Pro Perspectives 4/5/22

April 5, 2022

On January 5th, the minutes from the December Fed meeting spelled out exactly what Jay Powell had told us just weeks earlier in his (December) post-meeting press conference. 
 
What was the message? 
 
The Fed had set the table for a March liftoff in rates.  And they had contemplated a strategy for shrinking the balance sheet (i.e. quantitative tightening!).  
 
In this chart below of the S&P 500, you can see where stocks were, when this news hit. 
 
This reality that the Fed was going to become inflation fighters set off a broad sell-off.  It was largely led by the high valuation/ high growth stocks and the high growth/no eps stocks.  
 
Valuations began to reset for a world where a higher discount rate would be plugged into Wall Street models.  With that, the broad market forward P/E has since fallen from around 22x to 18x (still a bit above the long-term average P/E of 16x).   

Now, with all of that said, we have Fed minutes tomorrow. 
 
The minutes will be from the March meeting.  And we will learn what was said in the meeting that kicked off the inflation fight (i.e. the first post-pandemic rate hike).
 
On that note, we got some clues today from Lael Brainard. 
 
Brainard, who just months ago was up for the Fed Chair position (and has since been appointed Vice Chair), gave a well-scheduled prepared speech this morning.
 
What were the takeaways?   
 
On policy, she said "it's of paramount importance to get inflation down."  She said they will continue to tighten "methodically" through rate hikes.  And she said they will shrink the balance sheet "more rapidly" than they did in the previous recovery. 
 
The latter is not news. Jay Powell told us in December that they would be more aggressive in reducing the balance sheet in this hot economic recovery, with hot inflation (relative to the weak recovery, and weak inflation of 2017-2019… the previous period of quantitative tightening). 
 
What is surprising is that Brainard used the word "methodically."  Setting the expectation for autopilot like rate hikes doesn't do much to curtail inflation expectations.  
 
When Ben Bernanke was asked about the inflationary risks of QE, back in 2010, he said dealing with inflation is no problem.  "We could raise rates in 15 minutes." 
 
That kind of intermeeting large adjustment in rates would go a long way toward resetting the inflation trajectory — quickly.  So far, it doesn't appear that the Fed has given any consideration to it. 

Pro Perspectives 4/4/22

April 4, 2022

The banks will kick off earnings season next week.  They will be reporting on a quarter that slowed to an annualized growth rate of somewhere between 1.5% and 2%.
 
Let’s take a look at the trajectory of the growth projections over the past quarter.

We’ve heard a lot of “slowing economic growth” chatter.  You can see it in the chart.  If we look at the consensus from the economist community (the blue line), what started as an expectation for a little better than 3.5% growth, is now coming in closer to 2%.  
 
That looks anemic against the nearly 7% annualized growth in Q4.  But that was the book-end of the fastest growth since 1984.
 
For more perspective, if the Q1 growth comes in around where the Atlanta Fed and economists are projecting, it would be about in line with the trend levels of the decade that preceded the pandemic. 
 
That said, it doesn’t feel like a slowing economy.  This is not a weak demand economy.  This is an inflation thief economy.  Inflation is crushing “real” growth.  Conversely, we may very well have double-digit nominal growth this year.  As we’ve discussed, this is the “sprint on a treadmill” economy, where the economy is hot, yet it’s increasingly harder to maintain a standard of living.
 
Reference point?  If we look back to the inflation spikes of the early 70s and early 80s, nominal GDP grew by an annual rate of better than 10% during those periods. 
 
With that magnitude of inflated growth, our economy (nominal GDP) could balloon to $30 trillion economy within the next few years.
 
This is precisely what we talked about shortly after the government and the Fed fired the monetary and fiscal bazookas, to respond to the initial covid shut-down (back in March 2020).  They went unimaginably big, and with the intent of inflating growth, devaluing money and inflating away debt.  That initial response was probably enough to accomplish the mission.  But then the new administration had an agenda to execute, and continued to fire more fiscal bullets, in the name of “crisis.”  And they may not be done. 

 
We shouldn’t be surprised if we get another fiscal spend — the “Build Back Better” plan, packaged as a wartime response.
 
With that, nominal GDP would continue to float higher. 
 
As I said, this strategy of inflating growth and inflating away debt was always intentional/by design.  You can see that starting to reflect in this chart (to the far right). 

Pro Perspectives 4/1/22

April 1, 2022

We end the week, and open a new month and quarter, with the jobs report.
 
Not surprisingly, the data this morning showed a very hot labor market, and hot economy. 
 
