Pro Perspectives 2/14/22

February 14, 2022

Oil traded above $95 today, for first time since 2014.
 
Let's take a look at the chart …

What's similar and what's different about the current environment and 2014?  
 
First, throughout 2014, Russia was bullying it's way into Ukraine.  It ended with the annexation of Crimea. 
 
This time, Russia wants all of Ukraine. 
 
As you can see in the chart, oil prices rose from about $90 to a high of $108 when this conflict was unraveling back in early 2014. 
 
What happened in late 2014?  
 
In late 2014, Russia began withdrawing troops from Ukraine, and signed an EU brokered deal to begin supplying gas again to Ukraine (which flows to the EU). 
 
Oil prices began to fall.  Then, on the evening of Thanksgiving (2014), at a scheduled meeting, OPEC surprised the oil market with a well-timed announcement that they would not defend the price of oil with a production cut.

Oil prices fell about 14% over the next 24 hours (in a thin, holiday market) — and was nearly halved just two months later. 
 
What was the motivation?  They wanted to put the emerging, competitive U.S. shale industry out of business, by forcing prices below the point at which the shale companies could profitably produce.   

They nearly succeeded.  Shale companies started dropping like flies, with more than 100 bankruptcies over the next two years. 

 
What's different now?  Both domestic and global oil policy has done the job for OPEC, destroying competition (including U.S. shale).  OPEC is now back in the driver's seat, in full control of the global oil market.  They want higher prices (much higher).  
 
With that, today, with oil at $95, the Secretary General of OPEC rebuffed any ideas that OPEC might consider increasing production to stabilize oil prices.  As he should, he blamed an undersupplied market, due to the lack of global investment in new production. 
 
He said OPEC members were having challenges just meeting the current production targets (much less an increased target).  This is OPEC using the cover of the destructive global climate agenda, and the related investment withdrawal and regulatory noose placed on oil production.
 
So, OPEC now has every incentive to drive prices higher (not lower, like in 2014).
 
Add to this, unlike 2014, the Ukraine situation (as it appears) will pull the world into war, against the third largest producer of oil, in an oil undersupplied world. 
 
Prices are going higher, much higher. 

Pro Perspectives 2/11/22

February 11, 2022

Risk aversion hit markets this afternoon on the White House comments about the potential for a Russian invasion of Ukraine.
 
Without speculating on the likelihood, let's just take a look at the information to be gleaned from the market response.  
 
First, the 10-year yield completely (and quickly) reversed the move from yesterday.  So, a day after a 7.5% inflation number, and chatter of 100 basis points of rate hikes by July, global capital plowed IN to U.S. Treasuries.  This signals a "flight to safety," even in the face of likely depreciation in the value of Treasuries, given the rate outlook.
 
Another signal of flight to safety:  Gold.  Gold screamed higher on the White House/Ukraine news.  
 
What didn't perform like a safe-haven asset?  Bitcoin.  Gold went up almost 2%.  Bitcoin went down more than 2%.   
 
For something thought to be supplanting gold, it didn't perform as such (at least today). 
 
With the jawboning of war, what happened to oil prices?  Oil was up 4.5% today.  Given the global agenda to destroy fossil fuels, the underinvestment in oil exploration has led to an undersupply-meeting-pent-up-demand dynamic, which already has oil prices on path for triple-digits.  Now, add in the possible effects of "wartime," and against a country that is the third largest oil producer in the world. 
 

Pro Perspectives 2/10/22

February 10, 2022

The inflation data for January came in hot, again.  Remember, in consideration of the “inflation is petering out” scenario (believed by some), we took a look at Chinese PPI and broad commodities prices on Monday. 
 
This is the equivalent of “skating to where the puck is going.”  The price of the products we will be buying in the months ahead, will be determined (in large part) by the inputs into Chinese production (prices of which remain near 26-year highs). 
 
Commodities are the key input, and those prices, after a small dip following the Omicron new in late November, have been racing higher (as you can see in this chart below).  Add to this, the bull cycle in commodities in still in the very early stages.  

With the above in mind, the Fed is now 750 basis points behind the curve (with rates at zero and inflation at 7.5%). 
 
Not too surprisingly, comments from a Fed voting member hit the wires this afternoon suggesting the Fed could hike by as much as 100 basis points by July.  This is the Fed’s way of setting market expectations, which can be a form of (in this case) tightening (i.e. the Fed’s “forward guidance” tool).
 
A Fed that is posturing more aggressively, should be good for markets.  Remember, unlike the “taper tantrum” of 2013, the policy error this time isn’t removing emergency policies prematurely.  It’s a Fed that has been/is too late. 
 
In this case, the more, and the earlier, the better. 
 
The less, and the later, the more dangerous.   

