Pro Perspectives 7/5/22

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July 5, 2022

We had some big swings across global markets today.
 
It was the “rising likelihood of recession” that received the blame.
 
For example, we had a steep plunge in crude oil prices today.  That makes sense if you think recession is on the brink (i.e. less demand for oil).  
 
But as we discussed last week, we’ve likely seen the recession already. 
 
The Fed has already successfully killed animal spirits through it’s threats of aggressive interest rate hikes. 
 
It has already been reflected in the data.  Official GDP for Q1 was negative.  And the Atlanta Fed’s GDP model, which mimics the methods used by the BEA to estimate the government’s GDP measure, is projecting a negative second quarter.  Two negative quarters, is an official recession. 
 
That said, the big June data from Q2 has yet to be incorporated into the Atlanta Fed model.  The June jobs report will come this Friday.  And then we have June inflation data next week, and housing data the following week.
 
But we’ve already seen clues on jobs, inflation and housing, via other June economic reports, to safely assume a softening in these forthcoming data points. 
 
With that, by the end of July, when we see the BEA’s advance GDP number for Q2, we will likely get confirmation that have already seen the recession.
 
So, why the big swings in markets today?
 
As we also discussed last week, the drums of war are beating.
 
Remember, last week G7 leaders met, which rolled into a NATO meetings later in the week. 
 
And it was an eventful week.
 
>G7 allies banned imports of gold from Russia.  
>That was soon followed by a Russian debt default (a missed debt payment) — the first default to foreign creditors since 1918.
>Next, NATO announced plans to increase “troops on high-readiness” from 40,000 to 300,000.
>Then the the G7 included in its communique that they would phase out Russian oil, and in the meantime, threatened price caps on Russian oil imports (which would only further limit global supply, and increase prices).
>Finally, Finland and Sweden signed an agreement paving the way to join NATO.
 
Importantly:  Putin has already said that he will respond (in kind) if NATO were to deploy military and infrastructure in these bordering countries (Finnish land border, and Swedish maritime border). 
 
Was it a war flashpoint that kicked off the market turmoil today?
 
It just so happens, that the opening of European markets on Tuesday coincided with the signing of accession protocols by NATO allies, to add Finland and Sweden to NATO.
 
As it was happening, the euro began to plunge. That set the tone for markets.
 
Let’s take a look at the euro. 
Above, you can see the collapse of the euro this morning.
 
And when we think about this flashpoint of war, the longer-term euro chart tells a story that gives credence to this view of escalation toward WW3.  
The euro traded to a 20-year low today.  While the common currency in Europe launched in 1999, this chart engineers a history based on the member state currencies from the adoption of the euro.  As you can see, the big long-term trendline has broken.
 
Europe would clearly, continue, to suffer the brunt of the impact of a full blown world war.  And there would be a massive (global) fiscal spending response, which Europe is maybe the least equipped to absorb. 
 
Is this a message the euro is sending?  Perhaps. 
 
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Pro Perspectives 7/1/22

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July 1, 2022

We talked yesterday about the economic recession that is now projected in the Atlanta Fed’s GDP model. 
 
With the addition of today’s economic data, this model is now projecting the contraction of the economy by 2.1% in the second quarter (which ended yesterday).  That follows the official contraction of 1.6% in the first quarter. 
 
Again, two consecutive quarters of contraction is by definition a recession. 
 
That said, stocks have been pricing this in.  Bonds have been pricing it in.  And now, some inflation data is beginning to roll over.  We looked at core PCE yesterday (the Fed’s favored inflation gauge).  It has declined three consecutive months.  
 
Add to this, in today’s manufacturing data, the price component came in softer, also in decline for three consecutive months.  Inventories are high, and with that, new orders have been slowing. Freight costs are coming down. 
 
Again, this moderation of exuberance in economic activity is good news. 
 
The cooling in the inflation data takes pressure off of the Fed – reducing the chances that the Fed will crush the economy with draconian rate hikes.  In fact, as I said last week, it’s possible that the Fed could be done.  That would be extremely positive news for stocks. 
 
With that in mind, we head into a long holiday weekend, and into the second half of the year, with stocks trading just under 16 times forward earnings.  That’s right at the long-term average P/E for the S&P 500.
 
