Pro Perspectives 4/10/24

 

 
 

 

 

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April 10, 2024

There was a lot of fuss about the inflation data today.

March CPI came in a tenth of a percentage point hotter.

Stocks were crushed.  Yields spiked.  And the dollar rallied.

This reminds me of the inflation report back in February (the January inflation data).  Similar to today’s report, both the headline and core inflation came in a tenth of a percent above expectations.  Stocks were crushed.  Yields spiked.  And the dollar rallied — all of a magnitude similar to today’s market response.

With that, back in my February 13th note (here) we discussed what looked like a clear overreaction, given the magnitude of the decline in stocks, rise in yields.

And we looked back at the only two times, over the prior three years, that shared the features of 1) a down greater than 4% Russell 2000 and 2) at least a 14 basis point spike in the 10 year yield.

Let’s revisit that analysis …

It happened on February 25, 2021.

What was going on?

It was about inflation.  The 10-year yield had risen from 1% to 1.6% in less than a month.  And the move was quickening.  And this quickening was driven by the market’s judgement that the additional $2 trillion fiscal package coming down the pike from the new President and his aligned Congress was inflationary at best, and recklessly extravagant, at worst.

The $2.2 trillion Cares Act and the additional $900 billion in stimulus passed in December, before Trump’s exit, had already driven a nearly full V-shaped economic recovery (by late January ’21).  And the economy was projected by the CBO (Congressional Budget Office) to grow at a 3.7% annualized rate in 2021 (hotter than pre-pandemic growth), with an unemployment rate falling to 5.3% – about right at the average unemployment rate of the past 50 years.

The prospects of more, massive spending packages was an inflation bomb.

This feature of a big 4%+ down day in small caps and spike in yields also happened on June 13 of 2022.

What was going on?

It was a Monday meltdown, following a hot Friday inflation report.

The Fed had just started tightening and was way behind the curve.

Inflation was near 9%, the Fed Funds rate was below 1%.  With a Fed meeting just days away, the market ratcheted up expectations for an aggressive 75 basis point hike.  And history suggested they needed to take rates a lot higher in order to stop fueling inflation, and start curbing it.

So, in both cases (Feb of 2021 and June of 2022) stocks fell sharply and yields spiked on significant inflation fears.

It’s fair to say the circumstances are quite different today.

And you can see it in the chart below …

This is the continuation of the “stall” in inflation progress we discussed yesterday.  But it’s not a Feb 2021 or June 2022 “significant inflation fear” moment.  Far from it.

As we know, in the current case the stall in CPI is largely due to a couple of hot spots in the data (shelter and insurance).  On the latter, the auto insurance component was up 22% year-over-year in the March inflation report.  Just pulling that out, the headline CPI drops below 3%.

Bottom line, Fed policy remains “highly restrictive” (in the Fed’s words).  The next move by the Fed will (still) be easing.  It’s a matter of when and how much.

Today’s overreaction presents another opportunity to buy a dip in bonds.

 

Pro Perspectives 4/9/24

 

 

 

 

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April 09, 2024

We get the March inflation report tomorrow.
 
As you can see in the chart below, the yearly change on the headline inflation has stalled, and has hovered above the 3% level since last summer.  The consensus view is that this leveling-off continued in March (orange dotted line). 
 
 
With that, let's revisit the insurance component we've been discussing the past few months, which has been a key contributor to the stall in the disinflation.  In fact, Jerome Powell has said rising insurance prices have "added meaningfully to inflation."
 
As we've discussed, the insurance industry has dramatically increased premiums over the past two years.  That's in response to the dramatic rise in asset values.  But this is a lagging feature of a hot inflation period.  
 
The question is:  When will the reset in the price of insurance catch up with the reset that has taken place in the prices of the underlying assets? 
 
If we look at Q1 earnings expectations in the insurance industry, it doesn't appear that the price hikes are over yet. 
 
FactSet expects the insurance industry to report 37% year-over-year earnings growth for Q1.  That follows better than 50% earnings growth in Q4 (which nearly doubled Wall Street expectations).
 
That said, as we head into tomorrow's number, the insurance stocks were down big today, in a stock market (S&P 500) that finished slightly UP.  Was that a signal?
 
