May 7, 2020

Yesterday we looked at the big spike in inflation back in the early 70s.  Inflation spiked from under 3% to almost 12%.  The trigger:  an oil supply shock. 

With that in mind, as the Covid-torn economy reopens this month, I suspect it will be the trigger for a severe supply shock, and inflation — where a disrupted supply chain will prove to be out of synch with a resurgence of demand, driving prices higher. 

Add to this, as we get the jobs numbers tomorrow, the media will focus on the big and ugly payroll and unemployment rate.  But keep an eye on wage inflation.  Those that have been working (many essential workers) have been receiving pay increases

So, in the wake of historic joblessness, wages are ticking higher, not lower. The consensus view is for a 16% unemployment rate, 22 million jobs lost, and wage growth of 3.3%.  That wage growth figure has only been exceeded three times in the past decade (and that was last year).  And we may very well see the highest wage growth since before the Global Financial Crisis.  The high estimate of those surveyed in the Reuters poll on wage growth was +7.9%.

Now, some of these wage increases have been sold as temporary, but remember, the unemployment package including the Federal supplement gives a two member unemployed household, the annual equivalent of better than $80,000 a year.  That's 1.3 times the median household income.  With that, these wage increases will have to stick, to compete with the government. 

Add to this, if we do indeed feel the pain from supply shortages, the resulting rise in prices will put even more upward pressure on wages and wage demands.   
 

May 6, 2020

Last week stocks were approaching two big areas of technical resistance on the charts.  And we talked about the prospects that the top of a range would be marked there, for a while, until we are able to get some visibility on what the world looks like with economies reopening. 

That seems to be playing out.  

Now we have areas of the country slowly reopening. And we have two things to watch closely: 1) any rise in hospitalization rates, and 2) the effects of a sharp bounceback in demand. These two wouldn’t be mutual exclusive in the near term.  But the latter of which, may expose, very quickly, the supply chain disruption.  

In this case, unlike the aftermath of the global financial crisis, it’s easy to turn demand back on (removing stay-at-home orders), but it’s not as easy to turn production back on (re-staffing, manufacturing, inventory building/ new order fulfillment).  This will create a lag between demand, and when supply can satisfy that demand. That tends to be a formula for higher prices. 

We’re already beginning to see it in food prices. Just wait until the pent-up demand for a host of other products and services hits the economy. 

Let’s take a look at what the early 70’s supply shock in America did to prices.

This shows the dramatic move in inflation from a “shock event.”  In the early 70s, OPEC blocked oil exports to the U.S., sending oil prices up four fold in 1973.  Broader prices in the U.S. economy followed.  You can see in the chart above consumer price inflation (excluding food and energy) spiked from under 3% to nearly 12% in two years.  
 

May 5, 2020

Warren Buffett spoke for over four hours over the weekend, as he hosted his virtual annual meeting for Berkshire Hathaway.

Although his message "bet on America" remained consistent, as it has over time, his lack of buying in this stock market decline suggests he's not comfortable betting, just yet. At least that's the signal that has been taken.

 
Is it the right signal?

Don't forget, Buffett runs the biggest hedge fund in the world, dressed up like an insurance company.  It takes premiums and invests those premiums, primarily in stocks (the value of which have been marked down with this broad market decline).  But they have been sitting on an unusually high amount of cash — $120 billion worth

Why isn’t he putting it to work?

 

A possible reason:  In this ongoing extraordinary event, the insurance business has unknown liabilities.  As an industry overall, he said "the amount of litigation that is going to be generated out of what's already happened, let alone what may happen, is going to be huge … just the cost of defending litigation will be a huge, enormous expense."

On that note, I had heard over the past of month, anecdotally, that a portfolio manager at a big insurer was forced to sit on his hands, unable to make new investments in this environment, by mandate.  I've yet to see any industry-wide regulatory policy that would spell that out, but with Berkshire's lack of action, perhaps there is truth to it.  

What's another reason Buffett hasn't swooped in with a “deal of the century,” as he did in the financial crisis?  The Fed and the U.S. Government, in this case, through quick and decisive intervention, have curtailed if not eliminated the opportunities.  They squeezed out the vultures, by becoming the lender of last resort (with the deepest pockets of them all). 

May 4, 2020

Throughout the pandemic, Trump and his administration have been clearly positioning to punish (or retaliate against) the Chinese government for either 1) neglect and cover up, or 2) a deliberate attack.

In either case, Trump has said there will be "consequences."

This rhetoric has been slowly building over the past two months, but now is beginning to look like (more, bigger) conflict with China is ahead.  

Pompeo has been the stern voice all along, against China, and over the weekend said there is a "significant amount of evidence that this came from the lab in Wuhan….that it's manmade."

At best, this means the Chinese government lied about it, and covered it up. 

