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We are replacing the running Commentary with Daily Market Commentary. Daily Market Commentary provides the same market-related information you are accustomed to, as well as more technical guidance and a preview of what to watch for in the day ahead. Here is today’s Commentary.
December 9, 2021
**Due to technical difficulties, there will be no 3 Minutes on Markets today.
Jobless Claims at 50-year Lows
Initial Jobless Claims fell to 184k this past week, hitting its lowest level since 1969. In 1969, the U.S. population was 203 million. Today it’s 332 million. If you adjust for the population increase, jobless claims are well beyond the prior record low of the late 60s.
Between last Friday’s employment report, JOLTs data, and initial claims, the Fed will likely continue to shift toward inflation-biased policy. Such logic entails the Fed will be more aggressive in reducing QE. Asset prices and the current high-risk tolerance among many investors are largely supported by the Fed’s liquidity. While markets may ignore the circumstances for a while, we mustn’t forget the Fed regime is changing. We think the change in monetary policy will be an important theme driving investment results in 2022. Stay tuned!
How Big Is Apple?
Apple’s stock is up over 10% in the last five trading days. In the last month, its market cap increased $400 billion and is now approaching $3 trillion. To put that in context consider the $400 billion gain in market cap over just the last month is more than the total market cap of the world’s 20th largest company, Walmart ($380 billion). The two bar charts below compare Apple versus the total size of the top ten nations ranked by their respective aggregate stock market capitalization and nominal GDP. As shown, Apple is bigger than all but six nations in terms of stock market size and is bigger than the GDP of all but seven nations.
The graph below from Home Equity Insights, by Core Logic, sheds more light on recent home equity gains which directly boosts the amount of credit available to consumers via mortgage refinancing. Core Logic estimates homeowners with mortgages saw their equity increase by $2.9 trillion over the past year, an increase of nearly 30%. The map below breaks down the average equity gains by state. The amount of credit card debt has recently picked up back to normal levels. Further, savings rates have fallen to pre-Covid levels. While both of those data points argue that consumers do not have much money beyond their paychecks to spend, the sharp increase in home equity is a potential source to fund new spending. Assuming house prices stay stable or increase, we should expect consumers to tap equity to finance consumption and lessen the burden of inflation.
December 8, 2021
The BLS JOLTs report once again confirmed there is a severe shortage of labor. JOLTs data lags the employment report by a month, but it shows there are 11.033 million job openings, 400k more than last month. This data along with recent productivity and labor costs adds to the mounting evidence that corporate profit margins will come under pressure in the coming month. Simply, job seekers and current employees have more bargaining power today than in decades.
The first table below puts context to how outsized the current number of job openings are versus the last 20 years. The second table breaks down the number of job openings by industry.
Apple’s Nightmare Before Christmas
Nikkei Asia published Apple’s Nightmare Before Christmas this morning, detailing how chip shortages and energy restrictions are cutting down on Apple’s ability to produce iPhones. Despite the bad news, it is not denting investor enthusiasm. Apple’s stock price has been on a tear recently, rising 22% since early October. Our equity model holds a 3.75% position in Apple.
“Due to limited components and chips, it made no sense to work overtime on holidays and give extra pay for front-line workers,” a supply chain manager involved told Nikkei Asia. “That has never happened before. The Chinese golden holiday in the past was always the most hustling time when all of the assemblers were gearing up for production.”
After launching the iPhone 13 range and new iPads in September, Apple is falling millions of units short of its production goals and missing out on billions of dollars of revenue. In many countries, it is now too late for consumers to buy some Apple products in time to give as holiday gifts.
Is The Short Term Rally Here To Stay?
Consumer Credit is Finally Slowing Down
Consumer Credit rose by $16.9 billion in October almost half of an expected $30 billion increase. It also marks a sharp slowdown from September’s $27.8 billion growth. As stimulus checks were wound down, consumers started relying more on credit card debt and mortgage refinancings to meet their needs and compensate for inflation. One month does not make a trend, but this new data point along with weak consumer spending data for Black Friday and Cyber Monday argues consumer activity may be slowing.
U.S. Multiple Expansion vs. The World
The graph below, courtesy of Top-Down Charts, shows that since the Financial Crisis the CAPE P/E ratio has expanded 3x in the United States versus staying relatively flat in developed and emerging foreign markets. One reason to partially explain the outperformance is that the U.S. equity indexes are more highly dominated by higher growth tech companies which tend to command higher P/E’s. That said, when it comes to paying the piper and valuations normalize in the U.S., foreign markets may offer a little protection.
December 7, 2021
Profit Margin Pressures Are Coming
Unit labor costs rose 9.6%, year over year, in part due to productivity, which fell 5.2% over the same period. Hourly compensation rose 3.9%. While wage growth is higher than average, it is well below the rate of inflation. The decline in productivity is the largest since 1960. Surging labor costs and falling productivity is a recipe for profit margin compression for many corporations. Given margins are at historically high levels, a decline should not be a surprise.
Easy Money- “Buying The 50”
The graph below shows how the S&P 500 (SPY) has repeatedly bounced off its 50dma in 2021. The black bars quantify the 20-day returns from each trading day SPY was below its 50 dma. As we show, buying below the 50 dma and holding for 20 days has been easy money. On December 1st, as circled, SPY fell below its 50 dma. It has since rebounded 3.5% from that day. “Buying the 50” is a great trade and may continue to work well, however, there will come a time SPY breaks below the 50 dma and fails to recover quickly. That could be a signal the market environment is turning.
The black line below charts the difference between implied volatility (VIX) and realized volatility. We use this measure to help us quantify how risk tolerances are changing for the market in aggregate. The difference between implied and realized volatility is frequently above zero, so we prefer to key on the variance around its trend line to assess. When implied volatility spikes above the trend line, it signals that investors are becoming more risk-averse as they bid up options. This is what happened last week as the difference rose to 8-month highs. The large difference has since come down but remains elevated. Also of note, the trend for the differential is gently rising, meaning investor risk-averseness is slowly increasing with the market. Given high valuations and the Fed pivot, the upward trend makes sense.
Bonds vs. Stocks
Based on the hoopla surrounding the bullish stock market one would think bonds would have been a bad place to be invested. Contrary to popular opinion, long-duration Treasury bonds (TLT) have kept up with the S&P 500 since April. The graph below shows the price ratio between TLT and SPY. The recent increase in the price of TLT and the decline of SPY have brought the ratio back to April’s levels.
December 6, 2021
The Fed Pivots
As is quite common, the Fed likes to signal changes in policy via the media. Today, the Wall Street Journal published an article entitled, High Inflation, Falling Unemployment Prompted Powell’s Fed Pivot. The article confirms some of Chairman Powell’s testimony to Congress from last week. The bottom line per the article: “Officials are making plans to accelerate the process at their policy meeting next week, ending it by March instead.” The article clearly articulates that inflation, not employment, is now the Fed’s primary concern. While the Fed thinks high inflation rates will come down next year, they “can’t act as though we’re sure of that.” The Fed often gets economic data prior to their release. Is it possible this Friday’s CPI report is concerning?
In last Friday’s Relative Value Scorecard report for RIAPro subscribers, we noted the communications sector is performing incredibly poorly on a relative basis versus the S&P 500. To wit: “The standout on the relative charts is the incredibly oversold condition of the communications sector. Its score is -12.41 out of a possible -13.5.” While a bounce versus the market is likely we caution the sector is very top-heavy. As such, over half of its weighting is in three stocks- FB, GOOG, and NFLX. The fortunes of those companies, especially FB and GOOG are likely to drive the sector. The graph below, courtesy of Charles Schwab, further highlights how poorly the communications sector is trading. Every member of the sector is below its respective 50dma and 81% are below their 200dma (not shown).
The Week Ahead
There are not many relevant economic data releases but what data is coming out is important to better assess what the Fed may do at their FOMC meeting next week. Wednesday’s JOLTs report is expected to show the number of job openings continues at or near record-high levels, meaning the labor market is robust. Job Quits, another indicator of the jobs market is also supposed to be high, signaling employee confidence in their ability to quit and find a better or higher-paying job. On Friday the BLS will report on CPI. After last month’s shocking 6.2% print, economists are expecting another bump higher to 6.8%. Such a number will put further pressure on Powell and the Fed to speed up the taper process and start thinking about the timing of interest rate hikes.
On Wednesday and Thursday, the Treasury will auction 10 and 30-year bonds respectively. Typically the auctions can weigh on bond prices in the days prior. The Fed will enter its self-imposed media blackout window this week with the FOMC meeting next Wednesday.
December 3, 2021
Are Value Stocks in Vogue?
The Finviz heat map below shows there is a clear divide between the winners and losers. The winners in green, are companies and sectors that have been lagging the market. Many of these companies are considered value stocks, due to their relatively low valuations. Many of the companies in red are stocks that have done very well this year. In many cases, they are trading at or near record-high valuations. The last few days have been a rare instance of outperformance by the value sectors. It’s way too early to call it a trend but it is worth following closely.
Five Stocks for Friday uses stock screens to give readers five stocks that we expect to outperform if a particular investment theme plays out in the future. Investment themes may be relevant to the current or expected market, industry and/or economic trends. Check out our inaugural picks.
First Impressions can be Deceiving
Stocks initially rose on the employment data as the weak jobs print might mean the Fed would step down from recent hawkish tones. St. Louis Fed President Bullard, quickly put an end to such wishful thinking and took the wind out of the sails of the stock market. He said the Fed could consider raising rates before they finish tapering. Almost all investors were under the impression the Fed would finish tapering before raising rates. Such implies no rate hikes until July unless the Fed speeds up its taper schedule. The May Fed Funds Futures Contract now implies a 65% chance the Fed tightens before June. The market is betting that Bullard is on to something.
The BLS Employment Report- Good or Bad?
CNBC says “Job Growth Disappoints“. CNN Money writes “The U.S. economy added 210,000 jobs in November, far fewer than expected.” The headline number, +210k new jobs, is well off expectations for a gain of 545k jobs, thereby justifying the concerning headlines. However, the underlying employment data was robust. The unemployment rate fell from 4.5% to 4.2%. Maybe the most crucial data point persuading the Fed’s assessment of the labor markets is the labor participation rate which rose .2% to 61.8%. Chairman Powell repeatedly uses the low participation rate as an excuse to remove monetary accommodation at a very slow pace. Might the pick-up in labor participation further support his recent hawkish tone regarding combatting inflation? The market is reacting positively to the report, signaling it thinks weak job growth will impede the Fed from speeding up the pace of tapering at the December FOMC meeting.
Our graph below shows that professional and business services accounted for nearly half of the job gains. Curiously, retail lost 20k jobs in November, which is one of the biggest shopping periods. We suspect the seasonal adjustments and Covid-related anomalies make reporting an accurate number difficult for that sector.
The graph below shows that the risk/reward equation for the S&P 500 becomes much more skewed when the VIX is between 31 and 100. The VIX has been hovering near 30 recently. The green shaded area shows that S&P 500 returns tend to follow a relatively normal distribution curve with a skew toward positive returns. The black bars highlight the non-normal distribution of returns when the VIX is elevated. During such periods, returns tend to be better than average but the risk of a 10-20% drawdown is also much higher than when the VIX is below 31.
The graph below courtesy of Zero Hedge and Goldman Sachs shows the amount of stranded containership tonnage at U.S. ports is abating. Per Goldman Sachs: “While the amount of stranded tonnage is still historically elevated, a further decline in congestion could boost supply and ease inflation pressures for consumer goods and manufactured products in early- or mid-2022”. It is also worth noting that as we pass the holiday season the demand for many goods will lessen appreciably which should further relieve pressure at the ports.
December 2, 2021
OPEC is Threatening to Curtail Planned Output Increases
Oil prices opened the day 5% weaker as OPEC decided to go ahead with a planned output hike of 400k barrels for January. The news was a bit of a disappointment as there were expectations they might curtail the increase to 200k or even less. Oil prices came storming back, however, as OPEC said they may revisit the potential to reduce their planned output increases at the January 4th meeting.
The tweet and graph below show the bullish percent index on the S&P 500 has dipped below 50%. The last six times that occurred it proved to be a good buying opportunity. However, as shown, the first dip below 50% on the graph was a false signal. Do you feel lucky? The index is a measure of breadth that simply counts the percentage of stocks with a point & figure buy signal.
In yesterday’s commentary, we note that heavy short interest in Treasury note futures could propel bond prices higher (yields lower) if those with shorts are forced to cover their positions. The graph below provides a little technical context for what might cause them to do so. As shown, the price of TLT (20 year UST ETF) has bumped up against $152 numerous times since July. Each time it was repelled but to increasingly higher lows. If bonds can break through the current wedge pattern, the 2020 highs may be in sight. Many technical traders’ that are short bonds are likely watching how this plays out closely.
Will Inflation Heat Up More?
The first graph below shows the inverse correlation between rental vacancy rates and owners’ equivalent rent. Not surprisingly, a lower vacancy rental rate tends to result in higher rental prices. With the Fed seemingly getting more serious about inflation, rental prices and owners’ equivalent rent (OER), which account for nearly a third of CPI, become very important data points to follow more closely.
Rental vacancy rates are back to 30+ year lows which is pushing rents higher. Adding to the pressure on rents and ultimately CPI is surging home prices. The second graph, courtesy of Fannie Mae, shows their model based on home prices predicts a big jump in OER in 2022. Per the article: “On a year-over-year basis, house price gains historically lead to changes in the CPI shelter cost measures by about 5 quarters.” Home prices started spiking in September of 2020, about 5 quarters ago. If CPI continues higher, the Fed is more apt to remove liquidity quicker. As we discuss in Is a Stock Market Crash Like 2000 Possible, liquidity via QE and zero rates are the lifeline of excessive stock valuations.
December 1, 2021
National Manufacturing Surveys
The PMI manufacturing survey was weaker than expectations at 58.3 versus 59.1. Per the report- “November PMITM data from IHS Markit signaled the second-weakest rise in production recorded over the past 14 months as producers reported further near-record supply delays and a slowing of new order inflows to the softest so far this year. Jobs growth also waned amid difficulties filling vacancies.” Further- “While average selling price inflation eased as firms sought to win customers, the rate of input cost inflation hit a new high, hinting at a squeeze on margins.”
The ISM survey came in at expectations of 61.1. While below levels from earlier this year, the survey remains near 20-year highs. The much-followed prices paid index fell slightly. Supply line disruptions remain a big problem. Over half of the respondents report slower delivery times. The normal range is 10-20%. The table below annotated by Zero Hedge shows six of the ten ISM components were lower this month.
The chart below provides fodder for oil bulls and bears. The price of oil tends to rally strongly following periods when the OVX (oil volatility index) is above 65. Currently, the index is at 75. While the reading entails oil may rise in price once volatility declines, we must consider the volatility index can stay elevated resulting in further declines. For example, the index was above 65 from October 2008 to March 2009. In 2020, the index was above 65 from early March until late May. Currently, the index is only on its third day above 65. Bulls are waiting on a sub-65 reading and bears are hoping volatility remains elevated. We do caution, the index can fall slightly below 65 for a day or two before rising back above 65. In such prior cases, the price of oil continued lower.
The second graph below compares the price of the popular energy sector ETF, XLE, to the OVX index. As shown, like oil prices, XLE tends to do well once the index falls back below 65. However, XLE bucked the trend in 2020 as it rose when the index was above 65 and fell once it dropped back below 65.
Everyone Hates Bonds- Is That Bullish?
Per Reuters, the net bearish bets on U.S. Treasury ten-year note futures is now the largest since February 2020. In January and February 2020, bond prices were rising and yields falling as the economy was slowing and the Fed had begun cutting rates late in 2019. The advent of Covid in early March sent bond prices soaring, fueled in part by traders forced to cover their short bets. Today, like then, net shorts are extreme and some traders are starting to buy to cover their shorts as the new Covid variant and hawkish tones from Powell pressure stocks. History may not repeat itself, but it often rhymes.
Cyber Monday Disappoints
According to Adobe Analytics, sales for Cyber Monday were disappointing. Online sales for last Monday totaled $10.7 billion, a 1.4% decline from last year. While it is the first decline for Cyber Monday, one must factor that last year’s data was an anomaly due to Covid and consumers’ reluctance to go to stores. To wit, foot traffic is up 48% versus last year, but it is still down 28% from pre-pandemic years. Personal consumption accounts for approximately two-thirds of GDP. As such, holiday spending is an important component of growth. This year we must be careful reading too much into retail sales data. Inflation and shortages of many goods are resulting in timing and spending behaviors that are not comparable to years prior.
November 30, 2021
Consumer Confidence Continues to Weaken
The Conference Boards Consumer Confidence Index fell to 109.5, down from 111.6. Both the present situation index and the expectations index were lower. Driving consumers’ moods are concerns about rising prices and income prospects.
The Chicago PMI, a precursor to national manufacturing surveys, fell more than expected to 61.8 from 68.4. After hitting a high of 75 in April, the index has been trending lower. The slowing of new orders and employment were partially responsible for this month’s decline. The ISM and PMI manufacturing surveys will be released tomorrow. Both are expected to show slight increases from last month.
Sounding The Inflation Alarms
Chairman Powell was vocal about inflation and is finally backing off using the word “transitory” to describe it. Per his testimony to the Senate: “time to retire the term”transitory” regarding inflation.” He followed, “the risk of persistently higher inflation has increased. We will use our tools to make sure higher inflation does not become entrenched.” The inflation comments are an upgrade to his recent descriptions of inflation. However, he countered the discussion by mentioning the weak labor participation rate and covid related factors affecting economic growth. On balance, his statement was a little more hawkish than usual.
Chairman Powell spoke late on Monday. While his economic assessment was generally in line with other recent speeches, he did offer pause about the new Omicron variant.
The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation. Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.
Buckle Up – The Debt Ceiling is Upon us Again
The last debt ceiling debate ended with an extension to mid-December. December starts tomorrow, and the debt ceiling headlines are starting back up. For instance, Bloomberg reports that Congress needs to pass a stopgap funding bill to keep the government open beyond this week. The graph below, courtesy of Zero Hedge, shows that Treasury Bills maturing in mid and late December are now trading about 4bps higher than where they should. Such a kink in the curve is due to investors requiring a premium to take the risk that principal payments on maturing bills are delayed.
A Bull Market For the Ages
The chart below, courtesy of Fidelity, shows all of the cyclical bull markets since 1920. The rally starting in 1932, following the crash of 1929 and subsequent 89% drawdown, is the only rally that is steeper than the current post-March 2020 rally.
November 29, 2021
Twitter’s stock jumped almost 10% at the market open on news that CEO Jack Dorsey will be stepping down. The gains were short-lived as shown in the graph below. Twitter has become a large social media brand but its stock price is basically flat since IPO’ing in 2013. After the initial rush of enthusiasm, it appears investors are concerned that promoting a long-time Twitter veteran (current CTO – Parag Agrawal) to replace Dorsey will not result in the types of changes investors are asking for.
The graph below compares two widely followed foreign stock ETFs and the S&P 500, from the beginning of the Covid outbreak through today. EEM holds emerging market stocks, and EFA developed market stocks. As shown, all three ETFs performed similarly during the decline in early 2020 and the recovery afterward. However, starting in the spring of 2021, the foreign market ETFs peaked while the S&P 500 continued to new highs. Over the last nine months emerging markets (EEM)s have given up about 25% of their post-Covid gains, while developed markets (EFA) have essentially flatlined. The following factors help account for some of the U.S. equity outperformance:
Since June 2021, the USD index is up about 8%.
The economic recovery in the U.S. has been stronger than in most nations.
The Fed is slightly more hawkish than other central banks.
China’s economic activity has slowed significantly, weighing heavily on many emerging markets.
The week’s significant events will be the ADP employment report on Wednesday and the BLS report on Friday. Currently, the forecast is for a gain of 550k jobs in the November BLS jobs report. Investors are likely to focus on the labor participation rate as Fed Chairman Powell claims the lower rate is a sign of labor weakness. The current estimate is for the participation rate to uptick 0.1% to 61.7%.
Investors will also watch the ISM manufacturing and services surveys on Wednesday and Friday, respectively. Current indications are that both numbers will remain at their current levels. We will follow the price gauges in both surveys closely.
The next Fed meeting will be in two weeks on the 15th of December. Assuming the new covid variant does not become problematic for global economic activity, we might see some Fed members encouraging a faster tapering pace in speeches and comments this week. Voting Fed members go into their self-imposed media blackout period next week, so this week may be their last chance to speak up publically before the meeting.
November 26, 2021
**The equity markets will close at 1 pm ET today
Green in a Sea of Red
The Finviz heat map below shows many stocks are down 2-3% on the day, but there are a few bucking the trend. In most cases, the green on the map is in businesses that benefit from the lockdowns. In addition to the obvious winners in the healthcare industry, are Verizon, NetFlix, and Clorox. Moderna and Pfizer are up significantly. The restaurant and travel business are faring the worst. In the upper right corner, notice losses approaching 10% for Marriot, Las Vegas Sands, and Booking.com.
Stocks are declining worldwide due to a new variant of covid detected in South Africa. Per CNBC:
“South African scientist Tulio de Oliveira said in a media briefing held by the South Africa Department of Health on Thursday that the variant contains a “unique constellation” of more than 30 mutations to the spike protein, the component of the virus that binds to cells. This is significantly more than those of the delta variant.
Many of these mutations are linked to increased antibody resistance, which may affect how the virus behaves with regard to vaccines, treatments and transmissibility, health officials have said.”
The bond market is assuming the new strain will force the Fed into a more dovish policy stance. 2-year yields are down 12 bps this morning, essentially taking out half of a 25bps Fed rate hike over the next two years.
Many traders are out for the holiday, so liquidity will be poor and trading may likely be volatile.
The Dollar is on Fire
The dollar rose in light trading on Wednesday. The impetus behind the dollar continues to be economic data that the market believes will push the Fed to become more hawkish. It is worth noting many corporate and sovereign borrowers that borrow in dollars for use in their home country are exposed to currency risk. Essentially, a stronger dollar increases their net borrowing costs as they have to convert to dollars at a higher rate to pay interest and principal. As such, a strong dollar tightens liquidity for the rest of the world and will inhibit global economic growth if the dollar continues upwards. The graph below shows the dollar index is up over 7% year to date.
Defining “Prolonged” and “Substantially Exceeds”
The Fed recently informally updated its price stability policy. Under the new inflation averaging regime, they will allow inflation to run higher than 2% for short periods, to compensate for periods when it was below average. The graph below shows the three-year average inflation rate is now 2.7%. Further, the annual inflation rate is 6.2%. Fed members are increasingly getting nervous that inflation is running hot for a prolonged period and the current rate substantially exceeds the Fed’s target on both a short-term and longer-term averaging basis. We expect to see various Fed members discussing their thoughts on how to adjust monetary policy to better manage inflation.
November 24, 2021
**The stock and bond markets will be closed tomorrow. Trading volumes should be light this afternoon.
The Team at RIAPro wishes you and yours a very happy Thanksgiving holiday.
A Plethora of Economic Data
Jobless Claims fell to 199k in the latest week, marking a low going back to November 1969. Keep in mind that the population is 65% larger today than in 1969, so today’s number is off the charts on a population-adjusted basis. This is yet another piece of data that affirms the labor market is robust. Having an inflation problem and strong labor market is more evidence the Fed needs to speed up tapering QE and start contemplating rate hikes.
Durable Goods fell 0.5% versus expectations for a 0.3% gain and a prior month reading of -0.4%. Excluding transportation, the number was positive at 0.5%. Accounting for the difference is the auto sector, which struggles to produce cars due to the chip shortage.
Wholesale inventories rose 2.2% versus 1.4% last month. This is a positive sign that supply line problems and shortages are abating. However, Retail Inventories only increased by 0.1% versus falling 0.2% last month. Either retailers are not fully stocking up on goods to help justify higher prices, or trucking problems are making it difficult to deliver goods. It is likely a combination of both factors.
Are Junk Bonds Sending Us A Warning?
The graph below shows the strong correlation between JNK and the S&P 500. JNK is a popular junk bond ETF. JNK just hit lows going back to July, while the S&P is nearly 10% above its July levels. JNK is also back to its 200dma, something the S&P hasn’t done since it broke through the 200dma in June 2020. Higher yields for junk bond issuers can lead to financial hardship and bankruptcy in some cases as they tend to be overleveraged. Are inflation and the possibility of the Fed raising rates finally concerning JNK investors? Maybe the better question is, is the recent price action of JNK foreshadowing problems for the equity markets?
More Details on the SPR Oil Release
Of the 50 million barrels being released from the Strategic Petroleum Reserve, 32 million will be under the exchange program. Companies that successfully bid to receive oil under the program must pay it back and with interest, so to speak. The winning bidders can take delivery starting December 16th from one of four sites. They will then have to return the oil plus a premium in the future. Each site has a different premium and date range requirement regarding the return of the oil. For example, Bryan Mound will offer 10 million barrels. The oil has three return dates, with the first starting January 2023. If the oil is returned at that time, the winning bidder must return an additional 3.9% of oil. The premium increases to 5.3% and 8.6% if they choose the second or third delivery dates, respectively. In the short run, the release will add supply to the market but reduce it starting in July of 2022.
The graph below, courtesy of Bianco Research, provides context for the size of the SPR and recent withdrawals from the reserves.
President Biden is ordering the Department of Energy to release 50 million barrels of oil from the Strategic Petroleum Reserve. The action is in unison with China, India, Japan, Korea, and the U.K. Per the announcement:
“The President stands ready to take additional action, if needed, and is prepared to use his full authorities working in coordination with the rest of the world to maintain adequate supply as we exit the pandemic.”
What’s Wrong With Gold?
A reader asked us why gold fell over $40 an ounce on Monday. While some media outlets ascribe it to Powell’s nomination, the real answer lies in the two charts below. The first chart, from our article The Fed’s Ever Growing Footprint, shows the strong correlation between the price of gold and real interest rates (nominal interest rates less the implied inflation rate). Gold prices often rise when real rates fall and vice versa. The second graph, courtesy of Zero Hedge, shows real rates (green) have risen about 20bps (from -1.20% to -1.00%) from midday Friday through Monday. The sharp increase is due to the 10-year break-even inflation rate (red) falling and bond yields rising.
Will Bond Bears Be Proven Wrong, Again?
Short interest in bond futures is currently at or near record highs. Given the inflation outlook and the Fed’s lethargic response to combatting inflation, shorting bonds may seem like a nice trade. It may be, but context is valuable in this case. The graph below from Jim Bianco shows that professional forecasters have been consistently wrong in predicting the path of bond yields since 2002. Those short bond futures better hope this time is different.
Reminiscent of 1999
We stumbled upon the table below highlighting market performance by sector in the months leading to the Tech crash in 2000. It looks awfully familiar to the poor breadth of the last few days of trading.
November 22, 2021
Rivian Is Out of Favor
Last week’s favorite EV automobile company, Rivian (RIVN), is taking it on the chin. Today shares are down more than 10% as plans to develop cars jointly with Ford (F) have been canceled. The stock has lost a third of its value in the last few days, yet is still up 10% since its November 11th IPO. Ford is up over 5% on the news. Also helping Ford are rumors they may break off their electric car division.
U.S. Federal Reserve Chair Jerome Powell is being renominated by President Biden for a second four-year term. The runner-up for the seat, Lael Brainard, is the new Vice-Chair. The initial reaction from the stock futures market is bullish. The asset markets and betting markets had high odds for his renomination.
As we write below, the use of leverage by retail investors is up sharply. Similar behaviors are occurring by many institutional investors, including the more conservative types. The following comes from David Robertson and Almost Daily Grant’s
“Facing a high bar to generate necessary returns within the confines of public markets, the largest pension fund in the United States tweaks its own strategy in the opposite direction. The California Public Employees Retirement System (Calpers) voted in a board meeting yesterday to upsize its allocation to private equity holdings to 13% from 8% and bump private credit holdings to 5% from less than 1%, while adding $25 billion in leverage (equivalent to just over 5% of assets) to help juice returns. Without those changes, Calpers estimates that its portfolio would generate a 20-year return of 6.2% annually, lagging the 6.8% annual bogey established this summer, which was itself lowered from 7%.”
David’s summation- “To sum up, the largest pension fund in the country is not only increasing allocations to the riskiest assets at the most expensive valuations in history, but it is also taking on debt to boost returns even more.”
The graph from Top Down Charts below shows that investors’ participation in leveraged long ETFs has tripled since the pandemic. Due to zero interest rates, the cost of leverage has never been cheaper for the ETF managers and ultimately the investors. However, if the Fed gets closer to raising interest rates the cost of leverage will rise in anticipation. This may be a fly in the bull market’s ointment, but likely a story for next year, not this year.
The Week Ahead
Despite the Thanksgiving holiday, it will be a busy week for economic data releases. Of note are Existing and New Home Sales, PMI Manufacturing Survey, Durable Goods, GDP Price Index, and Personal Income and Spending. The Fed will also release the minutes from its November meeting on Wednesday.
November 19, 2021
More Bad Breadth
The graph below shows that despite the NASDAQ hitting new highs, the number of new lows is now the highest since March of 2020.
The more hawkish Fed members are finally expressing their views and it seems they want to speed up tapering. For instance, Fed President Chris Waller said “The rapid improvement in the labor market and the deteriorating inflation data have pushed me towards favoring a faster pace of tapering and a more rapid removal of accommodation in 2022.” A “more rapid removal of accommodation” implies raising interest rates. He also mentions the Fed should consider “contracting its balance sheet“, aka selling bonds.
What’s Ailing Europe?
As we note below, Covid infections are on the rise in Europe and we are now learning Austria is going on a full lockdown. We suspect other European nations may follow their lead. The Euro has traded poorly over the last week, in part due to the rising number of infections and their economic implications. As we show below, the Euro/USD is down about 4% since the start of the month. More importantly, it has fallen about 10% versus the dollar since early June. Europe’s economy is not rebounding as strongly as the U.S. which helps explain part of the underperformance. As a result, the ECB has been more dovish (if that’s possible) than the Fed.
This morning ECB President Christine Lagarde essentially ruled out rate hikes in 2022. Per her speech- “conditions to raise rates are very unlikely to be satisfied next year.” Currently, the Fed’s “dot plots” call for one rate hike next year, and the markets see as many as three hikes.
The Bloomberg graph below shows that the stocks spending the most on buybacks (orange) are outperforming the S&P 500 (white). The chart also shows that companies investing the most in R&D and Capex are considerably lagging the market. Investors should be concerned that the companies investing the most into their future are essentially being punished. Slowing productivity growth is a big factor limiting future economic growth. This chart highlights the personal incentive for most executives with equity-based salaries to buy back stock instead of engaging in productive investments.
Covid Infections are Spiking Again in Europe
The graph below from Longview Economics shows that Covid infections in many European countries are rising rapidly and in some cases at the highest levels since the pandemic began. The sharply increasing number of cases will likely result in lockdowns in Europe, which will stunt economic activity in Europe and to a much lesser degree worldwide. The big question for U.S. investors is will the high rate of infections spread across the Atlantic? Further, the euro versus the dollar has been declining rapidly. If the high rate of infections continues and European economic growth suffers, will the dollar continue to appreciate versus the euro?
November 18, 2021
NVIDIA (NVDA) Earnings
NVDA reported third-quarter earnings yesterday after the close. GAAP EPS of $0.97 easily topped the consensus estimate of $0.86, thanks to strong demand and favorable product mix. Gross margin increased +2.6% YoY to reach 65.2% in the third quarter. Revenue of $7.1B (+50.1% YoY) modestly beat expectations of $6.8B, driven by record sales in the Gaming (+42% YoY) and Data Center (+55% YoY) segments.
Management set guidance for Q4 revenue at $7.4B plus or minus 2%, which sits above expectations of $6.9B. In addition, they guided for gross margin to remain steady at 65.3% plus or minus 50 bps. The positive momentum and strong guidance are being well received by the market, as the stock is trading +10% this morning. We hold a 1.75% position in the Equity Model.
Higher Prices in Philly
The Philadelphia Fed Economic Survey, showing current economic conditions in the mid-Atlantic, points to robust activity. The index rose to 39, its highest level since April. Prices also continue to rise with the prices paid index rising to 80, just a hair below 80.7 in June, which was a 42 year high. A score of 80 means that 80% of those surveyed witnessed higher prices in November than October. Price received rose as well to its highest reading since 1974. The bottom line is companies are paying more for input goods but are able to pass the higher costs to consumers.
The most important part of this survey is this month’s special question. Per the Fed: In this month’s special questions, the firms were asked to forecast the changes in the prices of their own products and for U.S. consumers over the next four quarters. The results, as shown below, are clear that firms are bracing for more inflation in the prices of goods they sell as well as higher wage expenses. More telling, their longer-term inflation forecast rose by half a percent to 3.5%.
The chart below from the Leuthold Group shows that stocks are extremely expensive by all measures except those that compare valuations to interest rates. The Fed model and the two equity risk premium valuations are relatively cheap because interest rates are so low. The problem we have with those models is that interest rates are so low in part because future economic growth and therefore earnings growth are also trending lower.
Infrastructure Spending Forecasts
The graph below from Moody’s shows net spending from the recently passed infrastructure bill and the current proposal for the social infrastructure bill. Currently, nominal GDP is over $23 trillion. If we assume the social bill passes, as it is currently written, additional government spending from both bills will peak in 2025 at about $150 billion. That amount would add approximately .60% to GDP. While somewhat meaningful, we must also consider net government spending from the two bills in aggregate decline in the years 2028 and beyond.
November 17, 2021
The Next Big Shock
Fed’s Mester Says Improving Treasury-Market Resilience Is Top Priority
Fed’s Williams says: “We Must Think About How To Shore Up The Treasury Market So It Can Better Endure The Next Big Shock “
The two comments/headlines came out on the same day. The Fed owns 25% of all U.S. Treasury securities outstanding and north of 50% of the available float. Despite their holdings, and the significant effect it has on yields, they appeared worried that volatility could destabilize the bond markets. Do they see an event on the horizon that could significantly shock interest rates much higher or lower? The only obvious events we can think of are a quickened pace of tapering or the coming debt ceiling debate in Congress.
Powell or Brainard?
President Biden says he will choose the next Fed Chair in the coming days. The market is betting that Powell gets renominated, but some believe Lael Brainard has a chance. “Who Will Be The Next Fed Chair?” a Baron’s article, compares and contrasts the two candidates. While they certainly have differences, Brainard is likely to be equally as dovish as Powell if she were to get the nomination. However, from the market’s perspective change may be viewed poorly. To wit, Danielle DiMartino Booth is quoted in the article as follows:
“Moreover, a shift away from the continuity at the Fed that Powell represents would like roil the markets, which is the last thing Biden needs now, she adds in an interview.”
Mark Hulbert from MarketWatch shares a little-known secret about earning 7% yields in U.S. Treasury securities. In his article, Hidden In Plain Sight Is A U.S. Treasury Yielding More Than 7%, Mark walks through Treasury I bonds and the benefits of owning them in a higher inflation environment such as today. With the 6.2% inflation CPI print last week, the new coupon rate on I-bonds is set at 7.12% for the next six months. Because I-bonds reflect the current inflation rate, they are a viable alternative to TIPs for investors looking to retain their purchasing power. As a comparison, the real yield (nominal yield less expected inflation rates) on the 5-year Treasury note is -1.66%. The graph below compares nominal yields for I-bonds versus the Treasury curve.
Job Quitters are Driving Up Wages
The Job Quit rate is up to 3%, the highest level since they started tracking it twenty years ago. People typically “quit” or voluntarily leave jobs in search of higher-paying jobs. The graph below confirms a strong correlation between the quit rate and wages for those switching jobs. Given the record number of job quitters, we suspect wages will continue higher, putting further pressure on corporate profit margins and, more importantly, increasing the risk of a wage-price inflation spiral.
November 16, 2021
Stronger Than Expected Retail Sales
Despite weakening confidence, consumers spent a lot of money last month. Retail Sales rose 1.7%, up from 0.7% last month and well above the 1.0% consensus. While the number was great, there are a couple of factors that may be overstating it. First, Retail Sales is nominal, meaning it doesn’t capture inflation. As such, consumers may be buying a similar number of goods but paying more for them. Second, we believe many people are ordering Christmas gifts early due to concerns about supply lines and shortages. If this is the case, sales for November and especially December may end up being weaker than expectations. One last point, Hanukah starts on the Sunday after Thanksgiving this year, which is also driving earlier than normal demand.
As the first graph shows Bitcoin is down about 11% over the last few days. While a double-digit percentage move is quite often significant for most assets, it is fairly commonplace for Bitcoin. In fact, the five-day average price range using the high and the low for each five-day period since 2014, is 11.65%. The second graph circles the recent five-day range, highlighting just how average it is.
Lofty Earnings Expectations
“The attractive P/E to LTG ratio, or ‘PEG ratio’, of the S&P 500 is due to lofty growth expectations, not low valuations… LTG rates are better contrary than positive indicators… today’s level would suggest losses of -20% over the next 12 months” – BofA
Bottom line- implied long-term earnings growth of nearly 20% is well above any level witnessed since 1986, including 1999. It’s also more than double any actual growth rate over the period. Now consider, profit margins will be under pressure due to rising prices and wages, the Fed is removing accommodations, and economic growth will normalize. Given these headwinds, the implied growth forecast seems like pie in the sky. An adjustment of growth expectations is likely to make investing much more difficult in 2022 than this year.
Diversification Ain’t What it Used to Be
The graph below, courtesy of Jim Bianco, shows the diversification benefits of a passive portfolio are rapidly fading as the five largest stocks now garner nearly 25% of the contribution to the S&P 500. While many investors may think they are diversified because they indirectly own 500+ stocks, such is not mathematically accurate. Yes, they own a piece of 500+ stocks, but the returns are heavily based on five stocks.
November 15, 2021
Lofty Expectations for Interest Rate Hikes
The graph below shows the implied Fed Funds rate based on Fed Funds futures pricing. The blue bars represent the expected dates at which a 100% chance of a rate increase will occur. For example, the market assigns a 100% chance of a rate increase by August 2022 and a 100% chance of a second increase by November 2022. As we show, the market expects the Fed to increase rates five times to 1.25%, by the end of 2023.
There is definitely not a shortage of turkeys on Wall Street, but if you are planning on serving turkey for Thanksgiving you may want to buy one soon. As the graph shows, the volume of birds in storage is running at about half the normal rate for this time of the year.
Slumping Confidence and Political Ramifications
Last week we reported the University of Michigan Consumer Sentiment Survey fell more than expected and now sits at 10-year lows. After digging deeper into the report we discovered something interesting that will likely gain importance as we near next year’s mid-term elections. First, the divide in sentiment between Democrats and Republicans is massive at 90.8 and 53.1 respectively. More telling, confidence among those considering themselves independents fell sharply to 69.2. It is likely independents, along with moderate Democrats and Republicans that will decide the balance of power in the House and Senate. If the confidence of independents continues to fall, the Democrats are more likely to lose the House, Senate, or possibly both.
The Week Ahead
The economic calendar starts in earnest on Tuesday with Retail Sales and Industrial Production. Given the recent drop in consumer confidence, we would expect retail consumption to slump. However, retail sales do not account for inflation, thus forecasts are for an increase of 0.5%. The week will be relatively quiet on the economic front after Tuesday.
We expect to see numerous Fed speakers this week. With the recent barrage of employment and inflation data, a few speakers may call on the Fed to increase the pace of tapering and move up the timeline for interest rate increases.
Options expiration is on Thursday. As David Robertson points out below, options market volume has been extreme. Such high volumes and open interest along with generally low stock volume can lead to large price swings.
Retail is extremely active, and they love punting options. Below are a few stunning facts via Goldman’s Scott Rubner:
1. single stock option notional (140%) now exceeds single stock shares notional
2. over 70% of options traded have an expiry of two weeks or less (more in the 2,3,4 day range)
3. $904bn (Thursday stock option notional). This is largest single stock option notional traded of all time.
November 12, 2021
It’s Transitory They Say
Consumer Sentiment and JOLTs
The University of Michigan Consumer Sentiment Survey fell more than expected to 62.8. The one-year inflation expectation ticked up from 4.8% to 4.9%. The report states: “Consumer sentiment fell in early November to its lowest level in a decade due to an escalating inflation rate and the growing belief among consumers that no effective policies have yet been developed to reduce the damage from surging inflation.”
The BLS reports there are now 10.438 million job openings, slightly better than forecasts of 10.30 million. The two graphs below show the extreme imbalance between the number of job openings and the unemployment rate. The ratio of the two in the bottom graph is at 20-year highs. The “quits” rate rose from 2.9% to 3%, another sign of a robust labor market. Our latest article, What a Rate Hike in 2022 Might Mean for “Stonks“, discusses how the labor market is much healthier than the Fed believes.
Rivian vs Ford and Gm
Rivian (RIVN) is the latest company to benefit from the electric vehicle stock craze. Its stock went public on Wednesday and now has a market cap of over $100 billion. We thought it would be helpful to compare RIVN to Ford and GM for proper context. Keep in mind, both Ford and GM, have numerous electric vehicles already being distributed and more models in the pipeline.
Ford has a market cap of approximately $80 billion and GM is at $90 billion.
Rivian has revenue that is expected to range between zero and $1 million this quarter. Ford and GM have revenue of approximately $135 billion each.
Ford has EBITDA of over $12 billion for the last 12 months and GM is nearly double Ford at $23.8 billion. RIVN lost over $1.5 billion.
Speculative investors are putting the cart well ahead of the horse. They appear enamored with new entrants without contemplating established automakers with extensive financial and manufacturing means competitive electric vehicles for sale.
JNJ is Splitting Into Two
JNJ will split into two companies, separating consumer health goods from its medical devices and prescription drug businesses. The split is expected to occur within the next two years. Shares of JNJ are up about 5% on the news. We currently hold a 1.5% of JNJ in the Equity Model.
The chart below, courtesy of Charlie Bilello, compares IBM’s market cap to its buybacks and declining shares outstanding. Over the last 20 years, IBM has repurchased $132 billion worth of its shares. Its current market cap is now only $113 billion. Simply, they threw away a lot of money. Imagine what its market cap would be had they invested the $132 billion into other companies or projects that would boost earnings?
Yield Curves Are Starting to Invert
An inversion in the 2-year/10-year U.S. Treasury yield curve is frequently a precursor for a recession and accordingly well followed by investors. Other parts of the yield curve are not followed as closely but can give us hints about the future shape of the 2-year/10-year curve. For instance, the graph below shows the 20-year/30-year yield curve. It is currently inverted by about five basis points, having flattened by nearly 30bps in the last year. While not a precursor for a recession necessarily, it does warn the entire curve is flattening. The last time the 20-year/30-year curve was inverted was in the period leading up to and during the financial crisis.
November 11, 2021
Are Semiconductor Sales Peaking?
Semiconductor stocks have been on a tear lately as chip demand is incredibly strong. At the same, semiconductor manufacturers can’t produce enough chips which give them significant pricing power. SMH, a well-followed semiconductor ETF, is up 17% over the last month and 51% for the last year. The graph below warns the exuberance for the industry may be overstated. As shown, courtesy of Stouff Capital, semiconductor sales have a strong correlation with credit growth in China. Given China produces a large number of goods using chips, the relationship makes sense. Recently, China has clamped down on credit creation resulting in negative credit growth and, not surprisingly, weak economic growth. If the semi-credit relationship holds up, the graph portends semiconductor sales may appreciably underperform sales estimates for 2022. That said, the shortage of chips and demand for products using chips, such as cars, provides a decent base of demand for future sales.
Inflation, Inflation, and More Inflation!
The Dollar and Commodities Are Not Behaving Like Normal
The first graph below charts the dollar in orange and the CRB commodities index in blue. Typically a strong dollar results in weak commodity prices and vice versa. Throughout 2021, commodity prices and the dollar have a positive correlation, as circled. The second graph highlights the abnormal correlation a little better. In the Bloomberg graph, the dollar index (white) is plotted on an inverse scale to the left and Bloomberg’s commodity index to the right. The positive correlation is likely because commodity prices are increasing due to supply line factors and not traditional economic factors.
More CPI Worries
The graph below foreshadows that inflation may continue rising. It tracks the median CPI, measuring the breadth of inflation. As discussed in recent articles and commentary, the headline CPI figure everyone follows can be swayed by a few items. For instance, “shelter” represents nearly 30% of CPI. The median figure helps assess how the prices of many goods are behaving. As the graph shows, median CPI is now at highs last seen in 2008. More problematic, the 3-month change is running at levels more significant than any seen since at least 1984.
November 10, 2021
Ugly Bond Auction
Stocks and bond markets are under pressure as the Treasury Department’s 30-year auction went poorly. In the minutes prior to the auction, the bonds were trading at a yield of 1.888%. The auction went off at 1.940%, over .05% higher than expected. It appears the CPI data spooked traders causing them to back up their bids.
The Fixed Income Derivative Markets Imply Persistent Inflation
The graph below courtesy of Arbor Research shows the derivatives markets are increasingly pricing greater odds that inflation runs 3% or greater. Currently, the market implies odds of 88% that inflation will persist above 3% for two years. Even longer time periods, such as five and ten-year terms, have good odds of greater than 3% inflation for those respective periods.
