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June 21, 2023

Jerome Powell is back on Capitol Hill.

It was just a week ago that the Fed ended a series of ten consecutive rate hikes. Though for good measure, to keep any exuberance in check, the Fed projected a couple more (hikes) by year end.

He reiterated as much today. But the markets don't seem to care.

Why?

As we discussed last week, as long as the 10-year yield (the anchor market interest rate) is out of the danger zone (in the 3s), then financial and economic stability seem to be preserved.

It's a similar situation in Europe and the UK.

And as we also discussed last week, this phenomenon of "inverted yield curves" can clearly be attributed to bond market manipulation by central banks.

That said, the Bank of England will hike rates again tomorrow.

They are dealing with the highest inflation of G7 countries. And they are dealing with the highest 10-year government bond yield — which is creeping dangerously toward the levels of last September.

Importantly, in September, the BOE had to step-in to rescue failing pension funds, which was directly unraveling the UK government bond market, which would have quickly become a financial crisis.

The moral of the story: the central banks will continue to plug the holes, where needed, with the full support of their global central banking counterparts.

Pro Perspectives 6/20/23

June 20, 2023

We had strong housing numbers this morning.

Housing starts jumped, though off of the lows of the past year. The decline (to those lows) was driven by the Fed’s historic interest rate hikes, which (related) caused the quickest doubling of mortgage rates on record.

With that formula, following the post-covid boom in housing prices, the housing market has been a subject of “bubble talk.”

Let’s take a look.

First, here’s a look at building permits.

And here’s a look at housing starts. In May this was running at the hottest rate in seven years …

Now, from these two charts you can see the direct impact of rising interest rates on home building. We can also see, on the left side of the charts, what a housing bubble (and burst) looks like.

If we look back at that 2006 period, home builders were building at about a 40% hotter pace, with about 10% less population.

That real estate bubble was primarily driven by credit agencies AAA stamping high risk/high yielding mortgage portfolios (a mix of fraud and incompetence on the part of the ratings agencies). With a AAA rating and a high yield, massive pension funds had no choice, if not an obligation to plow money into those investments. And with that insatiable demand, mortgage brokers and bankers were incentivized to keep sourcing them and packaging them.

This post-covid housing environment was much different/ much less vulnerable to rate hikes.

You can see in the graphic below, the risk profile is very different, which aligns with the current environment of high creditworthiness (low debt service) and stringent lending standards (post-financial crisis).

We discussed these housing market comparisons by in my December 14th note in 2021, as we were a few months away from the Fed’s rate liftoff.

With that, I said … “What looks likely, in the face of a rate tightening cycle, is that real estate prices just stay persistently high, and even continue higher — driven by multi-decade high economic (nominal) growth, massive new money supply floating around, and a very tight labor market. And at higher rates, it will just cost more to live.”

This aligns with what we’ve discussed throughout on the inflation topic: “rate-of-change” in prices will slow, but the level of prices is here to stay.

And it’s by design: inflate asset prices and inflate away the value of debt.

Pro Perspectives 6/16/23

June 16, 2023

Yesterday we talked about the era of explicit central bank market manipulation.

They crossed the line in the sand, during the throes of the Global Financial Crisis, and unsurprisingly, they haven't looked back.

The Fed has now "normalized" interest rates, taking the Fed Funds rate to 5%-5.25%. And yet the 10-year yield is just 3.7%.

The UK has taken rates from 0.10% to 4.5%, still undershooting a hot 8.7% inflation rate, and yet the yield on the 10-year UK government bond is just 4.4%.

The European Central Bank has taken rates from negative 50 basis points to 3.5%, while inflation is running over 6%. And yet the German 10-year yield is under 2.5%.

Are these very tame government borrowing rates, the product of a "smart" bond market pricing in a (high) probability of recession?

Or are these very tame government borrowing rates, the product of governments intervening to fix market interest rates at a level they can afford, and thereby avoiding ballooning interest costs, a global credit crunch and sovereign debt defaults?

It's the latter (i.e. manipulation). And they've made little effort to hide it.

Early in the "rate normalization" phase, both the Bank of England (BOE) and the European Central Bank (ECB) had to rescue their respective government bond markets.

The ECB had to step in and promise to be the buyer of last resort in the big fiscally vulnerable constituents of the euro zone (namely, Italy and Spain). In the same month, they ended QE and restarted it (by a new name), by guaranteeing to keep the bond markets stable.

Then the Bank of England was forced to step in, after a doubling of UK government bond yields, in a little more than a month. A self-reinforcing debt spiral was underway.

