Pro Perspectives 10/22/24

 

 

 

 

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October 22, 2024

Let's take a look at the bond market.
 
This is the U.S. 30-year yield …
 
 
This has moved 48 basis points in 16 days.  The chart of the 10-year yield looks similar.  It's moved 52 basis points since the beginning of the month.  
 
Why? 
 
Is the market suddenly becoming concerned with overindebtedness?  Related to that, are the bond market vigilantes finally showing up to punish the egregious deficit spending and government handouts in an economy that's running at "above trend" growth.
 
Is it a bet that inflation will reignite under the policies of the next administration?
 
The sharp rise in yields isn't specific to the U.S.  It's global.  But then again, so is the overindebtedness problem. 
 
But, if we look at these three points denoted on the chart above, each has a commonality:  The Israel-Hamas War.
 
The Yom Kippur War started on October 6, 1973.  It began by a surprise attack on Israel by Egypt and Syria.
 
Almost 50 years to the day (50 years and one day), Hamas launched a surprise attack on Israel last October.
 
That's point number 1 on the chart.  
 
And with that attack on Israel, suddenly there was risk that retaliation could devolve into direct confrontation with Iran, and ultimately a global war.  It was a global war flashpoint. 
 
Where does capital tend to flow in times of heightened risk?  U.S. Treasuries (bond prices up, yields down).
 
In this case, it went the opposite way.
 
Over seven days, the 10-year yield went UP 50 basis points, crossing the 5% threshold.  It fell only when the Fed relented and signaled the end of the tightening cycle, because a 5% 10-year yield had tightened financial conditions — unwelcomed by the Fed. 
 
How did other markets respond to the attack in October?  Gold went up 11% in ten days. The S&P 500 went down 5%, before bottoming on the Fed signal.  Oil went up 10% and then down 10%.  
 
Let's look at point number 2 on the chart.  It's April. 
 
What happened in April?
 
Escalation.  Israel conducted an airstrike on the Iranian consulate in Syria killing the leader of the Iranian Revolutionary Guard. 

 

    

Stocks  fell 6% in fourteen days.  Gold went to new record highs, up 9% in ten days.  Oil went up, then down.  Once again, the 10-year yield went UP, not down — from 4.19% to 4.73% in nineteen days.

 

Fast forward to today, and we have another sharp move higher in yields, of a magnitude similar to these two periods we discussed above. And we have escalation again — which may, at this point, become a full-blown war between Israel and Iran. 

 

Gold is up almost 6% in eight days.  But stocks haven't done much.  And oil, the first move has been down.

 

So, given the discussion above, why would U.S. Treasury yields move higher if the risk of global war was heightened — and at a time when global capital should be flowing into the relative safety of U.S. Treasuries (demand that would put downward pressure on yields)?

 

Why higher?  In a wartime scenario, there would be no global government fiscal restraint – quite the opposite.  

 

Pro Perspectives 10/21/24

 

 

 

 

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October 21, 2024

With gold continuing to print new record highs, let's take a look at historical extremes in the ratio of gold prices to two key asset prices. 
 
Here's a look at gold prices relative to crude oil (WTI) …
 
 
As you can see to the far right in the chart, we are at an historic extreme, where the price of gold is 39 times the price of a barrel of WTI crude oil.  
 
If we look back over 75 years of data, these extremes in the ratio were resolved (i.e. turning point in the ratio) in each case by a sharp rise in the price of crude oil. 
 
Next is the S&P 500 to gold …  
 
  
The S&P is currently 2.2 times the price of gold.  Notice that the extreme of the late 90s tech bubble, which was ultimately resolved with a crash in stock prices, began at a much higher multiple of gold prices.
 

Pro Perspectives 10/17/24

 

 

 

 

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October 17, 2024

Over the past year, we've looked several times 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.

 

 

We are now twelve months forward, and indeed the October peak in the chart was followed with Fed easing, and indeed the subsequent 12-month period was very good for stocks.

 

And now, as you can see to the far right of the chart above, financial conditions are now indicating stimulative to economic growth (the line is below zero on the chart).

 

From the Fed's index inputs, when factoring in the current Fed Funds rate, the 10-year yield, the 30-year fixed mortgage rate, the lowest investment grade corporate bond rate, the DJIA stock market index, the Zillow house price index, and the value of the dollar, the Fed’s index now projects about a quarter point boost to real GDP one-year forward. 

