Pro Perspectives 8/18/21

August 18, 2021

The minutes from the July Fed meeting hit today. 

It's well known, now, that the Fed has been discussing the reduction of the bond buying program, to begin in the fourth quarter.  The minutes confirm that. Though the tone was far from hawkish.

Conversely, if we listen to Jim Bullard, not a voting member this year, but a vocal rational voice from the Fed, he has been publicly acknowledging the risks that inflation could come in much hotter than the Fed has positioned for.

Probably no coincidence, Bullard had some well timed comments today just before the July Fed minutes were released.    

He warned that the Fed might ultimately be forced into "inflation fighting mode."  He said growth is robust, labor markets are as tight as they ever get, and he said that firms are successfully passing higher input prices along to consumers. 

Remember, yesterday we talked about Fed Chair Jay Powell's admiring commentary on Paul Volcker's battle and defeat of the Great Inflation of the early 80s.   Bullard brought up Volcker today, too, saying that the Fed is already behind the curve on inflation, as compared to Volcker-era actions. 

So, again, given the somewhat dull tone from the Fed minutes (which are nearly a month old now), it's probably no coincidence that Bullard is rolled out to inject something closer to reality for the markets to chew on. 

And looking back at some of Bullard's commentary over the past two months, he's made the point that the Fed doesn't need another housing bubble.  With that, of the $120 billion a month of bond purchases currently being executed by the Fed, $40 billion are mortgage backed securities.  Expect the Fed to exit that market first (in the coming months).  That should put the brakes on the aggressively rising housing market. 

Pro Perspectives 8/17/21

August 17, 2021

Jay Powell spoke today in a virtual Town Hall meeting. 

Given that the Fed has had a change of tune over recent weeks on the monetary policy outlook, it's a good idea to pay attention when the Fed Chair speaks.   

Clearly the Fed has made a intentional pivot since its July FOMC meeting, in an attempt to set the stage for 1) a wind down of QE, and 1) to move forward expectations on raising interest rates.  Of course, this intentional pivot comes as the Fed is confronted with undeniably hot inflation, with trillions of dollars of additional fiscal stimulus about to rain down. 

So what did Powell say today? 

First, he said, very explicitly, that the Fed is in the process of "putting away its tools designed for actual emergencies."  This confirms the recent chatter from Fed officials, that they will begin dialing down asset purchases in the next couple of months. 

Now, maybe the most interesting thing said in today's Town Hall, was this:  When asked what book he recommends, Powell went into a long admiring discussion on Paul Volcker.  He recommended his book, "Keeping At It."  And he called Volcker "the most distinguished public servant, in economics, in my lifetime."

So, as Bernanke was known to be a student of The Great Depression (and happened to be the right guy at the right time to navigate us through what could have been a Great Depression 2.0), Powell seems to have spent a lot of time studying what he calls "The Great Inflation" period.  Like Bernanke, perhaps he may be the right guy, at the right time. 

Volcker was, of course, confronted with double-digit inflation in the early 80s (as high as 14%).  And he combatted it with an aggressive campaign of interest rate hikes.  He took short term rates to as high as 19%.  As Powell said, he took a lot of bashing.  He was very unpopular.  But in the words of Powell, "he did what was best for the country," over the medium and long-term.  He beat inflation.  And it led to, what Powell described as, "a long and very good period for the development of the U.S. economy."

 
For the first time in forty years, we have the very real threat of double-digit inflation.  Will Powell respond as aggressively as Volcker responded? He seems to be prepared.

 

Pro Perspectives 8/16/21

August 16, 2021

The stock market hit another record high today, again proving to be impervious to geopolitical risk.  Why? 

Liquidity.  There is a ton of liquidity in the system.  And if there were any shock event, we know exactly how global central banks would respond:  "more liquidity."

With that, equity prices continue to march higher, with plenty of tailwinds.  

Bonds, on the other hand, look like perhaps there is a geopolitical risk story being acknowledged.  Yields on the ten-year Treasury note traded back down to 1.21% today – from 1.37% just two trading days ago.

The question is:  With the quick collapse of the Afghan government, upon the withdrawal of U.S. troops, does it embolden China to act on Taiwan? 

Chinese state-owned media has already planted the seed to question the resolve of the U.S., to defend Taiwan, if China were to invade Taiwan.  If fact, as you can see in the tweet below, the language suggests when, not if "war breaks out in the Straits." 
 

With this, keep in mind, U.S. assets remain the safest and most liquid place to park capital in the world, and, as such, money will continue to flow into the dollar and our Treasury market as relative safe havens.  What else has had a big bounce back in recent days?  Gold. 

Pro Perspectives 8/13/21

August 12, 2021

Let's take a look at some pretty shocking data from this morning …

This is the University of Michigan monthly survey of consumer sentiment …

It's at a 10-year low. 

