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January 19, 2023

If we look back over the past 13 years, investors have had plenty to worry about.

Let's step through the post-Great Financial Crisis period.

Following the global government and central bank rescue efforts and stimulus of 2009, Wall Street told us the era of developed world dominance had come to an end, and that the future of investing was in China. By 2010, it was obvious that China couldn't thrive while the Western world economies were suffering. The slowdown in China became the worry for markets.

In 2011, during a debt ceiling fight on Capitol Hill, Standard and Poor downgraded the U.S. credit rating, cutting it from AAA.

Next up, Europe: Europe was on the brink of a sovereign debt default and collapse of the euro, over the course of a few years.

Then we had Ukraine/Russia 1.0. Then the Chinese stock market crashed, and China shocked global markets with a surprise currency devaluation.

Then oil prices crashed.

Then Trump entered, and was immediately impeached.

Then the world was shaken by the U.S./China trade war. Then we had a global pandemic. Then we had rampant, 40-year high inflation. And then we had Ukraine/Russia 2.0.

Along the way, stocks climbed the wall of worry. Including dividends, the S&P 500 delivered eleven wining years, averaging 17.6% — and two losing years, averaging down 11.3%. Fourteen years later, and throughout all of the chaos listed above, every dollar in the stock market is worth $3.48.

Here we are in 2023, and again, there is plenty to worry about, including another debt ceiling saga. Why does a "wall of worry" tend to be constructive for bull markets? Because it breeds positive surprise.

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Pro Perspectives 1/18/23

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January 18, 2023

The Bank of Japan held its ground overnight. They kept key short term rates negative. And they maintained the cap on their 10-year government bond yield at half a percent.

So, Japan continues with pedal-to-the-metal stimulative policy, even as inflation is running at four decade highs. And even as the rest of the world is well into tightening campaigns.

What did the the BOJ governor have to say?

He said he wouldn't hesitate to ease further if necessary.

He said it's important to support the economy.

And he said it's important to encourage companies to raise wages.

These are three diametrically opposite initiatives of that of the rest of the Western world.

The Fed has threatened to tighten more (err on the side of too tight), has explicitly worked against the economy, and has outright wanted to suppress wage gains.

For context, it's important to remember that Japan has been attempting to reverse nearly three decades of deflation. Former Prime Minister Abe was elected 11 years ago on the promise of ending the economic malaise and deflationary vortex that had troubled Japan for more than two decades. And he hand-selected a governor of the Bank of Japan (Haruhiko Kuroda) to execute an all out war on deflation.

So Kuroda is not going to let up (not on his watch). After dealing with three decades of deflation, he's going to let the economy run hot. And he's focused on preserving standard of living (against inflation) by encouraging wage growth. Meanwhile, hot nominal growth solves a lot of problems. It's a recipe for inflating away the government debt burden (Debt/GDP goes down).

It's a logical game plan. And it's a game plan the Fed and Treasury appeared to be executing in the early response to the pandemic shut-down. They erred on the side of being over-aggressive. They printed and they spent, and they restored economic output inside of a year. They stoked hot nominal growth, which inflates away the debt burden.

But then the political pendulum shifted, and restoring economic prosperity was abandoned for the global climate agenda.

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Pro Perspectives 1/17/23

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January 17, 2023

On Friday we talked about the signal gold may be sending.

Perhaps this will be the year that consequences are levied for $10 trillion-plus of deficit spending, globally, in response to the pandemic.

Of course, that was adding to what was already an unsustainable global sovereign debt situation.

It's a bubble.

And as we've discussed often here in my daily notes, it seems to be building toward a global debt restructuring, and a new currency regime (likely coming in the form of central bank backed digital currencies).

If that indeed is the ultimate destination, will it be slow moving, or will it be event driven (a shock event)?

With the above in mind, on Friday we looked at Japan as a hot-spot and potential catalyst for the onset of another crisis in global sovereign debt markets.

