Pro Perspectives 5/9/23

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May 9, 2023
 
We talked about the debt ceiling standoff, yesterday.
 
And we looked at the analogue of 2011. 
 
As we know, 2011 resulted in a downgrade of U.S. debt by Standard and Poors.
 
One might expect a downgrade in the credit rating of U.S. Treasuries, what the world has known to be the safest, most liquid government bond market in the world, would result in capital flight. 
 
It was just the opposite.  
 
Money flowed into Treasuries.  Prices went higher, yields went lower.  
 
Why?  Because it was still the safest, most liquid government bond market in the world.  The U.S. stock market bottomed a few days after the downgrade.  And so did the dollar.  Relative safety.  Relative value.  Deep liquidity.  Oh, and a central bank that was quick to launch another round of QE, just months after ending round one. 
 
Now, in the current situation, the Treasury Secretary has self-defined a drop dead date on the debt ceiling, of June 1.
 
And the meeting today with the President and the Speaker of the House resulted in "no new movement."  As we discussed yesterday, this standoff has as much, or more, to do with the policy path, as it does with debt levels.
 
The Speaker wants to slow the climate agenda spending/execution.  And, at the very least, he wants to pull back the "$50-$60 billion of covid money" that has been left unspent.
 
We need spending to result in growth, not waste!
 
We need a hot growth, stable (but higher than average) inflation, and rising wages. 
 
That's how we can grow out of a debt problem (as you can see below) – growing nominal GDP faster than debt.   

Pro Perspectives 5/8/23

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May 8, 2023
 
Let's talk about the debt ceiling drama.
 
Politically, this looks like 2011.  Obama had spent two years with an aligned Congress, and a war-chest of fiscal stimulus (the American Recover and Reinvestment Act – ARRA), which, in part, opportunistically funded his agenda.  It was the building blocks of the disruptive tech revolution and the early stages clean energy investment. 
 
$465 million went to Tesla, under the directive of "investing in emerging technology."  Tesla had a new CEO (Elon), was burning cash and amassing liabilities (they were broke), and had yet to produce a consumer viable car.  This was an uninvestable company, that the government plowed almost half a billion-dollars.
 
ARRA included around $90 billion in funding for clean energy and climate initiatives.  More than 90 percent of the 3.5 million jobs created, were promised to be in "rebuilding roads and bridges, constructing wind turbines and solar panels, laying broadband and expanding mass transit."
 
Despite the roll-out of an unimaginably large stimulus package, the economy sputtered. 
 
If we look back at historical recessions, the contraction tends to be followed by a strong snapback in growth – at least offsetting the loss in economic output. 
 
The growth that followed the 8.5% contraction of the Great Financial Crisis, was just a little better than 4%.  And that was while the Fed was at zero rates, and supporting markets with QE (and with tailwinds of $900 billion of fiscal stimulus). 
 
Yet, facing risks of a double-dip recession (which would have been economic apocalypse), Obama went to work on executing his health care agenda.  
 
This all brought about a split Congress by late 2010. 
 
And then the debt ceiling standoff in 2011.   
 
This, unsurprisingly, has a lot of parallels with the current environment.
 
In both cases, this is/was a debate on the budget.  The Republicans are effectively trying to claw back some of the agenda spending in a budget that was approved by the Democrat-controlled Congress. 
 
This is as much about policy-path, as it is about debt (probably moreso).
 
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Pro Perspectives 5/5/23

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May 5, 2023
 
We talked about regional banks and commercial real estate yesterday (here). 
 
The regional bank ETF, KRE, was the best performing (unleveraged) ETF on the day, up 6.4%.
 
We also talked about the year-to-date underperformance in the broader stock market, relative to the big and mega cap tech.  Today, the strength in stocks was broad-based.
 
Was it the strong jobs report — another record low unemployment rate, in the face of 500 basis points of tightening over the past year?  
 
I would say, don't underestimate the significance of the WHO's official ending of the global health emergency.  
 
That's 38-months from date they declared the emergency.  Biden called the end to the U.S. national emergency last month.  And U.S. public health emergency is due to end next week, May 11.  
 
And remember, it was the WHO, declaring the clear global health crisis a pandemic, back on March 11 of 2020, that set all of the government "special powers" into motion.
 