As for the Fed, the Kryptonite of 4%+ 10-year U.S. government bond yields coincided with 1) the collapse of the biggest crypto exchange, and then 2) the banking system shock.

Both have resolved in a return of the world's benchmark interest back to the comfort zone (of 3%-4%).

As we discussed yesterday, coordination with the Bank of Japan (who continues to print money and buy assets) is good way to keep this important global interest rate (the U.S. 10-year yield) out of the danger zone.

Not only does keeping this anchor rate in check go a long way toward keeping global sovereign debt markets solvent, but it keeps consumer rates (most of which are derived from the 10-year yield) affordable (promoting economic activity).

So, as we discussed yesterday, many continue to point to inverted yield curves as signals of a looming recession. But that ignores the central bank manipulation, which is promoting the opposite – stability and economic activity.

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Pro Perspectives 6/15/23

June 15, 2023

As we discussed yesterday, the Fed ended a series of ten consecutive rate hikes yesterday.

They took interest rates from zero to 5% over fourteen months.

And yet the 10-year yield remains in the 3s.

This describes the dreaded “inverted yield curve” that most have pointed to as the reason to expect looming recession.

But it’s important to remember, we are in a world of explicit market manipulation. The world’s central banks crossed the line in the sand at the depths of the Global Financial Crisis, and unsurprisingly, haven’t turned back. Their finger prints are all over markets, when it matters.

They’ve outright manipulated bond markets along the way, with no apologies.

With that, given the clear evidence of trouble that arises when the benchmark U.S. 10-year yield has crossed the 4% threshold, in this recent tightening cycle, it’s reasonable to think that the major central banks in the world might want to coordinate to keep a lid on the 10-year yield.

Who would be the logical buyer of Treasuries (therefore applying downward pressure on yields)?

For that answer, let’s revisit an excerpt from my April 28th note oflast year, just after the Fed started its rate hiking campaign.

How do you prevent a global economic shock that may (likely) come from reversing the mass liquidity deluge of the past two years (if not 14 years, post Global Financial Crisis)?

You keep the liquidity pumping from a part of the world that has a long-term structural deflation problem, and that has the biggest government debt load in the world (exception, only Venezuela).

The Bank of Japan, in this position, can be buyers of foreign government debt (namely the U.S.) to keep our market rates in check (keeps the world relatively stable), which gives the Fed breathing room on the rate hiking path.

And Japan’s benefit? The world gives Japan the greenlight to devalue the yen, inflate away debt and increase export competitiveness (through a weaker currency). They hit the reset button on an unsustainable, debt-laden economy.”

With the above in mind, which country has bucked the trend of the global rate hiking cycle? Japan. Despite experiencing four decade high inflation, they have continued to print yen, and buy assets (domestic and global).

And you can see the devaluation in the yen since the Fed started hiking last year.

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Pro Perspectives 6/14/23

June 14, 2023

The series of ten consecutive Fed rate hikes has come to an end.

It was telegraphed by the Fed, just two weeks ago, as two voting members introduced the word "skip," related to this June 14 meeting.

As we discussed that day, it was deliberate (a signal to set market expectations).

So, today we follow a unanimous May hike (despite plenty of uncertainty surrounding the bank shock), with a unanimous pause.

This unanimity streak in the Fed might sound familiar, as they were also in complete agreement back in 2021, that the multi-decade high inflation was "transitory." And subsequently, they unanimously flip-flopped, by late 2021, becoming tough-talking inflation fighters.

In one of the more complicated environments in history, finding 11 (in the case of today's vote) economists to agree with each other, so consistently, is hard to believe.

With that, it's fair to say that unanimity strengthens one of the Fed's very effective tools: "guidance," otherwise known as manipulating public perception.

In today's case, what else do they unanimously agree on? None of them see a rate cut this year.

That said, they upgraded their view on growth for the year. And they see inflation (their favored core PCE measure) sticking at firmer levels. This fits with the view we discussed yesterday: hotter growth, hotter than average inflation … hold there and inflate away the massive government debt-load.

Pro Perspectives 6/13/23

June 13, 2023

The headline inflation number came in this morning right at 4% year-over-year. And as we've discussed, even if June were to be a hot number, the rate-of-change in next month's report (relative to June of 2022) will fall to the mid-3s.

This is why the Fed has been telegraphing a "skip" on the rate hiking cycle tomorrow.

Not only is the headline number falling sharply, but the Fed, at an effective Fed Funds rate of 5.08% is above its favored inflation gauge, core PCE, which is running 4.7% at the last reading. And taking the Fed Funds rate above the rate of inflation has historically been the antidote for putting downward pressure on inflation.

