Pro Perspectives 2/27/23

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February 27, 2023
 
As we discussed on Friday, 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. 
 
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Pro Perspectives 2/24/23

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February 24, 2023
 
Inflation cooled in Q4.  And it has bounced back in the first month of the New Year.
 
Following another inflation reading this morning, stocks traded down, and we end the week with some big technical levels tested. Let’s take a look at the chart …
First, as you can see, this steep decline of the past seven trading days started with the hot inflation report on February 14th (CPI). 
 
And today we got the last major inflation reading from the month of January (core PCE), and the stock market traded down toward the big trendline that describes the bear market of last year (the yellow line).  Moreover, it (the S&P futures) traded perfectly into the 200-day moving average (the purple line). 
 
These are two significant technical levels – formerly technical resistance, is now technical support.  So, into the 200-day moving average, stocks bounced.
 
Now, importantly, despite the hotter January inflation data, we’re not getting the type of reactionary tough talk from the Fed, that we had last year.  Why?  Because they are in control.
 
As Jamie Dimon said yesterday, the Fed “lost control” of inflation for a bit.
 
When he says inflation, he means inflation expectations.  
 
You can see it in this chart …
As we’ve discussed throughout this runup in prices, what the Fed fears more than inflation itself, is consumer (and business) inflation expectations.
 
If you expect higher prices, you might behave in ways that lead to higher prices (and potentially runaway inflation).
 
Back in April of last year (as you can see in the chart), that threat was materializing. 
 
But now, look to the far right of the chart, inflation expectations are tame, and well under control.  
 
So, where does the Fed go from here?  Again, despite hotter prices in January, we haven’t heard the reactionary tough talk (i.e. threats against markets and the economy) from the Fed this time. 
 
To the contrary, two Fed Presidents and the CEO of the country’s largest bank all used the word “little” to describe how much higher rates will go from here.  Bottom line, the rate path expectation that has been built into markets (and the economy) haven’t changed with the latest inflation data. 
 
And don’t forget, the Fed needs inflation, while under control, to run hotter than average for a bit longer. 
 
Remember, back in September of 2020, Jerome Powell made an official policy change in the way they evaluate their two percent inflation target.  Because inflation had been too low, for too long he told us he would let inflation run hot, to bring inflation back to 2% on average over time.
Inflation has run hot.  But as can see, if we take the average over the past fifteen years (post-Lehman) inflation remains below the Fed’s two percent target.
 
That’s good.  Remember, we’ve fired a lot of fiscal bullets over the past fifteen years.  And government debt has ballooned, as a result. 
 
We need a period of controlled hotter inflation, as long as it comes with hot nominal economic growth.  On that note, the economy has been growing at a nominal (including inflation) 9% pace since late summer of 2020 (average quarterly annualized GDP growth).
 
With the above in mind, the absolute value of government debt doesn’t mean much.  The debt relative to the size of the economy is what matters.  As you can see in the chart below, debt has doubled, relative to the size of the economy since the Great Financial Crisis.  
 
It now has to be inflated away.  That comes through hot nominal growth.  And growth is beginning to chip away at the debt, but not fast enough. 
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Pro Perspectives 2/23/23

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February 23, 2023
 
Tomorrow morning we'll get core PCE.  This is the Fed's favored inflation gauge (of particular interest, the monthly change from December to January). 
 
On that note, what's most important for markets, isn't the number, but the expectations.  And given the other inflation data we've already seen for January, expectations are already well entrenched for a hot number.  With that built in expectation, the chances of a negative surprise are dramatically reduced (i.e. negative surprise = surprisingly high inflation).  
 
Add to that, the Fed has clearly telegraphed an intent to do a few more quarter point rate hikes.  So, there is little-to-no chance that tomorrow's inflation data would induce a negative surprise on that front (i.e. negative surprise = a higher peak Fed Funds rate).
 
So, if anything, the set of potential outcomes skews toward a positive surprise for markets.
 
What also is setting up for a positive surprise?
 
The economy. 
 
We heard from Jamie Dimon again today.   This is the CEO of JP Morgan, the biggest bank in the country.  No one has more information on the health and trends of consumer and business behavior.  With that position of power, he also has a seat at the table with the Fed chair and White House economic advisors, as a member of the "President's Working Group on Financial Markets."  He knows things.
 