Unemployment is 3.6%.  That's just a tenth of a percentage point away from pre-pandemic levels, which were 50-year lows.
 
The economy added 431k jobs.  That number will be revised higher by this time next month, as it has for eleven consecutive months. In fact, last year the labor department undershot the final payroll number, every single month, by an average of 158k jobs. 
 
Bottom line:  While unemployment is near record levels, the job growth every month is running just about as hot as it was last year, during the biggest "back to work" phase.
 
What about wage growth?   
 
Year-over-year wage growth was 5.6%.  That's a big number, and a big deal.  For much of the decade that followed the depths of the post-financial crisis, wage growth was stagnant, below 3%. 
 
Guess who wanted 3%+ wage growth as a driver for inflation, to assist in escaping the burdensome and dangerous deflationary forces? 
 
The Fed.
 
Now they have wage growth (a lot of it), and (still) 11 million unfilled jobs, with employers in a position of strength to continue commanding higher wages.  And they have every incentive to do so, as the cost of living has outpaced their wage gains.  
 
Again, what does the Fed tell us wage growth does?  It feeds into inflation.  This is known as a feedback loop.  More wage growth > more inflation > more wage growth … 
 
This should haunt the Fed.
 
Note for Billionaire's Portfolio members:  Our portfolio continues to perform very well (up 8.5% ytd, versus an S&P 500 that's down 5%). I'm still working through a portfolio update, with focus on how we are invested to take advantage of the increasingly important role of cyber security.  Please keep an eye out for that note in the next few days.
 
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Pro Perspectives 3/31/22

March 31, 2022

For the second time in four months, the President has announced a release of oil from the Strategic Petroleum Reserve (SPR).  
 
In this case, it's a big promise.  A million barrels a day for six months, or roughly 180 million barrels.  That's about a third of the U.S. SPR. 
 
Will it bring down oil prices?
 
Back in September, China released oil from its strategic reserve for the first time ever.  Oil prices went up, not down. 
 
Two months later, Biden issued an order to release 50 million barrels from the U.S. SPR.  The price of oil did very little that day.  But the next day, on the evening of Thanksgiving, the news of the Omicron variant hit the wires, and the price of oil (and most markets) fell sharply. 
 
Within six weeks, oil prices were higher.
 
What should we expect from this big oil supply injection from the Biden administration? 
 
Higher prices.  
 
Why?  Not only have we, and much of the world, committed to defunding new oil exploration, and regulating down domestic supplies, we are now (voluntarily) drawing down our reserves.  
 
This SPR release only weakens our position, from an already weak position.  OPEC countries will be even happier to sell us all the oil we will need (until we are all driving Teslas), just at higher and higher prices.  And so will the domestic producers that have survived this planned supply destruction of the fossil fuels industry.
 
 

Pro Perspectives 3/30/22

March 30, 2022

As March ends, all eyes will turn to inflation data.  And it's going to be a wrecking ball for central bankers that are trying to manage inflation expectations.
 
As we've discussed, the Fed is far more concerned about inflation expectations, than they are about inflation.  If they lose control of expectations, people start pulling forward purchases, in anticipation of higher prices, creating a self-fulfilling upward spiral in prices.
 
With this, you have to wonder what the first double-digit print in inflation will do to consumer psychology.  
 
I suspect we will find out on April 12, when we get CPI numbers for March. 
 
Keep in mind, for February, the data came in hot, with prices close to 8% from the same period a year prior.   And that did NOT yet account for the sharp spike in the price of oil.  Add in a 30% spike in oil prices, and a double-digit March inflation number seems like a done deal. 
 
We had some clues from the German inflation data this morning.   This was a preliminary reading for the month of March.  It was a huge negative surprise.  The 7.3% year-over-year increase in prices was more than two percentage points higher than the consensus estimate.
 
The consensus view for March U.S. inflation (thus far) is 8.2%.
 
Where would a negative sentiment shift in the inflation outlook most quickly tend to manifest?  The bond market.  Yields (market interest rates) would go on a tear.  Not only could that signal exacerbate inflation fears, but it could also trigger global capital flight, which could lead to a currency and debt crisis.    
 
This brings us back to my note from yesterday, where we discussed the prospects of global central bankers following the Bank of Japan's lead, by setting market interest rates (i.e. yield curve control).
 
So, just as the Fed has exited QE, they may be forced to return to the QE game very quickly (buying treasuries to maintain an orderly rise in market interest rates).    

Pro Perspectives 3/29/22

March 29, 2022

Stocks rallied today (again).  Oil and gold traded lower today (again).  This has the appearance of a relief in the risk environment. 
 