Global interest rates have been rising. Japan, having the world's largest debt load, relative to the size of its economy, is most vulnerable to rising interest rates. That's why the Bank of Japan has held rates near zero, despite the rest of the Western world ratcheting rates 250 to 450 basis points higher.

The rapid growth in that interest rate spread promotes the flight of capital OUT of Japan, and in search of higher yield. And the pain of that dynamic is only compounded by speculative capital trading the direction of those capital flows (i.e. out of Japanese assets, out of the yen).

Add to this, with inflation rising to four-decade highs in Japan, the Japanese government bond (JGB) market would be in sharp decline IF it were left to market forces.

But as we know, the Bank of Japan is in control of the government bond market. It is keeping a lid on JGB yields, through its "yield curve control" program. The question is: Are they losing control?

Will the selling pressure in JGBs become so great, in combination with the broader market forces of inflation and higher global interest rates, that the Bank of Japan is forced to back off, at some point, and let its bond market go (i.e. let market forces determine the appropriate interest rate)?

The Bank of Japan is meeting now, and will decide on monetary policy tonight (Wednesday afternoon in Japan). This may not be a graceful exit of emergency polices by the Bank of Japan.

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Pro Perspectives 1/13/23

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January 13, 2023

We end the week with stocks on the highs, and (still) trading into this big trend line that represents the bear market of last year.

We had a positive catalyst for stocks on Thursday, with the weak inflation report. And we had another positive catalyst today, as the big banks kicked off Q4 earnings season with solid performance.

Three of the four big banks beat earnings estimates. But each also set aside more reserves for potential loan losses — to the tune of $2.25 billion (between the four). And that is added to what is already a war chest of capital that remains in the coffers from the worst of the pandemic period.

If we add back these new Q4 allowances for potential loan losses, all four of the biggest four banks in the country would have beat earnings estimates, AND improved on the earnings from the same period a year ago.

So, as we discussed yesterday, Wall Street has been wrong on Q4 economic growth, and based on the bank reports today, it’s a safe bet that they have undershot on earnings growth in Q4.

Let’s take a look at gold …

Gold has been on a tear, up nearly 6% on the year, already. It closed on the highs today, and at the highest level since April of last year. It’s only $150 from the record highs.

Is gold finally signaling that the unsustainable global sovereign debt bubble is going to be pricked this year? Maybe.

And it may come from Japan. Japan has been fighting the deflationary vortex for the better part of the past thirty years. They’ve printed yen, and inflated debt, with no inflationary consequences — until now.

In fact, the post-covid global inflationary environment may prove to have been the perfect storm for stoking inflation in Japan. Inflation is running at a four decade high, and the Bank of Japan looks like it may lose control of the Japanese government bond market (JGBs).

The Bank of Japan has been intervening, daily, trying to contain the yield on 10-year JGBs to 50 basis points (part of their "yield curve control" program).

The question is: If they back off of this band, altogether, how low will the value of JGBs fall, and how fast?

I suspect that's why gold is heading for record highs.

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Pro Perspectives 1/12/23

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January 12, 2023

We’ve spent the week talking about the setup for a weak inflation report, and a bullish breakout in stocks.

We got the former this morning. The latter is yet to be determined.

As expected, there were well-placed Fed speakers, lined up, following this morning’s inflation data, ready to counter the optimism about the prospects of a less restrictive Fed, with promises that they would not be less restrictive.

But the credibility of the Fed’s tough talk is rapidly deteriorating, as the monthly change in prices, over the past seven months, averages to just 0.12%. Annualize that, and inflation has been running below the Fed’s 2% inflation target, for many months now.

The focus now turns to earnings and the health of the economy.

How much damage has the Fed done to consumer and business behaviors?

Earnings season will kick off tomorrow, with Q4 reports from all of the big banks. Head of the largest bank, Jamie Dimon, said earlier in the week that the consumer is still strong, balance sheets are in good shape, and “they are spending more than pre-covid.”

Those comments give us nice clues on what the banks should say tomorrow.