CPI ran much higher than expectations as shown below. The 6.2% annual rate of inflation is the highest since October 1990. The core rate, excluding food and energy, is also higher than expected. The Fed favors, excluding volatile food and energy prices when assessing inflation. CPI, and yesterday’s PPI, will add to the pressure on the Fed to speed up the pace of taper and raise rates. Some of the pressure may come from the White House which is increasingly vocal about inflation.
Yesterday the BLS reported PPI is running at 8.6%, insinuating the prices of goods used to produce final products are rising rapidly. PPI data from China confirms the data, showing inflation for manufacturers is running hot. Since China is a massive exporter of goods, they are likely to pass some of the inflation our way. China’s PPI rose 13.5% year over year, the highest pace in over 25 years.
Is Gold a Buy?
The Fidelity graph below shows the strong correlation between real interest rates and the price of gold. 5 and 10-year real rates (inflation-adjusted) are on the bottom with an inverse y-axis on the right side. Per Jurrien Timmer (Director of Global Macro- Fidelity) -“If the Fed is ultimately forced to accept higher inflation as the cost of financial repression, then real rates could fall further, much like they did during the 1940s. This creates an opportunity for gold and silver, not to mention Bitcoin.”
Party Like Its 1999
The graph below, courtesy of the Leuthold Group, shows there are many stocks trading at extreme valuations. At 73 S&P 500 stocks, there are almost twice as many companies trading at greater than 10x sales than in 1999. The current median price to sales ratio is 3.5x versus 2x in 1999. By almost all historical valuation standards 1999 is considered the peak. Recently more and more valuation measures have been surpassing those levels.
November 9, 2021
PPI rose 0.6% in October, rising to 8.6% year over year. Both readings met expectations. Over half of the gain came from energy prices. As shown below, PPI is running at over 3x the pre-pandemic rate. From an investment perspective, the question we face is whether or not companies can pass the rising costs on to consumers. So far, it appears they have been able to, but as stimulus dries up, and savings revert to normal, it seems less likely going forward, barring higher wages.
The NFIB small business optimism index fell to 98.2, the lowest level since March. More concerning is the forward outlook of those surveyed, in the second table below. Per the NFIB: “The NFIB Uncertainty Index decreased 7 points to 67. Owners expecting better business conditions over the next six months decreased 4 points to a net negative 37 percent. Owners have grown pessimistic about future economic conditions as this indicator has declined 17 points over the past three months to its lowest reading since November 2012.”
The survey acknowledges there is still a shortage of workers, but the survey results “hint at an easing of conditions in the labor market.” In regards to inflation, “price raising activity has reached levels not seen since the early 1980s, when prices were rising at double-digit rates.”
The first table below shows economic conditions and the political climate are primarily responsible for the poor outlook among small business owners. Per the SBA, small businesses account for nearly 65% of the private sector workforce, making this survey an essential part of our economic outlook.
Bond Auctions Today and Tomorrow
The U.S. Treasury will auction $39 billion of ten-year notes this afternoon, followed by $25 billion of 30-year bonds tomorrow. Dealers tend to be net sellers/hedgers of bonds going into auctions. As such, the prices of longer maturity bonds may be under pressure until Wednesday’s auction.
Baltic Dry is Plummeting
As shown below, the Baltic Dry Index is down 12 days in a row. The decline in the shipping price index of dry bulk ocean vessels is hopefully a harbinger that supply line disruptions are abating.
Powell Pressured to Act
Chairman Powell is up for renomination, and it does not appear to be a slam dunk as other Chairs were in the past. Rick Scott, a senator from Florida, penned a letter to Powell pressuring him to significantly change monetary policy if he wants the senator’s renomination vote. We suspect congressional pressure for the Fed to fight inflation will become more vocal as the 2022 Congressional elections near.
“Without a significant and demonstrable change in course, I will not be able to support your continued service as Chair of the Board of Governors of the Federal Reserve System beyond your current term ending February 2022. American families cannot continue down this dangerous path of rising inflation, broken supply chains, and continued workforce challenges.”
November 8, 2021
AMD Lands Meta Platforms Chip Deal
Shares of AMD are up roughly 11% in mid-day trading after announcing that Meta Platforms (Facebook) will use AMD’s Epyc processors in its data centers. According to Bloomberg, “The addition of Meta, the world’s largest social media company, to AMD’s customer list means it now supplies all the top operators of the giant computing networks that run the internet.” In addition, AMD announced its MI200 Instinct processor that will provide better competition against NVDA as AMD aims to gain market share in graphics processors. We hold a 2% position in AMD in the Equity Model.
Richard Clarida Speaks
Fed Vice Chair Richard Clarida largely mimicked Powell’s comments from last week. In regards to raising interest rates, he states: “While we are clearly a ways away from considering raising interest rates, if outlooks for inflation & unemployment turn out to be the actual outcomes… then I believe that these 3 necessary conditions for raising fed funds rate will have been met by year-end 2022″
His comments were generally dovish as widely expected. Jerome Powell spoke today but not on the topic of monetary policy. The Fed speaker schedule will be packed this week and we anticipate a wide range of thoughts on how to advance monetary policy in the near future. Some of these speakers will discuss raising rates much sooner than year-end 2022.
The graph below from Bank of America shows earnings growth is likely to decline quickly in the coming quarters. Given valuations, this is an important topic which we have been discussing. To wit, in 2022 Earnings Estimates Still Too Bullish we wrote:
“The “sugar high” of economic growth seen in the first two quarters of 2021 resulted from a massive deficit spending surge. While those activities create the “illusion” of growth by pulling forward “future” consumption, it isn’t sustainable, and profit margins will follow suit quickly.
The point here is simple, before falling victim to the “buy the market because it’s cheap based on forward-estimates” line, make sure you understand the “what” you are paying for.
Wall Street analysts are always exuberant, hoping for a continued surge in earnings in the months ahead. But such has always been the case.”
Valuations Are Soaring
As shown below, the Shiller PE ratio is now above 40, a milestone only seen for a few months in late 1999. The prior high was witnessed during the speculative markets leading to the crash of 1929. From a fundamental perspective, the risks are palatable but cash continues to flow into markets driving prices higher. Close attention to technical analysis is warranted to help establish proper risk strategies.
The Week Ahead
With the self-imposed public speaking blackout over, we look forward to hearing the thoughts of Fed members. Many members are more hawkish than Chairman Powell. As such, we expect some of them to voice concern over inflationary pressures and discuss their desire to speed up tapering and possibly start to raise rates. The strong employment report last Friday will further encourage some members to disagree with Powell regarding the timing of rate hikes. Chairman Powell will be speaking on Monday and Tuesday. We do not expect to hear anything new from him.
The market gets its next dose of inflation information, with PPI on Tuesday and CPI Wednesday. A consensus of economists expects CPI to uptick another 0.4% to 5.8% annually. JOLTS – job openings data comes out on Friday. The forecast is for a slight decline, but still at levels well above historical norms. Bond markets will be closed on Thursday for the Veterans Day Holiday.
DUK reported third-quarter earnings yesterday before the open. GAAP EPS of $1.79 was in line with expectations, while revenue of $6.95B (+3.4% YoY) missed the consensus of $7.46B. Management reported that the results were driven by continued strength in the Electric Utilities and Infrastructure segment. Leadership narrowed its FY21 adjusted EPS guidance to $5.15-$5.30, which compares favorably to the consensus of $5.21. In addition, it maintained guidance for a long-term adjusted EPS growth rate of 5%-7% through 2025. The market’s reaction is quiet so far; the stock has lost 0.5% since Wednesday’s close. We hold a 2% position in the Equity Model.
Pfizer (PFE) stock is surging on news its experimental anti-viral pill for COVID reduces the odds of hospitalization or death by 89% for adults in a trial. The results are better than Merck’s new anti-viral pill. Assuming these new medications prove effective, the use of vaccines will diminish rapidly. Moderna (MRNA) is paying the price down over 20% on today’s news and 30% on the week.
The BLS Employment Report
As foreshadowed by Wednesday’s ADP report, the BLS payrolls report was strong. 531k jobs were added in October, bringing the unemployment rate down to 4.6% from 4.8%. The prior two months were revised higher by 235k jobs. Monthly average hourly earnings slipped from +0.6% to +.04%, but year-over-year earnings rose 4.9% versus 4.6%. The average workweek declined by a tenth of an hour, which is surprising given the strong demand for labor. Jerome Powell’s key figure, the labor participation rate, was unchanged from last month despite the strong job growth. During his post FOMC press conference, he mentioned on numerous occasions that he would like to see the participation rate rise before entertaining rate hikes.
The graph below shows October’s employment gains or losses by industry. As shown, leisure and hospitality added 164k jobs to the economy, accounting for almost a third of the new jobs. The government sector was the only sector to lose jobs.
As shown below, the S&P 500 has only been down in 2 of the last 17 days, a feat only accomplished one other time since 2000. If the market closes green today, it will mark the only time in 20 years it has gone 18 days with only two losing days.
Ripples In Still Water
On the surface yesterday, the most followed stock indexes gave the appearance of just another healthy market rise. The S&P was up 20 points and the NASDAQ up 1.25%. The tech sector carried the weight with semiconductor stocks, notably being the best performers. Beneath the surface, there are ripples. The heat map below shows over half the stocks in the S&P 500 were down on the day. Also of concern, the VIX volatility index rose 5%, bond yields fell sharply, and gold was up 1.75%. Divergences and poor breadth bear watching as they can signal a change in direction. Our models are alerting us to overbought conditions, so a drawdown would not be surprising.
ALB reported third-quarter earnings yesterday after the close. Adjusted EPS of $1.05 smashed expectations of $0.77, but GAAP EPS of -$3.36 missed the consensus of $0.75. Revenue of $830.6M (+11.2% YoY) beat the consensus of $764.6M, driven by a 35% YoY increase in lithium sales. The GAAP EPS miss was related to a $657.4M charge from an arbitration decision in a dispute that ALB inherited in 2015 when it acquired Rockwood Holdings. ALB plans to appeal the decision.
Management guided to FY21 revenue of $3.3B-$3.4B, well above the consensus of $3.24B, noting that it expects higher lithium pricing because of tightening market conditions. In addition, ALB raised FY21 adjusted EPS guidance to $3.85-$4.15 versus analyst expectations of $3.61. The stock is trading 4.9% higher mid-day following the strong guidance. We hold a 3% position in the Equity Model.
Profit Margin Pressure Ahead
Worker productivity fell 5%, well below estimates for a 1.5% annual decline and the largest decline since 1981. The surprising move is largely the result of sharply increasing unit labor costs which rose 8.3% annually. This data set bodes poorly for corporate profit margins unless companies can continue to pass on higher input costs and wages to their end consumers. Large declines in labor productivity often result in more inflation and vice versa. This is certainly occurring today.
OPEC Is Ignoring Biden
Despite President Biden’s request to increase oil production, OPEC will not abide. OPEC will stick to its original plan and increase production by 400k barrels a day in December. According to Bloomberg, the administration was asking for an increase of up to 800k barrels a day. The price of oil initially rose on the news but has since given back a big chunk of the gains.
The options market and necessary options hedging by dealers are driving stocks like Tesla much higher than warranted by recent news or fundamentals. Essentially, dealers that write options must purchase the underlying stock to hedge their position. The combination of aggressive call purchases, and higher prices, adds fuel to the fire as dealers must buy more and more stock to hedge.
The graph below from Sentimentrader shows net long options exposure is about 15% of total NYSE volume. Net options volume is now about 5-7x the norm before 2020. Per Sentimentrader: “Last week, the smallest traders spent 51% of their volume on buying call options to open. The largest traders tend to be more conservative, but even they focused 43% of their volume on call buying. Both are in the top 2% of all weeks since the year 2000.”
Why Are Yields Blind to Inflation?
Some investors are questioning why bond yields are not higher given inflation is running hot. The graph below, courtesy of the Leuthold Group, shows that it is quite frequent to have yields remain relatively constant with rising inflation. Inflation rates have spiked on numerous occasions, and in most cases, those instances proved transitory. The oddball is the 1970s and 1980s, where greater than 4% inflation rates were the norm.
November 3, 2021
Jerome Powell’s Press Conference
Below are some key points from Powell’s press conference-
*POWELL: FOCUS AT MEETING WAS TAPERING, NOT RAISING RATES
“Our focus is not on raising rates at this time.” He essentially danced around questions regarding future rate hikes.
Fed members see something different from traders but are flexible to adapt & change course if incoming data challenge their thesis
“The inflation that we’re seeing is really not due to tight labor markets. It’s due to bottlenecks.” He is pushing back on the idea that wage pressures are driving inflation.
Powell acknowledges language shift around “transitory” was intentional because they’re basically less sure it will be transitory
“The level of inflation we have right now is not at all consistent with price stability“
In a nutshell, the press conference was dovish. Powell will delay raising rates solely due to the employment picture. He is willing to overlook high inflation and the Fed’s “price stability” mandate to keep policy easy to meet their full employment mandate.
FOMC Statement – Taper has Begun
As is widely expected the Fed will begin to taper asset purchases this month to the tune of $15 billion a month. LINK to the statement. The redlined statement below shows the changes made to the last FOMC statement. Of note, in the second paragraph, they appear to be fading their transitory inflation point of view. They changed transitory factors to factors that are expected to be transitory. There were no Fed members dissenting support of the statement.
CVS reported third-quarter earnings this morning before the open. GAAP EPS of $1.20 missed the mark versus expectations of $1.40, but adjusted EPS of $1.97 beat expectations of $1.79. Revenue of $73.8B (+10% YoY) beat the consensus of $70.5B on the back of growth across all segments.
Leadership raised FY21 adjusted EPS guidance from the prior range of $7.70-$7.80 to $7.90-$8.00, which compares to analyst expectations of $7.79. However, they revised FY21 GAAP EPS guidance lower to $6.13-$6.23 from its prior range of $6.35-$6.45. In addition, CVS boosted FY21 revenue guidance to $286.5B-$290.3B as it noted that management expects recent strength to continue throughout the fourth quarter. The stock is up 5.6% in mid-day trading, seemingly in response to the updated guidance. We hold a 3.5% position in the Equity Model.
The Service Sector is on Fire
The ISM services survey rose to 66.7, the high water market dating back to at least the late 90s, as shown below. Prices rose to 82.9, which is also the highest level in over 20 years. The only negative in the report is the employment sub-component fell from 53 to 51.6. The graph on the right shows the recent disconnect between the index and the employment component.
Per ADP, 571k jobs were added last month, similar to the 523k added in September. The Fed has continually noted that weakness in the labor is the primary reason they are waiting to taper QE. It seems that is no longer the case. With inflation running hot and the jobs market seemingly back to normal, we suspect the Fed might be more hawkish than expected today.
Atlanta Fed Q4 Forecast
Despite a minimal amount of data, the Atlanta Fed’s fourth-quarter GDPNow forecast is out. Currently, they expect growth of 8.2%, well above last quarter’s 2% growth. We caution the prediction is based solely on limited data for the quarter and not estimates of upcoming data points. The forecast will most likely come down over the next few weeks as October data is released. Wall Street’s 4.7% consensus forecast is lower, albeit high, compared to last quarter.
Watch out for the Whales
The graph below shows one risk of holding Bitcoin or Etherium. Less than one percent of the investors own over 90% of the respective crypto coins available. If one of these “whales” were to aggressively sell, they would potentially affect the price meaningfully. However, some of the addresses in the largest 1% are holding on behalf of many individuals or entities.
November 2, 2021
Hertz and Avis Follow Tesla
Joining the surge higher in Tesla are Hertz (HTZZ) and Avis (CAR). As of noon on Tuesday, Avis is up nearly 100% on the day. Prior to Tuesday, it was already up 50% since October 1, 2021. Hertz, who is supposedly buying Tesla’s cars has doubled since late September. We say “supposedly” because of the tweet from Elon Musk below. It is worth noting two things in his tweet. First, there is no contract yet between Hertz and Tesla. Second, Hertz will be paying retail prices for the cars, not discounted prices as is customary.
PSAreported third-quarter earnings yesterday after the close. Funds From Operations (FFO) of $3.42 beat expectations of $3.22 thanks to a 20.8% YoY increase in net operating income. Revenue of $894.9M (+21.8% YoY) also beat the consensus of $858.8M. A 14% increase in same-store sales combined with a 6.2% decrease in same-store direct operating costs drove the positive results.
PSA entered an agreement during the quarter to purchase an All Storage portfolio for $1.5B. Of 56 properties acquired, 52 are in the high-growth Dallas-Fort Worth market. Management expects the acquisition to be immediately accretive to FFO/share with acceleration through 2025. The stock is trading 2% higher today following the upbeat earnings announcement. We hold a 2% position in the Equity Model.
The LPL graph below shows, thus far in 2021, the S&P 500 hit a new record high each month. If it can register another high in December it will join 2014, as the only year since at least 1928 to have all 12 months set a record high.
The market is so bullish that even the bears are bullish. The graph and commentary below show that, per the NAAIM survey of active investment professionals, bearish managers have about 50% exposure to stocks on average. That figure is tied for the largest allocation since the pandemic started.
Manufacturing and Yields
The graph below, courtesy of Brett Freeze, shows the nominal adjusted ISM manufacturing index is highly correlated with the change in 10-year Treasury yields. The ISM index tends to oscillate, portending yields are likely to fall from current levels when the ISM index trends lower. That said, if inflationary pressures remain persistent, the nominal index may stay elevated even if the ISM index declines. If so, yields are likely to stay at current levels.
November 1, 2021
Manufacturing Growth Slowing
The ISM and Markit’s PMI Manufacturing surveys fell slightly as manufacturing growth continues to moderate. The more followed ISM index, shows price pressures continue, with the prices sub-index rising from 81.2 to 85.7. Inventories rose while new orders dropped considerably from 66.7 to 59.8, in a sign that output is set to slow in the months ahead. Along the same lines, ISM output expectations are now at a 12 month low. PMI notes, “the pace of new order growth is the slowest for ten months.” In regards to inflation, they state “the latest increase was the fastest since data collection began in May 2007.”
The graph below courtesy of Nordea Markets highlights that the drop in new orders and increase in inventories portends ISM could turn below 50, signaling that a contraction in the manufacturing sector might occur in the next few months.
The yield curve is starting to invert, albeit not in a well-followed part of the curve. Currently, the 30-year yield is 1.98%, below that of the 20-year yield (2.015%). Historically, as shown below, an inversion between the 2yr and 10yr maturities (blue line is negative) signals a recession is coming in the next six months to a year. The current 20-yr/30-yr inversion is only a start. We will watch to see if more well-followed curve inversions start occurring. The most followed, 2-yr/10-yr curve still has over 100 bps before it inverts.
The event of the week will be the Fed’s FOMC policy meeting on Wednesday. It is widely expected the Fed will announce a $15 billion reduction in its schedule of asset purchases. Assuming they follow through, the market will be intently focused to see if continued inflationary pressures are moving them to speed up the taper schedule and/or begin discussions on raising interest rates sooner than expected. A taper reduction of greater than $15 billion per month will be a surprise for the markets.
The ISM manufacturing survey on Monday and Markit PMI survey on Wednesday will provide further light on manufacturing sentiment. In addition to the headline numbers, traders will be focused on the inflation, deliveries, inventories, and employment subcomponents of the surveys. On Wednesday, ADP will release their employment report followed on Friday by the BLS. While still important data, employment may now be taking a back seat to inflation in regards to the path of monetary policy.
Europe May Have To Tighten Too
Euro-area inflation rose to 4.1% the highest level in ten years, and above estimates for a gain of 3.7%. This comes as ECB President, Christine Lagarde, stated that she did not think the ECB would have to raise rates next year. Traders seem to feel differently as they are now pricing in a rate increase for later next year. Per Bloomberg: “Based on market pricing, investors are expecting the ECB to raise borrowing costs for the first time in more than a decade to bring the deposit rate to minus 0.3% within a year.” Keep in mind, rates are negative and still will be even after a rate hike.
ABBVreported third-quarter earnings this morning before the open. GAAP EPS of $1.78 came in below expectations of $2.00, but adjusted EPS of $3.33 beat expectations of $3.22. Revenue of $14.34B (+11.2% YoY) inched above expectations of $14.30B, driven by strength across the board.
Management raised FY21 GAAP EPS guidance to $6.29-$6.33 from a previous range of $6.04-$6.14. Management also raised guidance for adjusted EPS to $12.63-$12.67, which tops the consensus of $12.57. Finally, ABBV raised its quarterly dividend by 8.5% to $1.41/share, implying a forward yield of 5.14%. The stock is trading +4.1% higher mid-morning following the release. We hold a 4% position in the Equity Model.
XOMreported third-quarter earnings this morning before the open. GAAP EPS came in above estimates at $1.57 versus the consensus of $1.50. Revenue of $73.8B (+59% YoY) also beat the consensus estimate of $72.1B thanks to surging oil & gas prices.
Management expects future capital investments of $20B-$25B annually with a four-fold increase in low-carbon spending. In addition, the board authorized a share repurchase plan to start in 2022 with a ceiling of $10B in buybacks over the next one to two years. The market’s reaction is muted amidst a slight pullback in crude prices, as XOM is trading 0.6% higher mid-morning. We hold a 2% position in the Equity Model.
Consumers are in an Inflationary Bind
The quarterly Employment Cost Index rose 1.3% versus expectations for a gain of 0.9%. On a year-over-year basis, the index is up 3.7%. While the data is a little old, it points to profit margin pressures for corporations.
Personal Income fell 1% in September. Personal Consumption Expenditures rose 0.6%. It appears expenditures are rising because of inflation, not because consumers are buying more goods. This data also helps explain the recent uptick in credit card spending.
The Fed’s preferred method for gauging inflation, the PCE Price Index, rose 4.4% over the last year, the highest rate of inflation since the early 90s.
The graph below courtesy of Eric Basmajian, shows Real Disposable Income per Capita is back below the 1.8% trendline growth of 2009-2020. Simply, the stimulus is gone.
The Bank of Canada (BOC) surprised markets by ending QE abruptly and predicting they might increase interest rates as soon as April. LINK to the press release. Further, they expect a total of four rate hikes next year. Their rationale appears to be a concern that price pressures “now appear to be stronger and more persistent than expected.”
Since the announcement, Canada’s 2-year notes are up 20bps, while its 10-year notes are slightly lower in yield. The Canadian 2/10 yield curve is now 50bps, down from nearly 100bps a month ago. The BOC’s actions and large effect on its yields and yield curves seem to be partially responsible for similar trading with U.S. Treasury yields and curves. On October 8th, the UST 2/10 yield curve was 130bps. Today it stands at 108bps. Both the U.S. and Canadian yield curves appear to be warning the respective central banks may be tightening policy right into an economic slowdown. With the Fed meeting next week, equities investors should be prepared for a statement that is more hawkish than expected. This may include a quicker taper timetable and or a more specific discussion on raising rates.
House Price Increases Are Slowing
According to Case-Shiller Home Price Index, the surge in house prices may finally be slowing down. As shown below, the monthly gain in the index was only 0.08%. That compares to the last 12 months which saw gains of around 1% or higher each month. The annual gain in the index is 19.8%.
October 28, 2021
Starbucks (SBUX) Earnings
SBUX reported its fiscal fourth-quarter earnings today after the close. GAAP EPS of $1.49 beat the consensus of $0.98; however, revenue of $8.15B (+31.5% YoY) fell short of expectations of $8.2B. Global comparable store sales increased 17% versus expectations of 19%, driven mainly by the North American region where comparable sales increased 22%. International comparable sales increased 3%, but China comparable sales fell by 7% during the quarter. The stock is trading 2.9% lower in the after-hours session. We hold a 1% position in the Equity Model.
Apple (AAPL) Earnings
AAPL reported its fiscal fourth-quarter earnings today after the close. GAAP EPS of $1.24 arrived in-line with expectations, while revenue of $83.4B (+28.9% YoY) missed expectations of $84.99B. Products revenue of $65.1B missed the consensus of $68.7B, largely due to iPhone sales of $38.9B versus expectations of $41.6B. The CEO told CNBC that supply constraints would likely intensify in its fiscal first quarter, but he expects “very solid” revenue growth. The stock is down -3.9% in the after-hours trading session. We hold a 3.5% position in the Equity Model.
Amazon (AMZN) Earnings
AMZN reported third-quarter earnings today after the close. GAAP EPS of $6.12 came in well below the consensus estimate of $8.93. Revenue of $110.8B (+15.3% YoY) also missed expectations of $111.66B, with AWS sales of $11.6B missing expectations of $15.4B. In addition, operating income decreased to $4.9B versus $6.2B in the third quarter of 2020.
Management guided to sales between $130B-$140B and operating income between $0-$3B in the fourth quarter. This stacks up against operating income of $6.9B in the fourth quarter of 2020. The CEO, Andy Jassy, warned that AMZN expects to incur several billion dollars of additional costs throughout the holiday season. “It’ll be expensive for us in the short term, but it’s the right prioritization for our customers and partners”. The stock is down -4.5% in the after-hours session. We hold a 3% position in the Equity Model.
Earnings Yield Warning
The graph below, courtesy of Nautilus Capital, shows that earnings yields on the S&P 500 are at the lowest levels since the early 1980s. The lower graph and table break historical readings of the earnings yield into quadrants. As the table shows, the lowest quadrant produces minimal positive returns versus double-digit returns for the other three quadrants.
Ford (F) Earnings
F reported earnings for the third quarter of 2021 yesterday after the close. GAAP EPS of $0.45 smashed the consensus estimate of $0.21, driven by “significant increases in semiconductor availability and wholesale vehicle shipments from Q2”. Automotive revenue came in slightly above consensus at $33.2B (-4.3% YoY) versus expectations of $32.8B. Notably, F saw its North America EBIT margin improve to 10.1% from 7.6% in 3Q20.
Management increased guidance for FY21 adjusted EBIT to a range of $10.5B-$11.5B from the previous $9B-$10B. FY21 adjusted free cash flow guidance remains unchanged at $4B-$5B. F also announced that it reinstated its quarterly dividend at $0.10/share after suspending it in 2020, implying a forward yield of roughly 2.5%. The stock is trading 8.7% higher this morning following the upbeat earnings. We hold a 3% position in the Equity Model.
The good news is Q3 GDP, at 2%, is much higher than the Atlanta Fed’s 0.2% forecast. The bad news, it is decently below the consensus of economists forecast of 2.7%. Of concern, inventories added 2.1% growth to GDP. Without inventories, which in the long run contribute zero growth to GDP, GDP was flat. GDP was boosted by personal consumption expenditures (PCE) which rose 1.6%. We suspect GDP will be revised lower as PCE is likely overstating consumer economic activity. Durable goods and auto sales weighed heavily on GDP, primarily due to shortages and transportation problems. As these problems resolve themselves, GDP should benefit.
An Odd Divergence
Economists have been racking their brains for the last nine months trying to pinpoint why there are still shortages of many goods. Yesterday’s inventory data and the graph below provide a clue. Retailer inventories fell 0.2% while wholesaler inventories jumped 1.1%. The graph shows this is not just a one-month divergence but a trend existing for over a year. The most logical explanation is there are not enough truckers to deliver the goods from the wholesalers to the retailers. If this is the case we should expect wholesale inventories to stabilize, resulting in fewer orders to manufacturers. The other explanation is that retailers are purposely ordering less, keeping shelves semi-stocked, thus allowing them to charge more and pass higher costs and wages on to consumers.
Q3 GDP Report Warning From the Atlanta Fed
A consensus of Wall Street economists expects today’s third-quarter GDP to increase by +2.7%. The Atlanta Fed’s most recent forecast is well shy of that at +0.2%. One of the main reasons for the Atlanta Fed’s weak forecast is Real Final Sales. The Atlanta Fed expects this large contributor to GDP to drop 1.6%. As the graph shows, every time Real Final Sales has fallen below zero since the early 1950s, a recession has occurred.
October 27, 2021
Visa (V) Earnings
V reported its fiscal fourth-quarter earnings yesterday after the close. GAAP EPS of $1.65 easily beat the consensus of $1.55. Revenue of $6.56B (+28.6% YoY) came in slightly above the consensus of $6.51B. Payments volume growth also topped estimates, coming in at +17% YoY versus expectations of +15% YoY. Cross-border payments volume rose +38% YoY versus expectations of +31.7% YoY; however, management’s outlook is not as rosy.
The CFO noted that revenue growth significantly depends on the pace of cross-border travel recovery, and V does not expect cross-border travel to reach 2019 levels until mid-2023. The outlook is weighing on performance as the stock is down 5.2% in mid-day trading. We hold a 1% position in the Equity Model.
Advanced Micro Devices (AMD) Earnings
AMD reported third-quarter earnings yesterday after the close. GAAP EPS of $0.75 beat the consensus of $0.61. Revenue also came in above consensus at $4.3B (+53.9% YoY) compared to expectations of $4.1B. According to the CEO, the growth is being driven by server chips, with data center sales more than doubling YoY.
Guidance for Q4 revenue was set to $4.4B-$4.6B, which blows analyst forecasts out of the water. As a result, management increased guidance for FY21 revenue growth to 65% from 60%. The stock is up 1.2% in mid-day trading. We hold a 2% position in the Equity Model.
The Yield Curve is Flattening
The table below shows the mid-day change in U.S. Treasury yields. Note the distinct flattening of the yield curve as short-term yields rise while long-term yields fall. For instance, 30-year bonds are down nearly 7 bps, while the 3-year note is up 3.5bps. Bond traders are pricing in future Fed rate hikes, while at the same time understanding that tapering QE and rate hikes will slow growth and inflation, to the benefit of longer maturity bonds. The 20/30 year curve will most likely be the first part of the curve to invert. The yield difference between those two maturities is only 1.7bps.
Microsoft (MSFT) Earnings
MSFT reported its fiscal first-quarter earnings yesterday after the close. GAAP EPS was $2.71, which beat the consensus of $2.07. Revenue also came in above consensus, at $45.3B (+21.8% YoY) versus an expected $44B. The beat was driven by a 50% YoY increase in Azure and other cloud revenue.
Management offered guidance for Q2 revenue above the consensus at $50.15B-$51.05B versus estimates of $48.92B. The stock is trading 1.7% higher in the pre-market session following the results. We hold a 2.5% position in the Equity Model.
Google (GOOG) Earnings
GOOG reported third-quarter earnings yesterday after the close. GAAP EPS of $27.99 topped the consensus of $23.32. Revenue of $65.1B (+41% YoY) also beat estimates of $63.2B thanks to impressive advertising revenues. This was GOOG’s largest quarterly revenue gain in 14 years, and the growth led to an operating margin increase of 8%.
Management included a caveat with the impressive results, noting: “Given the gradual recovery in results through the back half of 2020, the benefit from lapping prior year performance diminished in Q3 versus Q2 and will diminish further in Q4”. The market’s reaction to the release is muted thus far. We hold a 2.5% position in the Equity Model.
Labor Market Tightness
Per Goldman Sachs: The Conference Board’s labor differential — the “difference between the percent of respondents saying jobs are plentiful and those saying jobs are hard to get— increased by 1.5pt to 45.0, the highest level since 2000.”
This data provides even more evidence there are more job openings than those looking for jobs. Again, another sign of a healthy labor market. A shortage of candidates provides employees leverage to demand higher wages. This doesn’t bode well for the profit margins of companies that rely on large labor forces.
XLE is Neglected
The commentary and graphs below show that both ESG investors and traditional investors are underweighting the energy sector. Since January, XLE (energy) is up 58%, almost triple the S&P 500 which is up 21%. If such outperformance continues, we suspect investors will eventually gravitate toward the energy sector and try to capture the outperformance. The graph and commentary is courtesy of Callum Thomas and @mikezaccardi
October 26, 2021
Waste Management (WM) Earnings
WM reported third quarter GAAP EPS just short of the consensus at $1.28 versus an expected $1.33. Revenue of $4.7B (+21% YoY) topped expectations of $4.55B, driven by volume growth and increased yield. Management raised guidance for FY21 revenue growth to 17%-17.5% from 15.5%-16% previously. The new guidance is above the consensus of 16% YoY. Accelerating cost inflation was mentioned as a headwind, but the company remains on track to meet its full year targets according to the CEO. The stock is down 1.7% this morning following the release. We hold a 1% position in the Equity Model.
Raytheon Technologies (RTX) Earnings
RTX reported third quarter GAAP EPS of $0.93, which inched above the consensus of $0.91. Revenue of $16.2B (+8.1% YoY) came in short of expectations of $16.36B. Guidance for FY21 revenue was set at $64.5B from a prior range of $64.4B-$65.4B. This is slightly below the consensus of $65.2B. Guidance for FY21 adjusted EPS was raised to $4.10-$4.20 from $3.85-$4.00 previously; the consensus is $4.06. Management commented that a rebound in air travel was the impetus for raising earnings guidance. Despite the upbeat guidance, the stock is trading 2.5% lower this morning due to gloomy forecasts from its competitor, Lockheed Martin (LMT). We hold a 1.5% position in the Equity Model.
Yesterday we noted that Tesla’s market cap increased by approximately $100 billion. To put the gain in context, consider yesterday’s increase in market cap is worth about 1.5x the total value of Ford and about half of the entire domestic auto industry. Also interesting, Elon Musk added nearly $30 billion of personal wealth yesterday. He is now supposedly worth more than Exxon.
The graph below shows Tesla is valued at 42% of the entire auto industry despite having a very small fraction of total sales/revenue. Ford and GM recently reported annual sales of $137 and $139 billion respectively. Tesla’s latest report shows $46 billion in sales. Simply, the market is betting heavily that TSLA will be the dominant leader in auto sales over the next five to ten years. Anything short of 50% market share will likely be a disappointment for shareholders. If you do not buy into the prospects we offer caution. Tesla is one of the hottest stocks in the market, so selling or shorting the company may be painful in the short run.
Consumers Are Fretting
The Langer Consumer Comfort Index is a high-frequency confidence index. While lesser followed than the University of Michigan survey or the Conference Board’s consumer survey, it provides another data set to assess consumer attitudes. Given personal consumption traditionally accounts for two-thirds of economic growth, this measure is essential to follow.
In its most recent October 21st report, Langer notes: “Consumer sentiment continued down this week, dropping to nearly a seven-month low as Americans’ assessments of their personal finances and the buying climate extended their largest declines since early in the coronavirus pandemic.”
At 49.7, the Index is well above its March 2020 lows of 35 but a ways off its pre-pandemic highs near 70. For context, the Langer Index looks similar to the Conference Board Survey, sitting between post-pandemic highs and lows. On the other hand, the University of Michigan Sentiment Index is now at its lowest level since the pandemic and the lowest level in ten years. The importance of consumer confidence is not just economic. As their graph below shows, there is a strong correlation between the changes in stocks prices and consumers’ sentiment. Recently, stocks have soared despite weakening confidence.
October 25, 2021
*** There will be no Three Minutes on Markets Videos this week as we are refurbishing our recording studio. We expect to be back next Monday.
Tesla Surpassing Facebook
Tesla, rising over 10% this morning, overtook Facebook, becoming the ninth-largest company by market cap. The news propelling it to a market cap of just under $1 trillion is that hertz will buy 100k cars. The order is worth over $4 billion. Tesla’s market cap is up approximately $60 billion on the order. To put that in context, Ford’s market cap is $63 billion.
What If Inflation Isn’t Transitory?
It seems over the past few weeks more and more in the media are asking what happens if inflation becomes isn’t transitory. What if it is persistent. Mohamed El-Erian has been among the most outspoken on the topic. This morning he writes a concerning editorial in Bloomberg warning that underestimating inflation carries dire risks. To wit: “The longer this persists, the greater the risk of a historic policy error whose negative implications could last for years and extend well beyond the U.S.”
Oil In Backwardation
The table below shows the CME futures prices for crude oil. Typically the future contract prices of oil increase over time. Such a price curve is called contango. Currently, the front contract December is trading at $84.81 and the prices decline through next year. This somewhat unique circumstance for oil is called backwardation. It is a signal that there is strong demand for crude oil today but traders do not expect demand to be as heavy in the future. This indicator portends the supply/demand imbalance for crude oil will normalize over the next six to nine months.
A host of regional manufacturing indexes this week provide a first look at economic activity in October. Also of interest will be Thursday’s GDP report. Current estimates are for 2.5% growth in the third quarter. As we noted earlier this week, the Atlanta Fed forecasts 0.5% growth. Also on Thursday will be PCE prices, the Fed’s favorite gauge of inflation expectations.
The Fed meets on Tuesday and Wednesday of next week. Accordingly, they should be relatively quiet this week as they enter their self-imposed media blackout period.
Earnings will continue to dominate the news wires. As the first table below, from RIAPro, shows, ten of the companies we hold in the Equity model report earnings this week.
Less Stimulus, More Borrowing
The graph below, courtesy of Arbor Research, shows that consumer interest in borrowing is increasing. Some of the interest is likely from borrowers needing extra funds to replace the multiple stimulus programs from the last year and a half. It is also worth noting that consumers are also likely being pinched by higher prices and some are needing to borrow to make ends meet.
In a speech this morning, Jerome Powell said “its time to taper” but not raise rates. He expects to complete tapering by mid-2022. Powell now views “higher inflation” as the biggest risk. Equity markets are trading weaker as he finally acknowledges inflation is more persistent than “transitory.” Bond yields are falling as he implies the Fed should be more hawkish if inflation does not abate.
Flattening Yield Curve
5-year implied inflation expectations are up over 40 basis points (bps) since October 1st. They now stand at a 15+ year high of 2.94%. While inflation expectations rise, the yield curve is flattening. In this case, short maturity bonds are rising in yield much more than longer maturity bonds. The graphs below show what has happened to bond yields since the inflation expectations last peaked on May 18th. As we show the 30-year bond is 26 bps lower since then, while the 2-year note is 26 bps higher. As a result, the 2/30 yield curve has flattened 52 bps over the period.
Our portfolios are set up for the yield curve flattening. The portfolio’s largest bond holding is TLT with a duration of 20 years. The benchmark, AGG, has a duration of 8 years. The models are also not fully vested in the fixed income sleeves to further protect against higher yields.
The graph below, courtesy of Bank of America, shows a recent uptick in credit card spending among those making $50,000 a year or less. It appears consumers, especially those at the lower end of the income scale, are increasingly relying on credit to make ends meet as inflation rises quicker than earnings.
Quantifying The Cost of BITO
Yesterday we pointed out the new Bitcoin ETF, $BITO must roll futures contracts from month to month. We estimate the annual cost based on the current roll from October to November is 15% or even greater. The problem with our estimate is that it does not take into account how the futures curve may change. The graph below, courtesy of J.P. Morgan, provides some historical context to assess the roll cost. It shows the annual cost of rolling the first month to the second-month contract, as well as the second month to the fourth month. As the graph shows the average cost is around 10% annualized, but as the curve shifts the cost or benefit can vary significantly. The cost of rolling futures, ultimately paid by the ETF holder, is not a reason to avoid BITO, but it is a factor worth considering especially if you are planning to hold it for a long period.
Fed Chairman Jerome Powell is expected to speak at 11:00 am ET today. He has been quiet on the topic of tapering QE so it will be interesting to see if he uses the opportunity to lay out his thoughts on the topic. In particular, will he affirm the $15bln/month pace of reduction that was laid out in the recent FOMC minutes, or push for something either more aggressive or conservative? Also, will he discuss the possibility of increasing interest rates next year?
October 21, 2021
Federal Reserve Trading Policy
With the cat out of the bag, and many high-ranking Fed officials caught actively trading the markets with inside knowledge of what the Fed would say and/or do, the Fed is finally taking action. Per the press release below, Fed members are now subject to a number of strict rules that will greatly limit their ability to trade markets.
The Philadelphia Fed Manufacturing index came in below expectations at 23.8 down from 30.7 in October. That said, the details were not as bad as the headline. Employment, new orders, and the 6-month outlook for capital spending all rose.
The index is composed of indicators that tend to lag economic activity and ones that lead economic activity. The graph below, courtesy of Nordea, shows how the difference between the leading and lagging indicators leads the broader index by about 10 months. As shown, the leading-lagging differential portends the index will fall back into economic contraction in the coming months. This chart affirms the sharp deceleration in growth currently being forecasted by the Atlanta Fed GDPNow.
A few subscribers have asked our thoughts on trading the new Bitcoin ETF (BITO) as a substitute for Bitcoin. The biggest drawback in our opinion is the cost structure of the ETF is not as friendly as owning Bitcoin for two reasons. First, the ETF’s management fee is 0.95%. Second, and this is a flaw with many commodity ETFs, holders pay to “roll” contracts. BITO is currently fully invested in the October Bitcoin futures contract priced at 67,500. At some point soon they will have to buy the November contract and sell October. Currently, the November contract is trading at a premium of 1.27% to the October price. If the futures curve remains steep, holders of BITO will pay 15% or more over the course of the year to roll contracts. Including the management fee, BITO could underperform Bitcoin by nearly 20%. Obviously, that estimate will change based on the shape of the futures curve. Click HERE for Bitcoin futures prices for current and out months.
Oil CAPEX Declining
On Tuesday we shared a WSJ article that discusses the lack of investment in energy exploration (capex). We just stumbled upon the graph below which shows the problem has been brewing for about five years. Political and economic incentives favor green energy, leading us to believe that unless oil prices stay at current levels or higher and can sustain such levels, there is little reason to expect investment to pick up.
October 20, 2021
Verizon (VZ) Earnings
VZ reported third-quarter GAAP EPS well above consensus at $1.55 versus expectations of $1.35. Revenue was $32.9B (+4.4% YoY), which missed estimates of $33.2B. Wireless retail net adds surprised to the upside with 699K net adds versus 566K expected.
Guidance for FY21 adjusted EPS was raised to $5.35-$5.40 from $5.25-$5.35. The new range is well above the consensus estimate of $5.29. Management also narrowed FY21 guidance to a 4% increase in total wireless revenue from the previous range of 3.5%-4%. VZ is trading 2.1% higher this morning following the results. We hold a 1.5% position in the Equity Model.
NextEra Energy (NEE) Earnings
NEE reported third-quarter GAAP EPS of $0.23, which missed analyst estimates of $0.71. Adjusted EPS did beat estimates, however, at $0.71 versus expectations of $0.67. Revenue came in short of consensus at $4.4B (-8.8% YoY) versus expectations of $5.4B.
Guidance for FY21 adjusted EPS remains unchanged at $2.40-$2.54, with the mid-point slightly below the consensus of $2.52. NEE expects adjusted EPS growth of 6%-8% from FY21 in 2022 and 2023. NEE is trading 2.3% higher this morning after the release. We hold a 2% position in the Equity Model.
Abbott Labs (ABT) Earnings
ABT reported third-quarter GAAP EPS of $1.17, which beat analyst estimates of $0.67. Revenue of $10.9B (+22.8% YoY) also beat the consensus of $9.56B. Revenue growth was driven, in part, by strong results in COVID-19 testing products. Excluding COVID-19 related testing products, organic sales grew 11.7% versus the third quarter of 2019.
Guidance for FY21 GAAP EPS was set to $3.55-$3.65, while FY21 adjusted EPS guidance was boosted to $5.00-$5.10 from a prior range of $4.30-$4.50. This compares to a consensus estimate of $4.45. Following the positive results and guidance, the stock is trading 3.9% higher this morning. We hold a 2% position in the Equity Model.
The Atlanta Fed GDPNow forecast for Q3 economic growth was revised lower to 0.5%, down from 1.2%. The chart below shows how each major subcomponent contributed to the forecast. Increasing private inventories, adding 2.1%, is keeping the GDP forecast above zero. Typically accounting for two-thirds of GDP, Consumer Spending is only contributing 0.31% to the forecast, well off the 2.70% rate in August.
In Monday’s Industrial Production report, Industrial Production fell 1.3%, and the lesser followed capacity utilization fell from 76.4% to 75.2%. The data is a little surprising given the shortage of goods available to the public. At first blush, one would think factories would be running at maximum capacity and production rising rapidly. Unfortunately, manufacturers face the same problem as their consumers, a shortage of goods needed to produce products. For example, it is well documented most auto manufacturers are cutting production due to a chip shortage. The graph below shows capacity utilization for the auto industry is at recession levels of 55%. It was running between 70-80% before the pandemic and had prior peaks over 90%. Auto manufacturing contributes about 3% to GDP.
October 19, 2021
Netflix (NFLX) Earnings
NFLX reported third quarter earnings today after the close. GAAP EPS came in above consensus at $3.19 versus $2.56 expected. Revenue of $7.5B (+16.1% YoY) was in line with expectations. Global streaming paid net additions blew management expectations out of the water, coming in at 4.38M versus guidance of 1.54M.
Management offered guidance for 4Q21 revenue of $7.71B, slightly above the consensus of $7.68B. Guidance for EPS was less positive, however, at $0.80 versus expectations of $1.13. Finally, management offered above-consensus guidance for Q4 global streaming paid net additions of 8.5M versus 8.3M expected. We hold a 2% position in the Equity Model.
Johnson & Johnson (JNJ) Earnings
JNJ reported third quarter earnings today before the open. GAAP EPS of $1.37 missed the consensus estimate of $2.17. However, non-GAAP EPS of $2.60 beat expectations of $2.35. Revenue of $23.3B (+10.7% YoY) missed the consensus of $23.7B. According to the CFO, the revenue miss was just a matter of timing of shipments in the COVID vaccine and medical devices businesses. That revenue should be made up for in Q4 results.