Back in January, just before Q4 earnings season kicked off, Dimon said 

the consumer is still strong, balance sheets are in good shape, and "they are spending more than pre-covid."
 
A day later, the big four banks reported earnings.  Adding back the war chest of profits they set aside (in the name of "loan loss reserves"), all four of the biggest four banks in the country would have beat earnings estimates, AND improved on the earnings from the same period a year ago.  

 
What did Jamie Dimon have to say today?
 
He said the economy is doing "quite well."  And he reminded everyone, that there has been a sea change in the economy.  With some context of his interview, he's talking about the transformation from a low inflation, low growth environment, to a government spending-fueled high growth, higher inflation environment, with (his words) a "normalization of interest rates."
 
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Pro Perspectives 2/22/23

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February 22, 2023
 
The minutes from the February Fed meeting were released this afternoon.  Stocks went lower. 
 
Remember, some important things happened at this meeting.
 
But forget the minutes, let's look back at the message the Fed sent, in real time, back on February 1st. 
 
>They downshifted to a quarter-point rate hike, from an aggressive streak of big hikes.
 
>More importantly, with this quarter-point, they took the Fed Funds rate ABOVE the rate of inflation (the annual change in the Fed favored core PCE index).
 
>And as importantly, the Fed Chair, Jerome Powell, followed that meeting with a press conference that had clear change in tone. 
 
"Out" was the tough talk.  And "in" was acknowledgement of the ground that has been covered, the disinflation in the economy, the goal of "real rates" reached.
 
Add to all of this, after spending the better part of the past year, talking markets down (and therefore tightening financial conditions), he made no attempt to do so in the February post-meeting Q&A session.  Keep in mind, stocks had just rallied nearly 10% rally in stocks over the prior month.
 
And make no mistake, talking down stocks (destroying paper wealth and confidence) and threatening job security (proclaiming to bring job openings down to align with job seekers) were key parts of the Fed's "forward guidance" strategy.  And it was, indeed, effective in crushing the exuberance in the economy, and therefore, turning the inflation tide. 
 
Again, Powell didn't find a problem with easing financial conditions at this Feb 1 press conference.
 
All of the above was the real-time message from the Fed (with clear intent) following the February 1 meeting.  That outweighs the Fed minutes delivered today.
 
Additionally, this morning, just hours before the release of these minutes, the most hawkish voice on the Fed, James Bullard, echoed the Jerome Powell tone change.  He said the economy is strong, the job market is strong, and he did nothing to change the path he has projected for rates (they have "a little ways to go"). 
 
And he said this:
 
"In the age of forward guidance, economic lags make less sense now."
 
Translation:  The market and the economy have already priced in the inflation fight (i.e. the bear market and economic recession — it already happened, last year). 

Pro Perspectives 2/21/23

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February 21, 2023
 
The Fed's favored gauge of inflation is core PCE (personal consumption expenditures).  It 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. 
 
The January report on core PCE will come Friday.
 
As you can see in this chart, year-over-year Core PCE has been trending lower since last summer. 
That said, we already know from the CPI data last week, that price pressures were hot in January, compared to December.  We should expect a similar message from Friday's core PCE.  
 
So, the question: Is January a signal for what's coming (i.e. a strong bounce back in inflation)?  
 
Take a look at used car prices.  Used car prices topped out in January of last year, and bottomed in November.  Year-to-date this index is already up 7%.  
With the hot price data we've already seen from January, yields are on the move.  
 
The 10-year yield traded to 3.96% today.  That's up from 3.33% just earlier this month. 
 
This move in yields (higher) is triggering some fear in the stock market.  Stocks are down almost 4% in three trading days.  The VIX is up to the highest levels since the beginning of the year.  
 
Is this move in the bond market (yields higher), a signal to the stock market that the Fed might return to it's game of a year ago, where it put a strangle hold on the economy (and consumer confidence)?
 
If so, yields would be going the other way (lower). 
 
The bond market would be pricing in an even deeper and uglier recession, in the form of an even steeper inversion of the yield curve (an historic predictor of recession).
 
That's not happening.  The yield curve (2s/10s) is little changed from the beginning of the month. 
 
What is happening?  Contrary to the consensus view that recession is looming, we're seeing no signs that the economy is faltering (quite the opposite).  
 
