We had a broad bounce back in global markets today (stocks, commodities, currencies and yields).
Thus far, both the virus variant and the U.S. government's response to the variant has been tame. That's good news.
After all, much of the ugly price action in markets over the past two weeks originated from a headline that dropped on Thanksgiving evening about the new variant.
But there is plenty of other noise for markets to interpret: the continued infighting on Capitol Hill, over the debt ceiling and the next massive spending bill. Add to that, U.S./China and U.S./Russia tensions have been bubbling up.
Is this all bad for stocks?
We don't have to look too far for the answer. This sounds a lot like 2014. In fact, it sounds exactly like 2014 – including the presence of a scary virus (ebola).
What did stocks do in 2014? In the face of all of the worry, stocks rose 11%.
What also happened in 2014? In late October, the Fed finally ended its financial crisis QE response. That set the table for a liftoff of interest rates.
Again, the 2014 analogue continues to sound similar to the current period.
So, what happened in 2015?
With an anticipated tightening cycle coming, stocks went sideways for much of the year (including a 13% correction). The Fed started the liftoff of rates in December. It wasn't welcomed. By late January (2016), they were walking back on their rate path projections.
Bottom line: In the crisis era (both Great Financial Crisis and Great Health Crisis), where the Fed has crossed the line in the sand, and become directly involved in key asset markets, Fed policy has been, and will continue to be, the dominant catalyst for markets.
Last week we talked about the flip-flop by Jerome Powell on inflation. He flipped from inflation-denier to inflation-fighter, all over the course of just a morning congressional testimony.
Just like that, the market is now beginning to talk about a March rate hike.
On that note, we'll hear from the Fed next week, where they will likely layout a (new) timeline for that possibility.
As we discussed last week, this new interest rate tightening cycle will be bad news for the high-flying, high-valuation growth stocks — particularly, the "no EPS" stocks.
Many of these stocks that have been valued by Wall Street on a multiple of sales (not earnings) have already taken a beating in just the days since Powell's flip-flop.
The big asset manager, GMO has a good chart that describes the impending fate for these stocks …
In this chart, we can see the percent of companies in the Russell 3000 Growth Index that have negative earnings. It's a record high. As we can also see, things don't tend to go well at these levels (the red circles).
What else is at a record extreme? The ratio of growth stock performance (outperformance) relative to value stocks.
This all sets up for a rising rate environment, driving money out of growth and into value. The catalyst, a Fed tightening/inflation fighting cycle), is here.
We talked about the prospects of getting a hot jobs report this morning.
And we talked about the risk it would represent to "high multiple" stocks (namely, high-growth tech stocks).
So, what were the big numbers?
The unemployment rate came in at 4.2% (a big drop) – along with a big drop in the underemployment rate.
The jobs report was indeed hot. That's despite a softer payroll number, which will likely be revised higher (as the past four have), and is trending at more than double pre-pandemic levels.
Remember, the Fed has given us a condition for rate hikes. It's "maximum employment." This level of employment the Fed calls "maximum" (or full) hasn't been quantified, but if we go back through 70 years of history, there are only five periods in the U.S. economy where the unemployment has been lower.
It's a pretty good bet that the Fed has met its objective on employment. We already know they have exceeded their objective on prices (price stability). So, this report should seal the deal for a faster path to Fed rate hikes.
With that, the very high multiple, high growth tech stocks did indeed get punished today. Why? Higher rates tends to bring about lower valuations. When Wall Street analysts start plugging in a higher a discount rate (interest rate) into their cashflowmodels, they will get a lower price target (in some cases, much lower).
This, as the Nasdaq closes today at 36 times trailing-twelve month earnings – and 30 times forward earnings. The average P/E on the Nasdaq over the past 14 years is 20.
This is even more important than usual, because the Fed told us in early November that the condition for liftoff in interest rates would be "maximum employment."
Remember, just days after Powell made these comments (on November 3rd), we had a booming October jobs report, with an unemployment rate that dropped to 4.6%, on 5% wage growth. And then another effective oral Covid treatment option was introduced. And then Biden's vaccine mandate for businesses was blocked by a federal court. And then the House passed the $1.2 trillion infrastructure bill. And then the foreign travel ban was lifted.
This is a cocktail for creating and filling jobs. With that, it's a good bet that the employment situation in November was hot.
And if that's the case, not only are we looking at a faster taper (as Powell telegraphed this week), but validation for a much sooner interest rate liftoff.
With that said, the interest rate market has already been pricing in a more and more aggressive timeline on rate hikes. Now the market is pricing about a 30% chance of a March hike.
If we get a hot number tomorrow, the expectations for a March will jump.
What should also jump is the 10-year yield. This has been diverging from the trajectory of Fed policy and inflation, in recent days.
This scenario, where the 10-year yield begins to reflect an impending inflation-fighting Fed, would embolden the sellers in the very high multiple stocks (high growth tech). The Nasdaq may have quite a bit more pain to come.
We talked about Jerome Powell's flip-flop on inflation, at his testimony yesterday before the Senate Banking Committee.
