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 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.
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
April 2, 2021
Markets are closed today for the Good Friday holiday!
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.
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.
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.
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.
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
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
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
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
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.
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.
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.
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.
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%.
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.
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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.
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.
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!
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.
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.
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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
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.
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.
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.
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.
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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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.”
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
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.
- 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 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.
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.
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
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
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.
“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.
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
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.
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.
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.”
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.
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.
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
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.
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
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.”
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.
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
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
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
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
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
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
9:35 am ET
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
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
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
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
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
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.
NEWSLETTER IS OUT!
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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
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
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
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
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:
- 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
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
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
(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
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
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
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
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
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
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
9:15 am ET
7:15 am ET
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!!
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:
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.
- 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
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
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
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%.
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 MBA– “By 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 stimulus “could 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.”
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
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 pac