JNJ increased guidance for FY21 revenue at the low end to a range of $92.8B-$93.3B from $92.5B-$93.3B, but guidance remains below the consensus estimate of $93.97B. Guidance was also boosted for FY21 adjusted EPS to $9.77-$9.82 from $9.50-$9.60 previously. This is well above the consensus estimate of $9.64. The stock is trading 2.6% higher on the results. We hold a 1.5% position in the Equity Model.
Proctor & Gamble (PG) Earnings
PG reported third quarter earnings this morning before the open. GAAP EPS came in slightly above expectations, at $1.61 (-1% YoY) versus the consensus of $1.59. Revenue of $20.3B (+5.3% YoY) also beat expectations of $19.9B. Organic sales growth of +4% YoY was driven by increased volume (+2%), increased pricing (+1%), and positive sales mix (+1%). Gross margin, however, decreased by 3.7% YoY due to increased commodity and transportation costs as well as less profitable sales mix.
PG is planning to raise prices on certain beauty, oral care, and grooming products to offset increasing costs. According to the Wall Street Journal, “‘We do not anticipate any easing of costs,’ P&G Finance Chief Andre Schulten said in an interview. ‘We continue to see increases week after week, though at a slower pace’”. The article continues, “Despite the higher expenses, P&G maintained its sales and profit outlooks for the year, saying increased revenue and cost reductions will enable the company to stay on track”. The stock is trading roughly 2% lower this morning in light of the margin concerns. We hold a 2% position in the Equity Model.
For more on how cost pressures are affecting PG and many other companies, check out this article from the Washington Post.
“Despite varying perceptions, there were clear fundamental and technical warnings preceding the crash that were detected by a few investors. For the rest, the market euphoria raging at the time blinded them to what in hindsight seemed obvious.”
The quote comes from an article we wrote on the stock market crash of 1987. Today, being the 34th anniversary of the crash of 1987, we revisit some important lessons from that era. Read The Article.
Will Higher Oil Prices Become The Norm?
The Wall Street Journal ran an article discussing a growing investment deficiency into traditional and renewable energy sources. As a result oil prices may stay high until the industry closes the gap.
Per the article:
“Global oil and gas exploration spending, excluding shale, averaged about $100 billion a year from 2010 to 2015, but dropped to an average of around $50 billion in the years that followed after a crash in crude prices, according to Rystad Energy. Total global oil and gas investment this year will be down about 26% from pre-pandemic levels to $356 billion, the IEA said Wednesday.”
Green investments are not growing quickly enough to offset reduced CAPEX in the energy industry. Per the article:
To meet global energy demand, as well as climate aspirations, investments in clean energy would need to grow from around $1.1 trillion this year to $3.4 trillion a year until 2030, the Paris-based agency found. Investment would advance technology, transmission, and storage, among other things.
The bottom line: “The world isn’t investing enough to meet its future energy needs, and uncertainties over policies and demand trajectories create a strong risk of a volatile period ahead for energy markets,” the IEA report said.
Equity Model Earnings Announcements
Q3 earnings announcements for the RIA Pro equity model start this morning and continue on Wednesday as follows:
Tuesday (October 19th)
JNJ – Before Open
NFLX – After Close
PG – Before Open
Wednesday (October 20th)
ABT – Before Open
NEE – Before Open
VZ – Before Open
Over the last six months, the Fed has been dragging its feet and delaying the inevitable tapering of QE due to perceived weakness in the labor market. The graph below shows the unemployment rate less those labeled “quitters” is near 20-year lows. Quitters are those that left their jobs voluntarily and, in theory, are in search of better or higher-paying jobs. The current quit rate at 2.9% is the highest in its 20-year history. A high quit rate is a signal of labor market strength. Between 5.4% inflation and the graph below, is it any wonder the market is starting to think the Fed is behind the eight ball in tightening?
As shown below China’s economic growth rate for the third quarter was negligible at +0.2%, bringing the annual growth rate to just 4.9%. While still high, the annual rate is down from 7.9% last quarter. China’s economic slowdown bears watching as they are the marginal driver of global economic growth.
Equities are recently showing a little hesitation as investors gear up for QE in November. The bond market has been a lot more vocal about more hawkish Fed policy and the implications for growth. Over the last 5 months, as shown below, the Treasury yield curve (30yr-5yr) has collapsed by three-quarters of a percent. Over the last week or two, the rate of flattening picked up markedly.
A yield curve flattening trade should not be surprising. In Taper is Coming, Got Bonds? we wrote: “The yield curve and yield graphs look similar. Short-term yields were relatively constant during QE while long-term yields rose. In all three QE examples, the yield curve quickly flattened after QE ended.” The graph below, from the article, shows how the 10yr-2yr yield curve fell rapidly after the three prior episodes of QE ended.
The Week Ahead
We take a bit of a break this week after last week’s full calendar of important economic data. On the docket is Industrial Production on Monday, Housing and Building Permits on Tuesday, and Jobless Claims on Thursday.
More important for the markets this week will be Fed speeches and earnings. Recently Fed members have become increasingly vocal about their concern for the recent rise in inflation overstaying its welcome. Last week Bostic led the charge saying “inflation is broadening, not transitory.” If others use similar rhetoric, we will see the market continue to price in a quicker pace of QE tapering and rate hikes coming sooner than previously expected.
This is will be the first of a few important weeks for corporate earnings as shown below.
The graph below, courtesy of Jim Bianco, shows that a majority of employees in eight major cities are still not going back to their offices. While the number of employees going back to their offices will rise we think it’s likely the number falls well short of pre-pandemic levels. Per Jim Bianco “What a year at home did was open our eyes to what we are were capable of outside the office and what it was really like in the office. Few were ready to do this pre-pandemic.”
GS reported earnings for the third quarter of 2021 this morning. GAAP EPS of $14.93 (+66% YoY) easily topped the consensus of $10.04, driven by impressive revenue growth across segments. Revenue came in well above consensus at $13.6B (+26.3% YoY) versus expectations of $11.6B for the quarter. The stock is up +2.6% mid-day on the back of the strong results. We hold a 2% position in the Equity Model.
Inflation Concerns Weigh on Sentiment
The October University of Michigan consumer sentiment survey came in weak at 71.4 versus a consensus estimate of 74. The result, which fell from 72.8 in September, registered as the second-lowest outcome since 2011. The chart below, courtesy of Bloomberg, shows year-ahead inflation expectations based on the survey have risen to 4.8%, their highest point in 2021.
Retail Sales Surprise
September retail sales surprised to the upside this morning at +0.7% MoM versus estimates of -0.1%. Retail sales ex-vehicles grew +0.8% MoM versus +0.4% expected, and ex-vehicles and gas rose in line with expectations of +0.7%.
Incorporating Wednesday’s September CPI release, real growth in retail sales for September was only +0.3% MoM. Thus, over half of the nominal growth in September came from rising prices. Treasury yields are moving higher following the release, reflecting the market’s increasing expectations for taper.
On a monthly basis, the Cleveland Fed puts out the 16% trimmed mean inflation rate. Their modified inflation rate trims price change outliers, both high and low, from CPI. Currently, as shown below, the index is just short of the 2008 highs. At that time oil was nearly $150 a barrel and up well over 100% from where it was a year earlier. Take away that short burst higher and the trimmed measure is at its highest level since the late ’80s. The takeaway from this inflation gauge is that the number of goods driving higher inflation is broadening and not just confined anymore to a few extremes like used cars and gasoline.
EPS and Returns
The graph below, courtesy of Fidelity, shows the correlation between S&P earnings growth (EPS – X-axis) and price performance on the Y-axis. The EPS data is broken into 8 tiers and color-coded. Each color, or specific range of EPS, has a trend line drawn through it. In general returns and EPS are positively correlated as should be expected. There are exceptions. In particular, there seems to be no correlation when EPS is very strong -on the right side of the graph. This is likely due to strong but unsustainable earnings growth coming out of recessions. Conversely, the red circles on the far left are likely periods at market bottoms where prices rose in expectations of a rebound in EPS.
October 14, 2021
Initial Jobless Claims had another nice decline and now sits at +293k, the lowest level since the Pandemic began. The last two weekly claims reports bode well for the upcoming unemployment report. Unlike CPI, PPI was generally weaker than expectations. The headline number rose 0.5% versus +.07% last month. However, the year-over-year number was +8.6%, lower than expectations for +8.7% but above last month’s +8.3%. Core PPI, excluding food and energy, rose 6.8% on an annual basis.
The latest Fed minutes show that tapering of QE purchases is likely to begin in November. It appears they will reduce purchases by $15 billion a month which should eliminate this round of QE by July 2022. $15 billion now serves as a benchmark. Any changes to that amount will help us gauge if they are becoming more aggressive or conservative. There are some members that prefer a faster pace. Per the minutes- “Several participants indicated that they preferred to proceed with a more rapid moderation of purchases than described in the illustrative examples.”
We often note how the Fed uses language at times to complicate matters and put an understanding of their policies and forecasts beyond the reach of many non-economics or finance professionals. Fed members also use vague terminology, allowing them to be technically correct through a wide range of outcomes. In our latest article, What Causes “Transitory” Inflation to Become “Persistent”? we write: “Transitory is a vague term. It can mean minutes or hours or infer years or even decades. 400+ economics Ph. D.s are not dumb. They likely chose the word because it has no clear-cut definition.”
The Fed itself supports our notion of the high-level language they use. In a recent article, the Fed states: “Hernández-Murillo and Shell (2014) showed that the complexity of the language used in the FOMC statement increased towards the end of Bernanke’s tenure to a reading grade level of 20 to 21, equivalent to a least a doctoral degree level of education. The circles in Figure 2 illustrate that since then the Flesch-Kincaid grade level for the FOMC statement language gradually declined under Yellen and has averaged between grades 16-17 thus far under Chair Powell, equivalent to a bachelor’s or master’s degree level of education.“
The following graph accompanies the article. In short, Fed communications remain technical. Unless you hold a college degree or possibly a master’s, Fed communication may be going over your head. In normal times this may not matter. With inflation running hot and the word stagflation being used regularly, the Fed may want to simplify their language or risk creating even more confusion, fear, and behaviors that can foster even more inflation.
October 13, 2021
JPM reported earnings for the third quarter of 2021 this morning. GAAP EPS of $3.74 came in well above the consensus of $3.00, boosted by a $2.1B release of loan loss reserves. Revenue of $29.6B (+1.7% YoY) was in line with estimates, and guidance FY21 for interest income was unchanged at $52.5B. Average loans fell 2% YoY in the Consumer & Community Banking segment and 7% YoY in the Commercial Banking segment; however, they rose 5% YoY on a firm-wide basis, driven by the Assets & Wealth Management segment. The stock is trading 1.7% lower this morning following the earnings release. We hold a 2% position in the Equity Model.
The Market Thinks They Will Raise Rates Sooner
Over the last few weeks, Fed Funds futures have been pricing in greater odds of a rate hike coming sooner than was previously expected. For instance, the June 2022 contract now implies about a 25% chance of a tightening by June. The odds were near zero in mid-September. The December 2022 contract implies a 100% chance of a 25bps rate hike and a 50% chance of a second hike by the end of the year.
CPI came in slightly higher than expectations. The monthly rate of price increases was 0.4%, 0.1% higher than last month. The year-over-year rate, at 5.4%, is also a tad above expectations. The core monthly and annual rates, excluding food and energy, were in line with consensus.
It is important to note that some inflation is the result of deflation or lower prices this time last year. While “base effects” are rapidly lessening, they are still in play. Per Ben Casselman of the N.Y. Times- “Base effects” — the impact of the drop in prices earlier in the pandemic — are still playing some role in lifting year-over-year inflation. If prices had kept rising at their pre-Covid rate last year, September inflation would have been 5% instead of 5.4%.”
Chaikin is Providing a Warning
The graph below shows the S&P 500 with the Chaikin Money Flow indicator below it. The indicator looks back over 20 days and multiplies the daily volume with where the market closes within each day’s trading range. The multiplier is positive when the S&P closes in the upper half of a day’s trading range. Where the market closes in relation to the high or low is multiplied by the volume. High volume and a close at the high or low for the day will produce a strong signal.
Technical analysts use the indicator to help determine if institutions are accumulating or distributing. A green reading (above zero) signals accumulation as it is believed institutions tend to buy late in days. The strength of the recent string of red days signals early strength is followed by late-day weakness. This is a sign of institutional distribution (selling). The Chaikin indicator has not been this deeply negative since 2018.
“Broadening, Not Transitory”
Atlanta Fed President Bostic went where no Fed member has gone since the Pandemic. He stated, “U.S. inflation is broadening, not transitory.” This appears to be the first time a Fed member is voicing concern that higher inflation is no longer transitory. If other Fed members join him in this view, it might speed up the tapering process and bring forward the date of the first rate hike.
Humorously, he started his speech with disdain for the use of “transitory” to describe the recent bout of inflation. To wit: “You’ll notice I brought a prop to the lectern. It’s a jar with the word “transitory” written on it. This has become a swear word to my staff and me over the past few months. Say “transitory” and you have to put a dollar in the jar.”
October 12, 2021
Per the JOLTs report, the number of job openings fell for the first time since April. The number of openings in August was 10.43 million versus expectations of over 11 million. This may be a signal the labor market is getting better, or at least less bad, at matching workers with openings. The quits rate rose to a record 2.9% of the workforce. Typically workers quit jobs when they have confidence in finding a better, higher-paying job. Prior to Covid, the quit rate was around 2.2%.
As shown below the number of openings is still well above normal levels. The second graph below, the Beveridge Curve, highlights the anomaly. At the current unemployment rate of 5.2%, we should expect a job openings rate of about half of what it is. The million-dollar question is whether employers truly have as many job openings as advertised or are there too many unemployed workers either not trained for certain jobs or not willing to accept offered wages.
As we show below circled in red, the 50dma is turning lower for only the second time since the market rebounded in April of 2020. In late October and early November of last year, the 50dma turned lower for six days on a relatively steep 7.5% decline. The current market decline causing the 50dma to fall is only a 4% decline but its duration is almost twice as long as the prior one.
Used Car Prices En Fuego
After a brief rest bit, used car prices rose again in September back to all-time highs as shown in the Manheim Used Vehicle Value Index below. The accompanying report notes: “According to Cox Automotive estimates, total used vehicle sales were down 13% year-over-year in September.” Prices rising with sales falling clearly points to a lack of supply.
Per the report: “Using a rolling seven-day estimate of used retail days’ supply based on vAuto data, we see that used retail supply peaked at 114 days on April 8, 2020. Normal used retail supply is about 44 days’ supply. It ended September at 37 days, which is below normal levels. We estimate that wholesale supply peaked at 149 days on April 9, 2020, when normal supply is 23. It ended September at 18 days.”
October 11, 2021
Staples Getting Historically Cheap
In last Friday’s Technical Value Scorecard in RIA Pro we discussed how cheap the consumer staples sector was getting. To wit: “However, staples are nearly three standard deviations below its 50dma, arguing for a bounce in the coming days.”
SentimentTrader follows up our work with a much longer-term view. As shown below, staples, at about 6% of the S&P 500, have the lowest weighting in the S&P 500 since the tech boom in late 1999. In the year 2000 when that bubble popped, staples (XLP) ended the year up 42%. The S&P was down 10% and the technology sector (XLK) was down over 40%.
Buckle up! This is a big week for key economic data. The JOLTs report on Tuesday will provide more color on the labor market and specifically if job openings continue to at record levels. Wednesday features CPI and the Fed minutes from their September meeting. Given the importance of inflation to the Fed, CPI will help them further hone in on how to taper QE, in regards to amounts and timing. More inflation data follows Thursday with PPI. Retail Sales and the University of Michigan Consumer Sentiment Survey come out on Friday.
Also on tap are the 10 and 30-year Treasury auctions on Tuesday and Wednesday respectively. It will be interesting to see if demand is strong given the recent backup in yields.
If you crave more information, have no fear, earnings for the major banks start on Wednesday with JPM. Many of the largest banks follow them on Thursday. Most other companies will release earnings over the coming six weeks. Beyond earnings and revenues, investors will be paying close attention to forward guidance, in particular how inflation is affecting their bottom line.
Dividends over Oil Production
Last Friday we wrote how oil rig counts were rising slower than is typical considering the current price of oil. Another consideration is the transition to cleaner forms of energy. As Reuters writes below, companies like Occidental are not clamoring to increase production.
(Reuters) – U.S. oil and gas producer Occidental (OXY.N) wants to raise margins and re-establish dividend payments for its shareholders rather than focus on growing its production volumes, Chief Executive Vicki A. Hollub said on Thursday.
Oil companies can best contribute to the energy transition by producing just enough oil to meet demand in a way that is more efficient and produces fewer emissions, the CEO said.
“We don’t see that in 2022 and beyond that we need to grow significantly,” Hollub said at an online event by the Energy Intelligence Forum.
“Our growth in the period, and maybe over the next ten years, will more be to reestablish dividend and grow that dividend”.
Risk/Reward Measures show Energy and Financials stretched.
October 8, 2021
The BLS Jobs report was weaker than expected, with job growth of 194k. Expectations were for a gain of between 475k and 500k jobs. The BLS revised the prior month higher to 366k from 235k. The unemployment rate did fall from 5.1 to 4.8%, however, it was in part due to people dropping out of the workforce. 183k people left the workforce causing the participation rate to fall from 61.7 to 61.6%. With the number of job openings so high and jobless benefits ending we find it surprising people are leaving the workforce. Also interesting was temporary help fell slightly. With so many job openings one would expect many companies to hire temporary workers to fill gaps until they can hire permanent workers. The graph below from True Insights shows payroll growth is starting to fall back in line with pre-pandemic rates of 150-200k per month.
Bill Dudley, President of the New York Fed from 2009 to 2018, in a Bloomberg editorial, voices concern the Fed is too worried about deflation, or as he says, the “last war.” He argues the Fed should be concerned inflationary pressures are more than transitory. He prefers the Fed take on a more hawkish tack sooner rather than later. Per Dudley: “This dovishness increases the risk of a major policy error. If the economic outlook evolves in unexpected ways, Fed officials will almost certainly be slow to respond…” “Hence, if inflation proves more persistent than anticipated and even accelerates as the economy pushes beyond full employment, they’ll have to tighten much more aggressively than they expect.” Further, “A faster pace of tightening would come as a shock for financial markets and could risk tipping the economy back into recession. That’s the danger of fighting the wrong war.”
Oil Prices and Rig Counts
The graph below compares oil prices to rig counts. After falling to recent lows, rig counts are rising. However, they are still well less than should be expected given current oil prices. Why are oil producers not adding rigs and producing more oil to take advantage of higher prices? There are a few reasons. First, OPEC is increasing production and will get more aggressive if prices keep rising. Second, oil producers realize the current economic boom and spike in economic activity, and demand for oil is temporary. It is the result of short-term fiscal stimulus and economic normalization. Lastly, President Biden is threatening to release oil from the strategic oil reserves. If the government indiscriminately caps the price of oil via rhetoric and action, the incentive to produce and add rigs is lessened.
October 7, 2021
“Inflation” Coming Next Week
The graph below, courtesy of the Market Ear, shows how mentions of inflation are a hot topic for earnings calls. As we gear up for another round of earnings releases starting in earnest next week, there is little doubt the number of “inflation” mentions will increase further. The question facing shareholders is how well can companies deal with inflation? Can they take advantage of higher prices or will they negatively impact profit margins? Each company and industry has different factors to consider that will help answer those questions.
From a macro perspective, we will also learn a good deal about expectations for continued inflation in the coming quarters. The Fed speaks with executives at many large companies, so this information will also help us better assess our outlook on the potential pace at which the Fed tapers QE.
Following yesterday’s strong ADP report, the labor market showed more improvement. Weekly Initial Jobless Claims fell back toward a post-covid low of 326K. This was below expectations of 348k and well below last week’s 364k.
St. Louis Fed Expects an Ugly Jobs Report While JPM is Optimistic
Per Market News (MNI), the St. Louis Federal Reserve expects to see an 818k decline in tomorrow’s BLS payrolls report. St. Louis Fed economist Max Dvorkin states: “There’s still “a lot of uncertainty around these figures,” but the model has tracked actual CPS employment “quite well” through the summer, he said.” He blames the recent uptick in Covid cases and the impact on global supply lines. The current forecast is for a gain of 410k jobs. If the Fed’s forecast is proven correct the Fed might delay what appears to be a tapering announcement in early November.
On the other hand, JP Morgan is optimistic “we are looking for a 575,000 gain in jobs and a drop in the US unemployment rate to 5%. The driver for an above-consensus forecast is the expected rebound in the leisure and hospitality sectors.”
Retail Inventories are Low
Price pressures, especially on retail goods, will likely continue into the holiday season. The graph below shows the ratio of Retailers’ inventories to sales is at a 25+ year low and well below pre-pandemic levels. Given there appears to be little let-up in supply line problems, it’s becoming increasingly probably that many retailers will not be able to fully stock their shelves to meet the heavy demand for Christmas presents. With, the limited inventory we suspect many stores, both online and brick and mortar, will be able to raise prices over the next few months.
October 6, 2021
Delaying the Debt Cap Limit
Senator McConnell has supposedly told a closed-door meeting of Senate Republicans that he would offer a short-term debt ceiling extension today. Stocks recovered from their morning losses on the rumor.
ADP Jobs Report
The ADP Employment report shows strength in the jobs market during September. Per ADP, there was a net pick-up of 568k jobs in September versus 374k in August. The services sector accounted for about 80% of the gains with leisure/hospitality accounting for 226k jobs.
“Leisure and hospitality remain one of the biggest beneficiaries to the recovery, yet hiring is still heavily impacted by the trajectory of the pandemic, especially for small firms. Current bottlenecks in hiring should fade as the health conditions tied to the COVID-19 variant continue to improve, setting the stage for solid job gains in the coming months.” – Nela Richardson, chief economist, ADP.
The Atlanta Fed’s forecast for Q3 GDP growth fell again from 2.3% to 1.3%. The forecast was over 5% in early September. The worsening trade deficit and weaker than expected ISM Services Index are to blame for the latest revision.
Volatility Is Not Living Up To Hype
Watch a few minutes of CNBC and you would think recent daily market gyrations are extreme. In prior commentaries, we note that volatility and the put/call ratio are not signaling much concern. The reason is that the roller coaster the market has been on over the last week or two or is not that daunting. Dare we say it’s a kiddie ride. The graph below charts the absolute daily price change of the S&P 500. As circled, daily changes are running above 1% a day. While above-average, there is nothing too unusual about it.
Utilities vs. Energy
The bar chart below, courtesy of Charles Schwab, shows 100% of energy stocks in the S&P Energy sector are above their 50dma. Conversely, not one utility is above its 50dma. XLU, the utility sector ETF, is sitting on its 200dma while XLE (energy) is about 15% above its 200dma. The second graph shows XLU is resting on important support in both the 200dma (red) and a support line (lime) going back to June 2020. We added utilities to both RIA Pro portfolios over the last week, as we believe support will hold and a bounce is probable. However, caution is warranted as higher natural gas and coal prices may weigh on the sector, forcing it to break support.
October 5, 2021
ISM Services Weakening
The services sector is not showing nearly as much strength as manufacturing. Last week we noted the ISM Manufacturing Index rose to 61.1, which, while off recent highs, is still at levels commensurate with prior peaks over the last 20 years. ISM Services on the other hand fell to 54.9 today and is 15 points below recent highs of 5 months ago. It is now normalized with pre-pandemic levels.
Put/Call Ratio is not Fearful
In Monday’s commentary, we showed the VIX is higher but not rocketing to levels that would cause more concern. The put/call ratio, another indicator of investor stress, is elevated, but like the VIX, not at concerning levels. As shown, the ratio is still below levels seen in prior 2-5% declines over the last year. The current instance pales in comparison to the surge in March 2020.
The graph below, courtesy of Bianco Research, helps put the recent 7% sell-off in the NASDAQ into perspective. As shown, there have been four other declines which have been greater than the current one in just the last year. While recent price action may be concerning, the markets have not done anything overly concerning. That said, valuations are sky high and the Fed is about to embark on tapering QE, so we want to manage our risk closely.
Energy Defying the Market
Despite the S&P 500 falling by about 1.50% yesterday, the energy sector (XLE) rose by a similar 1.50%. As we have shown previously, crude oil ($77.70) is bumping up against long-time resistance of $76-78. A break above resistance could lead to a substantial rise in oil prices. Crude was up over 2% yesterday as rumors spread that OPEC will follow its plan and increase production by 400,000 barrels in November. Some traders were expecting a larger increase in an attempt to limit higher oil prices. Further helping many of the oil companies is a surge in the price of natural gas. Yesterday it rose over 2% to $5.75, more than double its price from spring.
In yesterday’s Gamma Band Update Erik Lytikainen wrote: “There have been three straight weeks that the SPX has failed to overtake the Gamma Flip level, which is currently near 4,440. Our risk-avoiding model currently has an allocation of 30% to SPX and 70% cash. If the market closes below what we call the “lower gamma level” (currently near 4,285), the model will reduce the SPX allocation to zero.”
Erik’s model is reducing exposure because options gamma has flipped negative. Simply, it is at a point where further moves lower in the S&P 500 result in increasingly more selling by options dealers. When prices are above the gamma flip traders need to buy to hedge their books. The graph below confirms his analysis, showing the Gamma Flip level just north of 4400. Given how large options volume has become this year and general market illiquidity, options hedging is a significant cause of price change and may result in more volatility.
October 4, 2021
We are about midway through the trading day and the equity markets are lower. The NASDAQ is leading the way down nearly 2%. The Dow is only down 1%, supported by energy stocks which are up over 2% today. Despite the decline, the VIX is not increasing as much as might be expected. As shown, the VIX is in the same range it has been for the past four days and below levels from the first leg lower on August 20th. A break out to higher highs in the VIX, in conjunction with lower prices, might force short volatility traders to cover, which would add further to downside pressure in the markets.
The graph below shows how well the 50DMA has supported the market since the swoon of March 2020. The bottom graph shows the difference between the S&P and the moving average. As highlighted it is currently 2-3% below the moving average, similar to dips in October and November of 2020. While the decline may not feel great, it has yet to show us something different from what we have witnessed over the past year and a half. A further breakdown, especially below the 100dma would be concerning. Conversely, if the S&P 500 re-takes the 50dma, it may likely head back to record highs. As we have been saying over the last few weeks, all eyes are on the 50dma.
This will be a quiet week for economic data, yet one of the most important of the month. ADP comes out Wednesday with expectations for a gain of 415k new jobs added. The BLS will release its payrolls report on Friday. Economists expect 475k new jobs versus a weak 235k last month in that report. If both data points come near or better than estimates we should assume the Fed will announce tapering QE at their next FOMC meeting (11/03).
Speaking of the Fed we expect they will remain quite vocal this week. As we saw last week, we expect them to continue to reflect concern about inflation and promoting taper soon. Vice-Chair Clarida joins other Fed members in being exposed for personal trading prior to important Fed statements. We suspect, as a result, Powell will not be renominated.
Earnings season kicks off this week but there are not any major companies set to report. The banks will effectively lead off Q3 reporting next week.
Banks Are Not Lending
The graph below from Brett Freeze is a very powerful summary showing why monetary velocity is not rising. As we have written, inflation is a function of money supply and monetary velocity. Fading velocity has offset a large chunk of the surge in the money supply. As his graph below shows, banks are investing in secondary securities, mainly U.S. Treasuries instead of lending money. The tradeoff between the two is normal but the current levels are somewhat extreme.
Today’s release of the Atlanta Fed’s GDP forecast took another big tick lower. As shown below, it now stands at 2.3% for the third quarter, down from 3.2%.
Farrell’s Rule #5 Continued
Yesterday we shared Bob Farrell’s rule #5- “The public buys the most at the top and the least at the bottom.”
Today we follow it up with evidence from Jim Colquitt at Armor Index ETFs. Jim’s graph below compares the average investor allocation to equities to S&P 500 future 10-year returns. As we see, the data is very well correlated lending credence to rule #5. Note the correlation statistics at the top left of the graph.
More importantly, current allocations to equities are more than two standard deviations above the norm. Per Jim- “Since 1952, we’ve only had 4 quarterly observations above the two standard deviation line. Each of which resulted in negative returns (CAGR) for the subsequent 10 years. We now have a 5th.”
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ISM Better Than Expected
The ISM national manufacturing survey was better than expected despite declines in many regional surveys. ISM Manufacturing rose to 61.1 versus estimates of 59.5 and 59.9 in the prior month. Employment bounced back into economic expansionary territory and inventories rose, hopefully signaling the supply side shortfalls may be getting better. Prices continue to reside at very high levels. The prices subcomponent is 81.2, up from 79.4.
Higher Prices, Weaker Income, and Strong Consumption
Today’s Personal Income and Outlays report was not welcome news for consumers. Personal Income only rose 0.2% versus 1.1% last month. Personal Consumption Expenditures (PCE) a direct feed to GDP was +0.8%, much better than last month’s revised -0.1%. Also, the price index and core price index were 0.1% above expectations and in line with last month. The PCE price index rising to 4.3% is the largest annual change since 1991. The PCE price index serves as the price deflator to calculate real GDP. The Fed’s term “Transitory” to describe the recent surge in inflation is starting to get long in the tooth!
The chart below, from MacroMarkets Daily, shows there are now 8 of 35 central banks increasing interest rates.
Bill Farrell Rule #5
The graph below, courtesy of the Daily Shot, serves as a good reminder of Bill Farrell’s rule #5. “The public buys the most at the top and the least at the bottom.”
Inflation Greater than 3%
The graph below, courtesy of Brett Freeze, shows the Minneapolis Federal Reserve’s implied probability for inflation running greater than 3% for the next five years. The probability is derived from derivative markets. Currently, the Fed puts the odds at approximately a one-third chance inflation runs at 3% or greater. The Fed’s long-term goal is 2%. Interestingly the President of the Minneapolis Fed, Neel Kashkari, remains the most dovish member on the board. Based on comments he expects inflation to run well below 3%.
September 30, 2021
QE is in the Budget Fray
As if the Democrats did not have enough trouble passing a budget deal, they have a new hurdle per the headline below. Fed independence continues to weaken as it is now a pawn in the budget battle.
MANCHIN TOLD SCHUMER HE WANTED THE FED TO END QE AS A CONDITION FOR A BUDGET DEAL
Chip Shortage for Autos
Want to know why production at most major auto manufacturers is being sharply reduced? The Bloomberg illustration below shows the average car uses 1,400 chips. Some estimates claim the chip shortage may not be fully resolved until 2023.
Yesterday we published China Plays The Long Game While The U.S. Blows Bubbles. The article discusses recent actions China is taking to boost productivity. Also in the article, we criticize the U.S. and other capitalistic countries for failing to prioritize productivity. For example: “For the better part of the last five years, S&P 500 companies have given back to investors via dividends and buybacks about 100% of their earnings. Why not? Executives are paid handsomely to boost share prices today, not to be more productive and profitable in the future.”
To further emphasize the point we share the Fidelity graph below which breaks down buybacks by industry. Since 2004, U.S. companies have spent $11 trillion to buy back their own shares. Instead, imagine if they invested $11 trillion into productive ventures. Corporate earnings, economic growth, and wages would certainly be higher today and more sustainable.
Initial Jobless Claims rose for a third week in a row to 362k. We are not overly concerned with the recent increase as there are seasonal aspects and hurricane Ida affecting hiring/firing patterns. However, we do not want to see the recovery in claims stop at this relatively high level. Prior to the pandemic, initial claims ran in the low 200k range.
The dollar was up over .60 cents yesterday and is now hitting formidable resistance as we show below. The dollar appears to be forming a head and shoulder bottom. Based on the pattern, a breakout above the red resistance line (neckline) might likely result in the dollar index moving up another $5. Commodities and possibly equities are at risk if that occurs.
Stocks and Bonds Travelling Together
Bonds typically fall in yield during measurable declines in the stock market, making them a great diversifier. The graph below shows that in each “sell-off” over the last ten years, except one, Treasuries had positive returns. That standout is occurring now. It’s early to claim bonds will not diversify equities if the decline continues but it bears watching.
September 29, 2021
Housing is Red Hot
Pending Home Sales rose 8.5% in August after two straight monthly declines. The change in year-over-year sales is still negative but the monthly trend is clearly on the rise again as shown below. Per the National Association of Realtors President, Lawrence Yun, “rising inventory and moderating price conditions are bringing buyers back to the market.”
His comment about moderating price conditions is debatable. Yesterday, the Case-Shiller 20-City Home Price Index rose another 1.5% monthly and is now up nearly 20% annually. Prior to the pandemic, the index rose approximately 3-6% a year. At the housing market’s peak in 2006, the Case-Shiller Index rose 15% annually.
Defense is not Working
As we discuss in our 3 Minutes on Markets video, bonds did not rally to help offset losses in stocks yesterday. While bonds and gold tend to historically provide diversification to an equity portfolio, such is not always the case. In fact, days like yesterday are recently becoming a little more common. The last 3 times the S&P fell by 2% or more in a day, the 10-year Treasury price, gold, and bitcoin also fell on the same day.
Extreme stock and bond market valuations are largely predicated on the Fed’s ability to provide excessive liquidity via low rates and QE. Given confidence in the Fed is paramount to valuations we offer some concern at recent disclosures implicating Fed members. In particular, are those of Dallas President Robert Kaplan. The quote below is from Wall Street On Parade.
Each of Kaplan’s financial disclosures forms dating back to when he first became Dallas Fed President on September 8, 2015 (which we obtained directly from the Dallas Fed), show that Kaplan was trading in and out of S&P 500 futures, a highly speculative form of trading used by hedge funds and day traders.
Given Kaplan had access to non-public information, including transcripts of potential market-moving speeches yet to be released from Fed Chairs, the allegations are serious. Over the coming days and weeks, we need to ascertain if investors care and further if Congress will take any action that might inhibit the Fed’s policy thought process.
Another consideration is whether or not the disclosures provide President Biden a reason to nominate Lael Brainard instead of granting Powell a second term. The graph below shows the odds favor Powell, but they have come down in recent days.
Will Yields Surprise To The Upside?
The graph below, courtesy of Ed Yardeni, shows the strong correlation between the Citi Economic Suprise Index and ten-year UST yield changes. The Citi index measures economic data estimates versus actual readings. Over time the index oscillates as economists move back and forth from overestimating economic activity to underestimating it. As shown below in red, economists have been over-optimistic recently but given this data series in the past, it is likely reaching a point where economists start under forecasting economic data. If this proves true, yields are likely to rise over the coming weeks.
September 28, 2021
Richmond Fed Goes Negative
The Richmond Fed Manufacturing Index now points to economic contraction at -3 versus estimates of 10 and a prior month reading of 9. The regional index is at its lowest level since May 2020. While most sub-indexes fell, the good news is that employment is still expanding. Yesterday, the Dallas Manufacturing Index fell from 9 to 4.6 but remains in expansion mode. The ISM National Manufacturing Index will be released on Friday. Expectations are for a minor decline but keeping it well within an expansionary mode.
Per CNBC: “Ford (F) – Ford is accelerating its push into electric vehicles, with plans for a new U.S. assembly plant and three battery factories. Ford and South Korean partner SK Innovation will invest more than $11 billion in the project. Ford shares rose 3.3% in premarket trading.” We hold a 3% in F in the 60/40 Equity Model.
Hawks are Fleeing The Fed
Dallas Fed President Kaplan is following Boston Fed’s Rosengren in retiring from the Fed. The announcements come in the wake of disclosures about their active trading activity. Both members were hawkish and outspoken about their desire to taper QE and ultimately raise rates.
Dow or NASDAQ?
In the aftermath of the last Fed meeting, value and cyclical stocks are edging out growth stocks. Given the recent jump in yields and outperformance of energy, materials, and industrials, the market may be voicing concern the Fed is late to stop inflation. We recently boosted allocations to cyclical and value sectors as their respective technical setups are enticing and the possible reflation rotation may be back on. To help us track a reflation rotation we can use the ratio of the more value-centric Dow Jones to the growth-led NASDAQ. The graph below shows the recent uptick in Dow versus the NASDAQ. Also, note that the MACD of the ratio is turning up and the RSI is above 50. If the reflation trade is on again, the relative upside of the Dow and value/cyclical sectors can be very rewarding. From February to June of 2021, during the last inflation scare, the Dow beat the NASDAQ by about 15%.
Inflation on the Mind
The graph below from Teddy Vallee shows that inflation concerns are top of mind in corporate earnings outlooks. In a couple of weeks, corporations will start announcing quarterly earnings. We suspect many companies will highlight how they are handling margin pressures due to higher wages and input costs. For companies that can push through said costs to consumers, the outlook should be better than for those that can’t.
September 27, 2021
Atlanta Fed GDPNow
The Atlanta Fed GDPNow forecast for Q3 GDP continues to fall. It now stands at 3.2%, down from 3.7% a week ago, and is now almost half of what it was in mid-August. As shown, the delayed forecast from economists is at 5% but following the GDPNow trend lower.
Northwestern University quantifies the effect of higher oil prices on a President’s approval rating. Per the Financial Times: “A study by researchers at Northwestern University in 2016 found that for every 10-cent rise in petrol prices, the approval rating of the incumbent president dropped by 0.6 percentage points, after controlling for other factors.”
With the mid-term elections a year away and oil prices on the verge of a breakout higher we may start to see the administration pressuring Chairman Powell to better control inflation. Powell is up for renomination as his term expires in February. Will political expediency push the Fed to tighten more aggressively than they might have otherwise?
Critical Technical Resistance For Crude
As we show below, crude oil is sitting just under $77 a barrel. Over the last ten years, that price has marked significant support and more recently resistance. A decent break above $77 and there is little resistance before possibly seeing triple-digit prices. Shortages in Britain are providing a tailwind to the price. Goldman Sachs is optimistic, raising their price target on Brent Crude oil to $90 for year-end.
The Week Ahead
This week will mark a quarter-end so expect a little more volatility as traders do a little window dressing.
There are a decent number of economic data points this week. We lead off today with Durable Goods Orders and the Dallas Fed Manufacturing Index. Later this week the Richmond Fed, ISM, and Chicago PMI will provide more updates on the state of manufacturing. Given heightened concerns over inflation, the reports’ prices sub-index and related comments will be important. On that same thought, the PCE price index for August will be released on Friday. The Fed prefers PCE over CPI. Current expectations are for a gain of 0.3% versus 0.4% last month.
There will be plenty of Fed speakers this week. Many of them will further clarify their thoughts and outlooks for monetary policy going forward. Keep an ear out for any comments on Evergrande and China, and their implications for economic growth and ultimately policy.
August new home sales came in above expectations at 740k (+1.5% MoM) versus a consensus of 708k. The median new home sales price grew to $390,900, which represents a massive increase of +20.1% YoY.
China Crackdown Continues
Cryptocurrencies are selling off following news that the PBOC has declared all cryptocurrency transactions illegal. According to ZeroHedge, “In a statement the People’s Bank of China said the latest notice was to further prevent the risks surrounding crypto trading and to maintain national security and social stability.” Prices have previously dipped and recovered from attempts by the CCP to squash digital currencies. Will this time be different?
COST reported earnings for its fourth fiscal quarter yesterday after the close. GAAP EPS of $3.76 comfortably beat expectations of $3.58. Fourth quarter revenue came in at $62.7B (+17.4% YoY) versus the consensus estimate of $61.5B. Sales growth was primarily driven by comparable store growth of 15.5% YoY, with double digit growth in all operating segments. We hold a 1.5% position in the Equity Model.
Bonds Get Routed
Bond yields rose significantly yesterday, following a decent performance after the Fed policy statement on Wednesday. While too early to tell if yesterday’s move is just technical, it may be an early warning from bond investors that the Fed is behind the curve in tapering. Market implied five-year inflation expectations rose from 2.41% to 2.48%, supporting our concern.
Today bonds are being punished further, with the 10-Y yield pushed up 4 bps to 1.45% by mid-morning. If the 10-Y yield remains elevated through the close, it will have reached its highest point quarter-to-date.
Did Ending Jobless Benefits Help?
The Wall Street Journal helps answer our question. Per their article, States That Cut Unemployment Benefits Saw Limited Impact on Job Growth, “States that ended enhanced federal unemployment benefits early have so far seen about the same job growth as states that continued offering the pandemic-related extra aid, according to a Wall Street Journal analysis and economists.” The graph below shows there is no discernable difference in job growth between states that ended benefits during the summer and the states in which they just expired.
Starting today and through next week, Fed members will make their thoughts known through a plethora of speaking engagements.
September 23, 2021
The PMI composite index fell slightly as growth is “hampered by severe supply chain hold-ups and capacity shortages.” Both manufacturing and services sectors continue to signal solid economic expansion. Inflation however remains a concern. The following paragraph from the report leads to concern the recent stabilization in headline inflation data may not be lasting: ”
On the price front, input costs rose at a sharper pace during September. The rate of cost inflation was the quickest for four months, and the second-highest on record, as supply chain disruptions and material shortages pushed prices and transportation costs up. Meanwhile, output charges continued to increase markedly, continuing to rise at a pace far outstripping anything seen in the survey’s history prior to May, as firms sought to pass on higher costs to clients where possible.
The Evergrande Saga
Evergrande is required to pay $83 million of interest on a dollar-denominated bond today. Per Newsquawk, they have a 30-day grace period as part of an existing agreement before the debt is classified as a default. It appears as if Evergrande may give a preference to paying off Yuan-denominated debt and obligations over foreign-held dollar-denominated debt. They have another $47.5 million dollar-denominated interest payment due next week.
The two graphs below are the “dot plots” from the Federal Reserve showing Fed member expectations for where the Fed Funds rate will be in the coming years. The graph on top is the set of projections from June. At the time only 5 members thought they would raise rates four times or more by the end of 2023. As shown on the bottom graph, with yesterday’s projections, that number stands at 9. There are also 2 more Fed members that think the Fed will hike rates in 2022 compared to three months ago.
All Ears on the Fed
With the Fed meeting behind us, Fed members can now speak publicly. We expect a deluge of speeches and interviews over the coming days as members try to clarify the Fed’s views as well as their personal opinions. We are on the lookout for dissension in the ranks by the members that are overly concerned with higher inflation. While Powell clearly set out a time frame for taper, the Fed might get cold feet if the equity markets turn lower. If that were to happen some of the hawks may become even more vocal about the need to taper and ultimately raise rates. In The Fed Speaks Loudly and Carries a Feather, we decompose the Fed members by their voting status and degree of influence. The chart below and the article provides some context for their latest thoughts on the economy and policy.
September 22, 2021
Powell Q&A Session: A More Hawkish Picture
Following a vague reference to taper in the FOMC statement, Jerome Powell made some hawkish comments during his press conference:
With respect to progress towards taper, Powell commented, “In my own thinking, the test is all but met”.
“I think if the economy continues to progress broadly in line with expectations and the overall situation is appropriate for this, we could easily move ahead [with taper] by next meeting, or not…”
Again, with respect to a decision for November taper, “I don’t need to see a good employment report next month; I just need to see a decent employment report”. Powell is clearly signaling that Fed is likely to announce taper in November barring an unexpected deterioration in economic conditions.
Powell commented that it may be appropriate for taper to conclude by mid-2022.
As expected, Powell is leaving a back door open in case taper doesn’t go over well. “If necessary, we can accelerate or decelerate the taper”.
Taper Talk Continues
Changes to the FOMC statement are highlighted below. Of note, the Fed signaled taper could be around the corner, but did not drop any hints in the statement with respect to timing. “Since then, the economy has made progress towards these goals, and if progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted”. However, in the FOMC press conference Q&A session, Powell noted that taper could come “as soon as the next meeting”.
The Fed reduced their projection for 2021 real GDP growth to 5.9% from 7%. Further, the Fed raised their core PCE inflation forecast for 2021 to 3.7% from 3.0%. The “dot plot” graph on the left shows the level of Fed Funds that each Fed member expects by year. There are now 9 FOMC members that think the Fed will hike rates as soon as next year, compared to only 7 in June. This represents an even split between members that see liftoff in 2022 and those who don’t, and could have implications for the pace of taper once initiated.
ADBE reported earnings for the 3rd quarter yesterday after the close. GAAP EPS of $2.52 easily beat the consensus estimate of $2.29. Similarly, revenue of $3.94B (+22% YoY) beat expectations of $3.54B, driven by a 24% increase in subscription revenue. Management guided to Q4 revenue of $4.07B- slightly above the consensus of $4.05B. Guidance for non-GAAP EPS is also above consensus, at $3.18 vs. an expected $3.09. ADBE is down ~4% in pre-market trading despite beating expectations across the board and guiding above consensus for Q4. We hold a 1.5% position in the Equity Model.
FedEx is Raising Prices
Federal Express announced that effective January 2022, FedEx Express, FedEx Ground, and FedEx Home Delivery shipping rates will increase by an average of 5.9%. FedEx Freight rates will increase by an average of 5.9% to 7.9%. We suspect UPS and other carriers will take similar action. Given a large number of goods are now ordered online, the increase in shipping costs will inevitably work its way into higher prices next year.
