Pro Perspectives 1/14/25

 

 

 

 

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January 14, 2025

We had the second post-election small business optimism report this morning.  And as we suspected back in November, a repeat of the Trump effect is back for small business.
 
Optimism surged again in December, to a six-year high …
 
 
This surge of the past two months was after spending 34 consecutive months UNDER the 50-year average.
 
And as you can see in this next chart, small business earnings is coming off of the lowest levels since the Great Financial Crisis. 
 
 
So, the past four years have been good for Wall Street, but haven't been good for small business. 
 
But notably, the highest point on this small business earnings chart was delivered by the first Trump administration.  And this recent survey says small business owners expect better growth, lower inflation and better business conditions under Trump (2.0), but they expect it to be "a bumpy ride."    
 
We get CPI tomorrow, and we hear from three of the four big banks on Q4 earnings.
 
This will kick off what is expected to be the highest earnings growth quarter in three years. 
 
So, there will be a lot for markets to digest tomorrow.  In the case of a hot inflation number and hot earnings, we should expect the trajectory of this chart to be most important.  
 
 
We've talked about this 5% level for the 10-year yield (likely the danger zone for financial stability and fiscal sustainability).  This is where the Fed flipped the script in October of 2023, and signaled the end of the tightening cycle, suggesting that the bond market had done the tightening for them. 
 
That said, look where inflation expectations were at that time, relative to now …
 
 
As we discussed yesterday, if bond yields test the 5% level again, we should expect the Fed to quickly swing the pendulum to unanimously dovish, and be vocal about it, in order to talk bond yields down. 

Pro Perspectives 1/13/25

 

 

 

 

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January 13, 2025

We've talked about the bond market as a shock risk that could quickly get to a flashpoint. 
 
With that, the strong jobs number this past Friday has extended the surge in the U.S. 10-year yield to as high as 4.80%.  That's the highest level since November of 2023 (more than a year ago).
 
And as we've discussed, this rise in bond yields (which has diverged from the direction of Fed policy) has put pressure on stocks.  
 
Let's take a look at a couple of charts …
 
 
Above is a look at the interest-rate-sensitive small caps index. 
 
The trendline represents the bull cycle for small caps that started in October of 2023, when Jerome Powell signaled the end of the tightening cycle.
 
If we look at the Russell compared to the less rate sensitive Nasdaq (below), we can see these divergences along the way. 
 
In this first circle, the divergence closed with the Russell falling (the orange line), as the Fed started curbing what were very aggressive rate cut expectations priced into markets.   
 
 
In the second circle, the divergence gap was closed with a sharp rise in the Russell.  And it was triggered by inflation data that showed the first monthly price decline since May of 2020. 
 
And now, in this third circle, we have another divergence between the Russell and Nasdaq, with small caps now in a 12% correction.  And this comes as we enter another big inflation data point to be reported on Wednesday (the December CPI report).  
 
With that, we go into this inflation report with the market already leaning in the direction of a more hawkish rate path for the year than the Fed has projected (which has weighed on small caps). 
 
The market is now pricing in just one quarter point rate cut for 2025, while the most recent Fed Summary of Economic Projections (from the December meeting) is looking for two quarter point cuts this year.
 
So, what are CPI expectations?  Pretty hot. 
 
Reuters has the monthly headline inflation change expected at 0.3%.  The Wall Street Journal's consensus Wall Street view is higher at 0.38%.  
 
A positive surprise (i.e. a touch softer inflation) would relieve some pressure in the bond market, and fuel a bounce in small caps. 
 
A hot number would push yields toward 5% (and stocks a lower) …
 
 
If so, we should expect a 5% yield on the 10-year Treasury to be the "uncle point" for the Fed, again. 
 
We should expect a similar response to what we saw in October of 2023:  A Fed that will quickly swing the pendulum to unanimously dovish, and be vocal about it, in order to talk bond yields down. 
 

Pro Perspectives 1/8/24

 

 

 

 

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January 08, 2025

We've talked about the divergence in the interest rate market, between the direction of the benchmark interest rate that the Fed sets (the Fed Funds rate), and the benchmark interest rate that's determined by the market (i.e. the U.S. 10-year Treasury yield).
 
