. Even with the increase, ECB asset purchases are still only running at about a quarter of the pace of the Fed. The initial reaction in the currency market is a strengthening of the euro versus the dollar.


7:30 am ET

The table below shows the consensus expectations for the CPI report due out at 8:30. Jobless Claims, also out at 8:30, are expected to rise from 712k last week to 724k.

December 9, 2020

12:00 pm ET

With 300-year low yields for bonds and zero returns on cash, investors have no choice but to chase stocks. That is the popular justification at least.  The graph below shows that is exactly what investors are doing. Equity allocations amongst four major investor groups are nearly the highest ever, while allocations to bonds and cash are at the lower end of historical allocations. While the narrative’s logic makes sense at first blush, investors would be wise to consider current valuations and the expected returns for equities.

In today’s article, Half Truths are Half Lies By Definition, we explore the common misconception that lower interest rates are necessarily good for stock prices.

“As such, the expected returns per unit of risk greatly favor bonds, even bonds with near-zero yields. Bonds may be rich, but stocks are richer.”


11:15 am ET

The BLS JOLTs data reiterated the slowing progress of job gains as we saw in the monthly payrolls report. There are now 4.2 million unemployed workers than there are job openings.  The reports also shows that hiring has slowed dramatically since June and is now lower than before COVID lockdowns occurred. This is a tough situation given the huge amount of jobs that need to be filled to get unemployment back to pre-COVID levels.

Per the BLS: “The number of job openings was little changed at 6.7 million on the last business day of October, the U.S. Bureau of Labor Statistics reported today. Hires were little changed at 5.8 million while total separations increased to 5.1 million. Within separations, the quits rate was unchanged at 2.2 percent while the layoffs and discharges rate increased to 1.2 percent.


9:15 am ET

The U.S. Treasury will auction $38 billion of 10 year notes this afternoon and $24 billion of 30 year bonds tomorrow. Both auctions are $3 billion shy of last month’s record-sized auctions. Yields are higher this morning as banks/dealers that bid in the auctions frequently short notes and bonds to hedge what they will buy in the auction. The weaker the end-user demand the more hedging is required.


7:00 am ET

Yesterday’s exuberance was sponsored by the Russell 2000 small-cap index. The index rose 1.5%, over 1% more than the larger cap S&P, Dow, and NASDAQ indexes. The graphs below show the Russell index (IWM) is now 2.5 standard deviations and 31% above its 200-day ma. Notable, the difference between the upper and lower Bollinger Bands (2.5) is now 50%. As you can see it is common for the index to hit the upper band and ultimately retreat to the lower band. The index can certainly go higher, but the risk is palatable at current levels.

December 8, 2020

1:45 pm ET

In yesterday’s commentary, we presented a few facts on Tesla’s valuation and shared some views on what needs to occur to justify current valuations. Of them were 1) Tesla becomes the world’s dominant automaker 2) Other automakers, including upstarts, can not create viable electric vehicle competition. This morning we saw the following headline- “In the year 2026 will be the last product start on a combustion engine platform,” Michael Jost told the Handelsblatt automotive summit conference at Volkswagen’s headquarters in Wolfsburg, Germany, NBC News reported.  Either Volkswagen fails miserably in the EV market or Tesla has real competition. Many other automakers are also aiming to reduce combustion engine production in the coming years.

12:45 pm ET

The chart below, courtesy of Sven Henrich @northmantrader, shows the Russell 2000 is now in unchartered bullish territory. On a monthly basis, the Index is 3% above two standard deviations, an occurrence that has not happened since at least 2000. At the same time, the Percentage Price Oscillator (PPO) is also at a 20 year+ high. Similar to the MACD, the PPO is a momentum oscillator that measures the difference between two moving averages as a percentage of the larger moving average. The CPCE indicator, at the bottom, is the put/call ratio, showing that investors are buying calls at nearly three times the rate as puts.  To quote Sven- “We have nothing to fear but the lack of fear. And maybe gravity.


10:05 am ET

The chart below, courtesy Otavio Costa, shows investment-grade corporate bonds now provide a lower yield than inflation expectations. A few things worth considering:

  • Current yields do not factor in potential losses due to credit events. As such actual yields will be lower than advertised.
  • Assuming inflation expectations are correct or underestimate inflation, investors holding investment-grade bonds will lose purchasing power with their “investments.”
  • Lower spreads typically occur when investors are comfortable with the economic outlook. Today we are in a recession and all but guaranteed to have slower economic growth over the next ten years.
  • Notice the exact opposite behavior between the current instance and that of the Financial Crisis in 2008. For what it’s worth, the anomaly is today’s instance, not the 2008 experience.


8:20 am ET

Technically Speaking: Margin Debt Confirms Market Exuberance is published!

7:15 am ET

Strategas recently polled 54 fixed income analysts about their yield forecast for 2021. Only 4 of the 54 analysts believe that the 10-year UST yield can get above 1.50%. Like most of these analysts, we believe yields will stay very low as the Fed has little choice but to keep them low if they are to keep the economy humming. That said, we are well aware of Bob Farrell’s rule #9 “When all the experts and forecasts agree — something else is going to happen.”

 

December 7, 2020

3:30 pm ET

Canceling student debt as a “stimulus” of sorts has been raised over the last few weeks. Recently, the CRFB wrote a great article showing that canceling student debt is far less effective than other forms of stimulus. To wit:

  • Student debt cancellation will increase cash flow by only $90 billion per year, at a cost of $1.5 trillion.
  • Student debt cancellation is poorly targeted to those most likely to spend, given that nearly three-quarters of repayments would come from the top 40 percent of earners.
  • Forgiving the full $1.5 trillion in loans will likely boost economic output during the current downturn by between $115 and $360 billion, a multiplier of 0.08x to 0.23x.
  • Partial loan forgiveness would cost less than total forgiveness but also offer a smaller economic boost. We don’t expect a significant improvement in the multiplier.
  • Simply extending the current executive action to defer loan repayments and cancel interest would achieve much of the economic benefit of loan cancellation at only a very small fraction of the cost.

There are a number of benefits and costs associated with canceling student debt. But as a stimulus measure, its “bang for the buck” is far lower than many alternatives under consideration or the COVID relief already enacted.


12:47 pm ET

Top 10 Buys And Sells

From TPA Research (Click on RIAPro+ today to add TPA Research to your subscription.) 

10:00 am ET

TESLA SHARES HIT RECORD HIGH, LAST UP 3.3%

Tesla’s (TSLA) stock has risen over 600% this year, including a surge over the last few weeks as it was announced Tesla will be joining the S&P 500. As shown below, Tesla now has a market cap equal to the next 6 largest automakers combined, yet it only has 1% of the market share of those automakers in aggregate. For Tesla to have a sales/market cap ratio equal to the average of the top 6, they would need to sell 39 million cars per year. To put that differently they would need to sell 60% of all cars sold in the world. At current valuations, Tesla shareholders are betting on the following:

  • Tesla becomes the world’s dominant automaker
  • Other automakers, including upstarts, can not create viable electric vehicle competition
  • Electric vehicles become a large majority of cars sold globally
  • The U.S. and/or other countries do not enforce monopoly laws

Needless to say, buyer beware!


9:30 am ET

The Weekly Gamma Band Update is published.


With inflation expectations on the rise, and stocks rising on a reflation narrative, the market will get to see if actual inflation is picking up this coming week. On Thursday, the BLS will release CPI and follow it up Friday with PPI. The current consensus estimate for CPI is +1.1% annually versus 1.2% last month. We will also keep an eye on the inflation expectations component of the University of Michigan survey on Friday, to see if consumers believe inflation is brewing. Other than inflation, the JOLT report due on Wednesday, and Initial Jobless Claims on Thursday, will help better assess the employment picture.

The graph below shows yet another market anomaly and the extreme technical levels many indexes are reaching.

 

December 6, 2020

Victor Adair’s Trading Desk Notes – Week Of December 5th

December 4, 2020

12:00 pm EST

The graph below, courtesy of Brett Freeze, helps explain why negative real rates dampen economic growth. The green shaded areas in the graph represent periods in which the yield on the 3 month Treasury Bills was below the expected inflation rate. In other words, anytime real rates are negative. As shown by the blue line, productivity growth tends to decline when real yields are negative and increase when positive. Currently, the implied rate of inflation is 1.86% and the 3-month Bill trades below .10%, meaning real yields are -1.76%. For more on the importance of productivity to economic growth, we share an article we wrote in January of 2019 – Productivity: What it is & Why it matters.


10:05 am EST

The Technical Value Scorecard is published


9:30 am EST

The Value Seeker Report (CSOD) is published

“As the pandemic and associated lockdowns have temporarily transformed the economy, many companies have been forced to adapt to new challenges by managing employees remotely. Cornerstone OnDemand (CSOD) provides software-as-a-service (SaaS) to firms, which may help them through some of these challenges.”


9:10 am EST

The BLS jobs report showed a further deceleration in jobs growth with payrolls growing by only 245k versus expectations of 500k, and a revised lower 610k last month. The unemployment rate fell from 6.9% to 6.7% but largely due to a decline in the labor participation rate from 61.7% to 61.5%.  The labor force shrunk by 400k accounting for the drop.

The graph below, courtesy Evercore ISI, shows that at the current pace of job gains, employment will not get back to February levels for about four years. The current gap is approximately ten million jobs.

The following are a few interesting facts:

  • 21.8% of employees teleworked in November, up from 21.2% in October
  • The household survey declined in November by 74k
  • The number of people out of work for more than 6 months increased by 385k to just under 4 million
  • The participation rate has been steady for the last 6 months at about 2% below the pre-COVID running rate

 


7:40 am EST

How Bipartisan Stimulus, McConnell Plans Stack Up: Side by Side

The article linked above from Bloomberg provides a nice summary comparing the two stimulus plans currently being debated by Congress. A deal will probably get done but any such deal will likely fall short Democrat lawmakers and Biden expectations. As such we should expect renewed stimulus discussions following the inauguration.

 

December 3, 2020

4:20 pm EST

PFIZER EXPECTS TO SHIP HALF THE DOSES IT HAD ORIGINALLY PLANNED AFTER FINDING RAW MATERIALS IN EARLY PRODUCTION DIDN’T MEET ITS STANDARDS – WSJ

That headline caused the market to give up decent gains and close flat on the day.


1:15 pm EST

The Bureau of Labor Statistics (BLS) seasonally adjusts monthly employment data to smooth it over time. In the retail trade sector, which is heavily influenced by holiday spending, they traditionally apply a negative multiplier to the number of retail jobs added in November and December and a positive multiplier to almost every other month. For instance, in 2019, payrolls in retail trade increased by 432k from October to November, however when seasonally adjusted it actually fell by 14k. In normal times these adjustments are easy for economists to factor into their forecasts.

This year will be very different. In the last two years the BLS reduced the actual number of retail of jobs by 2.8% or approximately 450k jobs. If economists use the same seasonal adjustment factor this year and a lower estimate for the number of jobs added than years past, they run the risk of underestimating retail employment. Seasonal adjustments hold true for all employment sectors. As such, we suspect the actual number of net jobs reported from the BLS and economists expectations could vary widely tomorrow.


10:30 am EST

Below is yet another chart for our recent collection showing just how exuberant markets have gotten.


8:50 am EST

Initial Jobless Claims fell nicely to 712k from 787k last week. Claims are now back to the same level as the beginning of November. Given typical hiring tendencies around Thanksgiving, Black Friday, and Christmas as compared to this year, we suspect seasonal adjustments to the data will flaw the output. Seasonal adjustments are also likely to have a big effect on tomorrow’s BLS employment data.


6:40 am EST
The graph below is yet another indicator showing the current state of extreme sentiment and fearlessness by investors. In the words of Peter Atwater- “At peaks in sentiment, it is less an abdication of risk management than it is the belief that there are no risks.

December 2, 2020

3:00 pm EST

The graph and commentary from The Market Ear paint a grim picture of Black Friday spending. Credit Card spending, based on data from JPM Chase cards, shows a significant 8%+ reduction from the same period last year. While some decline is expected, the size of the decline is very surprising given that online spending (almost all credit based) increased 20% versus last year.


2:10 pm EST

Gasoline demand has rebounded sharply from the March-April lows but still remains about 10% below where it was running pre-COVID. Clearly, a vaccine and return to more normal activity levels will boost demand further, but will the work-from-home trend result in a more permanent reduction in gasoline demand?


12:20 pm EST

Analysts are expecting a 43% decline in international students enrolling in U.S. colleges this fall. Foreign students typically pay full tuition and room and board. Colleges, lacking this income, will have to rely on their endowments, donations, and will also likely be under pressure to raise prices. The graph below shows how the cost of education has easily outstripped CPI over the last 25 years


8:30 am EST

The ADP jobs report fell well short of the +440k estimate, coming in at 307k. While still a very strong number, the weakening trend along with the bump up in jobless claims and weak ISM employment data is a reason for concern. The correlation between ADP and the BLS employment report, while traditionally strong, has been weak throughout this recovery. As such we must not read too much into ADP, however, we would not be shocked if this Friday’s BLS report is well below expectations given holiday seasonal adjustment factors and recent aforementioned labor trends.


7:25 am EST

A stimulus package is in the air again-

  • MCCONNELL SAYS WAITING UNTIL NEXT YEAR FOR FRESH COVID-19 RELIEF “IS NOT AN ANSWER”
  • Bipartisan Senate group to unveil $908B stimulus compromise. Details fluid
  • BIDEN on stimulus: “Any package passed in lame-duck session is – at best – just a start”

CNN posted a nice summary of recent negotiations, their importance, and the roadblocks they potentially face. Below are two key paragraphs:

“There are only two weeks left on the legislative calendar. That doesn’t mean members couldn’t stay longer on Capitol Hill and try to sort out an agreement before Christmas. But, the only hope for a stimulus deal right now is to attach it to the spending bill that has a deadline of December 11.”
“Congress might be able to kick the can down the road for a few days, but at the end of the month, there is a massive cliff when the expiration of unemployment benefits, student loan payment deferrals and a federal eviction moratorium all run out.”

December 01, 2020

2:24 pm EST

From TPA Research (Click on RIAPro+ today to add TPA Research to your subscription.) 

WHAT DOES A +10% MONTH MEAN HISTORICALLY? WE LOOK BACK 70 YEARS.

Last month the S&P500 was up 10.75%. There are many analysts and pundits out with their own take on what that means for stocks going forward. Many analysts like Tony Dwyer of Cannacord believe we are in for a “choppy stretch ahead” and that “the ramp has become a little too extreme.” Sam Stoval of CFRA sees muted gains for December after a 10% gain in November.*

Many of TPA’s indicators in the Canaries in the Coalmine and Marketscope are also flashing extreme alerts, but historically the numbers tell a more nuanced tale of what to expect.

TPA looked at the past 70 years of monthly performance for the S&P500. Before November 2020, there were 12 times in which the S&P500 has registered gains of 10% or more. TPA looked that the performance for the next 1, 2, and 3 months after a +10% month to tease out any patterns. TPA then looked at all months since 1950 to compare the average performance to that following an up 10% month. The results are not overwhelming, but certain patterns do appear.

Results:

  • The month after the +10% month has an average performance of 0.60% and is positive 50% of the time.
  • The average performance of 0.60% for the month after the 12 occurrences of an +10% month is slightly less than the 0.70% performance for the entire sample of 836 months.
  • The month after a +10% occurrence is less likely (50%) to produce a positive performance than after a normal month in the 70 years (positive 60% of the time).
  • If you move out further away from the +10% month, however, the evidence for better than average performance increases. The average 3-month performance after a +10% month is +4.73%, while the normal average performance is just +2.11%.
  • In addition, the chance of positive performance for the 3 months after a +10% month is higher, 75% of the time, versus only 65% of the time for all 836 months.

Although these results are far from conclusive, TPA’s takeaway would be that there could be a short-term pullback due to extremes, but the chances are pretty good that 3 months from now the S&P500 will be higher.


11:00 am EST

The ISM manufacturing survey was slightly weaker than expected at 57.5 versus expectations of 58 and a prior month reading of 59.3. While sliding, the index is still well into expansionary territory so the decline should not be overly concerning. The only real blot on the report was the employment sub-index which fell back into contraction at 48.4 vs. 53.2 last month. The PMI survey was unchanged from last month at 56.7.


10:00 am EST

December’s Cartography Corner is published.


9:40 am EST

The Gamma Band Update is published.


9:00 am EST

Is The “Narrative” Already Priced In?


7:50 am EST

The chart below shows the 11.84% gain for the Dow Jones Industrial Average in November was the largest monthly gain since January of 1987. It was also the only time in at least 50 years in which the index was up over 10% in two months within the same year. The index has seen its fair share of losses and volatility as well this year. On a 6-month annualized basis, the recent instance has witnessed greater volatility than any time since late 1987 and early 1988.


7:30 am EST

The graph below shows that short interest, as a percentage of market cap, is now well below anytime in at least the last 15 years. The reduction in short interest provides a boost to the market as those that were short have had to buy back stocks to cover their shorts. The flip side is that active traders that can trade from the short side now have plenty of room on their books to initiate short sales.

November 30, 2020

2:30 pm EST

With Bitcoin hitting record highs we have gotten a few emails and calls asking our thoughts. In particular, one reader asked if GBTC is a good proxy for holding bitcoin? Without going into details of the trust, the primary problem with the ETF is that it trades at an enormous 100% premium ($18.83 vs $9.1) to the value of the bitcoin it holds. The premium could easily collapse to fair value and result in a 50%+ decline despite no movement in the price of bitcoin. Below the table please find our thoughts on Bitcoin.

Salt, Wampum, Benjamins – Is Bitcoin Next? A Primer on Cryptocurrency

Bitcoin: Investment Or Speculation? Let’s Talk

 


12:15 pm EST

The two graphs below help explain why gold prices have been declining recently. The graph on the left shows the strong correlation between gold and real rates. Real rates are nominal Treasury yields less inflation expectations as implied from TIPs. The scale on real rates is inverted to highlight the correlation. Over the last 3 months, real rates have risen 22bps and gold has declined by almost $200.

The second graph shows the composition of the change in real rates since September. The 10yr real rate rose 22bps from -1.08% to .86%, almost entirely due to nominal 10yr yields rising 20 bps. Implied inflation expectations over the period fell 2 bps. If you think yields can keep rising without inflation expectations rising, real rates will increase and gold should continue to trade poorly. If bond traders start buying into the equity reflation trade, real rates may fall, or stabilize, as inflation expectations rise.


10:15 am EST

The chart below, courtesy of John Hussman, compares today’s extreme level of market exuberance, using his indicator, to the last time the market reached such levels in 1999.


9:20 am EST

3-Minutes on Markets & Money


9:15 am EST

Top 10-Buys and Sells From TPA Research

Click on RIAPro+ today to add TPA Research to start your subscription for just $20/month. 


7:45 am EST

The state of the economy, COVID lockdowns, and political wrangling over additional stimulus to consumers should weigh on holiday spending this year. Early Black Friday estimates show foot traffic at retailers was down over 50% while online shopping rose by over 20%. Again, typical seasonal spending patterns will sharply deviate from years past, so we must be careful reading too much into early spending data. The National Retail Federation forecasts a 3.6% increase in holiday sales versus last year. The map below, along with jobs data, and the fact that there will no stimulus given to consumers before the end of the year, makes such a rosy forecast hard to believe.

 


7:15 am EST

Starting today, with the Chicago PMI and followed up tomorrow with ISM and PMI, the state of the manufacturing sector will be reported on. Chicago PMI and ISM are expected to slip slightly but stay well in expansion territory.  The ADP labor report is scheduled for Wednesday, followed by the all-important BLS payrolls report on Friday. ADP and the BLS are both expected to show net payroll growth of 450-500k jobs.

Jerome Powell is scheduled to speak at 10 am on both Tuesday and Wednesday, along with a host of Fed speakers throughout the week. It will be interesting to see if he, or other speakers, bring up Janet Yellen’s appointment as Secretary of Treasury and what that might mean for future Fed-Treasury working relations.

November 27, 2020

The Technical Value Scorecard is published.


11:00 am EST

We stumbled upon the picture below showing prices of certain goods from 1938. We made the table below it to compare today’s prices and the ratio of prices to income. As shown, the ratio has increased substantially in all 6 instances, meaning goods are more expensive today on an income adjusted basis. Any wonder why consumer debt has exploded?


7:30 am EST

Bloomberg recently published an article entitled America’s Zombie Companies Have Racked Up $1.4 Trillion Of Debt.  The article discusses how Zombie companies have grown substantially due to the COVID recession. They state that over 200 corporations of 3000 analyzed have recently joined the ranks of Zombies. “Even more stark, they’ve added almost $1 trillion of debt to their balance sheets in the span, bringing total obligations to $1.36 trillion. That’s more than double the roughly $500 billion zombie companies owed at the peak of the financial crisis.” Adding more debt to entice economic activity and stave off bankruptcy is part of the Fed and government playbook. What they repeatedly fail to understand from such policy is the unintended longer-term consequences. Per Bloomberg: policy makers may inadvertently be directing the flow of capital to unproductive firms, depressing employment and growth for years to come, according to economists.”  This is one reason we believe GDP growth will necessarily be slower in the coming economic expansion than it was in the last.

***Reminder- The NYSE will close at 1 pm and the bond markets will close at 2 pm. With no economic data or Fed speakers, and many traders taking the day off, today’s trading sessions should be quiet.

November 25, 2020

3:30 pm EST

The FOMC minutes from the November 5th meeting were just released. While the minutes largely duplicate Chairman Powell’s press conference and many speeches by Fed members in the days following the meeting, there seems to be an emerging concern that massive amounts of liquidity might distort markets. The Fed would never tell us their actions have already distorted markets but equity valuations, credit spreads, and the housing market to name a few markets, have the tell-tale signs of Fed actions. To wit (per Zero Hedge):

  • Several participants noted the possibility that there may be limits to the amount of additional accommodation that could be provided through increases in the Federal Reserve’s asset holdings in light of the low level of longer-term yields, and they expressed concerns that a significant expansion in asset holdings could have unintended consequences.
  • A few participants expressed concern that maintaining the current pace of agency MBS purchases could contribute to potential valuation pressures in housing markets.

2:15 pm EST

Tesla will be joining the S&P 500 on December 21st as the 7th largest company in the index. Its stock price and valuation have gone well beyond what is justified using fundamental metrics of other car companies. With such an extreme valuation, a headwind facing shareholders going forward is competition. As shown below, the number of new electric vehicle (EV) launches in 2021 is expected to be 60, nearly double that of 2020, which was triple that of 2019. By market cap, Tesla is the world’s largest car company, but as measured by sales, they are dwarfed. Two important questions facing TSLA shareholders are 1) will EV command a large market share of all auto sales? & 2) can other car companies compete with TSLA?


11:45 am EST

Even Jim Cramer agrees with us that this market is grossly overbought.


9:58 am EST

The following graphs show that most sectors and factor/indexes are grossly overbought (>80%). The S&P graph at the bottom right shows the index is now more overbought than any time since the rally began in March.


8:58 am EST

Initial Jobless Claims rose again to 778k from 748k last week and 711k the week before that. Total claims, including Federal assistance, stand at 20.452 million, a slight uptick from last week. The 20.452 million total claims imply an approximate 13% unemployment rate.


In another market rarity, 91% of S&P 500 stocks are now trading above their respective 200 day moving averages. The last time this occurred was 6 years ago.

The graph below, courtesy of Brett Freeze, compares 6-month changes in the quantity, velocity, and total system liquidity to the movements of the U.S. dollar (inverse scale). When liquidity is rising, the dollar tends to fall and vice versa. Currently, we are witnessing the rate of liquidity change declining (green line). This will continue assuming the Fed and other central banks do not do more QE, but keep injecting the same amount or possibly less liquidity into the system. If this occurs, total system liquidity (TSL- green line) will continue to decline which should boost the dollar (gold line).

November 24, 2020

4:35 pm EST

Dick’s Sporting Goods (DKS) reported quarterly earnings today before the market open. DKS reported quarterly revenue of $2.41B (+23% YoY), which beat analyst estimates by $180M. Further, the company reported GAAP EPS of $1.84, which beat estimates by $0.80. The strong quarterly results came on the back of surging e-commerce sales (+95% YoY). Despite reporting a great quarter, the stock closed modestly higher, up 0.3% on the day.

Our Value Seeker Report on DKS can be found here.


4:15 pm EST

Equity mutual funds are “all in” so to speak. The graph below shows total assets at a record high while liquid assets (cash) have fallen to levels last seen in 2013. Cash now accounts for only 2.2% of assets, nearly half of where they were 8 years ago.


12:10 pm EST

Per The Market Ear, “abandon puts- put/call ratio needs no commenting.”


10:40 am EST

Consumer Confidence fell from 101.4 to 96.1. The index remains well off the pre-COVID highs of 131. The University of Michigan Consumer Sentiment Index also shows a lack of consumer optimism about their economic prospects. Weak confidence does not appear to be slowing homebuyers. The Case Shiller Home Price Index (20 city composite) was up at an annualized rate of 6.6%, a further gain from +5.3% last month. This month’s increase was the largest in over 5 years. The pricing surge is in large part due to record-low mortgage rates, pent up demand from the spring months, and a record low 2.5 months of housing inventory (NAR).


8:26 am EST

The graph below shows three reliable measures of bond market inflation expectations. Despite the reflation trade in the equity markets occurring over the last few weeks, all three measures in the graph imply no such change in the inflation expectations of bond traders/investors.


7:11 am EST

In a CNBC interview Janet Yellen, Treasury Secretary nominee, finally laid the groundwork for what we knew was eventually coming. “It would be a substantial change to give the Federal Reserve the ability to buy stock,” Yellen told CNBC’s Sara Eisen on “Squawk on the Street.” “I frankly don’t think it’s necessary at this point. I think intervention to support the credit markets is more important, but longer-term it wouldn’t be a bad thing for Congress to reconsider the powers that the Fed has with respect to assets it can own.”


6:45 am EST

Typically at this time of year investors are eagerly anticipating Black Friday sales figures as they serve as an indication of the pace of holiday sales. This year will obviously be very different as a much larger percentage of sales will be online. The thrill and urgency of finding bargains in the early morning hours on Black Friday will be replaced with at-home online shopping at the buyer’s convenience. As such, we must be careful about interpreting and extrapolating early sales data.

November 23, 2020

4:18 pm EST

Top 10-Buys and Sells From TPA Research

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 

3:45 pm EST

Its official– President-elect Joe Biden plans to nominate former Federal Reserve Chair Janet Yellen to serve as his Treasury Secretary. This is a big deal as it will further strengthen the relationship between the Fed and the Treasury.


1:30 pm EST

Equity Market to Harvest Best November Since 1933

by CIO Larry Adam/Raymond James

• #4: Equity Market Harvesting New Post-COVID Highs | The equity market had a strong start to 2020 due to trade resolutions, but ever since the ~34% virus-induced decline, the S&P 500 has notched 11 new record highs and the strongest start to a bull market due to an improving macroeconomic backdrop, stronger than expected earnings, and positive vaccine developments. With supportive factors still in place, we maintain a positive outlook for equities over the next 12 months.

• #8: Seasonality Sweet as Apple Pie | The S&P 500 has rallied nearly 9.7% so far this month, more than 5x the index’s average November return over the last 30 years. In fact, at this juncture, the S&P 500 is having its best November since 1933! Seasonal trends should continue to support the equity market, since the November to April timeframe is historically the best 6-month period, with the S&P 500 posting an average return of 7.7% and being positive 83% of the time.


10:50 am EST

The graph below shows that the Goldman Sachs Financial Conditions Index (GSFCI) is at its lowest level in at least 25 years, denoting ease in the ability to borrow. The shaded bars highlight periods where the GSFCI was weak, along with poor market breadth, high volatility, and toppy valuations. As shown, this condition can persist for a while but it’s not likely to end well for the S&P 500.


9:30 am EST

New Post – Viking Analytics Gamma Band Update


8:05 am EST

The chart below shows AAII Bullish Sentiment has recently surged to prior peaks. More interesting is that those investors claiming to be neutral, neither bullish nor bearish, are at levels typically seen when sentiment is decidedly bearish. This data set is just another quirk in a long line of anomalies we are witnessing in the markets.


7:40 am EST

For the third Monday in a row, we wake up to a new COVID vaccine and the markets rallying in response. This week AstraZeneca released news that their vaccine is 70% effective.

Economic data will be light this week due to Thanksgiving. Today at 8:30 the Chicago Fed National Index, covering 85 indicators of economic activity, will be released. The consensus is 0.1, versus 0.27 last month, and a three month average of 1.33. This index likes others points to a stalling of the recovery. Durable Goods and the Fed Minutes from the last FOMC meeting will be released on Wednesday.

November 20, 2020

1:45 pm EST

New Post

Value Seeker Report (RTX)

“RTX has been on a wonderful run since the encouraging news broke on the vaccine front. After a 22% gain since the beginning of November, we believe the stock is slightly overvalued. Based on our forecasts, RTX has roughly 4% of downside remaining before reaching its intrinsic value.”

 

Nick Lane: The Value Seeker Report- Raytheon Technologies Corporation (NYSE: RTX)


12:30 pm EST

The graphic below shows that the two frontrunners in the betting markets for the next Secretary of Treasury are former Fed Chair Janet Yellen and Current Fed President Lael Brainard. It appears that the link between the Treasury and the Fed will only grow stronger in the years ahead.


10:34 am EST

New Post

MacroView – A Vaccine and the NEW New Normal.
While $PFE and $MNRA announced potential vaccines, it won’t fix the damage caused by the lockdowns. While the #economy will recover, it will be a new normal that is weaker than the old “new normal.”

9:15 am EST

New Post

Technical Value Scorecard Report

  • On a relative basis versus the S&P 500, the reflation sectors (Materials, Industrials, Banks, Energy, and Transportation) remain the most overbought. Tech and traditional lower beta conservative sectors (Staples, Utilities, Healthcare, and Realestate) are slightly oversold versus the S&P. If you are looking to fade the reflation trade, Tech and Momentum are the most oversold indexes versus the S&P.
  • Utilities were the most overbought sector a few weeks ago. At the time we reduced our exposure to the sector and recommended doing the same. It has underperformed the S&P 500 by 5.35% over the last 20 days. XLU is not grossly oversold but bears closely watching to potentially add back positions. It is the only sector or index below its 20 day moving average.

Technical Value Scorecard Report For The Week of 11-20-20


Treasury Secretary Mnuchin is declining to extend most of the Fed’s emergency credit programs beyond December 31st, and he is asking the Federal Reserve to return all of the capital ($598 billion) allocated to unused CARES Act lending programs. While these programs are not being used extensively, this action will on the margin hurt the credit markets. In the words of Jeff Gundlach- “So the training wheels are coming off.


Initial Jobless Claims rose for the first time in four weeks to 742k, from 711K last week. We suspect the next two months of Jobless Claims and the next two BLS employment reports will be difficult to decipher as seasonal adjustments will not accurately account for the difference between normal seasonal hiring patterns and COVID related hiring. Clearly, many retail service industries will hire less this holiday season than in years past. That said, companies like Amazon and UPS will need to hire additional staff beyond what is average.

Expectations for a steeper yield curve have only been this high three other times in the last 15 years. As shown below, in all three instances, the yield curve flattened considerably shortly thereafter. Given that short term rates are stuck near-zero due to Fed policy, overwhelming investor expectations may be a warning that 10-year UST yields are about to decline sharply. One potential driver of a flatter yield curve is the Fed. To wit, MarketWatch published the following article yesterday- Bond traders talk up possibility of December Fed ‘twist’

 

November 19, 2020

Housing starts were stronger than expected, growing at 4.9% versus expectations of 2.5%. These houses will take approximately 6-9 months to complete and come onto the market. In the summer of 2021, when they are ready for sale, it is possible they will have to compete with a newly-formed glut of existing houses. Higher house prices and the vaccine will incentivize current homeowners to sell. It is worth adding that there are a lot of baby boomers likely to downsize over the coming years. The recent surge in prices may pull forward that supply. Simply a shortage is likely to cause a glut tomorrow. For more on this topic please read our article- 3-Reasons Why There Really Is No Housing Shortage.

The graph below shows the “K-shaped” recovery in real estate. Single-family housing permits are soaring while multifamily permits are at 5-year lows.

The graph and table below, courtesy of Ned Davis Research, show that the percent of “multi-cap” stocks trading above their 200 dma is extreme at 87.3%. The table below the graph shows that nearly 50% of the time when more than 61% of the stocks are above their respective 200 dma gains are limited. Not surprisingly, the largest gains occur when most stocks are below their 200 dma.

After reading our recent comments about Fed members raising the prospects for a national digital currency, a subscriber asked us how big the aggregate cryptocurrency market is. The graph below shows it at approximately half a trillion, or about a quarter of the size of Apple. Bitcoin is about 60% of the total. Digital currencies have been hot recently. The second graph shows the price of Bitcoin is fastly approaching record highs.

 

 

November 18, 2020

Retail Sales were weaker than expected coming in at +0.3% vs. a +0.5% consensus. Last month was revised lower from +1.9% to +1.6%. The control group, used to calculate GDP, was weak at +0.1% and last month was revised lower from 1.5% to 1.0%. The bottom line, as we are seeing with other data, the sharp rebound in economic activity is plateauing.

Import and Export Prices showed some deflationary trends. Import prices fell 0.1% versus +0.2% last month. Year over year they are -1.0%. Export prices are fairing a little better on a monthly basis up 0.2%. However, they are down 1.6% year over year.

The bright spot yesterday was Industrial Production which came in at +1.1%, a healthy increase from last month’s -0.4% decline. The Capacity Utilization rate increased from 71.5% to 72.8%.

Chairman Powell spoke yesterday and made it clear that QE and other “emergency programs” are here for a long time. To wit, he said it is “Premature to even think about normalizing the size of the Fed Balance Sheet.” Powell claims that they will deal with government deficits when the crisis is over.

HomeBuilder Sentiment continues to soar and is now at record highs as shown below.

In our article, The Fed’s Bazooka Is Broken Will Direct Lending Be Next? we discussed the process in which money comes into existence. To wit:

“With each additional loan, the money supply increases. If a bank does not lend, the money supply does not grow.

In the same way that banks create money, it can vanish. Money dies when a debt is paid off or when a default occurs.”

A key point of the article is QE is not money printing and therefore not inflationary. For inflation to occur the money supply must increase and this, under the current construct, requires banks to lend the reserves supplied by the Fed from QE. One of the reasons we are not overly concerned about inflation is because banks are not lending money. The graph below shows loans and leases, as a percentage of bank assets, continue to decline despite ever-increasing amounts of QE.

November 17, 2020

Like last week’s Pfizer’s vaccine announcement, Moderna’s vaccine news boosted many stocks. However, the severe sector rotation trades and large divergences, as seen last Monday, were not nearly as distinct. The Dow Jones Industrial Average set a record high (+1.60%) and beat the NASDAQ by about 1%. Last Monday, many Tech stocks fell sharply, gold was off nearly $100, and bond yields rose. Yesterday tech stocks rallied and gold and bonds were largely unchanged. The Energy sector (XLE) was up over 6% on the day and is now up over 25% for the month to date.

Moderna’s vaccine is more practical as it can be stored in a refrigerator for 30 days compared to Pfizer’s which must be stored in a deep freezer. Transportation and storage play a significant role in terms of distribution and logistics, giving Moderna a major advantage and speeding up distribution considerably. Moderna’s vaccine was slightly more effective at 94.5% versus 90% for Pfizer’s.

While the vaccines will undoubtedly help the economy in the future, more and more states and local jurisdictions are locking down as COVID spreads rapidly. Markets in general and in particular the buying of economically sensitive, beaten-down stocks are clear sign investors are looking beyond what is shaping up to be a tough few months. With the S&P 500 now over 10% above levels from February, we must ask ourselves if the market is getting too far ahead of itself.

To that point, we ask you to consider a few factors that are not part of the bullish market narrative.

  • What if vaccines fail or the timeline is pushed out.
  • President Trump plans on enacting a series of hardline actions against China.
  • The brighter the vaccine promises the dimmer the hope for stimulus.
  • Economic growth post-COVID will be less than it was prior to COVID. As such, future earnings will also be reduced.
  • Equity valuations are higher than pre-COVID levels, which at the time were at or near records.

Retail Sales will be released at 8:30 followed by Industrial production at 9:15. Retail Sales are expected to increase by 0.4% and 0.5% excluding autos and gas. The control group, a large component of GDP, is also expected to rise by 0.4%. On Wednesday Housing Starts and Permits will be released followed Thursday by Existing Housing Starts. As we have seen over the last month, there will be a large number of Fed members speaking this week. Fiscal stimulus, monetary policy, economic activity, digital currency, and inflation are likely to be discussed.

November 16, 2020

PPI ex-food and energy was up 0.1% versus expectations of 0.2% and a prior reading of 0.4%. Like CPI the day prior, these key inflation data releases point to a weakening of the reflation trend. Bond yields took notice, with the ten year UST yield falling .12% since Wednesday. Gold was higher, as its price is well correlated to the level of real yields, as discussed in the commentary from last Thursday.

The University of Michigan Consumer Sentiment Survey fell from 81.8 to 77. Prior to COVID, it was running near 100, and at its trough, in the lower 70s. The bulk of the decline came from the Expectations index which fell from 79.2 to 71.3. The Current index was unchanged. Per UM, the resurgence of COVID cases and the election were responsible for the decline. We would add that declining stimulus is also starting to weigh on individuals.