So, a "skip" by the Fed is fuel for stocks.

As we discussed yesterday, the Nasdaq and S&P 500 have well broken out of the bear market downtrend of last year.

The Dow and Russell (small caps) are just breaking out.

Here's an updated chart on the Russell, which was one of the best performing stock indices in the world today.

That said, this "skip" from the Fed doesn't look like a "stop," much less and "stop and reverse."

Why?

Oil.

The core inflation rate (ex food and energy) remains above 5%.

And, importantly, the sharp fall in the headline rate has been brought to us by manipulation, namely the Biden's administration's liberal use of the Strategic Petroleum Reserves — draining 40% of the reserves to put downward pressure on oil prices.

It's now time to restock.

And through anti-oil policies, we've ceded control over production to OPEC+. It seems likely that higher oil prices are in our future.

That will underpin inflation.

Meanwhile, the Treasury will be issuing over a trillion-dollars in new debt over the coming months (on top of the existing unsustainable debt burden).

All of this, and as we look around Japanese stocks are making new 33-year highs (nearing the old record highs). German stocks are near record highs. And U.S. stocks are resuming flight.

And we have the early stages of a fourth industrial revolution underway (driven by generative AI).

Complicated paradox? Or is this the formula we've been discussing in my daily notes taking shape?

For details, let's revisit my February 27th note …

We need a period of controlled hot inflation, as long as it comes with hot nominal economic growth.

Why?

The government debt has doubled, relative to the size of the economy since the Great Financial Crisis.

As you can see, this is Great Depression/World War II level debt.

The only solution: It has to be inflated away. That has to come through hot nominal growth.

With that in mind, a boom-time period in GROWTH is way overdue.

Remember, we've looked at this next chart many times throughout the history of my daily Pro Perspectives notes …

In my chart, the blue line is the path of real GDP IF it had continued to grow at the long-term average rate of 3.8% (that's the average growth rate from 1929).

So, if the economy had continued to grow "on trend" we would have a $26 trillion economy (the blue line).

Instead, we had the Great Recession. And instead of having the big bounce back in growth, that is typical following recessions, we had dangerously shallow and slow growth for the better part of a decade. And that growth was only due to the Fed propping the economy up through continued ultra-low rates and QE.

With that, the economy was knocked off (trend) path fifteen years ago, and the gap between trend and actual growth has only widened. We have an economy $6 trillion smaller than it would be had we stayed on trend.

This gap (between trend and actual GDP), and the (already) ballooned debt-load, explains why the Treasury (under Mnuchin) and the Fed (under Powell) didn't hesitate to go big and bold to respond to the Covid shutdown. It was an excuse to do what had to be done — inflate.

Of course, the politicos are opportunists, and they've taken advantage of crisis, pushing what was "big and bold" into "wild excess" (to fund their agenda).

With the damage from wildly excessive spending, the Fed's challenge has been to take the threat of hyper-inflation off the table, but leave the economy with stable, but hotter than average inflation. They may have done the job, but they will have to continue maneuvering/manipulating along the way.

Again, this note was from February. Fast forward to today, and this formula of hot growth, hotter than average inflation and rising wages appears to be coming to fruition. It would be good for stock prices. And it would inflate away the value of debt.

Pro Perspectives 6/12/23

June 12, 2023

As we discussed last month, nothing has had more influence on stocks over the past eighteen months than inflation, and the fears over a draconian Fed response to it.

With that, we get the May inflation report tomorrow.

What should we expect?

As we discussed last month, even if inflation runs at the average monthly rate we’ve seen in this post-pandemic hot/record inflation environment, the year-over-year headline inflation rate will have fallen off a cliff by next month.

It’s because of this …

As you can see, the June 2022 CPI steps significantly higher. That will come into play in next month’s report (of June prices). The year-over-year headline inflation calculation, against that higher base, should give us a number that will fall into the mid-3s (percent).

As for tomorrow’s report, it will still calculate against a lower base, but if the consensus view is right (expectation of a 0.2% m/m change in May prices), we may very well get a headline year-over-year inflation number tomorrow in the 3s (like 3.99%).

Keep in mind, a year ago, it was 9.1%.

Now, it may not feel like prices are rapidly cooling.

But 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 ten years worth of money supply growth (on an absolute basis), dumped onto the economy over just two years.

With that, the price of everything resets (higher).

What we don’t want to see, at this point, is the level of prices decline (i.e. deflation).

Deflation would kill growth, and leave us with trillions-of-dollars of fiscal bullets fired, with no growth to show for it (only the massive increase in debt, with no growth offset).

