Pro Perspectives 3/31/23

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March 31, 2023
 
The broad stock market finishes the first quarter up 7%.  
 
As we head into Q2, the Fed is back to expanding the balance sheet again (QE), and the 10-year yield is back down to the mid 3% area.  This is a recipe for a higher earnings multiple on stocks.  
 
If we look back through the history of QE, and low market rates (a 10-year yield at 3.5% is still low relative to the historical average), the S&P 500 P/E tends to run north of 20. 
 
Here’s a look at the history of the past fifteen years, in the multiple-crisis/ liberal-policy-intervention era.
Notably, all along the path, the market undershot on the earnings multiple. 
 
And here we are again, with a forward P/E on stocks at 17.8 times.  Even with earnings at the dialed down levels, if we apply a P/E of 20x for earnings expected over the next twelve months, we get a price target on the S&P 500 that implies 12% higher (from current levels).
 
With that, remember, going back to 1950, there has never been a 12-month period, following a midterm election, in which stocks were down.

 
And the average one-year return, following the eighteen midterm-elections of the past seventy years, was +15% (about double the long-term average return of the S&P 500).
 
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Pro Perspectives 3/30/23

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March 30, 2023
 
Tomorrow morning we'll get core PCE for the month of February.  This is the Fed's favored inflation gauge.
 
That said, a lot has happened since February, which has included another rate hike.
 
That puts the effective Fed Funds rate (at 4.83%) ABOVE the most recent year-over-year core PCE (which was 4.7%), a position where the Fed believes they put downward pressure on inflation.  Looking through Wall Street estimates on tomorrow's (February) numbers, the year-over-year inflation number is expected to be a touch lower.
 
All of this said, this inflation data is a lot less important than it was a month ago.  We already know the level of rates is creating more than just downward pressure on inflation, it has created a dangerous shock to the economy, which will undoubtedly result in a credit crunch.
 
And with that, the Fed has already been forced into reversing course on quantitative tightening (back to QE). 
 
As we've discussed many times, putting the QE genie back in the bottle doesn't have a good record.  In fact, there is no successful record of it (globally). 
 
Why?     
 
Unforeseen consequences tend to arise.
 
For example, back in 2019, after spending nearly two years draining liquidity from the financial system (quantitative tightening), the Fed created a cash crunch (a scramble for dollars).  From too much liquidity, to too little.  It erupted in the interbank lending market — and it erupted quickly. 
 
The spike in the chart below is what happens when banks lose confidence in their ability to access cash.
The Fed was quickly forced to pump liquidity back into the financial system, and at a record rate in Q4 of 2019.
 
QE was back, and the Fed balance sheet continued expanding right up to the covid shutdowns (where it subsequently went into a new, higher gear).
In the chart above, you can see the response of stocks to the restart of QE in late 2019 … up 15% at a near perfect 45 degree angle.
 
Fast forward to today, and the Fed has once again induced another liquidity shock.  And once again, the Fed is back to pumping liquidity, expanding the balance sheet.  
 
As Bernanke once said, QE tends to make stocks go up.  Let's take a look at the current chart on stocks … 
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Pro Perspectives 3/29/23

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March 29, 2023
 
Yesterday we talked about the powerful formula at work for a weaker dollar –maybe a structural decline in the value of the dollar.
 
Not only has the rate outlook swung dramatically over the past few weeks (from tighter to easier, by year end), but the dollar's world reserve currency status is simultaneously and opportunistically being challenged.  And from a supply standpoint, the Fed, in the midst of global banking stress, freed up access to dollars through currency swaps with major central banks (a relief valve on supply pressure).
 
This is all dollar negative.     
 
And the chart on the dollar is already vulnerable to a technical break lower …
What are commodities primarily priced in (at least for now)?
 
U.S. dollars. 
 
So a lower dollar tends to mean higher commodities prices.
 
With that, if we look at the chart of copper, we can see a near inverse of the dollar chart.  This is a market in structural supply deficit and now on the verge of a technical bullish breakout in price … 
Next, let’s take a look at oil …  
With a fall in the dollar, the rise (bounce) in the price of oil would only be amplified by 1) the challenge to the petrodollar, 2) an undersupplied oil market that is (by design of the clean energy agenda) underinvested in new production, AND 3) the U.S. government's need to replenish the Strategic Petroleum Reserves.
 
Finally, let's look at gold …  
We've talked about the gold trade often in my daily notes.  Here we are back around record highs, just below $2,000.
 
Remember, central banks around the world stockpiled the most gold on record last year.  When surveyed, central banks said their accumulation of gold, is with the goal of getting to their "historical positioning" in gold as a reserve asset.
 
Full disclosure:  We are heavily weighted gold, oil and copper stocks in our Billionaire's Portfolio. 
 