In addition to discussing the economy and need for fiscal stimulus, quite a few Fed speakers have mentioned a digital currency alternative. To wit, The American Banker published the following a month ago- “The Federal Reserve is primarily interested in looking at a central bank digital currency that would improve the payment system, rather than one that would replace the physical dollar, said Chair Jerome Powell.” This past week he stated “There’s quite a lot of work yet to be done. The Fed is still considering a central bank digital currency (CBDC) but it’s in no rush”

Last week a few Fed members reiterated his thoughts on a digital currency. Last Friday for instance, NY Fed President Williams stated- “digital currencies are getting a lot of attention. These are issues front and center for the next few years.” Digital currencies have benefits such as ease of payments and crime enforcement, but they are not without fault. For one, digital currencies, without a physical alternative, make negative rates much more effective as the threat of withdraws from the banking system is greatly diminished. Digital currencies also allow the Fed to more easily print and distribute money directly to the people. While illegal today, it would be a powerful tool to generate inflation.

 

November 13, 2020

October’s CPI was weaker than expected, coming in at 0% versus expectations of a 0.2% increase in consumer prices. Excluding food and energy, the inflation rate was also flat. There has been a lot of data showing that the housing market is red hot and prices are rising. Interestingly, as shown below, the growth rate of shelter prices (purple), a component of CPI, continues to decline despite the recovery. Earlier this week China, reported that their CPI was 0.5%, below expectations, and the lowest in over three years.

Initial Jobless Claims fell by 48k to 709k, the largest drop in five weeks. This is a good sign given the recent surge in COVID cases and new restrictions being put into place in many areas. We shall see if the improvement continues given the growing number of COVID restrictions being resurrected. While the trend remains favorable, we remind you that prior to recent data, the largest weekly claims number in the 2008/09 recession was 665k.

The graph below shows the daily changes in the ratio of Value (IVE) and Growth (IVW). As shown, Monday’s startling 9% outperformance of value was one for the record books. In over 5,000 trading days since the year 2000, there have only been 4 days with a greater outperformance. Three of the four occurred in early 2000 as the Tech Bubble popped and investors rotated from growth to value.

The Wall Street Journal had an interesting article yesterday entitled What Biden’s Election Means for the Fed. The bulk of the article deals with the Fed’s current personnel and how that may change. Chief among those changes is the question of will Biden reappoint Powell when his term expires in a little more than a year. Biden will also have two and maybe three Federal Reserve seats to fill. The important takeaway, and one we strongly agree with, is as follows: “There is therefore little reason to expect monetary policy to change, no matter who joins the Fed’s board in the next year.”

 

November 12, 2020

Bloomberg’s Smart Money Flow Index is a measure of how “smart money” is positioning itself in the S&P 500. The logic behind the index is that smart investors tend to trade near the end of the day, while more emotional-based traders dominate activity in the first 30 minutes of the trading day. The index is calculated as follows: yesterday index level – the opening gain or loss + change in the last hour. As shown below, the Smart Index and the S&P were well correlated until late August. Since then, as highlighted by the red arrow, they have diverged sharply. Over the last ten years, the S&P 500 and the Smart Index have a strong correlation of .65. As such, we expect they will converge in time. The light blue circle shows they also diverged, albeit to a much lesser extent, in January and February as the smart money correctly sensed problems.

The graph below compares 10 year UST yields versus 10 implied breakeven inflation rates. The current gap between the two is relatively wide but even wider, considering that UST yields are usually higher than the inflation rate, not lower. In other words, real rates are negative. If the economy is going to fully recover, we should expect the UST yield to gravitate to and above the inflation rate. If that were to happen, it would imply 10-year yields of approximately 1.50-2.00%. We do not think the odds of that occurring are high because such “high” rates would heavily weigh on the economy. It is more than likely the Fed continues to aggressively buy bonds to keep yields much lower than where they should be. The other way the gap potentially closes is if the market has inflation expectations wrong and the implied inflation rate falls. This scenario suggests the recovery falters.

The graph above shows the two components used to calculate real yields. As shown above, the blue line (UST yield) has made recent progress toward closing the gap with inflation expectations, ie real rates are now less negative. The next graph shows the strong negative correlation between the level of real rates (blue line) and the price of gold. If real rates continue to rise and become less negative or even positive, we should expect the price of gold to suffer, and vice versa if real rates reverse the recent trend.

November 11, 2020

The “end of pandemic trade” continued yesterday as the Dow added another 1% on to Monday’s gains while the NASDAQ fell by 1.75%. The S&P 500, with stocks representing both tech/momentum and value, fell slightly. Yields continued to rise while oil added 2.70%.

Data from yesterday’s JOLTS report indicates that there are two unemployed persons for every job opening in the U.S. That figure is down from 4.6 but still well above the .75-1.0 pace it was running at before March.
The graph below, courtesy of Indeed, is another “K-shaped” recovery graph. The country’s largest cities (>5 million) are witnessing the slowest recovery in job postings, while the smallest metro areas (<500k) are seeing job postings nearly back to pre-COVID levels.

We often talk about stimulus and the enormous role it is playing in this economic recovery. Because of its role, an extension of the CARES Act to replace or extend the current stimulus is vital if the economy is to continue on its current trajectory. To that end, CNBC recently ran an article entitled More than 13 million people could lose their unemployment benefits at the end of December. The gist, as quoted from the article, is as follows: “The number of workers claiming these federal benefits make up more than half of the total 21.5 million people receiving unemployment benefits as of October. However, these CARES Act programs expire at the end of December 2020.”

It’s also worth reminding you that at the end of the year and during the first quarter of 2021, mortgage and student loan forbearance programs will end, forcing millions to make payments on loans or default. Per the MBABy stage, the 30-day delinquency rate decreased 33 basis points to 2.34 percent, the 60-day delinquency rate increased 138 basis points to 2.15 percent – the highest rate since the survey began in 1979 – and the 90-day delinquency bucket increased 279 basis points to 3.72 percent -the highest rate since the third quarter of 2010.” Further- “The FHA delinquency rate increased 596 basis points to 15.65 percent – the highest rate since the survey began in 1979. The VA delinquency rate increased by 340 basis points to 8.05 percent over the previous quarter, the highest rate since third quarter of 2009.”

 

November 10, 2020

In over 30 years of investment experience, I have never seen such a divergent day in the markets. The stock market heat map below shows the large number of bright reds and bright greens, representing gains or losses of 3%. The markets opened significantly higher on news that Pfizer and BioNTech have an effective vaccine. However, as the day went some stocks kept going up and others fell rapidly. The S&P closed up 41 points but that is over 100 points lower than the highs of the day. The Dow Jones ended up 3% while the NASDAQ was down 2%.

It appears as if investors sold those stocks that outperformed over the past few months and bought the laggards. Banking, industrials, and oil stocks did particularly well while tech and communications fell sharply. Even within some sectors, there were huge divergences. For instance, in the communications sector, Netflix was down 8.6% while Disney was up by nearly 12%. It’s not just the divergences that caught our attention, but the size of the percentage moves up and down for many very liquid large-cap stocks.

The volatility was not just in the equity markets but also showed itself in many asset classes. Bonds and gold got hit hard, while oil and the dollar had strong days. At one point crude oil was up over 10% on the day. The VIX (volatility index) closed the day down slightly after being 10% lower earlier in the session.

Inflation data will be released later this week with CPI on Thursday and PPI on Friday. Other than those two figures it will be a quiet week for economic data. Jerome Powell is scheduled to speak on Thursday at 9:30 am. The blackout on speeches by Fed voting members is over so we suspect they will become active on the speaking circuit as they were before the blackout. As we saw prior to last week’s FOMC meeting, the bulk of their speeches will likely revolve around the need for more fiscal stimulus.

The combination of a resurgence in COVID cases and resulting stricter rules around dining, along with colder weather has put a halt to the recovery in the restaurant industry as shown below.

 

 

November 9, 2020

Both Georgia Senate seats appear to be headed for a January 5th runoff election as neither candidate received more than 50% of the vote. This will leave the Senate in limbo for two months and, while not likely, leave the potential for a Democrat-led Senate if both Democrats can win the runoff elections. Bond yields and energy stocks were under pressure Friday as the possibility of a blue Senate came back to light. For what it’s worth the betting odds for a Democrat majority and a Trump victory are nearly equal at around 10%.

Various members of Congress are again bringing up a stimulus deal. Mitch McConnell does not appear overly enthused as he stated “the economic recovery should temper the size of an aid package.”

Per the BLS employment reports, aggregate job growth was slightly stronger than expected at +638K but below last months +672k. More promising, the unemployment rate fell sharply from 7.9% to 6.9%. A large portion of the gains are coming from the number of workers that the BLS deems as temporary layoffs. The number fell from 4.64mm to 3.21mm in the last month.

The graph below, courtesy of Brett Freeze, shows that employment in the service sector continues to greatly lag good producing sectors. This is not a surprise given COVID and the damage it has done to many industries that rely on person to person contact. The graph also serves as a reminder of our “K”- shaped recovery in which there are stark discrepancies in economic activity.

It appears the virtual/remote workplace may be more than a temporary COVID-related measure. The graph below, from the Conference Board, shows that of 313 HR executives polled, 34% of them think that over 40% of their employees will be working from home one year after COVID subsides. This study has meaningful consequences for commercial real estate and some of the larger urban economies.

Per Freddie Mac, the recent surge lower in yields pushed mortgage rates to 2.78%, a new record low.

November 6, 2020

As expected the Fed’s FOMC statement was largely unchanged from the prior meeting. The red-lined paragraph below shows the entirety of the changes. The only surprise was they did not include a sentence or two about election contingencies in case the final results are held up which could likely preclude the passage of more stimulus.

The following are some bullet points regarding Powell’s press conference:

  • He voiced concern that the economic recovery is moderating. He stated that while this was expected, it raises the downside risks as moderation can turn into decline.
  • The Fed will maintain interest rates at zero and keep QE running hot until employment fully recovers and inflation hits 2% and appears to be heading higher.
  • He vowed to “put the tools back in the toolbox once the crisis is over.” Sounds reasonable, but keep in mind after the financial crisis QE didn’t end until 2014, and rates were held at zero for 7 years. When QE was introduced to the public Ben Bernanke said it was temporary and would be removed as quickly as it was employed. It has never been removed.
  • Powell would not comment on the state of the election.
  • He said the Fed is “not taking the gains in financial market functioning for granted.” His response alluded strongly that one of the goals of QE is to support asset prices.
  • If the idea is money-financed fiscal policy, then that is not something we would consider.” The problem with his statement is the Fed is already financing the Treasury, albeit indirectly.

Powell was asked if the Fed was in a liquidity trap as Christine Lagarde (President of the ECB) recently warned in the Financial Times. He sees no such threat and said “we do not doubt the power of the things we may do.”

On this topic, it’s worth sharing recent comments from Bill Dudley, ex-President of the New York Fed, from the WSJ- “No central bank wants to admit that it’s out of firepower. Unfortunately, the U.S. Federal Reserve is very near that point. “

The monthly BLS employment report will be released at 8:30 this morning. As shown below, the consensus estimate is for a net gain of 600k jobs and a reduction of the unemployment rate from 7.9% to 7.7%.  Initial Jobless Claims have been running at approximately 3.2 million jobs a month, so assuming the consensus proves accurate, the economy is adding new jobs at a rate of about 3.8 million jobs a month. As a comparison, in 2019, the average monthly initial claims were 945k and the number of new jobs averaged 168k per month. Accordingly, the economy is currently adding jobs at almost 3.5 times the normal rate. Keep in mind, layoffs are also occurring at 3-4 times the average. The abnormalities in hiring and layoffs make employment data very difficult to estimate.

 

November 5, 2020

The impetus behind yesterday’s and last night’s additional stock gains appear to be based on the prospects for a divided Congress. It’s likely that the Republicans will hold on to a majority of the Senate and the House will stay with the Democrats. The obvious beneficiaries are the Healthcare and Technology sectors as it becomes less likely that that recent regulatory/policy challenges facing those industries come to fruition. Industrials and Materials lagged as the odds of a big infrastructure deal are compromised.

From a macro perspective, it is worth highlighting that the odds of a large stimulus bill probably took a hit yesterday. While we think Congress and the President will eventually agree on a deal, its timing and size are tough to handicap. The other risk facing investors is if the fight for the White House is contested in multiple states and an official decision is held up for weeks or possibly longer. The Bush-Gore decision, which only hinged on one state, was not settled until December 12th, over a month after the election.

Longer-term bond yields plummeted yesterday as the odds of larger stimulus and/or infrastructure bills are diminished. Markets are trading with a more deflationary narrative post-election. Volatility (VIX) fell sharply as it appears many investors removed hedges despite the uncertainty hanging over markets.

ADP reported that payrolls grew by 365k versus expectations for a gain of 600k. Last month ADP reported a gain of 735k.

The Fed will release their FOMC statement at 2 pm today and follow it up with Jerome Powell’s press conference at 2:30. Again we are not expecting much change, but we do expect the Fed to continue with their full-court press on Congress for additional stimulus. It will be interesting to see if Powell addresses what the Fed may or may not do if a delay in election results holds up additional stimulus.

November 4, 2020

As of this morning, the presidential election hinges on a few key states. Markets are very whippy with stocks rising. Of interest, the NASDAQ is up over 2%, S&P +.6%, and the Dow is nearly flat. More notable, long term bond yields are plummeting with the 10yr UST yield down roughly 10bps. Commodities are mixed with oil up over $1 and gold down about half a percent. Based on those moves we believe the markets are leaning toward a Trump victory. We caution, the election is still up in the air and asset prices will be extremely volatile.

ADP, a strong proxy for Friday’s employment report, will be released at 8:30. The current consensus estimate is for a net gain of 600k jobs. The estimate for the BLS report is also +600k jobs.

Over the last year, we have written a number of articles in which we quantify the historical underperformance of value stocks. Our analysis has been based on French/Fama data going back to 1938. The Financial Times has one-upped us in the graph below. They show that value stocks are now experiencing the most significant drawdown versus growth stocks in 200 years. Either the concept of buying what is cheap (value) is dead, or it is setting up for a period of incredible outperformance versus growth stocks.

On Monday we published 3-Reasons Why There Really Is No Housing Shortage, which discusses the current state of the housing market. We stumbled upon the graph below which adds to the article. As shown it is as hard to get a mortgage today as it was in the aftermath of the Financial Crisis. The difficulty in getting mortgage credit, especially for lower-priced housing, weakens demand. Given the current supply/demand imbalance, any improvement in credit availability will increase demand and add more fuel to real estate prices. That said, and as mentioned in the article, it may take a while longer but elevated housing prices will incentivize potential sellers to come to market. It is also worth noting that many baby boomers are at or nearing retirement. A good many of these people will trade down to a smaller house/apartment in the coming years. Given a deficit in aggregate savings for this population group, many may be tempted to sell by the recent uptick in prices.

 

 

November 3, 2020

This week, in addition to the election, investors will also contend with the Fed meeting/Powell press conference on Thursday and the BLS employment report on Friday. On top of that, 128 S&P 500 companies will report earnings. Regarding the Fed meeting, we suspect they will once again lean on Congress for more fiscal stimulus. The tone is likely to be more pressing this time as additional stimulus is already being delayed, and could be in further doubt depending on the election results or possibly the lack of a definitive outcome when they release their statement on Thursday.

The ISM Manufacturing Survey was much stronger than expected and now sits at a two year high. Even more encouraging, the employment sub-index, which has been below 50 since March finally rose above 50, denoting an expansion of employment. The graph below, courtesy of Zero Hedge, shows the historical and current relationship between the ISM index and the employment sub-component. There was an interesting comment from the report as follows:  “There is increased production due to stores stocking up for the second wave of COVID-19.

As we prepare our portfolios for the election and post-election trading we share a graph from @macrocharts that offers caution. As shown, short open interest in VIX futures is near a record level. If the election turns out unfavorable in the market’s eyes, investors that are short the VIX may have to cover their trades en masse. In such a case, it would provide more fuel for a sell-off. This is just one of many factors that have led us to reduce risk until the election is over.

We leave you with a graph showing how the S&P 500 did in the ten days following the last 5 presidential elections.

 

November 2, 2020

As a follow on to our election comments from last Friday, bonds have traded poorly during recent equity sell-offs. This may be a signal that bond traders are concerned about the possibility of either a blue sweep or a Trump win but a Democrat majority in the Senate. Either outcome would likely produce vast amounts of stimulus. Per Tom Demarco from Fidelity- “Pelosi was out yesterday saying she would like to pass a massive COVID stimulus bill during the lame-duck session before Biden takes office.” She is putting the cart before the horse, but if she is correct bond traders have every right to be worried.

The Atlanta Fed put out their first estimate of Q4 GDP. They currently expect GDP growth of 2.2%. They overestimated Q3 GDP by 3.9%, which given the extreme data and unusual conditions, is much better than it appears.

The Fed made its emergency lending program for businesses & nonprofits available to more small firms. It’s lowering the minimum loan amount under its “Main Street” program to $100K from $250K. The change is due to the inability of Congress to approve more stimulus.

The graph below compares monetary velocity and GDP. Velocity measures the rate, or how often money is spent in the economy. As shown, GDP and velocity tend to be well correlated. With Thursday’s Q3 GDP data in hand, we see the GDP is well ahead of where one would expect given velocity. This tells us that stimulus funds were widely used by the recipients of the funds but then not recirculated. It hints that economic activity from the stimulus is one time in nature and not generating further activity, as is typical. If velocity stays weak, economic activity will curtail sharply unless more stimulus is not enacted.

In Friday’s commentary, we discussed the Euro and how a breakout higher versus the dollar would heighten its deflationary problem. On Friday, the Eurozone recorded its 3rd consecutive monthly decline in consumer prices, as shown below. It’s clear that negative interest rates are not solving the deflationary problem but worse, they negatively affect their banks. As we consider potential ECB policy, especially in light of new COVID-related shutdowns, they can lower rates to even more negative rates and worsen banking problems or try to generate inflation in other ways. A weaker euro is one such way.

 

October 30, 2020

GDP rose 33.1% in the third quarter, slightly above expectations. The recovery was led by personal consumption, which rose over 40%. The surge was widely expected given the massive stimulus, via generous unemployment benefits and outright checks, provided to many citizens. Looking forward, the stimulus has mostly been spent so without more aid, economic growth will be harder to come by. As we discuss below, the election outcome will provide better visibility on whether or not more stimulus is likely.

The recovery is encouraging, but the economy is still 5.2% below the peak in the fourth quarter of 2019. To put that in context, GDP was down 4% from its prior high at its trough.

The graph below shows a downward Euro/USD channel over the last 12 years. The Euro is currently bumping up against the upper resistance line. When this occurred in the past, the trend reversed. The odds are that will occur again, especially as Europe begins to reinstate lockdowns and enact stimulus plans to aid their citizens and businesses. However, if the Euro does break out higher against the dollar it could prove destabilizing to the Eurozone as it would induce further deflation. Such a move would also push the dollar lower with inflationary implications.

With a weekend to think about the election and how the results may affect markets, we provide a few thoughts. Before progressing, it’s important to consider that the Cares Act, which fueled the recovery, is quickly waning. Without further aid, or “not enough” aid, economic growth is likely to slip backward and stocks are likely to follow. As such, our points below are largely predicated on the timing and amount of more stimulus.

  • A very tight election, with no decision and the prospect of a long period of counting votes and legal wrangling, is the worst potential outcome. Not only will it incite outcry from both parties, induce protests, but more troubling from an economic/market perspective, it will further stall an additional stimulus package.
  • A decisive and uncontested Biden win but Republican Senate may not be a good scenario either. Such an outcome will make additional stimulus difficult to pass. While a bill will ultimately pass under this scenario it may fall well short of expectations.
  • A Trump win but Democrat Senate will be a little more conducive to pass a bill.
  • A scenario where the President and the Senate are from the same party are the best-case scenarios for the market as stimulus will likely happen fast. A Democratic sweep is easiest as the bill will likely be bigger, but importantly the House is Democratic so there should be little infighting between the houses of Congress.

From a bond yield perspective, any combination that helps the passage of a bill would likely push yields higher due to the additional supply of debt needed to fund stimulus. A Democratic sweep could cause a sharp jump in yields. Conversely, a no outcome/contested election result, with slims odds of additional stimulus might cause yields to fall.

Having said all of that, we admit this election is hard to handicap and even harder to forecast how the markets will react. The election four years ago was a humbling experience for many market “experts” that feared the market would crater if Trump won.

 

October 29, 2020

Election jitters and European lockdowns (more below) pushed most risk assets significantly lower yesterday. The S&P was down 3.5%, Crude Oil down 5.6%, and Gold down 1.8%. Bonds struggled for minimal gains while the dollar and VIX soared. The VIX is now over 40, its highest point since mid-June. We should expect extreme volatility to continue through the week and early next week.  The next levels of support for the S&P 500 will be 3200 (mid-September lows) and the 200 dma (3130).

Economic concerns are rising in Europe as it sees a resurgence of COVID cases. To that end, Germany unveiled one month “partial lockdown” restrictions starting on November 2nd. The new rules put limitations on large events as well as the closing of restaurants and bars. There is also talk that France is considering a month-long lockdown. Like Germany, this one would not be as onerous as they saw in the spring.

A few months ago, we introduced the Chapwood inflation Index. The index compiled by a private sector firm seeks to calculate an alternative inflation rate to what the government reports. They describe it as “a true cost of living” for each metropolitan area. The chart below shows the respective inflation rate for the five largest cities for the first of 2020. To get more information on how they compile and calculate the data on 100 cities, visit them at the following LINK.

Retired New York Fed President Bill Dudley wrote a startling editorial in Bloomberg Yesterday (LINK). The first paragraph was as follows:  No central bank wants to admit that it’s out of firepower. Unfortunately, the U.S. Federal Reserve is very near that point. This means America’s future prosperity depends more than ever on the government’s spending plans- something the President and Congress must recognize.” Dudley essentially argues that the Fed is limited in their ability to boost economic activity and worse that prior Fed actions have sapped future economic activity and asset returns. He heavily leans on the government to deficit spend. While we agree with his views on the Fed and their future ability to boost growth, he doesn’t explain the other trap, in that government spending is solely reliant on the Fed to buy the debt ensuring low-interest expenses.

October 28, 2020

Courtesy of Bloomberg: U.S. senators depart Washington for a break, making the logistics for passing a fiscal stimulus package before the election practically impossible”  As the benefits of prior fiscal stimulus fade, the need for additional stimulus to support the recovery will become more evident. While there is optimism for a post-election deal from both parties, we offer caution as the election results and the possibility of contested and/or delayed election results may incentivize one or both parties to hold off until after the inauguration.

Expect to find some coal in your stocking this Christmas. Per a Gallup poll, consumers plan to spend $805 this holiday season, down from $942 last year. They also highlight the October estimate of spending ran 10% higher than the November estimate over the past two years. Stay tuned for their next holiday poll to be released in late November.

The tweet and graph below, courtesy @macrocharts, shows that hedge funds have the most exposure to commodity futures in at least the last 15 years. There are a few takeaways from the graph and messages the hedge funds are sending us as follows:

  • First, large positioning in one direction by hedge funds has not historically resulted in a decline in commodity prices.
  • Second, the S&P Commodity Index is based on an aggregate of all commodities and therefore not representative of each commodity or commodity type. For example, agricultural commodities are currently not showing massive long interest.
  • Third, the recent pick up in exposure may be partially the result of the hedge funds betting on Joe Biden and the prospects for a large infrastructure deal. A Trump win, or a Biden win but Republican Senate, could greatly limit an infrastructure deal.
  • Fourth, the hedge funds may be betting on or hedging for inflation. The Federal Reserve is serving up massive amounts of QE and the government is running unprecedented deficits. Many investors believe that is the recipe for inflation.

October 27, 2020

As a result of yesterday’s sell-off, the S&P 500 broke through important technical support. As shown below, the S&P (3401) now sits below the 20 dma (3433) and its 50  dma (3408). It rallied late in the day to close just above the pre-COVID high (blue line) and the red support line starting at the March lows. The next levels of support are the dotted blue and orange lines and then the important 200 dma (3129). Last week we reduced equity and fixed income exposure in anticipation of volatility surrounding the election.

The economic highlight this week will be Thursday’s third-quarter GDP report. The current consensus is for a gain of 31%. That compares to a 31.4% decline last quarter. While upon seeing the number the media may declare the economy has fully recovered, it is important to consider the optics of economic growth/decline as measured in percentage terms.  Math dictates that GDP, even with equal percentage gains and losses, would still be about 10% below where it stood after the first quarter. As an example, start at $100 and you instantly lose 50% bringing your balance to $50. From that point, it will take a 100% gain, not 50%, to get back to the original $100.

The Fed will be quiet after two weeks of a large number of speeches due to a self-imposed media blackout heading into the next FOMC meeting. Get some rest this week because next week will have plenty of potentially volatility inducing events.  The election is on Tuesday, followed by the Fed meeting on Wednesday and Thursday, and on Friday the BLS will release the employment report.

Yesterday we showed that cash as a percentage of equity mutual funds holdings is now at decade lows. While we attributed some of it to the bullishness of fund managers, we should note that low cash holdings are also due to the shift from active to passive strategies. Active investors tend to hold more cash as they sell when holdings get too expensive and hold cash for future opportunities. Passive investors, with no need to trade and good liquidity in large ETF’s/Funds, have little need for extra cash. From a market perspective, the reduction in aggregate cash holdings (more investable cash) helps further explain high valuations. The negative, as we wrote in The Markets Invisible Guardrails Are Missing, is market instability and volatility as active investors are now not enough of a force to buy or sell when the markets reach valuation extremes.

October 26, 2020

“The ships are 100% full. The containers are 100% full. You can’t get a container built. You can’t pick up a ship from the spot market. The whole container-shipping cycle is at absolutely full pulse,” exclaimed Jeremy Nixon, CEO of Ocean Network Express (ONE), the world’s sixth-largest container line. – Container Slots Sell Out, Risking Holiday ‘Shipageddon’. -Freightwaves.com

Despite a global recession and supply line issues, demand for housing and retail goods is fully absorbing the number of shipping containers. Looking ahead, economic recovery coupled with the upcoming holidays, could worsen shortages for certain goods and drive up prices for imported goods. Interestingly, as we showed last week, pricing for domestic trucking and railway services have yet to recover fully.

This will be a big week for earnings announcements as shown below.

 

 

 

 

The Feds balance sheet has started rising again after stalling for a few months. In the latest weekly Fed balance sheet update, their balance sheet now sits at an all-time high. Last week total assets rose by $26bn from the prior week to $7.177 trillion. The Fed’s balance sheet now equals 37% of GDP. While high, it still pales in comparison to the ECB at 66% and the BOJ at 137%.

The graph below compares the Buffet Ratio, or the ratio of total equity market capitalization to GDP, for the U.S. and the nine largest economies. Italy was excluded as we were unable to find total market cap data. There are flaws in this type of calculation but it does show the degree to which US stocks are overvalued versus those of other leading nations.

The graph below, courtesy of @fadingrallies, shows that equity mutual funds are sitting on record low levels of cash. While not shown in the graph, the cash liquidity percentage is the lowest it has been in decades. Said differently, mutual funds are all in on this equity rally. The white line shows that cash accounts for 2.17% of the $254.467 billion of equity fund holdings. In the event of mass redemptions by fundholders, the fund managers will have no option but to sell equities.

October 23, 2020

For the first time in a while, Weekly Initial Jobless Claims painted an optimistic picture of the jobs market. New claims last week were 787k, almost 100k below estimates, and well below the mid to upper 800’s where it has stagnated over the last few months. Continuing claims (state and federal) are still very high at 23.1 million, but also declining. California reported this week after a two-week hiatus and its data was not nearly as bad as expected.

With about a quarter of S&P 500 companies having reported Q3 earnings, the results are much better than expected. Per CNBC, the average beat rate (actual less estimate) is 19% versus a historical average beat rate of closer to 3-5%.

Continuing on the “better than expected” theme, Existing Home Sales came in at a 6.54 million annualized rate versus 6 million last month. The year over year change in sales is now +20.9%. Further, the median home price is up 14.8% year on year. Record low mortgage rates, pent-up demand, limited supply (lowest since 1982), and an exodus from cities to the suburbs is having a huge effect on the housing markets. Existing home sales are now at 15-year highs, only elapsed by the 2005-2006 market which peaked at just above a 7 million sales rate.

In regards to record low mortgage rates comes the following: Freddie Mac today released the results of its Primary Mortgage Market Survey® (PMMS®), showing that the 30-year fixed-rate mortgage (FRM) averaged 2.80 percent, the lowest rate in our survey’s history which dates back to 1971.

The Citi Economic Surprise Index for the US and other major economies continues to decline from record highs. The index is not a measure of economic activity but a measure of the accuracy of economic forecasts versus actual economic data. The prior highs occurred as economists underestimated the pace of the recovery. Likewise, the index is retreating as they get a better grip on activity. A dip below zero, as may occur soon in the Eurozone and Japan, indicates that economists are overly optimistic in their economic outlooks.

 

 

October 22, 2020

The graph below shows that gold has followed a stair-step pattern with a series of slightly downward sloped, multi-month periods followed by a run higher over the last three years. After a big surge this past summer, gold is again consolidating similarly. We are likely to add to our position in IAU and GDX when we are comfortable that gold is breaking out of the consolidation. Fundamentally, the weaker dollar, massive deficits, and aggressive Federal Reserve/Central Bankers provide further reason to add to our gold holdings.

A topic that we haven’t written on recently but deserves attention is the yield curve. As we wrote in Profiting From A Steeper Yield Curve, before past recessions, the 2s/10s UST yield curve typically inverts marginally (10yr UST rates are lower than 2yr UST rates). Historically, it then steepens rapidly alongside a recession. After barely inverting in August 2019, the yield curve slowly steepened into the current recession. While the curve reacted as is normal in direction, it has not in steepness, in large part due to aggressive Fed purchases of Treasury bonds.

Over the last few weeks, the curve has begun steepening again. While we think the Fed will eventually keep a lid on higher long term yields, they may give them a little more room before acting. Given our economy is highly leveraged on existing debt and dependent on new debt for growth, it’s worth reviewing some of the pros and cons of a steeper yield curve.

A steeper yield curve is good for banks as it boosts their profit margins. However, higher long-term yields are bad for the housing markets, corporations, and the government. That said, interest rates for those borrowers, while higher over the last few months, are still extremely low. If the curve continues to steepen, higher interest costs will certainly weigh on economic activity. In addition to the banks, further steepening should benefit mortgage REITs such as AGNC and NLY. While more traditional REITs also benefit, we have a deep concern over potential credit losses. The concern is particularly true for office and retail REITs.

While U.S. rates creep higher, the opposite is occurring around the world. The graph below shows the global amount of negative-yielding debt is approaching a new high, having nearly doubled over the last six months. In the prior section, we discussed the Fed as a backstop for higher yields. It’s also worth considering that foreign investors will increasingly find the widening differential between U.S. and foreign yields tempting. The big question for fixed income investors is what yield gets the Fed and foreign buyers to spring to action.

As an aside, the price of gold and the amount of negative-yielding bonds has a strong correlation. As the number of negative-yielding bonds creeps higher the case for gold strengthens.

October 21, 2020

Stimulus discussions and rumors around those discussions, as well as, political gamesmanship, are contributing to sharp surges higher and declines lower. The combination of stimulus talks and the coming elections will keep volatility heightened for at least the next two weeks- buckle up!

The two graphs below tell an interesting story about the current state of the homebuilding industry. On Monday, the NAHB Home Builder Sentiment survey hit a record high, yet on Tuesday, Housing Starts graphed below rose slightly. Housing Starts have stalled for two months and the number of starts is still lower than in January. If builders are so optimistic, why are Starts not following suit?

The second graph compares lumber futures prices to the home builder ETF ITB. ITB sits at record highs and is up 20% year to date. Lumber, a key component in building homes, is well off recent highs and down for the year- another odd disconnect. Lumber prices and Housing Starts argue that home builders and investors may be getting a little ahead of themselves. Conversely maybe they think the strong recovery and insatiable demand for suburban housing will continue. One vital consideration in this story is interest rates, which have been rising as of late. Further increases will certainly put a damper on house sales, as well as home builder and investor expectations.

The graph below, courtesy of Jim Bianco, puts historical context toward the massive amount of COVID-related Federal stimulus. Current spending, as a percentage of GDP, dwarfs all prior recessions and is only bettered by expenditures for World War II.  As Congress works on another trillion or two of stimulus, keep this graph in mind as well the onus that such spending puts upon the Fed to keep rates at 250-year lows.

While broad BLS employment data continues to improve, employment by small businesses is grossly lagging. The September Paychex/IHS Small Business Jobs Index is not only at least at a 15 year low, but lower than in March and also slightly lower than at the trough of the 2008/09 recession. Per the SBA, small business accounts for 49% of employment. This data set along with persistently high weekly initial jobless claims remind us that the employment recovery has a long way to go.

 

October 20, 2020

For the third straight week, there will be a lot of Fed members speaking. We suspect this week’s speakers will continue to bang the drums for more fiscal stimulus. Also providing market direction will be a heavy earnings calendar as highlighted yesterday. We do get a break from economic data this week. Initial Jobless Claims and Leading Economic Indicators, both set for release on Thursday morning, are the only important data releases this week.

The stimulus pendulum seemed to swing away from a deal on Monday, which upset the stock market. It is being reported that Nancy Pelosi has put a time limit on a package. If they cannot come to an agreement within 48 hours, she may walk away from the negotiating table. That said, we have seen both parties walk away from the table numerous times only to come right back.

Conoco Phillips (COP) made an offer to acquire Concho Resources (CXO) at a 15% premium to CXOs closing price. One of the benefits of owning the larger energy companies, like COP, in the current environment, is their ability to buy assets on the cheap. We suspect the other majors are looking at similar opportunities. In the short run takeover targets will benefit most from the activity. In the longer run, the larger companies buying discounted assets should benefit greatly.

Jerome Powell spoke yesterday and touched on digital currency. He said the Fed has a lot more work to do before deciding on whether to issue a digital currency. He also noted that a digital currency would not replace physical currency, but be a compliment to it. The two biggest benefits we see from a digital currency is one, it forces everyone to have 100% of their cash in a bank. If the Fed were to institute negative rates, depositors would not be able to pull their money from the banking system. Second, it allows the Feds and local law enforcement agencies to easier track spending, specifically illegal activities.

 

October 19, 2020

This will be a big earnings week as shown below courtesy Earnings Whispers.

Retail Sales were much stronger than expectations at +1.9%, versus expectations of +.7% The gain was led by motor vehicles and parts along with clothing sales. In aggregate, they accounted for over 50% of the increase. The table below, courtesy of Brett Freeze, breaks down contributions by sector. The control group, after a negative reading last month, posted a strong 1.5% gain. The prior month was revised lower (-.4% from -.2%), but in aggregate the two readings will result in an upgrade to Q3 GDP forecasts.

As we have continually noted in this K shaped recovery, good economic data is often met with weak data. Unlike Retail Sales, Industrial production was down 0.6% versus expectations for a 0.6% increase. As a result, Capacity Utilization remains one such weak reading.  The Fed defines Capacity Utilization as follows: “how much capacity is being used from the total available capacity to produce demanded finished products.”  Capacity Utilization sits at 71.5%. Since 1965, the reading was only lower during the 2008 recession (66.8%) and marginally lower for one month in the early 1980s (70.8%).

Despite having laggards such as Delta Airlines, Jet Blue, and Southwest Airlines, the Dow Jones Transportation Index is trading at all-time highs and nearly 10% above the February highs. Might the index be getting a little ahead of itself? That question was recently posed to us by a subscriber. The question is tough to answer. Helping boost the index are UPS and FDX, which represent about 25% of the price-weighted index. Both shippers are up well over 50% year to date as they benefit greatly from COVID-related lockdowns. On the other side of the ledger are the airlines. The bulk of the index, as represented by trucking and rail, tell us a truer story about the health of the transportation industry.  As such, recent inflation data provides some clues as to how they are doing. Prices for trucking freight, as shown below, have recovered but thus far have gained back only about half of the COVID-related decline. The data for Rail transportation is similar. If freight/rail transportation were doing as well as the index portends, prices for shipping services should be back to February levels. The Transportation index has done very well, but underneath the cover lies a story of the haves and have nots.

October 16, 2020

September Retail Sales are expected to climb by 0.7% this morning versus a gain of 0.6% last month. As shown below, Arbor Research, using web browsing data, forecasts an 0.8% decline. Within the Retail Sales report will be control group sales data, which feeds personal consumption, the largest component of the GDP report. That is expected to increase by 0.2% versus a decline of 0.2% last month.

Weekly Initial Jobless Claims showed 898k people joined the ranks of the unemployed. The number was decently higher than expectations of 825k and the highest weekly number since August. Also of concern, California did not report claims this week due to operational issues, so the actual number is likely worse than reported. The graph below charts weekly claims back to 1968. As shown by the red dotted line, representing current claims data, the number of newly unemployed is unprecedented. Claims have now surpassed the prior record (695k) for 30 consecutive weeks. This chart should serve as a caution for Fed Vice Chairman Clarida, who thinks the recession is over.