The Fed has cut the Fed Funds rate by 100 basis points since September, and yet the U.S. 10-year Treasury yield has gone UP by over 100 basis points.
 
And as we've discussed, we have this breakout in yields.  If this continues to extend, the probability of a financial shock event rises.  
 
 
This move in the 10s has been attributed to inflationary policies of the incoming Trump administration. 
 
The minutes from the December Fed meeting were released today, and revealed that Fed officials did indeed adjust their inflation outlook based on their view of Trump policies — and they also cited concerns that upward pressure on inflation could come from continued "positive sentiment in financial markets and momentum in economic activity."
 
If this is the driver of the activity in the U.S. bond market, then we shouldn't see a similar dynamic unfolding in European bonds, where there is no economic momentum, and where Trump trade policies would be disinflationary, if not deflationary.
 
If we look at Germany, the historic growth engine of Europe, the economy has five years of no growth, which is expected to continue in 2025.  The European Central Bank has cut rates by 100 basis points since June, and yet the German 10 year yield is also breaking out (i.e. higher) …
 
 
The UK economy is flatlining.  The Bank of England has cut rates 50 basis points since August, and yet the yield on the 10-year gilt is breaking out (i.e. higher) — now trading at the highest level since 2008. 
 
 
A couple of things to keep in mind:  1) The government debt burden (as percent of GDP) in the UK has more than doubled since 2008, amplifying the debt service burden … and 2) just a little more than two years ago, the Bank of England had to intervene in the bond market at these levels to avert a financial meltdown that would have spilled over globally. 
 

Pro Perspectives 1/7/24

 

 

 

 

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January 07, 2025

Jensen Huang gave the keynote to kick off the Consumer Electronics Show (CES) in Las Vegas last night.
 
Let's talk about what the guy that runs the most important company in the world had to say about the future.
 
He laid out the waves of AI in this graphic below. 
 
 
It started with the "ChatGPT moment" just a little more than two years ago.  This was the introduction of generative AI, and it set into motion the race to "retool" the world's data centers to accelerated computing.
 
The big hyperscalers have already spent a couple hundred billion dollars, and might only be one-fifth of the way there.
 
The next wave is "agentic AI."  This is the digital workforce.  It's already happening — autonomous agents performing tasks and operating independently of direct human control. 
 
Jensen sees agentic AI as a multi-trillion dollar industry.   
 
And this leads into the theme of 2025, which is physical AI. 
 
This is AI systems integrating with the physical world.  And Jensen has said in the past that physical AI will reshape $100 trillion worth of global industry.
 
So, this is the big takeaway from the presentation.  It's about robotics. 
 
And Jensen says "the 'ChatGPT moment' for general robotics is just around the corner." 
 
He says over the next several years, the combination of agentic AI robots, autonomous cars and humanoid robots will become "the largest technology industry the world has ever seen."
 
Remember, Elon Musk thinks with the introduction of humanoid robots into the world, there will be "no meaningful limit to the size of the economy."
 
This all makes incremental surprises in daily economic data, the uptick in global bond yields, and parsing Fed communications on the next quarter point rate cut, seem relatively unimportant. 
 
But just as the technology revolution of the late 90s, driven by internet adoption, drove a stock market and economic boom, there were shocks along the way (like the Asian Currency Crisis, Russian Default and the related failure of the hedge fund Long-Term Capital Management).
 
And with that, we have plenty of shock risks that warrant respect. 
 
Among them, the one that could quickly get to a flashpoint is the bond market.  
 
Remember, we looked at this chart in my Dec. 23 note (here).
 
 
As we discussed in that note, the big downtrend in the U.S. 10-year Treasury yield has broken.  Yields have now moved 110 basis points higher, despite the Fed taking the Fed Funds rate 100 basis points lower.
 
And remember, the current Treasury Secretary, Janet Yellen, has left the bond market in a vulnerable position, by financing record peacetime deficit spending with short-term maturities.
 
