Pro Perspectives 6/21/21

June 21, 2021

With asset prices booming, and a Fed that has continued to feed the fire, there have been many that have feared a repeat of the 2013 “taper tantrum.”

Let’s take a look at that analogue …

In 2013, just a few months into QE3, the Fed began setting the table for reducing the size of its emergency bond buying program, and telegraphing an exit strategy. 

What happened?  Rates went crazy. 

In four months, the 10-year Treasury traded from 1.6% up to 3%.   In June of 2013, mortgage rates jumped a half a percentage point in a week (the biggest one week move since 1987).  That shook a very, very fragile housing market.  And it shook the fragile stock market.  Stocks first had an 8% drawdown, and then a 5% drawdown, all within those four months.  

Lesson learned. Fast forward to last week …

The Fed came clean and acknowledged what everyone already knows — the economy is booming, and inflation is hot.  And with that, they started the very subtle process of shaping market expectations, by planting the seed that the liquidity deluge (that is their bond buying program) will indeed be wound down, if the recovery continues on this trajectory.  That’s common sense.  But markets need to hear the Fed admit it, which they did. 

So, will rates go crazy, and scream to 3%, as they did in 2013?  Not likely.  In fact, today the 10-year yield traded to the lowest level since February (back down, as low as 1.35%).  

Why this market reaction?  As I’ve said before, from the lessons learned observing the past thirteen years of central bank intervention, we don’t have to wonder if/when the Fed might respond to a destabilizing force.  We know they are on red alert and will do anything/everything to maintain confidence and stability. 

With that, we have a Fed that already controls the Treasury market — explicitly.  That’s why rates have traded down, not up since the Fed meeting.  We should expect them to keep rates pegged precisely where they think confidence and stability is maintained.  This will continue to promote the asset price boom.  And with that, as we discussed on Thursday, this continues to be a “buy everything” market.

 

Pro Perspectives 6/17/21

June 17, 2021

We talked yesterday about the Fed meeting. Remember, this is a meeting that the legendary investor Paul Tudor Jones said would be the most important meeting in Jay Powell's career.

Jones was concerned that the Fed would stick to its mantra, ignoring the obvious inflationary signals and risks – which would give way to even crazier (and dangerous) speculation and even more inflated asset prices.

 
The good news: The Fed did indeed acknowledge the higher growth and inflation environment.

But as we discussed yesterday, unless they are acting now (which they aren't), by ending the emergency policies and beginning the process of taming the madness (of screaming asset prices and speculation), they are too late. They have already done the damage to their "price-stability" mandate.

 
Common sense should tell us that growing the money supply by better than 30% over the past year is going to create hotter inflation than we've seen in a very long time, as more money chases a relatively finite supply of goods. And, at this stage, our observations are confirming the common sense.

That said, markets today behaved in a way that signaled some approval of the Fed's message yesterday: The dollar was up, commodities were down big, and value stocks were down big, while big tech growth had a good day.

Does this response in the dollar mean that global investors are betting on some monetary policy divergence, coming sooner than expected (i.e. the Fed tightening money, while the rest of the world continues to ease)? Probably.

Does the response in commodities mean that investors think the Fed is signaling that they will be less rigid, and therefore might actually be able to quell a hyper-inflation scenario? Maybe.

Does the response in stocks mean that the rotation of money into value is over and the next big run in tech stocks is coming? Probably not.

What does seem to be happening today, is some profit taking on the trends of the past three months. With that said, we have only a couple of weeks until the market will be presented with monster catalysts for the inflation trade — we will get Q2 economic data and Q2 earnings data, which will be mind-blowingly big.

Add to this, expect the Biden monster "infrastructure"/clean energy bill to start working its way through a party-aligned Congress.  The inflation trade is, and will be, alive and well.
 

 

Pro Perspectives 6/16/21

June 16, 2021

Let's talk about the Fed meeting today …

The Fed now sees growth this year coming in at 7%. It sees unemployment falling to 4.5% (historically a level considered to be "full employment"). And it sees inflation running at 3.4% (right around the long-term average).