For the most part, the largest banks reported better than expected earnings. Despite what some analysts perceive as good news, most of the banking stocks are trading lower. The reason is that investors are voicing concern that they beat expectations because the banks stopped adding to their loan loss reserves. Per Bloomberg, the five largest banks increased their reserves in the third quarter by $172 million. That compares to a nearly $28 billion addition in the second quarter. Banks are making a bet that the economy will recover in the next quarter or two and their loan loss reserves are already adequate. Based on the poor recent and longer-term performance, investors are not as confident. The banks are running the risk that the recovery falters and the government does not provide adequate stimulus. On the flip side, more stimulus is ultimately likely which may help support loan repayment and may prove the banks correct in their reserves.

The graph below shows that energy stocks continue to languish as they approach the March lows. At the same time, high yield energy bonds have recovered nicely. One can interpret the graph as energy stocks being cheap, however, with the Fed purchasing junk bonds, such analysis is invalid as they have distorted the bond market.

 

October 15, 2020

PPI and PPI excluding Food and Energy were both 0.2% higher than expectations and each is up 0.4% monthly. The figures point to an uptick in raw materials and commodities prices and potentially some margin pressure on manufacturers.

Yesterday, Fed Vice Chair Richard Clarida made that the recession may already be over. “This recession was by far the deepest one in postwar history but it also may go into the record books as the briefest recession in U.S. history.”  While we would like to join in his optimism, the fact is that even with the rosiest of forecasts, GDP will not get back to pre-COVID levels this year and unemployment is still running historically high. Prior to Clarida’s comments, the IMF forecast that the global economy will lose $28 trillion of output over the next five years. Unfortunately, we think the IMF has a better-grounded assessment.

There appears to be an incredible amount of long-term value in the energy sector, but in the short term, trying to take advantage of the situation is painful. We have a position in CVX and look to add exposure to energy stocks when we are more comfortable that a longer-term bottom is in place. The following quote per Sentimentrader reminds how cheap the sector is getting: “If we net out the number of days in the past year when energy was the worst-performing minus best-performing sector, the spread is still extremely negative at more than -30 days. Going back to 1928, this is one of the widest spreads ever. The only time it got worse than this was in late 1982.”

Per data from Arbor Research, of companies larger than $300 million, almost 15% are classified as Zombies. This means they do not have enough in earnings (EBIT) to cover interest expense. For some of these companies, revenues and earnings will grow to cover the interest payments. A large majority, however, are heavily dependent on low rates and bond investors that continue to allow them to borrow new debt pay for the maturing debt plus ongoing operational needs.

 

 

October 14, 2020

The latest set of narratives driving the recent market rally, fiscal stimulus, and a Biden victory, might be misleading. It is becoming more apparent that the market is again in the grips of an options gamma squeeze. Essentially speculators are buying large amounts of short-dated call options, which forces dealers to buy the underlying stocks to hedge. This creates a circular buying spree. The surge is broken when options speculators sell and dealers must in turn sell stock to remove the hedges.  Strong evidence of this phenomena was provided on Monday when the VIX was up on the day despite the market trading much higher. Further evidence can be found in record gamma exposure and a near-record low put-call ratio.  The S&P 500 below shows how the squeeze ended in early September and the similarity in market structure to the past week or two.

The graph below shows that most S&P sectors are now overextended, trading around two standard deviations from their respective 20 and 50-day moving averages. Three standard deviations tend to be a good place to prepare for a sell-off or at least a consolidation.

The Consumer Price Index (CPI) met expectations rising .2% monthly and 1.4% yearly. The monthly data excluding food and energy, as the Fed prefers to assess it, was also up 0.2%.

A few weeks ago, we highlighted the tight correlation between Lumber, Tesla, Apple, and large-cap momentum stocks in general. Since then, Lumber futures have given up much of the gains, as shown below. Given the speculative nature we have seen in Lumber, it’s hard to assess whether the steep decline represents a sharp drop in demand or just the work of speculators. If it is a demand issue, this may be an early indicator that soaring new home sales may come back to earth.

 

October 13, 2020

CPI, PPI, Jobless Claims, and Retail Sales are the most important economic data points this week. CPI will be released this morning at 8:30 with current expectations of +0.2% (mom) and +1.4% (yoy). PPI follows tomorrow (+.2% mom and yoy). Jobless Claims are on Thursday and Retail Sales Friday.

JPM and C announce earnings today with most of the larger banks following on Wednesday. Within the RIA Pro portfolios, JNJ will also announce earnings today and UNH on Wednesday.

Yesterday, the market was led higher by Apple, Amazon, and tech stocks in general, but unlike prior surges, the broader market followed suit with much fewer laggards than early September when it last hit record highs. The optimism is tempered with caution as markets are becoming overbought as the S&P is nearing 3 standard deviations (Bollinger Bands) above the 20-day moving average. Further, the VIX rose despite the large equity gains. This potentially serves as a sign that a gamma-squeeze is once again pulling stocks higher.

According to the Economist magazine, of the COVID stimulus checks, “less than half of the money was spent; a third was saved for a rainy day.” The chart below shows that savings and debt payments constituted over half of the funds’ usage of those making $30k or more. If the government seeks to make future stimulus checks more economically effective, they may use a different distribution method, such as debit cards with an expiration date, to force consumers to spend the funds. That said, savings and reduced debt loads promote future consumption.

The Bank of England (BOE) appears ready to join Europe and Japan in initiating negative interest rates. After a few statements from BOE members alluding to negative rates, the BOE sent out the following information request: Letter to chief executive officers to request information about firms’ operational readiness to implement a zero or negative Bank Rate.”

October 12, 2020

The stimulus rollercoaster and confusion continued with the following Friday’s headlines:

  • “U.S. SENATE MAJORITY LEADER MCCONNELL SAYS WE DO NEED ANOTHER COVID-19 AID PACKAGE.” 
  • “TRUMP SAYS HE WANTS MORE AID THAN EITHER PARTY IS OFFERING”

For the last few trading days, the markets are behaving as if big stimulus and bailout deals are in the works. Given that McConnell has not been a participant in recent discussions, his new stance raises the odds of a deal getting done. The only question is can the two parties close the large gap in demands.

The breadth of the market has improved with the broader markets showing relative strength. For the past few months, the market was led higher by a select few stocks, mainly the large caps and, in particular, the FANMGs. Since March 1st, RSP (equal-weighted S&P 500) has underperformed the S&P 500 (market-cap-weighted) by nearly 6%. However, Since October 1st, RSP cut the differential as it beat the S&P by almost 3%. Similar story in value versus growth. Value (IVE) has beat growth (IVW) since October 1st, also by 3%.

The graph below, courtesy of Bloomberg, shows the stunning decline and slow recovery in ridership on New York City’s subway system.

On Friday it was reported that Microsoft is considering letting all employees work from home permanently. COVID lockdowns are teaching companies how to effectively and cost-efficiently allow employees to work from home. Given the immense office space that is currently vacant and will likely become vacant in the future in New York and other cities, ridership on the subway and other transit systems may be permanently impaired. This is not just a concern about transit, but commercial real estate and a host of other services supporting offices and workers. The work-from-home trend, if it continues post-COVID, has major positive and negative implications for businesses. The K-shaped recovery continues to present winners and losers.

 

 

October 9, 2020

Initial Jobless Claims continue to linger in the same range (840k this week vs 849k last week). Continuing claims are falling but, as we have stated, it’s hard to know how much of the decline is because people are finding jobs and how much is due to the expiration of state benefits. It is worth noting that California has stopped processing new claims for two weeks due to operational issues. As such, the Claims number may likely increase when California comes back online.

The market seems to have lost interest in the utmost importance of more Federal stimulus/bailouts. Nancy Pelosi said she was not interested in President Trump’s piecemeal approach to stimulus. On the other side of the fence, Mitch Mcconnell said “a big portion of GOP senators think enough has been done on aid.” Despite their respective comments, the market kept rising. Luckily investors now seem to be enamored with the latest narrative, that of a Biden victory and even more government spending. We say this partially in jest, but in reality, these are narratives created to help explain why markets move. Narratives, true or false, can propel the market higher or lower as investors buy into them. However, narratives are frequently wrong and can be harmful to investors that give them too much credence.

As shown in the tweet and graph below, courtesy of Liz Ann Sonders, the Fed is very concerned about the jobs market and is very vocal about it. Without the benefits of prior stimulus declining and no certainty of future stimulus and/or bailouts, the job recovery is likely to stall and possibly even reverse course. Any wonder the Fed is leaning hard on Congress for another round of spending and bailouts?

The stock market may be all that matters to Trump in the coming weeks. In a Bloomberg Article entitled The stock market may be too optimistic about stimulus chances, Julian Emanual head of equity trading and derivative strategy at BTIG was quoted as follows:

“Trump and his opponents know history- when the market has been higher in the 90 days prior to the election, the incumbent has won 85.7% of the time,” ’Emanuel said in a note. “Conversely, when the market is down in September and October cumulatively prior to an election (3,500) is the level to watch), the incumbent party has lost on 6 of 6 elections.”

October 8, 2020

The stimulus roller coaster continued yesterday when President Trump walked back his stance on no more fiscal stimulus before the election. He asked Congress for another round of PPP, a $25bn airline bailout, and a $1200 check per person. Given the excessive political jockeying ahead of the election, we have no realistic means of formulating accurate odds as to whether or not the Democrats and Republicans can agree on stimulus. Expect significant market volatility as the ebbs and flows of potential stimulus continues.

The following headline from Minneapolis Fed President Neel Kashkari reiterates many recent Fed comments and what appears to be a growing concern from Fed members that the economic recovery is at risk if Congress does not approve more stimulus. *KASHKARI SAYS VITAL THAT LAWMAKERS MOVE QUICKLY ON FISCAL AID

Per Bloomberg- The absence of a stimuluscould subtract roughly five percentage points from fourth-quarter GDP growth. The direct impact of no deal is large, but the indirect impact via a sentiment shock and consumer retrenchment could be more substantial

The following are a few takeaways from the FOMC minutes released yesterday from their September meeting:

  • There are a few mentions of concern over elevated asset prices. “participants were concerned about possible buildup of financial balances.” and “a couple participants indicated that highly accommodative financial market conditions could lead to excessive risk-taking.”
  • In general, the pace of economic, inflation, and labor recovery was to their liking but noticeably below pre-COVID levels. “the rate of real GDP growth and the pace of declines in the unemployment rate were faster over the second half of this year than in the July forecast, primarily reflecting recent better-than expected data.”
  • As we have noted, there is a lot of concern that Congress will not agree on enough fiscal stimulus to ensure the recovery continues. “In addition, most forecasters were assuming that an additional pandemic-related fiscal package would be approved this year, and noted that, absent a new package, growth could decelerate at a faster-than-expected pace in the fourth quarter.”
Over 40% of the S&P 500 stocks are still down more than 20% from their pre-COVID highs. This data point is yet another indicator of how narrow the market runup has been. The generals (FANMGS) are in charge, so careful attention should be paid to their trading activity.
State governments continue to suffer as a result of increased spending and reduced tax revenue. The graph below shows that they have reduced their staffing to levels last seen 20 years ago. Unlike the recovery in national employment data, state employment is not showing any recovery.

October 7, 2020

*TRUMP SAYS HE’S STOPPING STIMULUS TALKS UNTIL AFTER ELECTION

Yesterday’s headline put a likely end to stimulus talks and with it, the market fell sharply. The dollar and bonds rallied as the prospects for more debt issuance are reduced, at least in the next few months. The market appears to be trading on firmer ground this morning.

The JOLTS labor data was generally positive with the percentage of layoffs and separations declining. The number of job openings fell to 6.49 million, which is not far from pre-COVID levels, and well off the lows of March (5 million). The difference, however, is that today there are 12.5 million unemployed people trying to fill those 6.5 million jobs. In February there was more than one job opening per unemployed person. Two job seekers for every job opening is high, but it pales in comparison to the prior recession when the ratio was over six to one at its peak. The only problem in comparing the two periods is that many more people have quit looking for work this time than during the last recession, and, as such, are not included in the count of unemployed people.

Fed Chairman Powell spoke yesterday and, as he has done at every opportunity over the last few weeks, warned the President and Congress of “tragic” economic consequences if more stimulus is not forthcoming. He also said: “Monetary policy is not the first defense for financial stability.” Essentially he warns that the Fed backstop is limited in its ability to maintain a real economic recovery. Also of particular interest, he made it clear that negative rates are not a tool they are looking to use. This contradicts recent statements from other Fed members that have appeared more open to it.

Last week Germany reported more deflation than expected, and yesterday France lowered their Q4 GDP estimate to 0% growth. Both stats are euro negative/dollar positive as they increase the likelihood the ECB will take on more aggressive action to stimulate growth and inflation. Given the potential for no stimulus before the election and possibly not until the inauguration, the dollar should trade better versus the euro and other currencies.

The tweet and graph below from Michael Kantrowitz of Cornerstone Macro quantify what we and others have said about the unusual disconnect of the stock market and the economy. It turns out to be not only unusual, but unprecedented in at least the last 60 years.

October 6, 2020

President Trump took to the twitter airwaves in force on Monday morning. After a few days of relative silence, the media and markets took it a sign that he is recovering. The stock market rallied on both his health and increasing chatter that a stimulus deal is still possible despite the Senate recess.  The only odd factor in yesterday’s rally was the VIX also rose by 1%.  Bond yields increased sharply as there are growing concerns that a Biden victory would equate to more stimulus, ergo more Treasury bond issuance.

This week is shaping up to be a quiet week for economic data. That said, the Labor Department will release the Jobs Opening and Labor Turnover Survey (JOLTS) which will provide more detail on the labor situation. The FOMC minutes from the last Fed meeting will be released on Wednesday afternoon. Not much new is expected from this release as the meeting itself proved non-eventful. As we saw last week there are a large number of Fed members scheduled to speak this week.

Q3 corporate earnings reports will begin trickling in this week. Delta, Carnival, Levi Strauss, and Dominoes are the only well-known companies reporting this week. The banks will truly lead off earnings season the following week. To see the upcoming earnings dates on your holdings or those in the RIA Pro portfolios, click on the Portfolio Tab, then Dividend/Earnings, and Upcoming Earnings. As shown below, in the equity portfolio JNJ will announce on October 13th, followed by UNH the next day.

As shown below, courtesy of Zero Hedge, speculative short interest in 30 year Treasury Bond futures is now at a record high. As we discussed with the dollar yesterday, if these positions need to be aggressively covered, it could lead to a surge in Treasury prices and a decline in yields. It seems as if some of these traders are betting that 30-year yields potentially break above its 200-day moving average, which it is currently bumping right into.

 

 

October 5, 2020

661,000 new jobs were added in September, below expectations for 859,000. However, August data was revised higher by 110,000 jobs. The unemployment rate fell to 7.9% from 8.4%. While seemingly good, the reason for the decline was largely due to a decline in the labor participation rate from 61.7% to 61.4%. Currently, there are 10.7 million fewer people employed versus a year ago. Net net, the BLS data is weaker than expected and continues to show that the recovery is slowing. That said, it may not be weak enough to push politicians back to the negotiating table for more stimulus talks.

The price of crude oil and ten-year implied inflation expectations have been well correlated for the last 10 years as shown below. If oil continues to show weakness, inflation expectations will likely follow. If so, what does that mean for market expectations for a V-shaped recovery? Likewise, will the Fed take notice and potentially get more aggressive with QE or possibly negative rates?

8 SPACs conducted IPOs on Friday, raising a total of $3.25 billion. This year’s number of SPAC IPOs is already more than the total from the last two years combined. SPACs are special purpose acquisition companies, which collect investor funds today with the hope of acquiring assets in the future. Investors are essentially writing a blank check to an asset manager in hopes they can find value. As we noted a while back, these entities, in many cases, represent the epitome of speculation.

The graph below shows that short speculative positioning in USD futures is now the largest in at least the last ten years. When and how the shorts cover their positions is important. An event that would cause them to cover at the same time could result in a sharp dollar rally.  On the other hand, as witnessed in 2012 and 2017, the shorts may cover in a non-urgent manner without pushing the price higher.  The bottom line is that the dollar has been negatively correlated to risk assets.  As such, we must stay on guard as the shorts are potential fuel for a dollar surge.

October 2, 2020

Stocks traded weaker overnight on news that President Trump and the First Lady have COVID. We will monitor his situation to see if there are any repercussions.

The Senate was dismissed until after the election, further dashing hopes of additional stimulus. That said, they can easily be called back to vote if the two parties can come to an agreement.

It turns out the market swings on Tuesday night and Wednesday (detailed in yesterday’s commentary) are not that abnormal compared to the trading activity of the last four weeks. Average True Range (ATR) is a simple average of the daily difference between the high and low of each trading day. As shown below, the ATR on the futures contract is currently 2.03%. While it pales in comparison to the experiences of March, April, and May, it is at the high end of the range for the last five years. This is not bullish or bearish commentary, but just a note of caution as a high ATR is often a function of illiquidity. We believe illiquidity is currently an issue and will remain one through the election and possibly through year-end, especially in the event of a contested election.

Initial Jobless Claims registered a small decline to 837k but a big drop in continuing state claims, which are in part due to benefits expiring. Expectations for today’s BLS jobs report is as follows: Payrolls +894k (1.37mm prior), Unemployment Rate 8.2% (8.4%), and Participation Rate 61.8% (61.7%).

Continuing on the K-shaped recovery theme, the graph below, courtesy the Washington Post, shows the gross distortions in the recovery of jobs for the top 25% of wage earners as compared to the remaining 75%. The illustration also highlights the big difference in recovery for the four wages classes in this recession versus the prior three recessions.

We have mentioned that equity valuations are on par or, in some cases, even higher than those seen during the late 1990s tech bubble. The graph shows yet another indicator of the market froth that is only comparable to instances from 20 years ago.

October 1, 2020

ADP reported that job growth in September rose by 749k, beating expectations by 100k.

Steven Mnuchin put further doubt in the ability of Congress to agree on a stimulus deal. Per the Treasury Secretary- “If we can’t get a stimulus deal done before the election, we will come back and try to negotiate a deal after the election.” Later in the day, Mitch McConnell made similar disparaging comments. These comments may just be negotiating tactics so we must be careful to not rule out a deal in the next week.

U.S. stock markets have been extremely volatile since Tuesday’s close. From the 4 pm close through the Presidential debate,  S&P 500 futures rose by nearly 30 points. As the debate ended, it reversed sharply, erasing the 30 point gain plus falling an additional 35 points. From the lows at 2 am it recovered and rose nearly 100 points. A little after 2 pm the index gave up all the days gains but recovered and posted a 27 points gain from yesterday’s close.  This morning the index looks like it will open up 30 points. Yesterday was the last day of the quarter, which resulted in window dressing trades and added to the volatility. With yesterday’s gains, the S&P 500 index closed 6 points above both its 20 and 50-day moving averages. The technical picture is mixed. The bullish case is that the index is above both key moving averages but bearish because of the crossing of the moving averages.

Per Bloomberg: GERMAN INFLATION RATE FALLS TO -0.4%; EST. -0.1% (year over year). More signs of deflation in Europe will lead to more talk of QE and even lower negative interest rates. This should put pressure on the Euro and bolster the dollar.

As we recently wrote in The Fed’s Bazooka is Broken, the ability of central banks to generate inflation is dependent on the banking system’s ability and willingness to make loans. Per the article: The banks have enough excess reserves to make trillions of dollars in loans. However, the banks are on the hook for defaults and solvency issues arising from such loans. Banking margins are at historically tight levels, interest rates at record lows, and the unemployment rate is at levels rarely seen. To make matters worse the Fed is begging for inflation, which would raise future interest rates to detriment of bank profits. Should we expect banks to loan in such an environment?  Of course not.”  The graph below shows how aggressively banks have tightened lending standards, effectively negating the Fed’s inflationary stance. Until we see a change in bank behaviors and loan demand, or a new Fed program, as we allude to in the article, the threat of significant inflation is minimal.

The K-shaped recovery continues to show stark contrasts between the winners and losers of the recovery. For example, as shown below, small businesses are not seeing any recovery in hiring. ADP affirmed the problem in yesterday’s report- “small businesses continued to show slower job growth.

It is not just small business on the wrong side of the K. From the Air Transport Action Group; “Executive Director of the cross-industry Air Transport Action Group, Michael Gill said: “Air transport is in the midst of the deepest shock in its history. We expect a reduction of up to 4.8 million jobs in the sector by the end of the year and a massive hit to our ability to connect the world.”

September 30, 2020

The ADP labor report, typically a good proxy for the BLS report, is expected to rise by 650k, or about 225k more than last month. The BLS report has been running well ahead of ADP and is expected to beat out ADP again with expectations of a pick up of 900k jobs. There are a lot of moving parts, many of which are difficult to quantify, that did not exist before COVID to help explain the vast differences between the two reports. We know the labor market is improving, but it is very difficult to compare current employment statistics to pre COVID periods.

The Conference Board reported that its consumer sentiment index rose sharply to 101.8, up from 86.3. While encouraging, the index remains well below its 132.6 reading in February.

The House continues to negotiate additional fiscal stimulus, but the two sides appear further apart than they did late last week. Currently, the Democrats are offering a bill worth $2.4bn. It is believed the Republicans and the President are in the $1.5bn area. While $1bn is not necessarily a wide chasm, there are various components of the bill such as state and local funding in which they remain far apart. We still think it is likely a deal passes but time is running out as the election nears.

Boston Fed President Eric Rosengren mentioned that a credit crunch is “very likely” toward the end of the year if banks come under stress from Commercial real estate loans. The Financial Times recently published an article on securitized commercial loans (CMBS) in which the author makes a case that the number of troubled CMBS deals will increase rapidly. Essentially he argues that CMBS bonds have been able to pay enough interest and principal from special funds the bonds hold for maintenance purposes (FF&E accounts) to delay the underlying collateral from going into default. He fears FF&E funds are running out and as a result, some AAA-rated tranches are now dropping to BB.  “This process will now accelerate rapidly.”

The Bank of England may be the next central bank to introduce negative rates. Per Andrew Bailey, Governor of the BOE, “if we cut rates below zero, we would need to explain it very carefully to the public.”

 

September 29, 2020

There are quite a few Fed members on the speaking docket this week. On the economic front, the major industrial surveys will be released on Wednesday (Chicago PMI) and Thursday (PMI/ISM). Employment takes center stage with ADP on Wednesday and the BLS report on Friday. Politics will also be of importance with the first debate tonight at 9 pm and the likely re-upping of the Cares Act stimulus potentially coming at any time this week or next. Politics aside, the markets will probably do better with a strong Trump/weak Biden debate showing.

ECB President Christine Lagarde sounded the alarm against a stronger Euro and issued a warning about deflation. To wit: “A stronger euro is set to weigh on inflation.” With the Euro sitting at two-year highs, the ECB has likely seen enough euro strength for their liking. This is yet another reason the dollar may continue to break out and head higher versus the euro and other currencies in the coming weeks.

The markets surged yesterday with strong breadth. The VIX was the only fly in the ointment, which despite a 1.6% gain in the S&P 500, was up slightly on the day. With yesterday’s gains, the S&P is sitting at the 50-day moving average (3353) and only 20 points below the 20-day moving average (3373). Those averages may prove to be the only roadblocks on the way to new highs. We added exposure yesterday as the technical situation is improved. We remain cautious as we are very aware of the troubling economic and political environment. But, as they say, markets like to climb a wall of worry.

As shown below, equity volatility (VIX) remains more than two times higher than its recent record lows from 2019 and early 2020. At the same bond volatility (MOVE index) is at all-time lows as the Fed, via aggressive buying, has sharply reduced the daily trading range of U.S. Treasuries. Over the last ten trading days, the difference between the high and low closing yields for the ten-year UST was 2 basis points. Since 1962 the average ten-day difference is 22 basis points.

Evercore, with the help of data from Redfin, shows an 18% jump in homebuyers’ preference to move out of urban areas, in just the last 6 months.

September 28, 2020

The equity markets rallied on Friday and again overnight on news that Congress is coming to a bipartisan agreement on a $1.4 trillion expansion of the Cares Act. The possible agreement comes as a bit of a surprise given the election and political rancor. While good news from a market perspective, is it enough to boost the economy?

Investors outflows from the two popular junk bond ETFs HYG and JNK reached $3.7 billion this week, representing the largest outflow since March. The two ETFs have seen outflows for four weeks running. With yields and yield spreads near record lows, there is little upside tempting investors and substantial risks to be concerned about. Further, the Fed has been focusing QE on Treasuries and mortgages and not the corporate bond sectors.

The graph below, courtesy Zero Hedge, shows that over the course of the last month the market’s concerns for the election and, in particular, a contested election have escalated. Compare the gold line showing the VIX curve from late August to the current VIX curve (green line). A month ago, the high point on the VIX curve, or the point where the most volatility was being priced in, was October. VIX was lower in November. Today, the VIX curve shows that volatility increased over the last month, but importantly much more so for the November contract. November is now at a higher level than October.

The graph below by Brett Freeze shows how the misallocation of debt toward unproductive ventures has fueled each economic expansion. The unfortunate part of this economic strategy is that the overhang of unproductive debt has made each economic expansion slower than the one prior to it.

September 25, 2020

Initial Jobless Claims remain stuck, coming in slightly higher from last week at 870k.

For the third day in a row Chairman Powell pressed Congress for fiscal stimulus. To wit, the following Reuters headline: FED’S POWELL SAYS EVICTIONS, MORTGAGE DEFAULTS COULD INCREASE IN ‘NOT TOO DISTANT FUTURE’ WITHOUT FURTHER FISCAL ASSISTANCE TO FAMILIES

He also stated: Targeting Average 2% Inflation Will Give The Fed More Room to Lower Rates as Needed.” This is the first indication from any Fed member that negative rates are on the table. We are interested to see if this was a slip of the tongue or there is more to the comment.

Per Goldman Sachs- “We are lowering our Q4 GDP growth forecast from 6% to 3% due to Lack of Further Fiscal Support.”

Fed Vice Chairman Richard Clarida said the Fed will not consider raising interest rates until it actually achieves 2% inflation for at least a few months. While he is the Vice Chairman, he is contradicting recent comments from Chairman Powell and other Fed members who say the Fed will wait for a much longer overshoot of the inflation target before rate hikes are discussed.

The graph below shows that gold prices and real rates (10 year UST less the breakeven implied inflation rate) are very well correlated. If the reflation trade is fading and deflation again becomes a concern, real rates will rise unless Treasury yields fall. We do think yields can fall substantially but, for the time being, they appear grounded at current levels. Given this construct along with dollar strength, we reduced our gold and gold miner holdings on Wednesday. We still like gold in the long run, but in the short term, we are concerned that the recent trend changes in the dollar and real rates may put further pressure on gold.

The K-shaped recovery is alive and well. The tweet and graph below, courtesy Joe Weisenthal of Bloomberg, shows that three measures of economic activity in New York are failing to recover.

The graph below, courtesy of the Daily Shot, shows that small-cap stocks have not only taken on much more leverage than large caps but the amount of leverage has soared to record highs. Any sustained uptick in interest rates will likely spell trouble for many over-indebted small-cap companies. In such a circumstance they must deal with higher interest expenses along with reduced access to funds due to default risk. This is one of the main reasons we have stayed away from the small-cap sector recently.

The graph below, courtesy Bianco Research, shows that the current drawdown is the deepest since the recovery took hold in March.

September 24, 2020

The Russell 2k (IWM) closed two cents below its 200-day moving average. The small-cap index is the first of the major indexes to fall back to its 200-day moving average.

The House passed a bipartisan stopgap spending bill to fund the government through December 11, thus avoiding a pre-election shutdown. It was thought the Democrats might use the bill as leverage to delay or even prevent the nomination of a new supreme court justice.

Interactive Brokers (IBKR) sent the email below to its clients as follows: “implied volatilities indicate that the markets will be confronting elevated volatility both before and after the November 2020 election. IBKR shares that sentiment.” As a result, they are raising margins by 35% over the next month, starting September 28th. IBKR is a large futures and equity custodian. Their action will reduce the amount of leverage used in client accounts. We should probably expect other large custodians to take similar actions. Reduced leverage will undoubtedly force some investors to reduce their positions. The change will affect long and short positions but given the speculative nature of the markets, we suspect the net effect will be negative for risk assets. Click on the picture below to see the full note.

Chairman Powell made the following interesting comment yesterday: “We have done basically all of the things that we can think of.”  While there is certainly more the Fed can do, this is the Fed’s way of saying the economy needs more fiscal stimulus before any additional monetary stimulus. This is not a bullish signal for a market that has been uplifted by the “Fed will do whatever it takes” narrative.

The Citi Economic Surprise Index, measuring the difference between economist economic forecasts versus actual data, has fallen recently but stands well above any level in the past. At 166, the index is almost 100 points lower over the last month but still well above the 20-year peak of 100. For context, the lows in March were around -150. Bottom line: economists have grossly underestimated the recovery. Like many other indicators, this one is not easily comparable to the past due to the unprecedented shutdowns and amounts of stimulus. We advise ignoring the media narrative touting this index as a sign all is well. It serves as a reminder that economists, like the rest of us, are struggling to forecast economic activity.

The UK is on the brink of instituting national lockdowns as the number of COVID cases increases sharply. Europe is experiencing a similar uptick in cases. The U.S. has seen a rise, but not to the same degree. A COVID comeback may prove beneficial for stocks like Zoom, Amazon, and Clorox but further impede recovery for the restaurant, airline, and travel industries.

September 23, 2020

The Chicago National Fed Index, derived from 85 national economic indicators, was much weaker than expected at .79 versus expectations of 1.88 and a prior reading of 2.54. The index is expressed in standard deviations from the average. As such, the current reading represents growth of almost one standard deviation above the average, albeit with a sharp slow down from the prior month.

The major indexes are perched between the 50-day and 200-day moving averages. If they can break above the 50-day, the market may very well run back to its highs. A drop below may portend that the recent decline is more than consolidation. While most market participants focus on the market cap S&P 500 and NDX, the equally weighted S&P 500, provides a barometer of the broader market. The graph below shows it is closer to its 200-day moving average than the other major indexes.

The graph below of the VIX (volatility index) has yet to show that traders are concerned about the recent selloff. While VIX is historically high, options traders seem to collectively think the move is just a consolidation. Pay close attention to the VIX as it can tip us off if they are wrong.

Over the last two months, the materials and industrials sectors have outperformed the market. Part of the narrative behind the trade is reflation. As we noted in last Friday’s technical scorecard, both sectors hit extreme levels of overbought. A correction or consolidation is in order. The bigger macro question, however, for the sectors and the economy and markets as a whole, is reflation possible without fiscal stimulus? Along with those two sectors, we recommend following the Commodity Research Bureau (CRB) index of commodity prices, which has a nearly identical trend as the two sectors. The index, shown below, is recently stalling.

The chart below shows that despite improvement in the labor markets, Federal tax withholding has yet to reverse its slide.

 

September 22, 2020

It will be a slow week for economic data but Fed speakers will keep the calendar busy. In particular, Chairman Powell is scheduled to speak at 10 am today, Wednesday, and Thursday. While groundbreaking policy changes are not to be expected, we are on guard for more clarification around inflation averaging and its implications for future monetary actions. The health of banks may also be addressed as the Fed will undergo a new round of financial stress tests on the banks.

In yesterday’s Major Market Buy Sell Review and prior ones, we have noted that the U.S. dollar index is technically oversold. As shown below, the price of the dollar is close to breaking out of the range (red box) that has contained the dollar for the last two months. A strong dollar is negative for commodities and precious metals as we witnessed yesterday. It’s also worth considering that equities have rallied on the back of the weaker dollar since April. Yesterday’s moves in the dollar and the S&P 500 were complete opposites of each other, as shown below the longer-term dollar graph.

On September 30th the government will shut down if a continuing resolution is not agreed upon by Congress. With the passing of Ruth Bader Ginsburg, the political atmosphere is even more hostile, if that’s possible. As a result, the bill to continue government operations, which was expected to pass, is now in doubt. We should also lower our expectations for additional stimulus.

Vanguard and Fidelity recently made noteworthy changes to their money market fund lineups. Both entities reorganized their Prime money market funds into existing traditional government money market funds. Vanguard’s prime funds totaled $125 billion and Fidelity’s $86 billion. Prime funds are high minimum investment products that invest in short-term, investment-grade corporate, and commercial loans. The funds were preferred by larger investors as they had higher returns than government money market funds. In the current environment with very low rates and tight spreads, the benefit to holders of Prime funds, especially after fees and expenses, was negligible. These funds were a key source of short term borrowing for corporations.

Last Friday, the University of Michigan released its sentiment survey, which contained mixed messages. The overall index shows an uptick in confidence to 78.9 versus 74.1. Inflation expectations were lower at 2.7 versus 3.1. Of greater concern, and shown below, expectations for future income continue to languish.

 

September 21, 2020

On Friday, the NASDAQ 100 and S&P 500 closed below their respective 50-day moving averages. The Dow Jones is about 200 points above its 50-day moving average. Attesting to how overbought the markets were, it took a nearly 10% decline in the S&P 500, before the first significant level of technical support was broken.

We have recently been writing about the allure of value stocks as they have grossly underperformed growth stocks over the last few months as well as the last decade. This bout of recent history is an anomaly. Going back almost 100 years, value stocks have returned over 3% more annually than growth stocks. The million-dollar question is when will the trend favoring growth stocks reverse.

In our Technical Value Scorecard Report from last Friday, we shared the graph below showing how value has finally achieved overbought status versus growth using both our score and our normalized score. This is the first instance of outperformance since the recovery took hold in early April. While we are hopeful value can continue to outperform growth, we remain skeptical. The second chart below shows the 2020 trend of the ratio of value (IVE) versus growth (IVW). While the uptick has broken through resistance, we would like to see a continuation of the uptrend to get more optimistic. This trade has a lot of promise but we must also respect the decade-old trend until it has clearly changed.

When the Fed buys bonds (QE) they are not printing money per se. QE puts reserves in the banking system which then allows the banks to print money if they elect to make loans with the new reserves. Despite the central bankers’ goals, and intentions QE and forward guidance will not create inflation unless the banks lend. The graphs below show the Fed’s, ECB’s, and BOJ’s inflation estimates over time versus actual inflation. In almost all cases their estimates fall far short of reality. Should we expect that the Fed’s new inflation averaging policy to be any different?

The graph below, courtesy of the New York Times, shows the amazing growth of SPAC public listings. Per Wikipedia, a SPAC is defined as follows: A special purpose acquisition company (SPAC), sometimes called blank-check company, is a shell company that has no operations but plans to go public with the intention of acquiring or merging with a company utilising the proceeds of the SPAC’s initial public offering (IPO). The sharp increase in SPACs is yet another sign of the intense speculative nature of investors in today’s financial markets.

 

 

 

September 18, 2020

Initial Jobless Claims were higher than expectations but 33k less than last week’s figure. Continuing state claims continue to decline, however, not all of those people are getting new jobs. Some of the reduction is due to the expiration of claims benefits. The total number of people receiving jobless benefits, including Federal programs, rose by 100k to nearly 30 million.

The graph of the Dow Jones Industrial Average below shows that, despite the recent sell-off, the Dow has yet to break below material technical levels. First, it is currently sitting on the horizontal blue trend line marking the high in early June. The line also appears to be a minor neckline for a potential head and shoulders pattern. The 50-day moving average is the next level of support at 27431. Another 1000 or so points lower is the red parabola, which has served as good support since March. Lastly is the all-important 200-day moving average.

Keeping interest rates low and stable is hard enough for the Fed with the heavy supply associated with $3 trillion-dollar deficits. Making the job even harder is that foreign nations are not buying U.S. Treasury bonds to the degree they had been. The tweet and graph below, courtesy of Lyn Alden, shows that foreign institutions now own, in aggregate, about 8% less of the total debt outstanding than they did at their peak in 2013.

A few weeks ago we noted that Lumber was trading in line with the large-cap growth stocks driving the market higher. The graph below shows the strong correlation between Lumber, Apple, and Tesla. Prior to the last few months, lumber prices were a good economic indicator for the pace of construction and the real estate business.  Its recent price movement appears to be more a function of rampant speculation. The theme continues that the Feds effect on investors causes distortions to what were once good and reliable signals.

Manhattan apartment sales are being devastated by COVID and the emerging de-urbanization trend. Per Statista, second-quarter apartment sales are down 52%, total sales (1,147) is the lowest number of sales on record, and the median selling price is down 18%. It is also widely reported that rents are down sharply as well. The upside to the troubles facing New York and other big cities is that suburban real estate sales are setting records. To that end comes the following quote from the National Association of Home Builders Chief Economist Robert Dietz- “lumber prices now up more than 170% since mid-April, adding more than $16k to price of typical new single-family home…suburban shift keeping builders busy.” His quote accompanied their latest homebuilder survey which now sits at record highs.

 

September 17, 2020

In yesterday’s Fed policy statement, its 2020 economic outlook was upgraded.  GDP is now forecast to shrink by -3.7% in 2020, up from -6.5% in June. They also reduced the unemployment rate forecast from 9.3% to 7.6%. The Fed changed its policy statement to fit around its new inflation averaging policy. Per the statement: “With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well-anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.” The Fed will keep rates at zero and continue with QE at the current pace. In Powell’s press conference he mentioned a couple of times that the Fed would continue to buy $120 billion a month of Treasury bonds and mortgages. We are left to wonder if corporate and municipal bond-buying programs have ended.