That leaves incoming Treasury Secretary, Scott Bessent, with a third of the outstanding government debt to be rolled over this year, creating risks for rate volatility (a bond market attack) and “the potential for a financial accident.”

Pro Perspectives 1/6/24

 

 
 

 

 

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January 06, 2025

Happy New Year!  Stocks are already off to a good start, globally.

Commodities are climbing.  And so are government bond yields, at least in the Western world.

It all appears to reflect expectations of a more business friendly, market-determined economic environment coming to the U.S. on January 20th.   

And the political regime change in the U.S. is beginning to influence change elsewhere, as we discussed in my note last month. The populist pushback is bubbling up in Europe and in Canada (with Trudeau’s resignation today).

Like the beginning of last year, the market is expecting rate cuts this year.  But unlike the beginning of last year, the expectations on how many have already been tamed by the Fed over the past three months.  

With that, the easing cycle today isn’t the powerful tailwind for stocks. The tailwind is growth, driven by Trump policies — more specifically, the probability of a positive surprise on what is a very low expectation bar set by the Fed.  They are looking for just 2.1% GDP growth for 2025.

The other, bigger tailwind:  the new industrial revolution.  It’s driven by generative AI, and continues to be in the early innings of adoption.

And we should expect the attention to this tailwind to be amplified this week, as the most powerful tech event in the world will be hosted in Las Vegas.

The big Computer Electronics Show (CES) kicks off tonight with a keynote by Nvidia’s Jensen Huang.

It was the excitement around Jensen’s CES talk last year, in early January, that sparked the big Nasdaq rally — and as you can see, it never looked back.  

Last year, CES was all about “the digital world meeting the physical world.” 

The CEO of Siemens called 2024 a “turning point” where real and digital worlds converge.

We should expect the clear emergence of that theme in 2025, as AI-powered robots become part of the workforce, and soon-to-be part of everyone’s daily life. 

 

 

Pro Perspectives 12/23/24

 

 
 

 

 

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December 23, 2024

As we near year-end, let’s take a look at the bond market.

As you can see in the chart below, since the Fed kicked off the easing cycle back in September, the 10-year Treasury yield has moved almost 100 basis points higher as the Fed has taken the Fed Funds rate 100 basis points lower.

 

And as you can see in this next chart, with this rise in the 10-year, the big downtrend in yields has broken.

And this trendline is significant.  It represents the regime change in monetary policy, signaled by Jerome Powell back in October of last year — when he signaled the end of the tightening cycle.

The 10-year yield proceeded to fall as much as 140 basis points on the anticipation of an aggressive Fed easing cycle.

But when the easing cycle actually began, yields went straight up – now back at 4.58%, having broken above this big trendline.

What’s going on?

Is it reflecting a Trump-agenda-fueled outlook for higher growth and higher inflation?

Or is it reflecting potential trouble in the bond market?

On the latter, let’s revisit an excerpt from my note last month (here), where we discussed (now Treasury Secretary nominee) Scott Bessent’s concerns about Janet Yellen’s handling of the deficit.

Bessent argued that Yellen financed it in a way that traded short-term gain (in attempt at political gain) for medium and long-term economic pain — leaving the pain for the next administration.

As you can see in the right side of the chart below, the government has been funding the largest deficit spending in peacetime history, by issuing an unusually large proportion of short-term debt (Treasury bills, the blue bars).   

By funding more of the deficit with shorter dated Treasury bills over the past year, Yellen paid more to borrow, as short term rates were higher than long term rates (an inverted yield curve).

But by focusing on Treasury bills, and limiting the increase in longer-term bond issuance, Yellen was able to influence longer-term interest rates lower or prevent them from rising further.

Bessent has made the case that this looks like Yellen purposely manipulated financial conditions through this strategy to “goose the economy.”

And now, for the new administration, these short term Treasury Bills will have to be refinanced, creating risks for rate volatility and, as Bessent put it, “the potential for a financial accident.”

We have a lot of tailwinds for 2025, but we should expect the path to be bumpy.