So, that brings about the question of earnings.  What will the “E” of the P/E look like as we start seeing earnings reports from Q2?  Thus far, 18 companies have reported for their fiscal Q2.  Thirteen of eighteen have beat estimates. 
 
And according to FactSet data, Wall Street has a 12-month bottom-up price target on the S&P 500 that’s 30% higher than current levels.
 
That outlook would align with a mild recession, which we may have already seen.
 
Meanwhile, consumer and business balance sheets remain at (or near) record highs.  Debt service, as a percent of disposable income is near record lows.  Even a percentage point added to unemployment would still put it around historical norms.  And the housing market remains sustainable (more than half of mortgage holders have a fixed rate of 3.5% or less … and only 10% of mortgages have adjusted rate mortgages — and those ARMs have a fixed rate component, on average, for between 7 to 10 years).
 
With all of the above in mind, the stock market performance of the past six months has delivered us companies with strong balance sheets and predictable cash flows, that are now trading at single digit P/E’s. 
 
These broad-based declines are opportunities to buy high quality companies at a discount.  You can find some of the best value opportunities in this market by joining us in my premium portfolio service.  You can click here to subscribe. 
 
Have a great 4th!   
 
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Pro Perspectives 6/30/22

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June 30, 2022

We've talked a lot about the Fed's "tough talk" strategy.  They've gone from denying inflation less than a year ago (which people believed), to banging the drum about "expeditious rate hikes" (which people believe).
 
None of which have been accurate.     
 
We have 8%+ inflation and just a 1.6% effective Fed Funds rate.
 
Still, the Fed has successfully talked the economy down, without having to make meaningful adjustments to interest rates.
 
By verbally attacking demand, the Fed has flipped the conversation from an inflationary boom, to a recession.
 
They've induced a bear market in stocks, and a related "negative net worth effect."   And they've promoted layoffs, by explicitly threatening to loosen the tight job market.
 
With that the Atlanta Fed is now projecting the second consecutive quarter of negative GDP growth.  That's recession.  
The market has done the Fed's job for them. 
 
They've gotten the desired result of "bringing down demand."
 
That said, as we've discussed, this reduces the probability of an 80s style inflation fight, and therefore, reduces the probability of a "hard landing" (i.e. crash in the economy).  That's good news.
 
The recession has been predicted by the bond market (inverted yield curve in March) and has been discounted in stocks over the past six months.  The next piece we will need, is evidence of cooling inflation. 
 
On that note, this morning we saw the report on the Fed's favored inflation gauge (core PCE).  It came in softer, and as you can see in the chart below, a declining trend is underway. 
 
With all of the above in mind, the second half of the year should be about recovery.  
 
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Pro Perspectives 6/29/22

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June 29, 2022

We've talked about the G7 leaders meeting this week in Germany.
 
These meetings have rolled into NATO meetings in Spain.
 
With this, and the events of the week, we should be paying attention to World War III flashpoints.
 
To start the week, the U.S. and G7 allies banned imports of gold from Russia.  That was soon followed by a Russian debt default (a missed debt payment) — the first default to foreign creditors since 1918.  But it wasn't a "can't pay" issue, it was forced by the asset freeze and banking sanctions (transactional restrictions) placed on Russia from the Western world.  So, there was virtually no financial market impact.
 
Next, NATO announced plans to increase "troops on high-readiness" from 40,000 to 300,000. 
 
Then the the G7 included in its communique that they would phase out Russian oil, and in the meantime, threatened price caps on Russian oil imports (which would only further limit global supply, and increase prices).   
 
Late yesterday, Finland and Sweden signed an agreement paving the way to join NATO. Putin has already said that he will respond (in kind) if NATO were to deploy military and infrastructure in these bordering countries (Finnish land border, and Swedish maritime border.  And today, Biden announces that the U.S. will ramp military presence in Europe by opening a permanent army base in the Poland (formerly controlled by Russia and flashpoint of WW2).
 
Is this flexing a position of strength to deter or provoke?  We will see. 
 
We know that Western leaders are all coordinating to execute on an economic, social and political agenda.  And we know that the current economic environment (high inflation, record high debt and deficits, and record low interest rates) is a conundrum, which threatens the execution of the agenda.  Still, we also know that they have the appetite to keep spending, to keep executing.  
 
