Pro Perspectives 1/21/25

 

 

 

 

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January 21, 2025

On inauguration day eight years ago, the Washington Post published a story at noon (as Trump was being sworn in) with the headline, The campaign to impeach President Trump has begun.
 
Much of the next three years was under the cloud of impeachment threats. 
 
The actual impeachment vote in the House didn't come until December 19, 2019, which was just six days after the Trump administration's successful execution of the "Phase 1" trade agreement with China (which, by design, existentially threatened China's ability to manipulate global economic advantage).   
 
The Senate impeachment trial started a month later, and ended on February 5th (2020) in acquittal.  And then a month later, a global pandemic was declared, originating from China. 
 
Despite all of this, and a multi-year trade war, the three years of Trump 1.0, prior to covid, resulted in an economy that grew at an average of 2.7% annualized (the best three-year average growth since 2007), with an average of just 1.7% inflation (PCE).
 
Fast forward to today, and the second Trump term is now underway.
 
Good news:  No impeachments, so far. 
 
That said, a key part of the agenda includes cleaning house of the entrenched bureaucratic resistance.  If successful, that should minimize the obstruction against executing the Trump agenda.
 
And that agenda is pro-growth, pro-business and pro-national interests.  That puts America in sharp contrast to the rest of the world, which is fresh incentive for global capital to flow into the American economy (good for the dollar, good for Treasury demand and good for stocks).
 
We're already seeing it today, with Japanese investor Masa Son visiting the White House to announce a deal to invest as much as $500 billion on AI infrastructure in the U.S.
 
Remember, as we discussed last month, global policy making has been intentionally synchronized in the post-pandemic era (even much of the post-Global Financial Crisis era).
 
But that synchronization has broken, with the populist political shakeup in the U.S.
On that note, we looked at this chart of business optimism last month (U.S. relative to Europe). 
 
 
What's reflected in this chart above? 
 
The U.S. is now pursuing cheap and abundant energy, scrapping stifling regulations and cutting taxes.  Europe is doing the opposite.
 
But it's not reflected in this next chart … yet. 
 
 
Both U.S. and German stocks sit on record highs. 
 

Pro Perspectives 1/16/25

 

 

 

 

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January 16, 2025

We heard from Scott Bessent today, the next Treasury Secretary.

Right up front, in his opening remarks of his Senate confirmation hearing, Bessent addressed the dollar. 
 
He said, "critically, we must ensure that the dollar remains the world's reserve currency."
 
And with that, he rejected the need for a central bank digital currency.  
 
He called on Congress to make the Trump tax cuts permanent, and to communicate it to markets, which he thinks would unleash animal spirits and "a new golden age" for the economy.
 
How did markets react to the incoming Treasury Secretary's three-hour long Senate hearing?  Surprisingly, minimally.
 
That's because Bessent was upstaged by some dovish Fed comments that hit the wires in the half hour prior to the start of the confirmation hearing.
 
As we discussed yesterday, a couple of Fed officials over the past two weeks have attempted to temper market perceptions that inflation pressures are building again, perceptions largely driven by views on the Trump agenda.
 
Just a few days ago the market was pricing in just one quarter point rate cut for 2025, while the most recent Fed Summary of Economic Projections (from the December meeting) was looking for two quarter point cuts this year.
 
How worried is the Fed about the market's mis-aligned view? 
 
Well, today they (the Fed) marched Fed governor Waller out in front of a camera on CNBC to tell us that "three or four cuts could be possible this year," if the data cooperates.  And that, he "could certainly see rate cuts happening sooner than the markets are pricing in."
 
This is likely a response to this chart …
 
 
 

Pro Perspectives 1/15/25

 

 
 

 

 

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January 15, 2025

The big banks kicked off Q4 earnings season this morning.

As we discussed yesterday, this is expected to be the highest earnings growth quarter for the S&P 500 in three years, at 12% year-over-year (yoy) earnings growth.