Pro Perspectives 3/28/23

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March 28, 2023
 
Last week we talked about the growing risk to the "petrodollar," as China has taken advantage of global instability to strengthen influence and ties with oil-rich countries, with the prospect of trading oil in yuan.
 
As we discussed, the "petrodollar" has been the cornerstone of the dollar's role as the "world's reserve currency."  And the world reserve currency status has been key in building and sustaining the United State's position as the economic superpower.
 
This posturing by China on a "petroyuan" is, of course, an explicit challenge to dollar hegemony, and therefore to U.S. global leadership.
 
Even mainstreet media (CNN and Fox) ran tutorial-like stories on this over the weekend.   
 
And this challenge by China comes at a moment when the U.S. is in a position of weakness, trying to restore confidence in the banking system, while infighting over another debt ceiling raise — which is the product of record debt, record deficit spending and record high debt service.
 
That said, as we've also discussed in recent days, the interest rate market is now pricing in significant rate cuts by year end, driven by the recent confidence shock in the banking system, and expectations of subsequently tighter credit. 
 
This is all a powerful formula for a weaker dollar, which should be a powerful formula for another leg higher in commodities prices (particularly oil prices).  
 
Of course, a weak dollar would underpin inflation.  But that could be a good thing, if it's orderly.
 
As we've discussed in my daily notes often, we need inflation.  We need an inflationary boom (high nominal growth, hotter than average inflation), where the unsustainable government debt-load can be inflated away by growth. 

Pro Perspectives 3/27/23

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March 27, 2023
 
On Friday we talked about the similarities between the current environment and late 2018.
 
Back in December of 2018, as the stock market was in free fall through the first three weeks of the month, the Treasury Secretary called an emergency meeting with the President’s Working Group on Financial Markets (better known as the “Plunge Protection Team”).  
 
When called upon, among the purposes and functions of this group, formed following the 1987 stock market crash, is to “enhance orderliness” and “maintain investor confidence.”  The meeting marked the bottom for stocks. 
 
On Friday, in a growing crisis of confidence in the banking system, the Treasury Secretary called an emergency meeting of the Financial Stability Oversight Council (FSOC). 
 
Among the purposes and functions of this group, born out of the Global Financial Crisis, is to “mitigate risks to the U.S. financial stability.”  The meeting ended with a simple statement from the group, that “the U.S. banking system remains sound and resilient.” 
 
Following Friday’s emergency meeting:  Surprise!  Markets opened this morning to news of a deal:  First Citizen’s Bank (in coordination with the FDIC, part of the Financial Stability Oversight Council) bought the deposits and loans of the failed Silicon Valley Bank.
 
This was broadly a confidence boost for markets.  The next most vulnerable of the recent fallout/ teetering domino has been First Republic Bank.  The stock was up 13% today.
 
Remember, both the current and 2018 fallout have come from bad Fed policy (a tone-deaf Fed, mechanically tightening into clear warning signals).     
 
So, did this FSOC meeting mark the bottom in the banks?  Maybe the bottom.  But to restore confidence, I suspect it will take at least a verbal pivot from the Fed on the direction of interest rates.
 
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Pro Perspectives 3/24/23

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March 24, 2023
 
As we end the week, let's take a look at a couple of charts.
 
Here's a look at the S&P 500 …
After a volatile couple of weeks, stocks close above the 200-day moving average (the purple line), and above the big descending trendline (the yellow line) that describes the bear market of last year.
 
The bounce back in stocks today was largely sparked by news that the Treasury had called an emergency meeting with the Financial Stability Oversight Council.  This group includes the Treasury Secretary and the Fed Chair, along with leaders from a host of regulatory agencies.  
 
This reminds me of the emergency meeting Mnuchin (Treasury Secretary under Trump) called in response to the collapse in stocks in December of 2018.  Oil was crashing.  The yield curve had inverted for the first time in a decade.  Mnuchin called in the President's Working Group on Financial Markets. 
 
This group was formed by Reagan following the 1987 crash.  It's officially a smaller group than the Fin Stability group, consisting of the Treasury Secretary, the Fed Chair, and the heads of the SEC and CFTC.  But it also is done in consultation with the leaders of major banks (they call in the banks). 
 
As a whole, this group is better known as the "Plunge Protection Team."
 
So, stocks went into that 2018 Christmas having the worst December since the Great Depression.  This group met the day after Christmas.
 
That was the turning point.  The bottom was in for stocks, that day.
 
What does the current environment have in common with December 2018?  Bad Fed policy. 
 
In December of 2018, in the face of clear warning signals, the Fed continued to mechanically raise rates for a ninth time, projected another two hikes for 2019, and Jay Powell said their quantitative tightening program was on "autopilot."  Stocks fell a further 8% in just four trading days — penalizing a tone-deaf Fed. 
 