What better way to excuse more fiscal spending (to get the agenda done) than to enter a global war.  And I suspect, if the current proxy war, turned into a global war, it would be a war of posturing. It would be as ambiguous as the current war.
 
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Pro Perspectives 6/28/22

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June 28, 2022

We talked about the G7 leaders meeting yesterday.  That concluded today with the release of an official communique.
 
With confidence at record lows, stocks in a bear market, tightening financial conditions and layoffs on the rise, the world's most powerful consortium ignored it all, and doubled down on their climate agenda.  
 
So, just in case anyone thought the lack of approval from their constituents, due to economic and social calamities, might alter their course, now we know better.
 
Not only did they reiterate their commitment to the agenda (a "sustainable planet"), but they reiterated their commitment to each other (to coordinate).
 
These powers, consolidated, equal 40% of the global economy.  They will continue to do what they want to do.  And what they want to do, is end fossil fuels.  They will do so by continuing to impose their regulatory power.  And they will do so by continuing to spend, to advance renewable alternatives. 
 
Their latest:  They have committed to spend $600 billion on infrastructure in developing countries.  
 
With that, let's talk about "climate" stocks. 
 
Given the performance of these stocks in recent months, it has been fair to ask, is this agenda defunct — and, therefore, is this clean energy investment opportunity over? 
 
After all, the high valuation, no eps tech stocks were easy targets to dump with the new rising interest rate environment earlier this year.  But investment community went from selling garbage stocks, to selling big tech, to selling blue-chip stocks, to selling (policy) agenda-driven stocks, to selling commodities stocks with fundamental tailwinds, strong balance sheets and sustainable cash flows.  All have been thrown out with the bathwater. 
 
Telsa has been the world's proxy stock on the transition to "clean" energy.  It's down 41% on the year.  NextEra has led the way for utility companies in transitioning to renewables.  It's down 17% ytd.  Chargepoint operates the largest EV charging network.  It's down 28%.
 
Maybe more interesting, given the G7 restated allegiance to the clean energy agenda, is the oil trade.  The surviving oil and gas producers have continued to produce oil with wider and wider margins (higher prices/ less competition).  Those stocks too have been thrown out with the bathwater in recent months.  It's a dip to buy. 

Pro Perspectives 6/27/22

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June 27, 2022

We talked about the significance of the G7 finance ministers meeting last month.  This is the meeting that tends to prepare the groundwork for the G7 leaders to meet.
 
As we discussed last month, despite the economic conundrum of four-decade high inflation, record high debt and deficits, and record low interest rates, the economy was not the priority issue (for the most powerful finance officials in the world!).
 
In their communique, “support for Ukraine” was top priority.  Ukraine was mentioned twenty times throughout the communique.  The word economy was mentioned only four times.  Inflation, only three times.
 
Importantly, the word most used throughout the communique was climate.
 
For much of the post-financial crisis era, these meetings were about globally coordinating policy to avert economic disaster.  Now it’s about globally coordinating to execute the transformation agenda (climate and social).
 
With all of the above in mind, the G7 leaders meeting is now underway, through tomorrow.  Not surprisingly, supporting Ukraine is the broad theme.
 
Bringing down inflation, and restoring quality of life for the Western world (which gets amplified in the developing world), is not the priority. 
 
In fact, in the face of the ballooned global money supply of the past two years, and the subsequent four-decade high inflation, the Ukraine-centric focus is fueling even more profligate spending from G7 countries (none of which have the money to spend).  
 
This wartime-like spending only underpins inflation. 
 
Add to this, in the G7 leaders statement, they are doubling down on the inflationary input of high oil prices, by committing to “accelerate the transition on the dependency on fossil fuels.”
 
What do high oil prices give us?  Higher food prices.  A World Bank study from 2013, analyzing 52 years of data, found that “of all the drivers of food prices, crude oil prices mattered the most.”  
 
No coincidence, what was also widely discussed in Germany at these G7 leader meetings?  Food crisis. 
 
As with oil, global leaders deflect blame of food supply and prices onto Russia/Ukraine.
 
But as we know, these are results of intentional policy making.  
 
