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).  
 
 
 

Pro Perspectives 7/11/24

 

 

 

 

 

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July 11, 2024

Going into this morning's inflation report, the divergence in the performance of a handful of tech giants and "the rest" of the stock market was at historic extremes.
 
The market cap weighted S&P 500 was up almost 19% on the year, driven mostly by performance of the tech giants.  The equal-weighted S&P was up only a little over 4%.  The Russell 2000 (small caps) was up only 2%.
 
The divergence made sense in the tightening cycle, particularly as the Fed was relentlessly making verbal threats to bring down jobs and demand. 
 
It makes a lot less sense heading into an easing cycle. 
 
But what if the easing cycle gets derailed by an industrial revolution?
 
If we look at this chart, it appears that concern emerged in mid May. 
 
   
This above chart shows how the S&P and the Russell have performed since Jerome Powell signaled the end of the tightening cycle last October. 
 
As you can see, the two indices traded tightly for about six months, on the tailwinds of impending interest rate cuts.  But in May, the small cap index started trading south, diverging from the S&P 500.  And that was despite an inflation number, reported in mid-May, that was favorable for the rate cut outlook.
 
What happened?  Nvidia earnings.
 
It wasn't just another triple-digit growth quarter for Nvidia.  It was the announcement of a "next wave of growth," powered by "a new chip" that was revealed to be already powering the next iteration of ChatGPT, a version that was said would "change the world" (in the words of Sam Altman).
 
Would this undo the Fed's efforts to slow the economy, and inflation, and force the Fed back into the inflation fighting stance?  
 
The divergence in the chart suggests that was a consideration.
 
That brings us to this morning.
 
The June inflation data reported this morning showed a decline in prices from May to June.  And it was the first monthly price decline since May of 2020 (the depths of the pandemic lockdown and deep economic contraction).
 
The year-over-year change came down to 3%.
 
Of that 3%, two-thirds of it (2.01 percentage points) was auto insurance and rent (Owner's Equivalent Rent).  As we know, and the Fed knows, these numbers are lagging features of an inflationary period, and in the case of rents, it's old data – not reflecting the current rent climate (which is deflationary).
 
So, as we did in my post-CPI note last month, if we adjust the year-over-year change in the headline CPI number, using the pre-pandemic averages for auto insurance and Owner's Equivalent Rent, headline CPI drops to 2.25%.
 
With this disinflationary data this morning, as you can see in the far right of the above chart, the divergence of the past six weeks closed sharply today.   
 
Now, remember as inflation falls, and with the effective Fed Funds rate at 5.33%, the Fed's policy gets tighter and tighter. That means more and more pressure on the economy, and on employment. 
 
The result?
 
As for the economy, Q2 is now tracking just 2% growth – half of where the projections started (the green line in the chart below). 
 
 
That 2% growth, follows 1.4% growth in Q1.  So the economy is running at a sub-2% pace in the first half of 2024.  That's below historical trend.  And that's with historic multi-trillion dollar fiscal tailwinds.
 
So as the government has slammed down the accelerator, the Fed has simultaneously slammed on the brakes.     
 
With that, the employment data from last Friday shows a rate of change in the rise of unemployment data that's consistent with past recessions.
 
So, we've gotten all of the debt associated with hyper-aggressive fiscal stimulus over the past four years.  We've absorbed the related historic devaluation of purchasing power of our money.  But the Fed has throttled the requisite "bang for our (many) bucks."  They have given us a fraction of the growth.
 
If not growth, what has been the beneficiary of the explosion in money supply over the past four years?  The stocks of the tech giants, which has fueled the extreme divergence in the chart below, between the blue line (money supply) and the orange line (S&P futures).
 
 
With this above chart in mind, we had bearish technical reversal signals in the tech-heavy Nasdaq futures and S&P futures today. 
 

Pro Perspectives 7/10/24

 

 

 

 

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July 10, 2024

With the June CPI report due tomorrow morning, let's revisit the two hot spots in the report.

 
As we've discussed here in my daily notes, both auto insurance and owner's equivalent rent make up about 30% of the CPI.  Both have been propping up the overall index, and the Fed's current restrictive interest rate policy is powerless to bring them down.
 