Cash on the Sidelines
The graph below from Sentimentrader compares the amount of cash in money market funds to corporate equity issuance. Per Sentimentrader:
“During the pandemic panic, the ratio neared 30 and was the highest in 30 years. In other words, there was 28 times more cash available than shares offered in supply. There are ways to quibble with the technicals, but it’s simply meant as a reflection of sentiment.
Over the past year, the ratio has declined steadily as supply ramped up. Corporations are “feeding the ducks,” as the saying goes. Even though money market assets haven’t been drained much, the skyrocketing supply has caused the ratio to drop below 10 for the first time since the year 2000.”
Declining Earnings Confidence
The graph below, courtesy of the Market Ear, shows declining sentiment towards earnings expectations. Each line representing the four major global equity markets shows the number of earnings upgrades less the number of downgrades, divided by the total number of estimates. Each line is approaching zero but still above it, denoting net confidence remains positive but if falling.
Employment and inflation tend to get the headlines as far as rationales for the Fed to take action. As we consider what the Fed may do tomorrow, we should also consider lending standards. The graph below shows the lending standards for large banks’ credit card customers are as easy as they have been in 20 years. On its own, very easy lending standards, as we have, push the Fed toward a more hawkish stance. Easy borrowing conditions incentivize personal consumption. More consumer activity, especially given current supply line problems, is likely to further agitate inflationary conditions.
Trading Game Plan for the S&P 500
The markets are trading well in overnight trading following yesterday’s late-day bounce. The sizeable bounce provides us with another set of levels, in addition to the 50, 100, and 200-dmas, to guide our trading. The graph below shows the Fibonacci retracements from the recent high to low. If this rally proves to be a bull trap, it is likely to give up between the 38% retracement (4395) and the 62% retracement (4451). There is also a gap between 4400 and 4430. It is common for such gaps to fill and then reverse direction. If the market surges higher through the gap and retracement levels, the outlook becomes more bullish. A rally above the 4451 retracement level and well through the 50dma (4436) will likely lead to new highs. Conversely, the 50 dma (4436) may prove to be resistance. The first line of support is yesterday’s lows and the 100dma (4328). A break of the recent low leaves a target of 4106, the 200dma.
Will They or Won’t They?
In addition to concerns with China, Evergrande, and possible contagion, the markets are also grappling with Wednesday’s Fed meeting. In what was likely a purposeful leak last week, the WSJ laid the groundwork for a taper announcement Wednesday and the reduction in asset purchases in November. With the U.S. and foreign markets skidding yesterday some are asking how the Fed might react. In a Bloomberg interview, ex-New York Fed President, Bill Dudley, warns “They’re not going to react to small market moves and defer the tapering on that basis. They have to change their economic forecast,” he said Monday during an interview on Bloomberg Television with Lisa Abramowicz, Tom Keene and Jonathan Ferro. “At this point, it’s really premature to reach that conclusion.”
There is a lot more to the failure of China’s Evergrande company than meets the eye. At $16 billion, (China’s GDP) is no longer that far from that of the U.S. ($22 billion) and nearly three times Japan, the world’s third-largest economy. What China does and how they do it matters a lot, not just to China but for the global economy. To help keep you better informed, we share a must-read commentary of the situation from @INArteCarloDoss.
With the S&P trading poorly this morning, we share an important graph to help you manage risk. As we show, the 50dma in blue has proven great support. However, the market is now trading more than 1% through that support this morning. The next level to watch is the 100dma, which was supportive in the fall of 2020. Breaking the 100dma may likely lead us to the 200dma at just over 4100.
60 Minutes Warned Us
In a memorable show, which aired eight years ago, 60 Minutes reported on China’s property bubble and ghost cities. The Evergrande Company, on the verge of default and mentioned in the clip, is just the tip of the iceberg. If you want to better understand the imploding bubble China faces watch the dated but poignant short episode- LINK.
The Week Ahead
The Fed’s FOMC meets on Tuesday and Wednesday. Investors will focus on the policy statement and press conference at 2:00 and 2:30 pm ET respectively. Some sort of taper announcement is widely expected with tapering likely to begin in November. The market will need to digest the pace at which they plan on tapering and what events or economic data may cause them to speed it up or slow it down. If they do not announce tapering, there is another factor that few investors are considering. As we wrote in The Fed Speaks Loudly and Carries a Big Feather, there is the possibility of dissension from some voting members. Per the article: Will they dissent? One or two dissents, while not frequent, are not uncommon either. The market reaction might be muted to a bit of friction. Where we offer caution is if the number of dissenting voters totals four or five or even more.”
The economic calendar is relatively light this week with a slew of housing data. Of interest will be the Thursday PMI survey. This will be the first national survey of manufacturing conditions for September. Recent regional manufacturing surveys have been better than expected over the last week, leading us to believe PMI may as well.
After last month’s plunge, the University of Michigan Consumer Survey was stable at 71.0, up slightly from last month. The index is well off the 110-120 rate it was running at for most of 2018 and 2019. Of focus, one year expected inflation seems to be stabilizing albeit at a high 4.7% rate. Longer-term 5-10 year expectations are 2.9%. Per the survey, inflation concerns are spreading to a broader chunk of the population. Consider the following quote: “over the past few months, complaints about rising prices have increased among younger, richer, and more educated households”
Excess Cash No More
On many occasions this year we noted how the Treasury is carrying excessive levels of cash. The graph below shows the spike in cash due to the massive pandemic-related debt issuance and slow-to-follow spending. Federal spending has caught up, and cash balances are back to normal. The result will be an increase in the supply of Treasury debt. This dynamic is occurring at the same time the Fed is contemplating buying fewer bonds. Over the last six months, Treasury supply has not been a concern for the market due to large Fed purchases and reduced issuance. The supply/demand equation will change in the months ahead possibly pressuring yields higher.
Shipping Costs Soar
Is it Time to Buy the Dow?
The ratio of the Dow Jones Industrial Average to the NASDAQ is approaching levels last seen at the peak of the Tech Bubble. Favoring the Dow over the NASDAQ paid handsome dividends from 2000 to 2003. Are we nearing a similar opportunity? The composition of the Dow has changed over the last 20 years. Unlike, the late 90s the Dow now has more tech exposure, like Microsoft at 5.7% of the index and SalesForce at 4.8%. It also holds Apple, albeit at a lesser weight. The Dow’s three top holdings, accounting for a fifth of the index, are UNH, GS, and HD. That compares to the NASDAQ’s top three holdings AAPL, MSFT, and AMZN account for nearly a third of the index. While the Dow has MSFT and other tech companies, a bet on the Dow is a bet against the world’s largest technology companies. Currently, the FAANG stocks driving the NASDAQ’s outperformance are considered both high growth and safety stocks. That narrative must change before the Dow has a fighting chance.
September 16, 2021
Junk Bonds in China
The graph below continues our discussion of Evergrande. Yields in China’s junk bond market have doubled since late May. The problems facing its property markets and economy, in general, are widespread. China’s junk bond yields are back to levels when COVID first roiled markets. As a comparison, BofA’s B-rated U.S. junk index is 4.41%, well below 12.50% from March 2020.
Retail Sales on Fire
U.S. Retail Sales unexpectedly rose 0.7% in August versus an expected .8% decline. However, last month’s data was revised from -1.1% to -1.8%. Excluding gas and autos, sales rose 2.0%. While the data is economically positive, the markets may not like it as it bolsters the rationale for tapering.
Jobless Claims rose last week to 332k. Louisiana reports the biggest increase in large part to Hurricane Ida. This is the first report after the federal pandemic unemployment benefits were rescinded on September 6th.
China’s largest real estate developer, Evergrande, is suspending trading in its bonds today but intends to resume trading tomorrow. The rumor is they will not pay interest or repay principal on any of its debt this week. Evergrande, with over $300 billion in debt, poses risks to the Chinese banking system and many foreign creditors. It is unclear whether the Chinese government will bail out its shareholders. With its stocks and bonds trading down significantly, investors are betting against it.
The table below, courtesy of Goldman Sachs, shows the sensitivity of each sector to rising labor costs. Industrials, which are typically labor-intensive businesses are not surprisingly, the most affected sector. It’s also worth noting, as shown at the bottom of the table, smaller companies have twice the EPS sensitivity to labor costs as larger companies.
Ferrari’s are Cheap
We finally found a valuation technique that claims stocks are cheap. The graph below compares the earnings yield of the S&P 500 to junk bond yields. To put this technique into context, it is like saying a Ferrari is cheap when compared to a Lamborghini. Junk bonds have never been more expensive. Currently, the B-rated, Bank Americal junk bond index yield is 4.44%, about 2% below its average from 2016-2019. It’s also worth noting this measure deems stocks as expensive at the market lows of 2001, 2009, and recently in March of 2020.
September 15, 2021
Trouble in China?
Stringent lockdowns in response to a delta variant outbreak are showing up in China’s economic data. YoY growth in retail sales fell to 2.5% in August versus the estimate of 7% from a Bloomberg survey of economists. Furthermore, construction investment is down 3.2% YTD following China’s new property restrictions, which is impacting global demand for commodities. For example, Chinese steel output reached a 17-month low in August according to Bloomberg. China’s government has avoided broad stimulus to support economic recovery, but some economists believe conditions will ease on the margin moving forward due to slowing growth.
You are probably asking why I should care about the prices of materials I have never heard of. These largely unknown metals and other are worsening supply delays and causing inflation in many popular technology goods. “Tech industry braces for skyrocketing rare earth prices” by NikkeiAsia, discusses why the prices of many rare earth materials are surging and the effect it’s having on tech manufacturers.
Per the article:“Praseodymium and neodymium belong to a category of metals known as rare-earth elements and are used to make neodymium-iron-boron (NdFeB) magnets. These permanent magnets, as they are known, are essential to a swath of tech gear — everything from speakers and electric vehicle motors to medical devices and precision munitions.”
Peaking Natural Gas Prices?
On Monday we pointed out natural gas prices are broaching the upper band of its ten-year range. Forex Live has interesting commentary arguing there may be more gains to come. They cite the TD Securities graph below showing that gas storage as compared to demand is at record lows (outside of the green band) and well below the recent five-year average. They think many analysts are focused on the supply of gas but not on increased demand. Per the article, demand has picked up for the following reasons: “What that ignores is that demand for natural gas has grown considerably in the past five years. The construction of many LNG facilities, the conversion of coal-fired power plants to natural gas and pipelines to Mexico all mean that larger inventories are needed.” Further: “What’s especially worrisome is that there are no signs of increased drilling.”
The Delta variant is mentioned by quite a few Fed members as a reason they should delay tapering. John Hussman’s model below expects fatalities from Delta to peak in the coming weeks. Assuming his model holds up, as it has, the number of fatalities should hopefully drop significantly into November and December and alleviate concerns from some Fed members.
September 14, 2021
While the CPI data was lower than expected, the breadth of the data was not as friendly. As shown below, the median CPI rose .33% month over month and, unlike CPI, is up for three months in a row.
CPI came in weaker than expected across the board. Of most importance to the Fed, the core CPI (excluding food and energy) only rose 0.1% for the month. As a result, the annual core rate fell from 4.3% to 4.0%. Accounting for about 30% of CPI, Shelter costs continue to rise. Owners Equivalent Rent (OER) is up .25% on the month, while rent rose .31%. Given their large contribution and sharply higher rental prices, it’s way too early to claim inflation has been tamed.
Is the Sell-off Over?
Yesterday we shared the recent dependable market pattern. The S&P declines for a few days mid-month with upward-sloping movement before and after the decline. Similarly, the graph below also shows a reliable pattern for the VIX. The VIX spikes with each mid-month decline. Each of the recent spikes has been above its Bollinger Band. The current upper band is 21.46 and VIX is at 19.37, after coming close to touching the band. A similar spike, as we have seen, implies a run to the 24-25 area.
The table below from The Market Ear shows the lack of any substantial drawdown this year. Through three quarters of the year, the largest drawdown is only 4.2%. Of the 94 instances in the table, only three years (2017, 1995, and 1964) have seen smaller intra-year drawdowns.
Value In Washed-out Japan?
David Robertson, an author for Real Investment Advice, shares interesting thoughts on potential value in Japanese stocks. He cites a Bloomberg article in which John Authers reviews how beaten up Japanese stocks are versus those in the U.S.
“John Authers provides some good background on Japan and its struggles over the years. After so many people have been burned so many times, it’s hard to seriously entertain the idea of investing in Japan. Perhaps that is exactly the type of washed-out situation that presents a value opportunity, however. Further, Japan’s epic underperformance started from the top of an epic bubble. What if the tables are turning? In a world of precious few cheap stocks or sectors, Japan is interesting.”
September 13, 2021
Nat Gas is on Fire!
As we show below, the price of Natural Gas is up sharply over the last few months sitting at the upper bound of its 10-year range. Will it break higher or fall back as it did in 2014 and late 2018 when it was at similar levels?
Inflation and Confidence
The New York Fed, via their latest Consumer Expectations Survey, shows the role that rising inflation expectations are having in declining confidence. The graph below shows expected inflation is now over 5% and rising. At the same time expected wage growth is 2.5% stable/falling. As a result, consumers expect to lose 2.64% (red line) in purchasing power over the next year.
Will the Market Bottom on September 21st?
The graph below shows the incredible regularity of the market over the last four months. As shown, every 20 days the S&P 500 tends to decline for a few days, bottom, and then rally back to prior highs. If the cycle plays out again this month we should expect a market bottom on 9/21. Monthly options expirations, which fall around the market troughs, are largely responsible. Liquidity is lacking, so options-related trades are driving direction on the days surrounding expirations.
CPI on Tuesday is the big market event of the week. Given the Fed is making substantial progress toward its employment goal, inflation concerns are moving front and center. While the Fed laid out a timeframe for taper in the WSJ last week, high CPI could speed that schedule up. Expectations for the monthly rate are 0.4%, slightly less than last month’s 0.5%. Also of importance this week is Thursday’s Retail Sales report. Will the recent plunge in confidence be felt by retailers? Speaking of confidence, the University of Michigan Consumer Survey will come out on Friday.
Next Tuesday and Wednesday is the next Fed meeting. Later this week most Fed members will enter the media blackout period.
30% of the CPI index is based on “Shelter” cost, i.e. real and imputed rental prices. The graph below should provide a warning that tomorrow’s CPI report can run hotter than expected. Luckily, the BLS uses questionable means to calculate rent. In BLS’ Housing Inflation Measure is Hypothetical Bull*** we analyze “Shelter” costs. Our conclusion: “If either OER or Rental prices show some correlation to reality, CPI could not only continue to run hot but could rise from elevated levels. That said, looking at historical BLS data, it appears Shelter prices will not change markedly from current levels.”
In the ongoing legal case between AAPL and Epic Games regarding app store payments, this morning a Federal Judge said that AAPL violated California’s laws against unfair competition. The judge ordered that AAPL can no longer require developers to use its payment system within their apps. The ruling could prove painful for AAPL’s top and bottom line if upheld, as AAPL currently receives commissions of up to 30% on some app sales, according to the New York Times. The order is set to take effect in 90 days, although appeals are expected from AAPL in the meantime. AAPL’s stock is down nearly 2.5% on the news.
The Fed Has Spoken
Often the Fed leaks policy changes or sends trial balloons via the media. They tend to have their favorite media outlets and authors in which to do it. Nick Timiraos from the Wall Street Journal is a current favorite. His latest article, Fed Officials Prepare For November Reduction in Bond Buying, lays out a timeline for the Fed to taper QE. While the article is not an official declaration, it will become the market assumption until we learn more at the September 22nd Fed meeting.
Per the article:
While they are unlikely to do so at their meeting on Sept. 21-22, Fed Chairman Jerome Powell could use that gathering to signal they are likely to start the process at their following session, on Nov. 2-3.
Under the plans taking shape, officials could reduce those purchases at a pace that allows them to conclude asset buying by the middle of next year.
The producer price index (PPI) is slightly higher than expectations. PPI, while not as well followed as PCE or CPI provides unique insights. First, PPI tends to lead CPI. Higher or lower input prices often eventually make their way to changes in the prices of goods companies sell, i.e. CPI. Second, other than labor, input costs are often the second largest expense for companies. Given rising wages and PPI, producers and other companies dependent on labor and commodities are likely to feel margin pressure.
Dow Theory, a once-popular way of evaluating the market, is well over 100 years. The theory follows that transportation stocks lead the broader markets. Per Business Insider: “The general idea is that both averages, over time, should move in tandem, given that the transportation average represents companies responsible for the movement of goods across the country. For that reason, it should serve as a leading indicator.” Many question the value of the theory today due to the tremendous technological progress. However, the fact of the matter is we still consume goods that must be shipped.
The graph below shows the Dow Transportation Index is down nearly 10% since May. At the same time, the broad market S&P 500 has steadily risen by 10%. For those following Dow Theory, this is a warning.
Will They Taper?
The chart below, courtesy of InTouch Capital Markets, breaks down the Federal Reserve Board by the degree to which they are policy hawks or doves. The graph also shows their respective voting eligibility by year. There are about twice as many hawks as doves, but three of the four most influential voters are dovish (Powell, Williams, and Brainard). The other, Vice-Chair, Richard Clarida, is neutral. Five of the six doves vote in 2021, while only four of the ten hawks vote in 2021. Despite the hawkish overtone from many Fed speakers, this chart points to a more dovish policy stance going forward. We will have much more on this graph and its implications in our next article this coming Wednesday.
September 9, 2021
Another Strong Auction
On the heels of yesterdays’ strong 10-yr auction, 30yr bonds were very well bid. The 1.91% yield on the bonds is nearly 2bps below where it was trading before the auction and the lowest auction yield in nine months. 30-year bond yields are down 10bps since peaking at 2% on Tuesday. Per Zero Hedge: “Dealers were left holding on to 13.1% of the auction, the lowest Dealer takedown on record!” Given there is little need for dealers to distribute what they own, selling pressure may be minimal in the days ahead. The bond is trading about 3bps lower in yield post-auction.
Fed’s Beige Book- Labor Shortages
The Fed’s Beige Book is a summary of economic conditions in the 12 Federal Reserve Districts. Before delving into each district’s report, the document starts with a one-paragraph highlight from each district. As shown below, all of the summaries include a statement on labor shortages and or wage pressures. The topic is clearly top of mind at the Fed, as it should be. If there are widespread job shortages and strong pressure to hire, as seen in the record number of job openings, wages may continue to rise and foster more inflation. Is it any wonder many Fed members are increasingly growing concerned with inflation?
Boston: “inability to get supplies and to hire workers.”
New York: “businesses reporting widespread labor shortages.”
Philadelphia: “while labor shortages and supply chain disruptions continued apace.”
Initial jobless claims fell to 310,000, a decline of 35,000 from last week. This is the lowest level for initial claims since March 14, 2020, when it was 256,000. In 2018 and 2019 jobless claims were steady in the low 200,000’s.
The graph below shows inflation expectations have stabilized after rising sharply in 2020. Expectations are probably more important than actual inflation figures like PCE, CPI, and PPI as the Fed tends to believe inflation follows expectations. Given the unprecedented supply line pressures along with pent-up demand, and massive fiscal stimulus, the Fed’s reliance on the markets might be a trap this time.
The equity markets are affirming stable inflation expectations. Cyclical sectors, that traditionally benefit from higher prices and strong economic growth, are lagging while more conservative, less economically sensitive sectors are leading the way. The sector performance map below points shows where money is flowing to and from. It appears investors are seeking shelter in more conservative, lower beta sectors like utilities, healthcare, and REITs. Large-cap technology and communication, like Apple, Microsoft, Facebook, and Google, have also done well as their earnings are thought to be minimally affected by slowing economic growth. The cyclical sectors like energy, materials and industrials are lagging as growth prospects decline.
September 8, 2021
The Treasury Department’s 10-year auction was met with strong demand for the second month in a row. The recent backup in yields seems to be eliciting demand. Today’s auction has a bid to cover ratio of 2.59, meaning there are 2.59 bids for every bond offered. That was the second-highest bid to cover in over a year. The highest was last month’s auction. 30-year bonds will be auctioned on Thursday.
Jobs Jobs Jobs!
The BLS JOLTs report shows the number of job openings surged from 10.2 million to 10.9 million, blowing away estimates of 10 million. There are now over 2 million more job openings than the 8+ million the BLS says are unemployed. The data is for July when over 7 million were still receiving unemployment claims. It is widely expected the number of openings will fall in the coming months as the pandemic-related jobless benefits expired last week.
Bob Farrell’s rule #5 states: “The public buys the most at the top and least at the bottom.” The graph below from Longview Economics speaks volumes for where the equity markets are in the investment cycle based on Bob’s logic.
Goldman Joins, Morgan Stanley, and the Atlanta Fed
Last week we noted that Morgan Stanley and the Atlanta Fed sharply reduced their estimates for Q3 GDP. Goldman Sachs is now joining them. Per Goldman: “.. we have long highlighted that the fiscal impulse will fade sharply .. it might take a while for spending to recover in still-depressed categories .. we have lowered our forecast for 2021Q4 consumption growth by 2.5pp to 3.5% … We now expect GDP growth of 3.5% in Q3″
In mid-August Goldman Sachs was expecting Q3 GDP growth of over 8%! The effects of 7+million losing unemployment benefits and the removal of the moratorium on evictions have yet to be felt. Both actions will likely further complicate forecasting going forward and weigh on economic growth.
Volatile Auto Sales
The graph below shows the recent volatility in auto sales over the past year and a half. After plummeting to 40-year lows at the onset of the pandemic, auto sales roared back to 15-year highs. Since then they have fallen nearly 30%, sitting at levels consistent with previous recessions. There are a few factors wreaking havoc on this data including pent-up demand, massive fiscal stimulus, and car/truck shortages. It is being said chip shortages for auto could last well into 2022 and possibly 2023. Given the shocks to demand and supply of autos, we caution not to read too much into this chart. That said, the industry is important as it accounts for about 3-3.5% of GDP and about 4.5% of jobs.
September 7, 2021
Ready for a SnapBack?
Michael Queenan (@mjqueenan) provides yet another reminder the S&P 500 is extremely stretched from its trend. Per his tweet: “For anyone tracking, this is now the second-longest the $SPX has gone without touching the daily 200 EMA. April 1958 to June 1959 (289 bars) is the longest. We are currently up to 213 bars.”
Bond yields are about 4-5 bps higher this morning despite little market news or movement in the equity markets. Some of the sell-off may be attributable to dealers setting up for the upcoming 10 and 30-year Treasury auctions. Tomorrow the U.S. Treasury will auction $38 billion 10-year notes. They will follow it up on Thursday with $24 billion in 30-year bonds. Since Wall Street banks and brokers are the prime distributors of the auctions, they tend to sell or short bonds in the day(s) preceding auctions and buy them back at auction. This can work to their advantage as bond prices often weaken prior to auctions allowing them to purchase bonds at lower prices than they sold them. While the pattern doesn’t always play out as described, some investors seeking to make some trading profits will mimic dealer behaviors.
According to Bank of America, with $3.2 trillion of assets held by private clients, allocations to bonds are at an all-time low of 17.7%. At the same time, stock holdings are at an all-time high of 65.2%. Assuming the data is representative of most individual accounts throughout the banking /brokerage system, which seems plausible, there is a lot of fodder for a bond rally at the expense of stock prices.
This holiday-shortened week will be light on economic data. On the heels of the employment report, the BLS JOLTs report on Wednesday will tell us if the record number of job openings continues to increase to new records or are they starting to get filled. With over 7 million people losing benefits we suspect the demand for jobs will increase. Of importance, on Friday the BLS will release Producer Prices (PPI). We believe the market and many Fed members are increasingly worried inflationary pressures are overstaying their “transitory” welcome. PPI will also shed light on rising input costs for manufacturers. CPI will be released a week from today.
So, was the gain of 235k jobs normal? The graph below compares the monthly change in jobs as a percentage of the workforce to the median percentage over the last 70 years. As we highlight below, 235k job growth is perfectly normal.
Taxing Stock Buybacks
An idea floating around Democrat circles in Washington is taxing stock buybacks or treating them as taxable dividends. Is it likely? Probably not, given the massive lobbying efforts of corporate America. However, if they are able to pass such legislation, a key driver of stock prices may have a limited effect going forward. While we think the odds of passage are low, this bears watching closely.
Underwhelming Jobs Report
The BLS Employment Report fell short of expectations with only 235k jobs added versus estimates of 750k. Despite the relatively minimal number of jobs added, the unemployment rate fell from 5.4% to 5.2%. The participation rate is unchanged at 61.7%. Hourly earnings were higher than expected at +0.6% versus +.04% last month. While positive for employees, higher wages, if sustained, will pressure corporate earnings and can put further upward pressure on prices.
So what does this report mean for the prospects of tapering? Chair Powell has repeatedly said taper will come with significant improvement in the jobs market. While the August number was well below expectations, the unemployment rate fell by 0.2%. Further, the average gain for the last three months, including today’s data, is +750k. That is about 3x the rate of pre-pandemic levels. We should also keep in mind, there are a lot of seasonal factors in August. In an odd year like this one, the seasonal adjustments can wreak havoc on the data. Today’s report may cause Powell to pause, but we suspect many other Fed members are concerned about inflation. The strong wage growth will only further their concern that inflation may be more than transitory.
Our guess is the market will push out expectations for tapering QE to a November-January time frame. Despite the poor data, bonds are trading poorly this morning which affirms our taper forecast.
The chart below from the BLS provides some context for the pace of jobs recovery by industry.
The graph of the VIX (volatility) below highlights a fairly reliable pattern that has been occurring mid-month for the last year. As shown, VIX tends to decline into the middle part of most months, rally sharply for a few days, and head lower again. The pattern has been especially pronounced the last three months. One likely cause is the combination of mid-month options expiration and low volumes. The volume of trades needed to cover and roll options contracts may be enough to push volatility higher at these times.
September is thus far looking to repeat the pattern. A nice short-term trade may again occur if VIX approaches the 16.00-16.50 range later next week. 16 has been the recent floor so if you do get long the VIX and try to take advantage of the pattern, keep risk targets in place below 16.
Shown below, courtesy of the Daily Shot, the Citi Economic Surprise Index continues to decline. Any reading below zero denotes economists’ forecasts are too optimistic. The recent string of weaker economic data has caught them off guard. Despite the implications of weakening economic growth, the positive correlation between the graph and stock prices has significantly deteriorated over the last year.
September 2, 2021
GDP Guesstimates Falling Rapidly
The Atlanta Fed’s estimate of third-quarter economic growth fell sharply for the second time in a week. To blame were Factory Orders coming in at +0.4% versus +1.5% last month and a change in real net exports. As shown below, their estimate is now at 3.7%, down from over 6% about a week ago. The consensus remains at 6.5%.
It appears Morgan Stanley is in agreement with the Atlanta Fed. Per Zero Hedge: But if Goldman was a surprise, what Morgan Stanley did this morning – when the bank slashed its Q3 GDP from 6.5% to just 2.9% – was shocking.
“Tightness in the US natural gas market is beginning to manifest itself in low inventory levels. After having started the year at a 200 bcf surplus to the five-year seasonal average, US inventories now stand at nearly a 200 bcf deficit. Given the current trajectory, our models suggest we could end the injection season at 3.2 tcf of gas representing a 400 bcf deficit, or 700 bn cubic feet lower than the same time last year. If we are correct, inventories run the risk of starting the withdrawal season at the second-lowest level in fifteen years. At that point, any bout of cold weather this coming winter would likely lead to a price spike.”
As shown below, the price of Natural gas is up significantly in recent months. Assuming the deficit of gas persists, a colder winter might briefly push its price to the highs of 2019, 2014, or possibly higher. It’s worth noting the price of natural gas doesn’t always rise in the winter. Of the 10 years shown, over half saw stable or falling prices during the winter months.
In Valuations Are Extreme Even With Rose Tinted Glasses, we take a new approach to calculating stock valuations. We forget history and assume “this time is different” has merit. Accordingly, we throw out scary graphs like the first three below which compare current valuations to past periods. Instead, we only compare valuations to valuations in the same ten-year period. The math is different, but the overvaluation story is not. The last graph shows that even with rose-tinted comparisons this time is not different. Valuations are extreme no matter your logic.
September 1, 2021
ISM Bucks The Trend
Unlike weakening manufacturing surveys from other countries and various regional surveys within the U.S., the ISM manufacturing survey is slightly higher versus last month (59.9 vs 59.5). In a sign shortages are abating, inventories rose to their highest level since 2018. The only concern in the report is employment fell back to contractionary levels at 49. The broad ISM index, while off the peak from earlier this year, is still near the highs of the last 20+ years. The lesser followed PMI Manufacturing survey is slightly higher than ISM, but lower versus last month (61.1 vs 63.4).
The ADP report is well short of expectations at +374k jobs versus expectations for over +600k. The coming BLS report and ADP have not been well correlated over the last year, so do not read too much into this report. However, the timetable for taper hinges in part on continued substantial improvement in the labor market. A corresponding weak number in the Friday BLS data will likely push back market expectations for the start of tapering QE.
Over the last year, we have gotten a lot of questions on TIPS. In particular, readers want to better understand how they can protect themselves from inflation. Lyn Alden has an excellent paper describing how TIPS work as well as their pros and cons. CLICK HERE to read it.
In the article, she stresses that while TIPS can provide some protection when inflation is greater than expectations for inflation, they are still likely to result in a decline in purchasing power. One reason is the BLS CPI Index does not accurately capture inflation. Two, the yields on all TIPS are now negative. Negative carry offsets some of the bond’s inflationary benefits.
Negative Real Yields In Germany
The graph below compares the German central bank main rate (similar to Fed Funds) versus year-over-year inflation. Like the U.S., its lending rate is at zero and CPI is soaring. The last time their CPI was at its current level in the early 1990s, the lending rate was about 6%. Not shown, German 10-year bonds yield -0.40%, resulting in a real yield of -4.40%. Absurdly low-interest rates and rising inflation is a global phenomenon and one that could prove dangerous if the recent rise in inflation is not transitory.
August 31, 2021
Consumer Confidence affirms the University of Michigan survey that consumer confidence is falling quickly. The Conference Board’s Confidence reading was 113.8 versus expectations of 123, and a prior reading of 129.1. Both the present situation and expectations components fell by approximately 10 points. The clue as to why confidence is fading lies in the survey’s inflation expectations reading. One year inflation expectations rose from 6.6% to 6.8%. also in the report, the number of consumers saying jobs are plentiful fell slightly. Those answering jobs are hard to get rose slightly.
Another Weak Survey With Inflationary Implications
Over the last week, regional manufacturing surveys have been weaker than expectations. Today, the most followed of the regional surveys, Chicago PMI, fell to 66.8 from 73.4. Unlike China, the deterioration in these indexes appears supply-related. Order backlogs, for instance, have the largest increase. In fact, it is at its highest level since 1951! At the same time, production has the largest decline. The good news is inventories rose, but at 48.8 they still signal contraction. Prices paid rose to 93.9 a 40+ year high. New orders fell which is potentially a signal that demand is weakening from its torrid pace. Overall the report leads us to believe inflationary pressures are continuing.
The report has an interesting question as follows: “With enhanced Unemployment Insurance benefits set to expire in September, are you forecasting an increase in your staffing levels?” The answer: “The majority said they were not.”
Markets Extend Winning Record
Worrisome Signs From China
China continues to show signs of slower economic growth ahead. Its PMI Manufacturing Survey is clinging to expansionary territory at 50.1 vs expectations of 50.2. Both the Non-Manufacturing (47.5) and the Composite Survey (48.8) fell below 50, signaling economic contraction. In addition to the negative effect of Delta variant, China is also to blame for the weaker surveys as they are steadily imposing new regulatory laws limiting certain types of businesses and activities. The actions are meant to improve their economy in the long run, but in the short run, they will come at a cost. The latest round of legislation imposes more control over private equity funds and limits public stock offerings from these funds. Other recent laws including limiting the time children can play video games, curbing capital expansion in entertainment, and more closely enforcing IP violations.
Inflationary Headlines are Fading
Despite the highest inflation rates in decades, the scary “Brace For Inflation” headlines are fading. The interesting graph below, courtesy of Arbor Research, compares the ratio of articles saying inflation will rise versus it falling.
August 30, 2021
In the aftermath of Powell’s speech last Friday, investors are clearly favoring large-cap growth. The S&P and NASDAQ closed up by .44% and 1.13% respectively, while the Dow is slightly lower and Russell 2000 off by .50%. Given Powell’s dovish tone, we wrongly suspected cyclical sectors and small caps would trade better. Market breadth remains poor as the generals are leading the way higher. Apple is up 3% and Facebook and Amazon are up over 2%. There were more declining stocks on the NYSE than advancers.
Atlanta Fed-GDP Now
The Atlanta Fed revised its GDP-Now forecast from 5.7% to 5.1% in large part due to slowing personal consumption. The Delta variant is resulting in weaker dining and hotel spending but that is not the only problem. The recent torrid pace of spending is unsustainable and normalization is inevitable. The economic headwinds in addition to Delta, in our opinion, are as follows:
The graph below from Tavi Costa, charts the ratio of earnings over price. As he shows, investors are paying quite a premium for earnings. Most likely in the future, either earnings grow sharply or prices correct. As Tavi shows, the last four instances with similar yields were not market-friendly. Maybe this time will be different?
Watching The Paint Dry
Normally those Wall Street traders not sunning in the Hamptons watch the paint dry in trading rooms during the week preceding labor day. With the Fed providing more clarity on taper, that should be the case this year as well. However, the ADP and BLS employment reports come out Wednesday and Friday respectively. Given many Fed speakers are making it clear continued improvement in employment is the key to start tapering, we might see some fireworks this week. After a relatively weak report last month, ADP is expected to rise from 330k to 500k. Economists expect the BLS to show 650k more jobs in the workforce. With many unemployed people losing federal and state unemployment benefits, the incentive to find a job is higher which may lead to larger than expected additions to the workforce.
Also of interest this week will be the reaction of Fed speakers to Powell’s vague comments involving a taper timetable. We suspect dissension in the ranks will become more vocal over the coming weeks.
August 27, 2021
Investors were fretting the Jackson Hole symposium would result in a firm timetable for an aggressive tightening campaign beginning as early as September. As seen in Powell’s comments below, what it got was more ambiguity around timing and amounts. After Powell’s speech, Fed Governor Harker continued on with vagueness around taper as follows: “The Fed has reached an agreement that tapering will begin this year.”
The Oracle Speaks
Chairman Powell’s much-awaited speech is being met with optimism in the markets. In particular, the following line is assuring investors the Fed will not be aggressive with tapering QE. In regards to premature tightening he says: “Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful.”
Below are two key segments from his speech:
We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the “substantial further progress” test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.
The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time.
The Fed’s preferred inflation index, PCE, met expectations rising 0.4% in July. The level was 0.1% below the June reading. The year-over-year rate is 4.2%, which is more than double the Fed’s 2% inflation target.
The Fed is somewhat complacent on fighting inflation as they believe it’s transitory. They factor in the temporary impediments to the production and shipping of goods but think these problems will resolve relatively quickly. Bloomberg has an interesting article out which leads one to believe the supply problems may last longer than the Fed believes: The World Economy’s Supply Chain Problem Keeps Getting Worse. Here are a few noteworthy lines and a graph:
China’s determination to stamp out Covid has meant even a small number of cases can cause major disruptions to trade. This month the government temporarily closed part of the world’s third-busiest container port at Ningbo for two weeks after a single dockworker was found to have the delta variant.
“Port congestion and a shortage of container shipping capacity may last into the fourth quarter or even mid-2022,” said Hsieh Huey-chuan, president of Taiwan-based Evergreen Marine Corp., the world’s seventh-biggest container liner, at an investor briefing on Aug. 20. “If the pandemic cannot be effectively contained, port congestion may become a new normal.”
The cost of sending a container from Asia to Europe is about 10 times higher than in May 2020, while the cost from Shanghai to Los Angeles has grown more than sixfold, according to the Drewry World Container Index.
August 26, 2021
How Much Confidence Should We Have In Confidence Readings?
The graph below, courtesy of Rennassacience Macro Research presents quite the quandary. As we discussed last week, the widely followed Uof M Consumer Confidence fell sharply to levels below any seen in 2020. The lesser followed Langer confidence index continues upward. It’s difficult to fully understand why they are diverging, but we should note Langer rose steadily in 2019 and 2020 while the UofM indicator was flat. Other than that period preceding the pandemic, the two indicators are well correlated, including periods before the financial crisis and tech crash.
A day before Powell kicks off the Jackson Hole Conference, the host of the symposium, Esther George of the Kansas City Fed, is clear she wants to start tapering soon. Per her interview on CNBC:
“The U.S. economy has hit the necessary benchmark of “substantial” progress needed to start to slow down its $120 billion per month of asset purchases”
“My own view on that is that we have made substantial further progress and we can begin to talk to talk about backing off some of that accommodation”
“I would be ready to talk about tapering sooner rather than later”
She alludes that the timetable and amount of tapering will be on the agenda at the upcoming September 21-22 FOMC meeting.
Rinse Wash Repeat
The graph below from Northman Trader shows the predictable pattern the S&P 500 has fallen into over the last several months. The market grinds higher, hits an air pocket around the 15th of each month, and then sharply recovers and grinds higher again. The dips and surges all occur between the 14th and 19th of each month, corresponding with options expiration dates. Liquidity is poor as witnessed by light trading volumes, so heavier than usual options-related trade activity is driving price action on those days.
Bad Market Breadth
The Tweet below from Bespoke Investment provides yet more evidence the market is increasingly being driven higher by fewer stocks. Bad breadth is often an indicator of a coming market retracement.
August 25, 2021
When the Fed announced the coming Jackson Hole Conference would be virtual markets jumped. The assumption being the Fed is worried about the variant and therefore likely to downplay taper given new vulnerabilities to the economy. The reality is that new Delta cases appear to be falling. The graphs below from IHME/University of Washington show confirmed infections are stabilizing or declining and IHME’s estimates are also moving lower.
The graph below, highlighting President Biden’s declining approval rating, is an important macro factor emerging on the horizon. There are two points in regards to his ratings worth keeping an eye on.
First, Biden will try to improve his ratings. Will he push legislation for even more fiscal stimulus or other economic boosting measures to win approval? In a similar vein, will he back off on tax increases?
Second, will some Democratic Senators and Representatives, especially those facing tight reelection campaigns in a year, start to shy away from the President? If so, winning their votes for infrastructure, the budget, or anything else will become tougher.
Savings Rate Normalizing
The savings rate spiked early in the pandemic due to the abundance of fiscal stimulus sent directly to individuals along with less consumption as important segments of the retail economy were shut down. Since then, additional savings and further rounds of stimulus boosted consumption and nominal economic growth to levels last seen in the 1950s. Both sources of economic activity are coming to an end which helps partially explain why consumer confidence fell sharply last month and retail sales have been weak. The economy is slowly but surely being left to stand on its own legs. Will the Fed hold of tapering QE as economic reality emerges?
The graph below from Arbor Research provides a clue for the recent decline in consumer confidence. Based on Google search data, the term stagflation is now the leading ‘flation search word. Stagflation entails weak economic activity coupled with inflation. Stagflation results in higher unemployment and negative real wage growth.
August 24, 2021
More Pressure on Powell
Add Bloomberg to the list of people and groups asking Powell to taper sooner rather than later. The powerful message from Bloomberg’s editorial board states the following:
He ought to nudge expectations in the direction suggested lately by some other top Fed officials. Short of making a formal announcement, he should say he’d prefer tapering to start soon and be completed by the spring.
It isn’t the right tool for current conditions, and leaving the program in place serves to narrow the Fed’s options as conditions change.
Asset prices have surged and the risk of bubbles and financial instability is growing. All this suggests it’s past time to start dialing back the Fed’s commitment to maximum stimulus.
It is not just equity valuations that are near or have already exceeded levels from 2000. The graph below, courtesy of the Daily Shot, shows that investor willingness to bet against the market is also at levels last seen 20 years ago.
While a lesser followed manufacturing survey, the Richmond Fed confirms the slowdown that other similar surveys are relaying. Per the Richmond Fed: “The composite index declined from 27 in July to 9 in August but remained in expansionary territory, as all three component indexes — shipments, new orders, and employment — decreased but remained positive. However, several manufacturers reported deteriorating local business conditions.” There was some good news. The wage index hit a record high which should help those workers offset inflation and possibly boost consumption down the road.
As Market Ear’s graph below shows, the season of higher volatility is upon us. Their seasonality graph jibes well with others that show markets tend to have their worst few months of the year during September and October.
A Bigger Short
It has been revealed that Michael Burry, portrayed in the book and movie The Big Short, has a large short position in U.S. Treasury bonds. His stance is not surprising given he has been vocal about inflationary concerns. Burry’s expectations are largely in line with Wall Street. Per a Bloomberg article on this topic: The median forecast in a Bloomberg survey is for the 10-year yield to end the year at 1.60%…”
Bill Farrell rule #9- “When all the experts and forecasts agree — something else is going to happen”
Office Space Trouble?
The graph below, courtesy of Jim Bianco and Kastle, shows that well over half of the office space in major cities is being underutilized. Per Kastle’s data, nationwide only a third of office space is being used and no major city is above 50%. If the trends do not revert to normal over the coming year or two, the amount of vacant office space will become problematic, especially in the larger cities.
The following graph and commentary from GMO, show that over the last year corporations have been taking advantage of higher share prices. Interestingly, IPO issuance is currently running at the same pace as the market peak in 2000. Massive issuance from existing stocks is largely responsible for the big difference between total issuance today versus 2000.
August 23, 2021
The heat map below, from the RIA Pro Dashboard, is a good way to monitor the breadth of the market. Despite the Nasdaq rising nearly 1.50% and the S&P .85%, the map shows there were a good number of stocks lower in the more conservative, lower beta sectors such as utilities, healthcare, consumer goods, real estate, and consumer cyclical sectors. Despite weakness in the aforementioned sectors bonds were flat on the day.
The August PMI Flash Composite Economic Survey fell to 55.4 from 59.9, an eight-month low. The bulk of the decline was attributable to the services industry. Many other nations and regions saw declines in their PMI reports. Australia was the most pronounced, falling from 56.9 to 51.7. The combination of weaker growth from China and Covid related lockdowns is weighing on their economy. Japan fell deeper into contraction (below 50) with a composite reading of 45.9 versus 48.8 in July. Europe held up well, only falling to 59.5 from 60.2.
Unlike the PMI reading, the Chicago Fed’s National Activity Index rose to +.53 from +.09. As the graph below shows, it continues to oscillate around trend.
The big event this week is Chairman Powell’s speech at the Fed’s Jackson Hole conference on Friday at 10 am. Investors will be looking for any signs Powell is moving closer toward tapering in the coming months. It is possible he shares little, instead preferring to wait until the September 22 FOMC meeting. At that point, the Fed will have another round of employment and inflation data in hand.
On the economic calendar existing and new home sales will be released on Monday and Tuesday respectively. Durable Goods come out on Wednesday, followed by Personal Income and Spending on Friday. Also on Friday, the PCE price index for July will be released. PCE is the Fed’s preferred measure of inflation. In June PCE rose 0.5%. It is expected to rise 0.4% in July.
After rising rapidly in late 2020, new home sales are back to pre-pandemic levels as shown by the blue line in the graph below. Despite normalizing sales, shares of homebuilders D.R. Horton (DHI) and Lennar (LEN) are 61% and 59% respectively above pre-pandemic levels. This chart is just one of many examples where share prices are not reflective of underlying trends.
The graph below shows the small-cap- IWM (Russell 2000) index is now below its 200 dma for the first time since rising above it nearly a year ago. The S&P 500 is still 10% above its 200 dma, while the NASDAQ is nearly 15% above its. As we have pointed out on numerous occasions, this is another warning that markets may be on the cusp of a downtrade.
Dallas Fed President Robert Kaplan, a strong proponent of tapering in the coming months, put the markets on alert that taper may not be as inevitable as many investors believe. Per Reuters: “any economic impact from the Delta variant of the coronavirus and he might need to adjust his views on policy “somewhat” should it slow economic growth materially.”
The problem with his statement is in trying to discern why economic activity is slowing. Delta is certainly playing a role, but fading stimulus, reduced consumer confidence, inflation, China, and a sharp reduction in pent-up demand are also weighing on the economy. Delta may be a convenient excuse for the Fed to delay tapering until next year. The initial market reaction to his comments was positive.
As we have noted China’s economic activity is weakening. The message is not lost on its equity markets. Hong Kong’s Hang Seng Index is now officially in bear territory, down 20% from its February peak. The S&P 500 is up 10%+ over the same period.
Zero Hedge put out an interesting piece titled Morgan Stanley Spots a Flashing Red Market Risk warning about option gamma flip points. Morgan Stanley says gamma “flips to short below 4250. That is where we could hit an air pocket.” On Monday, in our Gamma Band Update, Erik Lytikainen pegged the S&P 500 gamma flip level at 4205. The gamma flip point is where dealers, on average, have to sell stocks versus buying them to hedge their options books. Given the increased volume in options, and call options, in particular, these flip points provide a level where the recent bout of selling could accelerate. In addition to key moving averages which have served investors well recently, gamma flip points another level of technical guidance worth following closely.
After a relentless grind higher, some key manufacturing metals such as copper and iron ore have begun to fall in price. Copper for instance is trading at $4.00, down from a high of $4.80 in early May. Iron ore is down 30+% over the same period. Not surprisingly the Australian dollar is also trading weaker as it is a large exporter of metals and minerals. China, whose economy has been slowing markedly, accounts for 42% of Australia’s exports. The second leading country they export to is Japan, constituting only 13%.
