March 5, 2021

The Senate may ram through the $1.9 trillion spending package over the weekend, which will likely require a tie breaking vote by the Vice President.  With that outlook, unsurprisingly, stocks reversed course from the beating of this morning.

We've talked about the dangerous inflation that is brewing under the expectations that another additional $1.9 trillion will be poured onto an economy that is already projected to run at least three times faster than pre-Pandemic levels. 

On that note, we had more evidence this morning that the hot economic recovery is already underway, thanks to the over $3 trillion of aid and stimulus rolled out last year.  The jobs number from February came in hot — twice what economists expected. And average hourly weekly earnings were up almost 6% compared to the February of last year (pre-Pandemic).  

And these numbers are coming with parts of the country still burdened by varying levels of government imposed constraints on their respective economies.  Any subjective economist would tell you the economy does not need another penny of stimulus, especially given that the constraints are being lifted. 

But it's coming.  And that's why yields have been running UP, and asset prices have been running UP.

So what happens when that next tranche of money gets the official stamp from Congress?  

We may find that foreign investors start voting on our policy decisions on Capitol Hill, with their feet.  That would mean, exiting the bond market, and selling the dollar.  This weaker dollar scenario is the typical and rational counter-balance to the rise global commodities prices (which are mostly priced and traded in dollars).  

With that, this will be the chart to watch next week …

March 4, 2021

We talked about the 10-year yield yesterday, as the spot to watch for market stability.

On cue, yields did this today …  

And stocks did this …

As we discussed yesterday, the sharp rise in yields, since the beginning of the year, may be a signal that the Fed has it very wrong on the inflation outlook.  

On that note, the Fed Chair, Jay Powell, had a perfect opportunity to atone for any mis-positioning on the inflation outlook today, in a scheduled interview with the Wall Street Journal.  He declined that opportunity, and stumbled through excuses.  The markets didn't like it. 

As we discussed a couple of weeks ago, we should all know that Powell's intent is to signal to markets that rates will stay ultra-low and QE will continue as far as the eye can see.  This is meant to set the expectations (for markets, consumers and businesses), that the Fed will be providing maximum support for years. The intent is to keep any possible impediments to the economic recovery (like behavioral changes from fears of rising prices) out of the picture, to best secure the recovery.  

Market participants are smart enough to see through it.  And I suspect they will continue to push the interest rate market in the direction of reality (up, and stocks lower), up to the point that the Fed will have to respond (probably very soon). 

On that note, as we also discussed yesterday, history shows us that the Fed will easily regain control of the bond market (to keep rates low, to continue unbridled fuel for the recovery).  But subverting market interest rates, at this stage in the recovery, will only create far bigger challenges when they are forced to deal with rapid inflation. 

March 3, 2021

At the highs of last week, the ten-year U.S. Treasury yield had nearly doubled since the beginning of the year (in two months). 

The Fed Funds Rate (the target rate which is set by the Fed) hasn't moved.  But the market interest rate (the rate determined by market participants) nearly doubled

This is creating concern for markets and the Fed. 

The concern is not that the economy is too fragile to survive on a 10-year interest rate of less than 1.5%. It's the idea that rates have moved fast, and may continue to rise, and to rise fast.  That would be trouble. 

Aside from the abrupt slowdown effect it would have on the economic recovery, it would represent either 1) a market that thinks the Fed has it very wrong on the inflation outlook, or 2) a market that is taking the cue of recklessly extravagant U.S. government spending, and political and social instability, to dump their long-term investments in our Treasury market (the historically safest and most liquid investments in the world).   Or it could mean both.

And both may be right.  But the Fed has been in control of the bond market.  And recent history (the past 12 or so years) suggest that they will maintain control of the bond market.  That means, we should expect the Fed respond to this sharp rise in market interest rates.  We've already heard them try to talk it down, with promises of keeping rates low, and assurances that they see little-to-no inflation risks.  That hasn't worked.     

Now there is speculation that the Fed will revisit the "Operation Twist" strategy.  They did this in 2011, selling shorted dated Treasuries, and buying longer dated Treasuries.  This flattens the yield curve, bringing down longer term rates (without having to buy more bonds … i.e. without having to increase the money supply).

Let's take a look at what happened to stocks when they did this in 2011.  

As you can see, stocks were already in bear market territory, due to an unraveling European debt crisis at the time.  And following the Fed's actions, stocks continued to fall another 7%, but bottomed within a couple of weeks.

With the 10-year trading at 1.47% today, the Treasury market continues to be the spot to watch.   

March 2, 2021

Yesterday Jamie Dimon said he expects that we will have "a gangbuster economy in 2021, and maybe into 2022." 

That's because the economy has nearly returned to its pre-pandemic operating rate (capacity utilization), and people have a lot more money than they did a year ago.