And, importantly, corporate America took marching orders from the WHO and CDC for the past three years.  
 
Now we're finally at official end point.
 
This should bring to an end, any remaining debt or eviction moratoriums.  Student loans are due to restart the first of July.
 
With the "emergency" guardrails removed from the economy, which may expose more of the pain from the reset in prices and interest rates of the past three years, we may find that companies will regain their leverage over employees, getting them back to work in-person. 

Pro Perspectives 5/4/23

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May 4, 2023
 
Let’s take a look at some charts …
 
The Nasdaq is up 15% year-to-date.  The S&P 500 is up 6%.  But as you can see in this next chart, when adjusted for market cap (if we equal weight the S&P 500), the stock market is flat on the year.  
Similarly, the yellow line is excludes the top 100 market cap stocks in the S&P 500.  It’s flat. 
 
Where’s all the performance?  
 
Below is the FANG+ Index, which includes Meta, Apple, Amazon, Netflix, Microsoft, Google, Tesla, Nvidia, Snowflake and AMD.  It’s up 35%!
What should we attribute this outperformance?  In the post-covid environment, these stocks soared on easy money, and multiple expansion.  And when the switch finally flipped on the policy cycle, these stocks were punished, as the valuation models were introduced to the concept of an interest rate — multiples contracted. 
 
But why the snapback rally this year, despite what has been a continuation of the tightening cycle?  Is it anticipation of the end of the cycle?  Or does it reflect the market acknowledgement of consolidation of power in the economy, allocating to  market dominance?
 
Let’s take a look at the regional banks.  
As you can see, this ETF is trading back toward covid-era levels.  
 
We’ve looked at the commonalities in the bank failures to this point.  It remains contained to specialty banks, with the most extreme duration risk, and significant exposure to volatile venture capital, startup, and in cases, crypto deposits.
 
On that note, the fear of regional bank shareholders, and the motivation of short sellers, seems to be surrounding the concept of a “next shoe to drop” in commercial real estate (CRE). 
 
Moody’s has some research on this, calling fears of the commercial real estate market reliance on small and mid-size banks “overstated or misstated.”  What about small and mid-size bank exposure to CRE defaults?  At a worst case scenario, where asset values fall by 40%, they see the average CRE loan loss at 8%.  They see “a manageable downcycle for the CRE sector and its lenders.”  Probably a dip to buy in this ETF. 

Pro Perspectives 5/3/23

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May 3, 2023
 
The Fed hiked another 25 basis points today.  That takes the Fed Funds rate to the 5%-5.25% range.
 
In the press conference, Jerome Powell, once again, made a good case for why they should have done nothing.
 
He said "policy is tight."  He said "real rates are around 2%, meaningfully higher than the neutral rate."  That's clearly restrictive territory. 
 
And for a guy that has spent the past year trying to kills jobs, as a means of controlling inflation, today he says "it's possible that this time is really different."  In that, he meant that the job market can cool, as in the evaporation of 1.6 million job openings since the beginning of the year, and yet unemployment can still hang around record lows.
 
So the Fed is at 5%.  Along that path of rising global interest rates, we had a near sovereign debt crisis in Europe, that was fixed by another emergency European Central Bank bond buying program.  We had a near insolvency in UK pension funds, that was fixed by Bank of England government bond buying intervention. 
 
And now we've had bank failures in the U.S., that have been fixed by coordinated action from the Fed, Treasury and the big banks.  About this, Powell says that "financial stability tools and monetary policy are working well together."  The manipulate and fix strategy is going well, he says.  
 
We may see that in practice, again, before the week ends.  Shortly after the Fed meeting, we find that another bank is on the ropes.  It's PacWest.  Remember, from my note yesterday, the three banks that have failed over the past six weeks are not typical regional banks, but rather, specialty banks. 
 
PacWest is effectively Silicon Valley Bank by a different name. 
 
PacWest acquired Square1 Bank back in 2015.  Square1 was the east coast version of Silicon Valley Bank.  It banks venture capital firms and their portfolio companies. 
 
Now, perhaps more important than all of this, is the drone attack on the Kremlin overnight.  While the mainstream media is debating the validity, let's look at what markets are telling us. 
 