Despite the declines in some key industrial metals, the well-followed CRB commodity index, shown below, has yet to break its uptrend. The index is weighted 41% to agricultural products, 39% to energy, 13% to industrial metals, and 7% to precious metals.
August 19, 2021
The graph below is 30-year UST yields with its 50 and 200 dma’s. The vertical lines highlight the last five times, 30 year yields have witnessed its 50 dma falling below its 200 dma, also known as a “death cross.” In 3 of the last 4 death cross instances yields fell appreciably and reached record lows. The only time they didn’t was in 2017 (red vertical line). At that time yields consolidated to negate the death cross. As shown, on Monday 30-year yields witnessed a death cross.
Ford, Toyota, and Volkswagen are trading lower on plans to cut production in September due to the ongoing chip shortage. The Delta variant will only further complicate existing shortages.
Per Barons: Production woes have hit Infineon, a German chip maker and major supplier to the car industry, which said earlier this week that plant shutdowns in Texas and Malaysia have caused deliveries to core auto clients to fall, according to reports.
Ford’s decision to shutter the Kansas City plant was rooted in shortages related to the pandemic in Malaysia, according to the Reuters report.
The “Buy the Dip” (BTD) graph below from the Daily Shot, shows each consecutive market drawdown since the pandemic has fallen less than the prior one. Consequently, the VIX volatility index (graph on right) has a similar pattern. Investors and algorithms are increasingly quicker to buy dips and short volatility as such behavior has been rewarded with profits. The risk going forward occurs if the market keeps falling despite dip-buying, forcing traders to cover leveraged positions and unleashing new behaviors detrimental to prices. Until then, BTD!
Volatility experts at Spot Gamma had this to say about the graph- “The longer volatility is suppressed the more it’s going to pop.”
An increasing number of companies are hopping on the crypto bandwagon and allowing their customers to use crypto on their sites. Software company Palantir recently reported, that in addition to crypto, they will now accept gold. Further, they bought about $51 million dollars worth of gold. Per Bloomberg, COO Shyam Sankar said: “Accepting nontraditional currencies “reflects more of a worldview,” Shyam Sankar, the chief operating officer, said in an interview. “You have to be prepared for a future with more black swan events.”
August 18, 2021
The Fed shed little new light in the FOMC minutes in regards to the schedule and pace of Fed taper. While some Fed members seem eager to start tapering as soon as September, others voiced concern about downward inflation pressure and how the market may perceive tapering. We look to the Jackson Hole Fed conference late next week for more guidance.
Highlights from the Fed minutes from the July 28th FOMC meeting:
“Most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year.”
“They are worried that accelerating plans to wind down the asset purchases could lead investors to question whether the Fed is in a hurry to raise rates or less committed to achieving lower unemployment.”
SOME PARTICIPANTS REMAINED CONCERNED ABOUT THE MEDIUM-TERM INFLATION FORECAST AND THE PROSPECT OF MAJOR DOWNWARD PRESSURE ON INFLATION RESURFACING.
“Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year”
“Most participants remarked that they saw benefits in reducing the pace of net purchases of Treasury securities and agency MBS proportionally in order to end both sets of purchases at the same time.”
“The staff provided an update on its assessments of the stability of the financial system and, on balance, characterized the financial vulnerabilities of the U.S. financial system as notable. The staff judged that asset valuation pressures were elevated. In particular, the forward price-to-earnings ratio for the S&P 500 index stood at the upper end of its historical distribution; high-yield corporate bond spreads tightened further and were near the low end of their historical range; and house prices continued to increase rapidly, leaving valuation measures stretched.”
The Fed’s Reverse Repurchase Repo program set another new high at $1.116 trillion. The increasing trend points to the large and growing amount of cash being held at banks and money market funds. These massive balances are a green light of sorts for the Fed to taper. The large amount of cash on the sidelines will help offset the Fed buying less.
Housing Starts were weaker than expectations at 1.534 million annualized versus 1.643 million last month. Higher input prices and a growing reluctance to buy homes are likely causing home builders to scale back. Building permits were up slightly to 1.635 million. Given the increasing supply of existing homes, higher home prices, and weakening consumer sentiment we might find that some builders will reconsider and delay using the permits to build.
Since February, the Russell 2000 (IWM), tracking small-cap stocks, is little changed. Over the same period, the S&P 500 has risen by over 20%. The smaller graph below shows the underperformance of small caps to the S&P via the IWM: S&P price ratio. Many small-cap companies are feeling the negative effects of higher prices and are not able to offset inflation with lower interest rates to the degree large-cap companies can. Stripping the S&P 500 of the FANMG stocks and a few other leaders would leave the S&P 500 looking a lot like the Russell Index. This serves as a reminder of Bob Farrell’s investment rule #7: Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
The graph below, courtesy of Goldman Sachs, shows the strong negative correlation between the price of gold to 10-year UST real rates. Recently, the correlation has failed. If the correlation regains its prior strength, the graph implies gold is underpriced by nearly $300, real rates are about to rise, or some combination of both. Real rates increase if Treasury yields rise and/or inflation expectations decline. We suspect it will be the latter.
August 17, 2021
Chairman Powell, speaking to educators today, had little to say about the future path of monetary policy. It looks like we will have to wait for next week’s Jackson Hole conference to see if he agrees with many Fed members that taper is in the cards for this fall. The following headline is the only clue he left us:
THE FED IS IN THE PROCESS OF PUTTING AWAY ALL OF ITS TOOLS THAT WERE BUILT FOR TRUE CRISES.
Retail Sales can be a misleading data point as it doesn’t account for inflation. For instance, if inflation was 5% and retail sales grew by 5%, 100% of the growth in retail sales is due to price increases, not more consumption of goods. The graph below takes the inflation component of sales to give us a clearer reading of true sales. Core retail sales exclude vehicle and vehicle parts, gas stations, and building materials. At a 3.4% annualized growth rate, real core retails sales are back to near pre-pandemic levels.
July Retail Sales came in at -1.1%, versus expectations of -0.2% and +0.7% last month. Excluding autos and gas retails sales fell by 0.7% versus expectations of a 0.3% decline. The weaker than expected data should not be a total surprise as BofA and JPM credit card spending tracking data has shown a decent drop-off in credit card usage.
Per Arbor Research, the University of Michigan’s Consumer Survey reported that buying conditions for durable goods, homes, and vehicles are at the lowest levels since 1980.
Economic data from China continues to come in weaker than expectations. China is the world’s second-largest economy and has been an important driver of global economic growth. While many developed economies continue to post outsized growth, China is flashing warning signals. This past weekend China reported the following:
Industrial Production 6.4% versus expectations of 7.8% and prior month 8.3%
Chinese Retail Sales 8.5% versus expectations of 11.5% and prior month 12.1%
Chinese Fixed Assets Investment excluding rural 10.3% versus Expectations of 11.3% and prior month 12.6%
The graph below serves as another reminder that valuations are at extreme levels. However, despite the graph below and many other valuation techniques at or near records, the market can get more expensive. Pay close attention to technical indicators to help navigate the current environment.
Sunday marked the 50th anniversary of the “Nixon Shock.” On August 15, 1971, President Nixon eliminated the convertibility of U.S. dollars to gold and thus removed the U.S. off of the gold standard. 5 years ago we wrote on Nixon’s decision and importantly the consequences in The Fifteenth of August. From the summary:
“Now, seven years after the end of the financial crisis and recession, these consequences are in plain sight. The Fed finds themselves crippled under an imprudent zero interest rate policy and unable to raise interest rates due to fear of stoking another crisis. Worse, other central banks, in a similar quest to keep prior debt serviceable and generate even more debt-induced economic growth, have pushed beyond the realm of reality into negative interest rates. In fact, an astonishing $10 trillion worth of sovereign bonds now trade with a negative yield.”
“With the August monthly options expiration on deck for this Friday, we may be looking for an options expiration “pin” near 4,500 as long as price remains near the current levels above the gamma flip.”
Retail Sales will be the important economic data point for the week. On Tuesday it is expected to show a 0.3% decline, yet despite the decline is still expected to be +11.5% versus last year. Given last Friday’s weak consumer confidence data, Retail Sales could surprise to the downside. Recent real-time credit card tracking data points to such a recent drop-off in consumer spending.
Fed Chair Powell will speak Tuesday afternoon. Many Fed members have been increasingly outspoken about the need to taper sooner rather than later. The market will pay close attention to see if his comments shift toward a more definitive time frame for tapering. The Fed’s annual Jackson Hole conference is at the end of next week, so this speech can provide a good chance to warn the markets of a coming change in stance. The Fed’s minutes from their prior meeting in late July will be released Wednesday afternoon.
August 13, 2021
Peter Atwater, a leading expert in market sentiment, provides us with his recent Financial Insyghts subscriber-only article discussing how diversification is not just a function of the correlation between various assets in a portfolio, but equally important, as Peter writes, “a variety of feelings associated with those assets.”
The University of Michigan Consumer Sentiment Survey plummeted from 81.2 to 70.2, the lowest level since 2011. Inflation expectations for 1 year forward were unchanged at 4.6%. It’s not clear whether consumers are suddenly concerned because of higher prices or the Delta variant. Either way, the report paints a grim picture for personal consumption which represents about 2/3rds of GDP. We will pay close attention to near-real-time credit card spending data and other consumer surveys to see how accurately Michigan’s survey is tracking reality.
From an investment perspective, the big question facing many companies is whether or not they can pass on higher prices to consumers. While each industry is different, the graph below shows retailers are more confident than anytime in the last 15+ years they will be able to raise prices and protect their profit margins.
The graphs and tables below break down the 153 components of inflation to provide a broader analysis of the recent July CPI data compared to June. At the headline level, monthly CPI fell to 0.5% from 0.9%. The average price of the 153 goods comprising CPI fell from 0.63% to 0.42%. However, the median price rose by 0.20% to 0.50%. Further, nearly 70% of the goods saw percentage price increases less than the CPI rate in June. In July that number fell to just under 50%. Also note, the average and median increases in the year-over-year changes rose significantly from June to July. The headline CPI number is supportive of those in the transitory inflation camp, but the underlying data is not as clear. Yesterday’s PPI data provides further concern that inflation may not have peaked yet.
The series of graphs below from Brett Freeze show the demand for money is weak. As we wrote in Inflation: Making the Complex Simple, “To correctly anticipate inflation, we must look beyond the supply and demand for goods and services. The truth lies in the supply and the demand for money. Unfortunately, the supply of money gets the headlines, while its demand is an afterthought.” Over the last few months, inflationists have been dwelling on the surge in the supply of money. They fail to notice that velocity, or the demand for money, both consumer and commercial, has been weakening and largely offsetting the supply. The year-over-year growth of the supply of money has been declining and will continue barring an unexpected increase in the amount of QE or more massive fiscal spending packages. Will the demand for money increase and offset the declining money supply growth?
August 12, 2021
As shown below Producer Prices (PPI) were stronger than expected. On a monthly basis, PPI and core PPI was the same as last month- +1.0%. The graph below shows PPI-commodities have been outpacing CPI since the recovery began. This is no doubt resulting in margin compression for many companies reliant on commodities to manufacture their final goods.
Yesterday Doug Kass shared a rant from his Real Money Pro subscription service on Twitter. He discusses the deleterious effects of excessive monetary and fiscal policy and joins the growing list of industry leaders imploring the Fed to stand down. We put his comments into the following link:
The Bloomberg graph below compares job openings from JOLTS and the NFIB small business survey. The NFIB confirms that there are plenty of jobs for the unemployed to fill. The question however is why are they not taking the jobs. Is it related to covid and related medical issues or are the generous unemployment benefits providing an incentive to stay at home? It might also be there are not enough qualified workers to fill the jobs? Either way, the situation is likely much more of a fiscal/legislative matter than one monetary policy can fix. This argues the Fed should commence tapering sooner rather than later.
As Nordea Bank shows, money supply growth is slowing which is resulting in a reduction of excess liquidity. The graph shows excess liquidity, with a 6 month lead time, has been well correlated with P/E ratios. If the correlation holds we should expect P/E compression in late 2021 and 2022.
August 11, 2021
Crude oil is trading 1.3% lower to $67.30 on a request from President Biden to OPEC. Per the WSJ- “The White House urged OPEC to boost oil production, saying recent planned increases are insufficient as countries around the world seek to emerge from the Covid-19 pandemic.”
After the last CPI report, we published “Just How Transitory is Inflation?” which provided a detailed analysis of what is driving the latest inflationary push. We showed how gasoline and used cars accounted for over half of the annual increase. In the latest report gasoline rose 2.4%, a tenth of a percent lower than last month. Used Car prices are finally cooling off. After rising 10.2% in June they only rose .2% in the July report. Other used car price indexes lead us to believe they will negatively contribute to CPI in next month’s report. It is important to note energy prices are delayed three months in the CPI report. Given the recent declines in crude and gasoline prices, we should expect energy to weigh less on CPI in upcoming reports. Of concern are rising rent and home prices as Shelter contributes almost 30% to the CPI index. The broad shelter category was up 0.4% last month versus 0.5% the prior month and is now up 2.8% on an annual basis. We expect an uptick in shelter prices following the end of the eviction moratoriums, but they should stabilize after that.
This report will help assuage inflationary fears as the largest contributors to inflation appear to be stabilizing or falling, as is the case with transportation services which are down 1.1% for the month, after rising by at least 1.5% in each of the last four months. We warn you, however, one month does not make a trend.
CPI came in slightly below expectations as shown below. The monthly inflation number was up 0.5%, the lowest increase since February and potentially a sign the inflationary surge in prices is abating. We will follow up with details later today as the BLS releases more underlying data.
Investor sentiment is showing signs of moderating as the timing of a Fed taper comes into question. Per Bloomberg, inflows into US buy-write funds of $1B in July were the most since 2012. Buy-write funds utilize an options trading strategy that profits most during periods with limited upside.
In the Bloomberg article linked above, Lu Wang wrote: “Call them cautious bulls — preparing for gloom, concerned about valuations, yet unwilling to completely bail. They’re hedging as growth slows and the Federal Reserve mulls rolling back monetary stimulus in a market that has gone nine months without a 5% pullback”.
The chart below from MKM Partners echoes the same tone. It shows bullish sentiment decreasing as the market recorded recent highs, a signpost of what MKM Partners describes as the “Reluctant Bull”.
“Risk-On” has been the mantra for the surge in the prices of risky assets since late March 2020. The graph below, courtesy of Nordea, shows an interesting divergence occurring between two “risk-on” favorites. The S&P continues to hit new highs yet junk bond yields are starting to rise (prices fall). Might junk bond investors be worried about the increasing odds of the Fed tapering, while stock investors brush it off?
August 10, 2021
What is full employment? The answer matters because the Fed warns they will taper when “significant progress” is made toward full employment. The Macrobond graph below, accompanied by the one we put out in yesterday’s commentary, argues we may be at or very close to full employment. In 2018 and 2019, when the Fed believed we were at full employment, there were more job openings than unemployed persons. With the recent round of JOLTS and employment data confirming a similar ratio, one may argue we are back to full employment despite the higher unemployment rate.
Mohamed El-Erian, former CIO at Pimco, wrote an editorial in the Washington Post imploring the Fed to end their “ultra-loose monetary policy” stance. The editorial follows Senator Manchin’s letter to the Fed in which he voices concern about their easy money policies and the hardships inflation can cause.
El-Erian’s article lays out five reasons the Fed’s overly aggressive policy might harm the economy over the next 12 months. They are as follows:
First, the Fed’s policy tools are ill-suited to address what is hampering the economy. The primary problem is widespread supply-side disruptions, from dislocated supply chains and higher input costs to transportation bottlenecks and difficulties in hiring workers.
Second, with both private and public demand already surging, the Fed’s policy stance risks fueling inflation.
Third, its continued massive intervention in markets has distorted the price signaling mechanism, encouraging all sorts of inefficient resource allocations that will eat away at the U.S. economy’s productivity and dynamism.
Fourth, the ample and predictable injection of cash into the system continues to encourage excessive risk-taking in financial markets while deepening the unhealthy conditioning among investors to always expect the Fed to boost asset prices.
Finally, the $40 billion of mortgages that the Fed insists on buying each month is contributing to a red-hot housing market that has been pricing out more and more Americans.
The chart below from Ned Davis Research compares the S&P 500 to a composite of three well-known market cycles: 1-year seasonal cycle, 4-year presidential cycle, and the 10-year decennial cycle. If the market follows these historical cycles, we should expect a weaker finish to the year. Note, the composite is in regards to trend and does not forecast the actual changes, ergo their note- “trend is more important than level.”
Per the headline below, Fed Governor Bostic affirmed what Chris Waller said last week in regards to employment and the timing of a potential taper. He also said he preferred a shorter taper period than prior episodes.
FED’S BOSTIC: THE FED COULD ACHIEVE ‘SUBSTANTIAL FURTHER PROGRESS’ ON EMPLOYMENT IF THERE ARE IS ANOTHER MONTH OR TWO OF STRONG JOBS GAINS
JOLTS data reported this morning shows there are now 10.07 million job openings a big jump from last month’s 9.3 million. The graph below puts the number of job openings and the number of jobs lost due to the pandemic in perspective. In April of 2020, the economy lost almost 20 million jobs. As of last Friday, it has regained about 14 million of those jobs and remains 6.5 million short. Job openings just eclipsed 10 million, meaning there are now 1.47 jobs per job loss since the pandemic. The Fed must be looking at this data and questioning if its monetary policy needs to stay uber aggressive.
Gold looks to open weak this morning but that is not even half the story. Last night, shortly after the futures markets opened, gold fell nearly $100. It bounced back quickly and has been slowly rising since. Silver also had a stunning decline and a huge recovery. It was down over 10% early last evening, yet is only down 1.5% this morning. Crude oil also had a rough night but not the same degree. Unlike the rebounding precious metals, it continues to leak lower. Crude oil now stands at $65.60 down nearly 4%.
Last week Fed Governor Waller said if the next two jobs reports come as strong as the June Report we can taper by September. Based on his opinion and last week’s strong July report, another good report on the first Friday in September may start the tapering process. With nearly 2 million new jobs added over the last two months, some Fed members are likely to join him this week in various speeches supporting the tapering QE.
All eyes this week will be on inflation data this week with CPI on Wednesday and PPI on Thursday. The current CPI expectation is for a small decline to 0.7% from 0.9% last month. Stronger than expected CPI and/or PPI data may further push Fed members to call for tapering QE. We will also keep an eye on JOLTs data on Monday for more evidence supporting strength in the labor market.
Joe Manchin, Democrat from West Virginia, wrote a letter to the Fed offering concern about their easy money policies and the hardships inflation can cause. Per the WSJ– “I am deeply concerned that the continuing stimulus put forth by the Fed, and proposal for additional fiscal stimulus, will lead to our economy overheating and to unavoidable inflation taxes that hard-working Americans cannot afford,” …. “He asked Mr. Powell and the Fed’s rate-setting committee “to immediately reassess our nation’s stance of monetary policy and begin to taper your emergency response immediately.”
We suspect other Congressional leaders, on both sides of the aisle, are harboring similar concerns. Given Powell’s term ends early next year and Congress must approve a new term, the pressure on Powell to reduce the pace of QE is mounting.
The BLS labor report was strong with the addition of 943k new jobs and a +88k revision to last month. The unemployment rate fell from 5.7% to 5.4%. Despite the strong growth, hourly earnings were unchanged from last month’s revised number as well as hours worked. It is worth noting that employment rose by 221k in local government education and 40k in private education. This is due to seasonal quirks due to the pandemic. Similar to the ADP report on Wednesday, leisure and hospitality were the main contributors adding 380k jobs, which also helps explain why wages are not increasing more. The initial reaction in the futures markets implies an inflationary bias with the Dow leading the way, S&P 500 flat, and the NASDAQ down. Bond yields are rising on the news. We suspect today’s report will spur further discussion about the Fed tapering as early as September or October.
In our article, Just How Transitory is Inflation, we showed which goods were largely responsible for driving CPI higher. While we acknowledge the difficulty of forecasting inflation in this environment, we came to the conclusion that most of the goods driving the recent price surge should fall in price in the coming months. To wit: “We think the current inflationary surge is temporary. When flexible prices, especially some of those mentioned, normalize, inflation is likely to follow suit.”
The graph below, courtesy of Arbor Research, provides some confidence for our expectations. It shows the prices of four key inflation contributors (two of which we detail in the article) and two pieces of inflation survey data finally appear to be peaking.
Apartment rent in metropolitan areas is increasing rapidly as workers return to cities, according to this report by the Wall Street Journal. Apartment List, a home search website, recently reported that median rent has risen over 10% in the last year. Camden Property Trust, a landlord in the Houston area, reported rent increases of 19% in July for new leases. A key factor contributing to rising rents is the state of the housing market as the economy reopens. Many individuals who would have otherwise purchased a home are being priced out of the market due to strong demand paired with lackluster supply, which is, in turn, bolstering demand for rentals. Investors appear to be exploiting this trend, as apartment REITs have outperformed the S&P 500 by almost 25% YTD.
August 5, 2021
As we noted in the Portfolio Trading Diary, Albermarle’s “GAAP EPS of $3.62 demolished the consensus estimate of $0.85.” The increasing demand for electric vehicles is driving lithium production and boosting ALB’s sales. If the chart below proves accurate, demand for lithium will continue to surge. ALB is the world’s largest lithium producer.
The graph below shows the historical correlation between the current ISM Manufacturing Prices index with 6 months forward S&P 500 returns and CPI changes. Currently, the ISM Prices index is at 85.7 and in the top decile, although slightly lower than last month. Based on the graph, stocks should be slightly lower over the next 6 months, and inflation running at 7.6% in March of 2022. Take this data with a grain of salt as the current supply/demand anomalies are unlike any of those in the past.
Initial Jobless Claims fell slightly to 385k this past week. The good news is new claims are down significantly from 800-900k at the beginning of the year. The bad news is they have been stuck at current levels for the last two months. As a comparison, the average weekly claims for 2019 were about 220k per week.
The new eviction moratorium extension will likely help keep a lid on core CPI through its expiration, as evidenced by the graph below from Andreas Steno Larsen. However, Primary & owners’ equivalent rent (OER/Rent), which makes up roughly 40% of core CPI, will likely push inflation readings higher when the moratorium is allowed to expire or if it is overturned by the Supreme Court.
On quite a few occasions we have talked about how the K-shaped recovery is benefitting wealthy individuals while other income classes are not benefitting to the same degree. As the Wall Street Journal writes in Heavyweight Companies Enjoy Outsize Rewards as Economy Rebounds, similar trends are occurring in the corporate world as well. The author provides a few examples of large companies thriving while smaller companies languish. We share the final paragraph, the story of a drone maker in Europe. Per the article: “Stefano Valentini, president of French manufacturer Drone Volt SA, said he is seeing strong demand for drones from large companies in Northern Europe and the U.S. in the wake of the pandemic, but little demand from Southern Europe, where small—and less capitalized—companies are the norm. For those companies, many of whom were slow to recover from the financial crisis, “Covid is the nail in the coffin,” he said.”
August 4, 2021
Fed Vice Chair Richard Clarida was nebulous in regard to his outlook for tapering QE. Per his speech today: “At our meeting last week, the Committee reviewed some considerations around how our asset purchases might be adjusted, including their pace and composition, once economic conditions warrant a change. Participants expect that the economy will continue to move toward our standard of “substantial further progress.” In coming meetings, the Committee will again assess the economy’s progress toward our goals. As we have said, we will provide advance notice before making any changes to our purchases.”
Fed Governor Bullard is following in Chris Waller’s steps saying the market is prepared for taper and does not expect a negative reaction when such an announcement is made. Further, he wants to move “earlier and faster on taper so the Fed could be in a better position to combat strong inflation.”
The ADP jobs report significantly missed expectations coming in at 330k versus expectations of 700k. Over the last year, ADP and this coming Friday’s BLS report have not had a great correlation. If the BLS report is similarly weak, recent talk of tapering QE as early as September may be pushed back toward the winter months. Of note in the ADP report, over a third of the net new jobs were in the leisure and hospitality industry which tend to be lower-paying. If the BLS shows a similar strong contribution, those jobs are likely to weigh on aggregate wages.
The graph below shows the two defensive sectors, staples (XLP) and utilities (XLU), are well correlated and both sitting at or near record highs. However, there is a noteworthy divergence occurring beneath the trading surface. 93% of the utility stocks in the ETF are above their respective 200 dma and that percentage has been steadily climbing for the last 2 months. Only 66% of staples stocks are above their respective 200 dma and the percentage has been steadily falling since May. The weakening breadth of XLP may result in relative weakness versus XLU, especially if inflation and inflation expectations remain high.
The stacked graphs on the left, courtesy of Arbor Research and the Daily Shot, show investors are clamoring for inflation insurance via the TIPs market. The top graph shows TIPs yields are trading at record low yields. The bottom graph shows TIPs have seen record inflows of cash while investment grade and Treasuries have seen large outflows. This helps explain why breakeven inflation rates have been rising. To recap, the yield on TIPs less the yield on a nominal Treasury equals the inflation break-even rate or rate where an investor is indifferent between either bond. As TIP yields fall more than UST yields, TIP investors are betting on more inflation. The third graph shows the growing divergence between 10-year TIPs and nominal bonds and the resulting rising breakeven rate.
August 3, 2021
The graph below, courtesy of Brett Freeze, shows the strong correlation of the ISM Manufacturing Survey with the year-over-year change in 10-year USTs. As we discussed yesterday, ISM remains at historically very high levels but is starting to decline. We expect it to decline further as fewer and fewer survey respondents will be able to continue to answer that manufacturing factors are again better in the current month than the prior month. If we are correct with ISM and the correlation holds up, a further decline in bond yields should be expected.
Yesterday we shared Fed’s Chris Waller’s hawkish stance on monetary policy. It is worth adding he has had a dovish stance similar to Powell up until that speech. While we doubt Powell will make such an abrupt turn in policy we will focus on Lael Brainard and Vice Chair Richard Clarida. Clarida speaks tomorrow. If he lays out similar goals and timelines as Waller, the speeches may be a coordinated trial balloon aimed at warning the market on the schedule of tapering QE.
Noah Smith, blogger and Bloomberg Opinion author, wrote a compelling article titled Why is China Smashing its Tech Industry. China has recently been punishing “tech” companies such as Alibaba, Ant Financial, Tencent, and Didi to name a few. At first blush, it may appear Chinese leadership harbors some of the same monopolistic concerns that are brewing in the United States. Noah thinks there is much more to the story. Per the article: “And so when China’s leaders look at what kind of technologies they want the country’s engineers and entrepreneurs to be spending their effort on, they probably don’t want them spending that effort on stuff that’s just for fun and convenience. They probably took a look at their consumer internet sector and decided that the link between that sector and geopolitical power had simply become too tenuous to keep throwing capital and high-skilled labor at it. And so, in classic CCP fashion, it was time to smash.”
Noah argues China is aiming for productivity growth, not profit growth, “fun, and convenience.” If true, China is playing the long macro-economic game which should greatly benefit their nation. While banning or even punishing ‘internet” companies is much less likely here, we should take notice of their desire for more productive growth.
August 2, 2021
Per the headlines below, Fed member Christopher Waller provided helpful guidance on the potential timing of tapering QE and what the Fed is looking for before tapering.
WALLER SAYS IF THE NEXT TWO JOBS REPORT COME IN AS STRONG AS THE LAST ONE, CAN TAPER BY SEPT; IF NOT, MAY NEED TO PUSH IT
WALLER SAYS ON TAPERING WE SHOULD BE EARLY, FAST, TO BE IN A POSITION TO RAISE RATES IN 2022 IF NEEDED
FED’S WALLER SAYS COULD MAKE AN ANNOUNCEMENT ON TAPER BY SEPT
I was in favor of tapering MBS first,” Waller says, adding, resignedly, that Chair Powell said in his press conference that it wasn’t an option.
The ISM Manufacturing Index fell to 59.5 versus expectations of 60.9 and last month’s 60.6 reading. Importantly, the prices paid sub-component fell to 85.7 from 92.1. Also of note, supplier delivery times fell 2.6 points. While early, it may mean supply line bottlenecks are easing. Employment rose to 52.9 versus 49.9. Employment is now in expansion mode as it’s above 50.
Fed President Lael Brainard indicates that the coming Jackson Hole meeting may lack any new indications about when the tapering of QE may begin. Per Lael; “I expect to be more confident in assessing the rate of progress once we have data in hand for September, when consumption, school, and work patterns should be settling into a post-pandemic normal.” She is an important voice at the Fed and is rumored to be in the running for the Chair job if Biden does not reappoint Jerome Powell for a new term.
The economic focus this week will be on the job market and the manufacturing sectors. The ISM manufacturing survey will be released this morning and the ISM services survey on Wednesday. We will keep a close eye on the inflation/prices and employment sub-components of the surveys. Wednesday will feature the ADP labor report followed on Friday by the all-important BLS jobs report. The consensus BLS forecast is for a gain of 900k jobs, following last month’s 850k.
Earnings reports will continue, but the pace should slow markedly versus last week. We expect a slew of Fed speakers this week further clarifying their individual thoughts around the economy, inflation, employment, and most important monetary policy. We will also be looking out for any possible policy changes announced at the late August Jackson Hole Fed meeting.
The excess savings racked up by Americans from trillions in stimulus payments is quickly waning. The chart below from Zero Hedge illustrates the effect of stimulus payments on personal savings over the past year and a half. Excess savings from the last round of stimulus is falling rather quickly, and as Zero Hedge notes, “… at the current rate that Americans are burning through savings, this means that the entire fiscal stimulus tailwind from Biden’s trillions will be gone by August… just in time for emergency unemployment benefits to end”. The upcoming fiscal cliff bears substantial risks to markets, especially as we move past the point of peak economic growth in this recovery.
The Chicago PMI surprised to the upside for July. It came in at 73.4 compared to expectations of 66.1 and a June reading of 66.1. The survey results suggest that, in July, business conditions improved more than expected in the Chicago area.
Personal income and outlays data were stronger than expected in June. Personal income increased 0.1% compared to a consensus estimate of -0.7%. Personal consumption expenditures increased 1% in June versus expectations of 0.6%.
The PCE price index increased 0.5% MoM (0.6% expected) and 4.0% YoY (4.1% expected). The core PCE price index, the Fed’s preferred measure of inflation, rose 0.4% MoM (0.5% expected) and 3.5% YoY (3.7% expected).
The toughest part of forecasting inflation is trying to properly assess the supply line problems and labor shortages. Wells Fargo put out a handy table recently, shown below, which tracks price pressures due to supply, inventory, shipping, and labor problems. Per Wells Fargo: “It suggests that bottlenecks are not yet easing in any widespread fashion, let alone close to being fully resolved”. The conclusions reached by Wells Fargo align with the reasons for missed expectations we saw in the second quarter GDP report yesterday.
Next week begins the weakest two months of the year for the markets, as shown below. While the graph below points to weakness, there have been plenty of prior Augusts and September’s that have produced positive returns.
July 29, 2021
NKLA founder, Trevor Milton, was charged with fraud this morning regarding lies to investors about breakthroughs and prototype vehicles. NKLA went public via SPAC in June 2020, thus Milton was not bound by the usual post-IPO restriction period on communication with investors. He quickly took to social media with the apparent intention of pumping the stock. According to MarketWatch:
“Prosecutors said in the initial period following Nikola starting to trade publicly, the value of Milton’s shares shot up by $7 billion”.
It doesn’t stop there.
“Prosecutors said that, in fact, the prototypes that had been unveiled didn’t function and were Frankenstein monsters cobbled together from parts from other vehicles. At public events, the vehicles were towed into position and were powered by plugs leading from hidden wall sockets”.
Milton has posted bail and proclaims his innocence. NKLA stock has sold off roughly 65% from its June 2020 highs.
Robinhood completed its IPO today and is trading under the ticker symbol HOOD. The stock opened in line with the IPO price at $38 per share after the indicated open fell from a high of $42 this morning. Based on the IPO price, HOOD is being valued at $32B.
Update: HOOD finished the day at $34.71 after retreating 8.7% from its open price. .
US GDP (initial) grew 6.5% in the second quarter versus expectations of 8%. This compares to first quarter GDP growth of 6.3%. PCE was above expectations at 11.8% versus the consensus of 11.4%. A key factor in the GDP miss was the decline in inventories, which highlights the supply-chain problems the economy is facing have yet to abate.
Initial jobless claims fell by 24k to 400k this week, slightly higher than expectations of 390k. Although weekly claims are falling, they remain elevated compared to levels you might expect to see in an improving economy.
The first estimate of second quarter GDP will be released this morning at 7:30 CT. This chart from The Daily Shot shows that economists’ estimates of GDP growth have been moderating in recent weeks.
The graph below charts the MBA’s mortgage purchase applications. These are the number of applications for mortgages, not the refinancing of existing mortgages. As shown, the number of applications has been steadily declining and now sits at pre-pandemic levels. The housing market is increasingly showing signs of normalizing. It is quite possible home prices will follow suit and begin to stabilize and possibly decline over the next few months.
The graph below, courtesy of Nautilus Investment Research, shows the current bull market rally, starting March 2020, is getting into rarefied territory. The market has gone 337 days without a 10% retracement. Of the 135 instances in the study, only ten bull market runs have been longer in duration, and of those, only two have gone up a higher percentage.
July 28, 2021
Changes to the FOMC statement are highlighted below. While most of the changes are inconsequential, they added the following to the section which discusses QE: ” Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings.”
We think this new statement, and its deliberate placement in the section describing asset purchases is a reminder they are closing in on their goals and a signal to the market to prepare for the tapering of QE and ultimately higher interest rates.
The Financial Times (LINK) put yesterday’s earnings from Google, Microsoft, and Apple into perspective.
“The three US tech groups brought in combined after-tax profits of almost $5bn a week during the latest quarter. At $56.8bn, the total was almost double the year before and 30 percent more than Wall Street had predicted. The figures were “absolutely stunning”, said Jim Tierney, a portfolio manager at AllianceBernstein, adding that “digital advertising is just on fire”, as advertisers race to follow audiences who have turned to online services in huge numbers.”
Since today is Fed day we thought we would share a quote about monetary policy from Jim Grant: “Persisting with the easiest policy in memory in the teeth of the fiercest inflation in a generation, the Fed reminds us of a diamond-handed Reddit bro pushing his last chips on to AMC Entertainment. He’d better not be wrong.”
Have trucking costs finally peaked? If the recent rise, as shown below courtesy of Arbor Research, is forming a peak, another factor pushing inflation higher may be abating. This would be welcome news for Amazon and other e-tailers.
The graph below compares the S&P 500 to the Shanghai Composite. As shown, the broad Chinese market did not perform nearly as badly as the S&P 500 during the early days of the pandemic but has since grossly underperformed the S&P. It is essentially flat over the last year. The tepid performance of their stock market along with signs China’s economic activity is slowing sends macro warning signs to the world. China has the second-largest GDP in the world and has been growing at twice the rate of most developed nations. Simply, Chinese economic activity contributes significantly to global GDP growth. We are also keeping an eye on the Chinese yuan for signs they devalue it versus the dollar to stimulate export growth.
July 27, 2021
Thinking of buying today’s dip? If so, you may be proven correct in a record short period of time as shown below.
Consumer Confidence rose to 129.1 versus 127.3 last month. Both the present and future indexes were up versus last month. Interestingly, inflation expectations are showing signs of stabilizing. The report shows 1-year inflation expectations at 6.6% versus 6.7% last month.
The Case-Shiller Home Price Index rose 1.8% monthly and 17% on a year-over-year basis. The data is for May so it will be interesting to see if the gains continue next month amidst poor home buyer sentiment and the very weak new home data released yesterday.
The table below shows the clear outperformance by sector, style, and factors of large-cap stocks versus mid and small caps.
The graphs below tell the story of the growth/cyclical rotations of the past 7 months. The graph on the left is the ratio of the equal-weighted S&P 500 (RSP) versus the weighted S&P 500 (SPY). When RSP outperforms SPY, the ratio increases and vice versa. RSP has a much higher percentage of cyclical stocks, including- value, energy, financials, and materials. The S&P 500 is heavily weighted with technology and growth-oriented stocks. The graphs on the right compare the correlation of the RSP/SPY ratio to the NASDAQ, S&P, and ten-year UST yields. With Tech and the S&P 500 recently outperforming RSP, the correlations versus the QQQ and SPY are strongly negative. Conversely, the correlation to yields is currently strong, meaning yields are falling as RSP underperforms. Simply, the market is rotating fiercely, and it is important to be on the right side if you want to keep up with the market. Currently, the growth rotation is in vogue.
Yesterday we wrote that 10 year real yields hit a new all-time low. The graphs below show that the price of gold and real yields have been well correlated over the last decade. In particular, the scatter plot on the right, shows a statistically significant correlation with an R squared of .82 between gold and real yields. The red square shows the current instance and the arrows direct your eyes to where a reversion to the mean would bring gold or real yields. Per the graph, either gold is underpriced by about $200 or real yields should increase to about -0.60% from -1.20%.
There are a lot of companies in our equity model reporting earnings today as shown below.
AAPL – After Close
GOOG – After Close
MSFT – After Close
RTX – Before Open
SBUX – After Close
UPS – Before Open
V – After Close
July 26, 2021
Since its recent lows in March, the NASDAQ has risen over 20%. At the same time, the volume of NASDAQ stocks trading higher each day is deteriorating. The graph below shows the 10 day moving average of up volume and the NASDAQ. This is another bad breadth indicator showing fewer stocks are leading the charge higher.
New Home Sales fell sharply from last month and were below expectations. June sales were down -6.6% versus an estimate of +3.7%. This marks the third straight monthly decline. New home sales are now down 20% year over year, at the lowest levels in a decade. The median price of new homes fell from $380,700 to $361,800. The supply of new homes is back to pre-pandemic levels.
10 year real yields are now trading at an all-time low as shown below in the Bloomberg graph. The real yield is calculated by subtracting the 10 year UST yield from the rate of expected inflation over the next ten years. At a real yield of negative 1.12%, investors will need to see the 10-year UST yield fall by about 15 bps. to approximately 1.10% to earn a 0% real return due to the gain in the price on the bond. This condition, in part, helps explain why investors are willing to pay outlandish valuations for equities despite poor expected returns.
There is a lot of information for the markets to digest this week. For starters, the Fed meets on Tuesday and Wednesday, followed by the updated policy statement and Jerome Powell’s press conference. We suspect there will be few changes to their current policy stance or economic outlook. However, we will not rule out a shift of QE from mortgages to U.S. Treasuries. The other thing to be on the lookout for is any hint at policy changes they might announce at the late August Jackson Hole conference. They have made big some big announcements in previous conferences.
More housing data comes this week with new home sales today, the Case Shiller Home Price Index tomorrow, and pending home sales data on Thursday. Personal income and spending and the monthly PCE price index will be released on Friday along with the Chicago PMI report.
Earnings will be lively this week with many S&P 500 companies reporting as shown below.
Despite most equity markets, foreign and domestic, rallying over the past few days, emerging markets remain the odd man out. As shown below, the popular emerging markets ETF, EEM, is touching its 200 dma today. The index is down 1.75% at noon today, while the S&P and developed foreign markets (EFA) are up .75%. Many emerging markets are heavily concentrated in commodity production. The second graph below shows similar weakness in the commodity-centric energy and materials sectors as compared to the S&P 500.
Rental prices have been rising as of late, which is leading to concerns that CPI will stay elevated as higher rent prices offset stabilizing and declining prices of goods that already had marked inflation. Rent constitutes about 7% of the CPI Index.
Zillow, in a report published earlier this week, had the following to say about rental prices: “Rent growth maintained widespread momentum in June, with the Zillow Observed Rent Index (ZORI) up 1.8% month over month, pushing typical U.S. rents to $1,799/month in June. A strong recovery in the rental market over the past few months pushed year-over-year rent growth up 7.1% — the largest annual increase in the series’ history reaching back to 2015. Even discounting a weakened market last year, rents have risen 5.1% since March, the fastest quarterly growth in Zillow’s data.”
Yesterday the National Association of Realtors (NAR) released data on home sales and prices for June. Per NAR: “The median existing-home price for all housing types in June was $363,300, up 23.4% from June 2020 ($294,400), as every region recorded price jumps.” The graph below, courtesy Lohman Econometrics, helps break down the sharp rise in house prices and the results are stunning. The more expensive houses rose much more in price than lower-priced houses. While lower prices for starter homes may be good for first-time buyers, which did account for almost a third of June’s home sales, the beneficial wealth effect is clearly going to those with large real estate investments and in many cases above-average levels of wealth.
July 22, 2021
This morning, Lance and Michael discussed the recent PBS Frontline episode, The Power of the Fed, and shared 10 important clips from the video. If you haven’t watched the video, today’s Real Investment Show podcast provides a nice summary of the show and important commentary expanding on thoughts aired by industry leaders and ex-Fed members.
Per Bloomberg: *POWELL HAS BROAD SUPPORT AMONG TOP BIDEN AIDES FOR NEW FED TERM.
His term expires early next year. A continuation of his term will likely be perceived as market-friendly as investors have green accustomed to his easy money policies and might fret about a potential change in policy if someone else were to take the position.
Economic data was a little weaker than expected this morning. The Chicago Fed National Activity Index which measures 85 economic data points fell to 0.09 from 0.29. A zero value denotes the economy is growing at its historical growth trend. Their inflation measure now points to subdued inflation after rising above their threshold for “sustained increasing inflation” last month. This data set has been volatile for the last 6 months, so take today’s release with a grain of salt.
Jobless Claims which had been trending lower popped up to 419k from 360k last week. Non-seasonally adjusted Claims have now risen for 3 weeks in a row.
Bloomberg’s article linked above does an excellent job explaining why there are shortages of so many products that rely on semiconductors, aka chips. The article discusses the factors behind the shortage, who is most affected, and importantly from an investment view, a long discussion of chip manufacturers, the industry, and what the future holds for chip production. The graph below, from the article, shows time from ordering a chip to delivery is about 50% longer than it was before the pandemic.
Per Bloomberg: of the Q2 earnings reported thus far, 85% have beat expectations as compared to the average of 71%. It is important to note that only 10% of S&P 500 companies have reported of which many are banks. Banks had a profit boost last quarter as many banks lowered their loss reserves. 87% of the companies which reported earnings mentioned “inflation” in their earnings commentary.
July 21, 2021
Per Ned Davis Research, individual investors own more stock as a percentage of their assets than at any other time in the last 70 years. We remind you of one of Bob Farrell’s 10 investment rules: “The public buys the most at the top and the least at the bottom.”
The price to sales ratio (P/S) of the S&P 500 is now double that of global equity markets. It’s important to note a couple of things. First, the composition of the S&P 500 is more tech-laden than global equity indexes. Given the higher growth rates of tech companies, investors are often willing to pay higher valuations for the S&P 500. That said, the S&P P/S ratio has well surpassed the all-time highs of the late 1990s while the global index is sitting at its highs. The takeaway: The ratio of the P/S ratio for the U.S. versus the world appears extended even considering compositional differences.
For more context of U.S. valuations versus the rest of the world, we present a comparison of CAPE (10) ratios by country/region.
Yesterday we showed how the price of crude oil was sitting on important support and being closely followed by the bond markets because of the strong correlation between crude oil and CPI. The two graphs below help further highlight the important correlation. The first scatter plot shows the relatively strong relationship between the year-over-year change in CPI and Crude oil. The second chart shows the annual changes but in a different format. Important in the second chart, the year-over-year price in crude has fallen sharply recently. Will CPI follow? If the price of crude oil stays around $75, the red line should flatten out near current levels until November at which point it will fall.
July 20, 2021
The graph below shows the decent correlation between rising inflation expectations and the S&P 500. Both measures of inflation expectations have stopped increasing and are gradually declining. It appears the equity markets might just be noticing.
As shown below, the price of crude oil fell to critical support yesterday. At this point, its risk and reward are fairly even. If it bounces from the recent support line and the longer support line from May 2020, it may go test $75, the prior high. A break of the two support lines may result in a test of the 200 dma at $56. The bond market is likely paying close attention to crude prices as it has a high correlation with CPI.
The graph below, courtesy of the Daily Shot, shows housing inventory is finally rebounding and back to levels last seen in 2019. The combination of higher prices and more inventory should quell further large increases in house prices. Will it be enough to push them lower?
The chart below, courtesy Lohman Econometrics, shows margin debt has only been more than 2 standard deviations above its trend two other times since 1997, before the current instance. As shown, the reversal back to and below trend in those two instances was accompanied by a 50%+ decline in the S&P 500.
The graph below, courtesy of Brett Freeze, shows the correlation between real earnings yield and future returns. The earnings yield is the opposite of P/E, or earnings divided by price. Real earnings yield subtracts the current inflation rate from the yield. As he shows, at current real earnings yields, we should expect a one-year forward return of close to -20%. The R-squared is strong at .50, but there is significant variance around the trend line.
July 19, 2021
The graph below shows Bitcoin (BTC) is sitting on key support at 30,000. BTC has been a good barometer of the risk trade in equities, so the support line may be of importance for not just crypto investors.
