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July 16, 2024

Back in December of last year, we looked 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.  

 

 

So, the Russell 2000 (small cap stocks) is now up 39% since the Fed's pivot to a dovish stance on rates back in October — running right around the average return for small caps after these turning points. 

 

And we've had about 10 percentage points of that performance just since the CPI report last Thursday.

 

But as you can see in this longer term chart for small caps, we remain about 8% away from the all-time highs.  And the tailwinds are just forming.    

 

 

As a reader of my daily notes, you can find my favorite undervalued small-cap stocks by joining me here.

 

 

 

 

 

 

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July 15, 2024

The assassination attempt on former President Trump over the weekend has bolstered the election probabilities heavily in favor of a Trump victory in November. 
 
You can see it reflected in the progression of the betting markets in the chart below …  
 
 
And a Republican sweep of Congress is now at better than a coin flips chance.
 
With this dynamic, let's revisit the summer of 2016, when it became apparent that Trump had a legitimate chance at a first term. 
 
Things were looking bleak in the latter half of 2015 and first half of 2016.  Oil prices had been crashing for more than year, driven by OPEC manipulation, in attempt to put the U.S. shale industry out of business.  It nearly worked.  There were mass U.S. oil and gas bankruptcies, and threats to creditors of the industry.  It came with heavy deflationary pressures in the economy. 
 
Meanwhile, China's economy was in bad shape.  The stock market had a boom and bust in 2015, and the Chinese had surprised the world by devaluing the yuan (a shock to global financial markets).
 
Despite these signals, the Fed mechanically made its first rate hike in a decade, to end 2015. 
 
And with that, to start 2016 U.S. stocks melted down, having the worst start to a New Year on record.
 
So, it was seven years after the failure of Lehman Brothers, and the government had blown through an $800 billion fiscal stimulus package, three rounds of QE and held rates at zero throughout, and yet the economy was on the verge of another downward spiral.
 
And the worse news:  The monetary and fiscal ammunition needed to fight another ugly downturn (which was a high risk of a deflationary spiral) had already been fired. 
 
This muddling economic recovery, turned deflationary spiral risk, was a global phenomenon.  And it brought about a revolt at the ballot box.  It started in the UK, with Brexit. 
 
And right about that time, it became apparent that U.S. voters were embracing change in the U.S. — a pro-growth candidate, in Trump.
 
Take a look at the response of the Trump effect on the Small Business Optimism Index in 2016. 
 
 
Also notice, where the index stands now.  It's lower than 2016, having just reported a 30th consecutive month UNDER the historical average. 
 
With that, we shouldn't underestimate the potential for a boom in optimism (business and consumer) for the second half of the year, if the election outlook continues to hold.
 
What would be on the chopping block in a Trump presidency and aligned Congress?  The radical multi-trillion dollar global energy transformation (which also has Biden social agenda spending).  
 
The anti-Trump campaigners (which include the media) have claimed that Trump would be more inflationary than Biden.  To the contrary, rescinding the already appropriated massive fiscal spending on the Biden agenda would be (maybe verydisinflationary.
 
On the inflation topic, as we discussed last week, the June inflation data showed the first monthly decline since May of 2020 (the depths of the pandemic lockdown and deep economic contraction).
 
And conveniently, Jerome Powell was on a stage today at the Economic Club of Washington for some Q&A. 
 
What did he have to say?  
 
He said they've been looking for "more confidence" that inflation (the rate-of-change in prices) was on its way down, toward its target of 2%. 
 
He said inflation came down by "a very large amount," in the second half of last year.    
 
He said they "didn't gain any additional confidence" in the first quarter, but the three readings in the second quarter, including the one from last week "do add somewhat to confidence."
 
The headline monthly CPI change for the past three months has been 0.3% (April), 0% (May) and negative 0.1% (June).
 
Interestingly, these last two numbers bring down the six month average to a lower number than the average of the second half of last year, which Jay Powell described as "good data" that gave them the "confidence" to start telegraphing the beginning of the easing cycle.
 