Pro Perspectives 2/9/22

February 9, 2022

Stocks continue to make a strong comeback.  
 
Let’s take a look at the technicals in the S&P 500.  After all, I called this January decline a “technical” correction.  So, how do things look now?

As you can see in the chart above, we had a 12% correction in the S&P 500.  We've since regained the 200-day moving average (the purple line).  And today, we may have broken-out of the down trend. 
 
This, as we are getting some fundamental fuel for stocks.  Covid restrictions are easing in the more rigid states and areas of the world, signaling perhaps the release of more pent up demand.
 
Meanwhile, U.S. corporate earnings continue to defy the belief (of some) that Q4 would be a hiccup in the earnings streak.  Positive surprises on earnings and revenues, are driving a better than expected earnings growth rate for the S&P 500 (with more than half of the constituents now reported for Q4). 
 
We're on path to see nearly 30% earnings growth (yoy).  That would be four straight quarters of earnings growth above 25%. 
 
Meanwhile, stock prices have come down to begin the year, which has reset the valuation on the broad market (lower "P", higher "E"), to a forward P/E of around 20.  While that's above the long-term market average (about 16), it's not too expensive.  Historically, when rates are low, the multiple on stocks tends to run north of 20.  Even with the projected rate path, rates will be low for quite some time. 
 
Importantly, within these Q4 earnings reports we are hearing "higher labor costs."  We talked about this coming into earnings season as the expected theme of Q4. 
 
But margins are solid – better than the year ago comparison, and better than the five-year trend.  Why?  Because labor costs and being passed along to consumers through higher prices.  And demand isn't waning.  That's good news.   
 
So we've seen the reset in the price of assets (and stuff).  Now we're seeing the reset in wages (though we should expect it to be uneven).  This is the debt devaluation formula that was intentionally pursued by policymakers from the outset of the pandemic response.  Inflate nominal prices (and therefore GDP) and pay back debt with less valuable dollars.  

Pro Perspectives 2/8/22

February 8, 2022

Let's take a look at Facebook. 
 
This stock closed below pre-pandemic levels today.  It's down 34% in just the past five trading days. 

As we've discussed for quite some time, a rising interest rate environment is bad news for high valuation, high growth stocks.
 
Despite it's size and maturity (being part of the "big tech" oligopoly, and having garnered a trillion-dollar valuation just months ago), Facebook remains a high growth stock. For 2021, the company grew revenues at 37% and operating income by 42% (year-over-year).
 
With that, as Wall Street contemplates factoring in an discount rate (interest rate) in their valuation models, the valuation comes down.  
 
But how far is too far?
 
Consider this:  Facebook was trading north of 25 times earnings before Jay Powell's pivot on the inflation outlook late last summer.  Today, it's 16 times.  That's now in-line with the long-term broader market multiple and its the cheapest valuation on Facebook since becoming a public company (which means, in the history of the company, including its history as a private company).
 
So, today you get a high growth company with a dominant market position, with 40% operating margins — at a long-term average broad market multiple.  It's a buy. 

Pro Perspectives 2/7/22

February 7, 2022

We get January inflation data on Thursday.  It's expected to show a 7.3% increase in prices compared to a year ago.
 
That will be another 40-year high.
 
It's important to note, this historical comparison is referencing the right side of this early 80s portion of the inflation chart.  That's AFTER Paul Volcker rolled out an inflation crushing 20% Fed Funds rate. 

So the question is:  Given the Fed hasn't even started raising rates, and at the moment has the Fed Funds rate set at 700 basis points UNDER the rate of inflation, are we on the left side of this early 80s spike?
 
But isn't it just high gas prices, that are feeding into the inflation rate?  Well, we will likely find that the Fed's core inflation rate (excluding gas and food prices) also hit a 40-year high in January (expected to be 5.9%). 
 
But what about the supply chain?  That should be softening prices, right?
 
Let's revisit this chart of shipping prices.  We've looked at this several times over the past year.
 
No sign of slowing in shipping prices. 
 
What about producer prices in China, where the products are made that we will be buying in the many months ahead? 
 
You can see in the next chart, the rate-of-change in producer prices in China has rolled over. That looks like good news.  But the year-over-year change still hovers around the highest in 26 years. 
What feeds into these producer prices in China?  Commodities prices.  And after a small dip in broad commodity prices, following the Omicron news in late November, the CRB Index that tracks broad commodities has returned to aggressively trending higher. 
 
With that, when we hear from China next week on producer prices, the rate-of-change will likely be ramping higher, again. 
 
Bottom line, we should expect the inflation picture to continue to be burdensome, until global central banks finally kick into a hyper-aggressive mode (which doesn't look like anytime soon). 