If the banks are any indication, it’s going to be another quarter of big positive earnings surprises.  From this morning’s reports, the average earnings growth for JPM, Wells Fargo and Citi was 48%.

The banks have been putting up big tech-like growth numbers, but trading at an average valuation of less than half the market forward P/E.  And between the three (JPM, WFC and C), they have over $60 billion in loan loss reserves that they can turn into earnings at their discretion.

And the tailwinds of M&A, IPO activity and deregulation are coming.

Does this indicate a resurgence of inflationary pressures?

Two vocal Fed voters (Waller and Goolsbee) have been countering this narrative over the past two weeks.

They’ve been reminding markets that the “base effects” in PCE and lagging features within CPI are propping up the year-over-year inflation data.

What does that mean?

The headline CPI number ticked UP to 2.9% in this morning’s report.

Waller (Fed governor) has made an attempt to cool the perception of an inflation resurgence by pointing to the lagging features in the data.

Here’s what he’s talking about:  Of that 290 basis points of year-over-year increase in prices (CPI) in December, 163 basis points of it was auto insurance and rent (Owners’ Equivalent Rent – OER).

It’s heavily influencing CPI.

In the case of OER (which is nearly a third of CPI), it’s old data – not reflecting the current rent climate.  As you can see below, the national median asking rents (from rent.com) have been mostly declining for more than a year.

On “base effects,” Austan Goolsbee, the Chicago Fed President (and voter on monetary policy this year) has been emphasizing the more recent PCE trend — the annulaized monthly PCE of the past six months, which is running right around the Fed’s 2% target.

 

Pro Perspectives 1/14/25

 

 

 

 

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January 14, 2025

We had the second post-election small business optimism report this morning.  And as we suspected back in November, a repeat of the Trump effect is back for small business.
 
Optimism surged again in December, to a six-year high …
 
 
This surge of the past two months was after spending 34 consecutive months UNDER the 50-year average.
 
And as you can see in this next chart, small business earnings is coming off of the lowest levels since the Great Financial Crisis. 
 
 
So, the past four years have been good for Wall Street, but haven't been good for small business. 
 
But notably, the highest point on this small business earnings chart was delivered by the first Trump administration.  And this recent survey says small business owners expect better growth, lower inflation and better business conditions under Trump (2.0), but they expect it to be "a bumpy ride."    
 
We get CPI tomorrow, and we hear from three of the four big banks on Q4 earnings.
 
This will kick off what is expected to be the highest earnings growth quarter in three years. 
 
So, there will be a lot for markets to digest tomorrow.  In the case of a hot inflation number and hot earnings, we should expect the trajectory of this chart to be most important.  
 
 
We've talked about this 5% level for the 10-year yield (likely the danger zone for financial stability and fiscal sustainability).  This is where the Fed flipped the script in October of 2023, and signaled the end of the tightening cycle, suggesting that the bond market had done the tightening for them. 
 
That said, look where inflation expectations were at that time, relative to now …
 
 
As we discussed yesterday, if bond yields test the 5% level again, we should expect the Fed to quickly swing the pendulum to unanimously dovish, and be vocal about it, in order to talk bond yields down. 

Pro Perspectives 1/13/25

 

 

 

 

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January 13, 2025

We've talked about the bond market as a shock risk that could quickly get to a flashpoint. 
 
With that, the strong jobs number this past Friday has extended the surge in the U.S. 10-year yield to as high as 4.80%.  That's the highest level since November of 2023 (more than a year ago).
 
And as we've discussed, this rise in bond yields (which has diverged from the direction of Fed policy) has put pressure on stocks.  
 
Let's take a look at a couple of charts …
 
 
Above is a look at the interest-rate-sensitive small caps index. 
 
The trendline represents the bull cycle for small caps that started in October of 2023, when Jerome Powell signaled the end of the tightening cycle.
 