With the improving outlook on rate cuts, we looked at this chart last week, which shows the divergent paths of the Russell 2000 (small cap stocks) and the S&P 500 (led by a handful of big tech stocks).  As you can see, it's now aggressively converging (i.e. Russell outperforming).  
 
 
 

 

 

 

 

 

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July 11, 2024

Going into this morning's inflation report, the divergence in the performance of a handful of tech giants and "the rest" of the stock market was at historic extremes.
 
The market cap weighted S&P 500 was up almost 19% on the year, driven mostly by performance of the tech giants.  The equal-weighted S&P was up only a little over 4%.  The Russell 2000 (small caps) was up only 2%.
 
The divergence made sense in the tightening cycle, particularly as the Fed was relentlessly making verbal threats to bring down jobs and demand. 
 
It makes a lot less sense heading into an easing cycle. 
 
But what if the easing cycle gets derailed by an industrial revolution?
 
If we look at this chart, it appears that concern emerged in mid May. 
 
   
This above chart shows how the S&P and the Russell have performed since Jerome Powell signaled the end of the tightening cycle last October. 
 
As you can see, the two indices traded tightly for about six months, on the tailwinds of impending interest rate cuts.  But in May, the small cap index started trading south, diverging from the S&P 500.  And that was despite an inflation number, reported in mid-May, that was favorable for the rate cut outlook.
 
What happened?  Nvidia earnings.
 
It wasn't just another triple-digit growth quarter for Nvidia.  It was the announcement of a "next wave of growth," powered by "a new chip" that was revealed to be already powering the next iteration of ChatGPT, a version that was said would "change the world" (in the words of Sam Altman).
 
Would this undo the Fed's efforts to slow the economy, and inflation, and force the Fed back into the inflation fighting stance?  
 
The divergence in the chart suggests that was a consideration.
 
That brings us to this morning.
 
The June inflation data reported this morning showed a decline in prices from May to June.  And it was the first monthly price decline since May of 2020 (the depths of the pandemic lockdown and deep economic contraction).
 
The year-over-year change came down to 3%.
 
Of that 3%, two-thirds of it (2.01 percentage points) was auto insurance and rent (Owner's Equivalent Rent).  As we know, and the Fed knows, these numbers are lagging features of an inflationary period, and in the case of rents, it's old data – not reflecting the current rent climate (which is deflationary).
 
So, as we did in my post-CPI note last month, if we adjust the year-over-year change in the headline CPI number, using the pre-pandemic averages for auto insurance and Owner's Equivalent Rent, headline CPI drops to 2.25%.
 
With this disinflationary data this morning, as you can see in the far right of the above chart, the divergence of the past six weeks closed sharply today.   
 
Now, remember as inflation falls, and with the effective Fed Funds rate at 5.33%, the Fed's policy gets tighter and tighter. That means more and more pressure on the economy, and on employment. 
 
The result?
 
As for the economy, Q2 is now tracking just 2% growth – half of where the projections started (the green line in the chart below). 
 
 
That 2% growth, follows 1.4% growth in Q1.  So the economy is running at a sub-2% pace in the first half of 2024.  That's below historical trend.  And that's with historic multi-trillion dollar fiscal tailwinds.
 
So as the government has slammed down the accelerator, the Fed has simultaneously slammed on the brakes.     
 
With that, the employment data from last Friday shows a rate of change in the rise of unemployment data that's consistent with past recessions.
 
So, we've gotten all of the debt associated with hyper-aggressive fiscal stimulus over the past four years.  We've absorbed the related historic devaluation of purchasing power of our money.  But the Fed has throttled the requisite "bang for our (many) bucks."  They have given us a fraction of the growth.
 
If not growth, what has been the beneficiary of the explosion in money supply over the past four years?  The stocks of the tech giants, which has fueled the extreme divergence in the chart below, between the blue line (money supply) and the orange line (S&P futures).
 