Is there reduced risk on the war front?  Is there energy supply relief coming from the Iran negotiations?  Are Covid lockdowns in China, foreshadowing another round of global pandemic restrictions?  
 
We talked about the latter yesterday.  But it now appears that none of the above are dictating the recent market activity.
 
With the behavior of the bond market the past two days, it does appear that the bond market is telling us something. 
 
We talked about the prospects of a yield curve inversion earlier this month, and we looked at this chart below …

As a reminder, this is the spread between the 10-year and 2-year Treasury yields.  This had declined to 23 basis points when we looked at it on March 8th. Today it's just 2 basis points (the 10-year yield is at 2.39%, and the 2-year yield is at 2.37%).   Why does this matter?  Each of the six recessions, dating back to 1955, were preceded by a yield curve inversion.  Recession followed between 6 and 24 months.
 
Now, with that in mind, you would not be going out on a limb to call for a Fed-induced recession to come in the next 24 months (regardless of what this chart above tells you).   After all, as we've discussed, the last time the Fed had to deal with an inflation problem like we're seeing now, they had to ramp rates ABOVE the rate of inflation, to bring inflation under control.  That would be applying a heavy foot on the brakes of the economy. 
 
But within this outlook, we should expect such a yield curve inversion to happen at much higher levels of interest rates.  It would be reasonable to expect the inversion to take place because the 2-year yield is aggressively moving higher (along with the Fed Funds rate), not because the 10-year yield is stagnating at historically low levels, and then aggressively moving lower.  That doesn't project a hot economy, where the Fed is just starting a tightening campaign (from emergency level rates). 
 
So, what's happening to push the 10-year yield aggressively lower the past two days?  It may have everything to do with Japan.  
 
The Bank of Japan intervened twice yesterday in the Japanese government bond market — buying JGBs in "unlimited amounts" to put a lid on rising bond yields (at just 25 basis points on the 10-year).  
 
This "yield curve control" is, and has been, explicitly part of the BOJ's game plan to promote economic activity in Japan.  But what is becoming clear, is that policy change in the U.S. is pulling all global interest rates higher.  It's unwelcome.  The 10-year yield in Germany has swung from negative 10 basis points, to positive 74 basis points, just this month!   The 10-year yield in Japan is at six year highs, the highest levels since they adopted the plan to outright suppress Japanese yields back in 2016.
 
With this in mind, and the actions by the Bank of Japan this week, the move in the U.S. 10-year yield today may be a signal that "yield curve control" could be coming to a central bank near you.
 
Remember, as we discussed last week, if we consider a 2% spread between mortgages and the (U.S.) 10-year … and a spread of about 2% between the 10-year and the Fed Funds rate … then we should expect the 10-year yield to be in the mid-4% area by year end (if the Fed gets back to neutral).  And we should expect mortgage rates to be over 6%.  But in anticipation, it's not crazy to think the 10-year yield (and therefore consumer rates, like mortgages, auto loans and credit cards) could reset to those levels very quickly (like a spike in rates).  
 
An aggressive spike in market interest rates would be bad news for the major central banks of the world.  How would they protect against that scenario?  Yield curve control — to (attempt to) carefully manufacture a stable path to higher interest rates. 

Pro Perspectives 3/28/22

March 28, 2022

Markets kick off the week digesting the inflammatory words from Biden over the weekend, about removing Putin.

And to add to the sentiment headwind, Biden was out pushing his 2023 budget today, which includes higher taxes and disincentives for investment (by taxing UNrealized gains!!).

I suspect it’s clear to anyone, an aspiration from the West for regime change in Russia would trigger a long, messy global war. Therefore, oil prices would go UP significantly, as the supply/demand imbalance would be compounded. And gold would go UP significantly, as global capital would move to relative safety.

That said, both (oil and gold) went down significantly today.

Meanwhile, tech stocks led the way, up — from very early in the day.

Neither Biden’s reckless foreign policy actions, nor his threats to curtail wealth at the top, could keep stocks down. Perhaps the White House policy news was overwhelmed by another factor: the return to lockdowns in China.

In fact, if we can read anything into the market behavior of today, it’s that the market considers the political appetite for more lockdowns to be greater, than the political appetite for global war.

These stocks that thrive in a lockdown were big performers on the day …

Amazon was up 2.5%. Zoom was up 3%. Roku was up almost 4%. Docusign was up 4%. Doordash was up 9%.

Pro Perspectives 3/25/22

March 25, 2022

Yesterday we talked about the coming food crisis.  Suddenly, the Biden administration is sending warning signals on this eventuality.
 