The FOMC statement also contained economic projections through 2023. The consensus expectation of Fed members is for the Fed Funds rate to stay at zero through 2023. Unemployment spent most of 2019 below 4% and, and, even at that historically low rate, most Fed members conceded that the economy was not at maximum employment. Unless inflation ticks up well above 2.5-3%, the Fed will likely keep rates at zero well beyond 2023.

Retail Sales were weaker than expected at +0.6% versus expectations of 1% and a revised lower +0.9% last month. The Retail Sales control group was down by 0.2%. This subset of retail sales is a more precise method of gauging consumer spending and is used to calculate Personal Consumption Expenditures (PCE) for the GDP number. The positive spin on the data is that the fiscal cliff is, thus far, not having a more significant negative effect on the consumer.

On Tuesday the Fed announced they are reopening the repo window with daily overnight repo and one-week repo auctions. The auctions are to be conducted through October 14th. There is no mention of a reason for the Fed’s sudden concern about liquidity. This new round of operations may be a prelude to further liquidity injections through the election period when the possibility for market volatility is heightened.

The Wall Street Journal recently published an article highlighting the enormous surge in stock options trading. The graph below, from the article, shows that the volume of trading in single stock options now exceeds volume for individual shares. Because of this unprecedented condition, Viking Analytics Gamma RIA Pro reports are important to follow. The weekly report identifies the market levels which are likely to induce buying or selling from dealers that must actively hedge options activity.

 

September 16, 2020

Retail Sales will be released at 8:30 this morning, with expectations for a 1% increase. Along with labor conditions, this is the most important data we can follow to assess the recovery. We suspect, given credit card data, today’s number could be on the weak side of expectations. That said, economic data has been hard to predict due to the unprecedented conditions put upon the economy as well as the massive amount of fiscal stimulus.

A reminder, the Fed will release its latest monetary policy statement and Powell will follow it up with a press conference. Little is expected from the Fed meeting as it comes on the heels of Jackson Hole and relatively stable financial markets. Odds are the meeting may be a disappointment as its difficult for the Fed to make a case that they need to do more. That is unless they make significant changes to their economic/policy forecasts (“dot plots”). If they do weaken their projections for inflation, jobs, and/or economic growth, the market may take that as a signal that the Fed could become more accommodative.

Yesterday we presented a graph showing that the Fed now owns a sizeable share of the TIPs market. As we discussed, their sizeable activity is skewing TIP yields, and therefore, implied real (after inflation) yields. Gold has a strong correlation with real yields, as such, real yields help us gauge richness and cheapness of gold prices. The graph below shows the strong correlation between the two over the last decade. The orange dot highlights that at current real yields gold is fairly valued. However, we now must question whether real yields are accurate using TIPs pricing.

The chart below showing the composition of debt by credit rating over the last 40 years is telling. Consider that since 1980, the amount of A or better-rated bonds has been relatively the same. Since 2000 the amount of investment-grade debt (BBB or better) has been relatively constant. The large contributor to debt outstanding over both periods has been largely junk-rated bonds.

Using its proprietary Global Fund Manager Survey, Bank of America believes “long tech” (aka FANMG) is the most crowded trade in at least the last seven years.

September 15, 2020

Of importance on the economic calendar, this week will be Retail Sales on Wednesday and Jobless Claims on Thursday. The Fed’s two-day FOMC meeting ends on Wednesday with the release its monetary policy statement at 2:00 pm followed by the Jerome Powell press conference at 2:30 pm et. Also of note this week will be Friday’s quadruple witching options expiration, whereby four sets of cash and futures options expire on the same day. The simultaneous set of expirations can lead to heightened market volatility leading up to and on the expiration day itself. Yesterday’s strong move may, in part, be related to the expirations.

Teddy Vallee, in his tweet below, shows the sharp increase in the Fed’s ownership of TIPs. Given that the Fed has purchased such a large percentage of the TIPs market in such a short time, is there value in following market-implied inflation expectations (derived from TIP pricing)?  The answer is yes, but its value is greatly diminished from years past. Unfortunately, there are few other indicators to help assess future inflation expectations. Equally problematic, and as we wrote in The Markets Are Sending Confounding Messages, the Fed is also eroding the value of market and economic signals they traditionally rely upon. To wit:

“Since inflation is, by definition, a monetary policy outcome, changes in market-based interest rates used to inform the Fed itself on the appropriateness of their policy stance. Today, however, the Fed thinks they are the wiser arbiter of the price of money. They override all market signals through quantitative easing (QE), among other extraordinary policy schemes.”

The Baker Hughes worldwide (1,050) and U.S. rig count (250) are now at the lowest levels since at least 1975. Both counts are also less than half of their recent averages. The graph below, courtesy EIA, shows that consumption of energy products fell sharper than production during the COVID lockdowns. However, the recovery of consumption is expected to rebound quicker than supply. If this forecast holds, and rig counts remain at or near current levels, oil prices may finally have a tailwind to grow.

 

September 14, 2020

The S&P 500 closed slightly higher, and in doing so, held above the 50-day moving average. The NASDAQ was not as lucky, falling .60% and below its 50-day moving average.  Oddly, the VIX was down nearly 10% despite the broader markets being relatively flat. With overnight gains in the futures markets, both indexes should trade comfortably above the 50-day.

The Federal Reserve meets this Tuesday and Wednesday to update their monetary policy stance. It is highly unlikely that the Fed will make any changes to its QE operations in terms of size, pace, or assets.  We do, however, suspect the Fed will focus its attention towards the growing headwinds to growth and recovery. In particular, they will likely highlight that fiscal stimulus is eroding quickly and without new legislation, the economic recovery could falter. Given the upcoming election and partisan politics, any warnings will likely fall on deaf ears in Washington.

CPI exceeded economists’ expectations for the third consecutive month, rising 0.4% monthly, and 1.3% annually in August. Used car prices were a significant driver of the gains as they rose 5.4%. 

In this past Friday’s Artete’s Observations, he points out that corporate executives, as judged by their personal financial decisions, may not be as optimistic about economic recovery as they would like us to believe. To wit:

US executives sold $6.7bn of stock in their own companies last month [August], cashing in on a record-breaking market rally with the biggest burst of selling in five years.”

“CEOs are normally optimistic about the companies they run. After all, that’s partly what they get paid to do. When they sell, then, it rarely bodes well for the stock. And, by the way, they know better than anyone else how the company is performing. This particular bout of selling meaningfully contradicts the market optimism at the end of the summer.”

The graph below, courtesy of the Pew Research Center, shows a rising trend of young adults living with their parents over the past two decades. Weak wage growth, housing inflation, and student debt are the predominant factors behind the disturbing trend. This age group is also the hardest hit from the COVID related shutdowns. As such, the percentage of young adults at home is now beyond that of the Great Depression.

September 11, 2020

Bespoke Investments helped put the recent market decline into perspective as follows: This has been the worst five days for the S&P 500 where the index still closed above its 50-DMA since 1934.”  As of yesterday’s close, the index is still about 20 points above its 50-day moving average despite being off nearly 7% from recent record highs. Little technical damage has been done. This serves as evidence of just how extended the market was. However, with that in mind, a break of the 50-day moving average may portend further weakness.

The weekly Initial Jobless Claims Report showed 884k new claimants, which was identical to last week and above expectations of 828k. Continuing state claims increased by about 100k. The total number of people claiming benefits, including Federal, rose by nearly 400k. It appears the number of filers for Federal assistance rose by 90k last week on top of an increase of 140k the week prior. These are predominately self-employed people.

Monthly and annual PPI were 0.1% higher than expectations. Year over year PPI, excluding food and energy, rose 0.6%. While low, it is 0.3% more than expectations. The Fed tends to gauge inflation trends excluding food and energy prices. The good news with a higher PPI, is that pricing power is being restored to producers meaning, economic activity is normalizing.

As we noted earlier in the week, Softbank’s strategy is to buy call options, which in turn forces options dealers to buy the underlying stocks which Softbank owns. The graph below, courtesy SentimenTrader, shows that small retail traders are also getting in on the game. The graph also attests to the highly speculative nature of many retail investors that have developed over the last few months.

The “K”-shaped recovery in real estate continues to roll on. While the residential property market in many suburbs is on fire, commercial real estate demand is crumbling, as shown below.

One of our concerns, which we have raised over the last month, is the recovery appears to be stalling. Our thought is largely based on near real-time retail spending, consumer confidence, jobless claims, and other indicators. Most government economic data is often lagged by one or two months, making it challenging to see precise turning points. Unfortunately, as shown in the graph below, courtesy Bloomberg, our concern may also be global.

September 10, 2020

As we have written over the last few weeks, gamma is an important factor in driving markets. On Tuesday, we introduced a new weekly RIA Pro report, from Viking Analytics, which shares important options gamma trading levels. In this week’s Weekly Gamma Band Update, they point out the S&P level of 3397.15 as being Gamma neutral. When the S&P is below that level, dealers are likely to be net sellers to hedge options positions and vice versa above it. As the index moves further away from the neutral level, the amount of hedge related buying or selling should increase. The neutral level at times can act as a magnet. For instance, yesterday the market sold off decently towards the close and ended at 3398 or on top of the gamma neutral level.

Jobless claims are expected to fall to 828k from 881k last week. Again, this data is not entirely comparable to the prior months due to last week’s change in the seasonal adjustment calculations. Producer Prices (PPI) are expected to rise by 0.2% monthly but fall 0.3% on a year over year basis. CPI, to be released on Friday, is expected to climb 0.3% monthly and 1.2% year over year.

The BLS JOLTs report provided interesting labor data as follows:

  • The number of unemployed persons per job opening fell from 3 to 2.5. The ratio was below 1.0 prior to COVID.
  • The number of job openings rose from 6mm to 6.62mm.
  • The only troubling piece of data in the report was that the number of hires fell from 7mm in June to 5.8mm in July. Essentially the pace of jobs recovery slowed in July, something confirmed in the ADP report but not the BLS employment report.

Over the last two and a half years, gold has rallied in a series of strong gains followed by triangular consolidations. Once again, after a price surge in July and early August, gold has been consolidating. Currently, the price of gold is sitting on its 50-day moving average as well as the support line of its recent consolidation. Its Williams %R is nearing oversold territory and its MACD is nearing a positive flip. If gold breaks higher, it could quickly elapse the prior record high near 2100, however, if it breaks below the pattern, the next level of strong support is 1700-1750, being the prior consolidation region and the 200-day moving average. We believe it will break higher and are positioned accordingly.

 

September 9, 2020

The only economic data of consequence this week will be the key inflation figures (PPI on Thursday and CPI on Friday). The Fed will be quiet as voting Fed members are now in a public blackout period prior to the FOMC meeting scheduled for next Tuesday and Wednesday.

Crude oil has fallen sharply over the last week and now sits at two-month lows. It is also below a technically important weekly resistance line and its 50-week moving average. The circles in the weekly chart below highlight the number of times that crude oil bounced higher off of what was support in the low 40s. In early 2016, the support was breached, but the price ultimately had no trouble rising back above the line. Now that crude is below the support line, we shall see if the line acts as resistance or it bounces back as in 2016.

The mystery behind the large percentage gains in the FANMGs, poor market breadth, and odd VIX behavior has been revealed. SoftBank disclosed they are sitting on multi-billion dollars of profits from options trades. The profits are the result of a self-orchestrated “gamma squeeze.” Essentially, as detailed in this telling Zero Hedge Report, Soft Bank and other hedge funds buy stocks and then buy short-dated call options on those stocks, which force dealers that hedge to buy the stocks. Their actions, along with those from copycat traders, creates a circular trading pattern that pushes these favorite stocks higher. To wit:

“These bizarre trends, where one or more players are furiously buying calls and pushing both the implied vol and gamma (in both single stocks and the broader market) ever higher while dealers were caught short gamma and were forced to chase stock prices to obscene levels, creating a feedback loop where the more calls were bought the higher the underlying stock price surged, leading to even more call buying and the paradox of a record high vix at an all time high in the S&P500 (in fact the last time we had observed such a confluence was the day the dot com bubble burst)…”

As we see, this strategy works both ways. To avoid getting squeezed, dealers may try to push some stock prices lower. We should expect extreme volatility, especially in the “market favorites” over the coming weeks as the battle between dealers and traders rages on.

September 8, 2020

Friday’s Employment report was strong, meeting expectations for about 1.4 million net new jobs and showing a sharp decline in the unemployment rate from 10.2% to 8.4%. While the report is very encouraging, there are two points worth considering. Permanent unemployment rose by about half a million people to 3.4 million. Second, nearly 300k of the new jobs are the result of temporary jobs created by the Census Bureau. Regardless, improvement in the labor market is beating all expectations from a few months ago.

From the Fed’s perspective, the employment data still gives them plenty of reason to keep providing excessive liquidity. Prior to Jackson Hole, the markets may have paused and asked if the jobs data implies the Fed is getting closer to ending QE or possibly raising rates. Since the new framework was announced, that should not be the case as unemployment can be too high but never too low.

On Friday, China’s Global Times reported that China may “gradually” reduce its holdings of U.S. Treasury bonds. Specifically, the article discusses a $200 billion decrease from approximately $1 trillion. Ballooning deficits and Trade war are cited as rationales. Normally this might be concerning, but with the Fed as active as they are, the prospect of the Fed absorbing $200 billion over a period of time is not daunting. Throughout March and April, the Fed added on average $277 billion in assets per week.  In fact, during the last two weeks of March, they added $1.143 trillion to their balance sheet, which is more than China’s total holdings. Bonds traded poorly on Friday in part because of the news.

The tweet and charts below, courtesy Liz Ann Sonders, show the strong relationship between implied volatility (traders’ expectations for volatility based on options pricing) and realized volatility based on what the market actually does.  Volatility has an inverse relationship with liquidity. When volatility is high, it is because there are gaps in the bid/offer market structure which, results in larger than normal price movements up and down. We recently wrote about this concept in Volatility Is More Than a Number, Its Everything. As Liz states, there may be more volatility to come.

Last week we mentioned how government stimulus was waning and the importance of the Fiscal Cliff. The graph below puts this concern into context. Federal Outlays typically account for about 15-20% of GDP. Currently, they account for nearly half of GDP. If government spending declines faster than economic activity recovers, a resumption of the decline in economic activity will almost certainly occur.

September 4, 2020

The consensus estimates for today’s BLS employment report are for the net creation of 1.4 million new jobs, unemployment falling from 10.2% to 9.8%, and a slight increase in the labor participation rate to 61.6%. The range of estimates remains extremely large. For instance, the increase is net payrolls is between 435k and 2mm, versus what is typically about 100k.

Initial Jobless Claims fell by 130k to 881k. The only problem is that it is not comparable to prior numbers. Starting this week, the BLS changed their computation methodology regarding seasonal adjustments. The non-seasonally adjusted number rose by 7k, likely meaning much of the drop in the headline number was due to their new math. Last week, the number of people using Federal assistance rose by 151k, 20k more than state claims dropped. As of August 15th the total number of persons claiming state and Federal benefits rose from 27mm to 29.2mm.

Over the last week, we saw some signs of life in value stocks. The relative outperformance of value over growth was noteworthy during yesterday’s selloff.  Yesterday, growth (IVW) was down 4.25% and value (IVE) was down 1.85%. We have been taking a more conservative tact recently by reducing exposure and positioning away from growth towards value. Accordingly, we will are paying close attention to see if the outperformance can continue.

Our World In Data, affiliated with the University of Oxford, compiles and shares interesting data on an array of topics. We recently stumbled upon an interesting report in which they show that the degree of economic sanctions put on various countries to stop the spread of COVID has little correlation with economic activity. To wit: “But among countries with available GDP data, we do not see any evidence of a trade-off between protecting people’s health and protecting the economy. Rather the relationship we see between the health and economic impacts of the pandemic goes in the opposite direction. As well as saving lives, countries controlling the outbreak effectively may have adopted the best economic strategy too.”  For example, Sweeden had few economic sanctions but it shows up on the graph right next to the United States.

September 3, 2020

ADP, which has a strong historical correlation with the BLS employment report, was much weaker than expected. ADP reported that 428k jobs were added in August versus a 1 million estimate. ADP revised the July report higher by 45k jobs to 212k, but it still stands well short of the July BLS report of 1.76 million new jobs. ADP data, which comes directly from employers, raises the specter that Friday’s BLS report could be well below the estimate for 1.4 million new jobs. That said, the BLS uses surveys, not hard data, so all bets are off.

Apple (-2.10%), Tesla (-5.90%), and Lumber (-4.00%), the three recent media favorites, were hit yesterday and the market didn’t skip a beat. The Dow, S&P, and NASDAQ were all up over 1%. The VIX continues to rise and bond yields fall despite the strong equity gains. At least the breadth was a little better yesterday, with total market advancers accounting for almost two-thirds of all U.S. stocks. Another oddity from Wednesday worth noting, gold was down 1.50% as the dollar was strong, yet gold miners (GDX) posted a gain.

Another day and another valuation extreme was reached. Yesterday, as shown below, courtesy of Zero Hedge, the forward P/E on the S&P 500 traded at a record high, breaking the prior record from 1999.

The Fed Funds futures market has fully bought into the Fed’s new policy framework, which essentially declares that interest rates will not rise for a long time. The furthest out Fed Funds contract, August 2023, is priced for a 25% chance of a rate reduction. Going forward, price fluctuation in the forward contracts will be almost entirely based on changing odds for a reduction of rates below the zero bound.

To put more context around Apple’s stock meteoric rise over the past six months, its market cap is now equal to the total market cap of the Russell 2000 Small Cap Index, as shown below. The stock is trading 65% above its 200-day moving average, an extreme last seen fifteen years ago.

September 2, 2020

Yesterday saw yet another bad breadth day in the equity markets despite a strong move higher in the broad indexes. Including over 7,000 stocks in the NYSE, NASDAQ, and AMEX exchanges, 43% of issues were lower on the day. The heat map below shows large swaths of the S&P 500 were red despite the index being up .75%.

Yesterday’s manufacturing surveys were mixed with ISM coming in slightly better than expectations and PMI on the weaker side. Both surveys are above 50, in expansionary mode, and thus signaling that managers of manufacturing facilities think the general direction of production is improving. The ISM Employment Index remains in contraction mode but improved from 44.3 to 46.4. New orders, a leading indicator, continue to rise sharply and is at the highest level in over 15 years. Again, this survey is not an absolute indicator of output, but simply a count of the number of managers that believe things are better this month than last month.

The term Fiscal Stimulus Cliff describes the declining amount of Federal stimulus flowing into the economy and the dampening it will likely have on economic activity. There is also a Legal Cliff that warrants our attention. To wit, yesterday, the Wall Street Journal wrote on the expiration and curtailment of various state moratoriums for retail tenant evictions. Many retail establishments have been able to stay afloat via reduced or even no lease payments over the last six months. That will begin to change as the landlords, many of which are leveraged and have interest payments of their own to make, will now be able to take action.

Tesla, continues to charge ahead. On Monday, the stock rose over 12%, seemingly because of the stock split. To put the gain into perspective, its market cap, on just Monday, increased by two times the market cap of Ford. The stock gave up some of those gains yesterday as they announced they would issue $5 billion worth of new stock. Interestingly, Tesla will issue new shares at the market on an ad hoc basis. Frequently, companies issue shares in a large block and often at a slight discount to the market price.

September 1, 2020

Today, the most widely followed manufacturing surveys, ISM and PMI, will be released. Both are expected to dip slightly but remain in expansionary mode. We will pay close attention to the ISM employment sub-index, which has not rebounded nearly as sharply as the entire index. On Wednesday, ADP will release its employment report to be followed on Friday by the BLS employment report. The consensus of forecasters expects ADP to show a pickup of 1 million jobs in August.

There are several Fed speakers throughout the week including, Mester, Kashkari, Brainard, Evans, and Bostic. We are on the lookout for more details about how the Fed will try to generate more inflation.

Fed Vice Chair Clarida spoke yesterday and stated the following about their new policy framework: “This change conveys our judgment that a low unemployment rate by itself, in the absence of evidence that price inflation is running or is likely to run persistently above mandate-consistent levels or pressing financial stability concerns, will not, under our new framework, be a sufficient trigger for policy action.”  – Essentially he tells us that even if we get back to record low unemployment, the Fed may still keep rates at zero, assuming inflation is weak. The framework argues that the rate hikes from 2015 to 2019 would never have occurred under the Fed’s new policy.

Bill Dudley, President of the New York Fed 2009-2018, had some alarming words about the marginal benefit of monetary operations in The Fed Lays Out New Goals, but Its Tools Could Be Lacking (WSJ). To wit:

  • “The Fed is never going to say the cupboard is bare because that’s alarming. But they’ve reached the area of very rapidly diminishing returns”
  • “The Fed is operating at the margins. That needs to be recognized. If it’s not recognized, there is a risk people are overinvested in what the Fed can do”

Last Friday, Japanese Prime Minister Shinzo Abe stepped down due for health reasons. Over the last 8 years, “Abenomics” or the three arrows of stimulus, have powered Japanese markets higher. The Nikkei has more than doubled over the period after trending downward for over 20 years.  While his efforts ended deflation and boosted asset prices, GDP shrunk over the 8 year period. From a market perspective, the concern is whether or not his predecessor will continue to stimulate markets to the same degree. Providing some comfort, BOJ Governor Kuroda is not expected to step down.

The VIX volatility index is now at a one month high and up about 25% over the last two weeks. The gains come despite the S&P 500 rising 7% over the same period. The red lines in the graph below show the last four instances when the correlation between the S&P 500 and VIX was positive.

Warren Buffett’s favorite market valuation indicator, total market cap to GDP, is now more expensive than it was before the tech bubble crashing.

 

 

August 31, 2020

IMPORTANT NOTE: APPLE & TESLA SPLITS

  • Portfolios do not current reflect the stock split yet on AAPL and TSLA so valuations and performance are incorrect.
  • We are in the process of updating the coding for the adjustment.

Thank you for your patience.


One of the oddities of this economic recovery is the number of gross distortions in steadfast economic and market relationships. These uncommon divergences are occurring in large part due to the unprecedented nature of the economic crisis and the substantial fiscal and monetary stimulus being deployed to counteract it. The graph below, courtesy of Pervalle Global, shows how a historically strong relationship, lending standards on credit cards and retail sales, has completely broken down. 

On a personal note, the credit line on my Capital One credit card was cut two weeks ago, despite a high credit score and a perfect record of paying the card in full monthly. I have come to learn on Friday that its not a reflection of my credit. Per Bloomberg : “Capital One Financial is cutting borrowing limits on credit cards, reining in its exposure as the U.S. reduces support for millions of unemployed Americans.”  Capital One is the 3rd largest credit card issuer in the U.S. Waning fiscal stimulus and reduced credit card limits from Capital One and other card issuers will surely be a drag on personal consumption in the months ahead.

The Capital One news helps us better understand why monetary velocity, as shown below, courtesy Brett Freeze, is falling rapidly. The charts approximate monetary velocity on a monthly basis. While the supply of money is rising due to QE operations, the velocity, or the rate at which money is circulating within the economy, is falling. QE will only drive inflation higher if the banks take the reserves the Fed gives them in exchange for bonds and lends the money. As the data shows that it is not occurring.

On numerous occasions over the last month, we have discussed the weak breadth underlying the market despite the strong performance. The graph below highlights the recent bout of the relatively weak correlation between the market-cap-weighted S&P 500 and the equal-weighted version. This is just another way of showing how the top five to ten companies are driving the market higher, while many other stocks are not faring nearly as well.

On CNBC, Cleveland Fed President Mester was quoted as follows: “I don’t feel right now that we are engendering an asset bubble. .. Yes, stock prices are elevated and you’re right to point that out.”  She is the second Fed President in as many days to acknowledge that valuations are “elevated.” Publically they will never voice too much concern over asset prices, but given these statements, we wonder if this is a bigger deal in internal Fed discussions related to monetary policy.

 

 

August 28, 2020

Second Quarter GDP was revised higher from -32.9% to -31.7%. Initial Jobless Claims were slightly higher than expectations at 1.006 million. Through August 8th, total jobless claims, including Federal beneficiaries, fell from 28mm to 27mm. As asked noted last week, is it falling because people are finding jobs or because people laid off in late February are exhausting claims. Likely a combination of both.

Jerome Powell led off the Jackson Hole conference by announcing the Fed has unanimously approved a new long-run policy framework statement. They are abandoning the prior policy, which relied on higher interest rates to fight inflation. The Fed has two Congressionally-chartered mandates: maximum employment and stable prices. Powell made it clear that employment will take precedent over price stability. To accomplish this goal, they will target an average inflation rate. Specifically, Powell said they would aim to average “2% over time.”

The Fed prefers PCE to gauge prices over CPI. If we assume the Fed wants PCE to average 2% over the last five years and the next 5 years, they will need to aim for a 2.6% target PCE rate. That equates to an approximate 3% CPI rate for the next five years.

The important takeaway is that the Fed’s focus is now on maximum employment. The dual mandate has become singular at the expense of price stability. Employment data, both weekly claims, and the monthly jobs reports will now become even more important gauges to assess monetary policy.

Click on the picture below for two paragraphs from Powell’s speech that are circular and raise a lot of questions. 

On Wednesday, we published The First Trillion is Always the Hardest- Analyzing Apple Mania, which in part, discussed how expensive Apple’s (AAPL) stock has become. For a more in-depth perspective, we take the analysis a step further by comparing AAPL to another market darling Amazon (AMZN). At the end of 2018, both companies had similar market caps of approximately $700 billion. Today AAPL sits at $2.1 trillion which is about $500 billion more than AMZNs market cap. The amazing part of Apple’s outperformance is that over the one and half year period, AMZN has grown earnings and revenue significantly faster than AAPL. Additionally, AMZN benefits much more from COVID related shutdowns than AAPL. The simple analysis below by no means is implying that AMZN is cheap, but you certainly get a lot more for your money with AMZN than AAPL.

Options trader Matt Thompson (@dynamicvol) noted the following:  “Spot $VIX now 12.4 points over 20d realized vol, near a record since 2004.”  Basically, the amount of expected volatility in the coming month is significantly more than what the market has witnessed over the last 20 days.

We leave you with a cartoon that seems appropriate for the Fed’s Jackson Hole conference this weekend.

 

August 27, 2020

Yesterday was another odd day in the markets. The S&P 500 closed up over 1% despite more stocks being down than up. Further confounding, the volatility index (VIX) rose 5.60%. The tweet below from Sentimen Trader is yet another example of the extreme state of investor sentiment.

Fed Chairman Powell opens up the Jackson Hole annual conference at 9:10 this morning with a keynote speech. It has been widely reported that he will deliver a “profoundly consequential” message in which he will increase the Fed’s inflation target. From what appears to have been leaked, the Fed, via average inflation targeting, will aim for 2.5% inflation, versus their current 2% target. Powell may surprise us with a new policy to generate more inflation, but we think it’s more likely the Fed’s plan will involve keeping rates at zero well after a durable recovery takes hold. Such a plan would also use guidance to stress their intentions to keep rates grounded going forward.

In addition to inflation and monetary policy discussions, we are curious to see if any Fed speakers make a note of high valuations in many asset markets. While we think it’s unlikely they would want to upset the markets with such talk, it was interesting that Richmond Fed President Tom Barkin stated: “There clearly is some risk as valuations get elevated.”

In our weekly Relative Value Reports (8/21 Report), we use 17 technical gauges to provide a score. The score helps us determine if an index or security is overbought or oversold versus its benchmark or on a standalone, absolute basis. The graphs below show that the S&P 500 is now more overbought using this assessment than only one other time in the last 20 years. This jibes with many other technical and sentiment indicators, some of which are components of this model. Extreme technical readings don’t necessarily mean a top is imminent. Still, it does mean we should be mindful of the potential for a reversal or, at the least, a period of consolidation.

The graph below, courtesy Cornerstone Macro, shows that value stocks underperforming growth stocks is not just a U.S. story but one occurring globally.

 

August 26, 2020

New Home Sales rose last month at a 13.9% pace, the largest growth rate since 2006. New Home Sales are now up 36% from a year ago. Toll Brothers reported that third-quarter net signed contracts were its highest ever for a third-quarter in both units and dollars. Two measures of house pricing data showed prices rose more than expected.

The Conference Board’s Consumer Confidence Index fell sharply from 92.6 to 84.8, well below expectations for a slight improvement. The reading is now back below levels from March and April. Consumer sentiment compared to housing data provides an interesting dichotomy. Consumer sentiment is weak, yet at the same time, some consumers are making large investments in real-estate. As we have suggested, the recovery is beneficial to some while hurting many others.

The graph below, courtesy JPM and The Market Ear, shows the net long position of euro futures contracts is at 3.5-year highs. The last time it was this stretched, June of 2018, the euro peaked and fell for almost two years. The extreme net long positioning, along with a high correlation of net positioning to price, is yet another reason we believe the dollar might rally from current levels.

The Wall Street Journal had a very interesting article showing which stores and companies are winning and losing the battle to gain consumers during the pandemic. Not surprising, companies with great online infrastructure and full inventories of products most in demand are able to grow sales despite the poor economy. To that point, “Walmart, Amazon, Target, Home Depot, Lowe’s, and Costco accounted for 29.1% of all U.S. retail sales in the second quarter.” The gains came at the expense of small businesses and traditional brick and mortar stores that do not have a great online presence.

 

August 25, 2020

A slew of housing data will be released this morning, including the Case-Shiller House Price Index, FHFA House Price Index, and New Home Sales. As we saw last week with soaring existing home sales, we suspect this week’s data will also be strong as a lack of supply, record-low mortgage rates, and de-urbanization are driving a suburban housing boom.  Jobless Claims on Thursday will be of interest, as will Personal Income, Chicago PMI and Consumer Sentiment on Friday.

Investors are anxiously awaiting the Fed’s Jackson Hole conference on Thursday and Friday. Jerome Powell leads it off Thursday with a speech at 9 am. Will he be dovish enough appears to be the question that is likely to steer markets? The answer to this question may likely revolve around their willingness to get more aggressive in pushing for higher inflation. Various Fed members have voiced a desire to let inflation run hot. In Fed-speak they call this average inflation targeting. The term means that even though the targeted inflation rate is 2%, they might let it run at 3-4% for some time to offset prior periods of slower than 2% growth. PCE, the Fed’s preferred inflation index, has averaged 1.50% over the last decade. The last reading was +0.8%.

The graph below shows that corporate debt has soared over the last few months. Prior to COVID, the ratio of corporate debt to GDP stood at a record high, and slightly above levels that preceded the last three recessions. Most of the corporate debt being added today is for liquidity uses and not for Capex or other productive purposes. As such, corporations will emerge from the crisis with more debt and interest expense but no corresponding rise in income. This new debt will be a drain on future earnings and economic growth. Keep in mind the graph overstates the increase in the ratio as GDP, the denominator, will rebound sharply this quarter.

The quote of the day is from Morgan Stanley- The equity market has traded soft under the surface of the headline indices, which are now being driven by just one stock—Apple.”

Investor greed and fear can be calculated and expressed in many different ways. Currently, many surveys and technical readings indicate near-record levels of optimism and greed. Per the graph below from SentimenTrader, the options market is “all greed no fear”! As their data shows, Gamma exposure, a measure of sentiment in the options market, has surpassed levels, which in the past resulted in sizable market downturns.

 

 

 

August 24, 2020

Despite new record highs in the S&P and NASDAQ 100 only 6% and 2% respectively of the underlying components are at records. The weakness of breadth is becoming starker by the day. The Tweet below courtesy of The Bear Traps Report shows that two of the worst ten breadth days, using his measures, occurred last week.

The “K” shaped recovery is alive and well, with some sectors doing well and others languishing. Residential housing, for instance, is a beneficiary of new motivations to move out of densely populated urban areas. On Friday, Existing Home Sales for July jumped 24.7% from June’s level, breaking a record for the largest single-month gain. Helping fuel sales is a lack of supply. The inventory of housing is still over 20% less than a year ago.  Per the National Association of Realtors (NAR)- “The housing market is well past the recovery phase and is now booming with higher home sales compared to the pre-pandemic days,” said Lawrence Yun, NAR’s chief economist. “With the sizable shift in remote work, current homeowners are looking for larger homes and this will lead to a secondary level of demand even into 2021.” 

We are paying close attention to the reflation trade. Since mid-March, when 5-year inflation expectations troughed at 0.14%, they have risen steadily to peak a week ago at 1.57%. Recently they have flatlined.  In last Friday’s Relative Value Report we stated- “Investors in Industrials and Transportations sectors are clearly betting on a continuation of the reflation trade. Recent weakness in oil and copper, as well as the daunting fiscal stimulus cliff, make us wary of the inflation trade. We reduced exposure to Transports and Industrials this week while adding to Realestate.”  Copper has historically been a good proxy for inflation and economic activity. Copper is often referred to as Dr. Copper for just that reason. The graph below shows that the price of copper has stagnated over the last month and is coming under pressure recently.

The graph below shows COVID-related stimulus distributed by the government. While the current level of stimulus appears to be small but at $15 billion a week, it represents over 4% of GDP.

The graph below shows how the number of small businesses opening back up recovered for a while but stagnated and, more recently, has begun to turn back down.

August 21, 2020

Initial Unemployment Claims ticked back up to 1.106 million versus expectations of 963,000. Continuing Claims fell to 14.844 million from 15.480 million. The drop in continuing claims may be considered encouraging by the media, but there is a negative side they may not be considering. State unemployment claims are only paid for 6 months. As such, some of the people fired in February as COVID shutdowns began, are seeing benefits expire. The number of people in this group should expand in the coming weeks. Including federal and state assistance, the total number of people receiving jobless benefits is still over 28 million.

Tom DeMarco of Fidelity provides commentary about possible market reactions to next week’s Jackson Hole Fed meeting and the FOMC meeting on 9/16: “At this point the risk of a “sell-the-news” reaction seems quite possible as it will be difficult if not impossible for the Fed to generate a dovish surprise as the papers have been jammed with articles previewing the “radical” shift to an average inflation target with the topic discussed in myriad Fed speeches and papers and I expect more to come at Jackson Hole on Aug 27-28.”  Essentially Tom argues the market may stumble as it is challenging for the Fed to provide even more stimulus than what they are doing or talking about doing.

As the heated Presidential election draws closer, the chart below, courtesy Bank of America, is worth consideration. During Presidential election years, September and October tend to be weak, while June, July, and August have been the strongest. Currently, the volatility term structure (VIX) is pricing in anxiety around the election. The September contract is currently trading at 25.60, October jumps to 29, and December through April is relatively flat at 27.50’ish. In the same periods running up to the 2012 and 2016 elections, there was no discernible kink in the VIX curve as currently exists.

The graph below shows the ratio of the S&P 500 value index to the growth index.  Growth has greatly outperformed this year and for the last several years. However, since July value has held its own versus growth, and may be providing early signs that the trend may be reversing. To be more confident in that thesis we would like to see the price ratio below break above the wedge pattern and the 50-day moving average. We have shifted slightly from growth to value over the last few weeks, including the purchases of XOM, CVX, T, and VIAC.

August 20, 2020

The Fed released its minutes from the most recent July 29th FOMC meeting. The key takeaways are as follows:

  • The Fed is still very concerned about the sustainability of the recovery
  • Many members voiced concern about the costs and limitations of yield curve control in the current environment. It seems, based on the minutes, they may shy away from targeting or capping yields unless market conditions change.
  • They still believe there are significant financial stability risks, especially with small and medium-sized companies.

The dollar rallied strongly on the Fed minutes. Gold fell as real rates rose (were less negative). Bond yields rose as yield curve control (more active QE) is not as definitive as once thought. Stocks struggled as the message may not have been dovish enough for the markets. Like an addict, the market needs more stimulus, not just the same amount.

There seems to be growing chatter about a Congressional compromise on a “small” $500 billion stimulus deal that does not include another round of one-time checks or any municipal aid.

Apple hit a $2 trillion market cap yesterday, and The New York Times had an interesting article yesterday, putting the recent gains into context. They state:

“It took Apple 42 years to reach $1 trillion in value. It took it just two more years to get to $2 trillion.

Even more stunning: All of Apple’s second $1 trillion came in the past 21 weeks, while the global economy shrank faster than ever before in the coronavirus pandemic.”

Year to date, Apple’s revenue has increased by 2.2% while EBITDA is flat. Needless to say, the entire gain this year is based on multiple expansion. Its price to earnings ratio now stands at 36, double that seen at its March lows, and well outside of the 15-20 range it traded in for the last five years.

The graph below shows the recent correlation between the S&P 500 and 5-year breakeven inflation expectations as measured by the TIPs market. Both indices have now fully recovered their losses from March. The relationship, while strong in the time frame shown, has not always been as well correlated. Before COVID, from March of 2018 to February of 2020, inflation expectations were generally declining while the stock market surged higher. Can inflation expectations continue to rise as the growth of fiscal spending flattens or even declines? If not, what does that portend for stocks? The following link from Ambrose Evans-Pritchard in The Telegraph provides a well-written discussion describing the combating forces of inflation and deflation to help you better assess the situation.

 

August 19, 2020

During Walmart’s earnings announcement yesterday, the CFO offered a warning of sorts as he stated that government stimulus checks were mostly spent by July. The comment helps explain why retail spending data started to stagnate over the last month or so. The recovery has been fueled by federal and state stimulus, and, as such, assessing third and fourth quarter economic activity relies significantly on determining how much more the states and federal government will provide citizens.

