Pro Perspectives 3/22/22

March 22, 2022

As we discussed yesterday, the Fed has now set expectations that they will aggressively take the Fed Funds rate back to neutral (where they are neither accommodative nor restrictive).   After Jay Powell's comments on Monday, the market is now pricing in about a coin flips chance that the Fed determined benchmark interest rate will be there (neutral/mid 2% area) by the end of the year. 
 
With that, the 10-year yield (the interest rate determined by the market) is starting to move.  We are just in the early stages of seeing what the interest rate market will look like without the Fed's constant intervention (i.e. bond buying) of the past two years. Remember, as of this month, the Fed is officially out of the QE business.  That's important to keep in mind, as the media continues to focus on the yield curve, which has been flattening and nearing inversion (a historical recession signal).  Now that the Fed is out of the treasury market, so is the suppression on the longer-end of the yield curve.   Translation:  This potential "recession signal" being derived from the yield curve should be reversing.   
 
With that, let's take a look at how the 10-year yield is behaving since the Fed meeting last week (it's UP, dramatically).  
 

The 10-year yield started last Monday (Fed week), trading around 2%.  Today it's close to 2.40%.  That is pushing consumer rates higher, rapidly.  The average 30-year fixed mortgage rate hit 4.7% today.
 
If we consider a 2% spread between mortgages and the 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%.
 
Add in $4+ gas, even with a strong labor market and higher wages, and we should be getting to a point (by year end) where the standard of living is sliding.   

Pro Perspectives 3/21/22

Last week the Fed laid out a more aggressive path and destination for interest rates.  

But the path they telegraphed still leaves them fueling the fire of a hot, high inflation economy through next year.  With that, it didn’t sound (at all) like a Fed that was prepared to do “whatever it takes” to slay inflation.   

Today Jay Powell may have corrected the mistake.  In a prepared speech, he set the expectations for possible 50 bps increments (in rate hikes).  And he made it made it clear that the Fed is no longer sitting back and waiting for supply disruptions to normalize.  They are looking to bring demand down, to come in line with supply.  This is a quite a stark contrast from the inflation-denying Fed of 2021.  

In fact, all along the way, they have been telling us that the deflationary forces of the past three decades wouldn’t turn on a dime, and therefore wouldn’t expose us to a dangerous inflation scenario.  That’s changed too.  Today, Powell’s flip-flop was expressed like this:  “it’s hard to say what the economy will look like post recent events, but no one is sitting around waiting for the old regime to come back.” 

To be sure, they were (arrogantly sitting back and waiting).  But hopefully not any longer. 

So, what will it take to beat inflation?   As we’ve discussed, in the 73-74 and early 80s inflation spikes, the Fed had to ratchet rates above the rate of inflation to finally get it under control.  And if history is a guide, the past five tightening cycles (’87, ’94, ’99, ’04 and ’15), the Fed has averaged about 50 bps of hikes a quarter.

 

Pro Perspectives 3/18/22

March 18, 2022

Today I want to copy in an excerpt from my premium service, The Billionaire's Portfolio. 
 
This bigger picture analysis from last month (before the Russian invasion of Ukraine), connects some dots and suggests an outcome that we seem to be quickly approaching:  World War 3.
 
Excerpt from Billionaire's Portfolio, February 14 [in blue font] …
 
The Fed is beginning to telegraph a more aggressive rate path. 
 
How aggressive will they become, and will they be able to tame inflation?  We will see.
 
If we look back to the early 80s period of high inflation, here is what stock returns looked like (the first column in the table below)…
 

Now, also notice the impact inflation had on the real (after adjusted for inflation) rate of return in stocks (the third column). 
 
And through a four-year period, where inflation averaged nearly 10% per year, you can see, in the far two columns, what it looked like for those that remained invested in stocks, relative to those that went to cash. 
 
The takeaway:  Being long stocks not only gave you a hedge, but increased your buying power by 30% over the period.  Going to cash, destroyed your buying power by 33% over the period.  
 