Hartford was down 3.8%.  AIG, down 3%.  Travelers, down 3%.  Progressive, down 2.7%.  Allstate down 2.3%.  Aflac, down 2.3%.
 
Here's what the chart of Allstate looks like (with a hook at the end) …
 
 
This is a chart consistent across the industry, driven by aggressive price increases, lower losses, and the related record margin expansion.  An analyst asked the Hartford CEO in the Q4 earnings call, are these peak margins?  Translation:  Has the power to push through price increases exhausted?

Pro Perspectives 4/8/24

 

 

 

 

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April 08, 2024

As we discussed last week, the market has gone from anticipating as many as seven quarter-point rate cuts this year, to five, to three.  Meanwhile the Fed has telegraphed three cuts, with some members chattering about the possibility of two, then one.  And most recently, the possibility has been floated of maybe none/ no rate cuts this year.
 
Meanwhile, little attention (still) is given to the fiscal spending side.  Jamie Dimon emphasized it today in his annual letter.  He noted "the economy is being fueled by large amounts of government deficit spending and past stimulus."
 
On the latter, we've been looking at this chart of money supply …
 
  
Remember, the massive monetary and fiscal response to the pandemic (plus the subsequent agenda spending binge) ramped the money supply by 40% in just two years.  That was almost ten year's worth of money supply growth dumped onto the economy over just two years.
 
The money supply remains trillions of dollars above trend.  And Biden's proposed 2025 budget would require printing another $1.8 trillion.
 
While the rate of change in prices has slowed, those trillions of dollars in excess money supply have underpinned the nominal price of stuff.  That goes for GDP (the total market value of economic output).  And that goes for the nominal revenues and earnings of companies.
 
With that, we kick off Q1 earnings season later this week, with the big banks.    
 
Despite the backdrop we've just discussed, corporate America has spent the past three months dialing down expectations on Q1, lowering the bar so they can step over it.  
 
Earnings growth estimates for the S&P 500 have been lowered to 3.2% year-over-year growth (from 5.7% heading into the quarter).  Keep in mind, that was in a quarter where the economy is expected to have grown at an annual rate of about 2.5% (a strong pace). 
 
So we enter another earnings season with the set up for positive surprises.
 
Before the banks report on Friday, we'll get March CPI on Wednesday.
 
Remember, Jerome Powell laid out conditions in his post-FOMC press conference last month, that would warrant starting the easing cycle: 1) unexpected weakening in the labor market, 2) the continued trend of falling inflation, toward the target and/or 3) any stress bubbling up in money markets (i.e. a liquidity shock).
Conditions one and three aren't showing stress.  And on condition two, it seems unlikely that the March inflation report will show progress on falling inflation.
 
With all of this in mind, we enter the week with the set up for a correction in stocks. 
 
As you can see in the chart below, we've moved up nearly 30% in five months, since Jerome Powell signaled the end of the tightening cycle in October.
 
 
And last week, as we discussed, the S&P futures put in a technical reversal signal (an outside day).  So did the Russell 2000.  So did the Dow.  So did the German stock market (DAX futures).
 
It looks like a technical correction is underway.  
 
If so, the appetite to buy the dip, particularly in the AI theme, will be very healthy.  

Pro Perspectives 4/4/24

 

 

 

 

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April 04, 2024

We've been watching this big trendline in stocks. 
 
 
As we've discussed here in my daily notes, this nearly perfect 45 degree angle ascent of the world's benchmark stock market (proxy for economic and geopolitical health and outlook) originated from late October commentary of Fed Chair Jerome Powell, when he signaled the tightening cycle was over. 
 
Since then, the market has gone from anticipating a change for seven quarter-point rate cuts this year, to five, to three.  Meanwhile the Fed has telegraphed three cuts, with some members chattering about the possibility of two, then one.  And today, from non-voting member Neel Kashkari, he suggested maybe none/zero rate cuts this year.
 
That comment from Kashkari hit the wires at a little after 1:00 today. 
 
Stocks did this …
 
 
Remember, from the first chart, stocks have risen nearly 30% since late October, despite the dramatic curtailing of rate cut expectations.
 