 
Above is motor vehicle insurance.  This has risen at a 20% year-over-year rate for six consecutive months (the actual data is represented by the blue bars). 
 
At 20%, it's adding more than half a percentage point to year-over-year consumer price index. 
 
The good news:  In the last inflation report, the monthly change in auto insurance prices declined for the first time in 29 months. 
 
But even if this auto insurance index were to flat-line from this point (i.e. zero month-to-month change in this insurance price index), it would still take five months for the year-over-year measure to fall below double-digits (that scenario represented by the orange bars in the chart above).
 
So, even if the insurance hikes are over, this year-over-year measure will continue to put upward pressure on the inflation data for months to come. 
 
The Fed knows this, and this dynamic continues. 
 
Next let's revisit the heavier weighted component that's been propping up CPI:  Owners' Equivalent Rent (which is also influenced by the sharp rise in insurance rates).
 
This makes up 27% of the consumer price index.  And you can see in this chart below, it has directly contributed at least 1.5 percentage points to the year-over-year change in CPI for 23 consecutive months.  The orange bars represent the path IF this component were to flat-line over the coming months (zero monthly change).  
 
 

This too, will continue to put upward pressure on CPI for the months ahead. 

 

But if we look at the national rent index from Apartment List, which has one of the most extensive databases of apartment rental listings, the rent inflation story is very different. 

 

As you can see, Apartment List has rent inflation peaking in late 2021 (the purple line), and turning to rent deflation in the middle of last year.  The government's calculation on rents is simply lagging — it's old data. 

 

And the old data is giving the illusion that inflation is "sticky" at higher levels. 

 

Pro Perspectives 7/9/24

 

 

 

 

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July 09, 2024

The Fed Chair gave testimony to Congress today.  And he was careful not to send the market a signal on the timing of a rate cut.
 
But as we discussed yesterday, the Fed has told us a condition for a policy response (i.e. a rate cut).  It's any "crack" in the labor market.
 
And with that, as we discussed yesterday, the unemployment rate in June ticked UP to 4.1%. And, importantly, the rate-of-change in the unemployment rate since the cycle low 14-months ago is at a pace consistent with the past four recessions, and (related) consistent with a Fed easing cycle. 
 
Now, interestingly, the San Francisco Fed released a study yesterday afternoon on the effect of immigration on the jobs data.
 
To put it simply, based on the CBO's high immigration scenario, the study says, in the short run, the economy needs to grow jobs by 230k a month to keep the unemployment steady.  If we look back at the first seven months of last year, when the unemployment rate was holding steady, the job creation averaged 253k a month (higher than the study estimates).
 
That number has averaged only 212k since August of last year, and the unemployment rate has jumped from 3.5% to 4.1%.
 
What was clear in today's discussion between Jerome Powell and the Senate Banking Committee, is that the Fed hasn't had a handle on how the mass immigration of the past three years has effected the labor supply.  This recent study would suggest the supply is bigger than they have assumed.  That's why the unemployment rate is rising, despite what looks like solid job gowth.  There are indeed cracks in the labor market. 
 

Pro Perspectives 7/8/24

 

 

 

 

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July 08, 2024

The Fed has told us they are watching the job market “carefully” for “cracks” as a condition to start the easing cycle.
 
So, were there cracks in Friday's jobs report?
 
We'll take a look, but first let's revisit the challenges that the Fed has had with allowing this type of report to dictate policy. 
 
As we discussed over the past three years, the Bureau of Labor Statistics (BLS) has a history of making large revisions in the jobs data under the Biden administration.
 
Back in 2021, when the Fed was ignoring inflation, dismissing it as "transitory," the BLS was, all along, under-reporting jobs — to the tune of almost 2 million jobs from when Biden took office, until the Fed started (finally) raising rates.  The initial reports on jobs during the period gave the impression that the job market was weaker than it was in reality, and the Fed accommodated weakness by maintaining its stimulative position.
 
And as we know, the Fed got caught behind the curve on inflation.  
 
Then the Fed began the tightening cycle back in March of 2022, and the BLS has since over-reported jobs by 749,000 — giving the initial impression to consumers, businesses, investors and economists that the job market is hotter than it actually is. 
 