All of this, and Jay Powell wasn't once questioned today on why the Fed is still (right now) running an emergency monetary policy program. This program is explicitly structured to promote lending and investing. Thanks to these policies, both investing and lending are at record levels. Goals achieved.

So, given the Fed's own projections on the economy for this year, and given the achievement of its goals on lending and investing, it should be exiting these emergency policies. Not in 2023. Not in 2022. But now.

So what did the Fed do today? They did nothing on the policy front. Of course, that is no surprise. But the consensus takeaway from the meeting and Jay Powell's press conference today was considered "somewhat hawkish."

My takeaway, "somewhat hawkish" doesn't cut it. This meeting only pours gasoline on the asset price fire. Given the economic scoreboard we listed above, every day that goes by that the Fed continues to keep the throttle wide open, the further the Fed gets behind on what will become an ugly fight against inflation.

With that, it has been a "buy everything" market since the Fed and Capitol Hill went all-in last year — flooding the economy with money, to inflate asset prices and deflate debt. The "buy everything" market continues.

 

Pro Perspectives 6/15/21

June 15, 2021

The conclusion of a big Fed meeting comes tomorrow afternoon.

Billionaire Paul Tudor Jones, one of the great global macro traders of all-time, called it the most important Fed meeting in Jay Powell's career.

Why? Because the Fed has been ignoring economic data and ignoring market signals. So, for an institution that supposed to be data-dependent, instead of responding the data (clearly high growth and inflationary data), the Fed seems to be anticipating an alternative outcome — and making policy based on that anticipation.

The last time the Fed did something like this was in December of 2018. Paul Tudor Jones drew the parallel between this 2018 meeting and tomorrow's Fed decision.

With that, we talked about this December 2018 meeting quite a bit in my notes.  Let's revisit what took place …

Going into that meeting the Fed had hiked rates three times that year.  And they had systematically hiked seven times since the 2016 election.  This was all despite tame inflation, and despite a slow moving economic recovery (an economy still mired by the effects of the Great Financial Crisis).   

Both stocks and oil prices had already been in a sharp decline heading into that 2018 meeting, signalling fear in the markets that the Fed had already gone too far (i.e. was choking-off economic momentum).  The Fed ignored the signals and mechanically raised rates again. 

The bottom fell out in stocks.  By December 26th, the S&P 500 was down 18% for the month of December.   That led to a response from the U.S. Treasury (i.e. intervention).  Mnuchin (Treasury Secretary) called out to major banks and the President's Working Group on Financial Markets (which includes the Fed) to "coordinate efforts to assure normal market operations." 

That was the turning point.  That put a bottom in stocks. 

Within days of that, the three most powerful central bankers of the past ten years (Bernanke, Yellen and Powell) were backtracking on the Fed's rate path — signaling a pause.  

So, we have the opposite environment this time.  We have signals of complete madness and speculation in markets, runaway prices in some markets, and yet the Fed has assured us that they are holding the line (that the price madness is all temporary).

As Paul Tudor Jones said, they seem to be valuing their perceived consistency and predictability over making the right policy moves.  With that, we should expect them to keep singing the same tune tomorrow.  And that should only pour gasoline on the fire of asset prices.

 

What will the ultimate outcome be?  It seems very likely that the Fed will ultimately have to chase prices higher, with a very aggressive tightening campaign that will crush the economy (at some point).  

Pro Perspectives 6/14/21

June 14, 2021

The G7 leaders wrapped up their meeting on Sunday.  In my last note, we talked about the significance of these meetings, especially in crisis periods (if you didn’t see that note, you can find it here).
 
So, what did we learn from the G7 communique that could impact markets? 
 
We learned that the G7 leaders are all-in on the climate and equality movement.  With the global economy coming out of one of the worst crises in history, the communique mentioned the economy only 17 times.  It mentioned equality 22 times.  And it mentioned either climate or “green” 51 times. 
 
