Back in December, we talked about the potential for the Fed to start moving on rates by March.
Just 30 days later, and the market has gone from a 30% chance to about 90% chance we will see liftoff … in March.
Also back in December, we looked at past tightening cycles, and we talked about the prospects of the Fed moving in 50 basis point increments, instead of 25 basis points, as markets are expecting. After all, with the latest inflation reading of 7% and the Fed Funds at near zero, the Fed is way, way behind. The longer that gap persists, the more the inflation situation is left to intensify.
Again, if we look back at the past five tightening cycles by the Fed (’87, ’94, ’99, ’04 and ’15), the Fed has averaged about 50 bps a quarter.
With the above in mind, over the weekend, billionaire investor Bill Ackman said this …
Add to this, the Wall Street Journal ran a piece this afternoon quoting a former “top Fed staffer” as saying that the Fed needs to start preparing markets for the possibility of a 50 basis point March hike.
Just like that, the rate outlook is looking quite different. And the events of the week ahead should only exacerbate it:
First, we’ve talked about the impact of rising oil prices on inflation. Though the Fed likes to pretend it doesn’t get too worried about “volatile oil prices,” history suggests they do worry, and they tend to act when oil prices are making big adjustments (up or down). On that note, oil broke out to $86 bucks today. That’s a 7-year high and up 62% over the past twelve months. The Fed should be worried.
Secondly, we get Q4 earnings from 35 S&P companies this week. As we discussed in my Friday note, we should expect to a lot of chatter about labor costs. Already, to kick off the week, Goldman Sachs took a chunk of money that could have (should have) gone to shareholders, and disbursed it to partners and employees (“wage pressure”). The Fed should be worried.
This all raises the specter of inflation pressures, and therefore underpins the prospects for a more aggressive rate outlook. In the short term, that is driving the continued unwind of positions in high growth, high multiple stocks.
Still, unlike the taper tantrum of 2013, where stocks sold off on a Fed that was prematurely removing emergency policies in a slow-growth/low inflation/fragile economic recovery, in this environment the bigger risk to stocks is a Fed that is moving too slowly to remove emergency policies. A more aggressive Fed should be a welcome force for market and economic stability.
In my July 2020 Pro Perspectives note, I said “with the Fed absorbing all credit risk, and flooding the country with money, the banks are profit printing machines.”
With that in mind, three of the big banks reported on Q4 this morning, kicking off Q4 earnings season. All beat earnings estimates, again (as they have throughout the pandemic environment). All are buying back stock.
For the full year 2021, Wells Fargo made $21.5 billion (net income). Citi made $22 billion. JP Morgan made $48 billion.
Combined, that’s better than the total economic output of 70% of the countries in the world.
So the banks win in crisis, as policy makers intervene to backstop risk.
And the banks win in recovery, as a tight labor market and strong consumer and business balance sheets lead to hotter demand for bank products — add to that, rising interest rates, where banks benefit more profitable lending spreads.
That said, bank stocks remain cheap. Against last year’s earnings JP Morgan trades at a P/E of 10. Wells Fargo at a P/E of 11.8, and Citi at a P/E of 6.6 (the cheapest of the big banks). Compare that to a broad market P/E of 29.
What’s showing up early in the earnings calls? Last year it was the supply chain disruption and inflation. This year it’s labor costs.
With that, a bigger move in wages is coming this year.
Few are more in tune with the economy and political agenda than Jamie Dimon (JPM CEO), and he said today that they are willing to squeeze margins in the name of pay. And he also sees a far more aggressive Fed this year than is anticipated (he thinks 6 or 7 hikes).
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.”
On Friday we talked about the set up for a dollar decline, to reflect 1) U.S. government spending recklessly beyond a rational crisis response, and 2) a Fed that denied the inflationary impact of such a fiscal response for too long.
And we looked at the long term cycles for the dollar. We are about 70% of the way (in time) through a very shallow bearish cycle, which argues that we could have a very steep drop in the dollar over the next two years.
With that in mind, we looked at a shorter term chart of the dollar yesterday. The dollar looked vulnerable to a break-down (lower).