As we discussed on Monday, disposable income is 13% higher than it was before the pandemic.  And the personal savings rate (at 20.5%) is more than double pre- pandemic levels, and more than double the average U.S. savings rate of the past sixty years.  And yet another couple trillion dollars worth of fuel is about to be poured onto the liquidity fire.

With that, when we get to first quarter earnings (and more so, second quarter earnings), we are going to see some huge positive surprises, as companies report against earnings of a year ago, when the economy was in various stages of lockdown. 

Q4 has already delivered big positive surprises.  Wall Street was looking for an earnings decline of 9% (compared to Q4 2019).  We're nearly through all of the reports, and earnings grew by 4% in Q4. 

With this, the Wall Street earnings estimates for 2021 have been dialed UP.  But these numbers will still be crushed.   For Q1, they're looking for earnings growth of 21%.  For Q2, growth of 50%.  That sounds like a lot.  But remember, these earnings will be measured against a very low base.  When things are broadly bad, corporate America will always "take cover" from a broad economic crisis, to manufacture lower earnings.  They did just that.

As we (easily) predicted, the banks threw the kitchen sink of loan loss provisions into earnings reports last year, even though the Fed, Treasury and Congress had already pumped trillions of dollars into the economy to keep consumers and businesses solvent. That was a direct backstop (protection) against bank loan losses.
So, as we look a little more than a month into the future, when Q1 2021 earnings start trickling in, and the reality of what full-year S&P 500 earnings will look like, sets in, we will find that stocks (at least at these levels) look cheap.
Even at the current estimate of $175 S&P earnings for full year 2021, FactSet says the twelve-month Wall Street forecast on the S&P 500 of 4,430 (about 15% higher than today).  

March 1, 2021

Trump signed a $900 billion stimulus package on December 30th.  

As we reviewed on Friday, that has fueled a jump in, already lofty, personal income levels and in the personal savings rate. 

Let's take a look at what this has done to asset prices, over just a two month period …

Now, consider what will happen to asset prices after another package is signed into law (maybe by the end of this week) that is twice as big, and will more than double (relative to the December package) the amount of money that is dropped directly into the hands of consumers.   

Prices will run wild. 

On that note, we had another inflation data point this morning.  The Prices Paid component of the ISM Manufacturing report for February came in hot, again — one of the hottest readings in close to 20 years. It was the ninth consecutive month of price growth, and came from hotter demand AND "scarcity of supply chain goods" — that's a double-whammy.   

I'm going to copy in the comments from the survey participants in the report.  There is clear theme, inflation:  supply shortages, labor shortages to deal with overwhelming demand and rising input prices …

With the above in mind, from a quality of life perspective, the wage growth picture has been as good as we've seen in a long time, but wages are going to have to surge aggressively to keep up with rising prices.   

February 26, 2021

As another $2 trillion spending package is due to pass the House later today, and move on to the Senate, where it will pass (likely with the help of the Vice President), let's take a look at what the politicians are calling, the "suffering" economy.

Remember, despite a high unemployment rate (which has improved dramatically), and forced business closures (in some, more than other, areas of the country) there has been incredibly aggressive aid disbursed along the way. 

The Federal unemployment subsidy has, for lower wage earners, paid them more than they made while working (about 80% more than minimum wage).  And this has put pressure under wages being paid to those that are working.  The private sector has had to increase wages to compete with what the government has (maybe unintentionally) set as a new living wage (via the unemployment subsidy).  

And within all of this, keep in mind, the economy was never completely shutdown.  At the depths of the health and economic crisis, the economy was still running at 64% capacity (from 77% capacity, pre-crisis).  

And as you can see in the chart, the economy is now nearly back to the pre-Pandemic operating rate.   

With that backdrop, the latest Atlanta Fed GDP model is now projecting an 8.8% annual rate of growth for the first quarter. That’s three times faster than the pre-Pandemic Q4 2019 growth.

Personal income was up 10% in January (compared to December), thanks to stimulus checks from the $900 billion aid package in late December and the extended federal unemployment subsidy. 

The personal savings rate was 20.5% in January. That's more than double pre-Pandemic levels, and more than double the average U.S. savings rate of the past sixty years.  

And real disposable income is 13% higher in January, than it was in before the Pandemic.  

These numbers are doing to go one direction after this next $2 trillion package hits:  UP

Sounds great.  But as we've been discussing in my daily notes, this will all be accompanied by prices going UP, maybe a lot. 

Let's revisit the chart from the early 70s, the last time we had a sharp spike inflation.  

This chart shows the dramatic move in inflation from a “shock event.”  In the early 70s, OPEC blocked oil exports to the U.S., sending oil prices up four fold in 1973.  Broader prices in the U.S. economy followed, spiking by double digits.  