 
With this above chart in mind, we had bearish technical reversal signals in the tech-heavy Nasdaq futures and S&P futures today. 
 

 

 

 

 

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July 10, 2024

With the June CPI report due tomorrow morning, let's revisit the two hot spots in the report.

 
As we've discussed here in my daily notes, both auto insurance and owner's equivalent rent make up about 30% of the CPI.  Both have been propping up the overall index, and the Fed's current restrictive interest rate policy is powerless to bring them down.
 
 
Above is motor vehicle insurance.  This has risen at a 20% year-over-year rate for six consecutive months (the actual data is represented by the blue bars). 
 
At 20%, it's adding more than half a percentage point to year-over-year consumer price index. 
 
The good news:  In the last inflation report, the monthly change in auto insurance prices declined for the first time in 29 months. 
 
But even if this auto insurance index were to flat-line from this point (i.e. zero month-to-month change in this insurance price index), it would still take five months for the year-over-year measure to fall below double-digits (that scenario represented by the orange bars in the chart above).
 
So, even if the insurance hikes are over, this year-over-year measure will continue to put upward pressure on the inflation data for months to come. 
 
The Fed knows this, and this dynamic continues. 
 
Next let's revisit the heavier weighted component that's been propping up CPI:  Owners' Equivalent Rent (which is also influenced by the sharp rise in insurance rates).
 
This makes up 27% of the consumer price index.  And you can see in this chart below, it has directly contributed at least 1.5 percentage points to the year-over-year change in CPI for 23 consecutive months.  The orange bars represent the path IF this component were to flat-line over the coming months (zero monthly change).  
 
 

This too, will continue to put upward pressure on CPI for the months ahead. 

 

But if we look at the national rent index from Apartment List, which has one of the most extensive databases of apartment rental listings, the rent inflation story is very different

 

As you can see, Apartment List has rent inflation peaking in late 2021 (the purple line), and turning to rent deflation in the middle of last year.  The government's calculation on rents is simply lagging — it's old data. 

 

And the old data is giving the illusion that inflation is "sticky" at higher levels. 

 

 

 

 

 

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July 09, 2024

The Fed Chair gave testimony to Congress today.  And he was careful not to send the market a signal on the timing of a rate cut.
 
But as we discussed yesterday, the Fed has told us a condition for a policy response (i.e. a rate cut).  It's any "crack" in the labor market.
 
And with that, as we discussed yesterday, the unemployment rate in June ticked UP to 4.1%. And, importantly, the rate-of-change in the unemployment rate since the cycle low 14-months ago is at a pace consistent with the past four recessions, and (related) consistent with a Fed easing cycle
 
Now, interestingly, the San Francisco Fed released a study yesterday afternoon on the effect of immigration on the jobs data.
 
To put it simply, based on the CBO's high immigration scenario, the study says, in the short run, the economy needs to grow jobs by 230k a month to keep the unemployment steady.  If we look back at the first seven months of last year, when the unemployment rate was holding steady, the job creation averaged 253k a month (higher than the study estimates).
 
That number has averaged only 212k since August of last year, and the unemployment rate has jumped from 3.5% to 4.1%.
 
What was clear in today's discussion between Jerome Powell and the Senate Banking Committee, is that the Fed hasn't had a handle on how the mass immigration of the past three years has effected the labor supply.  This recent study would suggest the supply is bigger than they have assumed.  That's why the unemployment rate is rising, despite what looks like solid job gowth.  There are indeed cracks in the labor market. 
 

 

 

 

 

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July 08, 2024

The Fed has told us they are watching the job market “carefully” for “cracks” as a condition to start the easing cycle.
 
So, were there cracks in Friday's jobs report?
 
We'll take a look, but first let's revisit the challenges that the Fed has had with allowing this type of report to dictate policy. 
 
As we discussed over the past three years, the Bureau of Labor Statistics (BLS) has a history of making large revisions in the jobs data under the Biden administration.
 
