Stocks open the week with another record high. The dollar continues to do better. And as we open the new month, yields are now up 32 basis points from the lows of early last month.
That’s a dramatic shift in the interest rate environment. And in recent days, underpinning that strength, is the idea that a hawk could be taking over for Janet Yellen when her term ends at the end of January.
Over the past few days the President has met with candidates for the Fed Chair job, and has said he will be announcing his decision in the next two to three weeks. That’s a big deal for markets and the economy — something to keep a close eye on.
His interview last Thursday was with a known hawk, former Fed governor Kevin Warsh – who has publicly criticized the Fed for keeping rates too low. He was also a hawk through some of the darkest days of the recovery – he’s been proven wrong for that view. As for Yellen: She has been among the most dovish Fed members throughout the crisis but has been leading the rate normalization phase (i.e. higher rates), which has proven to be questionable judgment, with missteps along the way resulting from the Fed’s overly optimistic and hawkish outlook.
Interestingly, though Trump criticized the Fed for keeping rates too low throughout the recovery, it’s higher rates, now, that are a significant threat to his growth policies. So he needs the Fed to step out of the way, and do no harm to the hand-off from a monetary policy-driven recovery, to a fiscal policy driven-recovery. Higher rates can choke off the positive effects of tax cuts and government spending.
On that note, his friend on monetary policy should be (and I think will be) Neel Kashkari (a new Fed member). Kashkari has been the lone dissenter on the Fed’s tightening path, arguing along the way to let the economy run hot, to ensure a robust recovery, before moving on rates.
Over the past two years, Yellen has blamed their pauses in their tightening program to the lack of evidence that the economy is overheating. It’s safe to say that the economy is not overheating (nor has it been), with both growth and inflation still undershooting long run averages.
With a Fed decision queued up for tomorrow, let’s take a look at how the rates picture has evolved this year.
The Fed has continued to act like speculators, placing bets on the prospects of fiscal stimulus and hotter growth. And they’ve proven not to be very good.
Remember, they finally kicked off their rate “normalization” plan in December of 2015. With things relatively stable globally, the slow U.S. recovery still on path, and with U.S. stocks near the record highs, they pulled the trigger on a 25 basis point hike in late 2015. And they projected at that time to hike another four times over the coming year (2016).
Stocks proceeded to slide by 13% over the next month. Market interest rates (the 10 year yield) went down, not up, following the hike — and not by a little, but by a lot. The 10 year yield fell from 2.33% to 1.53% over the next two months. And by April, the Fed walked back on their big promises for a tightening campaign. And the messaging began turning dark. The Fed went from talking about four hikes in a year, to talking about the prospects of going to negative interest rates.
That was until the U.S. elections. Suddenly, the outlook for the global economy changed, with the idea that big fiscal stimulus could be coming. So without any data justification for changing gears (for an institution that constantly beats the drum of “data dependence”), the Fed went right back to its hawkish mantra/ tightening game plan.
With that, they hit the reset button in December, and went back to the old game plan. They hiked in December. They told us more were coming this year. And, so far, they’ve hiked in March and June.
Below is how the interest rate market has responded. Rates have gone lower after each hike. Just in the past couple of days have, however, we returned to levels (and slightly above) where we stood going into the June hike.
But if you believe in the growing prospects of policy execution, which we’ve been discussing, you have to think this behavior in market rates (going lower) are coming to an end (i.e. higher rates).
As I said, the Hurricanes represented a crisis that May Be The Turning Point For Trump. This was an opportunity for the President to show leadership in a time people were looking for leadership. And it was a chance for the public perception to begin to shift. And it did. The bottom was marked in Trump pessimism. And much needed policy execution has been kickstarted by the need for Congress to come together to get the debt ceiling raised and hurricane aid approved. And I suspect that Trump’s address to the U.N. today will add further support to this building momentum of sentiment turnaround for the administration. With this, I would expect to hear a hawkish Fed tomorrow.
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As I said on Friday, people continue to look for what could bust the economy from here, and are missing out on what looks like the early stages of a boom.
We constantly hear about how the fundamentals don’t support the move in stocks. Yet, we’ve looked at plenty of fundamental reasons to believe that view (the gloom view) just doesn’t match the facts.
Remember, the two primary sources that carry the megahorn to feed the public’s appetite for market information both live in economic depression, relative to the pre-crisis days. That’s 1) traditional media, and 2) Wall Street.
As we know, the traditional media business, has been made more and more obsolete. And both the media, and Wall Street, continue to suffer from what I call “bubble bias.” Not the bubble of excess, but the bubble surrounding them that prevents them from understanding the real world and the real economy.