In a war escalation scenario (global war), we would see global capital move to relative safety.  That would mean, U.S. Treasuries (up), gold (up) and the dollar (up). 
 
Treasuries are indeed up (yields down).  Most notably, gold is challenging the record highs again (up $100 from the lows of Tuesday).  But the dollar isn't participating, yet … nor is oil (which should rise on war escalation).
 
For my Billionaire's Portfolio members, please keep an eye out for an update from me on the portfolio. 

Pro Perspectives 5/2/23

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May 2, 2023
 
After JP Morgan took over First Republic Bank yesterday, Jamie Dimon said "the banking system is very stable … there are only so many banks that were offsides this way … there may be another small one, but this pretty much resolves them all … this part of the crisis is over."
 
Remember, he's not just speaking from an industry perspective, as CEO of the biggest bank in the country, he's in in the conversations with the Fed Chair, Treasury Secretary, White House economic advisors and regulators in times of crisis in the financial system.
 
Despite the statement from Dimon, the short sellers went after the regional banks today.  This, driven by the thesis that the vulnerabilities in Silicon Valley Bank, Signature Bank and First Republic Bank were canaries in the coal mine — just an early warning of the vulnerabilities in regional banks.
 
But these three banks had a lot more in common with each other, and a lot less in common with regional banks, broadly.  
 
They all had very high percentage of deposits that were uninsured (balance greater than the FDIC insurance limit).  In large part, that had to do with banking venture capital firms, and the ultra-high net worth — but mostly this is about banking venture capital firms.  And just as a kicker, SVB and SBNY also banked crypto firms. 
 
These were all, what I would call, specialty banks.
 
And you'll see what else these three banks had in common in this next table …  
These three banks had the highest duration risk.  This becomes especially problematic when the securities they intended to hold to maturity have lost significant value — which they have, thanks to rising interest rates (rates up, bond prices down).  When forced to sell, to fulfill depositor demand for cash, they sell at a loss.
 
Interestingly, the fourth bank on this list (with high duration risk) had this to say:  "East West is a very different bank from both SVB and Signature, which has substantial concentrations in volatile venture capital and crypto deposits." 
 
This statement was from March 12th.  They knew early on, it was the unique specialty banking feature that was driving these bank failures. 
 
East West lost only 2% of deposit assets in Q1, and by their April earnings call, had trimmed the percent of uninsured deposits down to 41%.
 
With all of the above in mind, the short sellers are looking for more blood, hoping that dominos are lined up to fall in regional banks.  But the evidence doesn't fit the narrative.
 
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Pro Perspectives 5/1/23

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May 1, 2023
 
We have the Fed on Wednesday. 
 
They’ve raised 475 basis points in thirteen months.  And the market is pricing in a better than 90% chance that they will go another 25 basis points this week.
 
This, despite the banking shock of the past six weeks, which has now claimed a third victim. 
 
Remember, after hiking in March, on the heels of two bank failures, Powell actually made a strong case in his post-meeting press conference that they should have paused.  He talked a lot about the credit tightening that they thought was “quite real.”  In fact, he said directly that the banking stress, and related credit tightening, has an equivalent effect of a rate hike, and will weigh on inflation.
 
Well, we got the Fed’s favored inflation number this past Friday — the March reading.  It held pretty steady at 4.6%.  Even if we annualize the average monthly change of the past six months, it’s 4.2%.    
If we take that inflation data into account, and give a heavy weighting to market sentiment, we should expect the Fed to go forward with another 25 basis points on Wednesday. 
 
They’ve clearly made an effort to set the expectation.  The market has taken the “guidance.”  So that becomes the path of least resistance.
 
But if the discussion in the post-meeting press conference is not about pausing, it will be a negative surprise for markets.  
 
With the above in mind, the level of interest rates has proven to break things in the financial system. 
 
A hike on Wednesday will take the level another step higher. 
 
That said, by now we should know that the major central banks in the world have coordinated to normalize monetary policy — and have agreed, in coordination, to intervene, when necessary, to fix what they break. 
 
