Pro Perspectives 12/16/22

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December 16, 2022
 
As we near the end of year, let’s take a look at year-to-date performance of global assets.
As you might have expected, there are a lot of negative return assets on the year. 
 
But things become even uglier when we adjust for inflation (the “real return”).  In that case, we see fewer positive returning assets on the year, and those positive real returns are largely driven by the supply disruption in energy and grains, associated Russia/Ukraine conflict.
 
So nothing in this table of returns would suggest an over-demand problem in the economy (certainly not now).  However most of what we see in this table, is caused by the Fed’s policy actions to “bring demand down.”  That has been their goal, since stated in their March meeting.
 
Meanwhile, wages, after adjusted for inflation are negative on the year.  Personal savings, as a percent of discretionary income have gone to just 2% (almost nothing).  That’s record lows, going back over 60 years of history.
 
The question isn’t “will the Fed cut rates next year?”  The question is, how soon will they be forced back into quantitative easing – the Hotel California of monetary policy (“you can check out, but you can never leave”). 

Pro Perspectives 12/15/22

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December 14, 2022
 
The Fed sent a message yesterday, that they were quite willing to maintain a chokehold on the economy.
 
With the same hubris that they committed to the "inflation is transitory" messaging of last year, which inflated asset bubbles, they are now doing in reverse. 
 
Still, as I said yesterday, "we know that the Fed's projections have a history of being very wrong (AND their projections can, and do change, with no apologies)." 
 
The examples of how wrong they can be are not hard to uncover:  After finally acknowledging the level and persistence of inflation late last year, at the December Fed meeting one year ago, they projected that the Fed Funds rate would go to less than 1% in 2022.
 
It's now 4.4%. 
 
And at the December Fed meeting one year ago, they projected that the Fed Funds rate would go to just 1.6% in 2023.  Now they project 5.1%.
 
The formula for inflation last year was textbook.  Money supply had grown by almost 40% in two years.  That's about ten years worth of money supply growth, in two years.  Meanwhile we had disruption of supply.  Too much money chasing too few goods = inflation.  If you didn't believe the economic theory, it was clearly reflected in the data.
 
Fast forward a year, and we have declining money supply (since March). 
 
In fact, the six-month change in money supply is declining at the fastest rate on record, going back over 60 years of history.  Moreover, a negative six-month change in money supply is highly unusual. It's only happened twice prior to this recent episode ('92 and '93).  The Fed was cutting rates in 1992.
 

Pro Perspectives 12/14/22

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December 14, 2022
 
The Fed raised rates another half point today.  That puts the effective Fed Funds rate around 4.3%.
 
Given yesterday's inflation data (which shows clear cooling over recent months) is today's move the end of this rate hiking cycle?  
 
Let's take a look at how the Fed sees next year …
 
For 2023, the Fed sees very little economic growth (which would be a second consecutive year).  They see their favored gauge of inflation coming down to 3.5%.  And yet they they see rates UP another three quarters of a percentage point — at over 5%. 
 
That's an illogical formula. With that, the 10-year Treasury yield went down (on this news), not up.
 
What does it mean?  The market is not buying what the Fed is selling.
 
The benchmark market-determined interest rate (widely viewed to be the "smart money") is now trading 160 basis points below where the Fed is projecting to take short term rates next year. 
 
So, who's smarter: The Fed or the interest rate market?  Well, we know that the Fed's projections have a history of being very wrong (AND their projections can, and do change, with no apologies).   
 

Pro Perspectives 12/13/22

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December 13, 2022
 
The past three monthly inflation reports created outsized moves in the stock market.  Each produced a better than 5% trading range.
 
Today was nearly another one.  The November inflation report showed a cooling in the rate-of-change in prices.  Markets broadly performed well (stocks, bonds, commodities). 
 
We came into this morning's report, focused on the month-to-month change in prices (the current environment). 
 
That came in at just 0.1%.  Annualize that, and we are clearly well below the Fed's 2% inflation target.  If we annualize the monthly change in prices over the past three months, we get a 3.65% inflation rate.  
 
Bottom line:  Both of these annualized numbers give us a gauge on the recent rate-of-change in prices.  If the Fed wants evidence that inflation is "coming down" this chart tells that story …
 
With that, we have the Fed meeting tomorrow. 
 
Remember, we heard from Jerome Powell just two weeks ago.  He made a prepared speech at the Brookings Institution and took questions.
 
Let's revisit what he said …
 
In that prepared speech he said, it now "makes sense to moderate the pace" of rate increases.  Moreover, the "time for moderating the pace of rate increases may come as soon as the December meeting" (that's tomorrow).
 
Additionally, in the Q&A session at Brookings, he said, 1) "I don't want to over tighten."  
 
With this in mind, the market is pricing in a 50 basis point hike tomorrow.  Any accompanying language that suggests they might sit and watch from that point, would be rocket fuel for markets (as the Fed would be taking its foot off of the economic brakes).
 
