Pro Perspectives 7/31/24

 

 

 

 

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July 31, 2024

We've talked this week about the big central bank decisions, and the impact they may have on global liquidity, and therefore global financial stability.
 
Overnight the Bank of Japan took another step toward exiting its role as the world's global liquidity provider.  They raised rates for a second time this year (which is only the second time since 2007).  And the BOJ Governor Ueda signaled more to come. 
 
And they laid out the plan to reduce the size of the program that has supported the Japanese government bond market, and other key asset markets around the world (including U.S. Treasuries) for the past decade-plus.
 
As we've discussed over the past two weeks, the global liquidity spigot is closing.
 
So, did we get at least a signal from the Fed this afternoon that they would join the counter-punch from the other Western world central banks, by starting the easing cycle? 
 
Sort of. 
 
The Fed held rates unchanged for the twelfth consecutive month. 
 
But in the press conference, Jerome Powell made a good case (as he has in the past) for why they should have cut, which includes this very significant statement:  
 
"The job is not done on inflation, but nonetheless we can afford to begin to dial back restriction in our policy rate."
 
This is the precisely what we talked about in my July 2nd note. 
 
Remember, both the European Central Bank and the Bank of Canada positioned the start of the easing cycle as just "removing restriction," as to not fuel market euphoria about the easing cycle.  As I said, "that's an easy playbook for the Fed to follow … reducing restriction just to maintain the level of restriction as inflation falls. 
 
No surprise to see the shared language from what has been and continues to be highly coordinated policy among global central banks.
 
So, if central banks continue to coordinate, why is the Fed stubbornly maintaining the tightest policy among the major central banks (the highest "real rates")?  They will be the last to join the easing cycle, assuming the Bank of England cuts tomorrow, as expected.
 
Jerome Powell also admitted today that they have "a lot of room to respond" to a shock or weakness in the economy (i.e. plenty of rate cut ammunition, given the high level of the policy rate). 
 
With that, it's no secret that this high level of rates is dragging down economic growth, which is running below trend even with the tailwinds of trillions of dollars of fiscal stimulus.  And it's no secret that rates are harming the housing market, and burying the country in high government debt service costs. So, why are they stubbornly keeping rates high? 
 
Are they worried about the dollar — preserving global capital flows to protect the dollar? 
 
 

Pro Perspectives 7/30/24

 

 

 

 

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July 30, 2024

We head into two big central bank meetings with the most important stock markets in the world sitting on big technical trendlines …
 
 
 
Both the S&P and the Nasdaq sit on this big trendline that represents the trend from the October lows, which was marked by Fed signaling that the tightening cycle was over.
 
The trajectory of the trendlines represents the view that financial conditions will be easing.
 
That said, here we are nine months later, and the Fed has done a lot of talking, but has delivered no rate cuts.  And based on the Fed's Financial Conditions Index, conditions have indeed eased from the extreme levels of October, but remain "tight," and continue to act as a headwind to GDP growth.
 
Add to this, the Bank of Japan has, over the past four months, delivered a policy change that tightens global financial conditions (extracts global liquidity).  And they may add to that with tonight's decision.
 
With the above in mind, the policy expectations that induced the trendlines in the charts above, haven't materialized.  Considering that, and the current policy environment, we probably see a break of these lines, and a further correction for stocks.  We will see.     

Pro Perspectives 7/29/24

 

 

 

 

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July 29, 2024

After this week, we will have heard from the big tech oligarchy on the progress of the technology revolution.
 
The early clues from Alphabet (Google) last week:  1) the price to build generative AI computing capacity continues to go up, 2) the handful of companies that can afford to build it will spend whatever it takes on the infrastructure, 3) the AI model intelligence continues to rapidly advance, and 4) the stage of the technology revolution is still "early."
 
Additionally, we have three big central bank meetings this week.  We'll hear from the Bank of Japan tomorrow night, the Fed on Wednesday, and the Bank of England on Thursday.
 
As we discussed last week, we should expect the Bank of Japan (BOJ) to lay out the plan to "begin the end" of quantitative easing — ending a decade-long ultra-aggressive program to stimulate inflation in an economy that spent decades battling deflationary forces.
 