This supports the theme we've been discussing since the onset of the pandemic response.  In this environment, you have to be long asset prices.  
 
Now, on a related note, I want to revisit some of my analysis of the long-term path of the stock market and the long-term path of GDP.  
 
As you may recall, we've looked at these charts many times over the past five years (+).  
This chart shows us what it would take to put us back on path of 8% annualized growth in the S&P 500.  

The blue line represents what the S&P 500 would have looked like, had it continued to grow at its long-run annualized rate of 8%, from the 2007 pre-Great Financial Crisis peak.  

The orange line is the actual path of stocks (which includes the deep financial crisis decline and the subsequent recovery). 

Through the years of looking at this chart above, there has been plenty of chatter along the way about the huge performance of the stock market — plenty of bubble and overvaluation talk.  But the reality is, we were knocked off of the path of the long-term trajectory of stocks (the orange line).  And that path of a long-term 8% annualized appreciation has never been regained (the blue line). 

What can we attribute this gap to?
 
Post-recession economic recoveries in stocks are typically driven by an aggressive bounce-back in growth, to return the economy to "trend growth."
 
We didn't get it.  Instead, the post-Great Recession growth environment was dangerously shallow and slow. 
 
In this next chart, the blue line is the path of real GDP if it had continued growing at the long-term average rate of 3.2%, from the pre-financial crisis level. 
 
The orange line is actual real GDP.
The growth trajectory, too, was knocked off path fifteen years ago.  And because of the very sluggish recovery spanning more than a decade following the Great Recession, we are still well off of trend. 

 
This explains the big and bold monetary and fiscal response to the Covid shutdown.  It was deliberate, and it was done to inflate growth and inflate away debt (not just domestically, but globally). 
 
We've seen the outcome of the policy response in stocks (and broad assets).  Values have inflated. 
 
Importantly, the Fed has done nothing to stop the inflation.  This is intentional.  They told us along the way that they would let inflation sustainably overshoot their target of 2% before even thinking about removing emergency level policies.
 
As such, we are finally seeing the gap (between the orange line and the blue line) in stocks, close.  Another 13% from current levels in the S&P 500 will put us on the path of the long-term trend. 

But just as the Fed has (intentionally) let inflation overshoot, we should expect asset prices to overshoot as well.  We're seeing it in some prices (some commodities, housing, used cars).  For stocks, this means the orange line in the first chart (above) would shoot north of the blue line, and maybe for a considerable period of time.  That would argue for new, higher highs in the broad stock market. 
 
Now, this is where it gets, maybe, more interesting. 
 
What would it take to get GDP back to trend by the next Presidential election?
 
It would take 10% annualized real growth.   
 
Sound crazy?  
 
The last time we had that kind of growth was the early 40s.  This was the economy coming out of the depression, as you can see here…

  
What were the drivers of 14% average annual growth over these 5 years?  In part, the New Deal (government spending program), and in larger part, World War 2.
 
Probably no coincidence, what's a growing likelihood today?  World War 3, which would be leverage for the White House to get it's Green New Deal ("Build Back Better") government spending blowout approved.
 
This early 40s period may be a good analogue for what's coming.
 
With all of the above said, subscribers to my Billionaire's Portfolio are positioned well for this global war and "wartime spending package" scenario.  

 

While the broad stock market has had one of the worst starts to the year on record, our portfolio is UP on the year, beating the market by better than 10 percentage points.
 
This outperformance is driven by a tactical theme-driven allocation.  What does that mean?  The portfolio is designed to win from a rising interest rate environment (value stocks), inflation (and a related commodities price boom), 5G (and related cyber security demand) and the "clean" energy agenda (the planned supply disruption). 
 
Add to this, in a world of increasing cyber attack risks (if not, "cyber pandemic"), we've recently added a stock to the portfolio that gives us, not only a powerful hedge, but the opportunity to win big in the event of a negative cyber event for the stock market. 
 