February 25, 2021

Stocks got hit today.  What's going on?

It's about inflation. 

And the signal is in this chart …

This move in the 10-year yield is clearly quickening.  We've gone from 1% to 1.6% in less than a month.  This is the market's judgement on the impact of the additional $2 trillion package coming down the pike from democrat-led Congress.  That interpretation is:  inflationary at best, and recklessly extravagant, at worst. 

The media and politicians have pretended that there is some bipartisan debate and negotiation going on, on Capitol Hill, about the size and scope of the latest fiscal "stimulus" proposal.  But this package has been (all but) signed, sealed and delivered since the Georgia Senate elections gave control of the Senate to the democrats.  The 50/50 split in the Senate, gives the deciding vote on legislation to the Vice President, Kamala Harris.  It's a done deal. 

So even though the $900 billion aid package passed in late December is just in the early stages of being disbursed, another $2 trillion of deficit spending is being poured on the liquidity fire. 

Remember, Jay Powell just admitted this week that the economy could run as hot as 6% growth this year.  That's before any new stimulus.  So, with the onslaught of more money, we should expect nominal growth and nominal returns this year to surprise to the upside (maybe double digits).  But so will inflation

This is the chart to watch as the next spending package gets rammed through…

February 24, 2021

Keeping with the inflation theme we've been discussing, let's take a look at "hard assets."  This is the best performer, historically, in times of high inflation.

We've talked quite a bit about commodities.  Let's take a look at other physical, tangible assets that are on the move.

Here's a look at real estate/housing …

Keeping with the inflation theme we've been discussing, let's take a look at "hard assets."  This is the best performer, historically, in times of high inflation.

We've talked quite a bit about commodities.  Let's take a look at other physical, tangible assets that are on the move.

Here's a look at real estate/housing …

As you can see in the far right of the chart, the slope of the rise in prices has increased since the initial policy response to the pandemic.  The index had it's largest monthly increase (in January) since 2007.  

There are a few vintage watch indicies.  Here's a look at a tracking of used Rolex watches …

This index (from Japan) is up over 20% since June of last year.  

February 23, 2021

Inflation was a hot topic in Jay Powell's testimony to Congress this morning.

Some of the senate was clearly concerned about the risks of a spike in inflation.  Powell, was not. 

Even with the aggressive move in asset prices, hot import/ export prices, hot economic data and an economy that, Powell admits, could run as hot as 6% growth this year (even before another massive fiscal spending package), he continued to downplay concerns about inflation.

Moreover, he said the greater risk to inflation is on the downside.

Does he mean it?  I doubt it.  But it's his job to signal to markets that rates will stay ultra-low and QE will continue.  As part of that signaling, Powell (and the Fed) continue to promote an extremely passive plan toward addressing a ramp in inflation when/if it rises above their target of 2%.  

Make no mistake, this is meant to set expectations that the Fed will be providing maximum support for years.  The intent is to keep the constraints off of the recovery, at this stage.

When we do get a rise in the Fed's favored inflation measures, I suspect we will see them act, not sit on their hands.  And perhaps the Spanish Flu era inflation is a good lesson on why they need to be ready.  From 1917 to 1920, U.S. inflation averaged 16%.  Stocks did well to, but produced little-to-nothing after adjusting for inflation. 

February 22, 2021

Back in April of last year, a couple of weeks after the decision by policy makers (Fed and Congress) to go "nuclear" in response to the health crisis and economic shutdown, we discussed what this would mean for prices

Here's an excerpt from my April 14 note …

"With trillions of dollars of relief/aid/stimulus money beginning to work it's way into the economy, the early stages of the global asset price reset” is under way.

When global policymakers print money and drop it on your doorstep, the purchasing power of the cash in your pocket goes down. Inflation.

This is where we began talking about this theme:  the "global reset of asset prices."  Practically all asset classes have gone up (dramatically) in price since.

This is creating the mirage of wealth.  That's revealed in household net worth, which has returned to record levels. 

But the reset of prices has yet to be felt at the every day consumption level.  It's coming.  And that is what will put the policy response into perspective.  Even with an improving job market, the rise in everyday prices will expose the wealth effect of rising asset prices, as a mirage — especially after another $2 trillion is poured onto an already heating up inflation situation.  The consequence will be a lower standard of living. 

Adding to the inflation pain, will likely be the fact that not many, still, are expecting it — as you can see in the chart below …

As we discussed much of last year, you don't want to hold cash in this environment.  The value is being explicitly destroyed.  Hard assets have a history of being the best protection in times of inflation, followed by commodities.  On that note, we've talked about the historically favored inflation hedge, gold.  We talked about the buying opportunity in gold last week, on the dip into the $1,775 area.  Gold was a good mover today, back above $1,800.