The bounce back in economic activity in January has been strong.
 
Despite the Fed's best efforts, the job market remains tight.  And with the resilience of the job market, a sense of job security is good for confidence.  With that, confidence is coming back from record low levels of the early 80s.
 
And as we've discussed, the Fed has now taken the Fed Funds rate ABOVE the rate of inflation (it's favored gauge, core PCE).  That's historically where the Fed has gone to get inflation under control.
 
Meanwhile, they've normalized interest rates, and the economy is (still) on pace to put up another (consecutive) 2.5%+ growth quarter.    
 
Perhaps the bond market is beginning to price OUT recession (and a flattening of the yield curve). 

Pro Perspectives 2/16/23

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February 15, 2023
 
As we discussed yesterday, contrary to the consensus Wall Street view coming into the year, we're a month and a half in, and no signs of the economy faltering.
 
In fact, it's the opposite.  Here's a look at Citibank's index that measures surprises in the economic data (relative to consensus expectations)…
The bounce back in economic activity in January has been strong.  Despite the Fed's best efforts, the job market remains tight.  And with the resilience of the job market, a sense of job security is good for confidence.  With that, confidence is coming back from record low levels of the early 80s ….
This has come with hotter prices in January (both consumer prices and producer prices).  And hotter prices, combined with positive surprises in economic data has put a fire under yields, finally.
The purple line in this chart is the 10-year yield. This is the benchmark market-determined interest rate, which is the basis for setting many consumer rates. 
 
As you can see, market interest rates (purple line) have moved in the opposite direction of the Fed (orange line), through the past few rate hikes.  So, as the Fed was (and still is) projecting 5.1% as the ultimate stopping point for the Fed Funds rate, the 10-year has traded as low as 3.32% over the past month.  
 
Keep in mind, as the bond king, Bill Gross, has pointed out, historically the 10-year yield trades, on average, 90 basis points ABOVE the Fed Funds rate.  On that note, the bond market is thought to be the "smart money."  Does that mean it's right on the recession forecast?  
 
If the bond market were that "smart" why didn't the 10-year yield trade north of 9% when inflation was brewing in 2021?  
 
Why?  Because the government bond markets have been highly manipulated by central banks, globally — suppressing market interest rates.  It's safe to assume that's the only reason, at this stage, the benchmark 10-year yield trades in this 3%-4% range.   

Pro Perspectives 2/15/23

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February 15, 2023
 
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).
 
That said, we came into the year with a lot of negative expectations priced into markets (from the rate path, to earnings erosion, to recession).
 
On the rate path, Jay Powell has since signaled in recent weeks that the end is near, if not here.  On earnings, we're about three-quarters of the way through fourth quarter earnings, and 69% of companies have beat estimates (not far from the 10-year average), and the contraction in S&P 500 earnings overall is in-line with expectations.  As for recession, the consensus view coming into the year questioned not "if," but "how severe" it will be.  So far, no signs of the economy faltering (quite the opposite). 
 
And keep in mind, we've already had a technical recession (in Q1 and Q2 of last year), in reaction to high inflation, and in anticipation of higher interest rates.  We've since had a 3.2% annualized growth quarter in Q3, a 2.9% quarter in Q4, and thus far, the Atlanta Fed model is projecting 2.4% for Q1 of this year. 
 
And as we discussed in my January 26th note (here), we are in a hot economy, where demand has been throttled by the Fed.  It's a not a sputtering economy with a demand problem.  Today's retail sales number supports that:  up 3% on the month.  Excluding the covid period, that is the hottest month in over 20 years.
 
As I've said, the Fed is holding the beach ball under water.  As they back off, we need the economy to boom, and for the wage level-to-price level gap to start closing (to restore standard of living).  

Pro Perspectives 2/14/23

Pro Perspectives 2/14/23

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February 14, 2023
 
We had the January inflation report this morning.  Prices rose at the hottest rate in several months, from December to January.  But the year-over-year inflation number came down. 
 
Remember, this inflation report has caused extraordinary swings in stocks for the better part of the past six months.  What happened today?  Nothing extraordinary.
 
Why? 
 
As we discussed yesterday: 
 
1) The headline inflation number is still high, but it doesn't reflect the current price pressures, because it's a calculation that measures the January CPI index against the very low base of January 2022.  We should expect the number to be high for a few more months. 
 
