Pro Perspectives 1/20/21

January 20, 2021

We now have a new President. In his inauguration speech, he mentioned China exactly zero times. 

In contrast, the Trump administration (Pompeo) spent the past six months calling the Chinese Communist Party "the greatest threat to democracy and freedom worldwide." That's a very clear statement on a very big issue.  

But we should expect the Biden administration to walk back on it.  Biden has said himself he will "normalize relations with China."  And even though his Secretary of State nominee said yesterday that "China poses the the most significant challenge of any nation to the United States" — the language is softer, and actions will be even (much) softer.

With that, China is positioned to be a big winner, as we discussed earlier this month.  China goes back to the business that got them so close (pre-Trump) to becoming the global economic superpower — ramping up the global supply chain and manipulating the currency to ensure they maintain global dominance in exporting.  That means as the trillions of dollars in U.S. stimulus becomes U.S. consumption, a lot of those dollars will be sent to China for stuff.

This all puts China back on the path of 7%+ growth.  They haven't seen it since the first half of 2017 (when Trump entered office).  The IMF expects it (7%+ growth) this year. 

And that growth is fuel for Chinese stocks, which are bumping up against the Trump-era highs.  As U.S. stocks are at record highs and valuations continue to rise, Chinese stocks remain 30% off of 2015 highs.

Pro Perspectives 1/19/21

January 19, 2021

Fourth quarter earnings has kicked off with the big banks.  We heard from JP Morgan, Citi and Wells Fargo on Friday.  And today we heard from Bank of America and Goldman Sachs.

Were the numbers good?  Yes.  All beat earnings estimates.  Goldman had record revenues.  JP Morgan had record profits in the quarter.

Will the numbers get much better as we step through 2021, yes.  

Remember, if we look at the economic contraction of last year, the maximum drawdown in economic output, based on the Fed's quarterly readings, was $2.2 trillion.  During the same period, the Fed's balance sheet has expanded by $3.2 trillion.  And the Federal government doled out $2.2 trillion, with another $2.4 trillion coming down the pike (about $0.5 trillion of which is new money from the December aid, along with Biden's latest $1.9 trillion ask — which will all likely followed by another $1 trillion+). 

So, the easy math tells you, the response has far outweighed the damage. 

And no coincidence, the value of annualized GDP will have, by the end of this quarter, fully recovered all of the pandemic-induced losses. 

With the above in mind, the banks are big winners on a number fronts. 

 

First, the Fed's early and aggressive response to the economic lockdown addressed the stability of the banks immediately.  The banks were de-risked, as the Fed became the lender of last resort (the backstop).  Credit risks, worn by the banks, were transferred to the Fed.  Moreover, the Fed encouraged, if not forced, the banks keep liquidity flowing (make loans). 

So while the economy was in various stages of lockdown, business at the banks was good.  Deposits soared, mortgages and trading was hot and the banks made millions of ppp loans.  But as all of corporate America does, when things get broadly bad for the economy, you take any losses you can and you dial down expectations. In my July Pro Perspectives note, just ahead of Q2 bank earnings, we talked about this …

"We should expect all of corporate America to take this opportunity, in their Q2 earnings reports, to put all of the bad news they can muster on the table. 

In a widespread economic crisis, this is their chance to write down the value of anything they can justify, take loss provisions on as much as they can, and set the bar as low as they can, so that in the quarters ahead, they can outperform expectations… 

We'll see the kitchen sink of loan loss provisions (i.e. guesses on what losses may materialize in the future) in these reports.  They will put these out there, because they can.  But remember, the Fed, Treasury and Congress have already pumped trillions of dollars into the economy to keep consumers and businesses solvent. That's a direct backstop (protection) against these ‘provisional loan losses.’   

Add to that, the Fed has created tremendous revenue opportunities for the banks. They've eliminated the reserve requirement for banks — taking the ratio from 10% to zero.  The banks are now incentivized to make an infinite amount of loans.  The Fed has also become a buyer of corporate bonds, reducing risk in the credit markets, which has driven record first half volume in new corporate debt issuance.  That drives investment banking business at the big banks. And the liquidity deluge from the Fed has created a broad stock market boom, which drives trading revenue. 