And with the Japanese central bank exiting its role as the global liquidity backstop/support to Western world economies, the job becomes harder for Western world central banks to maintain global financial stability in a world of record sovereign indebtedness.
 
Remember, the BOJ continuing ultra-easy policy (including QE), as the rest of the world was tightening, was the only way the major central banks around the world were able to raise rates to combat inflation, without losing control of their respective government bond markets (i.e. runaway yields).  And runaway government bond yields, at record government debt levels, are a recipe for global debt defaults.
 
So, the BOJ had to be pumping liquidity, as Western central banks were extracting liquidity.  And it was overtly coordinated.
 
No surprise, now that the BOJ is attempting to tighten, the Western world central banks are easing again — with the exception of the Bank of England and the Fed.
 
The Bank of England will likely start on Thursday.
 
As for the Fed, as we discussed last week, they are running short on excuses for keeping rates overly tight.  Inflation is near target, the jobs data on Friday should show more softening, and the risk of a liquidity shock is rising. 
 

Pro Perspectives 7/25/24

 

 

 

 

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July 25, 2024

Yesterday we looked at this chart of the Nasdaq.
 
 
As we discussed, the Nasdaq put in a technical reversal signal on the day of the CPI report (July 11th).  That started an aggressive convergence in the stock market — closing the performance gap between a handful of big tech companies and the rest of the stock market.
 
And as we also discussed, the trend line in this chart has significance.  It represents the trend from the October lows, which was marked by the Fed's signaling that the tightening cycle was over. 
 
There's a similar line in the S&P futures.  It bounced from there today, which was good for 100 S&P points (a 1.8% bounce intraday).  But it didn't last. 
 
We'll head into tomorrow's PCE number with the S&P sitting on this big trendline (from the October lows), and the Nasdaq isn't far from it.
 
On that note, as we also discussed yesterday, what we're seeing in the behavior of stocks has everything to do the events of next Wednesday.
 
The Fed will meet on Wednesday, having held real rates at what are historically very restrictive levels for a full year. 
 
The result:  1) A rate-of-change in the rise of unemployment that is consistent with past recessions (and past Fed easing cycles), and 2) the first monthly decline in prices (CPI) since May of 2020 (the depths of the pandemic lockdown and deep economic contraction).
 
Add to this, the Fed's target for measuring inflation is PCE, and tomorrow's report will show that the previous report's number has been revised down to a negative monthly change in prices.  And after tomorrow's report, we should find PCE under 2.5%.  And the Fed has told us, many times, that they will start cutting "well before two percent."  As Powell has said, if they wait for two percent, "it would be too late" (they risk inducing deflation).
 
So, the Fed is running short on excuses for keeping rates overly tight.
 
Keep in mind, every other major central bank has already started the easing cycle except the Bank of England, which is expected to start next week.  
 
The easing cycle, of course, also excludes the Bank of Japan. And on that note, perhaps the most persuasive nudge the Fed is getting to start moving on the easing cycle, will also come next week. 
 
The Bank of Japan will conclude its meeting Tuesday night (EST).  And they will lay out the plan to "begin the end" of quantitative easing. 
 
They've already ended negative interest rates.  They've already ended ETF purchases (exchange traded funds).  They've already ended yield curve control.  This is all freshly printed yen that has found its way into foreign asset markets (like Western world government bond and stock markets) for the better part of the past decade.
 
That global liquidity spigot is closing.
 
And that's visible in this chart (the white box) …
 
 
This is the chart of the dollar/yen exchange rate in purple.  And the Nasdaq is in orange. 
 
As you can see the two have tracked closely, and it's not coincidence. 
 
This reflects the "carry trade" — the borrowing of yen for (effectively) free, converting that yen to dollars (USDJPY goes up), and investing those dollars in the highest quality dollar-denominated assets (U.S. Treasuries and the big tech oligopoly stocks).
 
As you can see in the chart above, with the Bank of Japan telegraphing the beginning of the end of QE (a plan to taper), this trade is reversing.
 