Back in 2021, when the Fed was ignoring inflation, dismissing it as "transitory," the BLS was, all along, under-reporting jobs — to the tune of almost 2 million jobs from when Biden took office, until the Fed started (finally) raising rates.  The initial reports on jobs during the period gave the impression that the job market was weaker than it was in reality, and the Fed accommodated weakness by maintaining its stimulative position.
 
And as we know, the Fed got caught behind the curve on inflation.  
 
Then the Fed began the tightening cycle back in March of 2022, and the BLS has since over-reported jobs by 749,000 — giving the initial impression to consumers, businesses, investors and economists that the job market is hotter than it actually is. 
 
This, in part, has resulted in a Fed that has held the real interest rate (the Fed Funds rate minus the inflation rate) at historically tight levels for the past twelve months.   This stance has arguably put undue downward pressure on the economy, and employment.  And we may find that the Fed has followed its mistake of being too easy for too long, by being too tight for too long. 
 
So, given this context, what did we get in this past Friday's report? 
 
The BLS revised down the job creation of the past two months, by over 100,000 jobs.
 
The unemployment rate ticked UP to 4.1%.  That's an historically low rate of unemployment, but it's the highest since November of 2021.  And 4.1% is higher than the unemployment rate for the two years prior to the pandemic (2018-2020).
 
On the surface, a 4.1% unemployment rate and 206,000 jobs added in June doesn't seem like too much to be concerned about. 
 
But the pattern of revisions in payrolls and the rate-of-change in the unemployment rate should be a "ringing bell" for the Fed.
 
The unemployment rate is 7/10ths of a point above the cycle low (3.4%) of just 14 months ago.  The speed of this change in joblessness puts it in the unique company of the past four recessions (and consistent with related Fed rate cuts).
 
We'll find out tomorrow morning, if Jerome Powell considers that a "crack."  He'll give his semi-annual testimony to Congress at 10am. 

 

 

 

 

 

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July 02, 2024

We get the June jobs report Friday morning.  

The Fed has told us they are watching the job market “carefully” for “cracks” as a condition to start the easing cycle.  Jerome Powell reiterated that today, saying if the job market “unexpectedly weakens,” it would cause the Fed to “react.”

Add to that, the Chicago Fed President, Austan Goolsbee said today that the goal is to “get inflation down without stressing the labor market.” 

Keep in mind the May unemployment rate was last at a 28-month high, and the under-employment rate is at 30-month highs. 

With that in mind, remember, we’ve talked about the playbook executed by the European Central Bank and the Bank of Canada last month, where they positioned the start of the easing cycle as just “removing restriction” — as to not fuel market euphoria about the easing cycle.

That’s an easy playbook for the Fed to follow, if the job numbers come in soft, reducing restriction just to maintain the level of restriction as inflation falls.

On a related note, the top central banker from the Fed, ECB and the Bank of Brazil today sat on a stage in Portugal and fielded questions.

Most notably, the Brazilian central banker warned that the “higher for longer” rate regime in the Western world (mainly the Fed) combined with record high debt will “start to stretch (global) liquidity.”

He noted that emerging market countries feel the pain first, when liquidity becomes “stretched.”  And he noted that in recent weeks, there are signs of that happening.

Perhaps not coincidentally, yesterday the Fed’s measure of liquidity (SOFR) hit the most “stretched” level since early January. 

 

And perhaps no coincidence, the Bank of Japan, which was the (very important) global liquidity provider throughout the Western world’s interest rate tightening cycle, is due this month to announce its plan to begin the end of its QE program (begin to taper bond purchases/ removing liquidity from global markets).

As I said in my March note, when the BOJ made its first step toward exiting its role as the global liquidity provider, “global central banks (led by the Fed) may now have less leeway to hold rates too high, for too long.”  

As the head of the Brazilian central bank alluded to today, doing so risks global liquidity swinging the direction of too tight (i.e. a liquidity shock).