The early signals on this bubbling conflict may be found in Bitcoin (yes, Bitcoin). 

As you can see in this chart below, Bitcoin spiked by as much as 23% in just two days, last week.  

What does this tell us?
 
As we've discussed throughout the rise of Bitcoin, it has everything to do with money moving out of China, and less to do with Silicon Valley genius/ global monetary system disruption. 

Bitcoin futures and off-exchange (peer-to-peer) trading are liquidity sources for Chinese citizens, allowing them to circumvent government capital controls, which restrict individuals from moving more than $50,000 out of the country a year.  In short, it has been a way for Chinese (especially the wealthy) to get money out of China

May 1, 2020

We talked the past few days about the significant technical levels of resistance that stocks were bumping up against.
 
Combine that with the end of month, a 36% rise in stocks over just 27 business days, AND the unknown about what the economy will look like as businesses are beginning to reopen, and it looks like the top of a new range is in, for the moment.

So, let's talk about the expectations that have been set for the reopening of the economy.

I think it's fair to say that the policymakers and the government officials have set some very conservative expectations.  If fact, I would argue that it leans more toward pessimistic

And just as we evaluate the probable outcomes for markets, based on the way sentiment is leaning, we can also evaluate probably outcomes for the economy. 

And after being in the business of markets for 24 years, I can tell you that the best trading opportunities are found in situations where sentiment is heavily leaning in one direction or another – and/or when the expectations bar has been set at an extreme level (either overly optimistic, or overly pessimistic).  These are opportunities to bet against sentiment, because these situations set up for the element of surprise.  And with surprise we tend to see sentiment violent swing from extreme levels. 

I think we are set up for this swing in economic sentiment.  Public officials have set the bar very low on expectations of getting back to normal life.  And they've set the game plan accordingly for the re-opening of businesses – slow, and in stages.  And the broad belief is that the behavior of people will follow this very conservative path. 

This is set up for a surprise, related to how both businesses and consumers behave.  And I suspect we're going to get it. 

Once people are out of the house, returning to some day-to-day life and interactions, I suspect the life-learned patterns and behaviors won't be changed after just two months of sitting at home.  I suspect we will all slip back into normal behaviors sooner rather than later, and possibly very soon – especially if hospitalization rates in the coming weeks are stable to lower. If that's the case, it will be a “rip the band-aid off” scenario for the economy, and a return to normalcy. 

If that’s the scenario, we may see very quickly how a big bounceback in demand will overwhelm supply, following two months of supply disruption and production stoppages.  That would be the first signal that inflation is coming.   

April 30, 2020

Stocks end the month lower today, after a 36% bounce from the March 23rd lows.

Let's take a look at the chart we've been watching, which presents some key technical resistance up here …

So, we have this big technical level around here at 2,930 which represents the 61.8% retracement of the full decline in stocks.  And just above here, we have the 200 day moving average, which comes in at 3,004.

As we've discussed, this looks like a sensible area to mark the top of a range for a while.  And I suspect we may see stocks trade back and forth in a range until there's some visibility into how the world looks with economies reopening. 

What has yet to show any signs of life in a world where governments are doing cash handouts and much more?  Commodities.

We have this chart of broad commodities …
 

This chart looks like a deflationary vortex, not a world where governments are handing out cash.    

I suspect this chart of commodities will change/will be the next spot to watch. 

As we've discussed, the government and central bank response is designed to inflate the value of the economy, and deflate the value of debt. That's a recipe for a global reset of prices (and a recipe for a reset of wages), and commodity prices should soar.   
 

April 29, 2020

The Fed met today.  As we discussed yesterday, they did indeed take the opportunity to recap the response of the past two months.  And it was a big one. 

If there was anything new that came from Powell's press conference, my takeaway was his remarks on protecting against long-term economic damage.

He said Fed policies to protect firms and families from "avoidable insolvencies" comes with a hefty price tag, but would avoid long term damage to the economy

He went on to say "now is not the time to worry about debt, but time to use the 'great fiscal power' of the U.S. to avoid deeper damage to the economy."  

With that, as we discussed yesterday, the Fed has been a buyer of corporate debt (in the secondary market), and that has greased the wheels of the market for new corporate debt issuance of the past month and half — enabling companies to stockpile cash, despite the fact that many (if not all) would be considered high risk for bankruptcy if the economic disruption were to carry on, through the time necessary to get a viable vaccine on the market. 

This should give us clues on the decisions coming from the Treasury and the White House on whether or not the domestic energy industry will be saved, or any other highly levered industry that has been crippled by the demand shock. I think the answer is "yes", they will be given government life support. 
 

April 28, 2020

The Fed meets tomorrow (virtually).  This meeting should be a review of their ‘whatever it takes’ response of the past two months. 
 
And it has been a busy couple of months. 