The graph below compares the gross underperformance of gold miners (GDX) to gold over the last ten years. From late 2011 to early 2016, gold fell sharply while fell by even more. Since they both bottomed in January of 2016, GDX has risen 250% while gold is up nearly 100%.  Despite the marked outperformance, miners are still about 30% off the highs of 2011, while gold recently set a record high. If the price of gold continues to increase, miners will most likely continue to play catch up as they are leveraged both operationally and financially.

 

A subscriber asked for an update on our article Tesla’s Moonshot, How High Can it Go? Since publishing the article on August 8th, Tesla’s market cap has risen 35% and is the largest automaker at nearly 1.5 times the market cap of Toyota, the second largest automaker. With the latest earnings update, Tesla has a price to sales ratio of 14, which dwarfs the industry ratio of .60. Despite accounting for less than 1.50% of global auto sales, Tesla’s market cap is about a third of the entire industry. To answer the question in our title- apparently much higher.

We end with a very well written report by James Montier in which he discusses the absurdity of markets. To wit: “Voltaire observed, “Doubt is not a pleasant condition, but certainty is absurd.” The U.S. stock market appears to be absurd.”

August 18, 2020

The economic docket will be slow this week. Of interest will be Housing Starts this morning and Jobless Claims on Thursday. The Fed will release its minutes from the July 29th FOMC meeting on Wednesday afternoon. Currently, there are no Fed speakers scheduled to speak this week. The Jackson Hole Fed conference is scheduled for the weekend of August 28th. Again, we will be on the lookout for any clues as to new or modified policies that may result from the meetings.

Over the weekend, Warren Buffett’s Berkshire Hathaway announced a $545 million stake in Barrick Gold (GOLD), a gold miner. While Buffet has been notably anti-gold for decades, the purchase does not come totally as a surprise. For one, his father was a gold bug and frequently preached the benefits of a gold-backed currency. Second, and probably the rationale for the purchase, miners are very cheap, and at current prices, they are profitable cash flow producing businesses. We should also put his new into context as it accounts for less than one percent of his total portfolio.

It is worth considering that if Buffett’s purchase gives a green light of sorts for traditional money managers to add gold exposure, it could provide a powerful lift to gold stocks as they are relatively small. Consider the two largest holdings of GDX are Newmont (NEM) and Barrick (GOLD), which in aggregate make up over 25% of the ETF. Their market caps are approximately $53 billion each.  If the market cap of the entire index is approximately $200 billion, it will not take much buying to push it significantly higher.

The chart below, courtesy Goehring & Rozencwajg, shows that commodities are the cheapest in at least 120 years as compared to the Dow Jones Industrial Average. With gains in productivity over time, we should expect the ratio to decline as it has done. However, as shown in the late 1970s and 1980s, inflation can reverse the ratio dramatically.

Lastly, on the topic of commodities, Lumber has risen sharply, as shown below.

 

August 17, 2020

Retail Sales fell short of expectations on Friday, coming in at +1.2% versus expectations of 1.9% growth and 8.3% growth last month. Given that stimulus is waning and consumer sentiment, as shown below, remains weak, the disappointment in consumption should not come unexpected. Looking forward, we will assess if the consumer recovery can continue with a smaller helping hand from Uncle Sam. It appears Congress will be on break through the month, so if there is any relief, it will likely have to come from executive orders.

The Baker Hughes Rig Count fell by 4 rigs to 172, from 176 last week, and a nearly 700 running rate prior to the crisis. Again, despite the price of oil stabilizing in the low $40’s, oil companies appear loath to expand drilling operations. This period of lessened activity is based on expectations for a continuation of weak demand as well as expectations for lower oil prices in the future. Currently, Crude futures predict little price change over the coming year. The current contract (September) is at $42.23, with the September 2021 contract at $44.67.

Over the last decade, stock buybacks have been a popular way for corporate executives to boost earnings on a per share basis. While earnings are not affected in a buyback, the denominator, number of shares, in the earnings per share (EPS) formula is reduced, thus EPS rises. The record number of shares buybacks, especially for larger companies, has been one reason attributed to recent stock gains over the last five years. Another reason has been a reduction in the number of listed companies. The graph and commentary below, courtesy the Market Ear, shows that there are about half as many public companies today versus 1996.

Tenants at Class C buildings paid 54% of rent by mid-month in June, but that percentage slipped to 37% in July. These renters are mainly blue-collar and heavily supported by fiscal stimulus. The decline in rents is likely the result of waning stimulus payments.

The graph below, courtesy Arbor Research, shows that investors have been rushing into inflation-protected bonds as inflation expectations have been rising.

August 14, 2020

Initial Jobless Claims improved again and dropped below the 1 million per week pace. Initial Claims were 963k versus an estimate of 1.15mm. The aggregate of all people receiving Federal and state unemployment aid also fell nicely to 28.25 mm from 31.3 mm. The two-week trend is positive, but the sheer number of claims are still enormous compared to January and February levels.

Corporate spreads and yields are at or near record lows, which denotes extreme economic confidence by investors. The condition is not necessarily confidence in the corporations and their ability to generate earnings, but solely due to Fed purchases of corporate bonds. By default, many bond investors must ignore the significant risks facing the corporate bond market and participate. The New York Fed recently made note of the risks in their article- Implications of the COVID-19 Disruption for Corporate Leverage  – “Looking ahead, we find that a sizable share of U.S. corporations have interest expense greater than cash flow, raising concerns about the ability of those corporations to endure further liquidity shocks.”

To further stress the disconnect between yields and reality, Lisa Abramowicz from Bloomberg recently noted that “The lowest-rated US investment-grade bonds are trading as if they were Treasuries. Yields on BBB rated debt hit an all-time low of 2.21% on average last week, less than the yield on 3-month T-bills back in March 2019.”

The graph below shows that 30- year conforming mortgage rates have fallen below 3% to 2.88%, the lowest in the last decade. In fact, they are also the lowest since at least 1971, when the Fed started tracking mortgage rate data. As we will elaborate in an article next Wednesday, bond yields no longer provide financial, economic, or price information.

As we have mentioned numerous times, consumer spending accounts for nearly 70% of economic activity. With that in mind, consumer sentiment and willingness to spend are always important gauges. The graph below shows that nearly 25% of households are worried to some degree about their jobs. The data does not bode well for spending, but as shown the last time the survey was at a similar level was toward the end of the 2008/09 recession when the economy was recovering in earnest and the jobless rate would fall for nearly a decade. The hope is the survey is at or near its peak and will turn lower soon.

We leave you with a graph that shows how massive flows into passive investments, and by default, into market cap weighted indexes, has benefited larger companies much more than smaller ones. For more on this topic, please read our article Passive Fingerprints Are All Over This Crazy Market.

August 13, 2020

The Treasury reported that the year to date fiscal budget hit a record of $2.8 trillion. Over the same period, the amount of Treasury debt outstanding has risen by nearly $4 trillion, half of which was purchased by the Federal Reserve. With still two months remaining in the fiscal year, the deficit is twice the prior record ($1.4trln) from 2009. Over the last decade, annual deficits have been running between $500bn and $1trln per year.

As stimulus wanes, we have a growing concern that the economic recovery stalls. The most widely followed economic data, emanating mainly from the government, tends to lag by one to two months. Using this data in such a volatile environment like today makes it tough to assess changes in recent trends. Alternative data, on the other hand, such as credit card spending and weekly Johnson Redbook Retail Sales, are much closer to real-time and can provide more clarity. Per the Bloomberg graph below, using alternative data, the economy in the U.S. and other major countries appears to have plateaued over the last month.

Tesla followed in Apple’s footsteps and announced a 5 for 1 stock split. The stock rose 13% on the news.

CPI, like PPI on Tuesday, was hotter than expected at +0.6% monthly and +1.0% annually. Excluding food and energy, on an annual basis, CPI was up 1.6%, not far from the Fed’s 2% target. Typically, rising inflation puts pressure on bond yields, but given the Fed’s very active buying program, yields are unlikely to reflect the inflation situation.

Per Arbor Research, the percentage of listed companies classified as “zombies” is now at a 20 year high. The graph shows the strong correlation between the number of zombie companies and inflation-adjusted Treasury yields. Zombie companies are defined as those that pay more in interest than they earn. The relationship is not surprising, as lower rates allow weak and struggling companies to borrow and refinance debt at a lower cost and stay in business. In the case of Zombies, the debt, in many cases, is used to pay off old debt and not for productive investment that might grow earnings in the future.

August 12, 2020

Bonds were under considerable pressure yesterday. It is partially attributable to this week’s Quarterly Refunding in which the Treasury is issuing $112 billion in aggregate of 3yr, 10yr, and 30yr notes and bonds. $48 billion of 3yr notes were auctioned yesterday, with $38 billion 10yr notes today, and $26 billion 30yr bonds tomorrow.  Frequently, banks and brokers, that will inevitably buy a measurable portion of the debt, sell bonds in advance of the auctions with the hope of buying them cheaper at auction.

PPI was stronger than expected at +.6% month over month versus -.2% last month. CPI, released at 8:30 today, is expected to 0.3% versus +0.6% last month.

Gold (-5.4%) and silver (-14.7%) got clobbered yesterday. The decline should not come totally unexpected given their recent breathtaking rallies of late. As we have noted over the last few weeks, both precious metals have become grossly overextended, and as such, we were expecting a pullback. In this week’s Major Market Buy Sell Review we stated the following:

  • Gold is extremely overbought and starting to push 4-standard deviations above the 200-dma. 
  • We suggest taking some profits for now and look for a pullback to increase our sizing. 

The graph below shows that prior to yesterday, silver was trading over 40% above the 50-day moving average. A feat last achieved 33 years ago. We are on the lookout for a good point to add back to our gold holdings.

The “Market Generals” and other momentum stocks are not leading the charge upward as they were in prior months. The graph below shows that MTUM, a popular momentum ETF has underperformed the equal-weighted S&P 500 (RSP) by about 10% since mid-July. The top four holdings of MTUM, accounting for almost 25% of the index, are Apple, Amazon, Microsoft, Tesla. The factor/sector rotation can also be seen in the NASDAQ 100, which has underperformed RSP by a similar amount over the last month.

Given the recent weakness in the “Generals” and gold and silver, along with some firming of the dollar, we are waiting to see if this is just a factor/sector rotation towards value-oriented sectors or a signal that risk assets, broadly speaking,  are about to come under pressure.

According to Bank of America, the words “optimistic” or “optimism” were mentioned on nearly 50% of corporate earnings calls. That is the largest percentage since late 2016, and prior to that, coming out of the financial crisis in 2009. Despite the seemingly optimistic outlooks, announced stock buybacks are near the lowest levels in a decade.

August 11, 2020

PPI and CPI inflation data will be released today and tomorrow, respectively. On a year over year basis PPI is expected to be flat at 0% while CPI higher at +0.8%. Forward inflation expectations, as measured by the difference between TIPs and nominal 5-year Treasury notes, is currently +1.50% and are back to January’s levels.  Friday will be active with Retail Sales, Industrial Production, and Consumer Sentiment on the docket. The early forecast for Retail Sales is a gain of 1.8%, well off the gains of the prior months (18% and 7%), but historically still a strong number.

Retail Sales are unchanged over the last 12 months, despite the global recession. The sole reason is the massive amount of stimulus provided by the Government via the Cares Act. To that point, President Trump, using an executive order, extended unemployment payments last weekend, albeit at $200 less than the prior amount. Trump also suspended the payroll tax. While both actions will help boost consumption, the big question is will the Democrats fight the legality of his actions? It is also worth noting that Goldman Sachs thinks the $400 weekly unemployment subsidy may only last a month or slightly longer. States are on the hook to pay $100 of the amount, which raises other concerns about payment. As an example, according to state Labor Department officials, Connecticut’s unemployment trust fund is headed for insolvency in the next 30 days. The additional $100 burden creates further problems for the state. This is a problem for many states.

Another issue with Federal stimulus is that PPP funds are exhausting quickly. Again, according to Goldman, via a survey of 10,000 small business owners, 84% of PPP loan recipients report that funding has been exhausted.

The Big Ten and PAC 12 athletic conferences are set to announce their plans for the upcoming college football seasons. It appears the options are delaying the start of the season or canceling it entirely. If they cancel, it may weigh on sentiment, especially if the other major conferences follow in their footsteps. If you recall, the suspension of the NBA was one of the events that seemed to tip the markets in early March.

New Additions to RIA Pro:

  • On the Dashboard tab, underneath the articles and videos, you will find the latest headline news.
  • On the Research tab, there is a new page that shows options pricing by expiry month.

August 10, 2020

The BLS Employment Report was better than expected at +1.76 million new jobs and unemployment fell to 10.2%. More good news, average hourly earnings rose 0.2% monthly and 4.8% year over year. Both were better than expected.

While the improvement is positive, we must maintain a proper historical perspective. Currently, the unemployment rate is the highest it has been since at least 1950, except for a few months in 1982.  Further, as compared to February, there are now an additional 2.8 million people classified as out of the labor force. Because of this they aren’t classified as “unemployed”. The additional 2.8 million people would add 2% to the unemployment rate, pushing it well above the levels of 1982.

The BLS uses a birth/death adjustment to its employment numbers. The adjustment adjust the payrolls data for estimates of net new business formation. Over the last three months, 881k jobs were added due to new net business formation. Even more confounding, according to the BLS, there is a net of +223,000 new leisure and hospitality jobs related to businesses formed since March. The fact of the matter is that many more businesses went bankrupt than were started over the last three months. That statement is even more true for the leisure and hospitality industry.

Gold is up over 20% since early June. The media is taking notice, and many talking heads are asking how far it can go. Answering the question is complicated as gold does not have earnings and cash flows like most other assets. There are however, many different ways to model gold prices which can result in vastly different forecasts. Frequently, investors, given the choice of owning gold along with or instead of stocks, will compare the price of gold to the stock market. The graphs below show that the ratio of gold to the S&P 500 has risen recently, but on a long term time frame, the ratio is still close to 50-year lows. When using this ratio, one must keep in mind the ratio can rise if gold falls, but the S&P 500 falls at a much greater rate. It can also rise if gold increases at a much faster rate than the stock market. Either way, the graph argues that gold has a reasonable chance of outperforming the S&P 500, especially if the Fed continues to print money at unprecedented levels.

The Baker Hughes rig count fell to 176 the lowest since 2008. The graph below shows the decline has continued in recent weeks despite the recovery in economic activity and oil prices.

August 7, 2020

We finally got a dose of good news in the weekly Initial Jobless Claims report. Initial Claims fell from 1.435 million to 1.186 million. On an unadjusted basis, the number of new claimants fell by a similar amount.

The all-important BLS Labor report is slated for release at 8:30 this morning. The consensus estimate is calling for a gain of 2 million jobs and an unemployment rate of 10%. At 3pm today, consumer credit will be released. It has fallen for three consecutive months but is expected to rise.

The Ten-year real rate (10yr yield less implied inflation rate) is now below -1%. The math behind the negative rate is worth discussing. As shown below, inflation expectations (green line) have risen steadily over the last few months but bond yields (red line) have remained stubbornly flat to declining. The net result is plummeting real rates (blue line). Most often, Treasury yields positively correlate with inflation rates. This time is very different as the Fed is buying massive quantities of U.S. Treasuries with the intent of not letting yields rise. The market implies investors will lose 1% annually in purchasing power if they own 10-year Treasuries. That is a tough selling point considering the Treasury will be looking to borrow $3-4 trillion this year and $2-3 trillion next year.

The stunning graph below, courtesy of Bianco Research, shows that New York City subway ridership is running at about 20-25% of what was considered normal before COVID.

 

 

 

August 6, 2020

ADP reported that July payrolls rose by 167k versus expectations for a gain of 1.2 million jobs. A weakening of the uptrend should not come as a surprise given unemployment claims are now increasing and despite some recovery, still at historically high levels. ADP further jibes with other recent indicators pointing to a stagnation of the recovery. Further, if you missed it yesterday, please read our commentary on the Cornell labor survey which also paints a weakening jobs picture.

Initial Jobless Claims, to be released at 8:30 this morning, is expected to increase slightly from 1.43mm to 1.44mm. The graph below shows the strong correlation between Jobless Claims and the Google Trends search for the phrase “unemployment benefits.” Recently, the Google trends search turned higher while Claims are only marginally higher. Will Jobless Claims follow searches higher?

Strong manufacturing surveys of late have led to media to assume a manufacturing recovery is well in hand. While the survey results may be at traditionally high levels, we struggle with the media’s synopsis.  The survey questions ask manufacturing executives, in what general direction do they think specific aspects of business are trending. The available answers  are “better”, “same” or “worse.” The answer is binary without any quantification for changes in production. For instance, if I used to make 100 widgets a month, reduced it to 20 last month, and then upped production to 30 this month, my survey response would claim conditions are better than the previous month. In reality they are better, but still 70% short of preexisting production levels.

We are nearly 5 months into the economic crisis and slightly less than half of the respondents see either no improvement or a worsening of conditions. One would hope that if the recovery were strong, the index would be well above 80. In this case, the index points to expansion but marginal expansion at best, and in many cases, production levels are well below those before the crisis.

August 5, 2020

The ADP Employment report will be released at 8:15 this morning. The current estimate is for a gain of 1.89 million jobs. Investors will take cues from this report as it tends to have a strong correlation with the employment report.

While ADP and BLS Jobs data on Friday will likely be strong, Cornell, Jobs Quality Index, and riwi, released a coauthored survey which deduces that a second wave of layoffs and furloughs is underway. The survey was conducted during the last week of July and included individuals that were laid off and re-hired. In many respects, the survey measures the effectiveness of the PPP program. Of note, the following question with results: “Since being put back on the payroll by your previous employer have you?: Been laid off again 31%, Been told you could be laid off 26%, Neither 43%. 

The following summary points to a weakening trend in employment that will not be picked up in this week’s reports:   “Conversely, the new data supports earlier observations that increases in the number of private sector jobs and the decline in unemployment that began to surface in the May BLS Employment Situation Report, and similar employment gains in the June jobs report, were not reflective of workers being “re-employed”en masse — in the conventional sense that they were getting back to the business of actually working — but were rather being “re-payrolled,” in many instances in order to meet the loan forgiveness requirements of the PPP.”  They go on-  “The US is experiencing a second round of layoffs not otherwise showing up yet in the mainstream data, with 39% of re-payrolled, but not actually working, employees likely being at a high risk of losing paychecks.

San Francisco Federal Reserve President Daly made an interesting comment yesterday. She said: “have room to let the economy go well beyond what people think is the maximum level of employment.”  If you recall, a few Fed members have made similar comments about running inflation beyond their target. It appears both of the messages are the Fed’s way of expressing that they intend to keep the monetary pedal floored, will not raise rates for years, and aim to push employment and inflation well beyond its stated targets.

On a seasonal basis, August, September, and October tend to be weak months for equities.  Not surprisingly, the graph below shows that realized volatility also tends to increase during those three months.

August 4, 2020

Nancy Pelosi said a $600 weekly Federal unemployment benefit is not negotiable. With that tough negotiating stance, we continue to wait on Congressional and Presidential agreement for an extension of federal unemployment benefits. In addition to extending legislation, we must also keep in mind that states are struggling to make good on their weekly unemployment benefit payments. It has been reported that many states may run out of funds as early as September. Secondly, most state programs have a six-month time limit. Those citizens that started collecting in March will reach expiration in September.

The most important economic data point week will be the employment report on Friday. Currently, the consensus expectation is for a gain of 2 million jobs, bringing the unemployment rate down to 10.5%. The range of estimates for payrolls spans from +350k to +2.5mm. We know that approximately 5.6 million people lost jobs during July based on weekly unemployment claims. The hard part is the estimate is how many new jobs were added in July. Making the task more difficult will be the fact that various parts of the country are opening up while other parts are stepping back their openings.

With last week’s Fed meeting in the rearview mirror, Fed members are free to speak again. This week there is at least one speaker a day on the docket. Still, we are on the lookout for discussions on yield curve control and Fed views on running inflation hotter than their 2% stated goal.

The image below, from Cornerstone Macro, helps explain why European equities have lagged the S&P 500 to such a large degree. Bottom line: Tech, Healthcare, and Communications account for nearly 50% of the S&P 500 versus only 20% of the MSCI Europe. On the flip side, MSCI Europe has a larger contribution from sectors that have been laggards.

The collage of headlines shown below, courtesy Pinecone Macro Research, speaks to the intense dollar negativity in the media. Similar sentiment pervades social media. Quite frequently, when everyone is on one side of a trade, it serves a strong signal of a reversal.

August 3, 2020

On Friday, the S&P 500 closed .79% higher, led predominately by Apple, Amazon, and Facebook. Apple was up over 10%, increasing its market cap by approximately $180 billion. To put $180 billion in context, Pepsi is the 32nd largest S&P company with a market cap of $190 billion and Abbot Labs is 33rd with a market cap of $178 billion.

Despite the strong efforts of Apple and a few other stocks, over half of the S&P 500 stocks closed lower. Two-thirds of the Dow 30 declined as well.  The heat map below shows a lot of red for a strong gain.

The Atlanta Fed published their first estimate of Q3 GDP. They currently forecast, based on July’s data, an 11.9% increase in economic activity.

The Federal enhanced jobless benefits amounting to $2,400 monthly, on top of state jobless claims, expired on Friday. We believe a deal to extend the benefits will occur, but the amount will likely be reduced. The timing of an agreement will increasingly concern the market.

The picture below shows the world’s four major currencies and how they are all sitting on critical longer-term support or resistance. We believe the dollar will bounce off of support, which will translate to the other three currencies reversing their recent trends. If we are wrong, and the dollar breaks down further, the technical damage across the currency complex would accelerate the recent trends in all the currencies shown. While the U.S. may prefer a weaker dollar, as its good for trade and inflationary, the other countries pay the price. Stronger currencies result in deflationary pressures. Considering Europe and Japan have negative rates and are on the cusp of deflation, they can ill afford additional deflationary pressures.

During a typical recession, business inventories get drawn down as business owners are slow to restock inventory that is sold. The graph below quantifies the inventory drawdown of the last two recessions and the current state of inventories. This monthly data point serves as a good indication of business owner sentiment. When confidence improves, inventory growth should exceed sales, and the decline will reverse. In the last two recessions, the trough in inventories did not occur until after the recession.

One of our recent discussion points has been data inconsistencies in housing. Last week, for instance, we learned that pending homes sales were up 16.6% following a 44% increase in the month prior. At the same time, we stumbled upon the chart below showing that over 40% of renters are at risk of eviction. The divergences are confounding.

July 31, 2020

Last night, Amazon blew the doors off of earnings. They earned $10.30 versus an estimate of $1.51. Revenues also easily beat expectations.  The company guided sales guidance up for Q3 from current estimates.

Google/Alphabet also beat on earnings and revenues versus estimates but posted a 2% decline in revenues due to a decline in ad revenue. The company committed to buying back $28 billion of its Class C shares.

Apple revenues were much better than estimates at $59.69 billion versus $52.30 billion. Earnings per share were also exceeded expectations at $2.58 versus $2.07. They surprised the market with an announcement of a 4 for 1 stock split. As a result of the split, Apple’s weighting in the Dow Jones Industrial Average (price-weighted index) will fall from 10.5% to 2.8% post-split.  There will be no effect on the S&P and NASDAQ as they are market cap weighted.

Initial Unemployment Claims rose for the second month in a row. New claims were 1.434 million up from 1.422 million. Continued claims increased by nearly one million to over 17 million.

GDP fell 32.9%, which was slightly better than expectations. A much weaker than expected GDP Price Index benefited the GDP number by about 3%. The Price Index fell 2.1%, versus expectations for a 1.1% increase. The decline in GDP was incomparable to anything witnessed in our lifetimes, as shown below.

The Census Bureau began conducting a series of surveys to understand better how the COVID crisis is effecting households. The chart below shows how six of their weekly surveys have trended over the last 11 weeks. Catching our attention are the recent upticks in the “loss in employment income” and “expected loss in employment income” surveys. As noted above, unemployment claims are confirming this data.

The value in this data set, along with weekly credit card spending data, and Redbook retail sales, is that it is as close to real-time as we can get. More traditional measures of consumer financial activity are delayed by at least one month, and in some cases, by two to three months.

On July 21st we presented the following: “To provide further context, consider that the 20-day volatility on Ten-year Treasury futures is now below 2%. The last time it was 2% or below was in the 1990s. The record low was recorded in April 1997 at 1.71%.”

We expand upon the lack of volatility in the fixed income markets with the graph below. It shows that over the last 85 trading days the daily trading range between 3-month Bills and 10-year notes was the lowest since 1977. Record low volatility periods tend to reverse abruptly. Whether that may be a big upwards or downward move is the question. Answering the question is difficult because the Federal Reserve, the largest buyer of U.S. Treasuries, is both price insensitive and is not concerned with taking losses.

July 30, 2020

Yesterday’s Fed statement was nearly identical to prior statement from mid-June. They did add one line saying that economic recovery is very dependent on the course of the virus. Will the Fed be more or less aggressive based on new COVID cases this fall?  The Fed also extended dollar swap and repo lines for foreign central banks through March of 2021. The use of these lines has been steadily declining over the last month.

The baseline market expectation going into yesterday’s FOMC meeting was for Chairman Powell and the Fed to say that they will do whatever it can to support economic growth. That is exactly what they did. Unlike prior meetings, the market liked the status quo. Powell’s press conference was uneventful as the reporters seemed to ask the same questions as the last few meetings. Powell did not disclose anything new.

It is worth mentioning that the Fed tends to release new programs, policies, and concepts at their annual Jackson Hole Conference. This year’s conference, while online, will occur August 27-28th.

We mentioned the critical role that consumer confidence plays in the economy yesterday. We follow that up today with the graph below showing the strong correlation of jobs to confidence. This strong correlation is one reason we are heavily focused on the weekly Jobless Claims data to gauge how quickly the jobs market is recovering. The consensus estimate for today’s Initial Jobless Claims is 1.388mm down slightly from last week’s 1.416mm. Also on today’s docket is GDP. The current consensus of economists is -35%, but the range of estimates is enormous (-38.5% to -28.5%). The current forecast from the Atlanta Fed’s GDPNow is -32.1%.

Visa, in its earnings report, provided more evidence that the recovery appears to be stalling. They said spending has plateaued over the final weeks of June. Powell made mention of this as well in his press conference.

Market mania has been on full display over the last few months. Wild price gyrations of bankrupt companies like Hertz and Chesapeake Energy were crazy. Trading in Kodak (KODK) over the last few days has been absurd. KODK, on the verge of bankruptcy, saw its shares soar on Tuesday when President Trump granted them a $765 million dollar loan to start producing drug ingredients. The market cap of the company prior to the loan was about $100 million. In the months leading up to the announcement, the stock traded between $1.50 and $3.00 per share. On Tuesday, it tripled from $2.62 to $8.06. Yesterday it opened at $18.50, hit a high of $53.37 and closed at  $33.20. In pre-market trading it is back above $40.

July 29, 2020

The Fed extended most of its emergency lending programs for the remainder of the year, many of which were set to expire at the end of September. Per the Fed: “The three-month extension will facilitate planning by potential facility participants and provide certainty that the facilities will continue to be available to help the economy recover from the COVID-19 pandemic.”

The Fed will release its FOMC monetary policy meeting statement at 2 pm, and Chairman Powell will follow it at 2:30 with a press conference.

Consumer Confidence slipped from 98.3 to 92.6, led by a sharp decline in the future expectations index. Last month the future expectations sub-index was 106.1 as compared to 91.5 this month. The present conditions sub-index rose from 86.7 to 94.2. Only 31% of those polled see business getting better within six months. Consumer Confidence, while tough to effectively measure, is an influential gauge of economic activity as personal consumption accounts for nearly 70% of GDP.

One the more timely investment-related questions that we grapple daily is – Is inflation on the uptick, or does deflation remain a strong possibility? To help with the matter, consider the thoughts of Lacy Hunt. Hunt, is not new to the deflationary camp. He has written for years on declining economic growth resulting from the burdens of unproductive debt and the negative effect that has on prices.

To wit: in the following paragraph from his Second Quarter Outlook he states the following:  “Four economic considerations suggest that years will pass before the economy returns to its prior cyclical 2019 peak performance. These four influences on future economic growth will mean that an extended period of low inflation or deflation will be concurrent with high unemployment rates and sub-par economic performance.”

To paraphrase, here are his four economic considerations are:

  • 90% of world economies are in a recession; thus no region or country can help offset economic contraction.
  • A major slump in world trade is occurring. This is certainly COVID related but also a function of recently enacted trade barriers.
  • The massive debt being employed to fight economic weakness is unproductive and will, therefore, weigh on future economic growth.
  • “2020 global per capita GDP is in the process of registering one of the largest yearly declines in the last century and a half and the largest decline since 1945. The lasting destruction of wealth and income will take time to repair.”

In regards to the causes of slow economic growth and its deflationary impact, his views are similar to ours. Where we possibly diverge is around the topic of monetary and fiscal policy. In particular, the Fed is now directly monetizing massive fiscal stimulus.  We are watching closely to see if the government and Fed’s combined actions are enough to drive inflation higher finally.

 

July 28, 2020

This week, 188 of the S&P 500 companies are set to report earnings. Thursday will be the most important day with market leaders Amazon, Apple, and Google scheduled to report after the close. The chart below shows the “most anticipated” releases this week.

The Fed will meet today and Wednesday, with the FOMC statement release and Powell’s press conference scheduled for Wednesday at 2:00pm and 2:30pm, respectively. We do not expect any material changes in Fed policy. Still, we will be on the lookout for any discussions on yield curve control, higher inflation targets, and/or new strategies.

On the economic front, Consumer Confidence will come out today at 10am and the University of Michigan Consumer Sentiment Survey on Friday. Also of note will be GDP and Jobless Claims on Thursday and Chicago PMI and Personal Income and Outlays on Friday.

Heading into tomorrow’s FOMC meeting, it is worth checking what the Fed Funds Futures markets are pricing in for the future rate moves.  As you move forward on the monthly Fed Funds futures curve, expectations for a rate cut into negative territory slowly increase. By January of 2021, futures imply a 35% chance of a 25 bps cut. The odds continue to increase slowly throughout 2021 to a little over 50%.

One of the more notable recent trends has been the decline the U.S. dollar, which seems to be fostering upward moves in most asset classes.  To quantify this negative correlation, we created a risk index comprised of one-third each of 30-year UST, S&P 500, and Gold. As shown below (red dotted line) our asset index was recently the most negatively correlated versus the U.S. dollar as any time over the last five years. Of the three assets, the negative correlation is strongest with 30-year yields/USD at nearly two standard deviations from the norm.

July 27, 2020

Gold is trading $40 higher in overnight trading, which at a new record high is besting its record from nearly ten years ago. The gains, in part, are due to the weaker dollar.

On Thursday, the BEA will release second-quarter GDP. The current estimate is -33%. Last Friday, JP Morgan released the following commentary- “We are lowering our 2Q real GDP growth forecast from -31.0% to -32.5% saar ahead of next Thursday’s [data]. We recently had been noting some downside risk to our forecast and we continue to see growth tracking below our prior estimate ..”  Their reduced forecast is not surprising given recent real-time credit card data is signaling that consumer spending appeared to have stalled in June.

In Volatility Is More Than A Number. It’s Everything  we stated: “volatility is an inverse gauge of liquidity, the foundation on which smooth-functioning markets and asset prices rest.” Volatility is currently sitting at 2-3x what was normal in 2019. As such, we know that underlying liquidity in the stock market is poor. Do not just take our word on it, just consider some of the rapid surges and declines that continue to occur months after the March fireworks.  For further consideration of liquidity, the illustration below from The Market Ear describes how options volumes have exploded during the recent surge in markets. Options trades are a direct bet on volatility and are actively hedged by brokers/dealers. This means that as markets move, hedgers must buy or sell regardless of market conditions to remain hedged. Now consider point 5 below- “given the fall in stock liquidity (TME pointed out earlier this week) options risks risk magnifying underlying moves purely as an effect of dealers hedging.Bottom Line: Liquidity is poor and therefore markets may experience abrupt moves up or down.

Over the last few days we have discussed quirky housing data and trends related to COVID. As such, below is a short list of recent housing trends that will make housing data difficult to assess, especially compared to historic data.

  • Consumers are leaving urban rental apartments to buy suburban homes which will skew purchase/rental data
  • Reduced supply of suburban homes
  • Work from home allows greater location flexibility and in some cases, people will move to cheaper geographic locations
  • Baby Boomers may delay downsizing to apartments or senior living facilities
  • Wealthier consumers appear more driven to buy second “getaway” homes
  • Home offices, usable patio/outdoor space, and other home amenities will add value to houses
  • Despite record low mortgage rates, non-conforming mortgages remain hard to qualify for

July 24, 2020

At 1.416 million, Initial Jobless Claims rose by 109k from last week’s number. The good news is that continued states claims fell by over 1 million. However, the total number of persons claiming unemployment benefits (federal and state) only fell by 200,000 to 31.8 million, representing approximately 20% of the workforce.

The market hit a rough patch yesterday afternoon when the Quinnipiac poll showed Floridians favor Biden at 51% over Trump at 38%. Polls can be very misleading this far from the election, but they can steer politicians’ actions, especially those fighting for re-election. In this case, some Republican Senators, locked in tight races, may take a tougher line regarding stimulus and spending to separate from the President. If so, the next version of the CARES Act could be a little more challenging to negotiate and possibly have reduced spending.

Is value finally starting to wake up? Per a Tweet from Bespoke- “Russell 3000 Value outperforming Russell 3000 Growth by 4.31% over the last three sessions. Biggest 3 day outperformance for that measure of Value/Growth since May 31 of 2001 if it holds into the close.”

With yesterday’s $20 gain, gold sits within $40 of record highs, yet gold miners (XAU Index) are still more than 30% away from its 2011 record price. The graph below compares the ratio of XAU to gold. As shown, XAU has outperformed gold over the past few months but has grossly underperformed it over the last 12 years.

German conglomerate Siemens will let many of its employees work from home two to three days a week permanently. Per Reuters, the policy applies to 140,000 employees at around 125 locations in 43 countries. Twitter and some other tech companies have made similar policy decisions. The implications for commercial real estate are massive if these companies are the leading edge of a full time or even partial work-from-home trend.

New and existing home sales have perked up recently, in part because COVID is making the land and space associated with houses more appealing than apartment buildings. We wrote about the recent robust housing data yesterday. Today we follow it up with the graph below showing the other side of the story. New York and Los Angeles are the nation’s two largest cities.

July 23, 2020

With the market rising on hopes for another round of federal stimulus, Tom Demarco, Chief Market Strategist at Fidelity, succinctly laid out possible market risks from a new stimulus bill. Per Tom:  “The risk for the market is if the ultimate size of the finished product is less than $1.5T with little to no state aid, a cut in federal unemployment benefits, and a round of stimulus checks to fewer people than before.”

To one of his points, late yesterday afternoon, it was reported that the GOP is considering cutting federal unemployment benefits. Currently, the GOP is pushing for $400 per month, well below the current rate of $2400 per month, set to expire on July 31st.

Following three successive declines, existing home sales increased by 20.7%, the largest monthly gain since at least 1968 when records were first kept. Sales, on an annual basis, are still down 11.3%. June sales were bolstered by pent up demand, reduced supply, as well as demand to move from cities (apartment buildings) to the suburbs (houses).

After significantly lagging Gold’s gains since March, Silver is quickly catching up. Over the last five days, silver is up nearly 20%. It now stands at seven-year highs. Unlike Gold, which is within 3% of the 2011 record highs, Silver ($23.25/ounce) is still about half of its near $50 price from 2011. The graph below shows the ratio of Gold to Silver. After blowing out in March and April, the ratio is now in line with the trend of the last five years.

Initial Jobless Claims, released at 8:30, are expected to be 1.308 million, similar to last week’s 1.300 million.

As we start considering the consequences of a Biden or Trump victory based on current polling, we must recognize that presidential polls can gyrate wildly. The graph below shows how quickly voter preferences changed leading into the last five elections.

July 22, 2020

The U.S. dollar index fell sharply to 95.00 yesterday and stands close to its March 9th intra-day low (94.54). In only two weeks after the March low, the dollar stormed higher to peak at 104. The dollar, having since reversed the entire March surge, now stands at a critical juncture. If it breaks lower, there is little resistance until 88. However, if it bounces, as few expect, it may cause pain for the equity, energy, and precious metals markets. As if markets aren’t tricky enough these days, the possibility of a false breakout lower may catch investors/markets offsides.

The Chicago Fed National Activity Index for June gained further ground, however, June’s rate of growth was not nearly as robust as May’s, raising questions about the sustainability of economic resurgence. The Chicago Fed index is a weighted average of 85 economic indicators. In June 54 indicators made positive contributions and 31 were down.

Weekly Johnson Redbook retail sales continue to languish, also raising questions about the strength of the recovery. Keep in mind the index does not include on-line retailers who are gaining market share.

On Monday, the S&P 500 posted one of its most quirky days. Per Stock Charts, the percentage of stocks up was -28.8%, stunning considering the index posted an .84% gain. The measure subtracts the number of declining stocks from those advancing and divides it by the total number of stocks.