 

 

 

 

 

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July 01, 2024

Last week we talked about the potential for pain in sovereign bond markets if the government policy pendulum swings, from the globally coordinated climate agenda, to a more nationalist agenda (under leadership change) — given that trillions of dollars of deficit-funded investment in the climate agenda could be abandoned.
 
After Thursday night's U.S. Presidential debate, the bond market did indeed react.
 
The U.S. ten-year yield is 20 basis points higher than it was pre-debate.  
 
In France, the elections have gone as anticipated, in favor of the nationalist party (Le Pen).  Yields across Europe were up.
 
As for the U.S., the narrative behind rising yields is that both candidates are fiscally profligate — both will lead to higher deficits.  And if anything, they say Trump policies will be more inflationary.
 
But as we've discussed, the result of a policy swing, from the globalist agenda to a more nationalist agenda (in both the U.S. and France) would simply mean that the massive deficits and record indebtedness pursued to fund a radical transformation agenda (in both countries) would be abandoned.  For the funding that can't be clawed back or redirected, it would be returnless investment.  
 
And that, my guess, would be penalized through higher bond yields — until the market gains confidence in a turnaround plan.  
 

 

 

 

 

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June 27, 2024

Yesterday we talked about the potential for pain in sovereign bond markets if the government policy pendulum swings, from the globally coordinated climate agenda, to a more nationalist agenda (under leadership change) — given that trillions of dollars of deficit-funded investment in the climate agenda could be abandoned.  
 
In France, with the threat to Macron's power, French bond yields are widening against the anchor bond yield in the eurozone, the 10-year German yield (chart below). 
 
And it just so happens that the European Commission has chosen now as the right time to "rebuke" France for its fiscal profligacy.
 
The result:  Higher French bond yields. 
 
It conjures up memories of the past 15-years, when bond yields in both Italy and Spain (in 2011-2012) skyrocketed above 7% (unsustainable levels), which put two of the biggest countries in the eurozone on default watch. 
 
This memory-jostling looks to be by design of the European bureaucrats, as a shot across the bow to French voters.
 
But don't worry, any spike in French bond yields would be countered by the European Central Bank.  
 
Remember, two years ago, just weeks after announcing an end to QE, the ECB had to effectively restart it.  They had to step in and curtail rising yields in the fiscally vulnerable constituents of the euro zone, by promising to be the backstop (they are the unapologetic buyer of last resort, to preserve stability … and solvency).
 
And we should expect the Fed to behave in a similar way, if U.S. yields were to spike (on prospects of U.S. regime change).  They would be back in the QE game (managing bond yields), as they did in response to the bank shock in March of last year.  
 
With all of the above said, if these central banks were to withhold their intervention power in these scenarios, they could have significant influence on a political outcome. 
 

 

 

 

 

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June 26, 2024

Let's talk about the political events ahead of us. 
 
The U.S. Presidential debate is tomorrow.  And a referendum on Macron in France comes over the weekend.
 
While the grip on power is tight, it looks possible that the global policy pendulum could swing.
 
As we know, Western world governments have highly coordinated the execution of a shared (globalist) gameplan, designed around the climate agenda.
 
Not only has this agenda necessitated the appropriation and printing of trillions and trillions of dollars to fund the transformation of global energy, but the dollars that are being printed are being devalued by the same policies.  And with that, so are the Western economies.
 
How?
 
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.  And the world reserve currency status has been key in building and sustaining the United State's position as the economic superpower.
 
So, anti-oil policies are self-inflicted threats to the wealth and sovereignty of the people executing them. 
 
That is giving way to a populist push back, that's beginning to look like Grexit, Brexit and the Trump election. 
 
The push back against the global agenda has come in Argentina, El Salvador and (somewhat) in Italy.  And the betting markets suggest it's coming in France and the United States. 
 
The question:  Will there be a government bond market shock, in response to the trillions of dollars in fiscal bullets fired for a global climate agenda that could be fractured, if not abandoned?