Today’s equity sell-off and big decline in bond yields are being blamed on OPEC for increasing supply and the spreading of the Delta Variant. In regards to oil, lower oil prices are beneficial for bonds as it lowers the inflation rate. Lower yields and oil prices are also good for the economy, which should help stocks. Of note, the major airlines are down between three and five percent thus far today, despite being a beneficiary of lower oil prices. The decline is likely growing concern over new restrictions due to the Delta variant. The good news is that, thus far, hospitalizations and fatalities are not following the number of new cases related to the variant.
Crude oil is trading nearly 3% lower and below $70/barrel this morning as OPEC agreed to boost supply by 400k barrels a day each month starting August. The monthly increases will continue until the output is back to pre-pandemic levels. Equally important for OPEC, Per Bloomberg: “It also puts an end to a diplomatic spat that unnerved traders, as the fight between the two long-time allies (Saudi Arabia and UAE) risked unraveling the broader accord between the Organization of Petroleum Exporting Countries and its allies that has underpinned the recovery in crude prices.”
Housing data takes center stage this week. Today, the NAHB Housing Market Index will be released, followed by housing starts and permits on Tuesday, and existing home sales on Thursday. New home sales will come next Monday.
There will be a limited number of Fed speakers this week as they enter their blackout period before next week’s FOMC meeting.
There are a slew of earnings reports this week as shown below.
The following article by Lacy Hunt at Hoisington (LINK) is a little heady but well worth a read. The simple takeaway is fiscal stimulus will help boost aggregate demand and GDP today but reduces it below where it would have been tomorrow. From his summary- “More debt does not cure a subpar economy mired in a debt trap.”
Last week we discussed the prominent role used car prices played in the CPI report. We follow up with the graph below courtesy of BofA which helps explain the supply/demand mismatch driving new car prices higher. With so few new cars being produced there are fewer trade-ins which, in turn, reduces the availability of used cars.
The University of Michigan consumer confidence survey declined from last month. The index fell to 80.8 from 85.5. It appears inflation is playing a role in eroding confidence. Inflation expectations rose sharply from 4.2% to 4.8%. Partially as a consequence, consumers expect their real (inflation-adjusted) income to fall 3.2%. The graph below also shows that many of those surveyed think now is the worst time in recent history, by a long shot, to buy a house.
Retail Sales were better than expectations at +.6% versus expectations of a .4% decline. Last month’s data was revised lower by .4% to -1.7%. Not surprisingly food services/drinking and gasoline stations accounted for almost 80% of the gain. Given the shortage of new and used cars, motor vehicles and parts reduced .4% from the number. The control group, which feeds GDP, rose 1.1% but May was revised lower by .7%.
Per Zero Hedge and Bank America, Today’s strong report may be fleeting in July. Per their report- “According to BAC aggregated debit and credit card spending data, after a strong June, consumers hit the brakes, and total card spending slowed to only up 13% over a 2-year period or 12% over a 1-year for the 7-days ending July 10th. This will mark the slowest 1-year increase since the covid crisis began.”
The Bank of England (BOE) is under pressure by Parliament to explain QE and justify its risks. Per the report: “The Economic Affairs Committee publishes its report ‘Quantitative easing: a dangerous addiction?’, which urges the Bank of England to explain in more detail why it believes rising inflation will be a short-term phenomenon, and why continuing with its quantitative easing programme until the end of 2021 is the right course of action.”
The Fed is also seeing some backlash against QE and the resulting financial bubbles. This pressure however is from the media, not the government. Frontline recently published a damming episode, called An Epic Mistake? on the Fed and QE. Of particular note, they interview Peter Fisher who was the NY Fed President for over a decade. Mr. Fisher has some choice words to say about financial instability and the risks the Fed is taking in their pandemic-related massive QE efforts.
Peter Fisher has been a lone voice of reason since leaving the Fed in 2001. Two years we wrote, The Wisdom of Peter Fisher, which discusses his concerns about QE. It’s worth giving it a quick read before watching the Frontline Video.
The graph below charts market expectations for the Fed Funds rate going out to March of 2023. The orange line shows the market currently expects about 30bps in Fed tightening between now and then. Said differently, they expect a 100% of one 25bps rate hike and a 20% chance of two by March 2023. The graph also shows that current levels are near the highs for each monthly contract. The blue line extends the current effective Fed Funds rate out until March 2023.
Lumber is down 7% this morning and, after the big surge in price earlier this year, has now corrected back into the pre-pandemic range.
One more tidbit on inflation. The graph below shows the difference between CPI and PPI. PPI, which measures commodity prices and other manufacturing inputs tends to rise before CPI in an inflationary environment. CPI follows PPI as manufacturers and retailers try to push input price increases on to consumers. That is exactly what happened over the last year. At one point CPI was 6% higher than PPI on a year-over-year basis. Currently, CPI is 4% less than PPI. CPI will catch back up to PPI as is typical. If prices can be pushed to consumers without losing too much demand, PPI will drive CPI. If consumers are unwilling to pay higher prices, corporate margins suffer, which usually leads to less demand for input goods and ultimately lower prices.
Used car prices only represent about 3% of the CPI Index but contributed to about a third of its recent increase. As such, used car prices have become an important factor to watch for gauging inflation. The Manheim Used Vehicle Value Index below shows the sharp increase in prices since the pandemic. The only positive takeaway from the latest data from Manheim is it shows that price increases may be abating. June prices show a monthly decline of 1.3% from the prior month. That said, the index is still up 34.3% from a year ago.
Movie theaters are being left behind in the economic recovery. This year’s big blockbuster, Black Widow, just pulled in $80 million in revenue in its best weekend. In 2019, Avengers: Endgame had the biggest grossing weekend at over four times the revenue- $357 million. The graph below shows that ticket sales are running grossly behind levels from before the pandemic. The data for 2021 is through June so you can essentially double the $2.5 billion in box office sales to $5 billion and compare it to the nearly $12.5 billion in sales pre-pandemic.
July 14, 2021
Stocks, bonds, and gold are off to the races this morning as Powell’s prepared remarks before his testimony later today was released. He essentially quelled concerns that taper might be coming soon. He continues to base that judgment on the slow improvement in the labor markets.
“While reaching the standard of “substantial further progress” is still a ways off, participants expect that progress will continue. We will continue these discussions in coming meetings. As we have said, we will provide advance notice before announcing any decision to make changes to our purchases.”
Like CPI yesterday, year over year Producer Prices (PPI) came in about .5% above expectations. PPI rose 7.3% and core PPI rose 5.6%. Monthly PPI rose 1% versus 0.8% last month and expectations of +.6%.
The following chart, courtesy of Macrobond, shows if you strip out food, energy, and goods that have been directly affected by the economic reopening, inflation is relatively tame. Over the coming months, we will closely track the individual components of inflation to best assess its future path. In this realm, watching sticky prices versus flexible prices will be important. Sticky prices are those that tend to trend, like housing. Inflation in sticky sectors is more likely to be permanent. Flexible prices tend to oscillate over time. These include energy and used cars for example.
Fed Chair Jerome Powell is scheduled to present testimony on monetary policy and the economy to Congress today and tomorrow. We suspect he will continue to walk the fine line between talking about tapering and wanting to wait for an improvement in the labor markets before tapering. It is increasingly likely that senators and representatives will grill him on yesterday’s inflation data and the widening wealth inequality gap. As we wrote in Two Pins Threatening Asset Bubbles, such pressure could force the Fed to taper sooner than they would like.
To wit: If the prices of food, shelter, and other necessities continue to surge higher without equivalent wage growth, wealth inequality will worsen. This problem represents a coming dilemma for the Fed.
When the media and politicians take notice, they will pressure the Fed on their inflation stance.
U.S. bond yields have been declining as the market buys into the Fed’s view of transitory inflation and declining economic growth. Bloomberg recently wrote an article providing more evidence for such an outlook. In China’s Slowing V-Shaped Economic Recovery Sends Global Warning, the author warns China’s economy may be providing the recovery road map for the global post-pandemic economic recovery. They were the first to experience COVID and the first to recover from it. We noted a few weeks ago the sharp slowdown in credit creation as a signal of decelerating growth in China. The outlook was emphasized last Friday when their central bank cut the reserve ratio requirement for banks, essentially making lending easier. In regards to inflation that we import from China, the article quoted the following: “China’s growth slowdown should mean near-term disinflation pressures globally, particularly on demand for industrial metals and capital goods,” said Wei Yao, chief economist for the Asia Pacific at Societe Generale SA.
China has long been the marginal driver of global economic growth as they are the second-largest economy and, prior to the pandemic, growing at twice the rate of almost all developed nations’ economies.
July 13, 2021
The initial market reaction to the strong CPI print was a decent rally in bond prices (lower yields). Some may wonder why yields are falling if inflation was much stronger than expected. The answer likely lies in the reasons CPI rose. The table below shows the contributions by sector to the monthly and annual CPI Index. Energy and Transportation prices were both up sharply. In aggregate they contribute 63% and 80% to the monthly and annual number respectively. Both are considered to have flexible pricing meaning they can fall in price as easily as they rise. As a result, bond investors seem to remain comfortable with the idea that the recent inflationary surge will be transitory. The Fed will also likely use this reasoning to brush off today’s data.
As shown below, CPI came in .4% higher than expectations on a monthly and year over year basis. Troubling for the markets will be that the monthly rate of inflation accelerated after having declined last month. Markets tend to focus more on the rate of change as it provides guidance about future trends. That said, the monthly rate of inflation on an annualized basis is nearly 11% and that will no doubt make headlines.
Per the BLS– “The index for used cars and trucks continued to rise sharply, increasing 10.5 percent in June. This increase accounted for more than one-third of the seasonally adjusted all items increase.”
The good news is that used car prices are not likely permanent as they are the result of severe shortages and strong demand which are both temporary. The bad news is that housing prices (OER) continue to tick up. These prices are considered more “sticky” and constitute a much larger proportion of the CPI number.
One of the recent market themes we have been discussing is the growing divergences between certain sectors and markets. Last week, for instance, we wrote: “The generals are leading the way higher but the troops are not necessarily following.” The graph below, courtesy Lohman Econometrics, shows that 1-year rolling correlations between many indexes have broken down to levels, that in eight of the nine cases haven’t been witnessed in 20 years. These graphs and other related data do not mean the market will crash but they do represent a change in market dynamics that bears close watching and caution.
July 12, 2021
Per Bloomberg: “The U.S. central bank’s purchases of Treasury and mortgage-backed securities are both contributing to lower housing costs, New York Fed President John Williams says”
The unfortunate reality, as shown below, is that housing is now more unaffordable than any time in at least the last 20 years.
Massive intervention by the Fed and other central banks is significantly reducing investors’ perceptions of risk. For example, many equity valuations sit at or near levels recorded in 1999 and 1929, despite economic growth rates that are declining and lower than those periods. The graph below highlights another manifestation of risk complacency. It shows the standard deviations of UST yield spreads for each credit rating of corporate bonds. As shown, the deviation escalates as the bonds’ riskiness increases. Junk-rated bonds, especially the worst in class (CCC or lower) are now over four standard deviations from their average. Investors in these bonds only require an additional 5.81% of yield versus UST notes. The average is nearly 12% since 1997.
Our first glimpse of inflation data for June comes Tuesday with CPI. The current expectation is for a decline in the monthly growth rate from +0.7% to +0.4%. On a year-over-year basis, a slight decline from 5% to 4.9% is expected. PPI will be released on Wednesday and a slight decline from May is also expected. We are more concerned with the rate of change of inflation than the rate itself. If the monthly rate declines for the second month in a row it provides some level of confidence that inflation might be peaking. Given the highly unusual supply line shortages and insatiable demand for some goods, we must understand that forecasting inflation will continue to be extremely difficult and likely humbling.
On Friday, we will learn more about the health of the consumer with Retail Sales. Economists expect it to fall -.5%, following last months -1.3% decline. We will also keep an eye on various surveys throughout the week to see if they continue to rise to record or near-record levels or begin to stabilize.
Earnings will start this week with the following key releases shown below. Of note will be the large banks with JPM and GS on Tuesday, followed by BAC and WFC on Wednesday.
The graph below helps to further highlight the underlying weakness in the markets. It shows the S&P 500 continuing to set record highs on a seemingly daily basis, yet the percentage of S&P stocks above their 50 dma continues to decline. Currently, half the stocks in the index are below their 50 dma! We also noticed that only 33% of stocks are one standard deviation or more above their 200 dma and that percentage has been steadily falling. For reference, it stood at 55% at the start of June and 70% in January and February.
The most recent data on inventories shows that some of the shortage problems may be lessening. Wholesale inventories rose 1.3% last month, slightly more than expectations of 1.1%. At the same time, wholesale sales only rose 0.8%, meaning the inventory to sales ratio at the wholesale level upticked. The ratio for retailers will be released next week. As shown below, it has been in a free fall since the early days of the Pandemic. If the ratio starts to stabilize or turn higher, inflationary pressures should alleviate on the margin.
The latest Consumer Credit data, released yesterday afternoon, shows consumer credit rose by $35.3 billion in May, almost double expectations. Non-revolving credit (auto and school loans) increased by $26.1 bn, the most on record. Revolving credit, mainly credit cards, rose $9.2 bn after falling last month. With the unexpected increase, consumer credit is running about 2% above January 2020 levels. The growth rate prior to the pandemic was in the 4-5% range.
The graph below, courtesy of Brett Freeze, shows how the returns between the S&P 500 and 16 year-zero coupon treasuries tend to oscillate over time. In March, the year-over-year outperformance of equities over Treasuries hit an extreme. Based on the previous two times this occurred, we should expect Treasuries to outperform the S&P 500 over the coming months.
July 8, 2021
The New York Fed announced they will start selling their holdings of corporate bonds on July 12th. While the amount they own is minimal, it does represent a normalization of monetary policy. This announcement was widely expected and should have minimal impact on the corporate bond market.
The minutes from the last Fed meeting were released yesterday afternoon. Bottom line: the Fed has begun discussions about reducing QE purchases and the likelihood of tapering mortgage purchases is likely sooner rather than later. We suspect such an announcement regarding mortgage purchases could come at the late July meeting or at their annual Jackson Hole retreat in late August.
“Several participants highlighted, however, that low-interest rates were contributing to elevated house prices and that valuation pressures in housing markets might pose financial stability risks.”
“Various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of in-coming data.”
“Several participants saw benefits to reducing the pace of these purchases more quickly or earlier than Treasury purchases in light of valuation pressures in housing markets.”
Owners Equivalent Rent constitutes nearly one-third of the CPI Index. As such, trends in rent prices are important to factor into inflation forecasts. Rents fell during COVID but have been recovering with the economy. The following paragraph and graph are from an in-depth report from Apartment List.
“Our national index increased by 2.3 percent in June, continuing the trend of rapid price growth since the start of the year. So far in 2021, rental prices have grown a staggering 9.2 percent. To put that in context, in previous years growth from January to June is usually just 2 to 3 percent. After this month’s spike, rents have been pushed well above our expectations of where they would have been had the pandemic not disrupted the market.”
While rental prices are recovering nicely we must put the gains into context. Rents are still below 2019 levels in many major cities. The ten cities hardest hit by the pandemic are shown below. That said there are many smaller cities seeing double-digit annual increases in rent. Boise and Spokane lead the way at +39% and +31% respectively.
July 7, 2021
Wolf Richter of Wolf Street shines a light on evidence the housing market is weakening quickly.
The evidence has been piling up for months in bits and pieces: While investors still have the hots for this housing market, potential buyers that need a mortgage and those who want to live in the home they’re thinking of buying are getting second thoughts, as evidenced by sharply dropping sales of existing homes and new houses even as inventories for sale have now risen for the third month in a row and new listings are coming out of the woodwork.
So here’s the latest piece of evidence: Demand from buyers who need a mortgage to fund the purchase of a home has been declining for months and in the week ended July 2 fell further and is now down 14% from the same week in 2020 and down 8% from the same week in 2019, according to the Mortgage Bankers Association this morning. Mortgage applications are now at the low end of the range in 2019.The entire Pandemic boom has now been worked off, plus some.
Per the BLS JOLTs report, the number of job openings declined slightly versus last month but remains near a record high at 9.2mm. New hires were also similar to last month at 5.9mm. Basically, the labor market remains tight despite the high unemployment rate. The quit rate fell but remains at 20 year+ highs at 2.5%. Typically employees that quit do so because they have confidence in finding another job and often one that is higher paying. Given the perceived leverage of those that quit over employers, there has been a strong correlation between wage growth and the quit rate. As shown below, the correlation broke down in 2017 and has been irrelevant during the pandemic. If the correlation normalizes we should expect an uptick in wages.
A WSJ article entitled Supermarkets are Stockpiling Inventory as Food Costs Rise discusses how grocery stores are stockpiling food inventories in anticipation of price increases. This is not the type of action grocers would take if they thought recent price inflation was transitory. “When you have a uniquely inflationary period like now, it’s a feeding frenzy,” said Tony Sarsam, chief executive officer of SpartanNash Co. The Grand Rapids, Mich.-based retailer and distributor is stockpiling about 20% to 25% more groceries such as frozen meat and boxed foods after more than 100 suppliers notified SpartanNash that they would raise prices, he said.
As grocers stockpile inventory, their actions fuel more inflation as demand further exceeds supply and supply line-related delivery problems. Such actions, especially if carried out by consumers and a large number of retailers, can create a repeatable cycle of higher prices.
The graph below, courtesy of the Cleveland Fed, suggests the surge in headline/core inflation is concentrated in a limited number of items. Per the Fed: PCE inflation jumped to 3.9% in May. But median PCE inflation, which excludes outlier components and focuses on the middle of the distribution, was steady at 2% for the third month in a row.
The data may provide some level of confidence for the Fed that the recent bump in inflation is transitory.
July 6, 2021
The Nasdaq Composite closed at a 52-week high today, something it’s done 1,080 times since 1984. On those days, an average of 50% of stocks on the Nasdaq advanced on the day. Today, 31% of stocks on the exchange advanced. That’s the lowest out of all those 1,080 days.
The Citi Economic Surprise Index, measuring economists’ expectations versus actual data, has been positive for 274 of the past 275 trading days. It currently sits slightly above zero and is trending lower. It appears economists’ predictions have finally caught up with reality. Markets now run the risk that economic data going forward will fall short of expectations. However, if investors perceive bad news as good news, as it keeps the Fed from tapering, then a run of negative readings may be a good thing and the risk of weak data minimal. Such is the distorted environment we must invest in.
The graph below shows the market’s breadth is diverging from prices. The orange line (S&P 500) has been steadily climbing despite the number of NYSE stocks sitting above their respective 50 dma’s falling. Looking back over the last four years you can see a similar divergence occurred in 2018. The S&P ultimately fell by about 20% as the Fed was reducing its balance sheet at the time. QE Taper is on the horizon, might that ultimately determine how this divergence ends?
Economic data will be relatively light during this holiday-shortened week. Of importance will be the FOMC minutes from the last meeting. We will be interested to see how much discussion there was around the timing of tapering. ISM non-manufacturing PMI is due out tomorrow. Expectations are for a slight decline, but the prices component should rise to a very high reading of 81. The BLS will release JOLTS job openings on Wednesday.
Over the weekend a few subscribers asked us to explain the Feds reverse repo program that is approaching $1 trillion daily and could rise to $2 trillion over the coming months. In particular, they want to understand how it is different from the repo program the Fed initiated in the fall of 2019 that lead to interest rate cuts and QE of T-bills. Our answer can be found at the 27:40 minute mark of last Thursday’s daily podcast- The Real Investment Show.
Despite the strong performance by the indexes today, the underlying breadth of the market remains poor. As shown below, 5 of the 11 sectors posted meager to negative returns, and only two sectors, Tech and Communication, beat the S&P. The generals are leading the way higher but the troops are not necessarily following.
Sharply rising prices at the pump are helping further stoke inflationary concerns among individuals. As shown, the price of gasoline futures are now at levels last seen in 2014.
As shown below, the headline number from the BLS jobs report was strong at 850k net new jobs added in June. However, the unemployment rate rose from 5.8% to 5.9% and the labor participation rate fell by a tenth of a percent to 61.6%. Also of concern, hourly wages and the average workweek were slightly lower than expectations. Earnings are tricky to make sense of as an increase does not necessarily denote increased wages. The mix of jobs is equally important and hard to gauge. For instance, many service jobs are low-paying and reduce earnings. This past month 343k jobs were added in the leisure and hospitality sectors and teachers accounted for 269k of the new jobs.
As we have noted recently, we expect the Fed will begin to taper purchases of mortgages, possibly as soon as the late July FOMC meeting. With mortgage rates just above all-time record lows of earlier this year and house prices rising at a double-digit pace, it’s hard for the Fed to deny some culpability in spurring a housing bubble. The graph below, courtesy of Jim Bianco, shows the Fed now owns about a third of all mortgages used in Barclay’s MBS index.
Markets will be closed on Monday, July 5th for Independence Day.
The series of graphs below show that almost half of the investors surveyed in the poll are taking on leverage to invest. Generation Z leads the pack with nearly 80% of respondents saying they are taking on debt to invest. Not surprisingly only 9% of the more conservative Baby Boomers are leveraging their assets. The second and third graphs show the types of loans and types of investments favored by personal investors. While the data is telling about the state of speculation in today’s market, we would like to see it compared to years past to put it into proper context.
July 1, 2021
The PMI Survey on manufacturing conditions, which has been rising sharply, is showing signs of peaking. The index came in at 62.1 versus expectations of 62.6 and the prior month’s reading of 62.1. However, input prices continue to rise and sit at a new record high. Per the increased price pressures Chris Williamson, Chief Economist for IHS Markit (survey producer) commented: “Supplier delivery times lengthened to the greatest extent yet recorded as suppliers struggled to keep pace with demand and transport delays hindered the availability of inputs. Factories were increasingly prepared, or forced, to pay more to secure sufficient supplies of key raw materials, resulting in the largest jump in costs yet recorded.
“Strong customer demand in turn meant producers were often able to pass these higher costs on to customers, pushing prices charged for goods up at a rate unbeaten in at least 14 years.”
China’s PMI continues to slowly weaken and their prices index is down from 59.8 in March to 51.4 in June. China is the driver of marginal global economic growth so their pronounced relative weakness versus the United States bears watching. Eurozone and UK PMI’s inched higher and are at similarly high levels as the U.S.
With the first 6 months of the year in the rearview mirror, it’s worth looking at how markets finished the year after a strong first half. The table below, from LPL, shows that in the 16 previous times since 1950 the S&P was up more than 12.5% in the first 6 months, the next 6 months were positive 12 times, with an average return of 7.1%. The S&P is up over 14% already this year so the statistics books tell us that +20% is a reasonable expectation.
One of the key factors driving inflation higher is supply line problems. The graphs below from Goldman Sachs show that supplier delivery times are now over 4 standard deviations above their norm of the last 20 years. Maybe more concerning, businesses expect the problem to abate somewhat in 6 months but they still expect the largest supplier delays in 20 years.
The graph below highlights the difficulty in trading modern equity markets. As shown, if you bought the S&P 500 at the market open and sold the close since 1993 you would have not made a dime other than dividends. Conversely, if you bought the market at the close and sold at the open you would have captured all of the market gains of the last 28 years.
The ADP jobs report came in nearly 100k jobs stronger than expected at 692k net jobs added in June but off the 978k pace from last month. Not surprisingly, leisure and hospitality jobs account for nearly half of the gain as shown below.
Liz Ann Sonders from Charles Schwab posted the commentary below on Twitter which rebukes the commonly held thought that enhanced unemployment benefits are keeping people from finding jobs.
Job postings on @indeed in states that have ended enhanced unemployment benefits early have been climbing right in line with openings throughout the country, supporting @CapEconomics view that added insurance isn’t that strong a factor in holding back employment.
When extended benefits end nationwide over the next few months, we will better understand why job openings are at a record at the same time the unemployment rate is elevated from pre-pandemic levels.
In the aftermath of the last FOMC meeting and numerous Fed speeches, it is clear that unemployment is the main factor holding the Fed back from tapering QE and raising rates. As such, today’s ADP report and Friday’s BLS labor report will be important in regards to estimating the timing of Fed actions. ADP is expected to show a gain of 533k jobs, a historically strong pace but well off last month’s 978k. Friday’s BLS report is expected to show a pick-up of 675k jobs, compared to 559k last month. Equally important will be the participation rate, unemployment rate, and wages and hours in Friday’s report.
The graph below, courtesy of the Brookings Institution, shows the massive amount of fiscal stimulus of the last year is waning. Going forward, the sharp decline in spending will detract from GDP growth. This graph does not obviously take into account unknown future stimulus spending bills.
June 29, 2021
The chart below highlights an important issue for markets and one hotly debated by market prognosticators. Does the amount (stock) of monetary stimulus or the change (flow) in the amount of stimulus matter more? The graph below, on the left, from JP Morgan, shows the size of the major central bank balance sheets has doubled since the pandemic started. At the same time, the 12-month change in balances just peaked at over $8 trillion and is heading sharply lower. We believe the flow or annual change of the stimulus matters more. Accordingly, we think caution is warranted as the correlation between QE and asset prices is strong as shown in the second graph.
Home prices remain red hot. The Case Shiller 20 City home price index rose 1.6% on a monthly basis and 14.9% annually. The FHFA (regulator of Fannie Mae and Freddie Mac) home price index confirmed Case Shiller by rising 15.7% annually.
Also of note on the economic front, consumer confidence was much better than expected at 127.3 versus 117.2 last month. It now stands only about 5 points below pre-pandemic levels. While market expectations for inflation have leveled out in recent months around 2.5%, consumer expectations, via the confidence survey, just hit a 10 year high at close to 7%. Keep in mind consumers tend to believe there is more inflation than reported by the government, ergo they have higher expectations for inflation than the market. The lowest levels of the last ten years occurred between 2016-2019 where they ranged between 4.5% and 5%.
The graph on the left shows the shape of the crude oil futures curve. Specifically, the black line is the price difference between the front-month contract and the forward contract settling a year in the future. As shown by comparing the curve to the price of crude oil (right graph), when the curve peaks (oil futures are in backwardation), oil prices tend to peak.
June 28, 2021
The graph below updates inflation expectations. As shown, both 5yr and 10yr expectations have stabilized for the last three months after rising sharply for almost a year. The other takeaway is the difference between 5yr and 10yr expectations. Typically 5yr expectations are lower than 10yr. Since late 2020 they have been higher. This can be interpreted as the market believing the Fed in that inflation will run “hot” but will be transitory. The difference between them is shown in gray. Recently it has been slightly declining, furthering the transitory view.
As shown below, B and CCC-rated junk bonds are now trading at 20+ year record low yields. As a spread versus U.S. Treasuries, both sets of bonds are close to levels seen in 1999 and 2007. With little upside and significant downside, we urge caution in the junk bond sector. Simply, the additional yield offered by junk bonds versus safer bonds is not worth the additional risk.
The S&P 500 is showing signs of weakness lately as it grinds higher at a seemingly slowing pace. This chart from Bloomberg points out the narrow breadth seen as the index made a record high last week. Only 46% of index members were trading above their 50-dma when the market closed on Thursday.
The following chart from SentimenTrader provides ominous historical context to the situation. The last time we saw the market making new highs with a similar lack of breadth was in 1999. Moreover, most other instances prior to 1999 preceded significant corrections or bear markets. This is not to say a large correction is imminent, rather keep an eye on signs of market weakness as the effects of fiscal stimulus fade.
The economic calendar will be busy this week. The Case-Shiller Home Price Index and Consumer Confidence Index will be released tomorrow, followed by the ADP Employment Report on Wednesday and the ISM Manufacturing Index on Thursday. Perhaps most important, Nonfarm Payrolls will be released Friday. Considering recent inflation prints, unemployment continues to grow in importance with regard to the Fed’s decision to taper asset purchases.
After last week’s barrage of Fed speakers, this week will be relatively light. We will hear from NY Fed President John Williams today.
Boston Fed President Eric Rosengren voiced some concerns regarding financial stability today. He commented that we should to consider some of the side effects of a “low for long” interest rate plan, and that the Fed needs to have a less ad hoc approach to crises. He continued by stating that monetary policy may not be as accommodative for as long if financial stability risks are not addressed. Regarding inflation, he largely stuck to the script reiterated many times this week by Fed members.
Rosengren also discussed a need to monitor the speed of increases in housing prices, noting that in several markets, prices are now higher than they were prior to the financial crisis. He suggested that the Federal Reserve consider tapering treasury and MBS purchases by the same amount when the time comes. Tapering of MBS purchases has become a hot topic with Fed officials lately, signaling this could be the first area of action when the time comes.
The University of Michigan’s Consumer Sentiment Index was 85.5 for the month of June, which measures below the estimate of 86.5. The index fell from the preliminary reading of 86.4 earlier this month, however, it represents an improvement from May’s value of 82.9.
Personal Income fell -2% in May versus expectations of -2.6%, while Personal Consumption Expenditures were unchanged on a monthly basis, missing the consensus of +0.6%. On a YoY basis, the PCE Price Index matched expectations of +3.9%. This represents a slight increase over the +3.6% seen in April.
The Core PCE Price Index, the Fed’s preferred measure of inflation, rose +0.5% on a monthly basis and +3.4% YoY in May. Both timeframes came in below expectations and compare to April’s readings of +0.7% MoM and +3.1% YoY. The Federal Reserve will likely stick to its story of transitory inflation caused by a strong reopening and supply chain pressures which will moderate going forward.
Lumber futures continue to retreat this morning as home builders wait out high input costs, buyers are increasingly priced out of the market, and saw mills begin catching up with demand.
The following chart from Julien Bittel shows that since 1990, every time the 30-Year T-Bond yield rose more than 1% over a 12-month period, it declined over the subsequent 12 months. The YoY change in yield reached 1.3% on March 8, 2021, and the rate has fallen over 21 basis points since. Thus, the data suggests we may have seen a local peak in long-term yields.
June 24, 2021
The bipartisan infrastructure agreement includes $579B of proposed new spending. According to President Biden, funding sources will not include a gas tax increase or fees for electric vehicles. The President also said he expects a vote on the bill before the fiscal-year ends.
“We’ve struck a deal. A group of senators – five Democrats and five Republicans – has come together and forged an infrastructure agreement that will create millions of American jobs.”
Weekly jobless claims came in higher than expected this morning, at 411K versus a consensus estimate of 380K. Initial claims fell by 7K, a slight improvement over last week’s data but still higher than the print two weeks ago. As we alluded to last week, the employment situation going forward will be an important factor in the timing of the Fed’s decision to begin tapering asset purchases.
A bipartisan group of Senators will meet with President Biden today at 11:45 AM EST to discuss plans for an infrastructure proposal totaling nearly $1 trillion. According to Senator Jon Tester, the group has reached a general framework for the deal but there are still some components that need to be fleshed out.
Yesterday Treasury Secretary Janet Yellen urged Congress to increase the government’s debt limit to avoid potential default on Treasury debt this year. The Wall Street Journal noted:
“Without congressional action to suspend or raise the limit after July 31, the government could begin to miss payments on its obligations, triggering a default on government debt, which Ms. Yellen called unthinkable.
‘Failing to increase the debt limit would have absolutely catastrophic economic consequences,’ she said, noting that the U.S. has never defaulted on its legal obligations. ‘I believe it would precipitate a financial crisis. It would threaten the jobs and savings of Americans at a time when we’re still recovering from the Covid pandemic.’”
It is highly unlikely that Congress would allow this to happen, but as Yellen stated, “We can’t tolerate any chance of defaulting on the government’s debt.”
The chart below compares the shape of the 2yr-30yr UST yield curve (orange) to the ratio of the S&P 500 Growth to Value indexes. As shown, the correlation has been strong since the start of the year. Growth has outperformed recently as the yield flattened. This chart falls in line with a lot of other trends which help define the inflation-deflation trade.
June 23, 2021
Following the hawkish stance from Bostic, the Fed’s Kaplan made some comments that inspired modest selling into the close.
“The U.S. economy will likely meet the Federal Reserve’s threshold for tapering its asset purchases sooner than people think, said Dallas Fed President Robert Kaplan, who has penciled in an interest-rate increase next year.
‘As we make substantial further progress, which I think will happen sooner than people expect — sooner rather than later — and we’re weathering the pandemic, I think we’d be far better off, from a risk-management point of view, beginning to adjust these purchases of Treasuries and mortgage-backed securities,’ Kaplan said Wednesday in an interview with Bloomberg News.”
Like Bostic, Kaplan said he expects an initial rate hike in 2022.
The Atlanta Fed President, Raphael Bostic, said today he now expects a rate hike in late 2022 with two additional rate hikes in 2023. He also expressed his belief that the economy is close to fulfilling the “substantial further progress” needed to begin tapering bond purchases and commented that a tapering decision could be made in 3-4 months. The S&P 500 briefly dipped into negative territory following his comments but returned to positive territory shortly thereafter.
Following yesterday’s stronger than expected Existing Home Sales report, New Home Sales fell 5.9% to 769K in May, missing expectations by a wide margin. The median sales price rose to a record high $374,400 (+18.1% YoY) as supply side constraints contributed to rising prices.
The median sales price of existing homes in the US rose to $350,300 last month, up 23.6% year over year. This chart from Bloomberg highlights the clear link between declining inventory and surging home prices. Meanwhile, the Federal Reserve continues its purchases of $40B per month in MBS despite fueling a supply-demand imbalance that is driving home prices out of reach for many first-time home buyers.
The graph below shows the absurdity of how low junk bond yields have gotten. Assuming no defaults, which is historically impossible, the Barclays junk bond index will return a yield slightly below the rate of inflation. Typically the real, post-inflation, yield is north of 4% to provide a cushion against defaults. Just to hit home with the stunning graph, in a better than best-case scenario, junk bond investors should expect to lose purchasing power.
June 22, 2021
The semiconductor chip shortage worsened yet again last month, according to an article published by Bloomberg earlier today.
“Chip-starved industries from automakers to consumer electronics will need to wait a bit longer for components, as delays in filling orders continue to get worse.
Chip lead times, the gap between ordering a semiconductor and taking delivery, increased by seven days to 18 weeks in May from the previous month, an indication that chipmakers’ struggles to keep up with demand are worsening, according to research by Susquehanna Financial Group.”
The chart below shows the drastic increase in lead times for semiconductor chips as the economy continues to reopen.
Per Live Squawk:
– Fed’s Daly: Appropriate To Debate Taper But We Are Not There Yet
– Could Reach Threshold For Taper Late 2021, Early 2022
– Looking To Autumn To Get More Clarity On Economy
Existing home sales for May came in above expectations at 5.8M versus the consensus of 5.72M. This represents a decline of 2.7% from the April level. The lack of supply of existing homes continues to pose a problem for the market, but it’s worth noting that inventory rose 7% month over month.
At 2 pm ET Chairman Powell will testify to Congress on Pandemic emergency lending and supporting economic recovery. This will be the first chance for Congress to pressure Powell on rising inflation and the problems it creates for the lower and middle class. This will also Powell’s first comments since the Fed meeting last week.
This excerpt from his prepared remarks echoes a familiar tone:
“Inflation has increased notably in recent months. This reflects, in part, the very low readings from early in the pandemic falling out of the calculation; the pass-through of past increases in oil prices to consumer energy prices; the rebound in spending as the economy continues to reopen; and the exacerbating factor of supply bottlenecks, which have limited how quickly production in some sectors can respond in the near term. As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”
June 21, 2021
New York Fed President John Williams said today that he believes recent inflation data is mostly due to rapid reopening of the economy and supply chain disruptions.
“I expect that as price reversals and short-run imbalances from the economy reopening play out, inflation will come down from around 3 percent this year to close to 2 percent next year and in 2023.”
Regarding the Fed’s policy, he went on to explain:
“It’s clear that the economy is improving at a rapid rate, and the medium-term outlook is very good. But the data and conditions have not progressed enough for the FOMC to shift its monetary policy stance of strong support for the economic recovery.”
Following some hawkish comments on Friday, the St. Louis Fed’s Jim Bullard appears to have dialed it back this morning:
BULLARD SAYS NO ONE REALLY KNOWS HOW THIS IS GOING TO UNFOLD BUT NEED TO BE READY FOR UPSIDE RISKS TO INFLATION
BULLARD SAYS THE COMMITTEE IS ONLY NOW STARTING TO TALK ABOUT TAPERING AND IT WILL TAKE SOME TIME TO GET THAT UP AND RUNNING
BULLARD SAYS LOW INTEREST RATE AND LOW INFLATION RATE ERA IS NOT ENDING ANY TIME SOON
Bullard: There Are Legitimate Questions About Fed Buying Mortgage Bonds
This upcoming week will be relatively light on the economic data front but should be chock full of Fed speakers. Jobless claims on Thursday bear watching to see if the recent downward trend continues. Friday will feature the PCE price index for May. This is the Fed’s preferred measure of inflation.
Given the Fed’s change in tone last Wednesday, we will closely follow Fed speakers. Many Fed members were already calling for the Fed to taper sooner than Powell was alluding to. Inflation is clearly becoming a concern of the Fed. As such, we will see if their calls for taper become more urgent. If Bullard’s recent comments that we shared are any indication, the market may be volatile.
Owners Equivalent Rent (OER), a proxy for housing costs, accounts for about a quarter of the CPI number. Rents are on the rise as discussed in a CNBC article entitled- Rents for single-family homes just saw the largest gains in nearly 15 years. While housing prices were rising double digits, rental costs were not following. Recent data, some of which is included in this article, shows that rental prices may finally be playing catch up. If so, they will provide a further boost to CPI levels.
Per the article: “Single-family rents were up 5.3% year over year in April, rising from a 2.4% increase in April 2020, according to CoreLogic. That is the largest gain in nearly 15 years.”
At Wednesday’s FOMC press conference Powell used the word “transitory” twice, compared to 9 times at the prior meeting in late April. He also voiced concern that inflation might be “persistent”. While parsing what we think the Fed is thinking is difficult, both examples suggest the Fed is much more concerned about inflation today than a month or two ago.
The market action since Wednesday’s Fed meeting has taken a decidedly deflationary bias. Since Wednesday afternoon, the 30 year UST yield has fallen from 2.23% to 2.10%. Commodity prices like copper and oil are off 5% and 3%, respectively over the same period. The NASDAQ rose 1.25% yesterday while the commodity heavy Dow fell by 0.60%.
Gold and silver were closely tied to bond yields and deflationary sectors over the prior month or so. Days in which inflation expectations fell and technology rose gold tended to do well. That has not been the case the last two days. We are keeping a close watch on precious metals to see if the correlation of the last month is breaking down. The dollar index is up nearly 2% over the last two days, which also helps explain gold’s weakness.
“Should we prepare for a sneaker shortage now? Get ready, folks…” That was the last line of a great Business Insider article entitled Why the World Is In a Shipping Crisis. We recommend reading it as it details problems in the transocean shipping industry that are driving shortages of many popular goods. One factor the author mentions is the surging price of shipping containers. The graph below, courtesy of Arbor Research, shows the dramatic price increase of containers since the start of the year.
The graph below, courtesy of Arbor Research, shows the tremendous inflows of money into ETFs that benefit from higher levels of inflation.
June 17, 2021
The graph below, courtesy of Arbor Research, shows the sharp drop in inflation expectations following yesterday’s Fed meeting. Market activity across many asset classes concurs, pointing to expectations for a more hawkish Fed going forward.
With the Fed boosting their inflation forecast it seems the only factor preventing the Fed from tapering sooner rather than later is the employment situation. As such, weekly jobless claims, in addition to the monthly BLS/ADP reports are important to keep a close eye on. If claims continue to decline, as they have done for the last three months, it will support yesterday’s shift in the Fed’s outlook about tapering. Initial jobless claims rose from 375k to 412k this past week. Prior to the Pandemic, claims were running in the low 200k’s per week. If the downward trend continues, claims will pierce 300k in one or two months and possibly normalize in the fall. Keep in mind the trend is predicated on continued economic recovery which may become trickier as the various forms of fiscal stimulus wane.
Tomorrow is quadruple witching day, one of four days each year in which index futures, options futures, stock options, and stock futures expire on the same day. Often, the confluence of expirations can lead to increased volatility as investors unwind their futures and/or options positions before contracts expire.
The popular narrative helping explain why Treasury yields are falling revolves around investors buying into the Fed’s belief that the recent bout of inflation is transitory. While it has merits, it’s also worth understanding the supply and demand dynamics in the U.S. Treasury market. Since January 1st, Treasury debt balances have risen by $271bn. At the same time, the Fed has purchased, $441bn of U.S. Treasury bills, notes, and bonds. Despite large deficits, the amount of debt outstanding in the markets has actually shrunk. Foreign holdings of U.S. Treasury securities also rose by approximately $60bn over the period. Simply, the supply/demand equation for U.S. Treasuries has resulted in lower yields. As we have mentioned, Treasury issuance has been lighter than normal over the past few months as they draw down their account at the Fed (TGA). Currently, their account balance is $730bn, down by over $1trln from last year’s highs. It will likely come down another $400bn by October, which should further keep net issuance after Fed purchases flat to negative.
June 16, 2021
Key comments and some commentary from Jerome Powell’s press conference:
“Inflation has risen significantly in recent months”
“Inflation could turn out to be higher and more persistent than we expect“
“Even after liftoff (tapering), policy will remain highly accommodative“
“Before adjusting asset purchases, the Fed would give advance notice”
“Over the summer, prepare to see a lot of job growth”
“Take the dot plots (Fed expectations) with a grain of salt”
He mentioned employment a lot in his opening speech. Given strong economic growth and rapidly rising inflation, employment is the only thing holding the Fed back from tapering QE and raising rates. If he is correct about strong summer job growth, taper could come as early as this fall.
“This is an extraordinarily unusual time. We really don’t have a template or any experience of a situation like this. I think we have to be humble about our ability to understand the data.” – This was his most important line- we are in unchartered territory and neither the Fed nor any “expert” should have full confidence in their economic or market expectations.
*POWELL: THIS WAS A `TALKING ABOUT TALKING ABOUT’ MEETING- In other words, they are now thinking about tapering. Prior to today, even “thinking about, thinking about”, tapering was off the table. He confirmed that with- “Near term discussions that will begin is about the path of asset purchases”
Powell left little doubt that the Fed is now strategizing about when and how to taper.
Bottom line: the Fed’s statement was little changed but the more optimistic changes in their economic projections are hawkish as it implies the Fed will taper and increase rates sooner than expected.
The Fed raised their core PCE inflation forecast for 2021 to 3.0% from 2.2% and the all-inclusive CPI from 2.4% to 3.4%. Further, the consensus of Fed members now expects to increase rates twice in mid-2023. The Fed did not taper mortgage purchases as we suspected they might do. The “dot plot” graph on the left shows the level of Fed Funds that each Fed member expects by year. There are now 7 Fed members that think the Fed will hike rates as soon as next year. There were only 4 in March. The Fed statement barely changed from the last meeting six weeks ago as shown in the second graphic.
The ten-day moving average of the S&P 500 put-call ratio is now at its lowest levels since those seen before the tech crash in 2000. The ratio is the volume of put options divided by the volume on call options. A low ratio, as we have now, denotes there is significantly more interest in making upside bets than taking on downside protection.
Last Friday’s University of Michigan Consumer Sentiment survey shared results for home-buying conditions as seen by buyers and home builders. The first graph below, courtesy of Lohman Econometrics, shows that consumers believe now may be the worst time to buy a home in at least 35 years. The second graph shows the massive divergence between the optimistic view of home builders and their potential customers. As an aside, buying conditions for automobiles also registered the lowest reading going back to the 1980s.
June 15, 2021
Rule #9 by Bob Farrell states: “When all the experts and forecasts agree – something else is going to happen.” Only 2% of those surveyed by Bank of America expect a bear market during the remainder of the year. We caution you, complacency is most often seen at tops, not bottoms.
Bank of America got it right, Retail Sales fell 1.35%. The table below from Brett Freeze breaks down its major components to show how each sector contributed to the data (column on the right). As shown, motor vehicle sales account for -.81% of the decline and building materials -.38%. Auto and home sales are the two hottest sectors over the last few months. Higher prices may finally be having a negative effect on sales. Not surprisingly, food services and drinking were the leading contributors as the economy reopens and people get comfortable going out again.
Producer Prices (PPI) were above expectations. Year over year prices rose 6.6% versus expectations for 6.2%. Core PPI was +5.3% versus expectations of 5.1%.
Retail sales are due out at 8:30 am ET this morning. Expectations are for a 0.4% decline. Bank of America, using its proprietary credit card spending data, suggests the number could be a full 1% weaker than expectations at -1.4%. Retail sales underwhelmed expectations last month as correctly predicted by Bank of America’s spending tracker.
As we wrote last week, we think it is possible for the Fed to reduce QE purchases of MBS as early as tomorrow’s FOMC meeting. Further fueling our speculation is comments from Andy Haldine, Chief Economist of the Bank of England. He states: “As things stand the housing market is on fire.” “There is a significant imbalance between incipient demand and available supply of houses, and because the laws of economic gravity have not been suspended, the result is pretty punchy rises in house prices.” Further, he tied the remarks to widening wealth inequality. Sound Familiar?