With that, there was another headline that hit a little after 1:00 this afternoon. 
 
 
Here's how Bloomberg interpreted it …
 
Markets will ignore domestic political infighting and geopolitical posturing until markets don't. 
 
This communication from the White House, describing the takeaway from a phone call between Biden and Netanyahu may be the tipping point — threatening a policy shift on Israel is a wakeup call for markets.
 
Stocks immediately sold off.  Yields ended lower.  Gold spiked.  The market response was broad-based risk aversion. 
 
But there was more.  Shortly after the White House headline on Biden/Netanyahu, in the daily White House Press Briefing, the White House Security Communications Advisor, John Kirby, fielded questions on Bidens call yesterday with Xi Jinping. In doing so, he said Biden was clear, in that "nothing has changed about our One China policy, we don't support independence for Taiwan."  I was watching it live.  So much for "strategic ambiguity."
 
Also this afternoon, the Secretary of State, Antony Blinken was at NATO headquarters, and said that "Ukraine will become a member of NATO," which is an affront to Putin's 2021 security ultimatum.
 
With these headlines this afternoon out of the U.S. administration, the world became more dangerous.  And just like that, the nuance surrounding tomorrow's job report, and rate cut timing becomes less important for markets.    
 

Pro Perspectives 4/3/24

 

 

 

 

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April 03, 2024

The climb in commodities prices continued today.
 
Let's take a look at the price of gold.
 
It traded above $2,300 this afternoon.  It's up 13% over the past 24 trading days.  Let's take a look at prior moves of this magnitude in the pandemic/post-pandemic environment.
 
 
As you can see above, gold had a move of similar magnitude in mid-April of 2020, in late July of 2020 and in March of 2022.
 
What was going on?  Inflationary policy.  These 2020 dates were pandemic response related.  Specifically, these spikes in gold align with the fiscal response — more specifically, government putting cash in the hands of citizens (checks, unemployment subsidies and the "Paycheck Protection Program).
 
The next spike?  The unemployment subsidy was due to expire (end of July), and was re-upped. 
 
The gold spike in March of 2022:  Inflationary policy.  Russia had invaded Ukraine.  Inflation was already nearing double-digits, thanks in part to supply chain disruption, but mostly to the multi-trillion dollar fiscal response to the pandemic. 
 
Adding fuel to the inflation fire, while the clean energy agenda was already curtailing energy supply, Congress responded to Russia with threats to place sanctions on Russian energy exports.  
 
That brings us to the current spike in gold.  Gold tends to be the global safe haven asset, where global capital flows in times of heightened geopolitical risk.  And gold is the historically favored inflation hedge.
 
That said, geopolitical risk and related uncertainty have become a constant, but these extreme moves in gold tend to be better aligned with episodes of overt fiscal profligacy (devaluation of the money in your pocket).  In this current case, perhaps the catalyst is the $7.3 trillion budget that Biden revealed early last month — an egregious 6% deficit spending plan in a economy that's growing at a 3% annual rate, with an already ballooning record debt.

Pro Perspectives 4/2/24

 

 

 

 

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April 02, 2024

We've started the second quarter of the year with a move up in global government bond yields, up in commodities prices, and down in stocks.
 
This start of the second quarter coincides with the beginning of the new fiscal year in Japan.  And as we've discussed in recent weeks, the Bank of Japan recently "began the end" of its role as the global liquidity backstop/support to Western world economies.
 
They raised rates, ending negative interest rates in Japan. 
 
They ended ETF purchases (exchange traded funds).  This was the Japanese central banks explicit involvement in, not just Japanese equity markets, but global equity markets — via ETFs. 
 
They ended yield curve control.  And by the design of that policy, in order to defend the upper limit of the 10-year Japanese government bond yield, they had the license to buy Japanese bonds in unlimited amounts (which pushed bond yields down). Those bonds were bought with freshly printed yen, which finds its way into foreign asset markets (like Western world government bond and stock markets).
 
With the above in mind, as we've also discussed in recent weeks, this move by the Bank of Japan may afford global central banks (led by the Fed) less leeway to hold rates too high, for too long — with the risk of global liquidity swinging in the direction of too tight (i.e. a liquidity shock). 
 