And with that, the risk rises of global liquidity swinging in the direction of too tight (i.e. a liquidity shock).  The question is, will the Fed surprise markets next week with a move, or will the market have to force the Fed's hand.    
 

Pro Perspectives 7/24/24

 

 
 

 

 

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July 24, 2024

We heard Q2 earnings from Alphabet (Google) and Tesla after the close yesterday.

We’ll hear from Microsoft, Meta, Apple and Amazon next week.

From these earnings we’ll learn about the state of the technology revolution (generative AI).  And we’ll find out how much these companies are spending on AI infrastructure.  And much of that spend is on Nvidia chips, which means there will be clues on Nvidia’s second quarter performance (which they will report August 28).   

Let’s take a look at Alphabet’s numbers …

Alphabet grew revenues by 14% compared the same quarter last year. They grew net income by 26%.  And they grew operating margins from 29% to 32%.

As we discussed heading into these big tech earnings, the Wall Street community will scrutinize the big investments necessary to stay at the leading edge of AI infrastructure — and look for return on investment. 

Alphabet spent $13 billion in Q2 mainly on AI infrastructure (chips, servers, data centers) — another huge number.  That’s up from $12 billion in Q1. 

So, the requisite investment to build AI infrastructure continues to rise.  

As for the return on investment:  Sundar Pichai (GOOG CEO) said “year-to-date, our AI infrastructure and generative AI solutions … have already generated billions in revenues.”

When questioned about the big outlays, he said “the risk of under-investing is dramatically greater than the risk of over-investing.”  And he said the technology revolution (driven by generative AI) is still “at an early stage.”

All of this, and the stock went down, despite trading for just 22 times forward earnings (in line with the market multiple).  

Let’s take a look at the Nasdaq chart …

As we discussed in my July 11 note, the Nasdaq put in a bearish technical reversal signal on the inflation report (an “outside day”).  That signal has predicted this 6% decline.

And this takes us into tomorrow’s Q2 GDP report, and Friday’s PCE report (another big inflation report). 

If these two numbers are soft, expect this decline in stocks to continue.  This yellow trendline support comes in 3% lower from today’s close.  And this line has significance.  It represents the trend from the October lows, which was marked by the Fed’s signaling that the tightening cycle was over.

And with that, we could head into next Wednesday’s Fed meeting with stocks threatening to break this trend, due in large part to a Fed that has stubbornly held rates too high for too long.

Add to that, the Bank of Japan will decide on policy the same day (before the Fed).  And they are expected to announce the plan to start reducing the decade long QE program that has been an important liquidity provider to global markets.

As we’ve discussed over the past few months, with the BOJ exiting its role as the global liquidity provider, “global central banks (led by the Fed) may now have less leeway to hold rates too high, for too long.” 

The risk of global liquidity swinging the direction of too tight (i.e. a liquidity shock) goes up.

With all of the above in mind, the market is pricing in almost no chance of a rate cut next week by the Fed (a 7% chance).  It seems underpriced. 

 

Pro Perspectives 7/23/24

 

 

 

 

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July 23, 2024

As we were heading into the July 11th inflation report, we talked about the huge divergence in the performance of a handful of tech giants and "the rest" of the stock market.  The divergence was at historic extremes.
 
And we looked at this chart (now updated) …
 
 
Let's step through it again.
 
As you can see, when the Fed signaled the end of the tightening cycle, we had broad based strength in stocks. 
 
That correlation broke down when Nvidia reported earnings last May.  After twelve months of explosive growth, Jensen Huang said Nvidia was poised for the "next wave of growth." 
 
We can deduce from the chart above that concerns emerged about the viability of an easing cycle, given the growth tidal wave of the technology revolution.  Cash rich tech stocks that don't have to worry about borrowing rates go up.  Almost everything else goes down. 
 
But, good news:  The inflation data continued to decelerate.  And then we got the negative monthly inflation print on July 11th (the first monthly price decline since May of 2020).  And that was the catalyst for this divergence to close.  
 