In part II of Two Pins Threatening Multiple Asset Bubbles we commented “Who benefits more from rising home prices, the wealthy or the poor? Who tends to rent more, the wealthy or the poor? Fed policy directly supports the housing market, and its benefits are overwhelmingly bestowed upon the wealthy.” The combination of surging housing prices and growing wealth inequality is certainly enough fodder for the Fed to reduce purchases of MBS sooner rather than later.
June 14, 2021
In last Friday’s Technical Value Scorecard, we wrote: “Note also that financials and materials are now both slightly oversold after being decently overbought last week and for many months prior. Both sectors underperformed the S&P by about 2.5%.” The graph below shows the recent weakness in the ratio of financial stocks (XLF) to the S&P 500 (SPY). Since last November, the ratio has bounced off the red support line three different times after dipping below the 50dma. Currently, the ratio is trading below its 50 dma, but it is still above the trendline. A break of the trendline may likely signal further relative weakness for financials and may prove to be another sign that the reflationary trade is coming undone.
Retail Sales and PPI will be released on Tuesday. PPI tends to lead CPI, so we will watch closely to see if rising producer prices start to ease. Housing Starts and Permits on Wednesday are expected to rise slightly. Recent MBA mortgage data shows their purchase index weakening. We shall see if weakening demand translates to less construction of new homes.
Most important this week will be the Fed’s FOMC meeting on Wednesday. We will again be on the lookout for signals the Fed is thinking about tapering. Equally important to Powell’s press conference following the meeting, will be the speeches following from various Fed members. Many have become increasingly outspoken about the need to start considering tapering QE purchases.
In the past, we mentioned that the Treasury accumulated a lot of cash from the stimulus relief bills that were not immediately spent. The excess cash balance sitting at the Fed’s Treasury General Account (TGA) must be reduced significantly by October. The Treasury, with the surplus cash, must significantly lessen its borrowing needs, specifically with short-term Treasury Bills, to meet its mandate.
Banks, hedge funds, and other leveraged investors are highly dependent on said bills as they are used for collateral for many trading opportunities. Further, money market investors are also facing problems finding positive yielding short-term paper as cash balances by retail and corporate investors are running high. As a result of the relative dearth of T-bills and strong demand, banks and money market funds are actively engaging in reverse repurchase (RRP) transactions with the Fed. The graph below shows the daily overnight repo balances at the Fed now account for over 50% of the decline in TGA balances. As we approach the Fed meeting next week, we need to consider if the Fed will take actions to combat short-term interest rates trading below their target. Fed Funds are trading between 5-6 bps versus 10 bps prior to the reduction in TGA balances.
Today’s University of Michigan Consumer Sentiment survey has interesting inflation results. The broad sentiment index increased over the past month with current conditions falling slightly but future expectations rising decently. Of particular interest, 1-year inflation expectations were only 4% versus expectations for 4.7%. 5-10 year expectations were also below expectations at 2.8% versus 3%. Might the consumer also be buying into the Fed’s expectation that inflation will be transitory?
The table below breaks down sentiment by political affiliation. The results show the stunning change in sentiment over the past year based on the change in political power.
The graph below, courtesy of Fundstrat, shows the strong correlation between the change in ten-year UST yields and the change in the ratio of financials to technology. Financials tend to outperform technology as yields rise and vice versa. As we have been writing about on many occasions, financials are part of the inflationary trade and technology along with Treasury bonds part of the deflationary trade. In the technical value scorecard below, we wrote: “One of the key themes this past week is the increasing investor buy-in to the Fed’s expectation that inflation will be transitory. Despite a 5% annual inflation print Thursday, bond yields fell and the deflationary sectors outperformed inflationary sectors.”
It’s too early to see if the market transition to a more deflationary regime will be lasting, but watching yields and the sector rotations, as the graph shows, will be an important and powerful tool.
Next Tuesday and Wednesday, the Fed’s FOMC meets to discuss monetary policy. Due to soaring home prices, we think, it is possible the Fed announces it will begin to reduce its $40bn/month of MBS purchases. If that were to occur, it’s likely to be matched with increased purchases of UST securities. If not, any net reduction of QE would go against the Fed’s forward guidance that they “are not even thinking about, thinking about tapering. The last thing the Fed wants to do is cause investor confusion and potentially harm investors’ confidence in the Fed.
As we wrote in Taper is Coming: Got Bonds?, tapering of QE has actually been good for bond prices in the prior instances. The graph below, from the article, shows that periods of QE – highlighted in gray- were followed by lower 10-year UST yields.
June 10, 2021
Early today we offered caution as the recent bout of low volatility might be a precursor to a move lower. LPL Research takes the other side. As shown below, when stocks are sitting near all-time highs “dull markets” offer decent average returns over the next six months.
CPI was stronger than expected with a monthly increase of 0.6% and year over year rate of 5%. Core CPI rose 0.7% monthly and is running 3.8% year over year, the highest since 1992. As we showed earlier today, used car prices are having a significant influence on inflation data. In today’s report, used car prices rose 7.3%, on top of last month’s 10%. Bond yields are up slightly on the report but equities seem comfortable thus far, posting a slight gain. The graph below shows that CPI, using a two-year annualized rate, is back to pre-pandemic norms.
The sleepy market is potentially a warning signal. The lower graph shows the average true range (ATR) using 10 day periods on SPY. It confirms the recent bout of lackluster trading we are witnessing. More often than not over the last few years, a low ATR resulted in a sell-off of sorts. One problem with relying on a low ATR is that it can drift at low levels for quite a while. It’s worth adding, our proprietary cash flow models are getting ready to turn bearish and the Fed is meeting next week. As such, the potential for a pick-up in volatility is increasing.
The Manheim Used Car Index continues to soar as shown to the left below. The index is up approximately 43% since January of 2020 while the used cars and trucks sub-index of CPI is only up 21%. The second graph compares the Manheim index to the CPI-used car index. Currently used cars only account for 2.57% of CPI, yet despite its low relative importance, substituting Manheim for the BLS data would result in a CPI number that is .57% higher than reported.
The graph on the left below, courtesy of Arbor Research and Trading, shows 10-year sovereign yields, worldwide, are the least volatile they have been in at least 25 years. Essentially, the chart quantifies that bond traders are complacent. Frequently, periods of low volatility are followed by more extreme volatility. The 10-year UST yield graph on the right highlights the latest four low volatility readings as shown on the first graph. The data warns of a big move coming, but not in which direction. With U.S. ten-year yields sitting on support at 1.50%, a break below could introduce the meaningful potential for a push to 1.25-1.00%. Trade carefully.
June 09, 2021
The graph below shows, based on expectations for tomorrow’s CPI data, CPI and Core CPI should peak at 4.65% and 3.41% respectively tomorrow. Thereafter, assuming a 2.5% annual rate of inflation, which is 1% higher than the previous five years, annual rates of CPI will fall throughout the next 12 months. Conversely, Core CPI, the Fed’s preferred method for assessing inflation, will stay at current levels until February 2022 before falling. Assuming a slightly higher 3% rate of inflation going forward, CPI will linger at slightly above 4% this year, while Core CPI will rise to 4% before peaking in early 2022. The Fed is likely following monthly data versus year over year data due to the skewed base effects.
The yield on the 10-year Treasury note broke below 1.50% this morning, down nearly .30% from its highs in March. As shown below, 1.50% has been technical support for yields. If it holds, we suspect yields will rise to about 1.60% where it will test the recent downward sloped resistance line and its 50 dma. A break lower in yield, possibly due to a weaker than expected CPI number tomorrow or hawkish language from the Fed next week, could result in yields falling as far as the 200 dma (1.15%). It’s worth adding, 5-year break-even inflation expectations have fallen from 2.72% in mid-May to 2.47%. Both indicators are currently opining that despite a spike in inflation that may last a few more months, inflation will ultimately be transitory and gravitate back to trend.
The graph below, courtesy of BofA Global Research, shows the power of the massive stimulus payments given directly to citizens. As shown, retail sales are nearly 20% above pre-pandemic levels despite employment which remains almost 10 million jobs below pre-pandemic levels. Had the government not infused massive stimulus, paid directly to individuals, retail sales would look a lot like the employment graph. Mind you, personal consumption accounts for about two-thirds of GDP. As such, GDP would also look like the employment graph. Going forward, with less fiscal stimulus likely, the economy will become heavily dependent on employment making a swift recovery and bolstering jobs and wages back to trend levels.
June 08, 2021
The JOLTS (job layoffs and turnovers) report from the BLS showed the number of new job openings reached another record high at 9.3mm. Despite the number of openings, the number of hires was little changed at 6.1mm. In a positive sign for job growth, the number of separations (quits) increased to 5.8mm, a series high. Workers tend to quit jobs when they are confident in their ability to easily find a better job. Click HERE for the full report. The updated Beveridge Curve below shows the job opening rate is near twice the rate it should be based on historical unemployment data. The conundrum continues: why are businesses not hiring given there are so many unemployed and why are people not taking jobs that are apparently abundant?
The series of charts below, courtesy of @robinbrooksiif, provides a rough profit margin proxy for manufacturers by country. Output prices (vertical) are what firms charge their customers, while input prices (horizontal) are what they pay for goods to produce their products. The dots shifting toward the right and away from the red line over the three-month period is an indication that producers are able to mark up their prices and more than offset the increasing cost of goods used to produce their goods. This is a positive sign for manufacturing profit margins.
The graph below, courtesy of Black Knight, helps partially explain why home prices are soaring. As shown, the number of active sale listings is running at less than half of the average running rate before 2020. Despite higher prices, the number of new listings still lags the average by about 25%. Further, new listings account for more than 75% of listings in April. This is because most homes are selling quickly and not lingering on the market, meaning new listings are largely the only listings. To wit: “Data from our Collateral Analytics group showed there was two months’ worth of single-family inventory nationwide in March, the lowest share on record and trending downward.” The second graph shows the rise in home prices has been relatively equally distributed across the country. LINK to the full report which also includes interesting data on delinquency and foreclosure activity.
Coupled with the lack of supply noted above is relatively strong demand resulting in higher home prices. However, a recent survey by Fannie Mae points to weakening demand which may help counter low supply and provide a headwind to further home price inflation. Per Reuters: “The percentage of consumers who said it is a good time to buy a home declined in May to 35% from 47%, Fannie Mae said in its monthly survey of the U.S. housing market. This reading, the lowest since Fannie Mae began the survey about a decade ago, marked the second straight monthly decline and represented a drop of 18 percentage points since March.”
Treasury Secretary Janet Yellen, during a weekend speech, made the following comment: “Higher interest rates would be a plus for the U.S. and the Fed.” We are unsure of what to make of her comment, but assume she is looking forward to a time the Fed can raise rates because the economy and jobs market is fully recovered.
Economic data will be in short supply this week. On Tuesday, the BLS will release the JOLTs report. On the heels of last week’s employment reports, it will be interesting to see if the job openings rate remains at record highs. Thursday will feature the all-important CPI report.
Fed members will go into a media blackout this week in advance of the next FOMC meeting on June 16th.
A couple more concerning tidbits from Friday’s employment report. Service producing jobs produced 556k of the 559k new jobs. These tend to be lower-paying jobs. Secondly, the graph on the right, courtesy of Brett Freeze, shows temporary help service growth has stopped increasing on a quarterly basis. Temporary help and GDP growth are well correlated as shown in the graph on the left.
Bloomberg recently published a great article highlighting the surge in the price of materials used to build houses. In their article, Building a home in the U.S. has never been more expensive, they open the financial books of a Boise Idaho based construction company and break down the cost increases of products used to build a new house. Based on this one builder, the cost to construct a new home has risen 58% from the pre-pandemic period. The following are a few of the examples the article shares:
The graph below, courtesy of the Peterson Institute, provides context for the jobs recovery and the 10 million job shortfall from the pre-pandemic trend. This is the key statistic that concerns the Fed and keeps them from tapering QE and or raising rates.
The BLS employment numbers were underwhelming. Payrolls grew by 559k versus expectations of 650k. More importantly, following the strong ADP report, many market prognosticators thought the number of new jobs could approach 1 million. Possibly more concerning is the monthly change in hourly earnings only rose by 0.5%. Expectations were for a gain of 0.7%. Wages are not keeping up with the spike in inflation, especially for necessities like food, energy, and shelter. The labor participation rate continues to languish, coming in at 61.6%, 0.1% lower than last month. The U-6 which is the broadest measure of unemployment was 10.2%, down from 10.4%. Jerome Powell has mentioned that this indicator is a truer measure of unemployment. As we look forward it is worth noting Thursday’s Challenger report showed job openings were at the lowest level in a year.
Glenn Kelman, CEO of Redfin (@glennkelman), posted a series of Tweets about the state of the housing market. We share a few of the most interesting comments, but urge you to read the entire thread as it is very telling about the state of the real estate market.
It has been hard to convey, through anecdotes or data, how bizarre the U.S. housing market has become. For example, a Bethesda, Maryland homebuyer working with @Redfin included in her written offer a pledge to name her first-born child after the seller. She lost.
There are now more Realtors than listings.
Inventory is down 37% year over year to a record low. The typical home sells in 17 days, a record low. Home prices are up a record amount, 24% year over year, to a record high. And still homes sell on average for 1.7% higher than the asking price, another record.
In 2020, new-construction permits were *down* 13% in DC and New York, 40% in LA, 48% in Chicago, 50% in Seattle, 79% in San Francisco. Permits were *up* 25% in Miami, 56% in Vegas, 96% in Greenville, 122% in Detroit, 246% in Knoxville.
In Redfin’s annual survey of nearly 2,000 homebuyers, 63% reported having bid on a home they hadn’t seen in person.
For low-tax states, 4 people move in for every 1 who leaves. For Texas, this ratio is 5:1; for Florida, 7:1. Cites & states have no leverage to raise taxes, after many promised new money for social justice; the federal government will have to fund long-term investments.
The average housing budget for out-of-towners moving to Nashville was $720K, ~50% higher than locals’ $485K budget. It used to be coastal elites who worried that every adult in the family had to win a career lottery, just to afford a home. Now that feeling may spread.
it’s not just income that’s k-shaped, but mobility. 90% of people earning $100,000+ per year expect to be able to work virtually, compared to 10% of those earning $40,000 or less per year. The folks who need low-cost housing the most have the least flexibility to move.
The ADP jobs report came in much stronger than expectations at 978k versus 650k expected. Last month’s figure was revised lower by nearly 100k to 654k. The current estimate for tomorrow’s BLS report is +645k jobs. While the ADP data is a great sign for economic recovery, the improving employment market also signals an end to excessive monetary policy. Further improvement may be a case where good news is bad news for the markets.
Yesterday we discussed how the Momentum (MTUM) ETF has switched from growth stocks to value stocks. The same is occurring in other factor-based ETFs. For instance, the two top holdings of IWN, the iShares Russell 2000 Value ETF, are GameStop (GME) and AMC Entertainment (AMC). Both stocks have risen considerably to valuations that are extreme. They are about as far from value as one can imagine. The scatter plot below shows that AMC’s valuation is now approximately 10x its historical valuation based on revenue. One can easily argue the number is even higher as the movie theater industry will likely not fully recover from the Pandemic due to the growing popularity of streaming services.
Last night, the Federal Reserve said they will shortly announce plans to wind down their Secondary Market Corporate Credit Facility (SMCC). The announcement is a far cry from tapering QE, but it is another reversal of pandemic-related actions. The facility only owns $13.8 billion of corporate bonds and ETFs.
The graph below is yet another way to assess inflation expectations. The Citi Inflation Surprise Index measures economists’ consensus forecasts for inflation versus actual inflation readings. The higher the level, the more the economists underestimated inflation. Conversely, negative readings mean they overestimated inflation. As shown, they are currently underestimating inflation by the largest amount since at least 1998.
The scatter plot below compares each monthly instance of 5 year UST yields with the Core PCE inflation index. As shown, the relationship over the last 30 years has been statistically significant. The orange dot shows today’s instance is straying far from the historical relationship. Either, the market thinks inflation is transitory and not pricing it into bond yields or the Fed, via massive liquidity injections, is artificially suppressing yields by about 4%.
June 02, 2021
In last Friday’s Technical Value Scorecard, we noted the popular ETF MTUM, which holds momentum stocks, has been shifting from a growth orientation to value, as sectors benefiting from inflation were showing the most momentum. To wit: “It is important to note that MTUM shifts its holdings based on individual stock momentum readings. In March TSLA, MSFT, AAPL, AMZN, and NVDA were the top five holdings. Today Tesla remains the top holding, but JPM, BRK/B, DIS, and BAC make up the remaining four. The index is more biased toward inflationary sectors versus disinflationary than it was 3 months ago.” The graph below, courtesy of Lohman Econometrics, shows that purely as a result of the shift of stocks comprising momentum indexes becoming more value-oriented, the forward P/E ratios are collapsing.
Our equity allocation decisions to different sectors and companies have been heavily focused on those most affected by the question of whether or not the recent bout of inflation is transitory. The graph below, courtesy of @jsblokland, shows the strong correlation between the price of oil and inflation expectations. The price of crude oil has not been able to break above $70 since 2019. It is once again closing in on $70. A break above $70 will provide further warning that the inflationary trade may have more room to climb and with it, Value, energy, financials, and materials may continue to outperform.
The Fed has repeatedly said they will not consider tapering QE or raising rates until they meet their 2% inflation objective. Over the past year, they switched their inflation target from monthly indications of inflation to its average over time, although they have not been specific about the time frame in which to average inflation.
Regardless, the table below shows the Fed’s preferred inflation gauge Core PCE (excluding food and energy) and the widely followed Core CPI. As shown, both indicators, over most time frames, are near or above 2%. Note the 6-month data is annualized. Given they are likely comfortable with their inflation target, the focus will be on employment data for signs the Fed may be ready to taper QE or raise rates.
On Friday we noted that the Chicago PMI report was strong except for the labor component. Today, the ISM manufacturing report was slightly better than expected but shows similar weakness in employment. The employment sub-index fell from 55.1 to 50.9, a six-month low, and is now barely in expansion territory.
The graph below from Brett Freeze shows the statistically significant correlation between the ISM index and the year-over-year change in ten-year UST yields. If the ISM is topping, as is probable, yields are likely to fall.
Over the weekend, China’s central bank (PBOC) took steps to reduce the value of their currency which has been surging versus the U.S. dollar. Specifically, they are forcing their banks to hold an additional 2% of their foreign exchange in reserves. In theory, this will reduce the supply of dollars in China and likely weaken their currency. From the U.S. perspective, the action should help temper inflation. America imports more goods from China than any other country. The strengthening yuan was making Chinese imports more expensive. From China’s perspective, it was making Chinese goods less competitive from a pricing perspective. The graph below shows the significant appreciation of the yuan versus the dollar since the Pandemic started. (a lower yuan/$, as shown below, denotes strength of the yuan as it takes less yuan to buy a dollar) Please click HERE for a Bloomberg article with more on the topic.
After last Friday’s strong Chicago PMI report, we get more manufacturing data today with ISM and Dallas Fed Manufacturing. The prices sub-index in the ISM report is expected to rise to 90, a level that was last recorded over 12 years ago. This week we will also get an update on the labor markets with ADP on Thursday and the BLS report on Friday. Economists are forecasting a 600k increase in payroll in the ADP report and 610k in the BLS report. Last month the BLS report was much weaker than expectations at +266k. Another weak report would be concerning as it signals job growth may be slowing at a faster pace than assumed by most economists.
Bloomberg reports that gold stored at the Bank of England has been selling for a premium. The implication, per the article, is the central banks, via the Bank of International Settlements (BIS), are buying gold. If true, their actions should provide a bullish tailwind for the price of gold. For more read BOE Gold Commands High Premium, Signals Central Bank Buying.
May 28, 2021
The Chicago PMI, measuring economic activity in the midwest, rose to its highest level in nearly 50 years. As noted in the report and shown below, all of the sub-indexes rose except employment. While the report is historically strong, it points to current supply line constraints and importantly a lack of confidence in the future. If confidence were stronger we would expect employment to rise. Simply, employers are not fully committing resources, likely under the assumption that current levels of activity are not sustainable.
“Chicago Business Barometer™ Pushed On To 75.2 in May The Chicago Business BarometerTM, produced with MNI, jumped to 75.2 in May, the highest level since November 1973. Demand provided a boost to business activity, but supply chain constraints remain. Among the main five indicators, New Orders and Order Backlogs saw the largest gains, while Employment recorded the only decline.“
Personal Income and Consumption data, shown below, remains extremely volatile due to the rounds of stimulus checks. Most important in this data series are the price indexes (PCE price index). April’s PCE was +0.6% monthly and +3.6% versus last year. Core PCE, excluding food and energy, rose from 0.4% in March to 0.7% in April. The Fed will pay close attention to that Core PCE trend to assess how transitory inflation is.
President Biden will propose a $6 trillion dollar budget for 2022 over the coming days. Per the administration, the deficit would remain around $1 trillion. To help assess the reality of their assessment, consider for the last 5 years, prior to the pandemic, tax spending average $4 trillion, while tax receipts averaged around $2 trillion per year. Taxes are expected to rise, but not likely enough to cover the additional deficit resulting from the increased spending. From an investment perspective, this matters because the Fed will have little choice but to support spending via very low-interest rates and more QE.
Yesterday we mentioned that Fed taper chatter is increasing. We follow up with an article from Zoltan Pozsar, Credit Suisse’s Fed analyst. Like us, he believes the Fed will taper QE in the coming months. The problem facing the Fed is the potential negative effect of tapering on asset prices. Zoltan offers a way for the Fed to reduce asset purchases with the help of Wells Fargo. As background, currently, Wells Fargo has a regulatory cap on asset purchases.
Per Zoltan: “While lifting Wells Fargo’s asset growth ban now would do more harm than good, it could come in handy when the Fed commences taper later this year or next. The market assumes that taper will lead to a sell-off in rates, like in the past–but that need not be the case. The Fed could announce its plans to taper, while at the same time announcing the end of Wells Fargo’s asset growth ban, so that fewer purchases by the Fed would be offset by more purchases by Wells.
Less buying by the Fed and more buying by Wells Fargo…”
The latest chatter on taper from Fed Vice Chair Randy Quarles:
“If my expectations about economic growth, employment, and inflation over the coming months are borne out, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings…”
May 27, 2021
Pending home sales fell 4.4% monthly versus expectations for a small gain. With the recent decline in new home sales, it appears the housing market is finally starting to cool off a bit.
Initial Jobless Claims continued to fall, reaching 406k this past week. Other than the past year, one has to look back to 2011 to find a higher number of new claimants. While the trend lower in claims is great, it is still confounding that such a large number of people are losing jobs on a weekly basis.
It seems with each passing day the volume of media discussion about the Fed tapering its QE purchases increases. Yesterday we published, Taper Is Coming: Got Bonds? to help our readers assess how bond yields and related interest-rate sensitive equities perform during QE and afterward.
To wit: “Currently, yields are close to their cycle highs. If we believe the Fed is nearing tapering, yields could be peaking. Based on prior QE taper experiences, a yield decline of 1% or even more may be in store for the next six months to a year if the Fed is, in fact, on the doorsteps of tapering.”
The graph below shows that 5yr, 10yr, and 30yr UST bonds are in multi-month consolidation patterns following a spike higher in yield. From a technical perspective, these patterns resemble bullish flags. Based solely on the pattern, we would expect them to break out higher in yield by about the size of the “flag pole.” In the case of the ten-year (orange) that would entail a .75bps increase to approximately 2.25%. The opposite of a bullish flag, a bearish flag, can be found in the 3 bonds during the fourth quarter of 2019.
While cognizant of the pattern and the potential for higher yields, we believe bonds may be ready to break lower in yield due to the potential for a sooner than expected Fed taper of QE. A break below the flag support lines would provide some confirmation. We recently added a very small position of TLT, but remain well underweight bond duration in our benchmark. We are closely watching and ready to react in either direction, as the charts are signaling the potential for a large move.
May 26, 2021
Typically inventories of crude oil and its byproducts increase going into the summer months. As shown below, courtesy of TFA, inventories for all products declined in an atypical fashion last week. If oil usage reverts back to levels of 2019 and prior, and inventories do not pick up, we run the risk of higher short-term oil prices.
Yesterday we noted the record surge in two home price indexes. Housing makes up almost one-third of the CPI Index, yet despite surging home prices, the housing component of CPI is relatively docile. The graph below, courtesy of Macrobond, highlights the discrepancy between the FHFA price index and CPI-shelter. In 2019 we wrote an article on MMT and discussed flaws in inflation reporting. In regards to home prices, we wrote: “The BLS replaced an index based on actual home prices with what is now called owner’s equivalent rent (OER). OER is a rental equivalence that calculates the price at which an owned house would rent. It is important to note that rents were then and continue to be a part of the CPI calculation.”
The next graph updates analysis from the aforementioned article to show that CPI would 2.58% higher if the CPI calculation used the Case-Shiller Home Price Index instead of its OER calculation.
May 25, 2021
Consumer Confidence in May fell slightly to 117.2 from 117.5. The present situation index rose sharply to 144.3 from 131.9 while the future expectations index dropped to 99.1 from 107.9. Such a divergence will likely be a headwind for larger consumer purchases. Personal Consumption makes up about 2/3rds of GDP, therefore consumer confidence is an important factor drive economic growth.
Both the FHFA and the Case-Shiller Home Price Index beat expectations. On a year-over-year basis, the FHFA index is now up 13.9% while Case-Shiller is up 13.3%. The FHFA’s 13.9% increase is the fifth straight record in the series dating back 30 years. The Case-Shiller number is the strongest since late 2005. Strong housing data provides the Fed a reason to reduce MBS QE purchases. Currently, they are buying $40bn a month.
The graph below from the Atlanta Fed provides more clues about the potential future path of inflation. The Atlanta Fed breaks all goods and services included in the CPI calculation into 2 categories, sticky and flexible. Sticky are those goods and services whose prices do not change often. Per the Fed: “Because these goods and services change price relatively infrequently, they are thought to incorporate expectations about future inflation to a greater degree than prices that change on a more frequent basis.” The r-squared between the core sticky price index and core CPI is .97, denoting a strong statistical correlation. The core index removes volatile food and energy prices.
Sticky prices are recovering but still below levels preceding the pandemic. The sticky price data series does not point to lingering inflation. On the other hand, the year-over-year change in the flexible pricing index is at ten-year highs. The flexible core index is at its highest level since the 1980s.
@not_jim_cramer offers a series of graphs below showing eight market gauges that should be of concern for investors. Seven of the eight graphs use red dots to compare current levels to prior similar levels. The graph without dots (left side, third from the top) compares the Fed’s balance sheet to forward P/E’s. The takeaway from this series of graphs is to buy stocks when the Fed is buying, but heed the warnings from the other seven graphs when the Fed stops.
May 24, 2021
Electric vehicle (EV) lithium-ion batteries rely on five critical metals: cobalt, graphite, lithium, manganese, and nickel. Per The Elements Newsletter, China is currently the number one ranked country based on their resource, mining, and refining capacity of the aforementioned metals. They are expected to maintain a dominant position until at least 2025. The United States currently ranks 15th and is expected to move up to 13th by 2025.
The Chicago Fed National Activity Index is the latest economic indicator to fall short of economists’ forecasts and the prior month reading. The Index comprised of 85 national economic indicators rose 0.24 versus a prior reading of 1.71 and expectations for a 1.2% increase. Production and Income accounted for about 2/3rds of the increase. Employment indicators rose slightly while personal consumption and housing fell slightly. Based on recent data, it is looking likely that the greatest effects of the latest round of fiscal stimulus are behind us and the economy is beginning to slow.
Economic data will be light heading into next Monday’s Memorial Day holiday. On Tuesday we get FHFA and Case-Shiller data on home prices. Both are expected to slow slightly from last month’s pace but are still running at very high rates. On Friday The BEA will release personal spending, personal income, and the PCE price index. These are key components of GDP and should help economic forecasters hone in on second-quarter economic growth. Also on Friday is the University of Michigan Consumer Expectations Survey. Again we will focus on the inflation expectations sub-index.
For what it’s worth, the Cleveland Fed sees little inflation on the horizon. The graph below shows their expected one and two inflation rates. We added a third line (Red) that computes, based on the one and two-year expectations, what the one-year inflation rate expectation is for one year from now (1×1). As shown, the forward rate is well below the Fed’s 2% target and less than pre-pandemic expectations.
May 21, 2021
The graph below, courtesy of Arbor, uses interest rate derivative markets to arrive at market odds for inflation over the next five years. The markets assign a 99% chance of greater than 1% inflation and 40% odds inflation runs greater than 3%. As we noted in Foreseeing The “Flation” Knuckleball, “However, we do not think markets are ready for a resumption of deflationary forces or a more pronounced outbreak of inflation. It is these two outliers where a fat pitch may lie.” The graph backs up the statement as the markets are not betting on deflation or stronger inflation. Also, note the big shift in expectations from September 2019 to today.
The graph below, courtesy of The Market Ear, shows the strong correlation between Tesla and Bitcoin. The author notes the two “assets” remain the number one emotional trades.” Not only are many investors of each asset emotional, but they are, to some degree, driving investor behaviors of the broader risk markets. As such, watch the “generals.” Quite often their price action leads markets. Both Bitcoin and Tesla were due healthy corrections. We now watch to see if they resume their uptrends or we must contemplate what comes next if they are indeed in bubbles as some investors believe.
Yesterday afternoon Jerome Powell and the Fed announced they will release a paper this summer exploring digital payments, with a focus on the possibility of issuing a U.S. central bank digital currency (CBDC). His short speech can be watched HERE.
A subscriber asked our thoughts on the graph below from ZeroHedge. Specifically, she noted that overnight reverse repo transactions transacted by the Fed just passed last March’s highs. Should we be concerned?
The Fed offers overnight reverse repo transactions (RRP) in which they lend securities in exchange for money. From the perspective of the counterparty, a bank or money market fund, they are making an overnight investment. The reason for today’s popularity is different than a year ago. In March of 2020, some money market investors wanted to reduce their credit risk and opted to invest with the Fed over weaker counterparties. At the time they were willing to accept a lower rate for the security offered by the Fed. Today, some overnight investment options have negative yields while the Fed’s RRP program has a floor of 0%. As such, investors are simply choosing a higher-yielding option in RRP.
The uptake in RRP usage is not a sign of a healthy funding market as it points to a shortage of collateral. Collateral is needed to create leverage. Many asset markets have been bolstered by extreme amounts of leverage. As such the situation bears watching.
May 20, 2021
The Philadelphia Fed Manufacturing Index fell sharply to 31.5, but still indicates a strong expansion. The Future Expectations Index also fell by a similar rate. The decline occurred despite the Price Index hitting the highest level since 1980. Also of note, the number of employees fell from 30.8 to 19.3. The index and all sub-indexes are all still in expansion mode but slowing. The special question of the month involved the outlook for prices the firm will receive and consumers will pay. The table below shares the inflation outlook.
Initial Jobless Claims fell to 444k in the prior week and continue to decline at a decent rate. Total continuing claims is also falling but still stands at a high number, just under 16 million. Continuing claims are more difficult to assess as it’s likely a portion of these claimants are seeing their claims period expire but are still jobless. It is also unclear how many “gig-economy” workers are included.
The chart below, courtesy of All Star Charts, shows the economic surprise index has been positive for a record 240 consecutive days. The index measures economic forecasts versus actual economic data. A positive number, as we have had, means economic forecasters have underestimated the pace of economic activity. It appears that after two-thirds of a year, forecasters finally have a better grip on what’s driving economic activity. With that comes the risk they begin to overestimate data, and as such, investors find economic activity disappointing. The recent labor and retail sales reports are two such examples.
The chart below shows margin debt as compared to the S&P 500 as well as the annual change in margin debt in the lower graph. Margin debt can be called from the borrower by the lender if markets become volatile. They can also be paid back by the borrower if they deem conditions too risky and want to reduce risk exposure. Margin debt growth can continue to propel markets higher but at the same time, it increasingly becomes a potential hazard if it declines.
On Monday we shared how Bitcoin, Tesla, and other market leaders have recently been falling sharply. If the correlation between Bitcoin and equities holds up, and Bitcoin continues lower, caution is warranted, as shown below.
May 19, 2021
Today’s FOMC minutes show there are some Fed members that are near ready to taper. To wit: “A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.” On the other hand, the minutes also said: “It would likely take some time before significant change is made.” The Jekyll and Hyde opinions within the Fed are likely a way for the Fed to prepare the market’s for tapering, yet have the excuse to delay tapering for much longer.
The following headline hit the wires this morning. BULLARD: U.S. MAY BE “GETTING CLOSE” TO POINT WHERE PANDEMIC IS OVER, THEN ATTENTION COULD TURN TO POST-PANDEMIC MONETARY POLICY
St. Louis Fed President Bullard is one of the more dovish Fed members. As such, his comment alluding to “getting close” to tapering (post-pandemic policy), is another sign the Fed is inching closer to tapering despite its official statements.
As shown below, courtesy of Investing.com, many cryptocurrencies are having a rough morning and, for that matter, week. Double-digit percentage gains or losses are somewhat commonplace for cryptocurrencies, so the recent downtrend may not be a concern for crypto investors. For the rest of us, they are worth watching as crypto and other more traditional risk assets have become somewhat correlated. To wit, equities are currently down over 1% this morning, and as shown in the FINVIZ heat map below, almost every other asset class except the dollar is trading weaker.
The graph below, courtesy of Ally Invest, goes a long way in explaining why there are shortages of so many consumer goods and resulting inflation. As we showed last week, retail sales are now 15% above the trend of the last decade. At the same time, retailers did not anticipate such a surge in demand and did not stock up their inventories appropriately. It is highly likely retail sales will fall back to the trend unless there are more stimulus packages that directly aid citizens. Inflationary pressures should subside if retails sales retreat to the trend. On the other hand, if retail sales maintain at current levels, retailers will have to bulk up their inventories which will further pressure prices to the upside. Essentially, the graph below is saying that retailers do not have much confidence in the sustainability of stimulus-induced spending.
The graph below, courtesy of Nordea, shows Chinese credit growth is shrinking rapidly after ramping up during the pandemic. Given China is the world’s largest importer of commodities, the relationship between credit growth and commodity prices has been relatively strong. Note, the credit impulse is pulled ahead by a year in the graph to show the one-year lag between commodity prices and Chinese credit. Might the recent downturn in credit growth be a harbinger for much slower growth in commodity prices shortly? Nordea helps answer the question: “the clear roll-over in the Chinese credit data could be the canary watch.”
May 18, 2021
Housing Starts were much weaker than expected, falling by 9.5% versus expectations of -2%. The decline was led by single-family home starts which fell by 13.4%. Building permits grew by +0.3%, slightly less than expectations and below the last month’s 1.7% pace. We have mentioned higher mortgage rates along with surging house prices and commodity prices would dampen new housing construction. We should add, the record cold snap in the midwest and Texas and the effect it had on home construction is still resulting in quirky data.
The dollar index is opening down 35 cents this morning and trading below 90. It is now within 30 cents of the low for this recent downward trend of 89.40 on April 1, 2021. Prior to that, the dollar had not traded below 90 since early 2018. The catalyst appears to be the Fed which seems to have no intentions of raising rates or tapering QE.
The graph below provides historical context for its current level as well as technical guidance. As shown, the dollar is sitting on the lower support line of a 10+ year wedge pattern as well as a horizontal line of resistance that turned into support. Both levels of support argue for a stronger dollar or at least a bounce. However, if support doesn’t hold, the dollar could tumble from current levels. A weaker dollar would provide further tailwinds for higher commodity prices and other imports.
The key to successful investing these days is to properly forecast the current and future path of inflation. A large part of the analysis is gauging how much longer supply line-related shortages will continue. Bloomberg published The World Economy Is Suddenly Running Low on Everything yesterday which helps explain why these shortages are occurring. The article also gives a concerning forecast as highlighted below.
“For anyone who thinks it’s all going to end in a few months, consider the somewhat obscure U.S. economic indicator known as the Logistics Managers’ Index. The gauge is built on a monthly survey of corporate supply chiefs that asks where they see inventory, transportation and warehouse expenses — the three key components of managing supply chains — now and in 12 months. The current index is at its second-highest level in records dating back to 2016, and the future gauge shows little respite a year from now. The index has proven unnervingly accurate in the past, matching up with actual costs about 90% of the time.”
May 17, 2021
It is worth adding to the prior comment that three other market leaders of the past few months are also struggling. Bitcoin is now down over 30% from recent highs to 42,000 while Tesla and ARKK (Cathie Woods ARK innovation ETF) are both down nearly 40% from their respective February highs. Bitcoin is resting just above its 200-day ma, while TSLA and ARKK have broken below it.
From March of 2020 until about a week ago, the price of lumber rose over 600%. While still greatly elevated from last year and years prior, its price is finally showing weakness. The graph below shows that lumber is down nearly 25% in the last 6 trading sessions. From a technical perspective, the prior two weeks of trading formed a bearish engulfing pattern, whereas the high and low last week exceeded the highs and lows from the prior week. Continued weakness would confirm the pattern represented a top. Further downside, along with weakness in other essential commodities, might alleviate some broader inflationary fears.
The New York- Empire State Manufacturing Index dipped slightly but remains at a very high level. However, prices paid and prices received surged higher to their highest levels since at least 2000.
Economic data this week will largely be focused on the housing sector. Today, the NAHB will release their Housing Market Index, followed by Housing Starts and Building Permits on Tuesday. Existing Home Sales will be released on Friday. Both Housing Starts and Permits are expected to decline from the torrid pace set earlier this year. Higher mortgage rates and surging prices for copper, lumber, and other commodities used to make homes are certainly a growing concern for homebuilders.
In recent months we have relied heavily on implied inflation expectations to help guide our allocation decisions. Periods where expectations were rising led to a clear outperformance of materials, energy, and financial companies. Tech, staples, and utilities tended to benefit when inflation expectations stabilized. What makes this analysis very difficult is that “market-based” inflation expectations are not really market-based anymore. The graph below shows the Fed has bought significant amounts of TIPs and Notes and Bonds, which can lead to distortions in these markets, and therefore skewed implied inflation calculations.
The University of Michigan Consumer Sentiment Survey data was decidedly weak as shown below. Interestingly weakness was equal for both current conditions and future conditions. Driving the weakness is likely inflationary concerns. The long-term inflation expectations rose to 3.1% from 2.7% last month.
As if supply lines were not fractured enough, the Mississippi River is closed to barge traffic near Memphis due to concerns over a bridge. Currently, there are 771 barges awaiting passage. Per CNBC– “The shutdown fueled concerns about shipping U.S. grain and soy to export markets at a time when global inventories are slim and prices are near eight-year highs.”
Retail Sales were much weaker than expected as shown below. The control group, which feeds GDP, was down 1.5% versus an expected slight increase. On the plus side, last month’s data was revised higher. The markets seem to be taking the data in stride with stocks and bonds at similar levels as prior to the release.
April Retail Sales are due at 8:30 ET this morning. Expectations are for a 1% increase, following last month’s 9.8% gain. March retail sales greatly benefited from stimulus checks. It would not be surprising to see a big deviation today from expectations as the timing of the stimulus checks and when/how they were spent is very difficult to forecast. Based on their credit card spending trends, Bank of America expects a decline in retail sales.
As we have discussed, base effects (comparison versus last year’s data) make price inflation appear much higher than it actually is. The graph below puts the CPI indexes in context with their trends of the last five years. Currently, the broad CPI index is only .011% above its trend. Core CPI, which excludes food and energy, is running 1.06% above its trend. If the inflationary impulse is in fact transitory and dies out over the next few months, inflation data will end up close to where it would have been had there never been a pandemic.
Almost a year ago Tim Duy wrote a powerful editorial for Bloomberg about how expects the Fed to maintain ultra-easy policy going forward. With inflation running hot and the recovery maturing, it is worth reviewing the summary paragraph of his article as we consider how the Fed might react to high inflation.
“The implication for financial markets is that the Fed expects to hold policy very easy for a very long time. They will reinforce this stance with enhanced-forward guidance and, eventually, yield-curve control. As long as inflation remains below 2%, the Fed will push back on any ideas that they will tighten policy anytime soon. And even inflation above 2% wouldn’t guarantee tighter policy if the Fed concluded the overshoot was transitory. Don’t doubt the Fed’s resolve to keep policy accommodative. They will keep reminding you if you forget.”
May 13, 2021
The charts below show that many of the grain futures have given up some of their recent gains. Crude oil is down over sharply today as well. While not a trend yet, a continued sell-off in these commodities and others will help relieve recent inflationary pressures.
PPI came in hotter than expectations, but much less so than yesterday’s CPI report. Of note, monthly PPI rose 0.6% which was more than expectations of 0.3%, however, last month’s gain in PPI prices was 1%, meaning the rate of increase is slowing. The year-over-year gain of 6.2% was above expectations for 5.9%. Based on the initial market reaction, the higher than expected PPI figures were priced in.
Jobless Claims continue to forge lower, coming in at 473k versus 498k last week.
Cryptocurrencies are opening up down 10-15% after Elon Musk said Tesla would suspend accepting Bitcoin for new purchases due to the excessive energy use required to mine Bitcoin. Prior to the announcement, Tesla bought and held a sizeable chunk of Bitcoin for “liquidity purposes” and Musk was a self-professed fan/promoter of Dogecoin. Given the wasteful energy use was a widely known fact, the announcement seems odd and we are left to wonder if there is more to the announcement.
On the heels of yesterday’s hot CPI report, PPI is due out at 8:30. The consensus estimate actually points to slower producer price growth on a monthly basis. The monthly PPI core (excluding food and energy) is expected to climb 0.4%, versus 0.7% last month. On a year over year basis, it is expected to rise 3.7% from 3.1%.
The graph below shows the difference between CPI and Fed Funds. The last time the difference was as large as it is was June of 1980. The Fed is making a big bet that inflation is transitory.
The graph below, courtesy of Sven Henrich, is a unique way to show the bubble environment. Wealth should stay relatively proportionate with the output of a nation. As shown, it currently sits well above what has been historically normal since at least 1950 and above two prior peaks. The last two times the ratio spiked higher (dot com bust and financial crisis) were followed by significant drawdowns in many asset markets. This time is not likely to be different, however, timing the eventual reversion to the mean is very difficult.
May 12, 2021
A subscriber commented to us that they thought the five-point increase in the VIX (as of 3 pm ET) was excessive given the S&P was only down by 1.6%. The scatter plot below charts daily changes of the VIX and S&P over the last five years. The orange dot shows that the relationship today is in line with the historical correlation.
CPI was much higher than expectations on a monthly and annual basis as shown below. The core CPI data (excluding food and energy) rose +.09% versus expectations of 0.3%. At 3% YoY, core CPI is now running at the highest annual rate since the mid-1990s. A big portion of the increase came from used cars. Per Zerohedge- “the index for used cars and trucks rose 10% in April. This was the largest 1-month increase since the series began in 1953. It accounted for a third of the seasonally adjusted all items increase.” The gain in used car prices is temporary as its a function of the low supply of new and used cars at the same time fiscal stimulus is flowing through the economy. Supply line problems and chip shortages will abate and stimulus will run its course, leading to a normalization of supply/demand. The Fed will find some comfort in this and likely discount today’s data.
Stocks initially fell on CPI but have been climbing back to near where they were before the release. Interestingly, bond yields are only slightly higher on the news. Bonds appear priced for the expected surge in inflation and maybe looking ahead to the Fed more actively discussing tapering QE. The dollar initially surged but has given back a big chunk of those gains.
In yesterday’s commentary, we provided a link to CNBC’s interview with Stanley Druckenmiller. As we shared, he commented- “I can’t find any period in history where monetary and fiscal policy were this out of step with the economic circumstances, not one.” To stress his point he presented a graph of retail sales. To his point and shown below, retail sales are now 15% above the pre-pandemic trend or about 5 years’ worth of growth. If retail sales were simply to revert to trend, it would have to decline more than in the 2008/09 recession. This is but one example of economic activity propped up by massive fiscal stimulus. As the benefits of stimulus fade, and with less new stimulus on the horizon, economic activity will suffer. That is the fiscal cliff we will be dealing with in late summer and fall.
Yesterday’s BLS JOLTs report showed that the number of job openings in March surged to 8.12mm from 7.53mm in February. The graph below is the Beveridge Curve, which compares the number of job openings as a percent of the labor force to the unemployment rate. As shown, historically we would expect a job opening rate in the 2-4% range, not at nearly 5.5%. Further, the rate of job openings is the highest on record since the BLS started tracking it in 2000. Extended and enhanced unemployment benefits are partially responsible for the gap between what we are seeing and what we should expect. The full JOLTs report can be read HERE.
May 11, 2021
On CNBC, famed investor Stanley Druckenmiller warned about the current pace of fiscal and monetary policy. Given his stature and extremely successful career, we think it’s worth your time to listen to today’s CNBC Interview.
“I can’t find any period in history where monetary and fiscal policy were this out of step with the economic circumstances, not one.”
In today’s 3 Minutes on Markets & Money (linked below) Lance Roberts mentions that the NASDAQ is relatively oversold versus the S&P and DJIA. The graph below helps provide some risk levels on the NASDAQ (QQQ). Since the market rout last March, QQQ has fallen below its 50 day moving average three times as labeled in the top graph below. Currently, the NASDAQ is down about 2% this morning. It would not be surprising to see it decline to the range of the prior episodes (another 2-4%). The second graph shows its deviation from the 200 day ma. It is still about 10% above the average. Falling to the 200-day moving average might be strong support, but a significant break of the moving average would be concerning. As Lance mentioned, the NASDAQ is over-sold on a short-term basis but not a long-term basis. There is a potential opportunity here but it entails a good eye on risk management.