And these interventions have a solid record of marking the bottom in stocks (and sentiment).  
Remember, we looked at this chart of the S&P back in March 10th, after the big run on Silicon Valley Bank.  This chart is a snapshot on that Friday afternoon. By Sunday night, the Fed stepped in, promising to provide liquidity to depository institutions to backstop deposits. 
 
Intervention.
 
The bottom in stocks was marked the next day. 
 

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Pro Perspectives 4/28/23

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April 28, 2023
 
As we end the week, and month, let’s take a look at the performance of global asset prices year-to-date.
As you can see, stocks are hot.  Not just domestically, but globally. 
 
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).
 
We’re five months removed from the midterm election, and the S&P 500 is up just over 12%. 
 
Related, we knew coming in that we had two important positive catalysts for stocks:  1) The rate-of-change in monetary policy tightening would slow dramatically this year (which it has), and 2) the rate-of-change in the fiscal policy madness would be zero (if not reversed), with a split Congress.  Gridlock.
 

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Pro Perspectives 4/27/23

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April 27, 2023
 
The first estimate on Q1 GDP came in this morning.  It was weak.  In fact it was spot on with the recent adjustment in the Atlanta Fed's model (1.1% growth).
As you can see in the graphic above, this model was tracking north of 3% growth for the quarter, before the bank shock of last month. 
 
With this in mind, the Fed has wanted to see a slowdown in economic growth, and a loosening of the labor market, as a means to ensure inflation is on a sustainable path lower.  
 
Well, they now have economic slowdown.  Growth has gone from 3.2% in Q3 of last year, to 2.6% in Q4, to 1.1% in Q1.  That 1.1% is well below long-term trend growth (3+%). 
 
They've gotten some job losses, particularly in the over-staffed tech sector.  The number of job openings (which Jay Powell has specifically referenced) has dropped by 1.3 million jobs since December (probably related to tech).
 
The important inflation number comes tomorrow morning.  It's the March core PCE.  This measures the change in prices of goods and services that people have actually paid — not just a selling price. "Core," means excluding food and energy prices.  And this March number will incorporate the fear, albeit brief, surrounding the safety of bank deposits.
 
The last reading was at 4.6%, year-over-year change.  This is the number the Fed wants to see back toward 2%.  But importantly, it's lower than the current Fed Funds rate, which should be applying downward pressure on inflation. 
 
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Pro Perspectives 4/26/23

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April 26, 2023
 
As we discussed yesterday, there is renewed pressure on First Republic Bank – the still standing, but still troubled bank that was exposed in the banking shock of last month.
 
With that, when the Fed releases it's weekly report of securities holdings tomorrow, we'll find out if this renewed stress results in another impulse of Fed balance sheet expansion.  
 
Below is what the Fed's job of "lender of last resort" looks like when they have to provide liquidity to a banking system that's having or fearing a liquidity shock.  In this case, it was a depositor run on a few banks last month.    
The Fed stepped in and plugged the gap with "loans." And, in coordination, the Fed and Treasury implicitly assured the safety of deposits in the banking system, but stopped short of an explicit emergency guarantee of all deposits (to include uninsured depositors beyond the failed Silicon Valley Bank and Signature Bank).
 
But, while the two banks that failed last month, and the teetering First Republic Bank, share(d) commonalities of an unusually high percentage of uninsured deposits, and an industry high duration mismatch (between asset and liability maturities), the real culprit in this meltdown was the depositor panic.  Moreover, how quickly it spread through social media.
 
All of that said, arguably, the trigger was the Fed's tone-deafness to the stress it has created from this tightening cycle.  That said, the interest rate market is pricing in about a 75% chance of, yet another, Fed rate hike next week. 
 
But we have a Q1 GDP report tomorrow, which looks like it will come in lower than had been projected now, given the downgrade in today's updated Atlanta Fed model (was +2.5%, now +1.1%).  And this appears to be driven by the lower revisions to January and February retail sales data (revisions that were released on Tuesday).
 
So this sets up for a negative surprise tomorrow.  And then we have the Fed's favored inflation gauge, core PCE (monthly, March), on Friday. 
 
This, while First Republic will likely require more attention from the Fed, FDIC and Treasury.  This may all be setting up for a positive surprise from the Fed next Wednesday (i.e. a pause). 
 
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