And it has, aggressively.
 
And we get the Fed's favored inflation data point on Friday, which should continue to support the rate cut picture, which will continue to provide fuel for the broadening of the stock market performance.   
 
 
 

Pro Perspectives 7/22/24

 

 

 

 

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July 22, 2024

With the exit of Biden from the November election, here's how the betting markets look now, blending the Biden/Harris nominee transition. 
 
 
 
Bottom line:  Last week, markets were beginning to price in a Trump win and possible Republican sweep.  Value stocks benefitted on the outlook of more business friendly, pro-growth policies.  Energy prices were lower, on Trump's vow to unlock domestic energy resources.  And stocks related to the clean energy agenda went south. 
 
Now with the change at the top of the Democrat ticket, and the expectations gap narrowing, we should expect the investor appetite to position for a major policy shift to moderate.  
 
This should turn focus to the earnings season.  And tomorrow we'll hear from two of the tech giants working on the frontier of generative AI:  Alphabet (Google) and Tesla. 
 
Remember, both are investing tens of billions of dollars in AI infrastructure.  And they are developing the AI models, and products and services surrounding those models, that will power the Fourth Industrial Revolution.
 
So, this will be the first glimpse into the progression of generative AI, advancements made, and outlook, since we heard from Nvidia on their May earnings call (Nvidia is supplying the most advanced AI chips to power generative AI).
 
And on that May earnings call, remember Jensen Huang (Nvidia CEO) said they are now "poised for the next wave of growth" — that's after putting up another quarter of huge year-over-year triple-digit growth.
 
So, just when the market thought the growth wave might be moderating, he upped the ante, and announced another new chip.  Moreover, he said they are in a "one-year rhythm" in chip development (i.e. a new chip every year).
 
This begs the question:  How long will the cash-rich big tech oligopoly continue to outlay the massive capital necessary to keep up with the rapid innovation in computing power?
 
Keep in mind, from 2022 through this year, all of the AI barons are spending in the neighborhood of $100 billion in capex on AI infrastructure. 
 
But if we look back at Microsoft's Q1 call, Satya Nadella said this is just the first wave, and they are building for the "second wave" of AI.
 
With all of the above in mind, there will be close scrutiny, in these earnings calls, on the outlook for continued investment in AI infrastructure — and the return on investment!
 
In addition to Alphabet and Tesla, IBM will report on Wednesday.  IBM has the data center business, the generative AI model platform AND a consulting business to deliver generative AI to large organizations and governments.  And we'll hear from Microsoft, Meta, Amazon and Apple next week. 
 
From these earnings calls, we will be able to glean how Nvidia performed in the second quarter.  They report next month.  

Pro Perspectives 7/18/24

 

 

 

 

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July 18, 2024

I had an email issue yesterday, so no note.  Unrelated, but worth noting again, with the election approaching the big email services are tightening up security features (more like suppression features, related to key words), which can make it more difficult for these emails to get to your inbox. 
 
To ensure delivery, please add this email address to your emails contacts or address book:  bryan@newsletter.billionairesportfolio.com
 
Also, if you know someone that might like to receive my daily notes, please add their email address in the box below (and give them a heads up that you've done so).  
 
Now, let's talk about the lengthy and unsurprisingly slanted article from Bloomberg on the Trump policy agenda that has created some waves in markets. 
 
This article was from a sit down interview back in June. 
 
This was clearly an example of Bloomberg doing an interview to elicit quotes to support the story they already planned to write — very common in a media world that works with the objective of shaping public opinion rather than reporting.
 
To their credit, they published the transcripts of the interview.  So we can see what was actually said.
 
So, let's do a little compare and contrast, on an interview that triggered a nearly 3% sell-off in tech stocks, and a slide in the dollar yesterday. 
 
On the Fed …
 
Bloomberg said Trump "warned" the Fed "should abstain from cutting rates before the November election" as it would give the economy and Biden "a boost."  He said, it's something that they know they shouldn't be doing."  
 
The Financial Times, from that article, wrote this headline (as did many in major financial media) …
 
 
What did he actually say, from the transcript?
 
