Pro Perspectives 8/7/24

 

 

 

 

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August 07, 2024

We looked at this chart on Monday, which shows the severity of the move in Japanese stocks relative to history …
 
 
And as we discussed in each of these extreme periods of decline, there was a central bank response that shortly followed (i.e. QE).
 
Just hours later it was reported that the Bank of Japan, Japan's Ministry of Finance and the Financial Services Agency would hold an emergency meeting to discuss international financial markets. 
 
Stocks went up.  
 
The next night, the Deputy Governor of the Bank of Japan was on the wires walking back on hawkish policy path.
 
Stocks went up. 
 
This was verbal and maybe actual intervention by the Bank of Japan to stem the sharp unwind of the carry trade that was shaking global markets.
 
But will it stabilize markets?  The Bank of Japan has a long history of currency market intervention.  It tends to have some short success in slowing progress, but limited long-term success. 
 
What has a history of working?  Coordinated central bank intervention.
 
In this case, this market instability is about the Bank of Japan laying out the plan last week for its final step in exiting its role as the world's global liquidity provider (i.e. tapering its QE program), while the Fed stubbornly held rates at historically tight levels —unnecessarily too tight, for too long.
 
With that comes the 1) the risk of a global liquidity pendulum swinging hard in the direction of too tight (i.e. a liquidity shock), and 2) the risk of the Fed turning deficit-funded economic growth into recession in the largest economy in the world.
 
The market is judged the combination of central bank decisions to be a policy mistake. 
 
The Bank of Japan seems to acknowledge it.  That's good. The Fed seems tone deaf to it.  That's not good. 
 
With that, if history is our guide, financial stress will probably grow until something breaks, and the Fed is forced to react. 
 

Pro Perspectives 8/6/24

 

 

 

 

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August 06, 2024

U.S. stocks continued the bounce today, off the lows of a two-day steep sell-off.
 
And it was led by the cue of a big bounce in Japanese stocks, and stabilization in the yen.
 
With the relative calm in stocks, U.S. yields bounced aggressively, with the 2-year yield up as much as 37 basis points from the lows of just 24-hours earlier.  That represents a reversal of safe haven flows.  
 
So is the storm over?  Unlikely.
 
Yesterday, we talked about the collapse in the Nikkei over a three-day period, which was of a magnitude we've only seen three other times over the past thirty years. 
 
And each of those extreme declines was driven by a major event (the Global Financial Crisis, the Tsunami/Nuclear Meltdown and the Covid lockdown response).
 
Let's take a look at the magnitude of the move in the U.S. 2-year relative to the past …
 
 
As you can see to the far right in the chart above, almost 76 basis points over four days in the 2-year yield is an historically extreme move.  And again, in the case of the 2-year there are also major policy actions associated with these types of moves, including an emergency intermeeting rate cut by the Fed back in January of 2008. 
 
With the above in mind, there are few signs of stress in the financial system thus far — but this widening spread between U.S. corporate and U.S. Treasuries yields is one (chart below). 
 
 

Pro Perspectives 8/5/24

 

 
 

 

 

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August 05, 2024

In the past couple of weeks, we’ve been looking at this chart of the Nikkei (Japanese stocks) and the Japanese yen.

As we discussed, with the Bank of Japan recently announcing plans to exit its role as the global liquidity provider while the Fed simultaneously holding interest rates in the most important global economy at historically tight levels, it raises the risk of a liquidity shock for global markets.

The first stage is a reversal of the “carry trade” — where global investors borrowed 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).

That unwind is being represented in the chart above, and the chart below …

And as you can see, it has resulted in trend breaks in major global stock markets.  Bond markets, too.  And the severity of these market moves are historically extreme.

If we look at the three day loss in the Nikkei (Japanese stocks), it’s comparable to only three other dates over the past thirty years.

Clearly these are not friendly comparables.  In fact, in each case a central bank response (i.e. QE) shortly followed.

That leads us the second stage of the carry trade unwind.

With the occurrence of rare/low probability market moves, the possibility of margin calls and forced liquidations rises in the financial sector.   And that can quickly spread, and lead to a liquidity shock and global financial instability.

With that, is the recent pressure on markets over?  Unlikely.

To this point, surprisingly, the Fed has yet to even signal that the policy outlook has materially changed, despite the recent weak labor data and despite the market activity of the past two days.

That said, remember Jerome Powell admitted last week 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) — and the Fed and other central banks have made it explicitly clear, over the past several years, that the balance sheet is now a tool used to fix “financial dislocations.”

They break it.  And they fix it.

In fact, Fed member Austan Goolsbee said it today: “If the economy deteriorates, the Fed will fix it.”

On that note, as we’ve discussed many times here in my daily notes, we’ve yet to see an example of a successful exit of QE.  It’s Hotel California — “you can check out, but you can never leave.”

 

Pro Perspectives 8/1/24

 

 
 

 

 

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August 01, 2024

Last week we looked at this chart …

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 no coincidence. 

This reflects the “carry trade” — the borrowing of yen for (effectively) free, converting that yen to dollars (dollar/yen goes up), and investing those dollars in the highest quality dollar-denominated assets (U.S. Treasuries and the big tech oligopoly stocks).

So, in the chart above, the rise in dollar/yen and rise in stocks are products of abundant global liquidity promoted by Bank of Japan monetary policy. 

On that note, let’s revisit an excerpt from my note last week: 

“With the Bank of Japan telegraphing the beginning-of-the-end of QE (a plan to taper global liquidity), the (carry) trade is reversing, as you can see within the white frame in the chart above.

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?”   

Fast forward to yesterday: The Bank of Japan did indeed lay 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.  They also raise rates, and signaled more to come. 

And the Fed did not surprise markets with a move (a counter-punch) but rather chose to hold rates unchanged (at historically high real rates) for the twelfth consecutive month.

With that dynamic at work, here is an updated look at this Nasdaq vs. dollar/yen chart …

As you can see to the far right of the chart, the reversal of the carry trade continues in dollar/yen and that suggests it will continue in the Nasdaq (in stocks).

That would mean a break of this big trendline we’ve been watching in the Nasdaq (and a similar line in the S&P futures).

As we discussed earlier this week, this big trendline represents the trend from the October lows, which was marked by Fed signaling that the tightening cycle was over.

The trajectory of the trendline represents the view that financial conditions will be easing.  But, again, the policy expectations that induced the trendline have not materialized.

So, back to the question in last week’s note:  Will the market have to force the Fed’s hand?

It appears so.

If we get a weak jobs report tomorrow, and if stocks break down, expect the Fed to line up the media tour for committee members to communicate certainty on a September cut.

Moreover, they should float the possibility of cutting by 50 basis points.  Notably, in five of the past six rate cut series the Fed started with a half point cut.

 

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.