Additionally, it had just four carefully positioned unprovocative mentions of China.   
 
What does it all mean for markets?  As I said on Friday, if there was any doubt that there is coordination and agreement among global leaders on the social and environmental agenda, there is no doubt now.  
 
So, while the global leaders in each of these major developed market countries have indeed vowed to continue supporting the economy, it will be following the gameplan of “future growth,” not crisis response (in their words).  
 
What does that tell us?  It tells us that they will allow some economic pain (a continuation of, if not newly established pain), in the name of future growth.  We can get a glimpse of what that looks like through the treatment of the fossil fuels industry.  Jobs have been lost and prices have soared, all in the name of future growth (i.e. a complete transformation of global energy). 
 
With this in mind, let’s consider what the Fed has been telling us about inflation.  It’s “transitory,” they say.  They may be right, if policy makers are planning to tear down, in order to “build back better.” 

 

Pro Perspectives 6/11/21

June 11, 2021

G7 leaders are meeting today in the UK.  What does it mean for markets? 

Possibly a lot.

Back in 2016 I stepped through all of the G7 meeting communiques and analyzed the message, and then the response in markets.

The takeaway:  There were plenty of crises in this time period, and when the G7 communique was focused on the economy, especially in the opening statements, stocks did well.

Let’s fast forward to last year, at the depths of uncertainty in a global health crisis and economic lockdown.

First came the phone call with the world’s leading finance officials.  Then came a statement, pledging to “expand health services” and “take action” to “aid in the response to the virus” and “support the economy.”  Importantly for markets, this was a signal from global leaders that they would work together on a containment strategy, AND coordinate support for the economy.  The Fed cut by 50 basis points hours later, and that was the beginning of the global central bank and government intervention that put a bottom in markets.

Now, going into this meeting, things are a bit different.  The economy is recovering, but unevenly around the world.  Will G7 leaders focus on the economy, or will they focus on the social and green/environment themes?  We will see on Sunday.

As a clue, we can look to the G7 Finance Ministers meeting communique of a week ago.  Here are the two opening sentences …

“We will continue to work together to ensure a strong, sustainable, balanced and inclusive global recovery that builds back better and greener from the Covid-19 pandemic, recognising the disproportionate impact of the pandemic on certain groups including women, youth and vulnerable populations. We commit to sustain policy support as long as necessary and invest to promote growth, create high-quality jobs and address climate change and inequalities.”

If there was any doubt that there is global coordination and agreement on the social and environment agenda, there shouldn’t be after reading that statement, and hearing the commentary out of today’s leaders meeting.

With this coordination, much like the era coming out of the financial crisis, when everyone is in the same boat (and rowing the same boat), we don’t see the financial market penalties from policy extravagance (like ballooning the money supply, and running massive deficit spending programs).  That means, the dollar and the treasury market probably come out of this unscathed (again).

Pro Perspectives 6/10/21

June 10, 2021

The inflation data this morning came in hot, as expected.

Still, the Treasury market moved in the opposite direction of what would be considered intuitive, in a world where the Fed looks to be almost certainly behind the curve on inflation (already).

Again, as we discussed yesterday, this has people debating over whether or not the bond market has it right.  After all, Wall Street likes its adages, and this one is an industry favorite:  "The bond market tends to be smarter than the stock market." So they say.    

Within this debate, there are plenty of believers in the theory that the decades-long structural low inflation environment 1) remains intact, and 2) doesn't change "on a dime" (in the words of Jay Powell). 

And a 10-year yield sliding back down to 1.45% today emboldens the view of those in that camp.  And it has swayed others into the camp.  

But they are all somehow ignoring the fact that the (smart) market isn't dictating the direction and level of yields (interest rates), the Fed is. The Fed is explicitly manipulating the interest rate market.  This is no secret. 