As I’ve said before, the Wall Street bubble for a very long time was a fat and happy one. But the for the past ten years, they came to the realization that Wall Street cash cow wasn’t going to return to the glory days. And their buddies weren’t getting their jobs back. And they’ve had market and economic crash goggles on ever since. Every data point they look at, every news item they see, every chart they study, seems to be viewed through the lens of “crash goggles.” Their bubble has been and continues to be dark.
Also, when we hear all of the messaging, we have to remember that many of the “veterans” on the trading and the news desks have no career or real-world experience prior to the great recession. Those in the low to mid 30s onlyknow the horrors of the financial crisis and the global central bank sponsored economic world that we continue to live in today. What is viewed as a black swan event for the average person, is viewed as a high probability event for them. And why shouldn’t it? They’ve seen the near collapse of the global economy and all of the calamity that has followed. Everything else looks quite possible!
Still, as I’ve said, if you awoke today from a decade-long slumber, and I told you that unemployment was under 5%, inflation was ultra-low, gas was $2.60, mortgage rates were under 4%, you could finance a new car for 2% and the stock market was at record highs, you would probably say, 1) that makes sense (for stocks), and 2) things must be going really well! Add to that, what we discussed on Friday: household net worth is at record highs, credit growth is at record highs and credit worthiness is at record highs.
We had nearly all of the same conditions a year ago. And I wrote precisely the same thing in one of my August Pro Perspective pieces. Stocks are up 17% since.
And now we can add to this mix: We have fiscal stimulus, which I think (for the reasons we’ve discussed over past weeks) is coming closer to fruition.
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We’ve past yet another hurdle of concern for markets this past week. Last Friday this time, we had a potential catastrophic category 5 hurricane projected to decimate Florida.
Though there was plenty of destruction in Irma’s path, the weakening of the storm through the weekend ended in a positive surprise relative what could have been.
So we end with stocks on highs. And remember, we’ve talked over past month about the quiet move in copper (and other base metals) as a signal that the global economy (and especially China) might be stronger than people think. Reuters has a piece today where they overlay a chart of economist Ed Yardeni’s “boom-bust barometer” over the S&P 500. It looks like the same chart.
What does that mean? The boom-bust barometer measures the strength of industrial commodities relative to jobless claims. Higher commodities prices and lower unemployment claims equals a rising index as you might suspect (i.e. suggesting economic boom conditions, not bust). And that represents the solid fundamental back drop that is supporting stocks.
With that in mind, consider this: In the recent earnings quarter, earnings and revenue growth came in as good as we’ve seen in a long time for S&P 500 companies. We have 4.4% unemployment. The rise in equities and real estate have driven household net worth to $94 trillion – new record highs and well passed the pre-crisis peaks (chart below).
Now, people love to worry about debt levels. It’s always an eye-catching headline.
But what happens to be the key long-term driver of economic growth over time? Credit creation (debt). The good news: The appetite for borrowing is back. And you can see how closely GDP (the purple line, economic output) tracks credit growth.
Meanwhile, and importantly, consumers have never been so credit worthy. FICO scores in the U.S. have reached all-time highs. So despite what the media and some of Wall Street are telling us, things look pretty darn good. Low interests have produced recovery, without a ramp up in inflation.
But as I’ve said, it has proven to have its limits. We need fiscal stimulus to get us over the hump – on track for a sustainable recovery. And we now have, over the past two weeks, improving prospects that we will see fiscal stimulus materialize — i.e. policy execution in Washington.
To sum up: People continue to look for what could bust the economy from here, and are missing out on what looks like the early stages of a boom.
After a week away, I return to markets that look very similar to where we left off 10 days ago. Stocks lower. Yields lower. The dollar lower. But commodities higher!
Now, this takes into account, another week of political volatility in Washington. It takes into account another week of uncertainty surrounding North Korea.
What’s important here, is distinguishing between a price correction and a real thematic change. If we’re not making new record highs in stocks every day, and stocks actually retrace 5% or so, does that represent the derailing of the slow but steady economic recovery and, as important, the dismissal of potential policy fuel that could finally lift us out of the post-crisis stall speed growth regime?
The narrative in the media would have you believe the answer is yes.
But the reality is, the economic recovery is stable and continuing. The policy stimulus has been a tough road, but continues to offer positive influence on the economy. And there are strong technical reasons to believe we’re seeing the early stages of a price driven correction in stocks.
Remember, we looked at the big technical reversal signal (the “outside day”) back on August 8th. That was the technical signal, and it was about as good a signal as it gets. The Dow had been plowing to new highs for eleven consecutive days — culminating in another new record high before. And the last good ‘outside day’ in the S&P 500 was into the rally that stalled December 2, 2015 and it resulted in a 14% correction.
Here’s another look at that chart, plus the first significant trend line that we discussed in my last note, August 11th.
I thought this line would give way, which it has today, and that we would see a real retracement, which should be a gift to buy stocks. If you’re not a highly leveraged hedge fund, a 5%-10% retracement in broader stocks is a gift to buy. Remember, the slope of the S&P 500 index over time is UP.