With all of this said, don't be surprised if the bank earnings (ignoring loan loss provisions) come in better, and maybe much better, than expected." 

The above has all played out.  The banks did indeed build a war chest of capital.  And the banks did indeed set a low bar of expectations, that they've been beating handily. And now, with a recovering economy and even more stimulus dollars to flood the economy, the banks are in position to begin turning "loan loss provisions" into earnings — at their sole discretion. 

As an example, Citi did $11 billion in net income for the full year.  That’s after while setting aside $10 billion for loan loss reserves.  So, much of that $10 billion will ultimately find it's way to its proper home — the bottom line of the income statement.   

Now, add this fuel to the fire: The investment banking business has been red hot with the proliferation of SPACs and IPOs over the past year.  But I suspect that's nothing, compared to what's coming.  With a multi-trillion dollar clean energy economic transformation plan coming, under Biden and the Dem Congress, the investment banking business is positioned to boom, for the banks. 
 

Pro Perspectives 1/15/21

 

January 15, 2021

Biden talked about his “American Rescue Plan” last night.  This is a proposed $1.9 trillion, in addition to the $900 billion that has yet to be spent from the late December aid package. 

And that does not include money for what he’s calling his “Build Back Better” recovery plan.  That’s the climate action economic transformation plan.  That will be another $1 trillion plus, probably $2 trillion.

Understand, this climate action plan is not a Biden aspiration, necessarily.  This is a global plan.  The U.S. is just now on board with it, with a new President.

In fact, a policy group in Canada wrote a paper back in June on a green energy economic plan for the Canadian government.  Guess what it was titled?  Building Back Better.

So, we have to wonder, what the consequences will be for the world that deficit spends its way to economic transformation, funded by central banks buying their own debt.  We know the early investors in the climate action initiative will get rich (the same ones that conceived, promoted and influenced the execution of these plans), but what will happen to the countries executing these plans?

This is the current picture of the U.S. Federal debt…

We should expect several trillion to be added to this $27 trillion. That’s against a $20 trillion economy.  But this plan, also in line with the initial covid policy response, is all about increasing the nominal value of the economy (inflating GDP through higher asset prices) and devaluing the debt (paying it back with less valuable dollars).  

With this fiscal and monetary strategy, the first assumption is that the currency gets punished.  But currencies are valued relative to other currencies.  With that, if everyone is doing it, the currencies look unscathed.

We can see that in the dollar.  It’s in a typical long-term bear cycle, but no extraordinary decline or volatility.
But as we know, the dollar has been punished relative to asset prices. The price of practically everything is going up, and will continue to.  And at some point, likely soon, we will begin seeing it in the Fed’s favored inflation measures.  Then the true test will come:  Will the massive investment in growth (and recovery), produce hot enough real growth (after adjusting for inflation). 

 

Pro Perspectives 1/14/21

 

January 14, 2021

Biden is set to unveil his stimulus plan tonight. 

This comes as Congress just passed $900 billion of aid in late December, about half a trillion of which was unspent from the original Cares Act from March.

Meanwhile, we have a vaccine in distribution.   The economy is nearly back to pre-pandemic economic output levels.  And even leaders of locked-down states and cities are changing their tune, pushing to open up.

So, one might ask, why do we need another multi-trillion dollar aid package?

We already have an exploding deficit and asset prices are ratcheting up day-in and day-out, eroding the buying power of the dollars in our pocket.  Why pour (more) gasoline on the fire?

Over the past 10 months, we’re now looking at three tranches of federal stimulus/aid, that total $4.5 trillion — all borrowed.  And there’s talk that he wants a separate/additional package to address his economic transformation/ clean energy plan.  With an aligned Congress, he will get it.

If that type of deficit spending doesn’t sound like something you would like to be a creditor too, you’re not alone.

And that’s why global investors are selling U.S. Treasuries, and those willing to buy (lend) are commanding higher compensation (higher yields).  And with that, it’s early days in a new long-term bear market for U.S. government bonds.  That means higher rates.  It’s a matter of how high, and how fast they move.

