Markets kick off the week digesting the inflammatory words from Biden over the weekend, about removing Putin.
And to add to the sentiment headwind, Biden was out pushing his 2023 budget today, which includes higher taxes and disincentives for investment (by taxing UNrealized gains!!).
I suspect it’s clear to anyone, an aspiration from the West for regime change in Russia would trigger a long, messy global war. Therefore, oil prices would go UP significantly, as the supply/demand imbalance would be compounded. And gold would go UP significantly, as global capital would move to relative safety.
That said, both (oil and gold) went down significantly today.
Meanwhile, tech stocks led the way, up — from very early in the day.
Neither Biden’s reckless foreign policy actions, nor his threats to curtail wealth at the top, could keep stocks down. Perhaps the White House policy news was overwhelmed by another factor: the return to lockdowns in China.
In fact, if we can read anything into the market behavior of today, it’s that the market considers the political appetite for more lockdowns to be greater, than the political appetite for global war.
These stocks that thrive in a lockdown were big performers on the day …
Amazon was up 2.5%. Zoom was up 3%. Roku was up almost 4%. Docusign was up 4%. Doordash was up 9%.
Yesterday we talked about the prospects of a gas subsidy. On cue, the governor of California presented ideas late yesterday for a number of transportation subsidies — including a $400 a month gas card.
As we discussed, a subsidy would only sustain the demand dynamic for oil. Apply that to a world that is undersupplied and underinvested in new supply, and the price of oil would continue to rise.
But it’s unlikely to stop there. Next up: bigger government handouts in the name of broad “inflation relief.” It’s already being proposed at the state government level and on Capitol Hill.
So, here we have the Fed raising rates, and as Powell said this week, they are doing so with the explicit intent of bringing down demand. And conversely, we have governments, which have broken supply through bad policy, looking to sustain demand through subsidies (more bad policy).
If you didn’t believe the inflation problem was going to get worse, these actions (if taken) ensure it will get worse.
Let’s talk about food…
Earlier this month, we talked about a coming food crisis. It was a topic at the NATO Summit today.
Here’s an updated look at the food price index, which is now on new record highs …
If we adjust this chart for inflation, current prices are at levels are matching the record highs of 1974.
That year might sound familiar because it was the last time we had a major global food crisis.
From the looks of this chart above, it appears that some saw this coming very early. Deere has quadrupled from the pandemic lows. And continues to make new record highs.
Last week the Fed laid out a more aggressive path and destination for interest rates.
But the path they telegraphed still leaves them fueling the fire of a hot, high inflation economy through next year. With that, it didn’t sound (at all) like a Fed that was prepared to do “whatever it takes” to slay inflation.
Today Jay Powell may have corrected the mistake. In a prepared speech, he set the expectations for possible 50 bps increments (in rate hikes). And he made it made it clear that the Fed is no longer sitting back and waiting for supply disruptions to normalize. They are looking to bring demand down, to come in line with supply. This is a quite a stark contrast from the inflation-denying Fed of 2021.
In fact, all along the way, they have been telling us that the deflationary forces of the past three decades wouldn’t turn on a dime, and therefore wouldn’t expose us to a dangerous inflation scenario. That’s changed too. Today, Powell’s flip-flop was expressed like this: “it’s hard to say what the economy will look like post recent events, but no one is sitting around waiting for the old regime to come back.”
To be sure, they were (arrogantly sitting back and waiting). But hopefully not any longer.
So, what will it take to beat inflation? As we’ve discussed, in the 73-74 and early 80s inflation spikes, the Fed had to ratchet rates above the rate of inflation to finally get it under control. And if history is a guide, the past five tightening cycles (’87, ’94, ’99, ’04 and ’15), the Fed has averaged about 50 bps of hikes a quarter.
The Fed started the liftoff in interest rates today, as expected.
In normal times, an interest rate tightening cycle is intended to cool an economy that’s running hot, to safeguard against a good economy turning into an inflation problem.
In this case, the Fed is just beginning to normalize policy, from emergency/crisis levels (i.e. zero interest rates, plus QE). Ideally, coming out of crisis, they would want to get rates back to the “neutral level” (which means neither accommodative nor restrictive … 2.5%-3.5%, historically), before having to deal with the challenge of cooling an economy.
But they’ve waited too long, in this case. They are already dealing with a hot economy and an inflation problem.
With that, for the first time ever the Fed is starting 8 percentage points in the hole, against inflation.
As we discussed in these notes, if we look back at the inflation bouts of the 70s and early 80s, both times the Fed had to ratchet up the Fed Funds rate, to above the rate of inflation to finally win the battle.
They have a long way to go.
With that, the Fed started making steps today, setting expectations for a more aggressive path, with a higher ending point (now projecting close to 3%). That puts the Fed closer to what the interest rate market expects for the path of rates.
What does that mean? The market was pricing in seven, quarter point rate hikes this year. Now the Fed is too.
So, if the difference between the Fed projections (coming into today) and the market projections represented the market’s view that the Fed was making a policy mistake — then the closing of this gap, should represent a reduced risk of a policy mistake.