And remember, we've been watching these big technical levels in stocks.  We head into tomorrow's Fed meeting testing both the 200-day moving average, again (the purple line), and the big trendline that defines the decline of the year.     

Pro Perspectives 12/12/22

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December 12, 2022
 
Tomorrow we'll hear from the Bureau of Labor Statistics on November inflation.
 
And then the Fed will decide on interest rates on Wednesday.
 
Going into this, the Fed's favored measure of inflation expectations is at the lowest level since the July meeting.
 
That July reference is an interesting one.  As you might recall, it was in the July post-FOMC press conference, that Jerome Powell said they had reached the neutral level on rates, and indicated that they might be ready to sit and watch. Of course, just hours later, the Democrat-led White House and Congress decided it would do another massive fiscal spend.
 
That said, within the fiscal largesse, maybe the most dangerous to the inflation outlook was Biden's plan to cancel student loan debt.  That has since been struck down in the courts.  And that has, importantly, removed the threat of seeing half a trillion dollars worth of consumer liabilities, become consumption.
 
So, here we are five months later, and it's clear that inflation peaked in June.
 
Key components of the CPI index have since been falling in price.  But we have yet to see that reflect in a negative monthly inflation number.
 
That said, in Powell's November post-FOMC press conference, he said "good evidence" of inflation coming down decisively, would require "a series of down monthly readings."
 
We may get one tomorrow.  That's deflation.
 
Let's take a look at some inputs into CPI that we know.
 
First, gas prices:  The Energy Information Administration (EIA) does a weekly survey of gas stations across the country.  Those survey results show a decline in gas prices by about 6% in November (and down 27% since June). Transportation carries almost a 1/5th weighting in the CPI calculation.
 
Used Cars:  The Manheim used car price index was down for a sixth consecutive month.
 
New Car prices were up in November, but inventory levels have hit the highest levels since May of 2021 (which should put downward pressure on prices).
 
Rents:  The Apartment List Rent Report showed a third consecutive monthly decline in rents.
 
House prices:  Realtor.com says the median house price fell 2.1% from October to November.  That's down 8% from the June peak.  What about mortgage rates?  Mortgage rates finished November about 50 basis points lower than the month prior. 
 
As we've discussed, the year-over-year headline number gets the media's attention, but that's measuring against old data.  It will remain high for many months, even if the month-to-month change in prices were to fall.
 
So, the important number to watch tomorrow will be the (headline) monthly change in prices.    

Pro Perspectives 12/9/22

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December 9, 2022
 
The big inflation report comes next Tuesday morning.
 
How big of a deal is it?
 
The past three reports triggered moves in stocks, of a magnitude that has historically (over 25 years of history) only been associated with major events.  
 
In each of these past three inflation reports, the S&P 500 has traded in a range of greater than 5%.
 
So, this November report should be a doozy, especially since the Fed will decide on rates the day after (Wednesday).
 
Here's what the chart on stocks looks like as we head into next week.   
This big trendline (in yellow) still holds, defining the decline from the record highs.  And stocks trade back below the 200-day moving average (in purple) this week.  Both of these big technical levels will likely be tested again next week.
 
As you can see in the chart, the white boxes highlight the market behavior surrounding the prior three inflation reports.  And it was an inflation report that marked the low of the bear market.
 
We've talked about the reasons to believe the Fed has actually induced declining prices (deflation), rather than just a deceleration in the rise of prices (i.e. cooling inflation).
 
With this in mind, let's revisit this chart of "six-month change" in money supply… 
Money supply is declining, and at the fastest rate on records going back over 60 years of history.  Moreover, as you can see in the chart, a negative six-month change in money supply is highly unusual. It’s only happened twice prior to this recent episode (’92 and ’93).

 
Deflation is typically associated with a contraction in the supply of money and credit (the former is happening, the latter not yet). 

Pro Perspectives 12/8/22

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December 8, 2022
 
Let's talk about China.
 
Both Chinese imports and exports crashed in November.  The economy has grown at just 3% through the first three quarters.  That's a fraction of its long-term average growth of the past two decades. 
 
Now after the recent social uprising against the Chinese Communist Party's Zero-Covid policy, and related lockdowns, the government has announced an easing of restrictions.
 
If it's true, what will it mean for markets/the global economy?
 
Will it be inflationary?  Keep in mind, this comes just as global central banks have, seemingly, hit the pain threshold for the level of interest rates.  And, in particular, in the U.S., just at the time inflation data is cooling (if not reversing).
 
A fully functioning Chinese economy is obviously positive for global demand.  But it should be especially positive for global supply (given the export nature of the economy).
 
On that note, the global central bank tightening campaign doesn't have the tools to deal with, what has been, supply shocks.  What they do have the tools to address is demand.  And they have explicitly been working to bring demand down to the level of supply.  
 