If you're interested in getting the details on this latest addition to our Billionaire's Portfolio, you can click here to subscribe.  I'll send you all of the details … plus you'll get members-only access to see our full portfolio of big-opportunity stocks, all owned by some of the most influential investors in the world.
 
Have a great weekend.
 
Best,
Bryan    

Pro Perspectives 3/17/22

March 17, 2022

We've talked about the irony of the Fed rate liftoff as a signal to buy stocks.
 
Remember, with the market valued at less than 19 times the twelve-month forward-earnings estimate, stocks are not expensive.  Not when the Fed Funds rate is, and will be, under the "neutral rate" for at least the next year (projected).  And not when the nominal price of everything is rising.  That includes financial assets/stocks. 
 
With that, let's take a look at some related technical signals …

After a 14.6% correction in the S&P 500, we get a technical break of this big downtrend.  
 
Same with the nasdaq …
Small caps (Russell 2000) and the Dow are approaching similar breaks …
 
What has led the way? 
 
Curiously, the rebound in global stocks started in Europe, early last week.  Take a look at German stocks … 
German stocks are up 16% since last Monday.  Italian stocks too (a far weaker and more fragile economy relative to Germany).
 
This, just as the world is cutting off Russia, and the European bank exposure to Russian debt has yet to be fully evaluated.  Not to mention, the European economy is the most vulnerable in the world to the Russia/Ukraine war impact, yet the ECB telegraphed a rate liftoff to respond to inflation.
 
So, what is this behavior in European stocks telegraphing? 
 
Perhaps, global war (and wartime fiscal spending).    

Pro Perspectives 3/16/22

The Fed started the liftoff in interest rates today, as expected.

In normal times, an interest rate tightening cycle is intended to cool an economy that’s running hot, to safeguard against a good economy turning into an inflation problem.

In this case, the Fed is just beginning to normalize policy, from emergency/crisis levels (i.e. zero interest rates, plus QE). Ideally, coming out of crisis, they would want to get rates back to the “neutral level” (which means neither accommodative nor restrictive … 2.5%-3.5%, historically), before having to deal with the challenge of cooling an economy.

But they’ve waited too long, in this case. They are already dealing with a hot economy and an inflation problem.

With that, for the first time ever the Fed is starting 8 percentage points in the hole, against inflation.

As we discussed in these notes, if we look back at the inflation bouts of the 70s and early 80s, both times the Fed had to ratchet up the Fed Funds rate, to above the rate of inflation to finally win the battle.

They have a long way to go.

With that, the Fed started making steps today, setting expectations for a more aggressive path, with a higher ending point (now projecting close to 3%). That puts the Fed closer to what the interest rate market expects for the path of rates.

What does that mean? The market was pricing in seven, quarter point rate hikes this year. Now the Fed is too.

So, if the difference between the Fed projections (coming into today) and the market projections represented the market’s view that the Fed was making a policy mistake — then the closing of this gap, should represent a reduced risk of a policy mistake.

Is that why stocks rallied this afternoon? Maybe.

As we discussed yesterday, coming into this big Fed meeting things were setting up for a “sell the rumor (assume the worst), buy the fact (rational)” scenario. This appears to be playing out.

But, we also had a very big catalyst for markets this morning: China.

Remember, late last year, the Chinese government waged a war against its own technology giants, and (maybe more so) against U.S. regulators of U.S.-listed Chinese stocks.

It started with the Chinese ride hailing company, Didi. It went public last June, as one of the biggest Chinese share offerings in the U.S., ever. Immediately, the Chinese government started harassing the company for a number of alleged violations.

But with over $1 trillion of Chinese companies on U.S. exchanges, it seemed to be more of a “shot across the bow,” related to the U.S. SEC’s new effort to crackdown on the lack of reporting accountability from Chinese companies.