So, what matters is rate-of-change in prices. And that rate-of-change has slowed dramatically.

We now need a period of hot growth, rising wages (to repair the living standard damage), and stable (but higher than average) inflation (to inflate away debt). Growth solves a lot of problems.

Again, nothing has had more influence on stocks, over the past eighteen months, than inflation, and (related) the Fed.

For the reasons we discussed above, the Fed has given us the signal in the past two weeks, that they may “skip” at Wednesday’s meeting (i.e. end the series of rate hikes).

With all of the above in mind, stocks go into this inflation number and the Fed meeting, sitting on big technical trendlines …

Both the Nasdaq and the S&P broke-out of this bear market trend in Q1. This set up (given the catalysts ahead) looks very favorable, for some aggressive catch-up in the big blue chip stocks and small caps.

This bodes well for our Billionaire’s Portfolio, which is full of small-cap value.

Add to that, we have the (likely) removal of the monetary policy headwind, which should unlock growth in the economy. And that comes as a technological revolution is underway, and in the very early stages (generative AI).

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Pro Perspectives 6/8/23

June 08, 2023

I try not to consume much financial media. Though I listened to some today, while traveling. I heard a lot flippant comparisons to 1999 – the late stages of the speculative internet-stock boom.

This view, of course, relates to the recent resurgence of the big tech stocks, including the leaders of the AI-revolution.

But as we've discussed, it's early innings. The guy that runs the technology that powers AI says, himself, that the realization of this revolution just happened six months ago (with the launch of ChatGPT).

And of course, the reference to 1999 has a lot to do with the fact that some of the professional investing community has been wrong-footed this year — positioned for a recession (likely the one we already had, in the first half of last year).

My view: This is indeed looking like the 90s analog. But it looks more like 1995. The beginning of the boom.

With that, we've looked at this period in my daily notes, particularly related to the Fed stance.

In 1994, the Fed went on an aggressive rate hiking campaign. They did 300 basis points in 12 months (raising into a recovering economy- worried about "sticky" and "persisting" inflation). Then they paused. Within five months they were cutting rates.

Following the Fed's pivot in '95, the economy went on to average 4.5% quarterly annualized growth through the end of the 90s. And stocks did this ...

PS: If you know someone that might like to receive my daily notes, they can sign up by clicking below …

Pro Perspectives 6/7/23

June 07, 2023

We looked at this chart early last week …

The big-tech driven Nasdaq was outpeforming the broader small cap market by more than thirty percentage points on the year.

That gap is closing aggressively, helped by the nearly four percentage points of outperformance today, by the Russell 2000.

What's going on?

We've had a market that has been positioned for a hard landing, bearish outcome. And yet, the overhang of risks have been removed one by one.

>Debt limit decisions are now, not only pushed out to 2025, but the Treasury now has license to issue unlimited debt between now and then (a greenlight, if given an excuse).

>By next month, we should be seeing a headline inflation number in the mid 3s (percent), thanks to the "base effect." And that has the Fed chattering about a "skip" in the rate hiking campaign (otherwise known as "pausing," more likely ending).

>The bank shock has proven to be just that: a shock, not a crisis.

That said, there was news yesterday that the Fed may be looking to hike bank reserve requirements by 20%. The last time I checked (still here), they took the reserve requirement to zero, during covid, and haven't changed it since. That gave banks a license to make unlimited loans. While twenty percent of zero is still zero, perhaps its a signal that the Fed is cleaning up some bank risk.

So, with risks being removed, the investors that have been positioned on the wrong side this year (which includes underinvested in equities), seem to be buying the market laggards.

PS: If you know someone that might like to receive my daily notes, they can sign up by clicking below …

Pro Perspectives 6/6/23

June 06, 2023

Yesterday we talked about Nvidia Founder/CEO's view of AI, and the future it will power (you can see that note again here).

We left off on his view of the "next big reinvention," where "the digital world meets the physical world."

Huang says it's Omniverse technology will power it, and will reshape $100 trillion worth of global industry.

How far off might this "next big reinvention" be?

Apple announced a new "augmented reality" device yesterday.

Here's how they describe the product: "Apple Vision Pro seamlessly blends digital content with your physical space."

Sounds familiar. What's most interesting about this new technology era, is that it's made for building faster and cheaper.

With that, the speed of change, in this "industrial revolution" could be unlike those of the past.

Among the many questions: Who will be the winners and losers? Who will be the AOL (the left behind)? Who will be the Amazon (become more relevant, as they leverage technological advancements)?

And will it all, ultimately, be executed in a way that changes the way we live for the better?