That (risk) includes the potential for rising government bond yields, which we are getting — the 10-year yield has jumped as much as 20 basis points to open the quarter …
 
 
The pop in rates is putting pressure on stocks.  And the S&P futures are testing this big trendline, after a 29% run-up from the late October lows (when Jerome Powell signaled the end of the tightening cycle) …
 
 
Add to this trendline test, yesterday the S&P futures put in a technical reversal signal (an outside day).  So did the Russell 2000.  So did the Dow.  And the German stock market (DAX futures) did the same today. 
 
So, this looks like a set up for some more weakness in stocks, as we head into this Friday's big jobs report.  Remember, the Fed is watching the job market "carefully" for "cracks" as a condition to start the easing cycle.  
 
Meanwhile, commodities are breaking out. 
 
Is it demand driven, given the outlook on the technology revolution? 
 
Or are commodities (finally) repricing against fiat currencies, now that the BOJ has signaled the final exit from the global central bank money printing era, which has delivered record (and unsustainable) global government debt.  
 
Maybe a bit of both. 
 
The chart below is silver.  We have a technical breakout.  It was up 4% today …  
 
 
We have a breakout in copper …
 
 
We have a breakout in crude oil …
 
 
And gold is making new record highs by the day. 

Pro Perspectives 4/1/24

 

 

 

 

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April 01, 2024

The Fed's favored inflation gauge was reported this past Friday morning (February PCE).  
 
Of course, markets were closed for Good Friday.  And with markets closed, it created the potential for a Sunday night reaction to the data in what is a very illiquid time for the futures markets.  
 
Probably no coincidence, hours after the PCE data, the Fed Chair was sitting on a stage at a San Francisco Fed conference for an interview on monetary policy.
 
The first question he was asked, was on the morning's inflation report. 
 
His response: "Pretty much in-line with expectations."
 
As you can see in the chart below, despite all of the hand-wringing on the inflation data, the path has been clear, and the target is nearly achieved. 
 
Arguably, as the pace of disinflation has slowed, it has created the perfect scenario for the Fed to sit and watch.  Inflation is low, and despite the highly restrictive policy stance of the Fed, the economy remains good (despite being throttled) and the job market remains solid.
 
This scenario actually plays into the Fed's historical policy making tendencies/preferences, which is reactive, not proactive.  
 
And as we discussed last week, Jerome Powell happened to lay out some conditions in his post-FOMC press conference last month, that would warrant a Fed reaction: 1) unexpected weakening in the labor market, 2) the continued trend of falling inflation, toward the target and/or 3) any stress bubbling up in money markets (i.e. a liquidity shock).
 
So, with the Fed Funds rate nearly 300 basis points above the rate of inflation, the Fed has restocked the ammunition (to stimulate or protect downside risks with rate cuts), and now can respond to any negative event, or deterioration in the economy (or markets).
 
This is a Fed stance that markets are very familiar with, unlike the stance throughout the tightening cycle, where the Fed was explicitly trying to bring demand down, trying to destroy jobs and was happy to see a weaker stock market (the latter, to help achieve the former).
 
As we discussed last week, the evolving current stance looks like a return of "the Fed put."  

Pro Perspectives 3/27/24

 

 
 

 

 

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March 27, 2024

The stock market rally broadened today, with the equal-weighted S&P 500 and the Russell 2000 (small caps) leading the way.  Importantly, this represents broader stock market strength.

As we discussed in my note yesterday, the Fed’s Financial Conditions Index had a turning point in October, from an historically tight level.  That turning point was triggered when Jerome Powell verbally signaled the end of the tightening cycle.

And as we also discussed yesterday, turning points from levels of historically tight financial conditions, have been good for stocks in the subsequent 12-month period — especially for small caps.

With that, as the major U.S. stock market indices have been routinely making new record highs, the proxies for broader stock market confidence and demand have been lagging.  The equal-weighted S&P 500 printed new record highs earlier this month (finally recovering the losses of the past two years).

But the Russell 2000 (small caps) remains 15% away from the 2021 record highs.