By November, Didi asked to delist from the NYSE (with plans to move the listing to Hong Kong). Coincidently, the tech-heavy Nasdaq topped just three days prior …

The future of Chinese companies trading on U.S. exchanges has since been in question. That includes some of the hottest technology stocks in the world (Alibaba, JD.com …).

But overnight, we had some news out of China that may have marked an end to the Chinese government saber-rattling. China “vowed to keep its stock market stable and support overseas share listings.” Alibaba ended the day up 36%.

Pro Perspectives 3/15/22

March 15, 2022

Stocks rallied ahead of tomorrow’s Fed decision.  As it stands, we head into a tightening cycle with stocks (S&P 500) down 11% from the record highs (and from the highs of the year).
 
This decline has reset the valuation on the broad market (lower “P”) — down to a forward P/E of 18.5.  That’s above the long-term market average (about 16), but it’s not expensive. 
 
Historically, when rates are low, the P/E tends to run north of 20x.  Even if the Fed were to ramp the Fed Funds rate to 2% this year (which would be considered an aggressive scenario), rates are still accommodative (i.e. stimulating growth).
 
What about the “E” in the P/E? 
 
As we observed in Q4 earnings season, margins are solid – better than the year ago comparison, and better than the five-year trend.  Why?
 
Higher input costs are being passed along to consumers through higher prices.  And consumers, while not happy about higher prices, are in a position of strength to maintain their standard of living (with a strong balance sheet and leverage to command higher wages).
 
For companies, inflation means higher nominal prices, which will result in higher nominal revenue.  With that, analysts have been revising UP revenue estimates for Q1.  And the expectation is for margins to hold in above 12%, which is above the 5-year average.  Add to this, companies are taking advantage of crisis to dial down expectations.  This is a formula for earnings beats (yet again) in Q1.  And positive earnings surprises are fuel for higher stock prices. 
 
So, we may find that the behavior of investors over the past two months has followed a long-standing investing maxim:  “selling the rumor, buying the fact.”  In this case, “selling the anticipation of the first Fed rate hike … and buying on the actual event.” 

 
 

Pro Perspectives 3/14/22

March 14, 2022

 
After two years of massive government and central bank intervention, that created almost $6.5 trillion of new money, the Fed will begin reversing these policies on Wednesday.
 
Despite months of telegraphing this move, we opened this week with the 10-year yield at just 2%.  That's also despite a new catalyst that may spike an already high inflation rate (i.e. the recent spike in oil prices).
 
So, why is the interest rate market not pricing in an impending Fed inflation battle?
 
Because they are betting on the "demand destruction" thesis.  They think higher prices will solve higher prices.  In the case of gas prices, we know $4 gas has, historically, proven to be a psychological level that changes consumer behaviors.  We saw it in 2008, 2011 and 2012.
 
But the economy is in a very different position this time. 
 
Ten years ago, consumer and corporate balance sheets were wrecked.  The economy was barely growing, even with maximum support from the Fed (QE and zero rates).  And the job market was abysmal with unemployment running around 8%, and about a fifth of the employed were "underemployed."  With these conditions, add in $4 gas and you will get demand destruction.  
 
Fast forward to today:  As we know, asset prices have reset higher (following the onslaught of new money creation).  But, very importantly, the job market is tight and wages are adjusting for the rise in asset prices.  And consumer and balance sheets are strong.
 
The demand destruction scenario is far less likely given this backdrop.
 
It's when the Fed ratchets rates high enough to reverse hot inflation, that the demand destruction will come.  Until then, the sprint on the treadmill will become increasingly faster to maintain quality of life, in the face of high prices.      

Pro Perspectives 3/11/22

March 11, 2022

 
As we end the week, let’s take a look at the year-to-date performance of global asset prices. 
The translation of this graphic:  Lower net worth (a quick hair cut in equity values), while simultaneously facing higher prices of everything.  No surprise, consumer sentiment has been, and continues to be, tanking. 
 