The scatter plots below compares daily instances of the advance/decline percentage and percentage gain/loss in the S&P 500 (2010-current). The graph on the left contains all of the data, while the one on the right zooms into to days where the S&P 500 was up or down by 1% or less. The orange dots highlight Monday’s anomaly. We went back to 2010 to see just how odd the occurrence was. Since January 1, 2010, there have been 410 days in which the market rose .84% or more. In all of the other instances, the percentage of advances over decliners was positive and at least by +20%. The average was 74%.  We increased the number of potential anomalies by reducing the S&P gain threshold to +.50% or more, and there were only two other instances out of 700 eligible days. Based solely on this analysis, the S&P 500 should have been down .25% on Monday.

The graph below shows that real yields, or the yield after inflation, has fallen to -0.79%. It essentially quantifies how much stimulus the Fed provides the markets and the economy.

July 21, 2020

Monday was another oddly divergent day in the markets. The S&P (+.85%) and NASDAQ (2.88%) surged on the backs of the largest companies in those indices- Amazon (+7.93%) and Microsoft (+4.28%). Of the 11 S&P sectors, Consumer Discretionary, Technology, and Communication were up sharply, Health Care had a marginal gain, and the remaining seven sectors fell. 52% of S&P 500 stocks and 66% of the DJIA were lower on the day. The Dow Jones Industrial Average eked out a 0.03% gain and the Russell was lower.

This will be a slow week in terms of economic data, with Initial Jobless Claims on Thursday and the PMI Manufacturing Survey being the only two numbers of consequence.

Voting Fed members should be silent this week and early next week due to the Fed’s self-imposed media blackout heading into its July 28/29 meeting. Following Fed President Evan’s speech in which he laid the groundwork for running inflation higher than the Fed’s 2% goal, we will keep a close eye out for similar comments from non-voting Fed members. It’s quite possible, the Fed and/or Powell will comment on its inflation targets at next week’s meeting.

Yesterday we noted the historically tight range that Treasury yields are trading in. To provide further context, consider that the 20-day volatility on Ten-year Treasury futures is now below 2%. The last time it was 2% or below was in the 1990s. The record low was recorded in April 1997 at 1.71%.

As shown below used car prices are surging. Similar to supply trends in housing markets, there is a shortage of used cars for sale. Combine limited supply with a new sense of frugality opting for cheaper used cars by consumers. Further stoking the price gains is the various forms of federal stimulus. Per Scott Allen of Auto Land in Fort Worth, Texas- “I’ve seen a lot of down payments this month of exactly $1,200.” Quote courtesy Autoblog.

This week and next week we will see a majority of companies issue their financial reports. The table below shows expected reports by date.

July 20, 2020

The University of Michigan Consumer Sentiment Survey took a step backward, with both current and forward expectations declining. Expectations are now below levels from March and April. The graph below shows the strong correlation between changes in this survey and the S&P 500.

Chicago Fed President Evans made some comments last Thursday about inflation that largely went under the market’s radar. He stated as follows:

  • Timing for the Fed taking its foot off of the pedal is simple… Need to get inflation to 2% or 2.5%
  • It would be good to see inflation above 2% for some period

Evans is pushing for the Fed to continue aggressive monetary policy until inflation runs hotter than the Fed’s 2% target. The direct mention of 2.5% inflation maybe the Fed’s way of testing the waters for an eventual increase in the Fed’s target. There was little reaction from the three markets that would typically react to such news: Treasury yields, implied inflation expectations, and precious metals.

Treasury yields continue to chop around with little volatility. The 10-year U.S. Treasury Note, for instance, except two weeks in June, has traded back and forth in a tight ten basis point range (0.70% to 0.60%). It currently stands at 0.62%. A break below the consolidation level would likely accompany downward pressure in risk markets.

As we look ahead to the Presidential election, we are paying attention to the implied volatility futures markets (VIX) to quantify market concerns. As a general rule, the higher the VIX, the more worried it is, and vice versa. For instance, VIX is currently around 27. While much lower than it was in March, it is still over two times what it was prior to the COVID crisis. For purposes of gauging the pricing of volatility around the coming election, it’s not the level of VIX in October/November, but how it compares to the month’s surrounding it.

We follow @vixcentral and use their web site to track the structure of the VIX curve. The first graph below is Friday’s VIX curve, and below that you will find the curve from July 18, 2016, the same period before the last election. Note in the 2016 graph, as circled, there was no discernible kink in the curve as there is today. We also looked at the same period prior to the 2012 and 2008 elections and did not find anything notable priced into October/November time frames.

Traders are more worried about this coming election than we have seen in the recent past. As you consider the potential implications of the election, both positive and negative, please consider that volatility is the opposite of liquidity. We will write more on this concept in a forthcoming article.

 

The tweet below from @macrocharts shows how sentiment for the NASDAQ has risen to nearly unprecedented levels over the last few weeks.

 

 

July 17, 2020

Initial Jobless Claims continue to stagnate (1.30mm vs 1.310mm last week). Non-seasonally adjusted (NSA) jobless claims rose by over 100k from the prior week. As a result, the NSA Insured Unemployment rate rose from 11.3% to 11.9%. The total number of persons claiming unemployment benefits (federal and state) fell from 32.4mm to 32 million.

The Retail Sales report was more optimistic. Retail Sales grew by 7.5% versus expectations of a 5% rise. After last month’s 18.2% increase, June was the second-largest gain since the data has been tracked. The juxtaposition between the employment data and Retail Sales is the result of the massive stimulus employed by the government. To reiterate an important point, the extension of existing stimulus programs will be vital for economic recovery to continue.

On July 31st, the Pandemic Unemployment Compensation (PUC) will expire. PUC provides an additional $600 to weekly unemployment insurance benefits. The Minneapolis Fed just published a telling article on who is benefiting from PUC and the effects if it is not extended. While we expect Congress to extend the subsidy, the economic fallout will be harsh if they do not. Keep an eye on Congress to see if it is extended and if any other stimulus might accompany the extension.

The National Association of Home Builders (NAHB) Index of market conditions rose sharply and sits close to pre-COVID levels. While a good sign, we remind you of a graph we presented last week, which showed the supply of homes for sales is down by about 30%. Also benefiting new home sales, many of which are in suburban and rural areas, is what appears to be the beginnings of a de-urbanization trend.

One of the more unique factors driving this bull market is massive speculation in the options markets, and in particular, the use of out of the money calls to make low-priced, high potential reward bets on stocks.  A recent Bloomberg article noted that: “With the company’s (Amazon) shares up 66% this year, traders are bidding up the price of options that have it jumping another 50% in the next three months. Contracts betting on the online retailer to reach $4,600 by October were among the most-traded calls for that expiry month on Monday.” Record purchases of out of the money calls is yet another sign of the speculative fever gripping the risk markets. The article’s theme was summed up well by derivative specialist Chris Murphy who is quoted in the article as saying: “It’s all FOMO related.

Bloomberg had an interesting article yesterday detailing how Japanese investors sold a record $34 billion of foreign equities last week. The amount is six times greater than any previous week. The anomaly may be quarter-end related or specific to SoftBank’s sale of T-Mobile. If, however, it proves to be more than a one time event, this story bears following. The graph below, courtesy Bloomberg, shows how irregular the selling was.

Rail traffic provides useful insight into economic activity. The table below shows the slump in rail traffic, by product, for the week ending July 11th and year to date. The graph below it shows the relatively strong correlation of rail traffic to GDP. The data in the graph is quarterly, so it only goes through the first quarter. For current reference, the latest monthly reading (through April) of rail traffic is down 17% versus last year.

July 16, 2020

After a slightly higher than expected CPI report on Tuesday, Import and Export prices also came in more than expected. Import prices rose 1.4% monthly versus +1.0% in the prior month and expectations of +1.1%. That marked the biggest gain in 8 years.  Export prices were also up 1.4% on a monthly basis.

The table below provides estimates for today’s Retail Sales report. Initial Jobless Claims are expected to be near 1.3 million. Again, continued claims will be watched closely.

As we have noted over the last week, real-time spending data is starting to show signs of stalling. In that realm, Calculated Risk provides more evidence that consumers are struggling. To wit: The National Multifamily Housing Council (NMHC)’s Rent Payment Tracker found 87.6 percent of apartment households made a full or partial rent payment by July 13 in its survey of 11.4 million units of professionally managed apartment units across the country. More importantly, they note that figure marked a 2.5% decline in the share of households that paid rent versus the reading from June 13th. If the employment situation were truly improving, the percentage should be increasing. Further, the Census Bureau, in a late June survey, found that only 63% of Americans have “high confidence” in their ability to pay next month’s mortgage. 16% had “slight or no confidence” in their ability to pay. If additional unemployment benefits are not extended at the end of the month, the situation will worsen.

Per Bank of America, and as shown below, 77% of stocks in the S&P 500 have a higher dividend yield than the Ten-year U.S. Treasury note. With an annual yield of only 0.62%, Ten-year notes do not exactly provide a high hurdle for stocks.

July 15, 2020

JP Morgan earnings and revenues surprised to the upside, largely due to Fixed Income trading revenue- thank you Fed. The blemish on its report is a $10.47 billion provision for credit losses, as compared to what was expected ($9.15 billion). Their loss reserve is based in part on an estimate of a 10.9% unemployment at year end and 7.7% by the end of 2021. That compares to the Federal Reserve’s estimates of 9.3% and 6.5%, respectively. JPM is now holding $17.8 billion of loan loss reserves for its $140 billion book of credit cards, which assumes approximately 13% losses on their credit card book. JPM’s net interest income (margin) continues to decline as yields hover at record lows. The quarterly margin is now 1.99%, down from 2.37%. The lower the margin, the less likely a bank is to make new loans. Given that debt drives economic growth, reduced lending profitability is problematic for future economic growth.

Wells Fargo’s (WFC) report was not as good as JPM’s. They reported their first quarterly loss since 2008 and sharply reduced their dividend to $.10 from $.51. Like JPM, they also saw a sizeable decline in the net interest margin from 2.58% to 2.25%. WFC is now down over 50% year to date and trading below its peak prior to the Financial Crisis in 2008.

Maybe the most concerning information from the announcements are their forward economic outlooks: From WFC- “Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter.” JPM’s CFO echoed the sentiment saying they now expect a “much more protracted” recovery. Simply, the banking sector does not have the rosy “V”-shaped recovery outlook the stock market has priced in. As you think about their outlooks, consider that banks have the latest economic data via credit/debit card spending, loan repayments, new loan applications, and a host other real-time economic indicators.

Monthly and annual CPI both increased by 0.6% for June. The gains were driven by food and energy prices. Excluding food and energy, monthly CPI rose by 0.2%.

Nancy Pelosi provided hope that further stimulus is a possibility by saying she would delay recess for stimulus talks. She provided the market a shot in the arm, which was trading poorly before her statement.

Last week we discussed the irregular divergence between the Citi Surprise Economic Index and Ten-year U.S. Treasury Yields. Today we present another chart, showing how copper prices are diverging from Ten-year yields. Is inflation starting to take hold?  Treasury bond yields and implied inflation expectations are not signaling concern. The hardest part of trying to assess inflation is the Fed’s influence on yields and the dislocations they cause. Over the coming weeks we will look to earnings reports for warnings of rising input prices.

July 14, 2020

CPI will be released at 8:30. As we previously noted, this will be a tough data point to handicap due to supply line bottlenecks and irregular demand patterns. The estimate is for a gain of 0.5%, month over month, and +1.2% on an annual basis. Retail Sales will be released on Thursday. Economists expect another big month, with a +5.3% monthly gain (+17.7% May). The report is for June, so retail sales benefited greatly from Federal and state stimulus, but not to the same degree as May. Barring any new or extended programs and stimulus funds stimulus dollars will wane significantly over the next few months to the detriment of Retail Sales. Jobless Claims, also released on Thursday, is expected to see 1.323 million newly unemployed, a slight increase from last week.

This week, Banks, Airlines, and Pharmaceuticals kick off second-quarter earnings reports. Over the following two weeks, 61% of S&P 500 companies will report. Many companies did not offer forward guidance last quarter. We will be interested to see if they continue to stay tight lipped or are more comfortable providing investors with insight into their sales and operations.

Tesla shares opened up sharply on Monday, at one point rising nearly 15% from Friday’s close. The gains quickly vanished and the stock closed down nearly 5% on the day. As goes Tesla, as goes the NASDAQ. The NASDAQ 100 (QQQ) traded in a 4% range from the daily high to its closing price. The S&P was up over 1% at noontime and finished lower by nearly 1%. The Dow eked out a slight gain.

Los Angeles and San Diego schools will not open in the fall. Further, California Governor Newsom ordered all bars to be closed and no indoor seating for restaurants. California has the worlds fifth largest GDP, right behind Germany.

Home prices and sales of newly built homes have held up well despite the COVID crisis. One reason, as shown below, is that the supply of homes for sale is down nearly 30% from last years level. The Real estate industry is also witnessing an exodus from urban living to the suburbs. The trend is resulting in healthy, above market bidding for houses in desired areas. The negative effect on urban prices has yet to be documented.

July 13, 2020

The graph below shows the deteriorating breadth of the NASDAQ despite the index’s surge higher. This dynamic is yet another indicator that a handful of stocks are driving the major indexes higher, while many of the index constituents are underperforming.

The year over year change in Producer Prices (PPI) fell for a third straight month. The CPI report will follow tomorrow. While PPI shows a deflationary impulse, the CRB commodities index and implied inflation expectations have been on the rise. Bond yields have been flat to declining, showing no concern about inflation. The tug of war between inflation and deflation will continue to rage as supply lines, both domestic and international, remain fractured. The demand side, in aggregate, is also far from normal. Some sectors have recovered nicely and others remain depressed. The odd supply/demand combinations are leading to inflation in some goods and deflation in others. Needless to say, arriving at one aggregate inflation number is difficult and misleading.

The Fed’s balance sheet shrank by $88 billion last week, marking a fourth consecutive weekly decline. While the Fed added assets last week, its repo lending shrank to zero and dollar swaps with other central banks declined further. The lessened need for repo and dollar swaps is a positive sign that domestic and international dollar liquidity is plentiful. That said, we may see a temporary increase in repo facilities this week as individual and corporate taxes are due on July 15th. These are the payments that were delayed from April. There are $179 billion in dollar swaps that will roll off the Fed’s books in the coming weeks and months. Once these mature, the Fed’s balance sheet will head upwards as they continue to increase their holdings of Treasury, mortgage, and corporate securities.
For all those subscribers invested in the Cannabis space, Politico is reporting that Bernie Sanders is not having luck pushing Biden to add marijuana legalization to his platform. Per Politico Another flashpoint over marijuana ended similarly: Sanders’ team argued in private meetings that they should legalize cannabis, but that idea was rejected. One task force member described the disagreements over qualified immunity and pot as “huge battles,” and multiple people involved said the criminal justice panel presented some of the biggest challenges for compromise.

July 10, 2020

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

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

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

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

July 9, 2020

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

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

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

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

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

July 8, 2020

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

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

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

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

July 7, 2020

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

July 6, 2020

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

July 2, 2020

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

July 1, 2020

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

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

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

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

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

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

 

June 30, 2020

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

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

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

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

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

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

June 29, 2020

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

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

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

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

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

June 26, 2020

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

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

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

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

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

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

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

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

June 25, 2020

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

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

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

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

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

The following Tweet and graph from Troy Bombardia is interesting.

June 24, 2020

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

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

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

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

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

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

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

June 23, 2020

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

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

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

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

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

June 22, 2020

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

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

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

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

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

June 19, 2020

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

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

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

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

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

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

June 18, 2020

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

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

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

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

 

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

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

June 17, 2020

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

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

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

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

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

June 16, 2020

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

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

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

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

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

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

June 15, 2020

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

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

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

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

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

June 12, 2020

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

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

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

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

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

June 11, 2020

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

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

Per Jerome Powell’s testimony:

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

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

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

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

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

June 10, 2020

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

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

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

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

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

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

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

June 9, 2020

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

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

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

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

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

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

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

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

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

June 8, 2020

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

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

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

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

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

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

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

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

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

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

June 5, 2020

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

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

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

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

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

June 4, 2020

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

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

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

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

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

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

 

June 3, 2020

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

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

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

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

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

June 2, 2020

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

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

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

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

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

June 1, 2020

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

Jerome Powell made some interesting comments on Friday.

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

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

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

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

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

May 29, 2020

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

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

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

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

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

 

May 28, 2020

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

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

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

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

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

May 27, 2020

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

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

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

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

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

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

May 26, 2020

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

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

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

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

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

Unfortunately, it never is. 

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

May 22, 2020

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

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

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

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

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

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

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

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

 

May 21, 2020

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

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

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

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

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

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

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

 

May 20, 2020

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

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

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

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

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

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

May 19, 2020

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

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

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

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

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

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

 

 

May 18, 2020

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

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

CBS: “Where does the money come from?”

Powell: “We print it digitally.”

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

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

Saber rattling with China continued on Friday. Per CNBC:

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

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

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

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

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

 

May 15, 2020

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

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

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

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

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

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

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

May 14, 2020

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

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

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

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

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

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

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

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

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

 

May 13, 2020

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

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

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

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

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

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

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

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

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

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

 

May 12, 2020

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

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

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

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

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

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

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

May 11, 2020

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

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

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

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

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

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

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

May 8, 2020

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

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

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

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

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

May 7, 2020

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

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

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

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

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

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

May 6, 2020

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

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

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

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

 

May 5, 2020

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

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

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

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

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

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

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

May 4, 2020

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

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

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

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

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

 

May 1, 2020

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

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

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

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

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

April 30, 2020

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

A few takeaways from Chairman Powell’s press conference:

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

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

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

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

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

 

April 29, 2020

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

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

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

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

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

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

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

April 28, 2020

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

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

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

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

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

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

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

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

April 27, 2020

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

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

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

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

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

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

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

April 24, 2020

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

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

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

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

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

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

April 23, 2020

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

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

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

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

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

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

April 22, 2020

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

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

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

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

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

April 21, 2020

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

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

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

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

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

April 20, 2020

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

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

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

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

April 17, 2020

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

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

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

The following comes from frequent RIA author Mish Shedlock:

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

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

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

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

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

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

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

April 16, 2020

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

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

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

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

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

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

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

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

April 15, 2020

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

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

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

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

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

April 14, 2020

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

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

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

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

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

April 13, 2020

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

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

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

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

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

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

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

April 9, 2020

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

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

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

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

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

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

April 8, 2020

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

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

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

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

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

April 7, 2020

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

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

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

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

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

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

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

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

 

April 6, 2020

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

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

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

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

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

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

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

April 3, 2020

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

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

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

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

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

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

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

April 2, 2020

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

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

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

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

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

April 1, 2020

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

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

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

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

March 31, 2020

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

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

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

Goldman Sachs revised their economic outlook as follows:

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

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

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

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

March 30, 2020

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

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

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

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

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

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

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

March 27, 2020

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

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

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

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

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

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

March 26, 2020

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

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

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

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

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

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

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

March 25, 2020

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

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

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

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

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

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

March 24, 2020

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

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

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

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

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

 

March 23, 2020

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

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

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

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

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

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

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

March 20, 2020

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

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

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

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

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

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

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

March 19, 2020

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

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

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

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

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

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

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

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

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

 

March 18, 2020

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

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

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

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

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

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

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

March 17, 2020

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

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

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

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

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

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

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

March 16, 2020

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

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

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

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

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

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

March 13, 2020

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

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

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

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

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

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

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

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

March 12, 2020

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

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

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

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

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

Trump bans travel from Europe.

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

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

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

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

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

 

March 11, 2020

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

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

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

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

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

 

 

March 10, 2020

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

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

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

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

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

The following is from Jim Bianco:

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

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

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

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

 

March 9, 2020

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

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

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

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

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

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

An important note on credit ratings:

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

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

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

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

March 6, 2020

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

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

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

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

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

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

March 5, 2020

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

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

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

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

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

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

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

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

March 4, 2020

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

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

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

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

March 3, 2020

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

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

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

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

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

March 2, 2020

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

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

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

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

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

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

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

February 28, 2020

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

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

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

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

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

 

February 27, 2020

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

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

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

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

February 26, 2020

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

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

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

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

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

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

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

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

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

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

 

February 25, 2020

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

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

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

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

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

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

February 24, 2020

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

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

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

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

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

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

 

February 21, 2020

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

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

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

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

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

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

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

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

 

February 20, 2020

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

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

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

 

February 19, 2020

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

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

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

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

February 18, 2020

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

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

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

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

 

February 14, 2020

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

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

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

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

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

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

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

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

 

February 13, 2020

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

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

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

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

February 12, 2020

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

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

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

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

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

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

February 11, 2020

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

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

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

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

February 10, 2020

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

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

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

February 7, 2020

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

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

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

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

February 6, 2020

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

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

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

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

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

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

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

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

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

February 5, 2020

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

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

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

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

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

February 4, 2020

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

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

 

 

 

 

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

February 3, 2020

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

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

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

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

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

January 31, 2020

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

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

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

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

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

January 30, 2020

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

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

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

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

January 29, 2020

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

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

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

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

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

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

January 28, 2020

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

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

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

We doubt its coincidental.

January 27, 2020

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

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

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

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

January 24, 2020

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

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

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

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

January 23, 2020

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

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

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

January 22, 2020

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

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

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

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

January 21, 2020

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

 

 

 

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

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

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

 

 

 

 

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

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

January 17, 2020

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

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

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

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

 

January 16, 2020

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

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

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

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

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

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

January 15, 2020

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

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

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

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

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

January 14, 2020

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

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

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

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

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

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

 

January 13, 2020

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

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

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

January 10, 2020

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

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

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

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

January 9, 2020

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

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

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

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

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

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

 

 

January 8, 2020

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

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

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

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

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

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

 

 

January 7, 2020

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

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

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

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

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

January 6, 2020

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

 

 

 

 

 

 

 

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

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

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

January 3, 2020

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

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

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

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

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

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

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

 

January 2, 2020

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

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

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

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

December 31, 2019

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

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

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

The graph below shows forward Fed Funds trading for this year’s turn. The Fed, through a massive supply of liquidity, seems to have managed an orderly turn. We do not anticipate problems today as the Fed is paying close attention and is willing and able to provide funds to alleviate any stress. CLICK TO ENLARGE

Just a reminder, the BLS will not release employment data on the first Friday of the month, as is customary. It is scheduled for next Friday on the 10th of January.

We wish you a happy and healthy 2020!

December 30, 2019

The low volume stock melt-up will likely continue this week. Of note, however, the VIX (volatility index) rose sharply on Friday and is up again this morning despite the market being slightly higher. It’s hard to tell if the activity is year end position squaring or investors hedging themselves early for potential downside in early 2020 when the Fed’s year-end liquidity programs are curtailed. Regardless, given the extreme overbought conditions and the seemingly steady rise throughout December, a pullback should be expected in January.

The China/U.S. trade deal boosted the price of oil as it hoped that relief of tensions helps resuscitate global trade and economic growth, both of which entail more energy usage. Crude is topping $62 a barrel this morning.

Economic data will be light this week, but of interest will be Chicago PMI on Tuesday and the ISM Manufacturing Index on Friday. Both data points will provide an update on the health of the struggling manufacturing sectors. Based on smaller regional indexes released over the last two weeks, the two indexes may remain below the crucial 50- economic contraction/expansion level.

December 27, 2019

Yesterday, the market closed sharply higher as the end of the year “melt up” continues. The main driver of that rally was the near 5% surge in Amazon (AMZN) on the back of stronger than expected online holiday sales. A couple of months ago we added AMZN to the Equity Portfolio and XLY to the ETF Portfolio in anticipation of this breakout in the stock, however, performance had been disappointing in both until yesterday.

With just three trading days left in the year, the S&P is now set to surpass the 29.6% full year return of 2013 at which point 2019 will be the best year in 22 years, since the 31% return posted in 1997. With the majority of humans out until after New Years, there is little impediment to the algos running the markets higher until the end of the decade.

While the media has continued to use the same strawman of trade optimism to justify the rally, the reality is whatever trade agreement there may actually be, it was priced in long ago. The reality is that the Fed’s $500 billion flush of liquidity into year end to meet short-term funding needs has been interpreted by the markets at “QE” and the rush to benchmark performance into year end is pushing equity allocations, and investor optimism, toward record highs. It is worth noting there could be “payback” after the beginning of the year when gains can be locked in with taxes deferred until 2021.

Speaking of optimism, and outright complacency, the difference (spread) between the high yield (junk debt) CDX index and U.S. Treasury yields has fallen back below 300 basis points. The index measures the cost of insuring high yield debt against default. This extremely low cost of insurance, especially this far into an economic expansion, reeks of complacency and a chase for extra yield as we are seeing in other asset markets.

While we are certainly enjoying the rally, just don’t forget “what goes up, eventually comes down.”

CLICK TO ENLARGE

December 26, 2019

Stocks are set to open slightly higher, based in part on reports from MasterCard of strong online retail holiday sales.

Jobless Claims, released at 8:30 are expected to normalize after a two week spike. The consensus of economists expects an increase of 223k.

Complacency as measured by volatility is not solely confined to the equity markets (as measured by VIX) but, as shown below, is rearing its head in the FX markets. Despite ongoing BREXIT discussions and the possibility of negative consequences for Europe, one year historical volatility in the Euro/USD is at the lowest levels since its formation.

December 24, 2019

Stock markets will close at 1pm and the bond markets at 2:00 today for Christmas.

Durable Goods fell 2% versus an expectation of a gain of 1.5%. Excluding transportation the index was down 0.2%.  Despite home builder optimism at 20 year highs, new home sales were weaker than expected. Both data points can be volatile so we caution reading too much into the data.

On Thursday morning the BLS will report on jobless claims, a data series that we are paying close attention to.

With no market to follow this afternoon, we provide you with an interesting article from Bloomberg on the quality of jobs in the labor market. The article helps better explain why wage growth has been weak despite the unemployment rate at 50 year lows. The Jobs Market Isn’t as Healthy as It Seems.

We wish you a Merry Christmas and happy holidays. We will be back on Thursday.

December 23, 2019

China announced they would reduce tariffs on over 850 goods. Markets are up slightly on the news as it was already rumored that tariff relief on U.S. imports to China would be part of the Phase One deal.

The Fed’s balance sheet increased by $43 billion last week (Thursday to Thursday) which annualized, is growing at a pace of $2.2 trillion a year, or a 50%+ increase in the balance sheet.

Consumer spending matched expectations, growing at +0.4% monthly, while Personal Income surprised to the upside (0.5% versus 0.3% expected).

The New York Fed’s GDP Nowcast, a forecast of Q4 GDP growth, increased from +0.69% to 1.32%.

Today’s Chart of the Day shows one of the reasons for the stress in the overnight funding markets. Commercial banks have had to help fund the massive surge in Treasury debt issuance which in turn, forced them to allocate less of their funds toward other loan products such as repo. To put Treasury issuance in context, over the last 12 months the amount of publicly traded Treasury securities has grown by $1.64 trillion. That compares to an average annual issuance of $600 billion during 2018.

Barring the emergence of a large buyer of U.S. Treasuries, this crowding out effect should continue until the Fed can permanently add reserves to bank balance sheets. This is why many, ourselves included, believe that the Fed will eventually buy longer term Treasury notes and bonds to replace maturing repos and short term bill purchases (QE4).

 

December 20, 2019

The Philadelphia Fed Manufacturing Index was weaker than expected at +0.3% versus an estimate of +8.0 and prior reading of +10.4. Due to the timing of this survey, following the Phase One trade agreement, it is not reflective of the current mindset of those executives that were surveyed.  Any benefits from the agreement should become evident in the January round of manufacturing surveys.

The Leading Economic Indicators Index was up 0.1% year over year. Since 1970, every time the indicator fell below zero, a recession followed. The index would probably have been below if not for the rising stock market, which is a key input.

Weekly Jobless Claims fell to 234k from last months elevated 252k. Due to the volatility of the weekly number, economists prefer to focus on the four week moving average. The four week moving average low for the current economic expansion was recorded in April at 201.5k.  Currently the average sits at the upper end of the range of the last two years. On a historical basis, the number is very low, but it is rising.

Today’s Chart of the Day shows that prior to last three recessions, the four week moving average of Jobless Claims spiked higher a month or two prior to a significant decline in payroll growth. As shown the recent increase is barely noticeable, but given the deterioration in non-BLS employment data this bears watching closely as a leading indicator.

At 10am Personal Income and Spending data will be released. This data will provide a good reading on the health of the consumer. Expectations are for income to be flat and spending to be up 0.3%. This implies that credit is being used to fill the gap.

December 19, 2019

The market looks to open flat following the House’s impeachment vote, as it is widely believed it will fail in the Senate.

The November Cass Freight Shipments Index was down 3.3% year over year and now lower for 12 consecutive months in a row. This provides further confirmation of weak global economic activity.

Boston Fed President Eric Rosengren, during a speech on Tuesday, made a statement about asset prices that is worth sharing. He stated: “If you look at the last two recessions, they were not situations where inflation got out of control. They were situations where asset prices went way up and then came way down. So if your goal is to avoid recessions, I think we need to be pretty focused on asset prices not just inflation.

It is widely surmised by investors that the Fed has their back. This statement provides all the more evidence supporting that feeling. We would just ask the Fed to pay more attention to periods like today when asset prices “went way up”, and well beyond normal valuations.

We have written a lot about inflation and how we believe it is underestimated. In this vein, we just stumbled across the Chapwood Index.  Chapwood provides inflation data broken down by each major city and based on the top 500 items that people spend money on in those cities. Based on the index, inflation is running at approximately 10% a year. This figure is in line with ShadowStats which calculates inflation the way the BLS calculated it in 1980. Given, approximately 3% wage growth on average, this discrepancy further helps explain the need for ever increasing amounts of debt and the poor situation many retirees find themselves in today.  Click on the link above to find the inflation rate in your city.

 

 

December 18, 2019

Following two bad monthly prints, Industrial Production rose by 1.1%, slightly above expectations. The GM strike played a large role in the fluctuations over the last three months so we will pay closer attention to this data over the next few months for a better indication of the health of manufacturing. We suspect the trend should be slightly higher due to the Phase One trade agreement, however with Boeing (BA) cutting production of the 737, there may be downward pressure on activity. Capital Economics forecasts that if the Boeing production cut continues through the first quarter, Q1 GDP could be reduced by 0.5%.

The JOLTS labor data showed some improvement with job openings (7.267 million vs estimate of 7.018 million) increasing 3.3% monthly, however they are still down over 4% year over year. We continue to be befuddled by jobs data. Some data has been very strong while other data has been weak. JOLTS is produced by the BLS which in general has produced the more bullish jobs data.

The yield curve continues to steepen, with the 2yr/10yr curve now at+25 basis points. With the Fed on hold, keeping short rates stable, and economic data coming in better than expected we expect the curve will continue to have a steepening bias.

Crude oil broke above the $60 barrier yesterday, however it remains well within its 2019 range ($44-$68). As shown below, from the Major Markets Review published on Monday, oil has cleared the downtrend resistance line from the $75 highs in October of 2018.  The case for crude is getting more bullish, which has inflationary implications.

 

December 17, 2019

Economic data this coming week will be relatively light, but there are a few items worth following. At 10:00 this morning, JOLTs data will provide more detail on the health of the labor market. Job openings have been trending lower in recent months. Just prior at 9:15, Industrial Production data will be released. Of key interest today will be a 12:30 speech by NY Fed President John Williams. The NY Fed manages repo and QE operations, so any information he can provide on the overnight funding stresses and year end operations will be helpful. Jobless Claims and Leading Indicators will be announced on Thursday and Consumer Sentiment on Friday.

As shown below, the European manufacturing sector continues to fall further into recessionary territory. The Eurozone Manufacturing PMI, shown below, has been below 50 for 11 straight months. Within the data set we learned that manufacturers cut jobs to the greatest extent since 2012. Fortunately, Eurozone Services PMI was higher and above 50, helping offset manufacturing woes. Japan and Australia also reported a contraction with PMI manufacturing data readings below 50. We are waiting to see if the Phase One trade agreement will help improve executive outlooks of the manufacturing companies and thereby result in improvement in the sector over the coming months.

CLICK TO ENLARGE

Today’s Chart of the Day shows the surge in the NASDAQ index, which occurred during the last few months of 1999. Most people attribute the massive gain to the final feverish pitch of the dot com bubble. We believe the real culprit was the Fed which added substantial amounts of repo liquidity to the banking sector due to concerns over Y2K and the potential for mass computer malfunctions. These repo funds designed as a buffer for the banking system worked their way to the financial markets. For more please read the following WSJ article from 1999- Federal Reserve Clears Loan Facility Linked To Y2K Computer Problems.

The graph below shows the 10x surge in repo funding during late 1999 and its quick removal shortly after the New Year. Note the recent surge, on the right side of the graph, dwarfs the 1999 experience and that is before an expected $500 billion spike in repo financing over the next week or two. Unlike 1999, we have our doubts as to how quickly the graph normalizes, as the Fed continues to underestimate the scope of the growing overnight funding issues. CLICK TO ENLARGE

To quote Yogi Berra “deja vu all over again.

 

 

 

December 16, 2019

The takeaway from the ongoing trade saga again is that Phase One appears to be finally agreed upon. As such, existing tariffs will remain in place and the new tariffs, expected to begin on December 15th, will be suspended. This seems to be predicated on China buying $40-50 billion of agriculture per year. As mentioned on Friday, the terms are not being announced, so we can only speculate as to what else might be included in the agreement. We have one opinion, that could greatly affect the asset markets, which we will share with you in a RIA Pro article coming shortly.

In case you are worried that the President will not be able to push the markets higher with daily trade related tweets now that Phase One appears to be done, he announced that negotiations on Phase Two with China will begin immediately.

Retail Sales were weaker than expectations coming in at 0.2% versus expectations for a 0.5% increase. More concerning, core retail sales (ex. autos and gas) were flat versus a +0.4% expectation.

We learned on Friday that for the first time since 2009, the number of people collecting unemployment insurance increased.

With Boris Johnson’s landslide victory in the UK elections it seems all but certain that Great Britain will leave the EU by January 31st. Terms remain to be negotiated, but based on the overwhelming support Johnson received, he has the backing of Parliament and the country to proceed.

December 13, 2019

Right after the stock market opened, President Trump tweeted the following: “Getting VERY close to a BIG DEAL with China. They want it, and so do we!”  And with that tweet stocks zoomed higher. The deal was confirmed later in the day, although it is being reported that no details will be released and there will be no signing ceremony. Rumors are China will buy up to $50 billion in agricultural goods in exchange for no increase in tariffs. The chart below shows that $50 billion is significantly more than China’s purchases of US agriculture over the last decade. CLICK TO ENLARGE

Long term bond yields rose sharply as a trade deal means further Fed stimulus is less likely as economic “uncertainty” will diminish. The yield curve steepened yesterday on the trade deal announcement and is further helped by the Fed’s new stance on inflation. Because the Fed is wanting for more inflation, the market  is pushing longer term yields higher, while short term yields remain tethered to the Fed’s Feds Funds Rate which is unlikely to rise or fall in the near term.

Lost in the trade news was weak economic data. Jobless Claims surged higher from 203k to 252k. It is worth reiterating that this data point is volatile and we should not make any presumptions based on one weekly reading. However, the increase is big enough to take notice, especially given signs of labor weakness in corporate and consumer surveys.

PPI, was weaker than expected, posting no change on a monthly basis and a 0.2% decline in the core (ex food and energy) reading of producer inflation. Retail Sales will be released at 8:30 this morning. The current estimate is for a gain of 0.5%, following last month’s 0.3% rise. This number is one of the key indicators used to assess the health of the consumer. As noted, personal consumption has largely offset weakness in other sectors of the economy. Consumption accounts for nearly 70% of GDP.

The Fed announced plans to provide an additional $365 billion of repo funding that will cover banks over year end. Typically year funding can be tight due to year end capital requirements. The Fed must concerned that this year end could be particularly troublesome.

 

December 12, 2019

Headline CPI came in one-tenth of a percent higher than expectations at +.3% monthly, and +2.1% year over year. Core CPI, excluding food and energy, was as expected at 2.1%. Given the Fed is taking a more pro-inflationary stance then what we have witnessed over the last few decades, this economic data point is less relevant than it had been. They will largely turn a blind eye to inflationary pressures that may arise, especially when inflation running below 2% as it is.

As expected the Fed left rates unchanged. They did make a few noteworthy changes that are worth mentioning. For one, the Fed removed the term “uncertainties” in regard to their outlook. Also of note 13 of the 17 Fed members predict no rate changes in 2020. Interestingly, the other four think the Fed will hike rates next year.

“We can sustain much lower levels of unemployment than had been thought and that’s a good thing because we don’t have to worry so much about inflation. The quote from Powell in his post meeting press conference provides further evidence that the Fed believes they can push on the economy harder without fear of employment causing inflation. Given that we are at 50 year lows in unemployment and inflation is scant tells us either unemployment isn’t as low as reported, or this time is different.  We doubt this time is different.

In general, Powell reiterated the minutes from the Fed meeting in stressing that the Fed is not concerned with the economic outlook. He also mentioned, that if needed, the Fed would purchase longer term Treasury securities making the current QE operation more permanent. The media avoided asking him tougher questions on the repo funding issues or QE4 operations and the questions they asked were largely swept under the rug by Powell.

The dollar was weaker while stocks, gold, and bond prices rose, telling us that the market interprets the press conference and meeting as dovish.