If we look at the Russell compared to the less rate sensitive Nasdaq (below), we can see these divergences along the way. 
 
In this first circle, the divergence closed with the Russell falling (the orange line), as the Fed started curbing what were very aggressive rate cut expectations priced into markets.   
 
 
In the second circle, the divergence gap was closed with a sharp rise in the Russell.  And it was triggered by inflation data that showed the first monthly price decline since May of 2020. 
 
And now, in this third circle, we have another divergence between the Russell and Nasdaq, with small caps now in a 12% correction.  And this comes as we enter another big inflation data point to be reported on Wednesday (the December CPI report).  
 
With that, we go into this inflation report with the market already leaning in the direction of a more hawkish rate path for the year than the Fed has projected (which has weighed on small caps). 
 
The market is now pricing in just one quarter point rate cut for 2025, while the most recent Fed Summary of Economic Projections (from the December meeting) is looking for two quarter point cuts this year.
 
So, what are CPI expectations?  Pretty hot. 
 
Reuters has the monthly headline inflation change expected at 0.3%.  The Wall Street Journal's consensus Wall Street view is higher at 0.38%.  
 
A positive surprise (i.e. a touch softer inflation) would relieve some pressure in the bond market, and fuel a bounce in small caps. 
 
A hot number would push yields toward 5% (and stocks a lower) …
 
 
If so, we should expect a 5% yield on the 10-year Treasury to be the "uncle point" for the Fed, again. 
 
We should expect a similar response to what we saw in October of 2023:  A Fed that will quickly swing the pendulum to unanimously dovish, and be vocal about it, in order to talk bond yields down. 
 

Pro Perspectives 1/8/24

 

 

 

 

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January 08, 2025

We've talked about the divergence in the interest rate market, between the direction of the benchmark interest rate that the Fed sets (the Fed Funds rate), and the benchmark interest rate that's determined by the market (i.e. the U.S. 10-year Treasury yield).
 
The Fed has cut the Fed Funds rate by 100 basis points since September, and yet the U.S. 10-year Treasury yield has gone UP by over 100 basis points.
 
And as we've discussed, we have this breakout in yields.  If this continues to extend, the probability of a financial shock event rises.  
 
 
This move in the 10s has been attributed to inflationary policies of the incoming Trump administration. 
 
The minutes from the December Fed meeting were released today, and revealed that Fed officials did indeed adjust their inflation outlook based on their view of Trump policies — and they also cited concerns that upward pressure on inflation could come from continued "positive sentiment in financial markets and momentum in economic activity."
 
If this is the driver of the activity in the U.S. bond market, then we shouldn't see a similar dynamic unfolding in European bonds, where there is no economic momentum, and where Trump trade policies would be disinflationary, if not deflationary.
 
If we look at Germany, the historic growth engine of Europe, the economy has five years of no growth, which is expected to continue in 2025.  The European Central Bank has cut rates by 100 basis points since June, and yet the German 10 year yield is also breaking out (i.e. higher) …
 
 
The UK economy is flatlining.  The Bank of England has cut rates 50 basis points since August, and yet the yield on the 10-year gilt is breaking out (i.e. higher) — now trading at the highest level since 2008. 
 
 
A couple of things to keep in mind:  1) The government debt burden (as percent of GDP) in the UK has more than doubled since 2008, amplifying the debt service burden … and 2) just a little more than two years ago, the Bank of England had to intervene in the bond market at these levels to avert a financial meltdown that would have spilled over globally. 
 

Pro Perspectives 1/7/24

 

 

 

 

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January 07, 2025

Jensen Huang gave the keynote to kick off the Consumer Electronics Show (CES) in Las Vegas last night.
 
Let's talk about what the guy that runs the most important company in the world had to say about the future.
 
He laid out the waves of AI in this graphic below. 
 
 
It started with the "ChatGPT moment" just a little more than two years ago.  This was the introduction of generative AI, and it set into motion the race to "retool" the world's data centers to accelerated computing.
 