 

We’ve talked about the opportunity for small caps, the laggards, to catch up to the performance of the major indices.  The good news, today the Russell traded to the highest level since January of 2022.

With the P/E on the S&P 500 running north of 20, which is historically high, there remains plenty of deeply undervalued stocks for investors to suss out.  That bodes well for this chart above to continue narrowing the losses against its 2021 record highs — and to narrow the divergence in this chart …

For my AI-Innovation Portfolio members, please keep an eye out for a note from me tomorrow morning.  We will be making a new addition to the portfolio.  If you are not a member, you can join us here. 

 

Pro Perspectives 3/26/24

 

 
 

 

 

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March 26, 2024

Yesterday we talked about the Fed’s overly tight policy stance, and the downward pressure it puts on the economy.  And related to that, we looked at the recent percentage point decline in the Atlanta Fed’s Q1 GDP projection.

With that, let’s revisit the Fed’s new financial conditions index, which gauges the impact of financial conditions on future economic growth.

They just made an update to the index last week.  Let’s take a look …

Remember, this index is designed to incorporate the lags of monetary policy, and project (in this case) one-year forward what the impact will be on real GDP growth.

If the line is above zero, it’s a drag on growth (restrictive policy).  If it’s below zero, it’s a boost to growth (stimulative policy).  As you can see to the far right of the chart, it’s still projecting a drag on growth one-year forward. 

They introduced this “new” index back in June, and Jay Powell included a footnote directing attention to this index in a speech he made back in early December.  We discussed it in my December 4th note (here) and stepped through some analysis of the turning points of the index, and the subsequent return on stocks.

Here’s a revisit of that analysis: 

1) Financial conditions were at historically tight levels, as you can see in the chart above (“Oct ’23”).

2) Each of the periods in the chart that shared the characteristic of “historically tight levels,” were soon followed with some form of Fed easing (either rate cuts, QE, or in the case of 2015-2016 – walking back on projected rate hikes). 

And, 3) in each of the turning points in financial conditions, denoted in the chart, stocks did very well in the subsequent 12-month period — and small caps outperformed. 

     

 

 

Pro Perspectives 3/25/24

 

 

 

 

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March 25, 2024

Let's revisit Jerome Powell's comments last week on the employment situation.
 
Remember, the Fed has a mandate from Congress to achieve price stability AND maximum employment. 
 
With that, they've recently started acknowledging that the pursuit of the former (at this stage), might create a problem with the latter (job losses).
 
And that's because of this chart …
 
 
This chart above shows the current level of the Fed Funds rate in purple (where the Fed has set the short-term benchmark rate).  And it shows the most recent inflation reading in orange (January PCE). 
 
Remember, the difference is the "real" interest rate (Fed Funds rate minus inflation).  And that real interest rate is at historically high levels.  So the Fed continues to put downward pressure on inflation and on economic activity.  And with the Fed keeping rates steady, as inflation has been falling the real rate has been rising, which means the Fed has been getting tighter and tighter (i.e. more downward pressure on inflation and the economy).
 
On a related note, the Atlanta Fed's Q1 GDP projection has been adjusted down by over one percentage point over the past few weeks (the green line in the chart below).  And as we know from the most recent jobs report, the unemployment rate ticked up in February.   
 
 
So, what did Jerome Powell say last week about the employment situation? 
 
He said, "unexpected weakening in the labor market could warrant a policy response."
 
So that's a condition to start rate cuts.  And, as he said, they are monitoring "very, very carefully" … for "cracks."    
 
What's another condition?  The continued trend of falling inflation, to satisfy the Fed's need for "confidence" that the stair step toward 2% remains intact.  With that, we get another inflation report this Friday (February PCE). 
 
What's another condition?  Any stress bubbling up in money markets as they try to navigate the end of quantitative tightening, and the level of reserves to be left in the banking system.  As Powell admitted, the last time they tried this (2018-2019), they triggered a liquidity shock, and returned to easing.
 
So, the Fed has a 300 basis points of restrictive cushion, should inflation remain sticky at current levels.  But the longer the duration of restrictive policy, the more likely the employment situation deteriorates, which triggers Fed action.
 
This is looking like the return of the Fed put.