So, it took intervention by the Treasury to stabilize and turn the tide for markets.  And within just days of that meeting, in response to the calamity in markets, the Fed marched out, not just Jay Powell, but also two of his predecessors (Yellen and Bernanke) to walk back expectations of more Fed tightening.  By July they were cutting rates again.
 
Fast forward to today, and here we are again, in the face of clear warning signals, the Fed has proven tone-deaf, mechanically raising rates, and projecting another hike.  
 
And again, we have an emergency meeting called by the Treasury.
  
How does the bond market see this resolving?  
The 10-year Treasury yield is now 163 basis points BELOW the Fed Funds rate.  It historically trades about 90 basis points (on average) ABOVE the Fed Funds.  
 
As you can see in the chart above, this dynamic tends to resolve in rate cuts.
 
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Pro Perspectives 3/23/23

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March 23, 2023
 
In my election day note back in 2020, I said this: "the stakes are extremely high in this election. China is on the doorstep of overtaking the United States as global economic superpower, and they won’t be looking to spread democracy – rather, they have a clear and explicitly stated goal of world domination."
 
Trump had been a wrecking ball for the Chinese Communist Party’s grand plan. And with that, it’s safe to say they would do anything and everything to get rid of him. 
 
Here we are, and America (the global hegemony) is now leading a high-risk global economic and social transformation plan for the Western world, which has resulted in eroding influence and sovereignty.  Meanwhile, China has been strengthening itself on both fronts.
 
Moreover, in the past two weeks, China has brokered a deal between the Saudi's and Iran.  And strengthened ties with/influence over Russia.
 
So, the Western world is purging itself of one of the world's most important resources (oil, which plays a vital role in national security and prosperity) — and China has, not only stockpiled oil at cheap prices through the global pandemic period, but has now strengthened its access.
 
And it appears increasingly likely that China will be buying oil from these oil-rich countries, with yuan, not dollars.
 
This is a huge deal.
 
The "petrodollar" has been the cornerstone of the dollar's role as the "world's reserve currency."  And the world reserve currency status has been key in building and sustaining the United State's position as the economic superpower. 
 
Anti-oil policies of the Biden administration are the equivalent of taking a shotgun to one's own foot.
 
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Pro Perspectives 3/22/23

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March 22, 2023
 
The Fed hiked another 25 basis points today.  That takes the Fed Funds rate to the 4.75%-5% range. 
 
Meanwhile, core PCE, the Fed's favored inflation gauge is 4.71%.
 
The Fed Funds rate is above the rate of inflation, where, historically inflation has been beaten. 
 
That said, after the rate hike, Jerome Powell (Fed Chair) actually made a strong case for why they should have done nothing (paused).
 
He talked a lot about the credit tightening that they think is "quite real," in his words.  In fact, he said directly that the banking stress of the past two weeks, and related credit tightening, has an equivalent effect of a rate hike, and will weigh on inflation.
 
With that said, given that the level of interest rates has been a catalyst for breaking things in the financial system, why did they take the risk of another rate hike, and do so unanimously (no dissenting voters)?
 
The market had priced it in, and there was plenty of Wall Street and media commentary suggesting that a pause would signal to markets that the Fed was aware of some deeper trouble in the banking system.
 
It does appear that the Fed caved to that sentiment.  
 
Still, up front, in prepared remarks, Powell assuaged concerns about financial system risks, saying the actions they've taken (providing liquidity to the troubled venture capital-related banks) "demonstrate that depositors' savings and the banking system are safe."
 
Overall, the markets were satisfied with the idea that the Fed said the banks are sound and depositors are safe, AND that they were likely done with rate hikes, while (importantly) back to expanding the balance sheet.  
 
Stocks went up.  Commodities went up.  Market-determined interest rates went down.  The dollar went down.  All market signals that the Fed is done.
 
But then stocks did this …
As Powell was holding a press conference, Janet Yellen (the Treasury Secretary) was sitting before the Senate Appropriations Subcommittee.  Just after Powell implied "all depositors" are safe, this comment from Yellen hit the wires: 
 
"We are not considering insuring all uninsured bank deposits."
 
In fairness, it was a response to a question from a Senator about the requirement of Congressional approval to increase FDIC insurance limits.  
 
Nonetheless, you can see in the chart above the impact that comment had on the stock market, particularly because of this stock (below), which has been the one of the three troubled U.S. venture capital-related banks that is still standing (barely) …
First Republic has already had an infusion of deposits from a consortium of big banks (arranged by the Treasury).  They may have to do more.  If so, they will (Fed, Treasury). 
 
For perspective, this continues to be confined to a few unusual banks, with unusually high uninsured deposits, and with concentrated groups of depositors.
 
On a final note, Powell was asked today about the Fed's return to expanding the balance sheet (in response to the confidence shock in part of the banking sector).
 