Despite watching an economy accelerate at nearly a double-digit growth pace, despite watching house prices balloon to new record highs, and despite seeing an inflation reading this morning that is as hot as we've seen in thirty years, the Fed continues to push down interest rates, by gobbling up more than $80 billion of Treasuries each month.  Why?  To "encourage lending and investing." 

On that note, while trying to "encourage lending and investing," the Fed, at the same time, reports that Debt Securities and Loans across all sectors ("lending") is at record levels, and Gross Private Domestic Investment ("investing") is a record levels.  So, mission accomplished.  Yet, the Fed stays at it.   

Meanwhile, the "structural environment" is changing quickly, through an unprecedented ballooning of the money supply and a broad-based reset of wages (higher). With that, the longer the Fed pins down market interest rates, the uglier and uglier the inflation damage will be. 

Pro Perspectives 6/9/21

June 9, 2021

We have a big inflation report tomorrow, and it's going to be hot (again). 

And yet, the market that should be reflecting the increasingly dangerous inflation outlook, Treasuries, have been moving higher, not lower. 

That means interest rates have been moving lower, not higher.

As you can see in the chart below, 10-year yields closed below 1.50% for the first time since March 3rd…

Just in case we think the interest market is perhaps telling us that the hotter inflation data should start petering out, let's take a look at what's happening in China, where the products are made that we will be buying in the many months ahead…

Overnight, China reported the hottest prices for producers in 13 years …
And when the producers get those final products on a ship, you can see in the next chart, what has happened to freight container prices coming from China …
So, if you are lucky enough to get your product on a ship, you're paying nearly three times as much to get it here, compared to a year ago.  To be sure, these prices, along with rising wages, will be passed through to consumers. 

Pro Perspectives 6/8/21

June 8, 2021

We looked at three bubble charts a few weeks ago (bitcoin, Tesla and Lumber), each of which continue to look like the air is coming out.

On that note, bitcoin has taken another few punches in recent days.  Over the weekend, a big bitcoin event was held in Miami which included a lot of dogmatic commentary (typical of bubble markets).  

Then yesterday, the Justice Department announced that they had recovered $2.3 million of the ransom collected from the Colonial Pipeline hack.  It turns out bitcoin isn't safe from government seizure. 

Add to that, today the IRS is asking Congress to require large crypto currency transfers to be reported to the IRS.

With the cracks in the security benefit of the bitcoin armor, this morning it traded back down the May crash lows… 

As you can see in the chart, the price of bitcoin looks very vulnerable to a bigger slide on a break below $30,000.  If that happens, gold should start to accelerate higher, as money moves from the “new inflation hedge” to the more trusted, historic inflation hedge.

As I've said before, bitcoin continues to look more like a tool of speculation and corruption, on the path for a typical bubble outcome (i.e. crash and irrelevance). 

Pro Perspectives 6/7/21

June 7, 2021

We get more inflation data this Thursday.  As we discussed the past few weeks, when the Q2 data starts rolling in (in early July), we are going to see charts that look like these big spikes from the early 70s and 80s.

This is the type of inflationary environment (and what followed) that put trend-following, as an investment strategy, on the map.
 

Two pioneers of rules-based trend investing became among the biggest and wealthiest in the hedge fund business by  the 1990s (John Henry and Bill Dunn).  And it was because of the returns they generated from commodities price trends (booms and busts) surrounding the early 80s spike in inflation.

That said, trend following as a strategy has been an underperformer for the better of the past two decades. It's even been thought of as a defunct strategy.  But it may be back.  To date, the IASG trend following is the leading CTA strategy, up 12%.  And that outpaces broad hedge fund performance by about four percentage points on the year. 

And it may be just getting started for the trend followers. 

In a boom period for the strategy, the returns can be high double-digits, if not triple-digits.  And that is driven by an adherence to rules, rather than emotions — which keeps them in trades that continue to trend, as long as they trend.  As John Henry once said, "trends always go further than rational people expect, or even imagine."