Pro Perspectives 1/13/21

January 13, 2021

The Washington Post ran a story at noon on January 20, 2017 with the headline, The campaign to impeach President Trump has begun. 

While much of the the next three years was under the cloud of impeachment threats, the actual impeachment vote in the House didn't come until December 19, 2019.  The Senate trial started on January 22nd, 2020 — and it ended on February 5th in acquittal.   

So, just a year later, and they have voted on a second impeachment.  But its reported that the Senate won't reconvene (prior to the inauguration) to hold a trial. 

So it’s not about removal.  Among the motivations of the democrats is to disqualify Trump from running for President again (as Pelosi admitted in her recent 60-Minutes interview).  With that, the Senate may try this after Trump is out. 

Importantly, this political chaos in the U.S. has weakened the U.S. economically, not just in this pandemic recovery, but over the course of the four-year term.  And it has opened the door for China to emerge as the global economic superpower. 

Remember, we looked at this China superpower scenario prior to the election.

As I asked then, what rational person thinks it's a good idea for a communist country to become the global economic superpower?  I suspect they won't be promoting democracy. 

And you can see in this survey we looked at last October (from Pew Research) China is nearly there already, i.e. global economic superpower …

This is a sample population survey, asking people around the world who they believe to be the leading economic power in the world.  This results of this study demonstrate where China has been buying influence (on that front, many gains were made in the global financial crisis) and how China’s neighbors feel about the prospects of a world led by China (i.e. not so fond of the idea).
 
With this in mind, while most of the world continues the pursue an exit from pandemic-induced recession, China is set to do the hottest growth (better than 7%), in four years (since Trump got entered office).  
 

Pro Perspectives 1/12/21

January 12, 2021

Global assets have been repricing over the past ten months, driven by the Fed's decision to go all-in to support the economy back on March 23rd. 

But oil has been a laggard, still about 20% off of the highs of last year. 

Remember, last year the May oil futures contract traded negative, deeply negative (as low as -$41/bbl).    

Why?  The largest oil ETF didn't factor in a scenario where the global economy would lockdown, and then two of the most powerful oil producers would collude to flood the world with oil supply.  

 
That created a situation where there was little-to-no storage around the world for oil.   And when this large ETF was forced to roll its May contract (i.e. sell it to move into the new front-month contract), there were no buyers.  Prices went negative. 

So, this was technical issue.  I suspect you were never paid to gas up the car.  And the price of oil has since made its way back to as high as $53 today. 

 
But this oil price recovery is in the face of structural headwinds for the oil industry.  
 
Remember, the money that has been pouring into the electric vehicle stocks (e.g. Tesla), has represented the anti-oil trade. 

The Biden clean energy plan vows to kill the fossil fuels industry in the U.S.

With that, most would expect oil prices to be heading toward zero.

As you can see in the chart, that's not the case.  In fact, since the election, it's risen alongside Tesla. 

Why?  If Biden regulates the U.S. shale industry into extinction, OPEC will be back in charge.  And oil prices will go much higher, even in a world that’s transitioning to cleaner alternatives to oil. 
 

Pro Perspectives 1/11/21

January 11, 2021

We talked about the push higher in yields last week. 

That continues today.  The 10-year yield is now trading up to 1.14%.  That’s still very low.  But the rate of change is huge.  That's a rise of 25 basis points in a week, against a very low base. 

This is a potential disruptor to keep an eye on, for stocks. 

Remember the taper tantrum? 

In 2013, just a few months into QE3, the Fed began setting the table for reducing the size of its bond buying program, and telegraphing a QE exit strategy.  Rates went crazy.  In four months the 10-year traded up to 3% from 1.6%.   As a result, in June of 2013, mortgage rates jumped a half a percentage point in a week (the biggest one week move since 1987).  And that was in a very, very fragile housing market.  Stocks had an 8% drawdown and then a 5% drawdown within those four months.  

So it created volatility, but stocks ended the year up big in 2013.  

This time around, a sharp move higher in rates would be painful for confidence, especially if it involved foreign selling of U.S. Treasuries.  But importantly, 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 — even if it means outright buying stocks.  
 