He wanted to make clear that this "expanding of the Fed balance sheet," is not QE.  
 
This sounds familiar. 
 
From 2017-2019, the Fed attempted to shrink the balance sheet (quantitative tightening), trying to reverse its massive response to the Global Financial Crisis (three rounds of quantitative easing – QE). 
 
Things started breaking in the financial system.  Specifically, we had a 300 basis point spike in the overnight lending market.
 
By late 2019, they quietly returned to expanding the balance sheet again. 
 
By the time Jay Powell acknowledged it, in a prepared speech (in October of '19), they had already bought $200 billion worth of assets.  When questioned, he downplayed it, saying it was "not QE."
 
Stocks behaved as if it was QE…
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Pro Perspectives 3/21/23

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March 21, 2023
 
The Fed will decide on rates tomorrow.
 
Given the events of the past two weeks, they should be done with this tightening cycle. 
 
Not only has the confidence shock from the events in the banking sector induced disinflationary pressures (if not deflationary pressures), for those that needed a signal, it is clear now that the level of interest rates are a problem.
 
Add to that, Powell was already setting expectations that they had done the job, in his February 1 post-FOMC press conference. 
 
Remember, this is the meeting where he talked over and over again about the disinflation in the economy (falling inflation).  He said they had "covered a lot of ground" and that the full effect of their "rapid tightening so far are yet to be felt."   And he said "real rates are positive," after telling us for the past year that "we'll want to reach positive real rates."
 
In my view, with core PCE (the Fed's favored inflation gauge) trending lower and right around the level of the Fed Funds rate, Powell (at that time) thought they had done enough.
 
For good measure, they had built in expectations for a few more hikes, via their "economic projections."  Those expectations have a way of influencing consumer and business psychology, and therefore putting downward pressure on inflation (a tightening effect).
 
So, even though we had some hotter inflation data roll in to start the year, it's fair to argue that the Fed was already considering a pause.
 
Fast forward to tomorrow, and the Fed's concern should now be squarely on stability in the financial system AND the depth of impact this confidence shock will have on credit availability (i.e. the risk of a credit crunch).
 
Far worse than high inflation, is a deflationary bust (low or contracting economic activity and falling prices).  Deflation can be impossible to escape.  Ask Japan, now in a fourth decade of battling against it. 
 
The Fed knows this very well, which is why they made a policy change in late 2020.  Inflation had been (dangerously) too low for too long. Powell told us he would let inflation run hot, to bring inflation back to 2% on average OVER TIME.
 
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Pro Perspectives 3/20/23

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March 20, 2023
 
For all of last week, we heard chatter about a “banking crisis” and speculation about an imminent meltdown of the financial system, with comparisons made to 2008.
 
With that, as we’ve discussed often here in my daily notes, since 2008, there is one thing we know about the way central banks (and governments) will respond to crises:  They will intervene. 
 
They will stand “ready to act.”  The will do “whatever it takes” to maintain financial stability and confidence. 
 
This is the mantra we've heard from global central banks over the past fifteen years. 
 
With that, in a world full of uncertainties, that has been a certainty.
 
So, knowing this, it wasn’t a matter of “what should happen,” it was a matter of “what will happen.”
 
Here we are a week later, and the fallout remains confined to just a few banks that operate in a very specific niche of U.S. banking (bankers to venture capital firms and their portfolio companies), and Credit Suisse (an already very wounded bank, having been propped up for some time as systemically important).
 
The troubled venture banks have been buttoned up, via intervention by the Fed and the Treasury.  
 
And Credit Suisse, unrelated to the U.S. bank issues, was saved over the weekend, via intervention by the Swiss National Bank.
 
But what if the shock in confidence spreads, overwhelming the capabilities of the central banks and governments?
 
They've proven that it can't happen (as long as they're all coordinating). Remember, just three years ago the entire global economy was effectively closed.  What became THE life support for the entire global economy?  Coordinated action by global central banks and governments.
 
They crossed the line fifteen years ago.  They've become far more emboldened since the Pandemic response. 
 
Let's talk about another coordinated action they took over the weekend.
 
The Fed announced an "enhancement in currency swap lines." 
 
What does that mean? 
 
In times of uncertainty, global banks tend to scramble for U.S. dollars, to meet dollar-denominated liabilities.  And just as the Fed did in the Global Financial Crisis, they have to give these banks access to dollars, to avert a collapse in global banking.
 
That's what they did yesterday, relieving stress in global dollar liquidity (and they did so quickly), by giving global central banks (likely unlimited) access to dollars. 
 
This should result in a weaker dollar. 
 
With that, take a look at the chart of the dollar, which already looks vulnerable to a technical break lower …
What does a lower dollar tend to lead to?  Higher commodities prices.
 
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