What have they done? 

In a world where revenues and incomes abruptly went to zero, for many, the Fed quickly and decisively resolved what was very likely to be a cascade of insolvencies. 

They did it by flooding the world with liquidity.  In addition to slashing rates to zero, they quickly backstopped the banks (no need to run and take money out of the bank).  They fixed the Treasury market (averting the threat of capital flight from what has been historically the world’s safest investment/ parking place for capital).  They fixed the corporate bond market (averting mass bankruptcies).  They provided access to U.S. dollars for global banks (where global credit was beginning to freeze).  They’ve kept mortgage markets moving (stabilizing the housing market – new buys and refinancing). They’ve kept the municipal bond markets functioning (keeping local and state government debt servicable and accessible). 

How did they do it?  By becoming the buyer of last resort – by threats and by action. 

 
When a buyer steps into the market with the ability and promise to by unlimited amounts, with money they can create with a keystroke, it tends to resolve fears for those market participants that are natural buyers in those markets, and it tends to invoke fear in those market participants that have been betting against those markets (speculators run for the exits).  

This playbook was written by Mario Draghi (ECB chief) in 2012.  Yields on Spanish and Italian sovereign debt had skyrocketed to unsustainable levels, which put two of the biggest countries in the eurozone on default watch, which threatened more dominoes to fall, and a collapse of the euro (the monetary system).  It was an ominous moment.  But Draghi threatened to do ‘whatever it takes.’ He threatened to buy unlimited Italian and Spanish debt.  Here’s what happened to yields on Spanish bonds …

Draghi’s threat put in the top for yields, without the ECB having to buy a single bond.  Within two years, yields on Spanish debt fell from almost 8% to 1%.  A European collapse was averted. 

With this in mind, as people continue to debate who will be/should be “bailed out” and who will not/should not be, keep in mind that Jay Powell has already stepped over the line.  When the line was crossed, the Fed became a buyer of anything and everything necessary to bridge the economy back to it’s pre-virus existence.  For that reason, it’s hard to see a scenario where companies that were adding value to the economy two months ago, are forced to take the path of bankruptcy. 

If you listen to earnings calls of the past couple of weeks, the common theme has been raising cash, by drawing down credit lines and new debt issuance.  And one after another, the reporting companies seem to be having no problem finding buyers for new debt.   

April 27, 2020

We’re in the heart of earnings season now.  This week we’ll hear more companies talk about beefing up liquidity (cutting dividends, pausing share repurchases, drawing on credit lines) and issuing new debt or refinancing existing debt, to the extent they can – all in an effort to buy time. 

 

And this comes just as states are laying out plans for reopening businesses.

 

But as businesses reopen we'll begin to see the damage done to supply, demand and incentives.

On the latter, as we discussed on Friday, employers will be trying to rebuild support staff, whom in many cases have collected more from the government sitting at home, than they ever have from working for their employers.

Aside from the yet resolved health crisis, the economic problems that will be revealed in the coming weeks will become a challenge for a stock market that has bounced 32% from the March 23rd lows. 

With that, here's another look at the chart we've been watching in stocks …

As we discussed a couple of weeks ago, with some big technical resistance coming in between 2,930 (the 61.8% retracement of the big decline) and 3,006 (the 200-day moving average), we will probably find the top of a range,  until/unless we have validation of a successful treatment option for the virus.  The U.S. trials should be reported soon, but they seem to be in no rush. 

April 24, 2020

As states look at reopening businesses, I suspect we’re going to see how obvious the political undercurrent is in this fight against the virus.   

All of the numbers out of New York today continue to be on the decline.  Less hospitalizations. Less getting to the severe stage. Less deaths.

As we discussed yesterday, the antibodies test done in New York show far more people likely have had the virus, which makes the death rate much lower (more like 0.5% of infected).  And we have trials that have been underway on treatment options, the results of which, should be public very soon.  And despite the continuous noise surrounding treatments, the anecdotals appear to be aligning with the results (less intubations).  

This all favors reopening American businesses. 

With that, there is now a political race against time.  The sooner economies start opening up again, the weaker the case is for the Democrat’s push for mail-in voting.  This (mail-in voting) will likely be the determining force in the November election (mail-in or walk-up voting).   With that, the Democrats will be in a war for “election reform” in the next aid package.  The bargaining chip for the Republicans will be aid for state and local governments.   My guess is there will be no “next package” anytime soon. We will see. 

Much of the aid has yet to make it’s way into the economy anyway.  By the time the unemployed finally start receiving money, many of them might be back in a job.  On that note, consider this:  The median family income in the United States is about $62k.  For a family with two unemployed (formerly low income workers with two children), the family stands to receive an annualized income of about $80k, for staying at home.   I suspect they might fight for more money when they do go back to work. Wage inflation is coming.