Among the tailwinds:  The continuation of the new industrial revolution (powered by generative AI), and it’s in the early stages.  If you haven’t joined our AI-Innovation Portfolio, you can learn more here.

This will be my last Pro Perspectives note for the year.  Thank you for being a loyal reader of my daily notes.  I want to extend my best wishes for a Merry Christmas and a Happy and Healthy New Year!

 

 

Pro Perspectives 12/19/24

 

 

 

 

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December 19, 2024

We get the Fed's favored inflation gauge tomorrow morning.
 
But there should be little suspense.  Powell leaked it yesterday afternoon in his press conference. 
 
He said PCE for the twelve months through November should be 2.5%.  And the staff projections from yesterday's SEP (Summary of Economic Projections) suggest they see this month's number (the December PCE) ticking back down to 2.4%.
 
Let's take a close look at this "inflation target" concept.  
 
The Fed issued a formal statement on the level (2%) and their preferred gauge ("the change in the price index of for personal consumption expenditures") back in 2012 (here).
 
So, let's take a look at how they've done …
 
  
In the above chart, you can see they spent much of the post-Global Financial Crisis, pre-Pandemic decade running below 2%. And with this recent high inflation period, it leaves the 12-year average at 2.24%.
 
Keep in mind, in the middle of the decade-long bout with deflationary risks, the Fed told us that the inflation target was "symmetric."
 
And in 2020, when inflation was still sub-2%, Jerome Powell formalized this by saying they're just looking to "average" 2% over time.  He was signaling that they would let the economy run hot (for an unspecified period of time), letting inflation run above 2%, to make up for the decade of below target inflation.
 
That's happening. 
 
So, is the Fed really hyper-sensitive to this stall just above the inflation target, even if it persists for a while?  Their own formal policy, and history, would suggest the answer is no.
 

Pro Perspectives 12/18/24

 

 
 

 

 

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December 18, 2024

The Fed cut by a quarter point today, in line with market expectations.

Stocks were crushed.  Yields spiked. The dollar rallied.

Let’s take a look at the culprit.

This is the Fed’s latest “SEP” (Summary of Economic Projections).

Going in, we expected them to dial UP the 2025 end of year level of the Fed Funds rate, by a quarter point.  They took it up by half a point.

That means they now see two cuts next year, not four.  They see inflation higher now (highlighted in red).  And they see growth a tick higher next year (also in red).

Remember, we talked about the Trump effect on the Fed back in 2016.

Just a month following the Trump 1.0 election, the pro-growth Trump agenda influenced the Fed to a proactive rate hike in an economy that had averaged only slightly above 1% PCE inflation that year.

Also in that December 2016 meeting, the Fed revised UP inflation forecasts, saying “some of the participants” incorporated the “assumption of a change in fiscal policy” into their projections.

This time around, they’ve revised UP growth, inflation and taken two projected Fed rate cuts off of the table (a tightening effect).

It probably wasn’t a regime change type of day, but Powell acknowledged that it has indeed a “new phase in the process” of finding the neutral level for rates.

When asked if it was because of Trump, Jerome Powell revisited the script from 2016, begrudgingly admitted “some people” did “incorporate effects of policies into their forecasts.”

Now, today’s market reaction reminded me of the shakeout from an inflation report earlier this year (on February 13th).

In revisiting my note from that day, indeed we had another rare type of day.

Today makes just the fourth time in four 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.

> 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).

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

> It happened on June 13, 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, these two episodes (in 2021 and 2022) were clearly about significant inflation threats — potential runaway inflation. 

Now, let’s contrast that with the two episodes from this year, which share the features of the 4%+ down day in small caps and the 14 basis point+ spike in yields …

> What happened on February 13, 2024?

Remember, heading into 2024, the Fed had telegraphed the beginning of the easing cycle, projecting three rate cuts for the year — while the market was looking for six.  And the Fed then spent the month of January trying to curb the market’s enthusiasm about the rate outlook.

With that, the inflation data reported that day came in a touch higher … and markets unraveled.