The NFIB Small Business Optimism Index rose in April to 99.8. The Index has recovered about 2/3rds of its losses from pre-pandemic levels. The survey was quick to point out “42% of owners reported job openings that could not be filled, a record high reading. Owners continue to have difficulty finding qualified workers to fill jobs as they compete with increased unemployment benefits and the pandemic keeping some workers out of the labor force.” The three graphs below highlight the disconnect between hiring workers and being able to find workers to hire.
The survey respondents also appear to be sounding inflation warnings. Per the report: “The net percent of owners raising average selling prices increased 10 points to a net 36% (seasonally adjusted), the highest reading since April 1981 when it was 43%. The highest was 67% in October 1974 when inflation reached double digit rates.” The graph below highlights the sharp increase in prices.
The recent uptick in inflation expectations is resulting in the outperformance of inflationary sectors like materials, financials, and energy. At the same time technology, communications, and cyclical stocks are underperforming. Yesterday for instance the Dow Jones Industrial Average was down by only 0.09% while the NASDAQ fell 2.63%. The tables below courtesy of Finviz show the significant divergence over the last week and month Last week’s Technical Value Scorecard highlighted these divergences in more detail as well.
The graph below, courtesy of CoStar, shows a large majority of workers are still working from home. Longer-term estimates forecast that the work from home trend is viable. Per forecasts, the numbers below are likely to only get back to about 80%. If that forecast holds true, there will be a sizable surplus of office space in big city markets.
May 10, 2021
The dollar, shown below, was showing signs of a bottoming process but it has recently turned more bearish. Recent weakness has taken it below the rising support line which started at the beginning of this year. A break below the early March and January lows would confirm more dollar weakness ahead. The MACD is currently oversold, but not at levels that might indicate a bottom is in place. The only bullish factor in the graph is the 50-day ma is about to rise above the 200-day ma.
The second graph compares the dollar to inflation expectations. As shown, they tend to have an inverse relationship. The current bout of dollar weakness is likely associated with the recent pick-up in inflation expectations.
CPI, PPI, and Retail Sales data will be released this week. CPI, due out Wednesday, is forecast to increase 0.4% monthly, and 3.8% year over year. The year-over-year data is skewed because of last year’s low inflation. As such most economists will focus on trends in the monthly data.
There will be a slew of Fed speakers this week. We are on the lookout for Fed members that are more inclined to see the Fed taper sooner rather than later. Given last week’s poor employment report, those in favor of tapering may not be as vocal about it in the coming weeks as they might have been if it were a stronger report.
Rumors have been circulating this past week about a potential merger between Chevron (CVX) and Exxon (XOM). While they may be serious, it is worth noting the two companies have been in discussions for the better part of the last five years. Interestingly, both companies were spun off of Standard Oil when it was broken up 110 years ago due to antitrust concerns.
Gary Gensler, the new SEC Chairman, sent a few warning shots toward the crypto markets last week. Some headlines as follows:
GENSLER SAYS WE NEED GREATER INVESTOR PROTECTIONS REGARDING CRYPTO TOKENS -CNBC
*GENSLER SEES GAPS IN OVERSIGHT FOR BITCOIN TRADING ON EXCHANGES
*GENSLER: BITCOIN TRADING ON LARGE EXCHANGES NOT PROTECTED
SEC CHAIR GENSLER: IF CONGRESS DECIDES TO ACT ON CRYPTO TOKENS, WE WILL COLLABORATE WITH THEM.
The graph below, courtesy of the WSJ, provides good context for the pace of the labor market recovery and how many jobs are needed before a full recovery.
The BLS jobs report fell far short of expectations at +266k versus a consensus estimate of nearly +1 million. The unemployment rate rose to 6.1%, which was +.3% above expectations. The average workweek rose to 35 hours from 34.9 and average hourly earnings rose .7% versus last month. On the wage front, hourly earnings are only up 0.3% versus a year ago. This is concerning given the denominator in the year-over-year math is April of 2020, the trough of the employment crisis. CPI is running at +2.6% YoY, meaning workers, on average, have lost 2.3% in purchasing power over the last year. Government stimulus has thus far eased the situation.
Leisure and Hospitality jobs added 331k, which accounts for more than the total number of jobs added. Temporary help lost 111k jobs which is surprising given how often we hear companies can’t find employees.
The initial market reaction was friendly for the deflationary sectors like technology. Bonds and gold are also off to a strong start. The market will likely perceive today’s report as evidence the Fed is far away from tapering.
The graph below, courtesy of Brett Freeze, shows the strong correlation between temporary help and GDP.
Goldman Sachs shines a light on its poor expectations for wage growth today and for the remainder of this year- “We expect that base effects will pull the year-on-year rate negative in this Friday’s employment report, and that the composition unwind will drag the average monthly growth well below +0.2% for the remainder of 2021”
Wage growth is important because inflation, without a boost in wages, will be crippling especially for the lower-income classes.
Expectations for the BLS Employment report due at 8:30 ET are as follows:
Last night Fed President Lael Brainard stated: “Vulnerabilities associated with elevated risk appetite are rising.” The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a repricing event.”
And therein lies the Fed trap they set for themselves. QE and low-interest rates elevate risk appetites which drive stretched valuations and high levels of indebtedness. Tapering QE and/or raising rates might very well “amplify the effects of a repricing event.” More simply: Fed stimulus is blowing bubbles that will pop if they stop blowing.
A day after the last Fed meeting, Fed President Kaplan said: “The Fed should start talking about tapering bond-buying soon.” This was due to his concerns about rising inflation. Brainard’s comments yesterday concern rising financial instability. We think her comments might represent a more cloaked effort to push the Fed closer to tapering and raising rates.
May 6, 2021
Jobless Claims continue to improve, crossing below 500k, to 498k, for the first time since the COVID lockdowns began. There are still over 16 million people receiving state or federal claims, a number the Fed would like to see drop meaningfully before they talk about removing stimulus.
Yesterday afternoon, Boston Fed President Rosengren said “the mortgage market probably doesn’t need as much support now.” Similar to hawkish comments from Dallas Fed President Kaplan, it seems Rosengren is indirectly pushing for a tapering of MBS-QE. Currently, the Fed is buying $40 billion mortgages a month.
Real (after inflation expectations) 10-year UST yields peaked at -.58 on March 21, since then they have fallen to -.91%. Treasury yields fell nearly 10bps over the period while inflation expectations have been on the rise as of late as shown below. As we have noted on numerous occasions, the price of gold is highly negatively correlated to real yields. Since mid-March, its price has gone from 1675 to near 1800. The question for gold investors is can Treasury yields remain rangebound while inflation expectations rise? That is a tall order.
We are not sure of the reliability of the graph below from the Daily Shot, but if somewhat accurate, it shows that farm values are expected to rise sharply. We think some of the credit for the increase is due to speculation and the recent popularity of owing hard assets, including land to protect from inflation. The recent surge in agricultural prices certainly helps as well.
Last Sunday, 60 Minutes aired a segment on the shortage of semiconductor chips in the United States. The shortage is part of the reason supply lines for so many products reliant on chips are troubled. Ford, for example, recently cut their production in half for the second quarter as it can’t source enough chips. Based on the segment, it is likely these shortages are likely to continue, to some degree, for two more years. Also of note, only 12% of chips are made in the United States leaving the U.S. vulnerable to Asian suppliers who manufacture about 75% of them. LINK to the video clip.
May 5, 2021
Earlier today we wrote: “Based on recent Fed comments, employment seems to be the key factor stopping the Fed from tapering QE.” Fed Vice Chair Clarida just said the economy needs to add 8 million jobs to get back pre-COVID levels. From the trough of the last recession to 2020 the economy formed 182k jobs a month. At double that rate it will still take two years to get back to pre-COVID levels.
The ADP Labor report was weaker than expected, showing the economy gained 742k jobs versus expectations for 850k. We suspect the report will be perceived by investors as equity market-friendly. Based on recent Fed comments, employment seems to be the key factor stopping the Fed from tapering QE.
Yesterday we reported that Yellen sparked a little fear by mentioning interest rates might “somewhat” if the economy overheats. Apparently, she got a tap on the shoulder as those remarks were rescinded in a speech later that afternoon. In those later comments she said “I do not see the rescue package as overheating the economy” and “I am not predicting anything.”
The ISM Manufacturing survey is an important gauge used by economists to assess the manufacturing sector. While most investors and economists focus on the quantitative results of the surveys, ISM also shares some commentary from respondents that can be illuminating. We share a few of the more interesting comments below. The rest can be found on the ISM website.
“Steel prices are crazy high. The normal checks on the domestic steel mills are not functioning — imported steel is distorted by the Section 232 tariffs.” (Fabricated Metal Products)
“It’s getting much more difficult to supply production with materials that are made with copper or steel. Lots of work on the floor, but I am worried about getting the materials to support.” (Electrical Equipment, Appliances & Components)
“In 35 years of purchasing, I’ve never seen everything like these extended lead times and rising prices — from colors, film, corrugate to resins, they’re all up. The only thing plentiful at present, according to my spam filter, is personal protective equipment [PPE].” (Plastics & Rubber Products)
“Demand continues to be very strong. Supply chain delays hamper our availability and ability to sell more.” (Machinery)
Over the past few months, we have noted the amount of margin debt, or leverage being employed in the equity market, is approaching, or in some measures greater than we have ever seen in the past. The graph below, courtesy of Topdown Charts, shows another form of leverage that is not captured in the margin data. The green line shows that assets under management (AUM) of leveraged long ETFs have risen by about 150% in the last year and sits well above pre-COVID levels as well as anytime in the 15 years prior. Signs of euphoria are everywhere but that doesn’t mean a top is imminent. However, it does mean, we should exercise caution, understand the potential downside, and manage our risk carefully.
May 4, 2021
“It may be that interest rates will have to rise somewhat to make sure our economy doesn’t overheat,” Yellen said in an interview with the Atlantic recorded Monday that was broadcast on the web on Tuesday. “It could cause some very modest increases in interest rates.” – Per Bloomberg
Take notice of this important comment from Treasury Secretary Janet Yellen. After largely agreeing with Jerome Powell that inflation will be transitory and there is no rush to raise interest rates/taper, she seems to be changing her tone. Given her current role and former role as Fed Chair, she might be tipping us off to coming changes in Fed policy.
Equities fell this morning, supposedly on the rumor of a Chinese aircraft entering Taiwan’s Air Defense Identification Zone (ADIZ). The ADIZ is not the same as Taiwan’s territorial airspace. This event is likely not the cause for the decline because similar incursions have been occurring and have been widely publicized. Further, as shown below in the map, China’s and Taiwan’s ADIZs overlap, making it a possible “legal incursion.” That said, the area is becoming more of a geopolitical hot spot and worth paying attention to.
Most recessions are cyclical events that occur when inventories are bloated and, as a result, manufacturers cut production, resulting in layoffs. As shown below, in the ISM report courtesy of Bloomberg, during the 2008/09 recession, inventories rose which resulted in order reductions, ergo fewer backlogs, for new goods. Today is quite different. Inventories are at the lowest levels in at least 14 years as customers are waiting on new orders to replenish their inventories and meet pent-up demand for many products. This graph argues supply line-related product shortages will continue to be problematic and result in reduced supply and upward price pressures. Over time we expect the situation to normalize but given the historic divergence, it may take longer than expected, and the resulting price pressures may last longer than expected. At some point, the markets may begin to question the Fed on the “transitory” nature of recent price increases.
One of the more notable aspects of this earnings season is that companies reporting good earnings and sales have not been rewarded as they have been in the past. Per BofA, “Companies beating on sales/EPS in 1Q have led by just 16bps the next day, vs. average +1%.” Their graph below provides historical context.
May 3, 2021
Similar to a graph we shared last week, this graph by Standard and Poors shows the percentage of firms in each industry feeling profit margin pressure.
The ISM Manufacturing Index was weaker than expected at 60.7 versus 64.7 last month. Noteworthy, employment fell 4.5 points to 55.1, and inventories fell below 50 and into economic contraction territory at 46.5. Prices paid were the only notable subcomponent rising on the month. It was 89.6 versus 85.6 last month. As shown below, it has only been above 90 twice, the 1970s and 2008. The combination of higher prices and slowing economic activity is not a good sign for corporate profits. That said, one month certainly does not make a trend.
The economic calendar will be busy this week. ISM releases its manufacturing survey this morning followed by its service sector survey on Wednesday. The most important data points of the week will be Wednesday’s ADP labor report and Friday’s BLS employment report. With inflation and inflation expectations near the Fed’s 2% target, employment appears to be the only factor keeping the Fed from discussing tapering QE and raising rates. The market is expecting the BLS to report that nearly 1 million new jobs were created in April, which should bring the unemployment rate from 6% to 5.8%. While great news, it is still well above pre-COVID levels.
We expect an active Fed speaking calendar this week. Again, we will be on the lookout for any dissension in the ranks in regards to the timing of removing monetary stimulus.
The earnings calendar will be busy this week as follows:
As shown in the graph below, the sharp increase in the amount of margin debt outstanding is only rivaled by similar increases before the meltdowns of 2000 and 2008. The red dots show periods when the annual change in margin debt exceeded two standard deviations. While an ominous graph, we caution that the amount of margin debt a year ago was falling rapidly with the market. As such, a year over year comparison may not portray similar circumstances as those leading to 2000 and 2008.
And just one day after the FOMC meeting, Fed President Kaplan is the first dissenter. This morning he said, “The Fed should start talking about tapering bond-buying soon.” He also said rate hikes should start in 2022.
The Chicago PMI Survey rose to its highest level since 1983. The index was 72.1 versus 66.3 last month. The broader ISM Survey, due out on Monday, is expected to be 65. Like Chicago PMI, that would be the highest level in nearly 40 years.
Earlier this year we discussed how the Treasury would draw down its $1.6 trln cash balance at the Fed which would result in less short-term debt issuance and lower rates. Yesterday the Fed auctioned $40 bn 1-month Treasury Bills at 0.00%. As a result of the Treasury’s actions, investors are clamoring for short-term paper with any positive yield. In the same vein, the Fed has recently been conducting its reverse repo program due to strong demand. In reverse repo (RRP), the Fed borrows money from participants in exchange for Treasury securities as collateral. The Fed only allows repo at 0% or positive rates. It sounds crazy but 0% is better than secondary market repo rates, so money market funds have interest in lending/investing at 0%. Unfortunately, like M2 money supply, the Fed discontinued providing Treasury balances held at the Fed. As such, we do not know how much longer the situation may last.
Late yesterday afternoon Department of Labor Secretary Marty Walsh said “a lot of gig workers in the United States should be classified as employees.” If his wishes are granted, companies like Uber (UBER), LYFT (LYFT), and Door Dash (DASH), will be on the hook to provide benefits to their employees that they are currently not supplying. All three companies were down nearly 10% on the news.
The first graph below shows that the U.S. savings rate increased markedly during the COVID crisis. This was due in to a combination of stimulus benefits received by many people that remained employed as well as limited opportunities to spend money due to economic shut-downs. Interestingly, as shown in the second chart, courtesy of the Financial Times, savings rates around the world increased sharply over the last year. The big economic question going forward is whether or not a global consumer mindset favoring savings versus consumption is emerging. As shown, in the U.S., the savings rate has been relatively stable. Given this long track record, we assume until proven otherwise, the recent spike in savings is an anomaly and will revert to historical norms once economic activity normalizes.
April 28, 2021
Comments from Jerome Powell:
“The unemployment rate of 6% understates the shortfall in inflation”
Prices will continue to rise due to economic reopening, pent-up demand, and supply chain bottlenecks, but price increases are temporary. He stressed this numerous times
The Fed will aim to anchor inflation at 2%, but will temporarily tolerate inflation above the target to offset prior periods of lower inflation
He made it very clear that a significant reduction of the unemployment rate and 2% inflation is needed before tapering QE or raising rates. Until those goals are met there will be no reduction in QE ($80bn UST and $40bn MBS)
Per Powell, it’s not time to even begin “thinking about thinking about” tapering
We are unlikely to see persistent inflation with slack in the labor markets- (ergo they think wages are the primary driver of inflation and do not see them rising up yet)
He does not see long-time “scarring” of workers, meaning he believes the job losses are not permanent as we saw after the financial crisis.
They are watching housing prices rise but do not characterize the situation as a bubble because they do not see financial stability problems like in 2005-2008. He thinks the primary driver of higher prices is the lack of supply.
“Some asset prices are high.” Powell also alluded that parts of the equity markets are “frothy”
As we expected, the Fed’s FOMC statement was little changed from the last one from March 17th. The red-lined version below, courtesy of Zero Hedge, compares the two statements. As shown, the only changes are a slight upgrade in their description of economic activity with credit given to policy support and vaccinations.
The graph below, courtesy of Optuma, shows the strong correlation between the ratio of Copper to Gold and 10-year U.S. Treasury yields. Historically, the Copper/Gold ratio has proven a durable measure of inflation. As shown, on a technical basis, the ratio is breaking out of a brief period of consolidation, portending yields will potentially move up in lockstep.
Prices for many agricultural products on the futures exchanges have been on a tear over the last month as shown below. The price increases of these goods will have a larger effect on the poor and middle class than the wealthy. Given the Fed has been outspoken about the divergence of wealth, and the poor being left behind, it will be interesting to hear their comments today on rising prices. We must also keep a close eye on staples stocks and assess if they can fully pass on the price increases to consumers. If not, they will take other measures to cut costs to try to keep profit margins stable.
1 Month Performance:
Soybean Oil +20%
The graph below, courtesy of All Start Charts, shows the economic surprise index has been greater than zero for 225 days, the longest such streak since at least 2003. The index measures economists’ economic forecasts versus actual economic data. The gist is economists have been consistently underestimating the pace of the economic recovery.
April 27, 2021
The graph below and commentary are courtesy of Danielle DiMartino Booth:
“Risk premiums on CCC bonds dropped below 500bps late Monday, a level only seen twice in the last two decades — the years leading up to 2008 financial crisis & right before the dotcom bubble burst.”
–By “risk premium” she is referring to the spread or differential between the yields on CCC-rated bonds and like maturity Treasury bonds.
The Fed’s two-day FOMC meeting concludes tomorrow at 2 pm with the FOMC monetary statement and the Powell press conference at 2:30. While we expect little to no change in the statement and no change to ongoing monetary operations, we do think they will pay more lip service to inflation than they have been. They are likely to acknowledge the recent uptick in prices, especially of food and energy, but we expect them to stick to their belief that the increases are transitory. The Fed conversation may become more interesting over the next week or two as Fed members will be back out on the speaking circuit.
Over the last year, Fed members have been in unison in regards to comments on monetary policy and their policy of allowing inflation to “run hot.” With the inevitable taper on the horizon and a recent uptick of inflation in consumer staples, which hurt the poor, it will be harder for Powell to keep the group in line. This may prove troubling for the markets in the coming months.
The graph below on the left, courtesy of Stifel, shows that almost all of the gains in the S&P 500 over the last decade occurred during periods when the year over year growth of the global money supply was increasing. The graph argues the rally may hit some headwinds in the coming months as the annual growth of the money supply will inevitably see a sharp decline. We are now a full year past the initial liquidity injections of 2020. As this occurs the denominator in the annual growth calculation will increase rapidly. The second graph quantifies this effect by showing how year over year U.S. M2 money supply growth will shrink despite the assumption that the Fed continues to add $120bn a month of QE.
The Fed likes to use trial balloons to assess how potential changes to their operations might affect investor behaviors. Given that the economy is recovering nicely, vaccinations are giving a further boost to economic activity, and inflationary pressures are on the rise, we suspect the Fed may be closer than they allude, to begin “thinking about thinking about tapering.” To wit, this morning comes a potential trial balloon by the WSJ article entitled The Fed’s Next Test Is Breaking The Ice Over Policy Shift. There is nothing in the article that leads us to believe change is coming at this week’s FOMC meeting, but it does state the Fed is closing in on the time when they must start to reverse emergency stimulus measures. It wouldn’t surprise us if Chairman Powell makes a short statement this Wednesday saying as much. The question is, how will the markets react.
The economic calendar is relatively light for a second week running. Of note this week will be personal income and spending and the PCE price index on Friday. The PCE index is the Fed’s preferred inflation gauge. Also on Friday will be the University of Michigan Consumer Survey and importantly their survey on inflation expectations, as well as the Chicago PMI report and their inflation sub-survey. After a weak durable goods report last month, economists are expecting a strong rebound to 2% when released at 8 am today.
The highlight of the week is likely to be the Fed’s FOMC meeting and Powell’s press conference on Wednesday. Similar to the last couple of meetings we suspect little will change in their statement that would lead us to believe they will be more or less aggressive with monetary policy. As such, any meaningful changes in QE or just in their tone or descriptions of economic/market activity may have an outsized effect on markets.
This will be a big week for Q1 earnings releases. The table below shows the more widely followed earnings release dates.
The graph below, courtesy of Goldman Sachs, shows that SPAC issuance has significantly slowed. Thus far in the second quarter, 6 SPACs have come to market. That compares to over 50 at the same point in the first quarter. Poor recent returns and heightened regulatory risks are largely to blame for the decreased issuance.
As shown below, the Baker Hughes Rig Count is still below pre-COVID levels despite the price of oil having fully recovered. Assuming the rig count does not spike higher as the economy continues to recover, this should limit supply and keep a bid under the price of oil. The wild card is OPEC, which has begun slowly increasing production levels.
The graph below, courtesy of the Daily Shot, shows that people are using mortgage refinancings and home equity lines to draw on their house’s equity. The extra money is providing homeowners additional funds to pay down other debts and spend. Recent trends in credit card debt lead us to believe that some people are using their home’s equity to pay down costly credit cards.
On Tuesday Fortune published an interesting article on some of the risks with Bitcoin mining. The key takeaways included pollution and national security. On the pollution front the article stated:
“Overall, de Vries reckons that fossil fuels power around 70% of all Bitcoin mines worldwide, and that coal provides the vast majority of that share. “We now know for sure that one-third of all production runs on pure coal from a tiny place in China,”
“Miners are going to unusual places in search of the cheapest power that’s also reliable—and that’s almost always fossil fuels.
In regards to national security:
Finally, “It’s now clear that one-third of all the world’s Bitcoin-mining power masses in a single hotbed of our archrival, China. He fears that if tensions between the U.S. and China escalate, Beijing could use the equipment in Hutubi and the rest of China to paralyze the network, halting all transactions. That shutdown would wreak havoc with the hedge funds that hold Bitcoin and the corporations piling the coins into their treasuries.”
Since sanctions constrain Iran from exporting oil, Tehran is developing a new market inside the nation’s borders by luring Bitcoin miners with super-low energy costs. By some reports, Iran now accounts for 8% of the world’s Bitcoin production.
April 22, 2021
President Biden will propose boosting the long-term capital gains rate to as high as 43.4% for those with earnings of greater than $1 million. It is rumored the tax will be retroactive to include 2021 gains. Stocks are trading lower on the news.
To show how deep our fiscal deficit issues are we share a paragraph from Bloomberg on the tax increase: “The Tax Foundation estimates that increasing capital gains taxes in the fashion suggested by Biden would result in just $469.4 billion in revenue over 10 years. That may seem like a lot, but most of the forecasted tax revenue will be back-end loaded and is actually paltry when compared with projected total government outlays of $6.6 trillion in fiscal 2020 alone. Capital gains taxes account for about 5.2% of tax revenue on average.”
Initial Jobless Claims fell again to a one-year low of 547k. Despite the recent decline in state unemployment claims, the total number of unemployment benefits, including Federal programs, rose by 500k to 17.4 million. It has been hovering around this level for all of 2021.
Existing Home Sales were weaker than expected at 6.01mm annualized sales, down from 6.22mm last month. The monthly decline of 6.6% is due to higher mortgage rates, higher prices, and a limited supply of homes on the market. The report stated there were slightly over 1 million homes for sale in March. To stress how little supply is available on the market, that number is 28% less than last March, when the economy was reeling from COVID lockdowns. Even with the declines over the last two months, Existing Home Sales remain well above the rates of the prior ten years.
Yesterday we discussed how SPACs and Bitcoin can help us gauge the market’s desire to take on risk. We would be remiss if we did not mention Lumber. The price of Lumber futures is up nearly 300% from pre-COVID levels. While supply line shortages and heavy construction demand for lumber are driving its price higher, speculation is also playing a role. Add lumber to the list of “risk-on” assets to keep an eye on.
Per Bloomberg, Dogecoin (cryptocurrency) is now worth more than Ford and Kraft Heinz. Per Yakob Peterseil at Bloomberg:
“No one thinks these blue-chip stocks are all that comparable to Dogecoin, a fringe asset with no real purpose beyond being a joke on social media. But the similarity of their market values underscores the boom in cryptocurrencies that’s taken Wall Street by storm.”
April 21, 2021
Over the first two months of 2021, SPACs were all the rage. From January through February 17th, the IPOX SPAC Index rose 27%. Since then it gave up all of the gains and is down over 3% year to date. The quick rotations into and out of risky products have been a hallmark of the last year. As we noted with BTC below, following these trends can yield important clues about market sentiment.
The Bank of Canada (BOC) appears to be the first central bank to reduce COVID-related QE bond purchases. Partially driving the decision is a sharp rise in home prices. To wit: “We will continue to have an eye on the threats posed by the dramatic increase in home prices.” One has to wonder if the Fed is harboring similar thoughts.
The graph below is of Bitcoin’s (BTC) price for the last year. We follow it, in part, because the “risk-on” trade in some equity sectors has been well correlated with BTC. As shown the recent 5-6x increase in price from last fall had good support in its 50-day ma as well as the white support line. Over the last few days, it has broken below both. BTC is certainly extended and due for a pull-back. Given how much its risen in just months, a decline to the 200-day ma (34,123) should not be shocking. Equity investors in some of the high-flying stocks linked to BTC, like Tesla, Coinbase, Overstock, and Microstrategy, should pay close attention.
The following series of graphs, courtesy of Brett Freeze, shows bank lending growth contracted for the first time since 2010. At the same time, securities and cash held by the banks are rising rapidly. QE is designed to spur loan growth but, as shown, banks are using the Fed reserves to buy investment assets, not make loans. This is one reason QE has been a strong tailwind for asset prices but unable to help sustain economic growth.
The graph below, courtesy of Zero Hedge, further confirms Brett’s analysis. As shown, loan growth from the four largest banks has been flat since the 2008 financial crisis despite a doubling of bank deposits. Prior to 2008, banks used deposits to make loans, and accordingly, they tended to grow at very similar rates.
April 20, 2021
Coca-Cola is raising prices to help offset higher input costs. Per CNBC they “join a number of other consumer giants, such as Kimberly-Clark and J.M. Smucker, in hiking prices.” With the price of many commodities up significantly over the past few months, investors will be looking to see if they can raise prices to help stop profit margins from shrinking, yet, at the same time, not hurt demand for their respective products.
Last week we shared data from the BLS JOLTs report showing that despite a large number of unemployed people, employers are having a hard time hiring. To that end, we ran across a report from Business Insider which claims McDonald’s is paying people $50 just to interview for a job and “it’s still struggling to find applicants.” The graph below tells a similar story for companies in search of truck drivers.
Julian Bittel, in his graph below, argues that the recent surge in equity valuations implies poor future 1-year returns. As such, the gray line, the equity to bond ratio, should fall sharply, meaning bonds will outperform stocks. If true this would represent a reversal of the last six months in which bond prices fell while stock prices rose.
The graph below, which was accompanied by a few tweets from Jim Bianco, shows the rolling annual Federal deficit in dollar terms at the top left, and as a percentage of GDP at the bottom left. Per Jim Bianco “As this chart shows, the last 12-months the deficit was hard to understand $4+ trillion. As a % of GDP it was equally hard to understand 19%.” The second chart shows that the only time the government went into as large a deficit, as a percentage of GDP, was during WWII. The financial crisis of 2008 and the Great Depression, pale in comparison to the current deficit.
“The headline numbers seem huge: Americans have $1.8 trillion in extra savings over the pre-pandemic total, according to the latest estimates by Bloomberg Economics based on data through February. A lot of this stems from about $877 billion of checks sent to U.S. households in three rounds of stimulus payments during the pandemic, which has helped consumers pay down debt and save.
The question, though, is how much of that they can truly deploy in the coming months. While March retail sales surged 9.8%, the most in 10 months, according to data released on Thursday, the jump comes on the heels of stimulus checks that spurred shopping sprees.”
Abramowicz goes on to explain,
“On average, American households set aside about 26% of their stimulus checks to buy things in the relatively near future, with most of the funds going toward savings and debt payments, according to an April 7 New York Fed research report.”
She concludes by stating that it’s tough to see how “helicopter money” alone could lead to sustained inflationary pressures in the US.
The economic calendar will be quiet this week. Of note will be existing home sales on Thursday and new home sales on Friday. The next Fed FOMC meeting is scheduled for next Tuesday and Wednesday. As such, speeches or comments from voting fed members will be sparse as they enter a self-imposed media blackout this week.
As shown below, the corporate earnings schedule will be much busier this week as we progress further into earnings season.
The graph below is a good tool to help define sectors according to Growth/Value and Defensive/Cyclical traits. As we have discussed sectors falling into the Cyclical/Value description were the best performing sectors when implied inflation was running higher in late 2020 and early 2021. Over the last month, with implied inflation values stalling out around 2.5%, Cyclical/Quality is taking back leadership. Generally speaking, the market has been keyed on value vs growth and seems to prefer cyclical over defensive sectors. You can map this to our weekly Technical Scorecard report to better evaluate sector rotations on a weekly basis. We are doing more work with this type of analysis that we hope to share soon.
Housing Starts for March came in above expectations at 1.739M units annualized versus the consensus estimate of 1.620M and a prior month reading of 1.421M. Housing Permits were 1.766M— slightly above expectations of 1.750M and a prior month reading of 1.682M. This is somewhat surprising given higher mortgage rates and record lumber prices are starting to weigh on homebuilders. Six to nine months from now, these positive readings could help alleviate the supply shortage currently facing the housing market.
Earlier in the week, we discussed the role higher energy prices are playing in boosting CPI. The graph below, courtesy of Jim Bianco, shows how Used Car prices are rising at their fastest annual pace in at least 20 years.
“How come? It’s a classic case of low supply and high demand.
There’s just not as many used vehicles for sale, for one thing. The pandemic forced rental agencies to slash purchases of new cars after a steep decline in individuals leasing cars at airport and other locations. Those vehicles typically are sold to used-car lots after a year or less.
At the same time, demand rose for used vehicles as more people avoided public transportation or moved from the cities to the suburbs to escape the coronavirus. Cox Automotive estimated that demand for used vehicles has doubled since last March.
Many Americans preferred used vehicles to save money in a time of great economic uncertainty, especially with the cost of new cars and trucks at an all-time. Earlier this year the average cost of a new vehicle surpassed $40,000 for the first time, the auto-research firm Edmunds found.
The imbalance is unlikely to end anytime soon.”
The chart below, courtesy of Ned Davis Research, shows retail investors are “all-in” so to speak. Rising stock prices and pitiful bond yields are pushing investors to take their highest allocation to equities since the days preceding the dot com bubble crash. It is worth reminding you of Bob Farrell’s investment rule #5: the public buys the most at the top and the least at the bottom.
April 15, 2021
**We apologize, there will be no 3 Minutes on Markets & Money this morning due to technical difficulties.
This morning CitiBank warned that peak credit losses may not occur until 2022. While the market is bulled up on the banks and their prospects, some seem to be losing sight that many loans and mortgages are in forbearance. As the borrowers are forced to make regular payments plus make up for missed payments, we are likely to see a decent number of defaults. The question facing banks is how much of their loan loss reserves do they need to hold in anticipation of coming defaults. Yesterday JPM said it released $5.2 billion in loss reserves, leaving it with $25.4 billion. As a comparison, they had $18.6 billion prior to COVID.
We start the day with much better-than-expected economic data. Initial Jobless Claims fell sharply to 576k versus expectations for a 700k increase. Retail Sales, with the help of newly minted stimulus checks, rose 9.8% on a monthly basis. Interestingly, despite the strong economic numbers, bond yields are falling this morning. The ten-year UST yield is currently down 4 basis points to 1.60%, about .15% below the highs from two weeks ago.
China has been a leading driver of global economic growth for the last decade-plus. Fueling the growth are exports, massive infrastructure projects, urbanization, and importantly, extreme leverage. U.S. economists pay close attention to their money supply or so-called “credit impulse” to gauge how much financial and economic leverage is being generated. As shown below, M1 has been growing at a relatively tepid rate despite the Pandemic. The PBOC (central bank) is making a concerted effort to limit further expansion of leverage in hopes of making economic growth more sustainable over the longer term. While prudent, it will weigh on short-term economic growth for not just China, but the U.S. and the rest of the world. The graph to the right shows Morgan Stanley’s expectation for reduced credit growth resulting from the PBOC’s actions to reduce leverage. As they note, commodity prices are likely to feel the sting as China is the world’s largest consumer of many commodities.
We have struggled over the last few months to reconcile the high and sustained rate of weekly jobless claims with the quickly recovering labor market. Zero Hedge recently published an article that seems to explain some of the divergences. Jobless Claims, as the title says, are claims for money, not actual payments. Just because one makes a claim for jobless benefits doesn’t mean they are given money. The graph below shows about 50% of claims, prior to COVID, resulted in payments. Currently, about 20-25% of jobless claims receive benefits. Assuming a quarter of claimants (versus historically half) actually receive benefits, the number of weekly claims is more in line with the unemployment rate.
April 14, 2021
The Coinbase (COIN – Crypto Exchange) IPO initially traded at $391, which is a market cap of just under $100 billion. For context consider Goldman Sachs has a market cap of $115 billion and Charles Schwab is $127 billion. Also, consider the largest stock exchange, prior to today’s offering, was the Hong Kong Exchange at $74 billion.
Following on the heels of CPI yesterday, we got more inflation data today. Import prices rose 1.2%, above the estimate of 0.9%, but 0.1% weaker than last month. Export prices rose 2.1% versus 1.6% last month and well above estimates of 0.9%. The Atlanta Fed released their Business Inflation Expectations at +2.5% annually versus +2.4% last month. Their reading is in line with CPI at +2.6% annually.
Per the latest NFIB survey, the number of small companies having trouble filling jobs is the highest since at least the early 1980s, as shown below to the left. Last week JOLT’s report also reported a high number of job openings. The graph to the right is the Beveridge Curve. It compares the number of job openings as a percentage of the working population (y-axis) to the unemployment rate (x-axis). The orange dots and the line show the path of this data over the last 13 months. While the labor situation has improved markedly, it is confounding unemployment is over 2% higher than pre-COVID despite a record number of job openings. Also, worth noting, the curve shifted right (green to blue) after the last recession. In light of the massive amounts of stimulus, which will weigh on future economic growth, might current readings be an early warning of another shift to the right?
Along with record prices come record valuations. The graph below, courtesy Top Down Charts, shows that a composite valuation using CAPE10, P/E (TTM), and 1yr. forward P/E is nearing its peak of 1999. This indicator will decline in the coming weeks with improved Q1 earnings reports. If earnings were to stay constant, the S&P would need to rise about 5% to take out the 1999 highs. While valuations are concerning and should raise our risk radar, we also have to recognize stocks may have further to climb. As we wrote in Zen and the Art of Risk Management–
“The market is grossly expensive, but as we stated valuations have poor predictive ability to help gauge what will happen in the next few weeks or months. Despite extreme valuations, we can ride the market higher with other greedy investors. However, unlike most investors, we are aware that the risk of significant losses is not minimal.”
“Quantifying downside risk allows us to have a plan in place to reduce or hedge risk when technical indicators and other signals alert us to potential changes.”
CPI was .1% higher than expectations on a monthly and annual basis as shown below. While slightly warmer than expectations it was not as hot as the PPI print last Friday. This non-confirmation may prove to be a temporary relief for the bond markets.
The graph below shows the market’s breadth, as measured by the percentage of S&P 500 stocks above their respective 200-day ma, is at its highest level in over five years. With a reading over 95%, this gauge serves as a warning as markets fell sharply when it peaked at slightly lower levels in early 2018 and 2020. That said, prior peaks such as in the first quarter of 2017, saw breadth deteriorate without a sharp drop in the S&P 500.
The graph below, courtesy of Brett Freeze, shows consumer credit trends. Noteworthy, the year-over-year change in revolving credit (credit cards- non-seasonally adjusted) is falling at the sharpest rate since at least 1994. Despite the housing boom, non-revolving consumer credit is also trending lower, albeit still exhibiting positive growth. Personal consumption typically accounts for about two-thirds of GDP. As such, consumer borrowing is an important driver of personal spending.
Below is the corporate earnings schedule for the week:
April 12, 2021
St. Louis Fed President Bullard made an interesting comment today as follows: Fed’s Bullard Says 75% Vaccinations Would Allow for Taper Debate. For now, we will treat this as a one-off statement and not necessarily representative of other Fed members. However, If we hear similar rhetoric from other Fed members, the equity markets will pay closer attention to vaccination data and likely fret as they rise.
This will be an important week for economic data with CPI at 8:30 am ET tomorrow, Fed Chair Powell speaking on Wednesday, and Retail Sales due out on Thursday. Also on the radar will be the University of Michigan Consumer survey on Friday and, in particular, its inflation gauges. With PPI rising well above expectations last Friday, investors will be looking for confirmation in other inflation indicators. More important, will be any indications pointing to whether this bout of inflation is transitory or longer-lasting.
Q1 corporate earnings start this week in earnest. The banks will lead the way with JPM and GS releasing earnings on Wednesday, followed by many other big banks on Thursday. We are expecting strong reports from the large banks as they are likely to significantly reduce loan loss reserves. Further, the steeper yield curve should have increased margins, and the active trading environment bolstered trading revenue.
In the upcoming Q1 earnings reports, investors are likely to focus on rising input inflation costs and how companies will try to maintain or boost profit margins. Our friend Eric Cinnamond at Palm Valley Capital wrote an interesting article on the topic (LINK) that is worth reading. Here are few noteworthy passages:
Recent quarterly results and commentary of the businesses on our 300-name possible buy list support my anecdotal observations. With declining inventories and rising costs, companies have been reducing promotions to protect gross margins and receive full price on their limited supply.
Another business we follow, Big Lots (BIG), also reported fewer promotions, stating, “As our inventory levels were sold through, we were able to navigate through the holiday period with fewer promotions than last year. This reduction in markdowns significantly mitigated the pressure felt from increased spot freight rates and higher supply chain charges we incurred.”
Nike (NKE) discussed how supply chain shortages are negatively impacting sales, saying, “Starting in late December, container shortages and West Coast port congestion began to increase the transit times of inventory supply by more than three weeks. The result was a lack of available supply, delayed shipments to wholesale partners and lower-than-expected quarterly revenue growth.” Management also commented on its improved gross margins, partially contributing them to “higher full-price product margins.”
Chairman Powell will appear on 60 Minutes Sunday night. We presume he will talk up the economic recovery, pledge to keep the stimulus coming, and try to allay any fears of sustained inflation.
Producer Prices (PPI) surprised to the upside, rising 1% in March and 4.2% on a year over year basis. Expectations were for a gain of half a percent and +3.8% year over year. The 4.2% increase is the largest since 2011. We remind you, year over year analysis involves a comparison to March of 2020 when the economy wash shut down. Core PPI, excluding food and energy, rose .6% versus expectations of a .2% gain. CPI will be released next Tuesday. It will be interesting to see how much of the increase in input prices (PPI) corporations are able to pass on to consumers. The current estimate for CPI is +.5% and +2.5% on a monthly and annual basis respectively.
The graph below, courtesy of the Daily Shot, shows that 42% of stimulus checks are being saved and 34% are being used to pay down debt. While this bodes well for personal finances and helps explain the reduction in credit card balances, the stimulus is not stimulating the economy as much as politicians desired.
On April 29th the BEA will release the first-quarter GDP. The graph below shows the Atlanta Fed estimates growth will come in around 6%, while the consensus of economists is closer to 4%. The recent bump up in the Atlanta Fed forecast is primarily due to increased government spending forecasts and the robust housing market.
The chart below, courtesy of Macrocharts, shows that large gold outflows from the GLD ETF, as recently experienced, are typically followed by decent rallies. As shown 660k metric tons of gold were removed from the ETF in recent weeks, the second-largest withdrawal in the history of the ETF. We added a 2.5% position of gold via IAU three days ago in both the Equity and Sector models. Our internal money flow models are turning bullish, signaling the recent downtrend may be ending. The second graph shows that when RSI and MACD are extremely oversold (vertical gold lines), gold tends to rally. Further, gold bounced off its support trend line (ascending purple line) and formed a double bottom. The double bottom and trend support line provides us two relatively low-risk areas to establish stop-loss limits. If gold continues to show signs of a trend reversal we may add another 2.5% bringing the total to 5%.
The economic recovery will face some challenges in the months ahead. One of them is that Federal/state actions allowing renters and mortgagees to skip payments and making evictions illegal will shortly end. As this occurs, those the did not make payments will have less money to spend for general consumption as they will have to pay rent/mortgage payments or face eviction. To this end, the Texas Supreme Court is allowing the emergency forbearance order to expire and will not enforce federal orders to stop evictions. For more, NPR wrote the following article: Texas Courts Open Eviction Floodgates: “We Just Stepped Off A Cliff.”
Despite the blockbuster jobs report last week, Initial Jobless Claims continue to make very slow progress lower. This past week 744k new people filed for claims versus 728k the prior week. The number of federal and state continuing claims continues to hover around 18mm, the same level it has been stuck at for the last four months.
Yesterday’s Fed minutes from the March FOMC meeting were as expected for the most part. Below are a few noteworthy sections:
“Participants noted that it would likely be some time until substantial further progress toward the Committee’s maximum-employment and price-stability goals would be realized and that, consistent with the Committee’s outcome-based guidance, asset purchases would continue at least at the current pace until then.”
Per CNBC -” Though inflation shows up 64 times in the minutes, Fed officials indicated little concern that it might become a problem anytime soon. One notion in the minutes said that inflation forecasts were right around where FOMC members expected.”
“Disorderly conditions in the Treasury markets or a persistent rise in yields that could jeopardize progress toward the Committee’s goals were seen as cause for concern”
After the minutes were released, Lael Brainard essentially defined “Disorderly Conditions”: “I would be concerned to see disorderly conditions, like we saw Feb. 25.” On February 25th, the ten-year UST yield increased 13 basis points which represents a 2.73 standard deviation move. The graph below shows the daily standard deviation of changes in ten-year UST yields over the last ten years. A change of 2.73 or greater has occurred 41 times in the last ten years. In other words, the bar is set pretty low for the Fed to potentially take action to limit yields rising.
April 7, 2021
Per the headline below, some of the supply line-related problems are improving. Any inflationary pressures due to these temporary problems should abate with continued normalization.
* NATIONAL RETAIL FEDERATION – CONGESTION AT U.S. PORTS IS ABATING AS CONTAINER CARRIERS AND TERMINALS ADJUST TO NEW NORMAL
The graphs below show the MBA’s Purchase and Refi Indexes as compared to mortgage rates. We are watching them closely to see how higher mortgage rates affect both indexes and therefore the economy. In the first graph, showing the Purchase index versus the mortgage index, the index has not fallen significantly despite rates rising by about .60%. The correlation between home purchases and rates will likely be low for the time being due to the limited supply of houses on the market and rates that are still well below the 4.25% average for 2018/2019. The Refi index, on the other hand, is much more sensitive to the change in rates. The Refi index is back to pre-COVID levels despite rates that are still .50% lower. New home purchases play a large role in economic activity and job growth. Refi activity is also economically important as it allows existing homeowners to reduce their mortgage payments, allowing them to spend more.
Most economic data is reported on a year over year basis to help minimize seasonal effects. Data coming out over the next few weeks, for March of 2021, will be compared to March of 2020 when the economy was paralyzed. The graph below of credit card spending shows how the so-called “base effect” warps annual change (year over year) reporting. As shown, credit card spending is up an astonishing 64% versus a year ago. However, compared to more normal economic periods it is actually down 3.2%.
The two graphs below tell a similar story- Investors rooting for more inflation better be careful about what they wish for. The first graph, courtesy of Brett Freeze, shows that valuations have historically declined as the volatility of CPI increases. The second graph, from the Daily Shot, highlights that lower valuations are associated with higher levels of CPI. The current CAPE is 35. As shown in the second chart, the maximum CAPE for any historical CPI reading greater than 3% is in the low 20s. A decline from 35 to 20, assuming no change in earnings, entails an approximate 40% price decline.
April 6, 2021
The Job Openings and Labor Turnover (JOLTs) report from the BLS pointed to more good news on the labor front. Per the report, the number of job openings rose by 286k to 7.37m, back above where it was before the pandemic. At the peak a year ago, there were 4.60 unemployed workers for every job opening. That ratio has shrunk significantly to 1.40 but it still has room to fall as it was below 1.00 for much of 2019.
The 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.
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.
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.
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.
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.
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, how