When you promise to kill the fossil fuels industry, and then you begin to make good on those promises, by regulating away supply, choking off investment in new exploration, and (consequently) ceding control of prices to Saudi Arabia, you get much higher oil prices.
 
And as I said in my March 3rd note, just a week after Russia invaded Ukraine, “a predicted-future climate crisis has led to policymaking that has created an immediate energy crisis.  Next up, looks like food crisis.”
 
This is how the chart looked on food prices back in early March …
From the chart above, you can clearly see that the food prices were already nearing record highs, before any impact on Ukrainian food supply (now 16% higher).
 
This is a squeeze on the standard of living for rich countries.  For poor countries, it’s full blown crisis.
 
Bottom line, the global agenda continues to drive the outcome. And it’s well coordinated.  This agenda will continue to fuel higher prices through supply shortages.  We’ve seen it in oil.  We’re going to see it more clearly in other commodities, through the secondary effects of high oil prices, only exacerbated by the “green” regulatory burden.
 
This all sets up for what history tells us should be a long-term bull cycle in commodities prices, and therefore, commodities investing. 
 
Remember, we looked at this chart at the beginning of the year …
This the ratio of commodities prices to stock prices.
 
As you can see, heading into this inflationary environment, commodities are coming out of a period of significant underperformance, relative to stocks.  In fact, commodities haven’t been this cheap, relative to stocks, in 50 years.  You can see how sharply this valuation divergence corrected back in the early 70s period – which shared the ingredients of oil crisis and inflation.
 
Bottom line:  The Fed-induced slow down in the first half of the year, has driven speculation that the deflationary forces of the past decade may return.  But the spending required in the transformation (political) agenda, and this commodities/stock valuation cycle suggests that higher prices and higher than average growth are the new economic regime.  But it comes with lower standard of living, until the wage/price gap closes (which won’t be soon).     
 
On a final note, I want to thank everyone for all of the kind and supportive messages and prayers for my family in response to my note on Friday.  Thank you so much! 

Pro Perspectives 6/24/22

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June 24, 2022

Special note today:  My Mom passed away on Sunday.  It was Father's Day.  She had three sons, all fathers.  She was married to an amazing father.  And she passed on to reunite with her father, and to join her Heavenly Father.
 
I received the news while traveling, just arriving in her birth state of Indiana.  I was her youngest child.  And I was traveling with her youngest grandchildren, and on the way to meet with her youngest sibling.  
 
She was an amazingly talented and giving person.
 
She spent a life doing for others, without expecting anything in return.
 
In that respect, (for family, friends and others) she took no days off.  
 
She served others, but she was a leader. 
 
She was short of perfect (as we all are), but she was a perfectionist.
 
She was gentle, but tough as nails.
 
She was confident, but humble.
 
She was consistent, but adventurous.
 
She guided, but let us learn. 
 
She was her own person, but selfless. 
 
She loved people.  She was authentic.  People loved her. 
 
More than anything, she loved her family. 
 
Her family and her relationships made her life full.  As a reader of mine, by supporting me (her son), you contributed to making her life full.  Thank you!

Pro Perspectives 6/23/22

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June 23, 2022

We’ve talked about the Bank of Japan’s newly amplified role as the shock absorber to the global economy, as they execute on their license to print unlimited yen and buy unlimited assets.
 
Remember, the global finance ministers (and politicians) have resolved that, in a world of global interconnectedness, the only way to avert the spiral of global economic crises into an apocalyptic outcome is to coordinate policies.
 
Japan is in the unique position, after battling decades of deflation while buried under the world’s worst-debt burden, to be the implicit provider of global liquidity — to keep printing, to devalue the yen and inflate away debt.  
 
With that, let’s take a closer look at the yen and Japanese stocks. 
 
As we discussed on Tuesday, since the Fed start the rate liftoff in March, the yen has crashed as much as 17% (in just three months).  By April, the Japanese currency had already posted a record losing streak against the dollar.  It hit a 24-year low this week. 
 
Strong dollar/weaker yen is the consequence of the policy divergence between the U.S. and Japan (the Fed tightening, the BOJ easing).  
The above is a chart of the dollar versus the yen (the line moving higher represents a stronger dollar/weaker yen and vice versa).  As you can see, through the 80s inflation era in the U.S., the dollar was dramatically stronger versus the yen. 
 