Pro Perspectives 1/8/21

January 8, 2021

We've talked this week about yields, as the spot to watch for the signal that the market is coming to the conclusion that, not just some inflation, but hot inflation is coming.

With that in mind, here's the chart on the U.S. 10-year yield …

Rates are breaking out – up 21 basis points, just six days into the year.
 
This reflects a Democrat Congress and President with a plan to pour gasoline on a fire of global liquidity (through another stimulus package). And that reflects the expectations that inflation is coming down the pike.
 
Now, add to this, one of the missing pieces in the inflation puzzle of the post-Great Financial Crisis era was the lack of wage growth.  That has changed. 

This morning's jobs report showed wages growing at 5.1% year-over-year (chart below)…
This reflects demand for labor that's competing with a government paycheck. You have to pay them more to them back to work.  And it reflects raises and bonuses that were given to essential employees at the depths of the health crisis.  Not surprisingly, those pay increases are proving to be "sticky." 

We've talked about this dynamic since the Fed went all-in back in March.  We were looking at a reset of asset prices.  We were looking at a reset of wages. We’re getting both.  

Pro Perspectives 1/7/21

January 7, 2021

Congress formally certified Biden overnight.  So, we officially have a Biden presidency and an aligned Congress.  With that, we know what's coming. 

The Biden Plan calls for a "100% clean energy economy" and "net-zero emissions no later than 2050."  This is a "tranformation of the economy" undertaking, and now he will have support in Congress to fund it and execute on it. 

That means something in the neighborhood of another trillion-dollars of deficit spending is coming.  And expect re-allocation of whatever is needed out of the $908 billion stimulus recently passed. 

The clearest manifestation of this bet on Biden has been Tesla, which has now risen more than 12x since March … 

Tesla is now valued at $770 billion because it makes cool cars, it's a clean energy company.  The biggest, most well funded and most powerful. This company gets to start the U.S. clean energy transformation in the pole position.  With that, the Green New Deal will likely make Tesla the Amazon of energy. 

The next big winner in the Biden presidency will be China.  Biden wants to "normalize" relations with China. That means China goes back to the business that got them so close (pre-Trump) to becoming the global economic superpower — ramping up the global supply chain and manipulating the currency to ensure they maintain global dominance in exporting.  

That means China can get back to 7%+ growth.  They haven't seen it since the first half of 2017 (when Trump entered office).  The IMF expects it (7%+ growth) this year.  
Expect Wall Street to return to the Obama-era mantra of:  investing in China, and passing of the economic torch to Asia. 

Pro Perspectives 1/6/21

January 6, 2021

We've talked about the prospects for increased risk to confidence, surrounding the Electoral College count.

The expectation was that the risk to confidence would involve the objections to certain state delegates, and the potential for those states to be asked to clarify the constitutionality of the vote on those delegates.  

The debate on the first objection was just getting underway this afternoon when the Capitol was overtaken by protestors.

Despite that, stocks held up throughout the afternoon. That's because the Senate race in Georgia looks like a democrat sweep, which would flip the Senate under a Biden presidency. 

That scenario means a big government spend coming down the pike.  And to be sure, adding a multi-trillion-dollar spend to the existing mix of fiscal and monetary stimulus means the value of your cash is being trashed. 

With that, it's (continued) lift off for asset prices today.  Translation: the value of your money goes down, the price of things go up. 

And as we discussed yesterday,  the 10-year yield is the spot to watch for the signal that the market is coming to the conclusion that, not just some inflation, but hot inflation is coming — and that the Fed will be caught behind the curve.

With that, even though the Fed continues to gobble up Treasuries, the yield on the 10-year traded as high as 1.05% today — the highest since March 20th.   

Add to that, if you're a global investor holding U.S. Treasuries, the domestic chaos today gives you even more reason to exit what has long been deemed the safest, most liquid investment in the world (the U.S. Treasury market).  That, of course, puts more downward pressure on Treasuries, upward pressure on rates — which would mean an even bigger challenge is ahead for the Fed.