He said, "inflation is a country buster."  He talked about "old Germany."  And he says inflation "eventually breaks a country … and so you know, you can't" (lower interest rates right now).    So, he said the Fed has a "dream that they want to lower interest rates" but "they are in a very tough (spot) right now."   
 
He says he would focus on lowering costs.  Because if you lower costs, then you can lower rates.  His plan is to cut costs by focusing on energy, to offset (for the moment) the higher costs associated with interest rates.
 
So he said of the Fed, "they want to try and do it" (i.e. lower rates), and "maybe they will do it prior to the election" (in response to Bloomberg's question), but "it's something they know they shouldn't be doing."   So his statement that they "shouldn't do it" is in reference to the dangers of inflation.
 
While he may be talking his book (very likely), it wasn't about "warning" or trying to intimidate the Fed as the Bloomberg article suggested. 
 
He wouldn't even take the bait when the questioner continued by asking if he were reelected, if he would nudge the Fed to cut rates faster.  
 
Trump's response:  "Well, you have to get other costs down, you cannot suffer inflation."  
 
On Big Tech …
 
On tech stocks, the article noted that Trump "took aim at the U.S. tech industry" during his presidency, including launching "antitrust probes" into Amazon, Apple, Facebook and Google.  It also noted that he signed an executive order "reducing legal protections" for the big platform companies under Section 230.
 
Section 230 of the Communications Decency Act protects the big social media platforms from liability associated with the content posted by their users, but also protects them from liability associated with removing harmful content.
 
Trump's executive order in 2020 simply clarified that Section 230 was not intended to provide protection to these companies to censor viewpoints of national discourse. 
 
The Bloomberg article goes on to say that "Trump wants to personally dominate" the big tech companies.
 
Here's what he actually said in the interview transcripts. 
 
He said he wouldn't ban TikTok because Facebook needs competition. 
 
But he said, he's America first.  He "doesn't want to hurt" the American big tech companies.  He wants "our companies to be the big, strong companies."
 
On Taiwan …
 
The Bloomberg article says "he's at best lukewarm about standing up to Chinese aggression." 
 
In the transcripts, Trump was posturing.   He noted "they did take out 100% of our chip business." He also implied, that China doesn't have the incentive to "bombard" Taiwan, as "they don't want to lose all those chip plants" that they rely on, as does the rest of the world.
 
Keep in mind, he spent two years of his first term fighting to end China's multi-decade economic warfare that created the global imbalances that have delivered the frequent economic booms and busts (primarily driven by China's currency manipulation, which has enabled them to corner the world's exports).
 
Also keep in mind, the Trump administration called China "enemy number one."
 
The Biden administration has called China, all along, just a "strategic competitor." 

 

Pro Perspectives 7/16/24

 

 
 

 

 

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July 16, 2024

Back in December of last year, we looked at this chart of the Fed’s New Financial Conditions Index.

 

Remember, this index is designed to incorporate the lags of monetary policy, and project (in this case) one-year forward what the impact will be on real GDP growth.

If the line is above zero, financial conditions are expected to be a drag on growth (restrictive policy).  If it’s below zero, financial conditions are expected to be a boost to growth (stimulative policy).

Also remember, each of the periods in the chart that shared the characteristic of “historically tight levels” (i.e. the peaks on the chart) were soon followed with some form of Fed easing (either rate cuts, QE, or in the case of 2015-2016 – walking back on projected rate hikes).

As you can see to the far right of the chart, one of those peaks was last October.

And as we know, that’s when Jerome Powell signaled the end of the tightening cycle, and the Fed started telegraphing the easing cycle.

With that, back in that December 4th note (here), we also discussed the performance of stocks following each of the turning points in the chart (the peaks).  Stocks did very well in the subsequent 12-month period — and small caps outperformed.

Let’s revisit that analysis and take an updated look at small cap performance since that October peak/turning point in the chart above.

 

So, the Russell 2000 (small cap stocks) is now up 39% since the Fed’s pivot to a dovish stance on rates back in October — running right around the average return for small caps after these turning points.