Pro Perspectives 10/16/24

 

 

 

 

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October 16, 2024

Yesterday we talked about the view on the U.S. presidential election from the betting markets. 
 
A swing in favor of Trump took place last week, and has continued through this week.
 
Are there any reflections of this outlook in financial markets? 
 
Maybe. 
 
Sector performance over the past week has been led by financials. 
 
What performed best into the end of the year following the 2016 Trump election?  Financials.  XLF (financials ETF) rose 17% from election day into the end of 2016, after Trump was elected.
 
Energy, industrial and material stocks also did very well in that immediate aftermath of the 2016 election.  The Russell 2000 and Dow are heavily weighted in financials, energy, industrials and materials stocks.  Both indices are outperforming the S&P 500 and Nasdaq since early last week. 
 
Part of the Trump economic agenda is defending the "right to mine Bitcoin."  Bitcoin is up 9% from early last week. 
 
And as you can see below, as the betting market on the probability of a Harris win has declined, so has the biggest Clean Energy ETF (an investment theme contingent on the Biden/Harris agenda).  
 
 
Where else might we see market positioning for a rising probability of a Trump presidency? 
 
In China. 
 
The Chinese central bank offset Trump tariffs during his term by weakening the yuan against the dollar (making Chinese goods cheaper in dollar terms to mitigate the impact of a cost increase to end users from tariffs).  The yuan is down 1.5% from early last week.   
 
In the seven weeks surrounding the 2016 election (early October through late November), the Chinese central bank made the largest seven week devaluation of the yuan since adopting the managed float exchange rate regime back in 2005.       
 

Pro Perspectives 10/15/24

 

 

 

 

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October 15, 2024

The latest betting markets have a gap that has widened in favor of Trump. 
 
Let's take a look …
 
Here's Polymarket, which is an offshore betting platform.  Regulatory restrictions prohibit U.S. users, so this is perhaps a pulse of global sentiment — and it's running away for Trump … 
 
 
Next is Kalshi.  This is the first fully regulated prediction market in the U.S., where U.S. users can bet on event outcomes.  And this too has had a dramatic widening in favor of Trump …
 
 
Lastly is PredictIt, which is a prediction market focused on political events, but operates under a U.S. regulatory exemption, which (among other things) limits the number of traders per market and maximum bet size.  This is a narrower margin but favors Trump …
 
 
With this in mind, Trump did a sit down interview with a Bloomberg economics reporter today at the Economic Club of Chicago where he talked about the economic agenda. 
 
These types of crowds have historically given a chilly reception to Trump.  That wasn't the case this time.
 
It wasn't the case last week at the Detroit Economic Club. 
 
The audiences were clearly in favor of pro-growth, pro-business, pro-American economic policy. 
 
Maybe the most important topic discussed was the world reserve currency status of the dollar.  And Trump puts the highest priority on preserving it.  He says, "if you want to go to third world status, lose your reserve currency."
 
So, if we look through the Trump economic policy platform, these are the three explicit actions that will protect the currency:  1) lift restrictions on American energy production, 2) terminate the Green New Deal initiatives within the Inflation Reduction Act, and 3) oppose the creation of a central bank digital currency.
 
Why are these moves critical to maintaining the world reserve currency status of the dollar? 
 
Because the agreement to trade global oil in U.S. dollars (i.e. "petrodollars") has been the cornerstone of the dollar's role as the "world's reserve currency," since the end of the gold standard.
 
Maintaining this global demand for the dollar has been central to the U.S. building and maintaining its position as an economic superpower. And the dollar's reserve currency status allows the U.S. to borrow cheaply and run large trade deficits, among other economic advantages.
 
So, the explicit anti-oil policies of the current administration are a self-determined path to loss of reserve currency status of the dollar, and therefore a destruction of wealth and sovereignty of the country.  
 

Pro Perspectives 10/14/24

 

 

 

 

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October 14, 2024

JP Morgan kicked off Q3 earnings season on Friday, beating on both EPS and revenue expectations. 
 
We'll hear from more of the big banks tomorrow. 
 
Once again, the expectations bar for S&P 500 earnings growth has been set low by Wall Street.  The estimate for the quarter has been revised down to just 4.1%.
 
And this comes in a quarter that the Atlanta Fed projects the economy to have grown at 3.2% — and in a quarter that ended with what is considered to be a hot jobs report.  So once again, we head into earnings season with a setup for positive surprises. 
 