Yesterday in Brussels, Biden said the food shortage "is going to be real."  Today, Janet Yellen (Treasury Secretary) said she's "concerned about countries dependent on wheat" due to rising prices from the Ukraine situation.
 
Remember, yesterday we looked at the inflation-adjusted chart of food prices.  We are now matching the record peak in inflation-adjusted prices from 1974.  The significance of 1974?  It was the period of the last major global food crisis. 
 
With this in mind, an annual agriculture report from the Congressional Almanac gives seven reasons for the food crisis.  Here are four of them:
 
> Apparent changes in the world climate, "which may have a catastrophic effect on food production."  (this quote was from a Harvard nutritionist).
> The Russians' decision in 1972, after a poor crop year, to buy massive amounts of grain from the U.S. and Canada.
>Natural and political disasters, such as war in Bangladesh.
>The sudden drastic rise in oil prices in 1973, which impaired the ability of poor nations to obtain fertilizer.
 
So, fear (my interpretation) of climate change, hoarding of grains by one country, natural and political disasters, and an oil crisis. 
 
Sound familiar?
 
On the hoarding front, guess who has been importing record amounts of grains (among many other commodities) over the past two years? China. 
 
Guess who had the largest reserve of grains back in 1974, from which the world (while in crisis) received allowances?  The United States.  
 
Guess who has the largest reserve of grains now, to the tune of 50% of world supply?  China.  

Pro Perspectives 3/24/22

March 24, 2022

Yesterday we talked about the prospects of a gas subsidy.  On cue, the governor of California presented ideas late yesterday for a number of transportation subsidies — including a $400 a month gas card.

As we discussed, a subsidy would only sustain the demand dynamic for oil.  Apply that to a world that is undersupplied and underinvested in new supply, and the price of oil would continue to rise.

But it’s unlikely to stop there.  Next up:  bigger government handouts in the name of broad “inflation relief.”  It’s already being proposed at the state government level and on Capitol Hill.

So, here we have the Fed raising rates, and as Powell said this week, they are doing so with the explicit intent of bringing down demand.  And conversely, we have governments, which have broken supply through bad policy, looking to sustain demand through subsidies (more bad policy).

If you didn’t believe the inflation problem was going to get worse, these actions (if taken) ensure it will get worse.

Let’s talk about food…

Earlier this month, we talked about a coming food crisis.  It was a topic at the NATO Summit today.

Here’s an updated look at the food price index, which is now on new record highs …

 

If we adjust this chart for inflation, current prices are at levels are matching the record highs of 1974.

That year might sound familiar because it was the last time we had a major global food crisis.

 

From the looks of this chart above, it appears that some saw this coming very early.  Deere has quadrupled from the pandemic lows.  And continues to make new record highs.

 

Pro Perspectives 3/23/22

March 23, 2022

With NATO leaders in Brussels tomorrow, the markets are reacting to a likely escalation in what looks like a Western proxy war with Russia. 
 
Oil goes out today around $115.  We should expect to see oil prices much higher (still).  Remember, we've been talking about the construct for $100 oil, long before the Russia/Ukraine disruption. 
 
Here's an excerpt from my note a year ago …
 
The globally coordinated ’Clean Energy Revolution’ promotes higher oil prices, not lower.  That's the structural driver for oil prices.  Funding for new exploration has been choked off.  So, foreign oil producers (particularly from bad acting countries) will be in the driver’s seat.  That movement is underway.  And these producers will command/demand higher prices, especially in a less competitive, lower supply world. 
 
As we discussed this dynamic back in February, I said 'get ready for $4 plus gas.'  With the monetary and fiscal backdrop that has evolved, and the inflationary pressures already bubbling up, it will probably be more like $6 gas. 
 
It will be self-fulfilling, and yet it will become the justification for the move to "clean energy" (just as high gas prices were in the Obama era).

 
Fast forward to today, and add in further supply disruption (in Russian sanctions), plus what will likely a wartime surge in demand for oil, and we will very likely see a spiral higher in oil prices.
 
Now, in a normal world, high prices stimulate more investment in oil exploration and drilling.  It won't happen this time, at least under the current global and domestic regime.  They want substitution ("clean").     
 
And that brings me to another probable outcome we've discussed for quite some time here in my daily notes:  price controls.  But as we've also discussed, a subsidy would only sustain the demand dynamic for oil.  Apply that to a world that is undersupplied and underinvested in new supply, and the price of oil would continue to rise.
 
With that, what could be added to such a White House game plan?  rationing.