He now sees an "accelerated taper" and the risk of persistently higher inflation. The Powell pendulum has swung from inflation denier, to inflation fighter – just like that.
As we discussed, perhaps he spent the better part of the year manipulating the narrative on inflation, in a way that would win him another term under the Biden administration — an administration with an agenda to carry out, which clearly would be burdened by a Fed inflation fighting campaign.
We also discussed a second/related motivation for Powell: With a successful re-appointment now in hand, flipping the script on the inflation situation will make it much more difficult for the Democrat controlled Congress to justify the final fiscal spending bazooka (i.e. the transformative "green" and social spending plan).
With that in mind, Yellen and Powell spent the day today, testifying to the House Financial Services committee.
While Powell was under the gun yesterday for his prior denial of inflation, today, the House Republicans went on the offensive against Yellen (Biden's Treasury Secretary) — utilizing their new-found leverage on the inflation situation to weaken the administration's pitch for another multi-trillion dollar spending package.
Bottom line: This dynamic of the past two days is increasing the probability that the monetary and fiscal liquidity spigots are possibly now closed.
Markets are reacting, accordingly.
Except for the bond market.
The 10-year yield continues to slide lower, following the Thanksgiving evening news of the virus variant. The uncertainty here continues to be weighed more heavily toward "what the government might do," rather than "what the virus might do."
With that, under Powell's new inflation stance, he views any uptick in restrictions as more inflationary — as the supply-chain disruption and labor supply shortage would only worsen.
We've parsed the words of the Fed Chair, Jay Powell, many times.
Despite the clear evidence of inflation, driven by the 30% growth in money supply since early last year, he (and the Fed) have called the rise in prices transitory (short-lived). This has, for some time, looked like maybe a monumental policy error in the making.
Today, he flipped the script. He telegraphed an "accelerated" taper and warned of persistently higher inflation!
That said, as we've discussed in the past, knowing the history of the Fed, especially the history of the post-financial crisis environment (the past thirteen years), the Fed well practiced in perception manipulation.
Let's take a look at how the perception manipulation by Powell (the Fed) has evolved, up to its latest iteration.
Throughout the year, as he has defended the drumbeat of "transitory." He told us that the deflationary trend of nearly four decades, just "doesn't change on a dime."
He told us the "short-term" inflation is simply a product of "bottlenecks" and "base effects." And he deflected responsibility on supply chain induced price pressures, saying the Fed's "tools don't do much for supply constraints."
Then he told us, sure prices have soared, but transitory means they just won't continue soaring at the same rate.
Along the way, over the past eleven months, taking the cover of the "no inflation problem" theme from the Fed, the politicians in power on Capitol Hill passed another $1.9 trillion in spending, and advanced their plans to pour an additional $4.5 trillion (at the time) onto the fire, to fund their agenda — again, pointing to the Fed to refute any concerns about a dangerous inflationary impact. With that, so far, the ticket on another $1.2 trillion has recently been punched. And another $2+ trillion is lined up.
With the inflationary fire already burning, finally, earlier this month, the Fed began the end of emergency level policies, but telegraphed a cautious pace.
This all leads up to Powell's re-appointment last week, by the President. As I said in my note here a couple of weeks ago, "it does seem like Powell has made a concerted effort to keep himself in the running for another term, through his maneuvering of the past year. Among those maneuvers, sticking to the 'transitory inflation' talking point far longer than he should have."
As we know, the alternative candidate to Powell, was Lael Brainard, who is among the most dovish on the Fed, and maybe the most political (aligned and committed to the administration's broad agenda).
Did Powell do what he had to do to get the re-appointment? And if so, is he now, after successfully winning the re-appointment, prepared to start the inflation fight, far more aggressively than almost anyone thinks?
Or, is he changing the perception on inflation, so that the Senate doesn't have justification to allow the big Biden agenda spending plan to pass, which could be an inflationary bomb, and could do irreversible damage, from a policy standpoint, to the country.
In the second half of 2014, the price of crude oil had fallen from $108 to the low $70s.
The market was oversupplied. Prices were plunging, and OPEC was expected to deliver an announcement of a production cut, to put a floor under prices.
Instead, they pulled the rug out.
On the evening of Thanksgiving, OPEC surprised the oil market with a well-timed announcement that they would not defend the price of oil with a production cut.
I say “well-timed” as their objective was, contrary to the market’s view, to pulverize the price of oil. And they chose a thinly traded holiday market to do it. With that, oil fell about 14% over the next 24 hours — 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.
This came to mind this past Thursday night, when the I saw the announcement of the new variant. Well-timed. By the time many market participants were seeing the news, in thin markets, stocks, yields and commodities were all much lower.
The concern, even Thursday night, had less to do with the virus, and more to do with how governments would respond. Lockdowns? More restrictions?
Thus far, the response seems mild (as do reports on the virus). With that, markets get a good bounce today. But as we know, even before omicron, parts of the world were tightening restrictions. And Austria went back into lockdown.