What about Japanese stocks?
 
Both German and U.S. stocks hit new record highs in the pandemic environment, thanks to the global liquidity deluge.  Japanese stocks never did.  It would take another 50% to revisit the 1989 all-time high in the Nikkei. 
 
Now, the interest rate divergence between the U.S. and Japan would typically drive money out of Japan and into the U.S. (seeking higher yield).  That would be bad for Japanese stocks.  But this is not a typical case.  It's important to know that the BOJ is still outright buying Japanese stocks as part of its QE program.    

Pro Perspectives 6/22/22

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June 22, 2022

Today, Jerome Powell spent two hours in front of the Senate Banking Committee.  Tomorrow he will do the same with the House Financial Service Committee. 
 
Just a week ago the Fed made the biggest rate hike in 28 years, raised interest rate and inflation projections, and the Fed chair spent over an hour answering questions from financial media.
 
What more could he reveal today that markets don't already know?
 
Nothing.  He maintained the Fed's stance that they will "expeditiously" raise rates to the neutral level, though he admitted that the Fed doesn't have the tools to deal with oil and food prices.
 
So, the Fed is guiding to a slower growth-high price economy, rather than a high growth-high price economy.  It doesn't make sense.  Even the most intellectually dishonest of the Senate Banking Committee are poking holes in the logic. 
 
As we've discussed, this "guidance" on the rate path by the Fed continues to look like lip service.  If we look at their actions, rather than listen to their words, we see a 1.6% effective Fed Funds rate in an alleged effort to fight 8.6% inflation. 
 
That said, the tough talk, alone, has taken a toll on confidence (record low).  Financial conditions have tightened.  The stock market is in a bear market.  
 
As we discussed last week, after the 75 basis point hike, it's possible that the Fed could be done.
 
What's happened since?  The S&P 500 opened at 3740 on the day of the Fed decision last week.  Today, it's 3740.  The 10-year yield opened at 3.45% on the day of the Fed decision.  Today, it's 3.14%. 
 
So, after an "historic" rate hike, as the media called it, stocks are flat, not down.  Yields are down, not up.
 
In fact, two key rate markets posted technical reversal signals last week. 
 
As we've discussed, Spanish bond yields have been a proxy on the probability of another European sovereign debt crisis.  This was quickly flaring up as of early last week, but has now reversed by 50 basis points in six trading days. 
The U.S. 10-year yield has reversed from 3.5% to 3.14% in four trading days.
 
The drivers?  The European Central Bank and the Bank of Japan. 
 
The former (the ECB), showed how quickly they can fold on their policy plans last Wednesday.  They responded to rising bond yields in the weaker spots of the euro zone (namely, Spain and Italy) with an emergency meeting and threats to backstop (again) the European sovereign debt market.  The chart above is the result.  
 
The latter (the BOJ), on Friday, doubled down on their unlimited QE strategy (i.e. they are the global asset buyer of last resort). 
 
This means demand for U.S. Treasuries.
 
The result?  A sharp reversal in U.S. yields. 
 
Again, this dynamic sets up well for a rebound in stocks.    

Pro Perspectives 6/21/22

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June 21, 2022

In my Friday note, we talked more about the importance of the Bank of Japan's role in offsetting the policy tightening that's underway in the rest of the world.
 
This "offsetting" is not by coincidence. 
 
Remember, if there is one common word we hear spoken from policymakers around the world (from the Great Financial Crisis era, through the pandemic and post-pandemic period) it's coordination. 
 
They have resolved that, in a world of global interconnectedness, the only way to avert the spiral of global economic crises into an apocalyptic outcome is to coordinate policies. 
 
With that, just a month ago, the top finance ministers from G7 countries met in Germany.
 
It's safe to say, they all know that the only way the world can start reversing emergency level monetary policy, while simultaneously running record level debt and deficits, is if the Bank of Japan is running wide-open-throttle, unlimited QE. 
 
In doing so, the BOJ has become the shock absorber for the global economy.
 
In return, they get to devalue the yen, and devalue the world's worst debt burden. 
 
With this policy divergence, and implicit license to devalue the yen, the yen has crashed more than 17% since the Fed made its first rate hike in March.  By April it had already experienced a record losing streak.  Today it posted a new 24-year low against the dollar.