With this in mind, let’s take a look at how the economy performed during this Q4 period.

As you can see in the above, the Atlanta Fed's model (the green line) has Q4 GDP growth at better than 4% annualized. Importantly, you can see in the same chart that Wall Street's projection (the blue line) has been much lower, all along the way.

With that in mind, if we look at Q4 earnings expectations, it should be no surprise that the Wall Street analyst community has spent the past several months dialing down earnings expectations for Q4. They've gone from expecting 3.5% earnings growth (back in September), to the expectation of a 4.1% decline now.

So, we'll see in the coming weeks, if the street was as wrong on earnings as they appear to have been on Q4 growth.

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Pro Perspectives 1/11/23

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January 11, 2023

We head into tomorrow's huge inflation report, with stocks closing on the 200-day moving average (the purple line in the chart below). And trading just below this trendline (yellow) that represents the bear market of 2022.

A weak inflation number tomorrow, would be a clear catalyst for a bullish technical break out in stocks.

Let's take a look at the CPI index …

You can see in this chart, inflation over the past six months on this headline index has already leveled off. The rate-of-change in prices, inflation, has clearly been curtailed. That's good!

But even if tomorrow is a seventh consecutive month of mild monthly inflation, when measured against the low base of twelve months ago, it's still a big number (and will be for months ahead). In fact, even if the November to December change in prices within this index, were zero, the year-over-year inflation would still be 6.8% inflation. This the "base effect" that the Fed once used, back in 2021, to dismiss inflation as "transitory."

Bottom line, what matters is the monthly change in prices. With that, let's look at some inputs into CPI that we know. Will it be weak?

First, gas prices: The Energy Information Administration (EIA) does a weekly survey of gas stations across the country. Those survey results show a decline in gas prices by about 8% in December (and down 35% since June). Transportation carries almost a 1/5th weighting in the CPI calculation.

Used Cars: The Manheim used car price index was UP less than 1% in December. That breaks a sixth months of consecutive price declines. Overall used car prices were down 15% from the beginning of the year.

New Car prices: Cox Automotive says average new car prices were up 1.9% in December..

Rents: The Apartment List Rent Report showed a fourth consecutive monthly decline in rents, down 0.8%.

House prices: Redfin.com says the median house price was up 1.3% from November to December. That's down 8% from the June peak. What about mortgage rates? Mortgage rates finished December about 17 basis points higher than the month prior.

And we know from the ISM services report, released earlier this week, services prices were down in December.

Food is the only big component remaining: This has been a hot area of the inflation report this year, finally showing some signs of cooling in November. As a proxy, the FAO Food Price Index, which measures global food prices, fell in December for a ninth consecutive month.

So, the price data look mixed in December. But as we know, the government data tends to be stale. If we look back at end of November data, from these same sources listed above, prices were broadly declining.

With all of this in mind, by no coincidence, the Fed has three officials (speakers) on the calendar before midday tomorrow.

We should expect them to continue doing what they've been doing: Combatting optimism, with threats of higher rates at the economy and financial markets, in order to keep a lid on confidence.

As we discussed yesterday, with the 10-year yield at 3.55% heading into tomorrow's number, the bond market isn't in agreement with the Fed's narrative. That gives courage to stock investors.

Pro Perspectives 1/10/23

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January 10, 2023

As we discussed yesterday, we should expect a big reaction in stocks from this Thursday’s inflation report.

The history of the past four months would suggest so (something on the order of 5%).

And with the inflation data trending toward a soft, if not negative, monthly change in inflation, it sets ups for a bullish breakout in stocks.

As you can see in the above chart, stocks were testing this big trend line (in yellow) and the 200-day moving average (in purple) last month, heading into the CPI report. The number came in soft. But the Fed meeting was a day later, and they attempted to crush any optimism about an end to the tightening cycle. Stocks went lower.

The stock market bought the message the Fed was selling. But the bond market didn’t.

At today’s close the 10-year yield is 150 basis points below where the Fed is projecting the Fed Funds rate at year end. As the bond king, Bill Gross, points out, the historical average spread is just 90 basis points.

