Pro Perspectives 4/19/23

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April 19, 2023
 
The March UK price data, released early this morning, showed double-digit inflation. 
 
This was the Wall Street Journal headline …
Given that the Fed (the global interest rate anchor) is clearly contemplating the end of the road for the tightening cycle, a big inflation number in Europe, in a month that should have reflected tightening global credit conditions, set off some alarms.  Rates went higher, stocks went lower and commodities went lower – globally.

 
But it was a false alarm. 
 
By this time next month, it's a good bet this same reading in the UK will have plunged. 
 
Why?  The "base effect."
 
The April inflation data will be measured against a significantly higher data point from twelve months prior.  
 
Here's a visual, for perspective …
Even if April (this month) were to bring about a hot inflation number in the UK, the year-over-year CPI will likely land somewhere within the white box on this chart below.  So, this time next month the media will be talking about an acceleration in the trend of "disinflation" in the UK.
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Pro Perspectives 4/18/23

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April 18, 2023
 
Let's take a look at mortgage rates.
 
As you can see in the chart below, the spread between the 30-year fixed mortgage rate and the U.S. 10-year Treasury yield is at extremes.  It runs about 2% on average, over this 20-year history.  It's closer to 3% at the moment. 
The blowout of this spread was triggered by the Fed's early telegraphing of an 80s, Volcker-like inflation fight.  That type of response would have entailed a double-digit Fed Funds rate.  Thankfully (for the economy) that didn't happen, but mortgage rates took the cue, and doubled at the fastest rate in history.  
 
Of course, another driver of this spike in mortgage rates was the Fed's stated intent to shrink the balance sheet, which would (expectedly) entail reducing its position (its bid) in the mortgage-backed securities market.
 
That said, the Fed was noticeably very cautious in its attempt to trim the $2.7 trillion mortgage portfolio.  It was four months into the "quantitative tightening" program, before they even made a ripple in their mortgage holdings.  Still, they are well behind on the planned asset sales, and probably for the reasons exposed in the chart (i.e. the risk of further disconnecting mortgage rates from the broad interest rate market, and therefore breaking the housing market).
 
We've already seen the Fed's response to its self-induced banking crisis:  They started buying Treasuries again. 
 
I suspect, soon, the Fed will have to start buying mortgages again, too (to normalize the spread).  The catalyst:  the trouble brewing in commercial real estate. 
 
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Pro Perspectives 4/17/23

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April 17, 2023
 
I'm back in action, following a week-long tour of colleges for my son.
 
We left off prior to Easter, heading into the March employment report. 
 
As we discussed, the employment situation had already given signals of softening.  The ISM services employment index for March was weaker than the prior reading.  The ADP report for March showed the weakest job gains in more than two years.  And the measure of "job openings" (JOLTS) had already contracted by nearly a million jobs — and that was before the effects of the banking fallout. 
 
With that, the BLS job report for the month of March did indeed show slower job growth.  The economy added 236k new jobs — quite a bit slower than the average monthly job additions of 334k over the prior six months.
 
Of course, this is of particular interest as the Fed has explicitly targeted the hot jobs market over the past year as a pain point for inflation (related to the leverage that workers have to negotiate higher wages).  With the justification of oversupplied jobs, they have mechanically stepped interest rates higher, with the intent of job destruction and, therefore, demand destruction (and therefore, bringing inflation down).  
 
So, again, the employment situation is now clearly softening.  And we also learned last week that the inflation data continues to soften.
 
And remember, the Fed Funds rate is now ABOVE, their favored inflation gauge (core PCE).  And historically, raising rates above the inflation rate has been the antidote to inflation.
 
Add to this, the shock in the banking system last month, should have signaled to the Fed that they've hit the intolerance level for interest rates.
 
So now, post-banking system shock, the already softening economic data will be exacerbated by a slowdown in bank lending.  This, and the 475 basis points of Fed tightening still hasn't worked its way through the economy. 
 
With this backdrop, the next Fed meeting is in two weeks.  This tightening cycle should be over.   
 
That said, the interest rate market is pricing in a near 90% chance of another quarter point hike. Given this market expectation, a "pause" by the Fed would be a positive surprise for stocks. 
 
We have also entered Q1 earnings season, with a low expectations hurdle – expectations are for earnings contraction of 6.5%.  Thus far, the big banks have posted big earnings beats, even AFTER adding to their respective war-chests of loan loss reserves.     
 
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Pro Perspectives 4/7/23

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April 7, 2023
 
Markets were closed today in observance of Good Friday. 
 
I’ll be away next week, so you will not receive a note from me.
If you’re a Billionaire’s Portfolio subscriber, it’s a great time to get your portfolio in line with ours.  You can find all of my past notes and the full portfolio here.  If you’re not yet a member, you can get involved by clicking here.
Happy Easter!
Best,
Bryan
 

 

Pro Perspectives 4/6/23

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April 6, 2023
 
Stocks are closed tomorrow for Good Friday.  But we will still get the March jobs report at 8:30.
 