Here's how consumers surveyed feel about current business conditions.  It's not good. The reading is moving back toward pandemic lows.  
Here's how consumers feel about the future?  Eight-year low. 
Questions that feed into these indices include:  Are you and your family better off or worse off financially now than you were a year ago, five years ago?  Do you think a year from now, you and your family will be better off financially, or worse off, or just about the same?  As to the economic policy of the government – would you say the government is doing a good job, fair or poor job? 

Keep in mind, people are asked these questions as the economy is running at a better than 6% pace, with record personal savings, over 10 million job openings and record high wages.

One commonality in the data, with that of 10-years ago (when these sentiment readings were last registering these low levels): high inflation expectations.   

Pro Perspectives 8/12/21

August 12, 2021

With a $1.2 trillion infrastructure package approved, let's take a look at industrial metals. 

We already know, from reading the monthly ISM reports, that manufacturing business is booming. But they are dealing with record long lead times on raw materials, due to shorages. And the price of commodity inputs are ALL going in one direction — UP. 

With the fresh demand of a massive government funded infrastructure plan coming, the supply problems will only get worse, not better.  That means higher prices. 

Let's take a look at some charts …

Above is copper, a commodity known to be an early indicator of economic turning points – among the most widely used metals.  And as we've discussed, with the global initiative behind electric vehicles, battery electric vehicles use 183 pounds of copper — 4 to 5 times the amount of copper in conventional vehicles. 

Copper is 11% off of the highs, and trading into technical support of this big trendline.  We should expect new higher, highs to come.

Here's a look at aluminum …
 
As you can see in the chart, aluminum prices have soared off of the pandemic-induced lows, but remain south of record levels. Expect new record high prices to come.

Two ways to get leveraged exposure to a continued rise in these key base metals:  Alcoa, the largest U.S. aluminum producer … and Freeport McMoran, the largest U.S. copper producer (disclosure: we own FCX in our Billionaire's Portfolio). 
 

Pro Perspectives 8/11/21

August 11, 2021

The Democrats need 50 votes in the Senate to steamroll Biden's $3.5 trillion spending plan through Congress.

We should expect it to happen.  After all, with an aligned Congress, they've yet to get pushback on anything.  With that, it has been a good bet that they will do whatever they want to do.   Why stop at $1 trillion when you can do $2 trillion or $3.5 trillion?

So, they're doing $3.5 trillion.  But not really.  Because they somehow they convinced Reublicans to vote for a separate bill on infrastructure, for another $1.2 trillion.  

Now, with the above said, it does appear that a voice of reason has infiltrated the Democrat Senate.

Remember, as we discussed last month, the great macro trader and dot- connector, Stanley Druckenmiller, met with Senators to warn them against pouring more fiscal gas onto the economic fire.  He said, if he wanted to destroy the U.S. economy, this $3.5 trillion spend, into an already hot economy, is exactly what he would do.

It's a recipe for bubbles and hot inflation – both of which historically (ultimately) lead to large economic declines. And he added, "every dollar we spend now that we don't need to, won't be available in a future crisis." 

He seems have gotten to at least one Democrat Senator.  Today, Joe Manchin, the Senator from West Virginia, was singing the same tune.  He says "given the current state of the economic recovery, its simply irresponible to continue spending at levels more suited to response to a Great Depression or Great Recession, not an economy that is one the verge of overheating."   He said it would "put at risk our nation's ability to respond to the to the unforeseen crises our country could face."

That's a pretty damning public acknowledgement of the effects of a policy vote.   Somehow, though, it's safe to assume he will find a way to justify a "yes" vote.

When that happens, the last leg of the asset price boom will ensue.  Inflation will soar.  And then the Fed will start the inflation chase.  And they will likely have to gap interests rates higher to get it under control (and kill the economy in the process).  

Pro Perspectives 8/10/21

August 10, 2021

The Senate has passed a $1.2 trillion infrastructure package.  It now goes to the house.  And the wheels are turning on a $3.5 trillion spending bill, that the democrats will ram through with a tie breaking vote by the Vice President (through the "budget reconciliation" process).  

With the spending blowout now reaching a crescendo, as we've discussed, the Fed has now fired the warnings shots on a reversal in the monetary policy path. 

Let's take a look at a couple of key charts …

Market interest rates have ripped almost a quarter point higher from the lows of last Wednesday …

You can see in the chart here, where a very well-placed comment came in from the Fed Vice Chair last Wednesday, suggesting they may be hiking rates by next year. 

As we discussed yesterday, the prospects of rising U.S. interest rates, while the rest of the world remains with the monetary policy path pointed in the opposite direction, will stoke foreign capital flows from rest of the world to the U.S. (U.S. assets). The dollar is already up 1.3% since Wednesday on the anticipation of this flow of capital. 

What area of the stock market responds the best, coming out of recession, when rates begin to turn?  Small Caps.  With blue chips stocks trading to new record highs today, you can get small caps (Russell 2000) at a 5% discount to the highs of the year. 
 

Pro Perspectives 8/9/21

August 9, 2021

You didn't hear from me the latter part of last week, as I was down with COVID.  Thankfully, I'm recovering well and back in action today.  