But unlike the two prior market episodes discussed above, the market reaction was unwarranted.  The disinflation trend, at this point, was well intact.  And the inflation data reported was the lowest level of the cycle, and a tenth consecutive lower year-over-year reading.

It was an overreaction.  Stocks recovered in two days.

Today’s market reaction was, too, about the inflation outlook — but it’s inflation that’s well into the 2s, in an environment of high productivity, and (still) restrictive monetary policy.

So, while inflation is the common theme in these four episodes that share these rare extreme market reactions, it’s fair to say the circumstances are quite different in these recent episodes, relative to the inflation backdrop of 2021 and 2022.

With that in mind, was the selloff in stocks (and bonds) today an overreaction in a thin holiday market?  It looks that way.

 

 

Pro Perspectives 12/17/24

 

 

 

 

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December 17, 2024

We get the Fed tomorrow.

As we've discussed, they should do nothing to disrupt the market expectations for a quarter point cut.  

 

As you can see in the chart below, the 2-year yield (the market determined interest rate) tends to be the guide for Fed policy.  It has historically led on the way up, and on the way down. 

 

In the current case, the 2-year is at 4.24% and the Fed is at an effective rate of 4.62% (still 38 basis points higher). 

 
 
That said, the market is expecting a "hawkish cut," where the Fed telegraphs fewer cuts for next year in its Summary of Economic Projections (which is due to be released tomorrow).  
 
As you can see in this table below, coming out of their September meeting, they saw the Fed funds rate at 3.4% level by the end of next year.  They will likely dial that UP by a quarter point tomorrow, which would align with the market view. 
 
 
Let's take a look at the year-to-date performance of the AI Kings (otherwise known as Mag 7). 
 
These stocks now represent 34% of the S&P 500 index.  And with that, they are contributing about 90% of the overall return of the index for the year. 
 
If we look at growth in world money supply since Covid, it's around $20 trillion.  The growth in market value of the AI Kings has been $12.5 trillion over the same period.  Add another $3 trillion in the growth in the value of cryptocurrencies, and it's fair to say that we know where most of the excess money supply (i.e. above trend growth money supply) has been absorbed from the covid response.  

Pro Perspectives 12/16/24

 

 

 

 

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December 16, 2024

In my last note we talked about the synchronized global easing cycle.
 
Major global central banks responded, in coordination, to the global health crisis. 
 
They responded, in coordination, to the subsequent inflation. 
 
And over the past year, they've responded, in coordination, to the disinflationary trend. 
 
So, global policy making has been intentionally synchronized, and that includes Japan — which served a very important role as the global liquidity provider (with QE + negative rates) as the rest of the world was inflation fighting.
 
Now Japan is attempting to "normalize" policy, as the rest of the world is easing.
 
But as we also discussed in my last note, while monetary policy has converged, the economic outlook within this consortium of major central banks/ leading countries has diverged. 
 
And if we simply use consumer and business confidence as our gauge, the divergent economic outlook has come from diverging structural agendas (structural policy). 
 
The U.S. has had a populist political shakeup. 
 
And that catalyst for change has infused confidence in the U.S. economic outlook.
 
 
It's a new roadmap.  And this chart highlights the impact (i.e. divergence in government policy paths = divergence in economic outlook).
 
And as I suggested in my note on Thursday, this divergence doesn't close without a catalyst, and that catalyst might come in the form of a populist political shakeup in Europe.

 
We've seen the Macron government fall in France over the past two weeks.  And just this afternoon, the screws were turned on Scholz in Germany.  He lost a confidence vote.  The Germans will have a snap election likely in late February to determine what might be a new political landscape.
 
And in Canada, Trudeau's government lost two key cabinet members today to resignation (Finance Minister and Housing Minister), and a no confidence vote looks likely early next year. 
 
This is beginning to look like the 2015-2016 populist pushback that delivered Grexit, Brexit and the Trump vote. The people want freedom from the globalist agenda, and they want sovereignty restored.
 
In Europe, if the political dominoes fall in the coming months, it will come with complicated financial risk — a reversion to nationalist governments in Europe would be a clear threat to the future of the euro (the common currency).