Prior to the reversal signal in stocks, we had already addressed the influence of the FAANG stocks. And I suggested the miss in Amazon earnings was a good enough excuse to cue the profit taking in what had been a very lucrative trade in the institutional investment community. Amazon is now down 12% from the highs of just 18 days ago.
What should give you confidence that the economic outlook isn’t souring? Commodities!
The base metals, as we’ve discussed in recent weeks, continue to move higher and continue to look like early stages of a bull market cycle — which would support the idea that the global economic recovery is not only on track, but maybe better than the consensus market view (which seems to be still unconvinced that better times are ahead).
The leader of the commodities run is copper. We looked at this chart in my last note (Aug 11). I said, “this big six-year trend line in copper (below) will be one to watch closely. If it breaks, it should lead the commodities trend higher.”
Here’s an updated chart of Copper. This trend line was broken today.
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Stocks are sliding more aggressively today. Wall Street and the media always have a need to assign a reason when stocks move lower. There have been plenty of negatives and uncertainties over the past seven months — none of which put a dent in a very strong opening half for stocks.
But markets don’t go straight up. Trends have retracements. Bull markets have corrections. And despite what many people think, you don’t need a specific event to turn markets. Price can many times be the catalyst.
If we look across markets, it’s safe to say it doesn’t look like a market that is pricing in nuclear war. Gold is higher, but still under the highs of a month ago. The 10 year yield is 2.21%. Two weeks ago, it was 2.22%. That doesn’t look like global capital is fleeing all parts of the world to find the safest parking place.
Now, on the topic of North Korea, the media has found a new topic to obsess about– and to obsessively denounce the administration’s approach. With that, let’s take a look at the Trump geopolitical strategy of calling a spade a spade.
As we know, Mexico was the target heading into the election. Trump’s tough talk against illegal immigration and drug trafficking drew plenty of scrutiny. People feared the protectionist threats, especially the potential of alienating the U.S. from its third biggest trading partner. We’re still trading with Mexico. And the U.S. is doing better. So is Mexico. Mexican stocks are up 11% this year. The Mexican currency is up 13% this year.
China has been a target for Trump. He’s been tough on China’s currency manipulation and, hence, the lopsided trade that contributed heavily to the credit crisis. Despite all of the predictions, a trade war hasn’t erupted. In fact, China has appreciated its currency by 5% this year. That’s a huge signal of compliance. That’s among the fastest pace of currency appreciation since they abandoned the peg against the dollar more than 12 years ago (which was China’s concession to threats of a 30% trade tariff that was threatened by two senators, Schumer and Graham, back in 2005). And even in the face of a stronger currency (which drags on exports, a key driver of the economy), stocks are up 5% in China through the first seven months of the year.
Bottom line: It’s fair to say, the tough talk has been working. There has been compromise and compliance. So now Trump has stepped up the pressure on North Korea, and he has been pressuring China, to take the side of the rest of the world, and help with the North Korea situation – and through China is how the North Korea threat will likely get resolved.
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James Bullard, the President of the St. Louis Fed, said today that even if unemployment went to 3% it would have little impact on the current low inflationevironment. That’s quite a statement. And with that, he argued no need to do anything with rates at this stage.And he said the low growth environment seems to be well intact too — even though we well exceeded the target the Fed put on employment years ago. In the Bernanke Fed, they slapped a target on unemployment at 6.5% back in 2012, which, if reached, they said they would start removing accomodation, including raising rates. The assumption was that the recovery in jobs to that point would stoke inflation to the point it would warrant normalization policy. Yet, here we are in the mid 4%s on unemployment and the Fed’s favored inflation guage has not only fallen short of their 2% target, its trending the other way (lower).
As I’ve said before, what gets little attention in this “lack of inflation” confoundment, is the impact of the internet. With the internet has come transparency, low barriers-to-entry into businesses (and therefore increased competition), and reduced overhead. And with that, I’ve always thought the Internet to be massively deflationary. When you can stand in a store and make a salesman compete on best price anywhere in the country–if not world–prices go down.
And this Internet 2.0 phase has been all about attacking industries that have been built upon overcharging and underdelivering to consumers. The power is shifting to the consumer and it’s resulting in cheaper stuff and cheaper services. And we’re just in the early stages of the proliferation of consumer to consumer (C2C) business — where neighbors are selling products and services to other neighbors, swapping or just giving things away. It all extracts demand from the mainstream business and forces them to compete on price and improve service. So we get lower inflation. But maybe the most misunderstood piece is how it all impacts GDP. Is it all being accounted for, or is it possible that we’re in a world with better growth than the numbers would suggest, yet accompanied by very low inflation?