Let's talk about the recent pivot from the Fed that continues to transform the theme for markets. 

We entered the year with a clearly telegraphed, massive fiscal spending agenda — and with a Fed, happy to keep the pedal-to-the-metal on monetary policy for the foreseeable future (until at least 2023).

So we are now eight months in, and the fiscal spending agenda is fully materializing.  And yet suddenly, the tune the Fed has been singing has changed.

It started with Powell's late July (post-FOMC) press conference, and continued with a well placed comment from the Fed Vice-Chair following last Wednesday's weak ADP number. 

Remember, in late July, with nearly $4.5 trillion lined up for approval on Capitol Hill, all advanced under the cover of the Fed's drumbeat that inflation is “transitory,” the Fed, conveniently, decided it’s time to explain its nuanced definition of transitory.

We heard for many months how the deflationary trend of nearly four decades, just "doesn't change on a dime" (in the words of Jay Powell).  Therefore, the drumbeat has been, that short-term inflation is simply a product of "bottlenecks" and "base effects."  Don't worry, when these supply chain disruption-related bottlenecks work out, "inflation is expected to drop back down to our longer-run goal," we were told.

Now, the in the span of two weeks, the Fed has told us that, sure prices have soared, but transitory means they just won't continue soaring at the same rate.  Slower rate-of-change, after what is tracking to be double-digit annual inflation, still means we've all been hit with a massive inflation.  And it’s forcing wages higher, which is a driver for higher inflation rates.  

Bottom line, the Fed has been doing what they do.  They've tried to manipulate expectations on inflation through their "guidance."  That doesn't necessarily have anything to do with reality.  When it's time to move, they move.  And it appears that they will be tapering into the end of the year.  And the Fed chatter has started about moving on rates next year.    

So, the Fed has pivoted.  Market interest rates are going up.

What does this represent for the global economy?  Does it represent the end of the pandemic and economic crisis?  On the latter, a change in the direction of the interest rate path in the United States, especially leading the way out of global economic crisis, will only draw capital out of global economies and into the U.S. (in search of yield and relative growth and safety). 

That especially won't bode well for emerging markets.  We've seen the movie before, following the great financial crisis.  Capital flees.  With that, if you've enjoyed the rewards of this chart, it's probably time to sell.  

Pro Perspectives 8/4/21

August 4, 2021

It's jobs week.  The July ADP jobs report today showed 330k jobs added.  That was a big miss.  The expectation was 653k. 

The July data was supposed to be our first glimpse at what the job market looks like after half of the states have withdrawn from the federal unemployment subsidy — in effort to incentivize people to go back to work.  But the jobs number came in lower, not higher. 

Why?  The move by state governors to reject federal unemployment money was offset by more "relief" government handouts. 

Remember, the Biden administration launched the child "tax" credit last month.  That seems to have kept people at home.  And it's not going away.  Biden has proposed running it through 2025.  But as we've discussed, this is just another step toward the administrations universal income gameplan (i.e. my bet is, it's permanent).  

As we've discussed, it's not really a credit.  It's a direct payment. It’s cash.  And it's not really a "tax" credit, as those that do not pay taxes, receive and will continue to receive direct payments. 

So, this is the likely culprit for the  continued labor shortage.  And the ADP report today, telegraphs a "below expectations" government jobs report on Friday.

 
Best,

Bryan  

Pro Perspectives 8/3/21

August 3, 2021

Earnings continue to blow away estimates.  As of Friday, with more than half of the S&P 500 reported, nearly nine out of ten companies had beaten estimates, and by an average of 85% over the estimate. 

The week has opened with more big earnings beats.  Expect more of the same.

This puts stocks back on new record highs, but the more aggressive growth in earnings simultaneously puts downward pressure on the P/E multiple on the stock market, making it cheaper even as stock prices are rising.

What about the delta variant?  The resurgence in covid doesn't appear to carry the risk of additional lockdowns.  The administration has dismissed it.  Jay Powell (last week) said the same, and added that each wave, thus far, has tended to have less economic implications.

So we should expect the economic boom to continue and the asset price boom to continue — only further bolstered by another $4.5 trillion coming down the pike from Capitol Hill.

Now, we talked yesterday about the Fed's shifty repositioning on the inflation outlook.  They now acknowledge big inflation, but dismiss any concern about it with the argument that the rate-of-change in prices, year-over-year, won't keep rising at the same aggressive pace.  That doesn't mean you and I won't be paying more and more for everything, for the foreseeable future. 

On that note, yesterday we heard from manufacturers in the ISM report.  The manufacturing index had a 14th straight month of expansion in July.  And the commentary included all of the same stuff we've heard for many months now:  strong demand, low inventories, labor shortages, supply chain reductions, rising raw material prices … have all led to higher labor costs, higher production costs and higher prices being passed along to end consumers.  There's no end in sight.  
 

Best,

Bryan