As for the banks, remember last week we talked about Jamie Dimon's comment surrounding AI and the "backlog for IPOs."
 
And we looked at the parallels between the current environment and the late 90s boom, both of which had the driver of a technology revolution.
 
If history is our guide, we should expect a coming boom in IPOs.
 
Let's revisit how the late 90s IPO boom influenced the Wall Street kings of underwriting (with emphasis on the performance from the first Fed rate cut up to the March 2000 stock market peak). 
 
Here's JP Morgan … 
 
 
Citibank …
 
 
Morgan Stanley …
 
 
And no one was responsible for more IPO underwriting volume in that era than Goldman Sachs.  And they went public in 1999, in the height of the frenzy.  The stock went up 60% in 10 months, before the stock market topped in March of 2000. 

Pro Perspectives 10/10/24

 

 
 

 

 

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October 10, 2024

We had the September inflation report this morning (CPI).

Investor’s Business Daily said it was “hot” and a “gut-check for the Fed,” implying it will test their resolve on the policy path (i.e. perhaps dial back on rate cut expectations). 

So, what was the number? 

It was 2.4%. 

As you can see in the chart below, it’s the lowest since February of 2021, continuing the clear trend lower.  That’s good. 

And if we look at the real interest rate (inflation adjusted), it remains near the highs of this recent tightening cycle.  This means the Fed is still putting significant downward pressure on the economy — highly restrictive policy, even with the recent 50 basis point rate cut. 

But if interest rate policy is still historically very restrictive, which gives the Fed plenty of room to cut rates, why did famed macro investor Stanley Druckenmiller and former Treasury Secretary Larry Summers both criticize the Fed last week for the large rate cut?

Druckenmiller, in fact, argued the Fed’s policy wasn’t restrictive.  And that would imply no rate cuts needed.   

He said GDP is running “above trend” around 3%, corporate profits are strong, equities are at all-time highs, credit spreads are tight and gold is on highs.

Things are good.  Why cut? 

Why?  Because we shouldn’t be satisfied with a 3% economy, after we’ve expanded money supply by 40% and continue to run crisis-level budget deficits. 

The potential output for the economy should be much better than 3% real growth.  More importantly, much better than 5% nominal growth.

Remember, the government debt has doubled, relative to the size of the economy since the Great Financial Crisis.

We are at Great Depression/World War II level debt.

The only solution is to inflate the debt away. 

That has to come through hot nominal growth.

Instead, the Fed has held down the economy with highly restrictive policy. 

Still, the economy has mustered 3% real growth.  That’s “average” in average times.  Dumping $6 trillion onto the economy and running crisis-level deficits aren’t average/normal.  We should be getting a much bigger bang for our buck.  The level of real rates is evidence.

What is “hot nominal growth?”  The last time we had this level of debt, (chart above), the economy grew at an average nominal rate of 19% (in the early 1940s).    

  

 

Pro Perspectives 10/9/24

 

 

 

 

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October 09, 2024

We talked about the interview with Jamie Dimon yesterday, and his expectation that we will see more episodes of volatility in the Treasury market, driven by the Fed's quantitative tightening (QT). 
 
The Fed's minutes were released today from its September meeting, where they decided to start the easing cycle with a larger than expected 50 basis point cut.  They said nothing to change the ongoing reduction of the Fed's balance sheet (QT).  
 
 
As you can see in the chart above, the Fed has reversed nearly $2 trillion of the securities it added to its balance sheet in the covid QE response. 
 
That said, in line with the commentary from Jamie Dimon yesterday, most of the major bank economists came into the year expecting the Fed to end QT between this past summer and the first quarter of 2025 — with the concern of doing so before any signs of stress emerge. 
 
So far, no signs of stress translates into record highs for stocks. 
 
With that, let's take a look at the divergence developing again between small caps (the Russell 2000) and the big tech led, cap-weighted S&P 500. 
 
 
If we look back at the last two months of 2023, when Jerome Powell signaled the end of the tightening cycle, the Russell 2000 (small caps) went on a tear — rising 24% by year end.
 
Now we have the easing cycle officially underway, and yet the underperformance between small caps and the S&P on the year is double-digits.  
 
  
 

Pro Perspectives 10/8/24

 

 

 

 

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October 08, 2024

The big banks will kick off Q3 earnings season on Friday.
 
And preceding that, today we heard from Jamie Dimon the CEO of JP Morgan.
 