With that, an opening up of China can help address the supply side of the imbalance.  And we should note, that China has been an exporter of deflation for the past two-plus decades (i.e. they put downward pressure on global goods prices).
 
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Pro Perspectives 12/7/22

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December 7, 2022
 
In recent days we've talked about the signal the decline in the 10-year Treasury yield might be giving us.
 
Today, it closed another 10 basis points lower, at 3.42%.  At today's low, the most important market-determined interest rate in the world was down almost a full percentage point from the highs of late October.
 
This, as the Fed has been trying to set expectations for a stopping point in this tightening cycle (for the short term interbank lending rate it sets), somewhere around 5%.  That's about a full point higher than the current Fed Funds rate. 
 
Again, market-determined interest rates are going the other way.
 
Remember, this move in the 10-year yield started on Wednesday of last week, when Jerome Powell told us "I don't want to over tighten."
 
With that, as we've discussed here in my daily notes, there are reasons to believe that the Fed has already over-done it.  Instead of slowing the rate-of-change in prices (inflation), we may find it has induced a decline in prices (deflation).
 
We know from real-time CPI inputs (like new and used cars, rents) that prices have been rolling over for months.  The government's report hasn't reflected it … yet. 
 
With this in mind, an astute Pro Perspectives reader (and very good hedge fund manager) reminded me yesterday, the Fed historically hasn't stopped a tightening cycle before taking the Fed Funds rate above the rate of inflation (headline CPI).
 
This is the condition of "positive real rates" (Fed Funds rate – inflation rate) Powell has talked about.
 
With that, if the Fed did nothing further from this point (stopped where they are), and the rate-of-change in prices was zero from this point, how long would it take to get to positive real rates?  
 
Let's take a look …
So, in this scenario, if the monthly change in prices went to zero (i.e. headline CPI stayed unchanged) over the coming months, by March we would have positive rates.
 
That said, with key inflation inputs rolling over, AND persistently lower oil prices, we could see negative monthly price changes in the coming months, which could get us to positive real rates sooner than March.
 
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Pro Perspectives 12/6/22

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December 6, 2022
 
We looked at this chart of the S&P 500 last week …
As we discussed, stocks closed above the 200-day moving average (the purple line) for three straight days.

 
Moreover, heading into this past Friday’s jobs report, stocks were trading into this big descending trendline (in yellow) that represents the eleven-month decline from record highs. 
 
As you can see, that trendline held.  
 
Stocks are down 4% from that point, and have now fully retraced the rise that was attributed to Jerome Powell’s (relatively) dovish statements at his Brookings Institution discussion last Wednesday. 
 
Importantly, what hasn’t retraced?  Yields. 
 
The yield on the 10-year Treasury closed at 3.52% today.  That’s  30 basis points lower than it was trading when Jerome Powell spoke last Wednesday.
 
This comes after Friday’s hotter than expected wage growth.  And it comes after yesterday’s hotter than expected ISM services report.  Remember, it’s “services” that have been a hot spot in the Fed’s assessment of inflation.
 
This behavior of the world’s benchmark interest rate (the 10-year yield) continues to send a signal. 
 
As we discussed last week, it may be signaling an over-restrictive Fed (already), which will translate into falling prices (deflation) in the coming months, perhaps starting to show as soon as next week’s November inflation report.  We will see. 
 
By the way, Bank of America has taken a look at the past thirteen Fed hiking cycles.  Dating back to 1954, when the Fed stops hiking, stocks rise, on average, 14% over the following twelve months. 
 
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Pro Perspectives 12/5/22

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December 5, 2022
 
Let's talk about oil. 
 
The Western world put a $60 price cap on Russian oil, beginning today. 
 
What does it mean?
 
The view from the politicians is that the price cap keeps Russian oil flowing to the world, but squeezes Russia's energy revenues (which fund almost half of the Russian federal budget).
 
Russia has said they will respond to a price cap by refusing to sell oil to those countries supporting the price cap.
 
Who has the leverage?
 
The Western leaders would have us believe they can suffocate the Russian economy, and therefore force an end to the war in Ukraine.
 
But guess which of the largest economies in the world aren't part of the oil price cap coalition?  China.
 
And guess who has become China's largest oil supplier?  Russia.
 
Given the structural global supply deficit in the oil market, China should be happy to snap up all of the oil Russia can sell to them (and then stockpile it, or sell it to the Western world).  And no surprise, they have been importing oil at record levels for much of the past two years.  
 
Not only is the world undersupplied of oil, we are (most importantly) underinvested in new supply.  And it's all by the design of the global clean energy transformation, which is coordinated by:  the Western world (the purveyors of the price cap).
 
Leverage doesn't appear to be on our side.  And that's apparent through OPEC's response to the Russia price cap, which was a threat of further production cuts (i.e. less supply). 
 
With that, this price cap should ultimately give us lower global supply, and higher prices. 
 
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