Bottom line: The probability of economic headwinds, associated with the virus, are higher today than where we left off before the holiday.
With that in mind, we looked at the key reversal signal in the Nasdaq last week (also in the S&P 500) …
Technically, the charts, have already been flashing some warnings signals.
And with the introduction of some new uncertainty for markets and the economy, the Fed will come back into the crosshairs. As we know, they have recently began dialing down QE. And they have given us a target of "full employment" as a trigger to start the lift-off of interest rates. That trigger point is already arguably close, and we get a new data point on jobs this Friday.
So, by the end of the week, with any negative virus news, we could have a deteriorating economic outlook, just as data is hitting (from last month) that shows perhaps a trigger for Fed liftoff (or closer to it).
This scenario would put pressure squarely on the Fed, to walk back on its well-telegraphed exit of emergency level policies. And if the history of the past 12-years is our guide, stocks would punish the Fed (i.e. move lower) until they respond — and they would respond.
Earlier this month, the Fed laid out a timeline and plan for ending emergency level monetary policies. Today we got some insight into the conversations they had to arrive at that plan.
The broad takeaway from the minutes of the Fed's meeting: a Fed that sounds compelled to move even faster than they publicly telegraphed.
That means an end to asset purchases, maybe sooner than June of next year. And a rate liftoff, also maybe sooner than June of next year (maybe as early as March). With that, not surprisingly, there are some Fed members out doing some media interviews in recent days, to start setting expectations for a more aggressive timeline to rate hikes.
A more aggressive path to a tightening cycle: Is this good or bad for markets and the economy?
Consider this chart …
As you can see in the chart above, despite what the Fed and politicians would like us to believe about inflation (i.e. "transitory"), consumers have their own views. And those views tend to be led by the reality of prices that are impacting their daily lives. Prices up. Sentiment down. And ultimately consumer sentiment dictates consumer behavior.
The Fed clearly knows they are dangerously close to the point of losing control of consumer behavior. So, a faster path to normalizing rates (and stabilizing prices and sentiment) should be good for market and economic stability.
As we discussed yesterday, the big tech trade has run into what looks like a catalyst for some unwinding. The catalyst? The re-nomination of the Fed Chair, Jay Powell, which confirms a new tightening cycle for interest rates.
We ended yesterday looking at the key technical reversal signal on the Nasdaq chart. We have the same signal on the S&P 500 chart. Of course, both are heavily weighted and influenced by high growth tech.
Why don't high growth stocks do as well in rising rate environments?
Higher rates tends to bring about lower valuations. When Wall Street analysts start plugging in a higher a discount rate (interest rate) into their cash flow models, they will get a lower price target (in some cases, much lower).
Now, with this said, this should further confirm the shift in market focus to value stocks.
Among the most interesting value stocks, we've talked a lot about the beaten down oil and gas sector.
With that, I want to copy in an excerpt from my note from six months ago (May 20th) on the oil situation …
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 $6gas.
It will be self-fulfilling, and yet it will become the justification for the move to "clean energy."
So, this has all come to pass. And today, in an attempt to bring gas prices down, the President announced that he will be releasing oil from the Strategic Petroleum Reserve.
This only further solidifies the trajectory of oil prices (up).
Not only have we, and much of the world, committed to defunding new oil exploration, and regulating down domestic supplies, we are now (adding insult to injury) drawing down our reserves.
OPEC+ countries will be even happier now 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, thus far, this planned supply destruction of the fossil fuels industry.
On the latter, these remaining domestic producers have become cash machines, producing at wider and wider margins, and distributing the cash to shareholders.
How are we positioned in our Billionaire's Portfolio for this oil market dynamic? Join us here to find out.
As we discussed on Friday, few things will create more uncertainty in markets than uncertainty surrounding the path of monetary policy — especially, when its related to "who will lead Fed policymaking."
With that, there was strange price action across markets last week, as there was a growing view that we might be in for a change in Fed leadership. Markets started pricing in the prospects of a Fed that would be "easier for longer" (maybe forever), with the idea that a Brainard-led Fed would make the White House agenda an input in Fed policymaking.
With the goal of stability in mind, there was good news this morning.
Before the market opened, the financial media was tipped off that Biden would re-nominate Jerome Powell.
What does it mean for markets?
It means the Fed policy that has been telegraphed (tapering asset purchases with prospects for a June liftoff in rates) remains on path.
That should remove the lid on the interest rate market, which has been suppressed, given the economic and rate picture. The 10-year yield traded up to 1.63% today. And now we may see rates march higher, to test of the highs of the year (perhaps before year end).
What suffers when we get a confirming event (the Fed renomination) of a new tightening cycle for interest rates?
Growth stocks — particularly, the much-loved big tech stocks.
No coincidence, the Nasdaq was among the worst performers on the day. Moreover, the decline on the day produced a big technical reversal signal (an outside day).
This will be the spot to watch this week. Will the air come out of the Nasdaq into the end of the year? Conversely, what benefits from rising rates, into a recovering economy? Small caps and value stocks.