If the bond market is right, the stock market is going higher (breaking out of this downtrend).

Pro Perspectives 1/9/23

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January 9, 2023

Remember, on Friday the ISM services report showed a decline in December services prices.

As you can see in the chart below, the decline in the prices paid in this area of the economy has been dramatic, nearly returning to December 2020 levels — and the fall has been even faster than the rise (of last year).

Also remember, it has been inflation in this area of the economy (services) that the Fed has highlighted, as justification for its guidance on the rate path (higher).

Now, with the above chart in mind, it's logical to think that softening services inflation will make its way into the government's inflation report soon, perhaps in the December report that will be released this Thursday.

This, as inflation data has already been trending toward a monthly negative price change (i.e. deflation). Still, the Fed continues to put officials in front of cameras to talk about how committed they are to raising rates above 5% (another 100 bps).

This sets up for a very interesting CPI report on Thursday.

Expect a massive move in stocks.

Remember, the last four of these reports have resulted in a daily trading range in stocks (S&P futures) with a magnitude that has historically only been associated with very significant events: a 5.8% range on September 13th, a 5.4% range on October 13th, a 5.9% range on November 10th and a 4% range on December 13th.

Pro Perspectives 1/6/23

January 6, 2023

We had the December jobs report this morning.

The labor market remained tight last month, despite a Fed that has been verbally attacking jobs for the better part of the past year.

Why does the Fed want to induce a softer job market? Wages.

In a labor supply shortage, employees should have leverage in negotiating higher wages, particularly in what has been a hot inflation environment. With that, the Fed has feared an upward spiral in wages, where wages feed into higher prices, which feeds into higher wages … and so the self-reinforcing cycle goes.

It hasn’t happened. Wages have well lagged the inflation of the past year. And the wage component of the December jobs report showed no signs of trouble with wage growth.

How did markets do today? Yields fell sharply. Stocks were up big.

But much of the action today in markets was driven, not by jobs, but by another December report that came later in the morning.

The ISM services report showed a contraction in business activity in December, after 30 consecutive months of growth.

The last time the services industry contracted was covid. The time before that was the Great Financial Crisis.

Related to this, take a look at the chart of services prices from this morning’s report …

This is important: While goods prices and energy prices have been falling in the government’s inflation report, it has been services prices that have been persistently hot. That has been the Fed’s rationale for “keeping at” the inflation fight.

As we’ve said here in my daily notes, the real-time data has been telling us for months that those services prices have been rolling over. It just hasn’t been reflected yet in the stale government inflation report. This chart above supports that view.

And with that, the bond market is telling us that the Fed that has overdone it on rates, already.

Pro Perspectives 1/5/23

January 5, 2023

With a split Congress we should expect Capitol Hill to be noisy, but with little-to-no action. The latter is what matters. No action in DC is a positive for the economy and markets, following the reckless, and inflationary policy making of the past two years.

Ignore the noise.

The catalyst for global markets and economies continues to be interest rates.

And as we discussed yesterday, we should see a much slower rate-of-change in interest rates in the U.S., relative to last year (maybe zero rate of change). And with that, we should expect the interest rate differential between the U.S. and much of the rest of the world, to narrow (as other major central banks play catch up to the Fed’s moves of the past year).

A faster rate of change in foreign interest rates, relative to the U.S., means money will move out of the dollar (weaker dollar).

For those searching the world for value, with a catalyst, it can be found in emerging market Asia. If history is our guide, this is likely where we will see the best stock market performance in the world over the next few years.

As of October of last year, Morgan Stanley says the decline in the MSCI Emerging Markets index had exceeded the decline in the previous 10 bear markets, including the 1997 Asian Financial Crisis. Stocks in Hong Kong have already jumped nearly 50% since (October).

And now we have a catalyst in China for the Asia trade, with the Chinese government scrapping its zero covid policy, AND stimulating (both fiscal and monetary).