With this jobs report in mind, remember, it was mid-March that bank runs started on a few vulnerable venture capital related banks.  Not only did that send shock waves through the banking sector, but it had a clear and direct blow to the technology sector. 
 
It was safe to assume, that confidence shock had a direct and indirect effect on jobs.  And we’ve already seen it reflected in some March employment data. 
 
The ISM services employment index for March came in quite a bit weaker than the prior reading.   
 
Wednesday’s ADP jobs report for the month of March was weak.  In fact, it showed the second weakest job gains in more than two years.
 
And as you can see in the chart below, the six-month rolling average of jobs added in the ADP report, have been going one direction since the Fed started raising rates last year (down).  This average has returned to pre-covid norms.
Of course, the Fed has explicitly threatened jobs along the path of its inflation fight.  
 
And Jerome Powell has specifically targeted the mismatch between job openings and job seekers.  We heard more on that front earlier this week.  It was February data (prior to the banking fallout), but already nearly a million jobs had evaporated.  This job openings/job seekers ratio has probably since collapsed. 
So, this brings us to tomorrow morning’s government published jobs report.  It’s a safe bet that it will be soft.
 
This number was running around 200k (on average) prior to covid.  Wall Street consensus for March is around 250k.  This, and the trend of the six-month rolling average, is all in-line with the data points mentioned above (i.e. a weaker employment situation).
 
If we needed anything else to confirm to the Fed, that they should avoid another mistake with interest rates, this (a soft jobs report) should do the trick.
 
With that, a soft jobs report should be good for stocks. 
 
But, given that influence on the rate outlook, it should be bad for an already declining and vulnerable dollar.     
 
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Pro Perspectives 4/5/23

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April 5, 2023
 
Let’s revisit the long-term dollar cycles, which we’ve kept an eye on throughout the history of my daily note. 

Since the failure of the Bretton-Woods system through the onset of the Global Financial Crisis, the dollar traded in five distinct cycles – spanning 7.4 years on average.  
As you can see, the era of QE has seemingly distorted these cycles. 
 
Let's call this current cycle, an exceptionally long bull cycle for the dollar.
 
The top was October.  And now with the events of the past month, the fundamental picture for the dollar is clearly negative.  The rate outlook has swung dramatically, from tighter to easier, by year end.  And the dollar's world reserve currency status is simultaneously and opportunistically being challenged.
 
So, if we assume this extraordinarily long bull cycle for the dollar ended in October, we are just five months into a new bear cycle. 
 
It's very, very early.  And the average change in the value of the dollar (in the prior five cycles), from extreme to extreme is > 50%. 
 
So, in this case, this bear cycle would portend a better than 50% decline in the global purchasing power of the dollar (relative to a basket of major currencies).
 
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Pro Perspectives 4/4/23

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April 4, 2023
 
Over the past few weeks, we’ve talked a lot about the fundamental threat to the dollar.
 
That scenario continues to unfold, and the value of the dollar is (as a result) in decline.
 
Here’s the latest look at a chart of the dollar index …
As we’ve discussed, a lower dollar tends to mean higher commodities prices. 
 
On that note, today gold traded back above $2,000.  This is back in record territory.
 
The last time gold was here (at $2,020) was March of last year.
 
Importantly, the demand for gold, at that time, was driven safe-haven flows.  Russia had invaded Ukraine, and global capital flooded into what is known to be the safest and most liquid parking place:  gold, the dollar and U.S. Treasuries.
 
All went up in value.  
 
This time, the threat is different and so is the market outcome.  Gold is back to above $2,000.  U.S. Treasuries are in demand, and moving higher.  But the dollar, the historic safe-haven currency, is sliding.  
 
What’s going on?  As we’ve discussed in my daily notes, the dollar’s role as the world’s reserve currency is being challenged. 
 
This eventuality has been talked about for a long time.  The time appears to be here.  And with the challenge to the dollar, fiat currency is broadly being challenged.  Gold is reclaiming it’s historic role as a store of value — evidenced by record accumulation of gold last year by global central banks, to rebuild their allocation to gold as a reserve asset. 
 
But if the dollar is being shunned, why are dollar-denominated Treasuries continuing to move higher (market rates lower)?  The answer:  Domestic demand! 
 
For a long time, we’ve heard the doomsdayers suggest China would dump our Treasuries, send U.S. rates soaring, the economy collapsing and the dollar collapsing.  It hasn’t happened, even as China has, indeed, been selling Treasuries.  Who’s buying?  Japan.  And more recently, American depositors. 
 
With the bank fallout of last month, depositors are leaving near zero yielding bank deposit accounts, for relative safety AND a 3.5-4% yielding Treasury security. 

Pro Perspectives 4/3/23

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April 3, 2023
 
We open the week with this spike in oil prices …
This 7% rise comes from relatively low prices of a year ago, but, as you can see, this is a significant trend break.  Moreover, the fundamental picture is ominous (ominously supportive of much higher prices).
 
So, what was the catalyst of today’s price spike?  
 
Oil producing countries (OPEC+) decided to cut production into a structural-deficit supply market (structural deficit from non-OPEC+ underinvestment in future production).  
 