Is that why stocks rallied this afternoon? Maybe.
As we discussed yesterday, coming into this big Fed meeting things were setting up for a “sell the rumor (assume the worst), buy the fact (rational)” scenario. This appears to be playing out.
But, we also had a very big catalyst for markets this morning: China.
Remember, late last year, the Chinese government waged a war against its own technology giants, and (maybe more so) against U.S. regulators of U.S.-listed Chinese stocks.
It started with the Chinese ride hailing company, Didi. It went public last June, as one of the biggest Chinese share offerings in the U.S., ever. Immediately, the Chinese government started harassing the company for a number of alleged violations.
But with over $1 trillion of Chinese companies on U.S. exchanges, it seemed to be more of a “shot across the bow,” related to the U.S. SEC’s new effort to crackdown on the lack of reporting accountability from Chinese companies.
By November, Didi asked to delist from the NYSE (with plans to move the listing to Hong Kong). Coincidently, the tech-heavy Nasdaq topped just three days prior …
The future of Chinese companies trading on U.S. exchanges has since been in question. That includes some of the hottest technology stocks in the world (Alibaba, JD.com …).
But overnight, we had some news out of China that may have marked an end to the Chinese government saber-rattling. China “vowed to keep its stock market stable and support overseas share listings.” Alibaba ended the day up 36%.
We are a week away from the Fed’s first meeting of the year, and as it stands, they will be contemplating a 10-year yield that has gone from 1.45% to 1.90% since they last met (a month ago!).
And that has translated into a sliding stock market: Rates up, lower valuations on the high growth (especially no EPS) stocks.
The Nasdaq index, full of the much-loved “companies of the future,” is down 8% to open the year.
The question is, what would make the Fed balk on the guidance it’s given to exit emergency policies?
It’s a question that markets have been conditioned to ask. After all, we’ve seen an about-face more than once from the Fed, in the years emerging from the financial crisis. Lower stocks has equated to a Fed response (a lifeline).
Consider this: They began rate liftoff in December of 2015, with the guidance of four rate hikes through 2016 — only to pause, and return back to damage control just a month after the first hike.
Will it happen this time? The short answer is, no.
As we discussed yesterday, the policy error from the Fed emerging from the financial crisis, was acting too soon. The policy error now, is acting too late, too slow.
We can see the difference in these two environments through the sector performance in this recent decline in stocks. In a sea of red (from the sector level), financials and energy are green on the year. Energy is up, as a result of undersupply in a hot economy with hot demand. And financials are up, as a supplier of credit, winning from a hot economy and prospects of more profitable lending. Bottom line, post-financial crisis is not an analog for post-pandemic.
Of course, an easy differentiator is the $5 trillion in new, excess liquidity added to the system over the past two years. That has slowly turned the tide in what has been a long bear market in commodities, into a young secular bull market in commodities.
With that, let’s revisit this chart we’ve looked at many times in my Pro Perspectives notes … the commodities/stocks ratio.
As you can see, commodities are coming out of a roughly 12-year period of significant underperformance, relative to stocks. In fact, commodities haven’t been this cheap, relative to stocks, in 50 years.
The SCOTUS decision on the Biden vaccine mandate for the private sector was a huge hurdle cleared today. This should bolster an already tight employment situation.
And with that, we may see the upward pressure on wages pickup. The wage reset has already happened at the low end. The higher earners are next, and are well positioned to command higher wages.
Hotter wage growth will only add fuel to the inflation fire.
With this, the inflation situation and (consequently) the interest rate outlook haven’t been a good formula for the high multiple tech stocks.
On that front, let’s take a look at a victim of this environment, and a potential destabilizing force to keep an eye on for markets: Cathie Wood’s infamous ARK ETFs.
As you likely know, she has been a financial media darling (likely thanks to a well compensated PR agency), as a leading investor in the “companies of the future.” Just a year ago, she had amassed more than $60 billion in ETF assets. It’s since been cut in half.
As the tide is going out on the growth trade, people are realizing that the structure of an ETF isn’t a fit for a private equity-like investment process.
What does that mean? The ARK ETFs give intraday liquidity to investors investing in long-term structural themes. It’s a mismatch. And that can create forced buying when things are going higher (over inflating some of these tech stocks, as we’ve seen), and forced selling when things aren’t working (which can spiral to the downside).
We’re seeing the latter. As you can see in the chart below (the orange line), some of the excess from the “companies of the future” has been rapidly unwinding. And as you can also see, it may be a bad influence on the “money of the future.”
Stocks continued the big bounce today into technical support.
Let’s take an updated look at the S&P 500 chart …
So, we had a 5.5% decline in this benchmark index to start the year, and now we have a sharp bounce of nearly 3% from this big technical trendline, which comes in from the election day lows of November 2020 (an important marker).
We heard from Jay Powell today, in his renomination hearings before the Senate. He did nothing to change the expectations on the Fed’s guidance on the rate path. Whether it be three or four hikes this year, we’ve just finished a year with around 10% nominal growth and over 5% inflation.