2) The Fed has already taken short term rates ABOVE the its favored inflation gauge (core PCE, which measures what consumers are actually paying for goods and services, less food and energy).  This "positive real rate" dynamic (where interest rates are above inflation) has historically proven to contain inflation and produce macroeconomic stability. 
 
3) The Fed has already built in market expectations for a few more hikes, so there was little-to-no risk of a change in that view, after seeing today's report.
 
Bottom line:  The Fed has been THE burden on the economy for the better part of the past year.  But Jerome Powell has given us plenty of signals the past two weeks, that the Fed has finished the job on the inflation fight (if not finished, then very near).  Nothing in this January inflation report should alter that position.  

Pro Perspectives 2/13/23

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February 13, 2023
 
We get the January inflation report tomorrow.  
 
Remember, these have been huge events for the stock market … 
 
>For four consecutive months (Sept – Dec), the inflation report induced a trading range in stocks, on the day, of about 5% (on average).
 
>It was the inflation report on October 13th, that marked the low of the bear market in stocks.
 
>And, arguably, it was the weak inflation report on January 12th that cleared the way for the break above the 200-day moving average, and the break of the big technical downtrend in stocks (chart below).
Of course, the reaction in stocks is predicated on what the inflation arc means for Fed policy. 
 
So, what should we expect for tomorrow?
 
The bad news:  The monthly change in prices is expected to be the hottest in four months.
 
The good news:  The market will likely ignore it, for a couple of reasons…
 
Reason #1: Expect the market to focus on the year-over-year number.
 
Remember, we’ve looked at this chart over the past several months …
You can see in the chart, inflation over the past seven months, on this headline index, has already leveled off.  The rate-of-change in prices (inflation) has clearly been curtailed.  That’s good!
 
Even if tomorrow’s report shows that inflation in the month of January was hotter than the past few months, when measured against the base of twelve months ago, the headline inflation number the media will tout will still show a decline (“inflation moving in the right direction” – lower).    
 
That said, even if the monthly number tomorrow is surprisingly weak, the headline year-over-year number will still be a big number, relative to the inflation that the Fed is targeting (2%).  
 
Bottom line, the year-over-year headline inflation is still likely running  around 6%.  And, it will continue to measure at historically high levels in the months ahead, regardless of what’s really happening with current inflation.  Why?  Base effects.  Because of the aggressive rate-of-change in prices twelve months ago, the most recent CPI Index reading will continue to be measured against a very low base.
 
Now, for Reason #2 (that the market will likely ignore a hot monthly inflation number tomorrow):  The Fed’s favored inflation gauge is core PCE.  And the effective Fed Funds Rate is now above core PCE. 
 
And as the Fed has reminded us, the inflation storms of the past have only been quelled when interest rates are taken ABOVE the rate of inflation.  Not only are they there, but they’ve built in expectations that they will do a couple more rate hikes, for good measure.
 
The hawkish expectation setting by the Fed, should reduce (if not eliminate) the potential for a negative surprise (and adverse market reaction) in tomorrow’s inflation report.  

Pro Perspectives 2/10/23

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February 10, 2023
 
We’ve talked about the oil situation this week, after Biden mistakenly admitted that U.S. producers have no incentive to invest profits in new production, given the administration’s (and Western world’s) war on oil.
 
As we’ve discussed the past two years here in my daily notes, the Western world’s war on oil has put OPEC and Russia in the driver’s seat to dictate supply, and therefore price. 
 
On that note, the world has been naively hoping that OPEC would increase production to help ease the global oil price crunch (namely, for Western consumers).  Not only have they rejected that notion, they have cut production since (last October).  Add to this, Russia announced a 5% production cut today. 
 
Just as oil revenue dependent companies will act in their best interest, so will oil revenue dependent countries. 
 
On the demand side, this all comes as China has scrapped its zero-covid policy, the IMF has upgraded its global growth forecast, and the U.S. will be replenishing its Strategic Petroleum Reserves.
 
We should expect triple-digit oil prices to return.  And higher oil prices would reverse what has been a falling rate-of-change in overall prices (i.e. inflation).  This fits with the scenario we’ve been discussing, of persistently higher than historically-average inflation. 
 
The good news:  With interest rates now normalized, persistently higher inflation can also be stable inflation. 
 
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.