Why the cut?
 
Because they can.  And we should expect them to continue to do everything in their power to maximize revenue on every single barrel of oil they sell.  And they have a lot of power these days. 
 
Not only has power and leverage been ceded by the Western world, in its pursuit of the clean energy agenda, the anti-oil policies are agitating to countries that rely heavily/primarily on revenues from oil production.
 
On the latter, this is precisely why we’re beginning to see China, opportunistically, step-in, and promote a movement to buy oil from OPEC+ in yuan, or other non-dollar currencies (rather than dollars, the global standard). 
 
China is filling the void left by the Western world, gaining valuable access to global oil supply, gaining influence-while diminishing Western world influence, AND simultaneously threatening the dollar’s role in the world, and, therefore, threatening America’s global leadership status.     
 
On oil prices:  It’s important to understand, the reprieve from triple-digit oil prices has only come as the result of market manipulation (from the U.S.). 
 
And unfortunately, that manipulation, to satisfy short-term political gain, has created an even greater position of weakness.
 
Because of this …
Remember, over the past sixteen months, the President has drained 40% of the U.S. Strategic Petroleum Reserves in effort to manipulate the price of oil lower (and therefore gas prices).
 
It has worked. But as we’ve discussed here in my daily notes, it’s temporary.  And we will be forced to restock those reserves as prices are moving higher, which will only exacerbate the rise.
 
This dynamic in the energy sector is what led a Texas billionaire, that made his money in distressed real estate, to set up a company buying existing, cash flowing oil and gas assets, at a discount. He says it’s the biggest opportunity of his lifetime. 
 
We own his stock in our Billionaire’s Portfolio, along with two other stocks that give us the opportunity to see gains leveraged to the price of oil.  For details, subscribe to our Billionaire’s Portfolio here. 

Pro Perspectives 3/31/23

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March 31, 2023
 
The broad stock market finishes the first quarter up 7%.  
 
As we head into Q2, the Fed is back to expanding the balance sheet again (QE), and the 10-year yield is back down to the mid 3% area.  This is a recipe for a higher earnings multiple on stocks.  
 
If we look back through the history of QE, and low market rates (a 10-year yield at 3.5% is still low relative to the historical average), the S&P 500 P/E tends to run north of 20. 
 
Here’s a look at the history of the past fifteen years, in the multiple-crisis/ liberal-policy-intervention era.
Notably, all along the path, the market undershot on the earnings multiple. 
 
And here we are again, with a forward P/E on stocks at 17.8 times.  Even with earnings at the dialed down levels, if we apply a P/E of 20x for earnings expected over the next twelve months, we get a price target on the S&P 500 that implies 12% higher (from current levels).
 
With that, remember, going back to 1950, there has never been a 12-month period, following a midterm election, in which stocks were down.

 
And the average one-year return, following the eighteen midterm-elections of the past seventy years, was +15% (about double the long-term average return of the S&P 500).
 
If you’re a Billionaire's Portfolio subscriber, it's a great time to get your portfolio in line with ours.  You can find all of my past notes and the full portfolio here.  If you're not a member, you can get involved by clicking here.

Pro Perspectives 3/30/23

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March 30, 2023
 
Tomorrow morning we'll get core PCE for the month of February.  This is the Fed's favored inflation gauge.
 
That said, a lot has happened since February, which has included another rate hike.
 
That puts the effective Fed Funds rate (at 4.83%) ABOVE the most recent year-over-year core PCE (which was 4.7%), a position where the Fed believes they put downward pressure on inflation.  Looking through Wall Street estimates on tomorrow's (February) numbers, the year-over-year inflation number is expected to be a touch lower.
 
All of this said, this inflation data is a lot less important than it was a month ago.  We already know the level of rates is creating more than just downward pressure on inflation, it has created a dangerous shock to the economy, which will undoubtedly result in a credit crunch.
 
And with that, the Fed has already been forced into reversing course on quantitative tightening (back to QE). 
 
As we've discussed many times, putting the QE genie back in the bottle doesn't have a good record.  In fact, there is no successful record of it (globally). 
 
Why?     
 
Unforeseen consequences tend to arise.
 
For example, back in 2019, after spending nearly two years draining liquidity from the financial system (quantitative tightening), the Fed created a cash crunch (a scramble for dollars).  From too much liquidity, to too little.  It erupted in the interbank lending market — and it erupted quickly. 
 
The spike in the chart below is what happens when banks lose confidence in their ability to access cash.
The Fed was quickly forced to pump liquidity back into the financial system, and at a record rate in Q4 of 2019.
 
QE was back, and the Fed balance sheet continued expanding right up to the covid shutdowns (where it subsequently went into a new, higher gear).
In the chart above, you can see the response of stocks to the restart of QE in late 2019 … up 15% at a near perfect 45 degree angle.
 
Fast forward to today, and the Fed has once again induced another liquidity shock.  And once again, the Fed is back to pumping liquidity, expanding the balance sheet.  
 
As Bernanke once said, QE tends to make stocks go up.  Let's take a look at the current chart on stocks … 
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