Here’s an updated look…
Indeed the dollar broke to two-month lows today – and it looks like this technical break will get the ball rolling.
This comes on a day when the inflation report showed a 7% year-over-year increase in prices (the highest in 20 years).
With that, notice in this chart the clear trend in CPI, and where it started in March of last year.
I focus on March of last year, because that’s when the word “transitory” started showing up in the Fed lexicon. Clearly, they were wrong.
As important, that language gave the politicians on Capitol Hill the cover of a “no inflation problem” to push through another $1.9 trillion in spending, a $1.2 trillion “infrastructure” package, and advance the dangerous (and massive) clean energy and social agenda spending plan, which finally fell flat, ONLY when Jay Powell did an about face on the inflation view.
Bottom line: The dollar may be in the early innings of paying the price for the monetary and fiscal policy errors of the past year.
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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Yesterday we talked about the surgical manipulation Trump is (seemingly) attempting to perform, to force the Fed’s hand on a rate cut — and therefore, to optimize the economy heading into the election.
At this stage, the harder he is on China, the lower stocks go, which puts more pressure on the Fed to cut rates. But as the Fed has now signaled it’s prepared to act, stocks have risen, which makes it less likely that the Fed will act.
With that, yesterday, I surmised that Trump might ramp up the rhetoric as we near the June 19th Fed meeting, to keep a lid on the bounce in stocks.
On that note, Trump had some very firm comments on China trade this morning, implying he’s not willing to give any ground. He says “we’re going to either do a great deal with China or we’re not doing a deal at all.” He gets his demands, or no deal. Again, as we discussed yesterday, he’s in the driver’s seat. And he said as much today: “It’s me right now that’s holding up the deal.”
Stocks have given some back today, after a six day rally from the lows of this recent correction. And we get this chart going into the close…
As you can see, the S&P 500 put in a big technical reversal signal — a bearish outside day. The last signal like this we observed was on May 1, which resulted in a 7.6% correction. Perhaps we have a signal here of some softness in stocks to come, until we get to the June 19 Fed meeting.
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Last week we had signals from the Fed Chair that they were prepared to cut rates if needed.
That’s all the market needed to hear to fuel a bounce back in stocks. And that bounce accelerated when the weak jobs numbers report hit on Friday.
This is the “bad news is good news” dynamic. Souring economic data gives more impetus for the Fed to move. And expectations for lower rates are fuel for stocks.
So, the market is now pricing in an 80% chance of a rate cut at their Julymeeting. But I suspect that’s not soon enough.
If stocks continue the strong recovery, on the expectation of rate cuts coming down the pike, the likelihood of the Fed actually delivering on rate cuts diminishes greatly. To put it simply, the better stocks do, the less likely it is that the Fed will cut. The stock market matters.
Remember, this overhang of concern in markets is less about what’sactually happening in the economy, and more about what might happen (i.e. the prospects that the U.S. economy and global economy may deteriorate IF the stalemate with China continues indefinitely).
I suspect that Trump wants and needs a move from the Fed at their Junemeeting, which is just seven business days away. The G20 meeting comes later this month (June 29-30) where Trump and Xi are expected to have a sit-down to discuss the trade deal. With a rate cut under his belt, Trump might feel more compelled to claim victory on the China trade talks and do the deal, giving himself enough runway into the 2020 elections to have a booming stock market and booming economy.
With the above in mind, it makes since for Trump to ramp up the trade rhetoric (and any other threatening rhetoric) ahead of that June Fed meeting (keeping pressure on stocks), in attempt to force the Fed’s hand, sooner rather than later.
This would explain why he called into CNBC this morning. Reminding everyone of his hardline stance on China (his indifference on hammering them with tariffs indefinitely), is perhaps his way of trying to tame the stock market recovery. It may sound like a crazy theory (Trump leveraging a monumental trade deal to manipulate Fed policy, in effort to surgically optimize the economic outcome going into the election), but I think it’s happening. And he’s doing it because he can. He’s in the driver’s seat. He has the leverage and he is pulling the levers.
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