December 11, 2019

Zoltan Polzar, a well followed Fed and Banking analyst at Credit Suisse, is making headlines in regards to his thoughts on the Repo funding situation. He claims that reserves and regulatory constraints are “shaping up to be a severe binding constraint.” To paraphrase- The Fed’s repo and QE4 operations, as currently being administered, are papering over a much bigger problem. He thinks the Fed will be forced to do much more extensive QE before year end.

This morning we published our thoughts on the topic- When It Becomes Serious You Have To Lie – Update on the Repo Fiasco.

In part due to skyrocketing pork prices, food prices in China have risen 19.1% year over year. In addition to hurting consumers, inflation makes monetary stimulus harder for the Bank of China to administer as it is inflationary. From a trade perspective, consumer inflation will likely be one factor that pushes Chinese leaders to come to some sort of Phase One agreement. Not surprising, there were numerous press releases yesterday claiming that a delay of the December 15th tariffs is a strong possibility.

The Fed will report on monetary policy at 2pm, followed by Jerome Powell’s press conference at 2:30. Given the new attention to repo funding and QE, we will be on the look out for any changes to their daily repo/QE4 liquidity operations or proposals for how they might address the issues in the near future. We suspect the media will ask a lot of questions on this topic.

CPI will be released at 8:30 and the current estimate is for a 0.2% increase both in the core (ex food/energy) and the headline number.

 

December 10, 2019

The Bank of International Settlements (BIS) reported that the overnight repo problems of the last few months might stem from the reluctance of the four largest U.S. banks to lend to some of the largest hedge funds. The four banks are being forced to fund a massive surge in U.S. Treasury issuance and therefore reallocated funding from the hedge funds to the U.S. Treasury.  Per the Financial Times in Hedge Funds key in exacerbating repo market turmoil, says BIS: “High demand for secured (repo) funding from non-financial institutions, such as hedge funds heavily engaged in leveraging up relative value trades,” – was a key factor behind the chaos, said Claudio Borio, Head of the monetary and economic department at the BIS.

In the article, the BIS implies that the Fed is providing liquidity to banks so that banks, in turn, can provide the hedge funds funding to maintain their leverage. The Fed is worried that hedge funds will sell assets if liquidity is not available. Instead of forcing hedge funds to deal with a funding risk that they know about, they are effectively bailing them out from having to liquidate their holdings.

In addition to the Fed’s monetary policy meeting and press conference on Wednesday, UK elections on Thursday, and the 12/15 China tariff deadline, is a good amount of important economic data slated for release this week as follows:

  • Tuesday: NFIB Small Business Optimism Index- keep an eye on the labor component as discussed below
  • Wednesday: CPI
  • Thursday: PPI and Jobless Claims
  • Friday: Retail Sales

Last week we were amazed by the large gap between the ADP and BLS labor reports. After  some research we discovered that weakness in small business jobs growth is the predominant cause. Because ADP services many small businesses they are quicker and more accurate in reporting changes to small business payrolls than the BLS. The divergence of data is also supported by the NFIB’s (Natl. Federation of Independent Business) employment measure which is also weakening. While the effect on the overall BLS jobs number is not big as it is for ADP, the BLS does show weakness in small businesses. From January to November, the year over year growth in hiring at small employers (1-19 employees) has shrunk from 1.2% to 0.1% while hiring growth at large employers (1000+) has grown from 1.8% to 2.1%. The concern with this finding is that smaller business are more sensitive to business cycles and quicker to react to changes than larger, more bureaucratic companies.

 

December 9, 2019

The BLS employment report exceeded all expectations, registering a gain of 266k new jobs. Of the 50+ economist estimates that comprise the consensus forecast, the highest one called for a gain of 210k new jobs. Also positive, the unemployment rate fell from 3.6% to 3.5%, although that is partially the result of the participation rate dropping from 63.3% to 63.2%. The GM strike resolution added the 41k jobs that were taken away in the prior month.

This will be a busy week. On Wednesday the Federal Reserve meets to discuss monetary policy. No changes to interest rates or the balance sheet are expected but their comments on growth and implications for policy should be informative. On Thursday, Great Britain will go to polls to elect a prime minister. The biggest market mover may be the December 15th deadline on tariffs. We suspect this week will be filled with many official and unofficial comments as well as plenty of rumors. While it appears that some sort of deal is likely to be agreed upon, there is also a decent likelihood that no deal is reached and the trade war escalates rapidly.  Buckle up it should be a fun week.

In numerous commentaries we have discussed the role that the Fed Balance sheet (QE/repo operations) plays in pushing asset prices higher. The following graph puts the current balance sheet expansion into context with the prior episodes of QE. It is truly stunning to consider that QE4 is on the same pace as QE1. QE1 occurred during a recession and with the financial system melting down. At the time major banks and financial companies were in danger of failing. We still have yet to hear a viable rationale for why QE4 was abruptly started. We will have more on this topic in an article coming out on Wednesday.   CLICK TO ENLARGE

 

NEW PORTFOLIO UPDATE:

Due to many requests, we have now added the ability to ADD CASH to the TRANSACTION BASED portfolio.

This is found in the PORTFOLIO TAB / MYPORTFOLIO TRADING

Click To Enlarge Image

 

December 6, 2019

China is supposedly waiving some tariffs on soybeans and pork. This is hopefully a step in the right direction towards a resolution before U.S. tariffs go into effect on December 15th.

Yesterday we discussed the sharp decline and weakening trend in payrolls as reported by ADP.  Jobless Claims bucked the trend and fell sharply from 218k to 203k. The Claims report is making it difficult to figure out the labor market. Private labor market indications such as ADP, NFIB, and various independent surveys point to a definitive weakening trend that the BLS has not picked up on to any large degree. However, it is worth noting that BLS data tends to lag by a few months so we may have to continue to wait for another month or even more to assess which data source is correct. We also remind you that BLS data is sharply revised up and down years after it is first reported. For example, in August the BLS announced that they will revise 2018 payrolls down by 501,000 jobs.

Today BLS jobs report will be released at 8:30. The current expectation is for a gain of 180k jobs and an unemployment rate of 3.6%. That compares to last months readings of 128k and 3.6% respectively. Keep in mind payroll growth was reduced last month by over 40k jobs due the GM strike which has since been resolved. The data report should include the GM jobs which will boost the number by over 40k jobs. The two month total gain will compensate for this and should be correct. Our labor model estimates much weaker growth of 110k jobs.

German Industrial Production fell 1.7% last month and now stands at -5.3% year over year. While some global manufacturing data has turned higher this is not a good sign for global trade.

As shown in Today’s Chart of the Day, the year over year change in both exports and imports is declining. The trade deficit declined from -$51.1 billion to -$47.2 billion as a result of imports declining more than exports.

December 5, 2019

The ADP Employment report was much weaker than expectations coming in at 67,000 versus an estimate of 156,000. That compares to the consensus estimate for the Friday BLS report of 180,000. Our model based on ADP and temporary hiring, estimates the BLS will report payrolls growth of 110,000. For what its worth our model has been within 25,000 of the BLS number on average for the last six months. Even if our estimate is low by 25,000, the jobs number will still be  disappointing. To reiterate a big theme of ours, economic growth has been largely supported by the consumer. Any weakness, or perceived weakness in job growth, is likely to spill over into consumption trends and could be problematic for economic growth. Today’s Chart of the Day provides perspective on the slower employment growth trend from the ADP report.

The ISM non-manufacturing survey also disappointed coming at 53.9 versus 54.7 last month and expectations of 54.5. The index is now at a ten year low after being at a 15 year high only 9 months ago. For a different perspective, the following graph, courtesy Brett Freeze, shows that the year over year change in this survey has fallen to levels seen during the prior two recessions.  CLICK TO ENLARGE

Despite the weak economic data stocks had a good day, fueled by rumors from an anonymous source that trade talks were progressing. The volatility over the past few days highlight how trade talks are a double edged sword for investors. We think it is important to not overly focus on press reports, government statements, and even rumors, but at the same time be aware that many traders and algorithms are keying on these statements and they can have a big impact on the markets.

December 4, 2019

Fox reported that the administration is planning on moving ahead with tariffs on December 15th. The combination of Trump’s admission that a deal may be postponed until after the election along with the December 15th tariffs caused the S&P 500 to fall by over 40 points. By the end of the day the losses were cut in half, closing the day at 3093.  To put the recent decline and current price level in context, the S&P closed at 2938 the night before Phase One of the trade deal was announced.

This morning an unnamed source said the trade talks were going well and with that, the S&P 500 is set to open 15 points higher. Rinse-wash-repeat…

Since last Friday, the VIX volatility index has increased from 11.50 to an intraday high of 17.50. It is approaching the range (18-25) where it has stalled and reversed numerous times over the past 9 months. We will watch VIX trading closely for signs that either the sell-off is abating or that it may break higher. A break above 25, especially if sustained, would be concerning.

The ADP jobs report will be released at 8:15am. The consensus is for an increase of 156k jobs which is about 25k higher than last month. Keep in mind however, last month was reduced by 42k due to the GM strike which has since been resolved. With this number in hand we will run our model and provide a prediction for Friday’s important BLS jobs report.

Following the weak ISM Manufacturing Survey on Monday, all eyes will be on the ISM Non-manufacturing Survey. Current estimates call for a small decline from 54.7 to 54.5. A sharper decline, getting the index closer to 50, would cause concern as ISM has a strong track record in signaling economic activity.

 

 

December 3, 2019

This morning the following headline hit the wire: TRUMP SAYS I HAVE NO DEADLINE ON CHINA DEAL AND IT MIGHT BE BETTER TO WAIT UNTIL AFTER NOVEMBER 2020 ELECTION. We will now wait and see what happens on December 15th, when the suspension of tariffs is scheduled to end.  The S&P 500 looks to open about 10 points on weaker on the news, following a 1% decline over the prior two sessions as such a result was becoming more likely.

The U.S. ISM manufacturing survey was disappointing on Monday, coming in at 48.1 versus expectations of 49.2 and a prior reading of 48.3. This follows the encouraging PMI manufacturing survey which rose last Wednesday and better manufacturing surveys from other nations. The employment component within the ISM report dropped further signaling the potential for weakness in Friday’s employment report. The new orders component has dropped and is now at its lowest level since June 2012.

China’s Caixin manufacturing survey rose above 50 and into economic expansionary territory (50.2 from 49.3), while the non-manufacturing survey is showing robust readings at 54.4 vs 52.8 last month.  Given China drives about a third of global GDP growth, this is an encouraging sign for a turnaround in weakening global growth. The only potential drawback is that the improvement of China’s economy allows the government to take a harder stance on trade which could re-introduce more tariff threats and/or actions.

Trump raised the prospect of steel tariffs on Argentina and Brazil. Last Tuesday Brazil signed an agreement with China allowing them to export  soy products to China. This is the first time they have been able to sell agricultural products to China in decades. Argentina signed a similar deal in September. These tariffs are likely a warning to those countries. China has been trying to diversify other products in addition to agriculture. Our friend Mike “Mish” Shedlock recently wrote about similar actions that China is taking in regards to the production of cell phones- China No Longer Needs U.S. Parts in its Phones.

The Fed is considering allowing inflation to run above its target of 2%. In an article released yesterday by the Financial Times, (LINK) the Fed’s review of monetary policy is likely to include a rule that allows them to overshoot their inflation target after a period of undershooting. As we mentioned after the last FOMC meeting, the Fed is making it abundantly clear they want more inflation and will not raise rates if inflation picks up. Bond yields rose on the news.

 

December 2, 2019

The ISM PMI manufacturing survey will be released at 10am this morning. Expectations are for the survey to remain in economic contraction territory (<50) but rise from 48.3 to 49.1. The ISM non-manufacturing (services) survey will be released on Wednesday. Also of note this week will be the ADP jobs report on Wednesday and the important BLS employment report on Friday.

Currently there is a near zero percent chance of a rate cut at the December Fed meeting and only a 25% chance of a 25bp cut by April.

In September, the 2yr/10yr Treasury yield curve went from -5bps to +27bps. Since then, it has flattened back to +15bps. We believe it can flatten further, but with the Fed currently doing QE and having reduced rates by 75bps, we think the market will be quick to price in further rate cuts if economic data weakens or the China/US trade deals falls apart. As such, we continue to think any inversion will be limited and that over the longer term the curve will steepen significantly.

The Atlanta Fed GDPNow forecast for Q4 GDP has risen sharply from 0.4% in mid-November to 1.7% as of last Wednesday due to the encouraging economic data released over the past week.

 

November 29, 2019

Economic data on Wednesday was better than expected but with some important caveats as follows:

  • Durable Goods rose 0.6% which is much better than an expected decline of 0.7%. Last month was revised lower from -1.1% to -1.4%. While October’s data was better, the year over year change in durable goods, excluding aircraft and defense, is still negative. These two sectors are commonly excluded as they are very volatile month to month.
  • GDP was revised higher to 2.1% from 1.9%, of which .17% of the .2% increase was due to a revision of inventory data.
  • Jobless Claims fell to 213k versus expectations of 218k. As we have been discussing this measure of labor is showing no sign of weakening. That said, due to seasonal adjustments and the Thanksgiving holiday falling a little later than last year, we must take today’s number with a grain of salt. To this point, the non-seasonally adjusted number posted its largest year over year increase since 2010.
  • Chicago Purchasing Managers Index (PMI) continues to show improvement rising from 43.2 to 46.3. This is potentially a good sign that the slump in manufacturing is abating. We will look for confirmation in the more followed ISM surveys.
  • Personal Income was flat versus expectations of a 0.3% increase. This did not effect consumer spending which rose by 0.3%.

President Trump signed the Hong Kong Bill of Rights and Democracy Act on Wednesday night. The Chinese quickly responded with strong rhetoric denouncing the bill which call trade talks into question. Despite Trump’s actions, the S&P 500 is only slated to open down 6 points. Trump had a week to discuss the bill with China so it is possible that any harm has been largely resolved. That said, we should not rule out that the signing will be a huge impediment to trade talks. For consideration- China knows how much Trump cares about the stock market and it therefore raises the possibility that they take actions when the markets are open and liquid today or even next week.

November 27, 2019

Dallas Fed President Robert Kaplan conveyed some noteworthy concerns about debt and leverage in an interview on CNBC. Here are a few quotes from the interview:

  • “The thing I am worried about is if you get two or three BBB credit downgrades to BB or B, that could lead to a rapid widening in credit spreads, which could then lead to a rapid tightening in financial conditions,”
  • “We’re got a record level of corporate and to be specific BBB debt has tripled over the last 10 years,”
  • “Leveraged loans as well as BB and B debt have grown dramatically.”
  • “The problem with ’08-’09 was that the lenders were overleveraged. Right now, we have an issue where the borrowers are highly leveraged,” Kaplan added. “My concern is if you have a downturn where we grow more slowly it means that this amount of debt could be an amplifier.”

Kaplan’s discussion about BBB-rated bond downgrades is potentially a big problem, and one which we believe is greatly underappreciated. We raised the issue in May with our article The Corporate Maginot Line. To wit: “If 50% of BBB-rated bonds were to get downgraded, it would entail a shift of $1.30 trillion bonds to junk status. To put that into perspective, the entire junk market today is less than $1.25 trillion, and the subprime mortgage market that caused so many problems in 2008 peaked at $1.30 trillion.”

Consumer Confidence was slightly weaker than expectations at 125.5 vs 126.9. While the decline is not worrisome, of concern is that consumers continue to see worsening labor conditions. Per Econoday: “those saying jobs are “plentiful” decreased from 47.7 percent to 44.8 percent, while those claiming jobs are “hard to get” increased from 11.6 percent to 12.7 percent.” We suspect this slow, but steady deterioration in the two job survey questions will eventually result in higher jobless claims.

Due to the holiday on Thursday, Jobless Claims will be released this morning. The current expectation is for a decline from 227k to 218k. The 4-week moving average is 221k.

Durable Goods, due for release at 8:30, is expected to decline by 0.7%, following a 1.1% decline last month.

November 26, 2019

The Dallas Fed manufacturing index dropped from +4.5 to -2.4 and has turned negative for the time first time in three years. The regional index is a good barometer of the energy sector.  The last time it was negative, crude oil traded below $30 a barrel. As we discuss below, CCC bond yields are rising of which a good chunk of the increase is due to the energy sector.

Over the past 6 months yields on CCC-rated bonds have been rising while those of other junk rated bonds (B and BB) have been stable. Some in the media believe this divergence to be a signal of brewing corporate credit problems that will soon show up in B and BB rated debt. Over the last 6 months the yield spread, or difference, of CCC rated debt to U.S. Treasuries has increased by 2.63%. At the same time those spreads for BB and B rated debt slightly declined. Such a divergence may seem extreme, but when historical data comparing these spreads is examined, as you can see in Today’s Chart of the Day, the differential is not statistically significant.  The current intersection of CCC and B rated yields is represented by the orange dot. Based on the strong regression (R2=.85), B spreads would need to rise by 0.29% to normalize to the historical relationship. BB spreads would need to increase by 0.74%. Neither move would be overly concerning.

What is more interesting is divergence between the S&P 500 and CCC rated spreads as shown below. CLICK TO ENLARGE.

Of note on the economic calendar is Consumer Confidence at 10am, Durable Goods and Jobless Claims on Wednesday and Chicago PMI on Friday. The stock markets will be closed on Thursday and close early at 1pm on Friday.

November 25, 2019

Of Friday we published an Update to our RIA Pro article- UPDATE: To Buy Or Not To Buy- An Investors Guide To QE4 in which we discussed the possibility that QE4 could be modified or curtailed.

Based on the recent speeches of Jerome Powell and other Fed members, we sensed a growing concern for increased Federal and corporate debt levels along with higher stock valuations. Prior to Friday, there were only a few of us voicing such concerns. On Friday this changed, as CNN published The $4 trillion force propelling US stocks to record highs. The fact that such a broadly followed non-financial media outlet made this insinuation, linking QE to stock market prices, will certainly catch the Fed’s attention. As we posited in our updated article, the Fed may unexpectedly alter QE4 to the chagrin of the market.

The Consumer Sentiment index improved again and is back to the same levels of mid-summer. Expectations led the improvement in the index while the current conditions component was down.

Jerome Powell will speak at 7pm tonight. We are interested on his thoughts about QE and repo as well as the Fed’s newfound concern with downside economic risks as mentioned in Thursday’s Commentary.

November 22, 2019

Weekly jobless claims registered at 227k, 10k above estimates and at the same slightly elevated level as the upwardly revised number from last month. This is a historically small number of jobless claims, but it has been rising recently. While the number of new claims is small, what concerns us is the rate of change. The chart below shows that the year over year change in continued claims (new and old claims), turned positive for the first time in this economic expansion. Positive readings have preceded all prior recessions since at least 1970, but it’s not a full-proof indicator as there have  been a number of false signals.  CLICK TO ENLARGE

The Philadelphia Fed survey on manufacturing conditions rose in a possible sign that manufacturing in the Mid-Atlantic region is recovering.

Leading Economic Indicators rose 0.3% year over year, which is the slowest rate of growth in a decade. The last 5 times the index went from positive to negative growth on a year over year basis resulted in four recessions (2008, 2001, 1990, and 1981) and one false signal (1996). On a monthly the basis the indicator was negative for the third month in a row. Since the data was first calculated in 1959, three consecutive monthly declines occurred 11 times and 7 of those 11, were followed by a recession within 6 months. Needless to say, this indicator is flashing a warning sign.

There are a couple of leading indicators that are not widely followed which have caught our attention recently. The daily Baltic Dry Index, which measures dry bulk shipping costs, has fallen sharply since the beginning of the fourth quarter. The index was rising throughout the first three quarters of the year. Lower shipping costs are in part the result of weakened demand for shipping as global trade is weak. The pickup in the first few quarters was likely a function of inventory stocking to front run potential tariffs or other trade restriction.

The other indicator is the Citi Economic Surprise Index. This measure quantifies whether economic data is coming in better or worse than a consensus of Wall Street economists. During the third quarter the index rose sharply, meaning economists were underestimating the pace economic activity. However, over the last month or so, it has fallen back below zero, a sign that economic data is in general coming in weaker than expectations. For the last few weeks we have heard many in the media claim the Fed has successfully avoided a recession or economic slowdown. Might they have spoken a little too soon?

Per the South China Morning Post- “China Watching Donald Trump’s Response To US Hong Kong Bill As It Threatens To Become New Barrier To Trade Deal.”

November 21, 2019

According to Reuters, Phase One of the China/US trade deal is unlikely to be signed this year. The market sold off sharply on the news but regained more than half of the losses by the close. As discussed yesterday, the passing of the Hong Kong Human Rights and Democracy Act is probably making difficult negotiations even more trying. Indications are that the President will sign the act. As we are publishing this a rumor is circulating that China invited the U.S. to Beijing for trade talks.

On Wednesday afternoon, the Fed released the minutes from the October 30th FOMC meeting. Of note, the minutes stated “many Fed officials view downside risks as elevated.” This was clearly a departure from the language used in the FOMC statement as well as the words of Jerome Powell following the October meeting. In both instances, we were lead to believe that the balance of risks was even and in fact, downside risks had been reduced over the prior month or so.

We believe that the meeting between Powell and Trump was probably a heads up to Powell to let him know the China trade deal is running into problems. The change in the Fed’s tone gives them leeway to provide even more stimulus if need be.

Target and Lowes reported strong earnings on Wednesday. Contrary to Home Depot, Lowes increased their sales forecast for the coming quarters. Unlike Kohls and Home Depot, today’s earnings news paints a healthy picture of the consumer.

 

November 20, 2019

Home Depot (HD) traded 5.50% lower on a weak quarterly earnings report. While earnings exceeded expectations, sales and same store growth missed expectations. Further the company revised Q4 earnings lower.  Sales for HD are highly dependent on personal consumption. As such this provides a clue that all may not be well with the consumer. Contrary to this data, home builders seem to believe consumers are able and willing to buy. Housing building permits are now at 12 year highs. Kohls (KSS) also cut their outlook in another warning about the health of the consumer. KSS fell by almost 20% yesterday.

The equity markets were largely unaffected by the news from HD and KSS as QE and FOMO appear in charge for the time being.

According to the American Staffing Association, the Temporary Staffing Index has declined sharply throughout this year and now stands at its lowest level in ten years. Reductions in temp staffing tends to be a first step employers take to reduce costs when they anticipate a slowdown. This index, at times, is a leading indicator of changes in payrolls and the unemployment rate.

Yesterday, the Senate passed the Hong Kong Human Rights and Democracy Act by unanimous consent following the House which had already passed it by unanimous consent. Given the veto-proof majority, Trump will have to sign the deal, which supports the protestors. This could greatly complicate trade talks.

The Treasury announced that foreign holdings of U.S. Treasury securities declined by 1.2% in September. As we have discussed foreign accounts used to account for about a third of Treasury securities purchases, making debt sales easier. Today, they are net sellers and, at the same time, the supply of debt has risen sharply. You can read about this troubling situation in our article Who Is Funding Uncle Sam?

November 19, 2019

As the riots and protests escalate in Hong Kong, it worth reminding you Hong Kong is the world’s third largest financial center, only behind New York and London. The increasing possibility of major disruptions to the flow of funds in and out of Hong Kong will have an impact on global markets and trade. Another thing to consider with Hong Kong is that any U.S. support for Hong Kong is problematic for the Chinese. If the U.S. officially starts siding with Hong Kong and openly provides support to the protesters, we expect trade negotiations will suffer greatly with any trade talk failures likely resulting in increased tariffs. Not surprisingly, on Monday morning, after two days of a well publicized standoff at a University,  it was “leaked” that Chinese government officials are pessimistic about a trade deal. Further, they are considering postponing any discussions until the U.S. election occurs.

President Trump, Treasury Secretary Mnuchin, and Fed Chair Jerome Powell unexpectedly met on Monday morning. The timing is interesting given a potential breakdown in trade talks.

The economic data front this week will be quiet. Of note is Jobless Claims, Philly Fed Outlook, and leading indicators on Thursday, followed by the PMI composite FLASH and Consumer Sentiment on Friday. There are not many speaking engagements scheduled for Fed members.

Over the past week we have warned that the major equity indexes are at grossly overbought levels. As shown in Today’s Chart of the Day, the S&P 500 has now reached MACD (moving average convergence/divergence) levels that have been hit seven times since 2018. The correction from each prior instance was at least 5%. We are now at the 8th instance and the only question in our mind is not if but when. Last Tuesday we hedged a portion of our equity exposure against such a sell off. We may add to the position on further market strength.

RIAPRO SITE UPDATE – NEW PORTFOLIO FEATURES

Do to popular request we have added a TRANSACTION BASED portfolio (MyPortfolio New) which now allows you to enter a starting cash balance and buy and sell positions for tracking purposes (same as the RIAPro Portfolios)

The previous portfolios (MyPortfolio Snapshot) remains for a simpler portfolio tracking system along with the Watchlist.

We have also added a new feature which allows you to enter MULTIPLE BUY/SELL Orders at one time when managing your portfolios.

We have lot’s of other new features coming from backtesting to Guru Portfolios so stay tuned for more updates.

November 18, 2019

Not surprisingly Hong Kong’s GDP fell by 3.2% in the third quarter and they officially entered a recession. While much of the weakness is due to the protests and the toll it takes on consumption and tourism, the China-U.S. trade war is also weighing on economic activity.

Retail Sales were slightly better than expectations (0.3% versus 0.2%) but the closely followed core data which excludes autos and gas, was only up 0.1% versus expectations for +0.3%. This number is important to follow as strength in personal consumption has thus far outweighed weakening in the manufacturing sectors and slow global growth. Signs of weakening consumer demand, especially if accompanied by a pickup in job layoffs, will increase the odds of a recession greatly.

Industrial production fell by 0.8% and the capacity utilization rate fell to 76.7% both much worse than expected and a further indication the manufacturing sector is struggling. Despite the increase in the price of oil, import and export prices declined 0.5% and 0.1% respectively. On an annual basis import prices are down 3% and export prices down 2.2%.

After Friday’s spate of weak economic data the Atlanta Fed reduced their Q4 GDP forecast from 1% to 0.3% in-line with the New York Fed at 0.4%. Despite the bad news and lower growth trajectory the markets rallied to even greater overbought levels. Clearly QE is in the drivers site while little else seems to matter.

 

November 15, 2019

Jobless claims jumped from 211k to 225k. One higher than expected weekly number certainly does not make a trend, but this data point is worth paying attention to in the weeks ahead. Unlike CPI, PPI was stronger than expectations but like CPI the year over year rate excluding food and energy was lower than the prior month. Core (ex food/energy) CPI and PPI is relied upon heavily by the Fed for inflation guidance.

On Thursday’s Real Investment Show podcast, Lance Roberts and Michael Lebowitz talked about inflation and the ways in which the government consistently modifies inflation calculations to help keep inflation readings lower than the real rise in prices. In particular Shadow Stats was mentioned. Shadow Stats simply recalculates CPI using the same exact price data in the BLS reports, but uses the formulas that were used in 1980. As shown in Today’s Chart of the Day, CPI using Shadow Stats logic is now running at about 10% a year versus the current CPI run rate of 1.5-2%. While inflation is impossible to calculate to a single number for a large population with diverse needs and demographics, we believe an approximation of inflation lies between the two calculations shown.

Beyond the current gap between the two lines, what we find to be very interesting is the trends of the two calculations. CPI (red) has been flat to declining, while the Shadow Stats figure (blue) has been flat to inclining. We tend to agree with Shadow Stats that prices in aggregate are rising, which helps explain why so many Americans find themselves in debt and living pay check to pay check.

Jim Bianco, of Bianco Research, recently presented the graph below. As shown, Fed Funds have been trading about 5-10bps below the mid point of the Fed Funds target range. Prior to the recent funding problems and liquidity operations by the Fed, Fed Funds traded 5-10 above the mid point. Jim’s takeaway is that maybe the Fed has supplied too many reserves to the market. If he is correct, Fed Funds should continue to trade at an increasingly greater distance below the midpoint. Might there be another purpose for QE?  CLICK TO ENLARGE

November 14, 2019

CPI was higher than expected by .10% on a monthly and annual basis. The increase was largely due to rising oil prices. The annual change in CPI less food and energy fell by .10% versus last month. MBA mortgage applications were strong last week. This is not necessarily an indication of a stronger real-estate market, but most likely buyers rushing to lock in mortgage rates on fears they will increase further. Such activity is typical when rates rise after a period of low rates.

Japan’s GDP rose 0.2%, well below expectations for 0.8% growth and last quarters 1.8% growth. Germany narrowly avoided a recession as their GDP climbed 0.1% versus an expected 0.2% decline.

The key line from Chairman Powell’s Congressional testimony yesterday was the following as reported by Reuters- “Powell repeated in his testimony that the Fed was unlikely to use its remaining capacity to cut rates unless there is a “material reassessment of our outlook.” 

In addition, Powell upgraded the Fed’s economic forecast, as they believe the odds of any further slowdown are diminished. The takeaway is that rates will not be reduced further, barring a sharp downturn in economic activity.  Currently, a full 25 basis point rate cut is not priced in until the fourth quarter of 2020. There is less than a 50% chance the Fed cuts by April 2020. Based on his statements about inflation and Fed policy from the prior FOMC meeting, the odds of rate hike are slim.

On the topic of Federal Deficits, Powell warned that rising debt levels could impair the government’s ability to boost economic activity during a recession. He also mentioned, correctly, that high government debt levels restrain private investment which has a negative effect on productivity and by default economic growth. This is an important topic that we have written numerous articles on.

Neel Kashkari, quite possibly the most dovish Fed member on the board, was quoted as saying he is “feeling better about the economy.” This is a good indication that those members who voted for more rate cuts than the Fed delivered are starting to coalesce with the Fed view that they are done cutting rates for the time being. If this continues it will make Powell’s job of forming a consensus at the Fed much easier.

November 13, 2019

The NFIB (small business optimism index survey) rose to 102.4 from 101.8, but remains down from the 106.7 average in 2018. There was good news on the small business employment front as there was an increase in the number of those that responded that they are increasing hiring plans and compensation. Small businesses are the largest employers in the U.S.

As we have discussed in prior articles and commentaries, QE has sparked a buying frenzy.  A recent Bank of America survey of fund managers “finds investors have traded fears of recession for the FOMO (fear of missing out).“- Per CNBC.  The question we need to stay on top of is- will improved confidence in the stock market translate to an uptick in economic confidence and ultimately economic activity?

Keep an ear out for Jerome Powell’s testimony to Congress today and tomorrow for more clues about monetary policy and the overnight funding situation. Also on today’s agenda is CPI. Current expectations are for a +0.3% m/m change and a +1.7 y/y change.

The market got a slight boost yesterday afternoon on a new proposal by Donald Trump to cut the middle class tax rate to 15%. The odds of such a proposal passing the Democrat led House are near zero, but we suspect similar types of tax cuts will also be proposed by Democratic presidential nominees.

Interesting fact- The Dow Jones Industrial Average was unchanged yesterday. The last time the index registered a zero change was in May 2007.

November 12, 2019

Britain’s GDP grew by 0.3% for the third quarter, and at the slowest annualized pace in almost ten years. No doubt concerns over a hard BREXIT and trade weighed on economic activity for the quarter. The market expects a weak, but positive GDP reading from Japan on Wednesday and the possibility of Germany posting a second straight negative GDP, meaning they will be in a recession.

Today’s Chart of the Day compares China’s Hang Seng Stock Index to the S&P 500. The two indexes have tended to be well correlated on a daily basis, yet the S&P is in an uptrend while the Hang Seng is trending lower. Note the Hang Seng has been making lower highs and lower lows since peaking in April, while the S&P 500 has done the opposite.  On Monday, the Hang Seng was down nearly 3% while the S&P was only down .25%. Will the S&P 500 follow the Hang Seng in the days to come?

Fed Member Neel Kashkari speaks tonight and again on Wednesday. He has been one of the more outspoken doves, pushing for aggressive rate cuts. Given the Fed’s new wait and see approach for further rate cuts, as relayed by Chairman Powell at the last FOMC meeting, it will be telling to see if Kashkari moderates his stance. If he does appear less dovish, it would a good sign that Powell may have corralled Fed members into a more united front.

On Monday, Bloomberg released an Odd-Lots Podcast interview with Zoltan Pozsar of Credit Suisse. The interview is worth a listen as it provides great insight into the recent surge in repo funding costs and the new QE operation.

 

November 11, 2019

Consumer Sentiment was on top of expectations and at a similar level as last month. Of note, those voicing concern over the pending impeachment were “virtually non-existent” while a quarter of those surveyed said tariffs were a concern.

Since early September, 10-year Treasury yields have risen by nearly 50 basis points. As a result of longer term bonds rising while shorter term bonds remain somewhat anchored to the Fed Funds rate, the yield curve has steepened. Currently the 2yr/10yr curve is +26 basis points, over 30 basis points steeper from the slight curve inversion experienced in late August.

Economic data this week will be sparse but meaningful. On Wednesday and Thursday the BLS will release CPI and PPI respectively. The current expectation for CPI is for a 0.1% increase while PPI is expected to fall by 0.3%. Following last month’s weak Retail Sales, expectations remain poor with retail sales expected to fall by 0.4%.

Chairman Powell will testify to Congress on the state of monetary policy and economy on Wednesday. We suspect he will face a lot of questions on the repo situation and the new round of QE. Elizabeth Warren has accused banks of creating liquidity problems in an effort to push for a relaxation of regulatory and capital measures. She and others are likely to revisit this charge with Mr. Powell on Wednesday.

The markets will most likely be quiet today as the bond markets are closed for Veterans Day. For all those who served, we thank you.

 

TRIAL USERS:

As referenced in our weekly newsletter, here is the referenced report on QE-4:

Click The Image To Read

November 8, 2019

Jobless Claims fell slightly to 211k from 219k, showing no signs of increased layoffs. We remain in limbo as to whether the survey data alerting us to labor concerns from employers and employees is a leading indicator of the jobs market or simply a false signal. It is worth noting that the jobless claims and the monthly employment data from the BLS tend to lag other indicators by 2-3 months. Thus far it appears that companies are hiring less. The decision to fire people is harder as  skilled workers are hard to find in many industries.

As we have harped on, personal consumption is providing a strong ballast for economic growth. As such, we are on alert for signs that consumption is being impeded by economic concerns or a change in financial conditions. Consumer sentiment, released at 10am today, will help us further asses the mindset of the consumer.

Markets rallied on Thursday morning on talk that China and the U.S. agreed on tariff rollbacks as a precondition to signing the Phase One Trade Agreement. Later that day we learned that there is strong opposition to tariff reductions from Trump’s chief negotiators. The market gave up most of the morning gains as the trade soap opera continues!

The stock market will be open on Monday for Veterans day but the bond markets are closed.

November 7, 2019

Labor productivity fell for the first time in four years due in large part to rising labor costs. An underappreciated culprit in falling productivity levels is the massive amount of share buybacks occurring over the last five years, which has come at the expense of investment. Had corporations invested more into their future earnings power, they would currently be more efficient and better able to offset rising wages. This data is having a direct impact on corporate margins which have been weakening after hitting record levels over the prior few years.

In December 2018 we published DIY Market Forecast, in which we quantified the positive impact on stock returns from rising profits margins (shown below). If profit margins are indeed falling and revenues are relatively flat, the expansion of valuations, which are already at record highs, is the last leg holding stock prices up.  CLICK TO ENLARGE

We elaborate further on labor costs and profit margins in Today’s Chart of the Day, courtesy of John Hussman. His graph shows that profits margins are very well correlated to the ratio of labor costs to prices (GDP price deflator). As labor costs rise faster than general prices, corporate profit margins tend to decline. Simply, labor costs are rising faster than corporations ability to pass on higher prices to consumers.

Ray Dalio who manages the world’s largest hedge fund just released a short, but very important, piece about the current stance of monetary and fiscal policy and its consequences. We urge you to give it a read-  The World Has Gone Mad And The System Is Broken.

Confidence in Phase one of the trade deal appears to be waning.  The signing ceremony for the deal is now being delayed until December as deal terms and a venue/date are being negotiated. That said it appears that Trump is willing to phase out tariffs, which is a key sticking point for the Chinese.

November 6, 2019

In yesterday’s Chart of the Day we showed that there is currently a record number of short positions in VIX futures, attesting to the zealousness in which traders are piling into the stock market.  Today’s chart of the day, highlighting the put/call ratio provides more evidence. These charts, and other data we follow, provide a strong signal that a short term correction is overdue.

Yesterday, the Fed transacted $31 billion of overnight repo. The amount of daily repo being used by the banks has been declining recently. The reduced daily amounts are not necessarily a sign that the funding issues have been resolved, but likely due to the fact that new QE operations are increasingly replacing the overnight repo liquidity.

The trade deficit declined in September in part because of reduced trade with China. The U.S. exported more oil than it imported, representing the first surplus in this category since data was first collected over 40 years ago.

ISM-services beat expectations as the service sector continues to remain in economic expansion and, along with personal consumption, is more than offsetting the decline in manufacturing. The lesser followed PMI services index was also above 50, but, unlike the ISM survey, came in slightly below expectations. Within the report was an interesting comment from Chris Williamson, Markit Chief Business Economist-

“With inflows of new work drying up, firms are relying on previously-placed orders to sustain current output growth, meaning the rate of expansion could weaken further in coming months if demand doesn’t revive. Hence we’re seeing jobs being cut at an increased rate among surveyed companies, with employment falling for a second successive month and to a degree not seen since 2009. Such a weakening of the survey’s employment index will likely feed through to the official jobs numbers as we move toward the end of the year.”