And we’ve had about 10 percentage points of that performance just since the CPI report last Thursday.

But as you can see in this longer term chart for small caps, we remain about 8% away from the all-time highs.  And the tailwinds are just forming.

As a reader of my daily notes, you can find my favorite undervalued small-cap stocks by joining me here.

 

 

Pro Perspectives 7/15/24

 

 

 

 

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July 15, 2024

The assassination attempt on former President Trump over the weekend has bolstered the election probabilities heavily in favor of a Trump victory in November. 
 
You can see it reflected in the progression of the betting markets in the chart below …  
 
 
And a Republican sweep of Congress is now at better than a coin flips chance.
 
With this dynamic, let's revisit the summer of 2016, when it became apparent that Trump had a legitimate chance at a first term. 
 
Things were looking bleak in the latter half of 2015 and first half of 2016.  Oil prices had been crashing for more than year, driven by OPEC manipulation, in attempt to put the U.S. shale industry out of business.  It nearly worked.  There were mass U.S. oil and gas bankruptcies, and threats to creditors of the industry.  It came with heavy deflationary pressures in the economy. 
 
Meanwhile, China's economy was in bad shape.  The stock market had a boom and bust in 2015, and the Chinese had surprised the world by devaluing the yuan (a shock to global financial markets).
 
Despite these signals, the Fed mechanically made its first rate hike in a decade, to end 2015. 
 
And with that, to start 2016 U.S. stocks melted down, having the worst start to a New Year on record.
 
So, it was seven years after the failure of Lehman Brothers, and the government had blown through an $800 billion fiscal stimulus package, three rounds of QE and held rates at zero throughout, and yet the economy was on the verge of another downward spiral.
 
And the worse news:  The monetary and fiscal ammunition needed to fight another ugly downturn (which was a high risk of a deflationary spiral) had already been fired. 
 
This muddling economic recovery, turned deflationary spiral risk, was a global phenomenon.  And it brought about a revolt at the ballot box.  It started in the UK, with Brexit. 
 
And right about that time, it became apparent that U.S. voters were embracing change in the U.S. — a pro-growth candidate, in Trump.
 
Take a look at the response of the Trump effect on the Small Business Optimism Index in 2016. 
 
 
Also notice, where the index stands now.  It's lower than 2016, having just reported a 30th consecutive month UNDER the historical average. 
 
With that, we shouldn't underestimate the potential for a boom in optimism (business and consumer) for the second half of the year, if the election outlook continues to hold.
 
What would be on the chopping block in a Trump presidency and aligned Congress?  The radical multi-trillion dollar global energy transformation (which also has Biden social agenda spending).  
 
The anti-Trump campaigners (which include the media) have claimed that Trump would be more inflationary than Biden.  To the contrary, rescinding the already appropriated massive fiscal spending on the Biden agenda would be (maybe very) disinflationary.
 
On the inflation topic, as we discussed last week, the June inflation data showed the first monthly decline since May of 2020 (the depths of the pandemic lockdown and deep economic contraction).
 
And conveniently, Jerome Powell was on a stage today at the Economic Club of Washington for some Q&A. 
 
What did he have to say?  
 
He said they've been looking for "more confidence" that inflation (the rate-of-change in prices) was on its way down, toward its target of 2%. 
 
He said inflation came down by "a very large amount," in the second half of last year.    
 
He said they "didn't gain any additional confidence" in the first quarter, but the three readings in the second quarter, including the one from last week "do add somewhat to confidence."
 
The headline monthly CPI change for the past three months has been 0.3% (April), 0% (May) and negative 0.1% (June).
 
Interestingly, these last two numbers bring down the six month average to a lower number than the average of the second half of last year, which Jay Powell described as "good data" that gave them the "confidence" to start telegraphing the beginning of the easing cycle.
 

With the improving outlook on rate cuts, we looked at this chart last week, which shows the divergent paths of the Russell 2000 (small cap stocks) and the S&P 500 (led by a handful of big tech stocks).  As you can see, it's now aggressively converging (i.e. Russell outperforming).