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As we know, inflation has been soft. Yet the Fed has been moving on rates, assuming that they have room to move away from zero without counteracting the same data that is supposed to be driving their decision to increase rates.
Thus far, after four (quarter point) increases to the Fed funds rate, the moves haven’t resulted in a noticeable tightening of financial conditions. That’s mainly because the interest rate market that most key consumer rates are tied to have remained low. Because inflation has remained low.
A key contributor to low inflation has been low oil prices (though the Fed doesn’t like to admit it) and commodity prices in general that have yet to sustain a recovery from deeply depressed levels (see the chart below).
But that may be changing.
Commodities have been lagging the rest of the “reflation” trade after the value of the index was cut in half from the 2011 highs. Remember, we looked at this divergence between the stocks and commodities last month. Commodities are up 6% since.
Things are picking up. Here’s the makeup of the broadly followed commodities index.
You can see, energy has a heavy weighting. And oil, with another strong day today, looks like a break out back to the $50 level is coming.With today’s inventory data, we’ve now had 12 out of the past 14 weeks that oil has been in a draw (drawing down on supply = bullish for prices). And with that backdrop, the CRB index, after being down as much as 13% this year, bottomed following the optimistic central bank commentary last month, and is looking like it may be in the early stages of a big catch-up trade. And higher oil (and commodity prices in general) will likely translate into higher inflation expectations.
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With some global stock barometers hitting new highs this morning, there is one spot that might benefit the most from this recently coordinated central bank promotion of a higher interest environment to come. It’s Japanese stocks.
First, a little background: Remember, in early 2016, the BOJ shocked markets when it cut its benchmark rate below zero. Counter to their desires, it shook global markets, including Japanese stocks (which they desperately wanted and needed higher). And it sent capital flowing into the yen (somewhat as a flight to safety), driving the value of the yen higher and undoing a lot of the work the BOJ had done through the first three years of its QE program. And that move to negative territory by Japan sent global yields on a mass slide.
By June, $12 trillion worth of global government bond yields were negative. That put borrowers in position to earn money by borrowing (mainly you are paying governments to park money in the “safety” of government bonds).
The move to negative yields, sponsored by Japan (the world’s third largest economy), began souring global sentiment and building in a mindset that a deflationary spiral was coming and may not be leaving, ever—for example, the world was Japan.
And then the second piece of the move by Japan came in September. It was a very important move, but widely under-valued by the media and Wall Street. It was a move that countered the negative rate mistake.
By pegging its ten-year yield at zero, Japan put a floor under global yields and opened itself to the opportunity to doing unlimited QE. They had the license to buy JGBs in unlimited amounts to maintain its zero target, in a scenario where Japan’s ten-year bond yield rises above zero. And that has been the case since the election.
The upward pressure on global interest rates since the election has put Japan in the unlimited QE zone — gobbling up JGBs to push yields back down toward zero — constantly leaning against the tide of upward pressure. That became exacerbated late last month when Draghi tipped that QE had done the job there and implied that a Fed-like normalization was in the future.
So, with the Bank of Japan fighting a tide of upward pressure on yields with unlimited QE, it should serve as a booster rocket for Japanese stocks, which still sit below the 2015 highs, and are about half of all-time record highs — even as its major economic counterparts are trading at or near all-time record highs.
Without a doubt, there was a significant shift in the outlook on central bank monetary policy this week. In fact, the events of the week may represent the official market acceptance of the “end of the easy money” era.
Draghi told us deflation is over and reflation is on. Yellen told us we should not expect another financial crisis in our lifetimes. Carney at the Bank of England told us removal of stimulus is likely to become necessary, and up for debate “in the coming months.” And even the Finance Minister in Japan joined in, saying Japan was recovery from deflation.
With that, in a world where “reflation” is underway, rates and commodities lead the way.
Here’s a look at the chart on the 10-year yield again. We looked at this on Tuesday. I said, the “Bottom May Be In For Oil and Yields.” That was the dead bottom. Rates bounced hard off of this line we’ve been watching …
This reflation theme confirmed by central banks has put a bid under commodities…
That’s especially important for oil, which had been trading down to very dangerous levels, the levels that begin threatening the solvency of oil producers.
That’s a 9% bounce for oil from the lows of last week!
This all looks like the beginning of another leg of recovery for commodities and rates (with the catalyst of this central bank guidance). Which likely means a lower dollar (as we discussed earlier this week). And a quieter broad stock market (until growth data begins to reflect a break out of the sub 2% GDP funk).
Have a great weekend.
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Stocks open the week with another record high. The dollar continues to do better. And as we open the new month, yields are now up 32 basis points from the lows of early last month.
With some global stock barometers hitting new highs this morning, there is one spot that might benefit the most from this recently coordinated central bank promotion of a higher interest environment to come. It’s Japanese stocks.