Is the global war-threat to blame?  Or is the Fed to blame?  
 
History would tell us, it’s the latter.  The Fed is typically the culprit for ending economic expansions.  In this case, the Fed has waited way too long to address the clear inflation formula that has been brewing from the covid policy response. 
 
They will start the rate liftoff next week, almost 800 basis points behind the year-over-year inflation rate.  
 
What was the Fed Funds rate when inflation finally peaked in 1980 at nearly 15%?   17.6%. 
 
What about the spike in 1974-1975?  Inflation started to come under control, only after the Fed ratcheted rates up above the level of inflation.  In late summer of ’74, inflation was running 11.5%.  The Fed took rates up to 13%.

Pro Perspectives 3/10/22

March 10, 2022

Inflation came in hot this morning, as expected.  And with the recent pop in oil prices, the next inflation reading will likely be in the double-digits (year-over-year). 
 
With that, the Fed starts is inflation chase next week (beginning the rate hiking campaign).  The European Central Bank began setting expectations for a similar plight this morning (telegraphing an end of bond buying and a rate liftoff).  
 
Let's talk about  Europe …
 
Remember, last week we looked at the euro, as the proxy for trouble in Europe.  The common currency of Europe has been on the slide since the Russian invasion in Ukraine.  And today, despite a hawkish ECB, the euro ended lower.
 
There are plenty of things to worry about in Europe.  Telegraphing a tightening campaign to address the hottest inflation in 30 years, in the face of downgraded growth is one (thing to worry about). 
 
Another, is ending the asset purchase program (by Q3) that has been the force behind maintaining stability in the sovereign debt market in Europe (i.e. ECB intervention/bond buying has kept countries like Italy, Spain, Portugal and Greece solvent since the days of the financial crisis). 
 
The ECB ending its backstop of the weaker euro zone countries, alone, could create a dangerous spike in European sovereign bond yields.  
 
This, as we are just in the early days of discovering what European (and global) banks are directly or indirectly exposed to Russian debt. 

Pro Perspectives 3/9/22

March 9, 2022

The risk environment had a huge bounce today.  But don’t get too excited.
 
Remember this chart (we looked at last month) …  

After two years of a liquidity deluge, we’re now seeing the effects of illiquidity on markets.  Translation: The swings become exaggerated.
 
By this time tomorrow, markets will have digested another big CPI number.  And as we’ve discussed, with oil prices gapping higher, people will begin to extrapolate out the next CPI print (for March).  It will be bigger (likely, much bigger), not smaller.
 
On the Russia/Ukraine front:  Headlines will continue to create confusion/ whipsaw in markets.  Overnight there was (again) talk that a potential cease fire was coming, and perhaps a concession on Ukrainian territory. 
 
The safe assumption:  This won’t be a two-week war.  
 
Back in 2014, when Russia annexed Crimea, the timeline was nine months, and the scale of global escalation is far greater this time.  
 
With the above in mind (existing inflation + further commodity supply shocks, driven by geopolitical strife), dips in commodities prices (and commodity stocks) are a buy.   
 
What’s not a buy?  Bitcoin. 
 
Bitcoin rallied today on an executive order from Biden to “ensure the responsible development of digital assets.”   This followed a statement last night, in kind, by the U.S. Treasury.
 
This got the crypto-enthusiasts excited, as they assumed this meant the government is taking steps toward accepting and legitimizing private cryptocurrency.  It’s precisely the opposite.  As the executive order says, “sovereign money is at the core of a well-functioning financial system, macroeconomic stabilization policies and economic growth.”
 
The government wants to regulate away private crypto and strengthen their monopoly on money through a “central bank backed digital currency.”  Remember, back in June of last year, Elizabeth Warren held a hearing on this.  Warren made it clear that a central bank-backed digital dollar would “help drive out bogus digital private money (bitcoin, stablecoins, etc.).”  This executive order starts the ball rolling, toward this goal — and a cashless society (not good).  
 
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