This, in part, has resulted in a Fed that has held the real interest rate (the Fed Funds rate minus the inflation rate) at historically tight levels for the past twelve months.   This stance has arguably put undue downward pressure on the economy, and employment.  And we may find that the Fed has followed its mistake of being too easy for too long, by being too tight for too long. 
 
So, given this context, what did we get in this past Friday's report? 
 
The BLS revised down the job creation of the past two months, by over 100,000 jobs.
 
The unemployment rate ticked UP to 4.1%.  That's an historically low rate of unemployment, but it's the highest since November of 2021.  And 4.1% is higher than the unemployment rate for the two years prior to the pandemic (2018-2020).
 
On the surface, a 4.1% unemployment rate and 206,000 jobs added in June doesn't seem like too much to be concerned about. 
 
But the pattern of revisions in payrolls and the rate-of-change in the unemployment rate should be a "ringing bell" for the Fed.
 
The unemployment rate is 7/10ths of a point above the cycle low (3.4%) of just 14 months ago.  The speed of this change in joblessness puts it in the unique company of the past four recessions (and consistent with related Fed rate cuts).
 
We'll find out tomorrow morning, if Jerome Powell considers that a "crack."  He'll give his semi-annual testimony to Congress at 10am. 

Pro Perspectives 7/2/24

 

 
 

 

 

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July 02, 2024

We get the June jobs report Friday morning.  

The Fed has told us they are watching the job market “carefully” for “cracks” as a condition to start the easing cycle.  Jerome Powell reiterated that today, saying if the job market “unexpectedly weakens,” it would cause the Fed to “react.”

Add to that, the Chicago Fed President, Austan Goolsbee said today that the goal is to “get inflation down without stressing the labor market.” 

Keep in mind the May unemployment rate was last at a 28-month high, and the under-employment rate is at 30-month highs. 

With that in mind, remember, we’ve talked about the playbook executed by the European Central Bank and the Bank of Canada last month, where they positioned the start of the easing cycle as just “removing restriction” — as to not fuel market euphoria about the easing cycle.

That’s an easy playbook for the Fed to follow, if the job numbers come in soft, reducing restriction just to maintain the level of restriction as inflation falls.

On a related note, the top central banker from the Fed, ECB and the Bank of Brazil today sat on a stage in Portugal and fielded questions.

Most notably, the Brazilian central banker warned that the “higher for longer” rate regime in the Western world (mainly the Fed) combined with record high debt will “start to stretch (global) liquidity.”

He noted that emerging market countries feel the pain first, when liquidity becomes “stretched.”  And he noted that in recent weeks, there are signs of that happening.

Perhaps not coincidentally, yesterday the Fed’s measure of liquidity (SOFR) hit the most “stretched” level since early January. 

 

And perhaps no coincidence, the Bank of Japan, which was the (very important) global liquidity provider throughout the Western world’s interest rate tightening cycle, is due this month to announce its plan to begin the end of its QE program (begin to taper bond purchases/ removing liquidity from global markets).

As I said in my March note, when the BOJ made its first step toward 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.”  

As the head of the Brazilian central bank alluded to today, doing so risks global liquidity swinging the direction of too tight (i.e. a liquidity shock).

 

Pro Perspectives 7/1/24

 

 

 

 

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July 01, 2024

Last week we talked about the potential for pain in sovereign bond markets if the government policy pendulum swings, from the globally coordinated climate agenda, to a more nationalist agenda (under leadership change) — given that trillions of dollars of deficit-funded investment in the climate agenda could be abandoned.
 
After Thursday night's U.S. Presidential debate, the bond market did indeed react.
 
The U.S. ten-year yield is 20 basis points higher than it was pre-debate.  
 
In France, the elections have gone as anticipated, in favor of the nationalist party (Le Pen).  Yields across Europe were up.
 
As for the U.S., the narrative behind rising yields is that both candidates are fiscally profligate — both will lead to higher deficits.  And if anything, they say Trump policies will be more inflationary.
 
But as we've discussed, the result of a policy swing, from the globalist agenda to a more nationalist agenda (in both the U.S. and France) would simply mean that the massive deficits and record indebtedness pursued to fund a radical transformation agenda (in both countries) would be abandoned.  For the funding that can't be clawed back or redirected, it would be returnless investment.  
 
And that, my guess, would be penalized through higher bond yields — until the market gains confidence in a turnaround plan.