Pro Perspectives 2/4/22

February 4, 2022

We now have job growth running twice as hot as December 2015 levels, when the Fed started normalizing rates coming out of the Global Financial Crisis.  And the unemployment rate is currently 110 basis points lower than that 2015 reference point.
 
For perspective, this is all as pandemic restrictions (like threats of firings for vaccination status) continue to be a negative drag.
 
How hot would the data look without that drag?  
 
On that note, if we extrapolate out the change in wages from December to January, you have wage growth running at an 8%+ annualized rate.
 
For workers that sounds great, until you back out inflation, and the wage increase becomes insignificant, if not insufficient.  
 
This brings me back to my note from May of last year, when we were discussing an inflation number (YOY Core PCE) that had just been reported as the biggest monthly change on record (dating back to 1960).
 
I said, "despite easy access to money, and despite rising stock and housing prices, and despite a tightening labor market, this type of economy is not a 'feel good' economy. In an inflationary economy consumers feel like they are sprinting on a treadmill just to maintain status quo."  

Pro Perspectives 2/3/22

February 3, 2022

We've talked in recent days about the end of globally coordinated easy money policies. 

 

The Fed triggered it all in December, when they laid out a timeline for the end of QE.  The next day, the Bank of England surprised the world, with a rate hike. 

 

And today they raised again, another quarter point, with four of the nine voting committee members wanting a 50-basis point hike.

 

Then the European Central Bank followed.  They did nothing today, but in a flip-flop from just months ago, Lagarde signaled a rate hike could come this year.

 

So, over the past couple of months, we've talked about what to expect when the reality of inflation-fighting central banks sets in.  A rising interest rate environment is good for value stocks, but bad news for the high growth, high multiple tech stocks (i.e. it's "re-rating" time).  

 

We've seen it early this month in the aggressive selling of small cap, no eps tech stocks.  Today we're seeing it one of the most widely held stocks in the world, Facebook.  

 

Facebook was trading north of 25 times earnings before Jay Powell's pivot on the inflation outlook late last summer.  Today, it's closer to 17 times earnings.  

 

And this is within the context of a broader market (the S&P 500) that was trading close to 30 times trailing-twelve-month earnings last summer.  Now it's 26 times (19 times forward twelve-month estimated earnings).

 

The long term average P/E on the S&P 500 is 16. 

 

Pro Perspectives 2/2/22

February 2, 2022

As we know the Fed is due to end its QE program in March, and begin the liftoff in rates. 

 

Let's take a look back at the many iterations of QE, and the subsequent ending points, following the depths of the financial crisis. 

 

What impact did these events have on market interest rates (i.e. yields)? 

The idea behind QE is that the Fed's involvement in the Treasury market puts downward pressure on yields.  Lower yields stimulate economic activity through more affordable credit, and forced investment into higher returning (higher risk) assets (among other effects).  
 
As you can see in the chart, QE1, QE2 and QE3 had mixed results.  If anything, it could be argued that it created the opposite result in the interest rate market (yields went up, not down).  Of course, it can then be argued that the stimulative effect of the Fed's bond purchases improves the economic outlook, and therefore yields go higher. 
 
But you'll also note, from the chart, when QE ended, yields generally went lower.  
 
Now, moving along to the right side of the chart, you can see that this pandemic round of QE pushed yields up (not down). 
 
With all of the above in mind, will the end of QE next month send yields lower?
 
Unlikely. 
 
A key difference this time?  Inflation and growth are clearly better.  But maybe more important, other global central banks will be following the Fed to the QE exit door (and following into a subsequent tightening cycle).  For much of the post financial crisis environment, as the Fed was ultimately able to exit QE and start lifting rates, deflationary forces continued in Europe and Japan.  With that, the emergency policies continued there, and became a heavy anchor for global interest rates.    

Pro Perspectives 2/1/22

February 1, 2022

As we discussed last month, when the Fed laid out a timeline for the end of QE and a potential liftoff in rates, it signaled the end of globally coordinated easy money policies.

 

A day after that December Fed meeting the Bank of England raised rates for the first time since the pandemic. 

 

The Reserve Bank of Australia ended its QE program today, and set expectations for a potential rate hike this year. 

 

The European Central Bank meets on Thursday.  It has dismissed the idea of rate hikes this year, but the market is pricing in two. 

 

Even the Bank of Japan, which has been dealing with three decades of broad deflation, and has had interest rates near zero for nearly a quarter of a century, is debating a post-pandemic rate hike.

 

This, all because the central bankers know they are way behind.  Europe, the UK, Canada, and the U.S. are starting from near zero rates, and they will be chasing inflation that is running around 5% or higher.   

 

The global inflation fight is here and is in the very, very early stages.

 

The good news:  Thus far, central bankers have done a good job managing inflation expectations.  If inflation expectations were to become unhinged, the central banks would have a far bigger battle to fight.