No one has more information on the health and trends of consumer and business behavior than the head of the biggest bank in the country.  With that position of power, he also has a seat at the table with the Fed chair and White House economic advisors, as a member of the "President's Working Group on Financial Markets."  He has influence.
 
So, what did he say?  
 
His comments started hitting the wires a few minutes after the open of the stock market this morning.  
 
He said "AI is real."
 
Not coincidentally, the AI trade was dominant today.  Nvidia finished 4% higher.  The Nasdaq and S&P both had big days, led by big tech. 
 
With the technology revolution in mind, he talked about the backlog for IPOs.  
 
We talked about this IPO outlook earlier this year, in looking at the parallels between the current environment and the late 90s boom.
 
A technology revolution was underway in the late 90s, with the rapid adoption of the internet.  Productivity was high.  Growth was hot.  Inflation was low. And the Fed juiced it with rate cuts, starting in 1995.
 
Take a look at the volume of IPOs in the late 90s, the biggest of which came early, in 1996. 
 
Then the frenzied return chasing came in late 1999.
 
     
If history is our guide, we should expect a coming boom in IPOs. 
 
And the Wall Street kings of underwriting (the big banks) will be big beneficiaries.
 
What else did Jamie Dimon say today? 
 
He agreed with the Fed rate cut.
 
And he had another comment about monetary policy that is interesting, particularly ahead of tomorrow's release of the minutes from the last Fed meeting.
 
Remember, as of September, the Fed is now easing policy through interest rate cuts, but it continues to withdraw liquidity from the system (i.e. it's simultaneously tightening) via its quantitative tightening program.
 
On the latter, Jamie Dimon has said in the past, that "rate cuts relate to inflation," while "QT relates to volatility and liquidity in the Treasury market."
 
And in this interview this morning, he talked about the risk of volatility in the Treasury market. 
 
He complained that the banks have tons of excess cash but can't use it efficiently due to regulatory constraints.  It's affecting their ability to provide liquidity in the Treasury market, while the Fed is simultaneously extracting liquidity from the Treasury market.  
 
And with that, he implies that we will likely see another episode of big Treasury market volatility, caused by the Fed's quantitative tightening (he mis-spoke and said QE in the interview).
 
Jamie Dimon said the Fed should start "fixing" this "today."
 
Remember, back in 2019, the Fed's attempt at quantative tightening brought about this 300 basis point spike in the overnight lending market …
 
 
The Fed explained it as …  "strains in money market … against a backdrop of a declining level of reserves, due to the Fed's balance sheet normalization and heavy issuance of Treasury securities."

 

So, after a period of "balance sheet normalization" (QT), the Fed was forced to return to QE.

 

With all of the above in mind, we'll see in tomorrow's Fed minutes what the committee had to say about plans to end QT (if anything). 

Pro Perspectives 10/7/24

 

 

 

 

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October 07, 2024

We came into Friday's jobs report with the Fed projecting two additional quarter point cuts into the end of the year, with "unexpected weakness" in the labor market as an explicit condition that would prompt them to move faster.
 
The jobs report came in unexpectedly strong.
 
Remember, this follows the recent upward revisions that were made to Q2 economic output, personal incomes, consumer spending and the personal savings rate.  And in the words of Jerome Powell, that removed what the Fed perceived to be "a downside risk to the economy."
 
So, with this good jobs report, we have more new information that suggests the economy (maybe) isn't as fragile as many have feared, including the Fed.
 
Does that mean the Fed's September cut was a mistake?  Is inflation coming back?
 
Let's revisit my chart from my May 7th piece, where we looked at the relationship between the change in money supply, and inflation.
 
 
As you can see, we had a growth shock in money supply (the blue line), from the 2020-2021 policy response to the pandemic.  
 
That was the inflation catalyst.
 
And you can see the lagging effect on inflation (orange line), as it peaked 16 months after the peak of money supply growth.  
 
We've since had the disinflationary effect (falling inflation) from the decline in money supply growth.  And not only has money supply growth dramatically declined, it contracted for sixteen consecutive months.  Contracting money supply is historically deflationary.
 
From this, we should expect the pressure on prices to continue to be downward.
 
With that in mind, let's take a look at a few comments made today by the Chicago Fed President (and voting member) Austan Goolsbee.
 
He said, he's "extremely happy with the jobs report."  But he wanted to make clear that the "large majority of Fed policymakers feel rates are going to come down a lot over the next year to 18 months."
 
And he said, "there are some signs that inflation might undershoot target."