JOLTs data is also pointing to a slowing in the labor markets. Per Econoday:

“Hiring has been keeping pace but job openings, in a possible warning sign of slowing for the labor market, have been on the decline. Job openings fell 3.8 percent in September to 7.024 million, which is the lowest total since March last year and is down 5.0 percent from September last year.

Hirings rose 0.8 percent in the month to 5.934 million and, compared to September last year, were up 4.7 percent. The spread between hirings and openings, at 1.090 million, is the narrowest since February last year.

In a further sign of slowing in the labor market, quits fell a sharp 2.9 percent in the month to 3.498 million which hints at less worker mobility and less pressure on wage growth.”

 

November 5, 2019

After the barrage of economic data last week we get a few more important figures this week. Today, ISM services sector will be released at 10:00 am. The services sector has offset manufacturing weakness thus far. Expectations are for a increase from 52.6 to 53.5. JOLTS (Job openings and labor turnover survey) will also be released at 10:00 am. We will look to see if recent weakening trends in employment surveys continue. If so, it is potentially an early signal to labor weakness not found in last Friday’s BLS report.  On Thursday, jobless claims and consumer credit will be released, followed by consumer sentiment on Friday.

With the Fed meeting conducted last week, voting Fed members are now allowed to speak to the public.  We look forward to hearing their views on future rate changes, QE, Repo, and the general state of the economy.

Rising equity markets are starting to have the old QE feel to them. Stocks have been rising steadily while volatility has fallen back to historically low levels. At the same time bonds and gold are losing some luster. Within the equity markets, the defensive sectors have taken a back seat to the small and mid cap indexes as well as the higher beta stocks. Today’s Chart of the Day shows that shorts on VIX (equity volatility) futures are at record levels, implying the investors are betting heavily on a rally. This and other indicators of extreme sentiment make us think a correction is due.

From an investment perspective this round of QE is playing out as prior QE episodes did. For more on this please read To Buy Or Not To Buy- An Investors Guide to QE.

 

November 4, 2019

Payrolls rose by 128,000 in October and the unemployment rate increased from 3.5 to 3.6%. After taking into account the GM strike which reduced payrolls by 42,000, the data was in line with prior months and close to our estimate of 156,000.  Hourly earnings and hours worked met expectations. The only concern within the report is that temporary help service jobs were negative for the first time in nearly three years. Frequently, business owners will stop hiring temp workers or let them go before making decisions on permanent employees. At times it can be a leading indicator.

ISM was weaker than expected at 48.3 but slightly better than last month’s reading. Interestingly, new export orders improved, however employment, new orders, and order backlogs remain at economic contraction levels. Of concern in this report is that the import index is now at its lowest level since 2008. The divergence between GDP and the important index is wide. Are imports being dragged down by the trade war and not a meaningful sign of the economy? Conversely, is the sharp decline in the import index a harbinger of weak GDP readings in the quarters ahead? The graph below shows the widening gap. CLICK TO ENLARGE

Despite the good employment data, the Atlanta Fed cut their Q4 GDP forecast to 1.1% from 1.5%. The revision is more in line with the NY Fed which currently forecasts 0.8% growth in the fourth quarter.

November 1, 2019

Chicago PMI was much weaker than expectations, coming in at 43.2 vs 47.1 last month. The range of estimates from 27 economists was 46.1-53. Today we will look for confirmation of further weakening in the manufacturing sectors when ISM is released at 10am. Expectations are 49.3, an increase from last months 47.8.

Also on the block today is the all important BLS labor report due out at 8:30am. The market is expecting a gain of 90k jobs which is 46k less than last month. The unemployment rate is also expected to uptick from 3.5% to 3.6%. The expected data is weaker than last month in part due to the GM strike which has since been resolved. According to Econoday, the strike reduced payrolls by 50k jobs.

Last week we compared Federal budget deficits to the net amount of debt held by foreigners. Our purpose in providing the data/graphs is to highlight the record funding demands currently being put upon domestic investors. We follow up today with an important point and chart that shows we underestimated the funding problem. Today’s Chart of the Day shows the stated Federal deficit versus the actual government funding needs. The black dotted line is the 3 year moving average which removes volatility to better highlight that the reported deficit has recently been undershooting the government’s true funding needs by $200-400 billion annually. As an example, the stated deficit for 2018 was $980 billion, however the increase in debt, or true funding need for the year was $1.2 trillion.

On the China/U.S. trade front we are getting mixed messages. On Wednesday night China said that they doubt a long term trade deal is possible while Trump is in office.  The next morning, Lawrence Kudlow declared that trade talks are “going smoothly.” With the election coming up in a year, we continue to believe that phase one of the deal is likely all that will be agreed upon. The risk to markets and the economy remains a flare up of tensions resulting in increased or expanded tariffs.

October 31, 2019

ADP came in at the consensus estimate of +125,000. Concernedly, job growth for small firms (1-19 employees) is only growing at .08%, far off the 1-2% growth rate of the last 8 years. Our forecast for the payrolls number on Friday is +156,000. It is worth noting however, that the GM strike will reduce an estimated 40-50k jobs, which when factored in moves our forecast closer to near 100,000 which is close to the consensus forecast of +90,000. Over the last 6 months, our model has missed estimates by 26k on an absolute basis and only 4k on an average basis.

GDP was slightly better than expected at +1.9% fully supported by the contribution of personal consumption expenditures of 1.93%. Simply, the consumer is keeping GDP afloat and that is why our focus is on personal consumption trends and data. Not surprising, business investment (non-residential) was down 3%, in part due to trade war anxieties as well as a focus on stock buybacks and dividends over investment.

As expected the Fed cut rates by 25 basis points to 1.50-1.75%. There were two Fed members that dissented on voting for the rate cut. As shown in the red lined version below, the only change of note is the removal of the phrase “act as appropriate” and new language describing what is motivating policy decisions. It appears they will be more dependent on incoming economic data over the coming months.
CLICK TO ENLARGE.

Chairman Powell, during his press conference, confirmed the view that the Fed is pausing and may be done with  rate cuts unless economic data weaken. In particular, jobless claims, payrolls, inflation expectations, and retail sales are key data points.  This new stance likely means that any economic data surprises will create market volatility.

The most important line of the press conference came when he addressed the possibility of raising rates. To wit: “I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.

Simply the Fed is not raising rates anytime soon.

Happy Halloween!!!

October 30, 2019

Today will be a busy day with the potential for economic data and/or the Fed to move markets.  ADP releases their employment report at 8:15 followed 15 minutes later by the BEA release of Q3 GDP. Expectations for GDP are for a 1.7% increase. Our focus will be on consumer spending with consensus expectations of +2.6% growth. While still a nice growth rate, the expectation is well below last quarters strong pace of +4.6%.

Later in the day at 2pm, the Fed will announce their policy stance followed by Jerome Powell’s press conference at 2:30. The market assigns a nearly 100% chance of a 25 basis point rate cut, and we agree that is the likely result. The bigger question relates to the Fed’s next move. For this, we should get guidance from the FOMC statement and the press conference. Given the Fed has lowered rates twice already, maybe three times after the meeting, and is now pumping the market with liquidity, we suspect they will ease off on projections for future rate cuts. Many Fed speakers, including Powell, have characterized the rate cuts as “mid cycle” and “insurance”, therefore if they continue to forecast more rate cuts it raises into question whether they are much more concerned about the economy than they should be if the economy were just hitting a mid-cycle speed bump. We suspect the media will think the meeting is more hawkish than expected.

As if that wasn’t enough, Apple will report earnings after the close.

Currently, the market is pricing in a 60% chance of another rate cut by the end of March 2020. We can follow changes in the March 2020 Fed Funds contract (current price – 98.54) to see how the market consensus changes following the meeting. Every .01 increase in the price represents a 4% increase in the odds of a cut. The opposite holds true for each .01 decline.

The Case-Shiller 20 city home price index fell last month for only the second time since 2012.

October 29, 2019

The market opened higher and rallied throughout the day. The S&P 500 closed at 3039, a record high. We are watching closely to see if this is a false breakout or if there is more upside to go. Based on prior QE one can easily argue there is another 5% or more upside, however economic and earnings fundamentals along with technical divergences leave us concerned. Regardless of fundamentals we remind you that liquidity is a powerful tool.

According to a survey conducted by the National Association of Business Managers (NABE) jobs gains fell to their lowest level since 2012. This is another survey pointing to weaker employment data. Keep in mind, other than slightly weaker growth in payrolls, we are not seeing weakness in jobless claims or the unemployment rate.  Friday’s employment report will be another chance to see if that remains true.

We are about halfway through earnings season and both operating and “as reported” earnings per share are down 3% as shown below. Comparison to the prior few quarters of double digit growth is difficult as earnings growth over the last year was boosted by reduced tax rates due to the changes to corporate tax laws. CLICK TO ENLARGE

The Chicago Fed National Activity Index was reported at -.45. The index has a strong correlation with GDP, which is not surprising as it is calculated with 85 measures of economic activity. Based on yesterday’s level, GDP should be at 2%. A reading of approximately -1.50 would correlate with zero GDP growth. The BEA will release Q3 GDP on Wednesday and the current expectation is for +1.7% growth.

There will be a heavy dose of economic data releases this week. Of the most importance will be the following:

  • Wednesday- ADP labor report and GDP
  • Thursday- Jobless claims, Personal Income and Outlays, and Chicago PMI
  • Friday- BLS jobs report, PMI and ISM manufacturing

October 28, 2019

The S&P 500 is trading higher by about 10 points which puts it in position to set an record high today.

Today’s Chart of the Day graphs the money supply, in particular the M1 -Money Stock. During episodes of QE the Fed did not print money to buy securities, instead they swapped bank reserves for the assets. This is why they pound the table and insist that they did not print money. However, what is left out of the story is that the newly created reserves are then used by the banks to create loans. Keep in mind that all debt is money as anyone who is owed money via a loan has a claim on dollars. The important takeaway, as we begin a new round of QE, is that QE does not create money but it does create the fodder to allow banks to print money. If you notice in the graph the slope of the line has just begun to increase from the prior pace.

As we have discussed personal consumption accounts for almost 70% of GDP. Therefore the odds of a recession in the coming months depends heavily on the state of consumption. We have stated concerns about various surveys and recession headlines but other than recent retail sales data, we have seen little hard evidence the consumer is slowing meaningfully. One area however that is catching our attention are rising credit problems, especially in the credit card and auto sectors. To wit, on Friday Moody’s said that sub-prime auto loans “are souring at the fastest rate since 2008, with more consumers than usual defaulting within the first few months of borrowing.” While subprime auto loans are a relatively small component of consumer lending it does tend to be a leading indicator of credit issues. Stay tuned.

The weekly GDP Nowcast, the New York Fed’s public GDP forecast now stands at +1.9% for the third quarter, reported on Wednesday, and +0.9% for the fourth quarter.

October 25, 2019

Phase one of the China/US trade deal largely rested on tariff relief and an increase of agricultural/hog purchases by China. Yesterday, China committed to purchasing $20 billion of agricultural products from the US. The good news is that the amount is almost double that which China has bought since the trade war started. The bad news is that it is actually slightly below the annual average which they bought from the US between 2014-2017. Needless to say, Phase one of the deal does little to advance trade between the countries.

Durable Goods Orders were weaker than expected, coming in at -1.1% versus consensus of -.7%. The ex-transportation and core numbers were also weaker than expectations. Jobless Claims continue to hum along showing no signs of labor weakness. The four week moving average dropped slightly to 215k.

Median Home Sale prices, shown below, have been declining despite lower interest rates. The Shiller 20 city home price index, while still rising, had dropped to its lowest growth rate in the last 5+ years. While lower mortgage rates have certainly boosted demand, these graphs show the marginal benefit of lower rates is much less than in years past. CLICK TO ENLARGE

October 24, 2019

Today’s Chart of the Day is probably one of the most important macro charts to understand, yet is so underappreciated. The chart highlights that net purchases of U.S. Treasury debt by foreign investors (central banks, governments, corporations, and citizens) have been negative over the last two years. This is occurring as deficits topple the $1 trillion mark. In other words, not only are trillion dollar deficits being entirely funded with domestic funds, but domestic funds must also absorb the foreign net selling. To better understand the implications of this new dynamic, we suggest reading an article we wrote in June titled Who is Funding Uncle Sam?

We believe the funding situation is one causes of the overnight funding issues and the sudden introduction of QE.

Speaking of which, the Fed announced that they will double the size of their overnight repo facility to $120 billion and two week term repos will increase from $30 to $45 billion.

There is a good amount of economic data coming out this morning. Of note is Durable Goods (expectation -.7%), Jobless Claims (+214k), and PMI (composite 50.9, manufacturing 50.5, and services 51.0).

WeWork, which was only a few days away from doing an IPO at a valuation of $47 billion a month ago, now says it would have run out cash next week had SoftBank not purchased it for only $8 billion. WeWork is a reminder that valuations in both the public and private markets are excessive, and in many case unjustifiable.

Later this morning we will release To Buy QE, or Not To Buy QE. The article provides a construct to help you think about the effect that QE 4 may have on asset prices. It uses quantitative measures to project returns based on prior QE, as well as qualitative commentary that points out the differences between today’s environment and those in the past.

 

October 23, 2019

The Fed conducted their third QE4 purchase yesterday and, like the two prior ones, it was met with huge demand from the major banks. The Fed bid for $7.5 billion of Treasury Bills and received offers to sell over $40bn, resulting in a nearly 6x over-subscription rate. The prior two operations were also over-subscribed by at least 5x, meaning that the banks are still hungry for reserves. Overnight repo continues to trade 10-20 basis points above where it should, which is also a warning that liquidity is lacking and/or a credit issue is looming.

Senator and Presidential Candidate Elizabeth Warren is asking Treasury Secretary Steven Mnuchin for more information on the recent overnight repo funding issues. Her concern appears to be that the banks created or magnified the problems in part to have regulations and capital limits lessened. Per Warren and CNBC- “These rules were designed to ensure that banks have enough cash on hand to meet their obligations in the event of another market crash,” Warren wrote in a letter dated Friday and released Tuesday. “Banks are reporting profits at record, levels, and it would be painfully ironic if unexplained chaos in a small corner of the banking market became an excuse to further loosen rules that protect the economy from these types of risks.”

This election could get interesting from a market perspective if other candidates start questioning what the Fed has done and what they are currently doing.

Poor earnings and earnings outlooks are pushing stocks lower this morning, in particular Texas Instruments (TXN), Caterpillar (CAT), and Chipotle (CMG). Boeing (BA) will report earnings this morning.

October 22, 2019

The administration continues to support the stock market with positive statements regarding trade talks with China. Yesterday morning Lawrence Kudlow told the media that there is a chance that the planned tariff hikes in December will get called off. The S&P 500 closed up 20 points to 3006, which is only 19 points below its all-time high set in July.

With BREXIT still up in the air, Today’s Chart of the Day provides a nice schematic with expected odds for all of the possibilities. Based on the illustration, the odds are clearly in favor of an orderly BREXIT.

CNBC ran an interesting article yesterday based on a letter that Goldman Sachs sent to clients. The article starts: “Corporate buybacks are “plummeting” as companies tighten their purse strings, and it could have a big impact on the market, Goldman Sachs warned.” There is no doubt that corporate buybacks have driven stock prices well beyond valuation norms. We have warned that at some point debt levels will preclude companies from continuing to buy back shares. Combine Goldman’s sentiment with a recent WSJ article accusing bond rating agencies for being lenient on heavily indebted corporate issuers and the tide on buybacks may be turning. The WSJ article is linked HERE.

Third quarter earnings will be a key driver of stocks over the next few weeks. To see what the calendar holds in store, click on the Research tab and then Dividends and Earnings. Then click on a date and below the calendar you will find a listing of companies reporting that day.

 

October 21, 2019

The BREXIT saga will most likely be extended until February 2020 as Parliament forced Boris Johnson to ask the EU for another deadline extension and the EU delivered. If Parliament cannot pass the deal Johnson struck with the EU over the coming days, a general election will be held.

Japanese and Korean import/export numbers were weak last night attesting to the poor shape of global trade.

Today’s Chart of the Day shows an interesting graph from Crescat Capital.  The difference between inflation (CPI) and inflation expectations has expanded to levels that have only been seen before or during recessions. If we are heading into a recession, we should expect CPI will fall and likely more than inflation expectations, as had happened the past three times the difference between the two was positive. It is important to caution however, inflation is the most underappreciated risk to the stock and bond markets. In an inflationary environment the Fed will need to raise rates and possibly reduce their balance sheet to stem inflation. Such monetary action would not bode well for risk assets that have risen appreciably on the back of ultra-easy Fed policy.

The following appeared in a WSJ article on Friday- “In an Oval Office meeting, there was consensus “the economy was really strong…and that what’s going to get him re-elected…,” said economist Stephen Moore.” The point is, and always has been, that a sitting President has much better reelection odds during a strong economy. We expect, Trump, like many prior Presidents, to do whatever is in his power to boost economic activity and push stocks higher. Whether he can do this or not is the million dollar question.

October 18, 2019

The weekly Jobless Claims data continue to show no signs of trouble in the labor market. The four week moving average increased slightly with new claims rising from 210k to 214k. We will not be concerned until the four week moving average markedly trends higher and new claims broach 250k. It is important to note that BLS employment data tends to be a lagging indicator.

There are five Fed members speaking tomorrow. Most important will be Vice Chair Richard Clarida at 11:30 am. Interestingly, he is speaking at a CFA conference entitled : Fixed Income Management 2019 Late Cycle Investing. Remember the Fed has characterized the recent rate cuts as “Mid-Cycle” adjustments/insurance.  In all 5 speeches close attention will be paid for clues as to the rate decision at the coming October 30th meeting and any more discussion of the overnight funding problems. This will be the last speech before the Fed’s self-imposed media blackout starts on Saturday and continues through the next Fed meeting.

The Wall Street Journal published an article this morning which basically makes the case for the Fed to cut rates by 25 basis points at the coming meeting and then put further rate cuts on hold. The Fed often uses the WSJ and in particular the author of the article, Nick Timiraos, to alert the market to what they are currently planning in regards to policy. The link to the article is HERE.

All eyes will be on the UK this weekend to see whether or not Parliament will accept the BREXIT terms that Johnson and the EU have agreed to.

China’s third quarter GDP fell to 6%, .2% below last quarter and .1% below expectations. The rate of growth is the lowest in over 20 years.

 

October 17, 2019

Based on news reports this morning it looks like the EU and UK have reached a BREXIT deal. It also appears that Boris Johnson, UK’s Prime Minister, may have enough support to get a BREXIT compromise through Parliament by Saturday. Saturday is a self-imposed deadline for the UK to reach internal agreement. Failing to reach agreement would likely lead to a vote of no confidence and make a BREXIT deal with the EU more difficult to reach before the October 31 deadline. Over the last five days the pound has risen sharply from 1.22 to 1.29 per USD in anticipation of a deal being reached.

The overnight repo markets are again showing some worrying signs. Yesterday, overnight borrowing rates traded 10-15bps higher than where they have been over the prior two weeks. Further, the Fed’s overnight repo operation was oversubscribed to ($80.35bn in bids versus an offering of only $75bn). Given the amount of temporary and permanent liquidity (QE) the Fed is supplying the system, the current increase may be tipping us off to a credit issue and not necessarily a liquidity issue as the Fed leads us to believe.

Retail Sales, a good barometer on personal consumption which accounts for nearly 70% of GDP, was well below consensus forecasts falling 0.3% versus an expected increase of 0.3%. The reading was below all of the 69 economist estimates. Core retail sales, less auto and gas, were flat versus expectations of +0.3% and a prior month gain of 0.4%. The market is clearly keying on incoming data such as Retail Sales for guidance on what the Fed may do. Prior to the data, Fed Funds futures were priced for about a 50/50 chance of a rate cut at the October 30 meeting. The odds rose to 80% after the Retail Sales data.

The Fed’s Beige Book which describes economic conditions across the Federal Reserve districts pointed to continued expansion in most areas. While it mentioned some layoffs in the manufacturing sector its overall assessment of the labor markets was strong.

October 16, 2019

The market surged yesterday on __________ (fill in the blank). It is pointless to search for catalysts or market moving headlines to fill in the blank. Equities opened with a panic bid on the basis of nothing and rallied throughout the day.

The price surge coincides with the first day of QE and that is as good a guess as any to explain yesterday’s rise. It was interesting that the defensive equity sectors, gold, and bonds that were market leaders, lagged yesterday. The price surge and sector rotation trade may be marking the beginning of a new risk-on trade higher as we saw during QE 1, 2, and 3. We will pay close attention to technical resistance levels to help confirm if this is the case so we can act appropriately.

If you are not satisfied with QE as the driver, here the biggest headlines, most of which are not market friendly:

JPM released earnings yesterday and the market focused on the solid overall income numbers yet glanced over disturbing credit news. To wit, Lisa Abromowicz of Bloomberg tweeted the following:

At JPMorgan, charge-offs surged 33% to $1.37 billion from $1.03 billion last year. I’m curious to hear how much this stemmed from either riskier loans or weakening consumer & corporate credit.”

In yesterday’s Chart of the Day we showed the growing divergence in yields within the junk bond sector. In particular, the lowest rated bonds, CCC, have increased in yield, while BB and B bonds have been relatively flat. In response to a subscriber asking us for more data on the topic, we expanded the graph and show it in today’s Chart of the Day. The graph includes the last two recessions as well as investment grade BBB bonds. A few points worth discussing:

  • Prior to the recession of 2001, CCC spreads started widening well in advance of the recession.
  • About a year before the great financial crisis, spreads of all corporate bonds widened in unison.
  • CCC rated bonds are much more volatile than BB and BBB-rated bonds and therefore frequently sends false signals.
  • There has been no uptick in yields in BB and BBB over the past year despite CCC bonds widening.

It is too early to tell if the rising CCC yields is a harbinger of things to come or a technical gyration due to specific bonds such as WeWork and/or those of energy companies which make up a decent amount of the CCC sector.

October 15, 2019

There were no economic data releases or Fed speakers yesterday due to Columbus Day. Of importance this week will be the release of Retail Sales data on Wednesday and Jobless Claims on Thursday. In both reports we are looking to see if worrying signs in various labor and sentiment surveys is showing up in hard data.  There are also a number of Fed speakers throughout the week so we will be on guard for more clues about the new round of QE and what it might mean for interest rate policy at the coming October 30th meeting.

Having a few days to digest the trade news we have a few thoughts worth sharing. The supposed Phase 1 deal is a good sign as it means the two sides are amicable and willing to talk. It signals a de-escalation of trade tensions which should relieve some anxiety of corporations and consumers. On the margin it should help economic activity as the threat of more tariffs is reduced, at least temporarily.

The problem however, is that the agreement is very limited in scope and fails to touch on the bigger picture items like IP and geopolitics. These items will be much more difficult to negotiate and may cause a re-escalation in tensions between the two countries when they are addressed. Given the difficult nature of reaching future agreements and the election coming up in a year, we would not be surprised to see trade negotiations tabled and slowly faded out of the news, leaving the status as it is today.

Trade activity between the U.S. and China is certainly being depressed in part because of the trade war. China reported that exports to the U.S. fell 10.7% and imports of U.S. goods dropped 26.4%. The results, reported by Reuters, cover January through September.

The third quarter earnings calendar is starting to heat up. On Wednesday 39 companies will release earnings including Netflix, Johnson & Johnson, and IBM. For the complete list of companies reporting, mouse over the Research Tab and click on Dividends and Earnings. A calendar will pop up. When you click on a specific date, the listing of either earnings or dividends for that day will display below the calendar. The dates can also be found in the Portfolio section for stocks in your customized portfolios and in the RIA Pro portfolios. Click on Dividend to the right of the portfolio graph and then select Earnings. The companies are sorted by date.

October 14, 2019

Trump announced phase one of a trade deal with China on Friday afternoon. This morning we are waking up to news that China wants more discussions before signing phase 1. The market sold off Friday after the deal was announced and a little lower this morning as well. While progress is being made, investors are signaling that the deal is not that different from prior statements in which China said they would buy agriculture in exchange for tariff relief.

The Fed surprised the market on Friday and announced that they will start buying $60 billion of Treasury Bills monthly starting next Tuesday. The purchases will continue into the second quarter, meaning the Fed plans on purchasing at least $320 billion of assets. The Fed will also continue with temporary repo operations. The suddenness of the announcement leaves us wondering. Why the urgency to announce the action on Friday, when there is a Fed meeting in less than three weeks in which such an announcement would have been more appropriate? When answering the question, keep in mind that the temporary repo facilities are working well to alleviate the funding problems. Might there be another reason for this sudden change? We believe there is a credit issue with a bank or numerous banks, most likely European.

As Powell alluded to earlier in the week, this operation is not QE. As we discussed in QE By Any Other Name, if it walks like a duck and quacks like a duck it is a….. The stock market soared on the news, albeit it was already doing well based on the probability of a trade agreement with China. The yield curve steepened as shorter maturity Treasuries were flat to lower while longer securities rose in yield. The 3m/10yr curve was 8bps stepper on Friday.

On a year over year basis import and export prices both fell by 1.6%, despite the rise in oil prices in early September. Along with CPI and PPI, Friday’s Import and Export Prices report paints the same picture of deflationary impulses at work.

 

October 11, 2019

Stocks are trading sharply higher this morning as a trade deal seems likely to emerge from this week’s trade meetings. At 3:30 today, Donald Trump will meet with a leading trade negotiator from China and it appears a deal could be announced following the meeting. While the market is giddy about the prospects of putting the uncertainty of trade talks behind it, we believe the terms of the deal and importantly how it will treat past and future tariffs are important to assess before betting on the market beyond the next few days. Daniel Lacalle, a frequent guest on the Lance Roberts podcast, has an interesting take in CNBC on what to expect from a trade deal. The link is here – A US-China Trade Deal May Not Be The Catalyst The Market Is Expecting.

Further helping sentiment this morning is renewed hopes of a BREXIT agreement before the coming October 31st deadline.

CPI was slightly weaker than expected showing no change month over month and 1.7% inflation year over year. Jobless claims were strong at 210k and not revealing the labor weakness we have seen in other reports and surveys.

The following quote, as reported by Market News International, caught our attention yesterday: “although we can reduce interest rates further, the side effects of monetary policy are becoming more and more evident and more and more tangible” – European Central Bank (ECB) Vice President de Guindos

This quote follows similar comments by officials from the Bank of Japan (BOJ). Essentially they are finally figuring out that excessive monetary policy, including negative rates and QE, has its limits and more importantly, consequences. As far as consequences, little to no economic growth for almost a decade, along with the slow death of European and Japanese banking systems is finally catching their attention. We hope the Fed is paying attention.

The University of Michigan Consumer Sentiment report will released at 10am. Current expectations are for a slight decline from 93.2 to 92.

October 10, 2019

Following unexpectedly lower inflation in Tuesday’s PPI report, we get CPI today, the more important gauge of prices. Current expectations are .1% and .2% increases month over month and year over year respectively.

In yesterday’s JOLTs report, job openings fell from 7.217 million to 7.051 million. The number is still historically high but has been fading for a year as shown below. Hires and quits also fell, tipping off further signs of labor weakness. While the overall data in the report is healthy, the report lines up with the latest  BLS employment report and numerous employment sentiment surveys that give us concern. We will watch today’s weekly jobless claims data for further confirmation. Jobless claims are expected to come in at 219k, about 7k greater than the running four week average. CLICK TO ENLARGE

Trade talks with China start today so expect heightened volatility based on a deal/no deal or even just rumors and Tweets. Last night was extremely volatility as rumors were flying around that the Chinese delegation would leave talks a day early. The story was refuted by the administration. We still believe there is a better than 50/50 chance a trade-lite deal being announced. If so, we will focus on whether or not there any changes to tariffs. The potential market’s reaction is hard to gauge. A deal with reduced tariffs may pacify the market and ease concerns about slowing growth. However, a partial deal, may leave investors with concerns that little was accomplished and the possibility for more tariffs and other actions in the future.

The Fed released the minutes from their September 18th meeting. In general there was a lot of different views on the future path of monetary policy. Some members want to end rate reductions while others think more cuts are needed. The topic of using the balance sheet to help the overnight funding issues arose but, based on the minutes, was not discussed at length. Overall, the minutes did not shine much new light on monetary policy.

October 9, 2019

Yesterday afternoon Chairman Powell said the Fed will increase its purchases of short term Treasury bonds. Within this speech he went out of his way to claim that such actions do not constitute QE. In particular, he stated the following: “I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.” He then stated: “In no sense is this QE.”  The Fed is trying to alleviate the overnight funding shortage via QE, but they want to do so without calling it QE. For more on this “sleight of hand” read our article published last week titled QE By Any Other Name.

Fed member, Neel Kashkari followed later in the day by saying “Fed policy makers now view Quantitative Easing (QE) as a tool in its tool kit.”

Shortly after Powell laid the ground work for a new round of “QE” the market started rallying. The gains were quickly given up as President Trump imposed visa bans on Chinese citizens involved in humans rights abuses. The market recovered some losses overnight on rumors that China would buy more soybeans from the U.S.  The bottom line is try to ignore the trade headlines. We suspect the market will continue to get whipsawed on headlines and tweets going into this week’s trade negotiations.

BREXIT negotiations are heating up with both sides publicly blaming each other for non-compromise on key issues. It is increasingly looking like the exit will be disorderly when the October 31st deal deadline comes. A no-deal exit will result in economic consternation in Europe and the UK. This comes at a time when Germany is likely already in a recession and other European nations are not far off. The economic effects will not be limited to the Euro region.

Producer Prices (PPI) surprised to the downside falling .3% versus expectations for a .1% increase. The year over year change also dropped to 2% from 2.3%. The market will pay closer attention to CPI tomorrow for confirmation. A lower CPI would provide the Fed with a better rationale to cut rates later this month.

October 8, 2019

As we noted in yesterday’s commentary and witnessed since then, the markets will be volatile as trade comments from the U.S. and China will be overly scrutinized for clues about the progress of this week’s talks. We urge you to resist trading on these comments as they are largely a public display meant to sway negotiations.  It is worth noting China appears adamant that IP and government subsidies are not on the table. These are the key items that Trump and Navarro have argued must be changed.

Trump understands that a trade “victory,” even if not a full deal, helps his reelection odds. We continue to believe there is a wide chasm between the two parties but we expect a deal, likely lacking in specifics and meaningful reform. If we are correct, will a “trade-lite” deal be enough for the markets and will it ease the worries of corporations that have been reducing output and investments?

There is not much economic data being released this week to take the markets mind off of trade. That said, the BLS will release PPI at 8:30 and CPI on Thursday. If the recent upticks in both data points continue, the Fed will find it more difficult to cut rates at the upcoming Fed meeting. The market is priced for a near 100% chance of a 25bps cut at the October 30th meeting.

The price of gold slipped 35 points over the last week. While gold was overbought and certainly technically due for a pullback, Zero Hedge leads us to believe that a lack of Chinese participation due to China’s week long Golden Week holiday also played a role. The following graph shows the performance of gold during Golden Week and in the week or two afterwards for the last 6 years. CLICK TO ENLARGE

October 7, 2019

Trade deal jitters are weighing on the market this morning. Last night China said they were reluctant to make a broader level deal. In particular they said they would not negotiate government subsidies and other bigger ticket items the U.S. wants included in a deal. Keep in mind, last week Trump and trade negotiator Peter Navarro made comments that they will only settle for a full deal, including the items China said are not negotiable at this time. This may seem grim but we caution, this may easily be negotiation tactics by both sides and not necessarily a breakdown of talks. The market will be volatile heading into the talks later this week.

The employment report was a mixed bag. Payrolls were slightly weaker than expectations, increasing by 136,000 in September versus a consensus estimate of 145,000 and a revised prior month of 168,000. On the positive side, the unemployment rate fell to 3.5% from 3.7%. Most concerning is that average hourly earnings were flat versus  a gain of .4% last month and estimates of +.3%.  The year over year change in hourly earnings fell to 2.9% from 3.3%. The BLS employment report tends to lag other labor data but the earnings data is another sign of cooling in the labor market.

The market popped higher on the employment data as it supports the notion of a weakening labor market which in turn provides the Fed more leeway to cut rates on October 30th. Further supporting the market on Friday were numerous headlines from Lawrence Kudlow and President Trump in relation to the possibility of a trade deal when China and the US meet Thursday and Friday.

The New York Fed announced they will continue “emergency” repo operations to November 4th including term repo options and overnight funding. As judged by the fact that the Fed’s balance sheet continue to rise, short term bank funding needs have not alleviated. Friday’s announcement makes it possible the Fed will announce some sort of permanent funding (QE) at the October 30th FOMC meeting. The date, November 4th, allows the short term, temporary measures to help banks get past month end balance sheet constraints and would give the Fed a few days to begin more permanent actions if they are announced on October 30th.

Jerome Powell will speak on Monday, Tuesday and Wednesday. The minutes from the prior Fed meeting will come out on Wednesday. In a speech on Friday, did not discuss the short term funding problems. He also didn’t provide much guidance as to his views on a rate cut. He did say the economy is “chugging along despite the headwinds it faces.”

October trading has been volatile thus far, with three of the four trading days having moves of greater than 1%.

October 4, 2019

The ISM- Service Sector Survey was weaker than expected at 52.6 versus 56.4. This is the lowest rate in three years and further confirms the weakness we are witnessing in the manufacturing surveys.

On Wednesday, the Conference Board CEO Confidence Survey reported that expectations of corporate executives for the next 6 months has fallen to levels last witnessed at the trough of the prior three recessions. On a year over year basis the confidence reading is the lowest since the late 1970’s. These two graphs can be found in today’s Chart of the Day.

Chairman Powell will speak at 2pm this afternoon. With Fed Funds futures back to pricing in a nearly 100% of a cut at the October 30th meeting it will be interesting to see if he goes along with the market or gives the market reason a for pause.

Jobless claims rose slightly to 219k, but have yet to reflect the employment concerns we have seen in consumer and corporate surveys. Today’s jobs report will shine more light on the employment picture. The table below, courtesy of Econoday, contains expectations for the 8:30 monthly employment report. CLICK TO ENLARGE.

October 3, 2019

Late yesterday afternoon, the U.S. announced they will put tariffs on European aircraft, agriculture, and other products.  The tariffs are effective on October 18th.

The ADP report showed a gain of 135k jobs in September which beat the consensus forecast of 125k. Last month’s report was revised lower by 48k from 195k to 147k. The average ADP jobs growth for the last 12 months is 177k, despite markedly slower growth recently. Today’s Chart of the Day shows that the six month average is hitting the lowest levels since the recovery from the Financial Crisis.

With ADP data in hand, our model estimates a gain of 162k jobs in Friday’s BLS employment report. Based on other employment data released over the last two weeks we believe there is a decent likelihood the number falls far short of our estimate and the streets estimate of 145k.

The S&P fell 1.74% yesterday which marked the first time the index had back to back declines of more than 1% this year.

While Europe has started back up QE and rumors abound about the Fed introducing a new round of QE, Japan is taking QE in a different direction. The BOJ announced they would trim their domestic bond purchases but boost buying of foreign bonds. This is partially due to the fact they own over 50% of Japan’s outstanding government bonds.

The BOJ has been much more aggressive with QE than Europe or the U.S. Currently the BOJ’s balance sheet stands at 102% of Japan’s annual GDP. That dwarfs the Fed’s balance sheet at 18% of GDP and the ECB’s at 39% of GDP.  Buying foreign bonds will provide a steady bid to U.S. Treasury bonds as they are the most abundant and liquid of sovereign bonds. Doing so would also be appreciated by President Trump and might curry them favor in any trade disputes. It should also help Japan’s exports as it will put pressure on the Yen.

Australia, feeling the effects of the slowdown in China and the trade war, cut their overnight interest rates to 0.75%, the lowest on record. Further, they said more rate cuts may be needed as well as other measures, which we assume means QE.

October 2, 2019

ISM Manufacturing fell to 47.8 and further into economic contraction. Today’s reading compares to 49.1 last month and expectations of 50. As we have been recently harping on, employment is showing signs of weakness across a few different indicators including ISM. The ISM Employment sub-component came in at 46.3 versus 47.4 last month.  Also of concern, as shown below, new export orders continue to decline and are now below any level since the 2008/09 recession. On the brighter side, the lesser followed PMI Manufacturing rose to 51.1 from 50.3, however, some of the commentary included weaker labor market signals.

The weak report immediately pushed the market lower and it slid throughout the day, with the S&P closing down 38 points to 2938. This weekend’s newsletter, “Trade Deal” Is Coming stated: “(S&P 500) support at the 50-dma, which coincides with the January 2018 top, but a break of that level will put the 200-dma into focus.”  The 50-dma is currently 2947, a level which has proven to be support and resistance since 2018. The 200-dma is over 100 points lower at 2835.

Today’s Chart of the Day by Teddy Vallee shows a huge divergence between the reliable relationship between ISM and annual changes in the S&P 500. if the relationship holds up and the stock market is right, ISM should rise to the upper 50s. If, however, the market is wrong the current 20% gains could quickly turn into double digit annual losses.

ISM in the Eurozone fell from 47 to 45.7 led by Germany 43.5 to 41.7. Italy, France and Spain were also lower with Italy and Spain in contraction, while France (50.1) barely clings to expansion.