The big hyperscalers have already spent a couple hundred billion dollars, and might only be one-fifth of the way there.
 
The next wave is "agentic AI."  This is the digital workforce.  It's already happening — autonomous agents performing tasks and operating independently of direct human control. 
 
Jensen sees agentic AI as a multi-trillion dollar industry.   
 
And this leads into the theme of 2025, which is physical AI. 
 
This is AI systems integrating with the physical world.  And Jensen has said in the past that physical AI will reshape $100 trillion worth of global industry.
 
So, this is the big takeaway from the presentation.  It's about robotics. 
 
And Jensen says "the 'ChatGPT moment' for general robotics is just around the corner." 
 
He says over the next several years, the combination of agentic AI robots, autonomous cars and humanoid robots will become "the largest technology industry the world has ever seen."
 
Remember, Elon Musk thinks with the introduction of humanoid robots into the world, there will be "no meaningful limit to the size of the economy."
 
This all makes incremental surprises in daily economic data, the uptick in global bond yields, and parsing Fed communications on the next quarter point rate cut, seem relatively unimportant. 
 
But just as the technology revolution of the late 90s, driven by internet adoption, drove a stock market and economic boom, there were shocks along the way (like the Asian Currency Crisis, Russian Default and the related failure of the hedge fund Long-Term Capital Management).
 
And with that, we have plenty of shock risks that warrant respect. 
 
Among them, the one that could quickly get to a flashpoint is the bond market.  
 
Remember, we looked at this chart in my Dec. 23 note (here).
 
 
As we discussed in that note, the big downtrend in the U.S. 10-year Treasury yield has broken.  Yields have now moved 110 basis points higher, despite the Fed taking the Fed Funds rate 100 basis points lower.
 
And remember, the current Treasury Secretary, Janet Yellen, has left the bond market in a vulnerable position, by financing record peacetime deficit spending with short-term maturities.
 
That leaves incoming Treasury Secretary, Scott Bessent, with a third of the outstanding government debt to be rolled over this year, creating risks for rate volatility (a bond market attack) and “the potential for a financial accident.”

Pro Perspectives 1/6/24

 

 
 

 

 

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January 06, 2025

Happy New Year!  Stocks are already off to a good start, globally.

Commodities are climbing.  And so are government bond yields, at least in the Western world.

It all appears to reflect expectations of a more business friendly, market-determined economic environment coming to the U.S. on January 20th.   

And the political regime change in the U.S. is beginning to influence change elsewhere, as we discussed in my note last month. The populist pushback is bubbling up in Europe and in Canada (with Trudeau’s resignation today).

Like the beginning of last year, the market is expecting rate cuts this year.  But unlike the beginning of last year, the expectations on how many have already been tamed by the Fed over the past three months.  

With that, the easing cycle today isn’t the powerful tailwind for stocks. The tailwind is growth, driven by Trump policies — more specifically, the probability of a positive surprise on what is a very low expectation bar set by the Fed.  They are looking for just 2.1% GDP growth for 2025.

The other, bigger tailwind:  the new industrial revolution.  It’s driven by generative AI, and continues to be in the early innings of adoption.

And we should expect the attention to this tailwind to be amplified this week, as the most powerful tech event in the world will be hosted in Las Vegas.

The big Computer Electronics Show (CES) kicks off tonight with a keynote by Nvidia’s Jensen Huang.

It was the excitement around Jensen’s CES talk last year, in early January, that sparked the big Nasdaq rally — and as you can see, it never looked back.  

Last year, CES was all about “the digital world meeting the physical world.” 

The CEO of Siemens called 2024 a “turning point” where real and digital worlds converge.

We should expect the clear emergence of that theme in 2025, as AI-powered robots become part of the workforce, and soon-to-be part of everyone’s daily life. 