The coming year may be more of the same, and yet we have a market and Fed posturing and speculating over how close to 1% the Fed Funds rate might be by year end. That dynamic only adds fuel to the inflation and growth fire.
On that note, we’ve been watching three key spots that should be on the move with this policy outlook: bonds (down), gold (up) and the dollar (down).
Gold was up 1.25% today, making another run at this 1830-50 level. If that level gives way, the move in gold should accelerate. As you can see in the chart, we would get a breakout from this big corrective trend that comes down from the August 2020 all-time highs.
On a related note (dollar down, commodities up), the dollar looks vulnerable to a breakdown technically …
We kick off fourth quarter earnings this week. We’ll hear from the big banks on Friday: JP Morgan, Citi and Wells Fargo.
Bank of America and Goldman Sachs earnings will come early next week.
Last year, across the broad market, the table was set for positive earnings surprises, against a backdrop of deliberately dialed down expectations. And those low expectations were against a low base of 2020, pandemic/lockdown numbers.
With that, we’ve had positive earnings surprises throughout the first three quarters of 2021. The expectation is for 21% earnings growth for Q4, which would give us four consecutive quarters of 20%+ earnings growth and 40% earnings growth on the year.
That said, of the nearly 100 S&P 500 companies that have issued guidance for Q4, 60% are negative. That’s straight from the corporate America playbook: Using the cover of the Omicron news from late November to lower expectations, to position themselves to manufacture positive earning surprises OR withhold some earnings power for next quarter.
So, in addition to the changing interest rate cycle, could the slide in stocks to open the year have something to do with weaker Q4 earnings? Maybe.
On that note, let’s take a look at the big technical support hit today …
In the chart above, the S&P 500 hit this big trendline that comes in from election day. This rise in stocks, of course, has everything to do with an agenda that entailed even more massive fiscal spending programs — AND a central bank that remained in an ultra-easy stance.
Indeed, we’ve since had another $1.9 trillion spend passed in late January of last year, plus a $1.2 trillion infrastructure package later in 2021.
Now we have a Fed that has flipped the script, and the additional bazooka agenda-driven fiscal package has been blocked — and we get a test of this big trendline.
The good news: The line held today, and stocks bounced aggressively (about 100 S&P points) into the close.
As you can see in the chart below, we have a similar line in the Nasdaq, dating back to the election. This breached but closed back above the line today.
With the above in mind, we should expect the banks to continue putting up big numbers to kick off the earnings season later this week. That will be fuel for stocks.
Remember, the banks set aside a war chest of loan loss reserves early in the pandemic, and they have been moving those reserves to the bottom line since, at their discretion. As an example, both Citi and JP Morgan have another $5 billion to release, to bring their loan loss reserves back in line with pre-pandemic levels. That’s $5 billion (each) that will be turned into earnings.
Yesterday we talked about the plunge in oil prices and the importance of holding above the big $50 level. And oil gets a big bounce back today on the Iranian attack of two oil tankers in the Middle East.
Iran has made threats, in the past, to choke off global oil supply in the narrow strait (Hormuz) that about 30% of the world’s crude oil passes through. Today’s attack follows an attack on Saudi tankers last month. So Iran is posturing to deliver on threats of disrupting global oil supply.
This all stems, of course, from Trump’s efforts to bring Iranian oil exports to zero (sanctions that were upgraded back in April) — to get them back to the negotiating table on weapons of mass destruction.
Without getting into speculation of where this will end, let’s just take a look at gold, which has gotten a renewed “fear of the unknown” bid this month. A conflict with Iran would fall into that category. In an interview yesterday, the great macro trader Paul Tudor Jones called gold his favorite trade over the next 12-24 months (for a number of reasons). He said if it breaks $1,400, it will quickly push to $1,700.
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Remember, last week we talked about why $50 is a very important level for oil.
A recent Dallas Fed survey has the breakeven level for shale producers at $50. In other words, the shale industry needs oil prices above $50 to produce profitably.
If the shale industry becomes unprofitable, that becomes a problem. As we found in 2016, when oil prices crashed, the shale industry became vulnerable. Defaults started lining up in the industry, which made banks vulnerable. When banks are vulnerable, credit tends to tighten and the financial system can quickly become unstable.
Now, as we know, the price of oil bounced from that $50 area last week, but we’re getting another test today. Oil was the mover of the day — down close to 4%, and back under $51.
This, I suspect, will play a very important role in the Fed decision next week.
Despite the fact that expectations point to a rate cut in July, we’ve discussed the pressures building that might lead the Fed to move next week (which would be a big surprise for markets). Oil plays into that scenario.
Stocks and crude oil have been two clear influences on Fed policy over the past few years. The latter weighs on inflation. While the Fed claims to ignore the influence of food and energy in their inflation measure, they have a history of acting when oil moves sharply. On that note, oil is down 22% over the past year. And, again, we’re testing an important level that can have spillover effects into the economy. That’s why a sharp decline in oil prices tends to influence stocks. That’s why the charts of stocks and oil have tracked so closely …
So, we’ve had a nice bounce in stocks over the past week or so. We had the same for crude. But now crude is back testing the lows of this decline.
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