 

 

Pro Perspectives 12/23/24

 

 
 

 

 

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December 23, 2024

As we near year-end, let’s take a look at the bond market.

As you can see in the chart below, since the Fed kicked off the easing cycle back in September, the 10-year Treasury yield has moved almost 100 basis points higher as the Fed has taken the Fed Funds rate 100 basis points lower.

 

And as you can see in this next chart, with this rise in the 10-year, the big downtrend in yields has broken.

And this trendline is significant.  It represents the regime change in monetary policy, signaled by Jerome Powell back in October of last year — when he signaled the end of the tightening cycle.

The 10-year yield proceeded to fall as much as 140 basis points on the anticipation of an aggressive Fed easing cycle.

But when the easing cycle actually began, yields went straight up – now back at 4.58%, having broken above this big trendline.

What’s going on?

Is it reflecting a Trump-agenda-fueled outlook for higher growth and higher inflation?

Or is it reflecting potential trouble in the bond market?

On the latter, let’s revisit an excerpt from my note last month (here), where we discussed (now Treasury Secretary nominee) Scott Bessent’s concerns about Janet Yellen’s handling of the deficit.

Bessent argued that Yellen financed it in a way that traded short-term gain (in attempt at political gain) for medium and long-term economic pain — leaving the pain for the next administration.

As you can see in the right side of the chart below, the government has been funding the largest deficit spending in peacetime history, by issuing an unusually large proportion of short-term debt (Treasury bills, the blue bars).   

By funding more of the deficit with shorter dated Treasury bills over the past year, Yellen paid more to borrow, as short term rates were higher than long term rates (an inverted yield curve).

But by focusing on Treasury bills, and limiting the increase in longer-term bond issuance, Yellen was able to influence longer-term interest rates lower or prevent them from rising further.

Bessent has made the case that this looks like Yellen purposely manipulated financial conditions through this strategy to “goose the economy.”

And now, for the new administration, these short term Treasury Bills will have to be refinanced, creating risks for rate volatility and, as Bessent put it, “the potential for a financial accident.”

We have a lot of tailwinds for 2025, but we should expect the path to be bumpy.

Among the tailwinds:  The continuation of the new industrial revolution (powered by generative AI), and it’s in the early stages.  If you haven’t joined our AI-Innovation Portfolio, you can learn more here.

This will be my last Pro Perspectives note for the year.  Thank you for being a loyal reader of my daily notes.  I want to extend my best wishes for a Merry Christmas and a Happy and Healthy New Year!

 

 

Pro Perspectives 12/19/24

 

 

 

 

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December 19, 2024

We get the Fed's favored inflation gauge tomorrow morning.
 
But there should be little suspense.  Powell leaked it yesterday afternoon in his press conference. 
 
He said PCE for the twelve months through November should be 2.5%.  And the staff projections from yesterday's SEP (Summary of Economic Projections) suggest they see this month's number (the December PCE) ticking back down to 2.4%.
 
Let's take a close look at this "inflation target" concept.  
 
The Fed issued a formal statement on the level (2%) and their preferred gauge ("the change in the price index of for personal consumption expenditures") back in 2012 (here).
 
So, let's take a look at how they've done …
 
  
In the above chart, you can see they spent much of the post-Global Financial Crisis, pre-Pandemic decade running below 2%. And with this recent high inflation period, it leaves the 12-year average at 2.24%.
 
Keep in mind, in the middle of the decade-long bout with deflationary risks, the Fed told us that the inflation target was "symmetric."
 
And in 2020, when inflation was still sub-2%, Jerome Powell formalized this by saying they're just looking to "average" 2% over time.  He was signaling that they would let the economy run hot (for an unspecified period of time), letting inflation run above 2%, to make up for the decade of below target inflation.
 
That's happening. 
 
So, is the Fed really hyper-sensitive to this stall just above the inflation target, even if it persists for a while?  Their own formal policy, and history, would suggest the answer is no.