Pro Perspectives 5/12/20

May 12, 2020

We've talked quite a bit in that past couple of weeks about the recipe for a return of inflation. 

Remember, we have deluge of money flooding the world from global policymakers, and pent-up demand that will be chasing supply that has been disrupted and will take some time to rebuild.  Add to that, the wage bar has been reset higher — from the impact of wage increases that have been given to essential workers to the impact of federally subsidized unemployment pay (exceeding that of median income).   

That said, as we've discussed, what will become a wave of possibly very hot inflation, first looks like deflation, in this environment.  After all, when you put money in the hands of people but tell them they have to stay home (with little visibility on an endpoint), it's safe to say that consumption (aside from necessities) is going to be crushed in the lockdown phase.

With that, there was a big deal made of the inflation data this morning. 

Here's a look at the chart of core CPI … 

And with this chart, we heard a lot of commentary about the prospects of negative interest rates, and fears of a deflationary spiral. 

But we have a very important catalyst at work that can turn this dynamic on its head.  The reopening of economies.  

This is a "light switch" effect for demand – not a return to pre-health crisis demand by any means, but it's the "rate of change" in demand (from virtually non-existent) that should put pressure on businesses to go from “opening the doors” to ramping up operating capacity (including staff and supply).  And again, this is where the supply disruption should be exposed and price pressures should appear.  We shall see in the coming weeks. 

Another very important spot to watch on the inflation front, as demand comes back into the economy:  On March 26th, as part of the Fed's policy response, they cut the reserve requirement ratio at banks to zero (from 10%). This was an incredible move – another explicit devaluation of money.  Banks no longer have to keep reserves to make good on your demand for your deposits.  If you need your money, the Fed will pass it through (the banks) to you. 

 
This move to "zero" incentivizes, if not mandates, banks to make loans (an infinite amount of loans).  What  does this do to the supply of money?  At a zero reserve requirement ratio, the stock of money could increase infinitely.

Pro Perspectives 5/11/20

May 11, 2020

In my daily notes, we spent the better part of the past month observing the daily changes in the New York data, as a guide on a turning point for the health crisis.  

Remember, all along, we were being told by the experts that New York was the ‘canary in the coal mine’ — it represented what was coming for the rest of the country.  It hasn’t happened.  The crisis in New York peaked the first week of April, with the peak of daily intubations.  And daily cases and daily deaths peaked nationwide and worldwide shortly thereafter.  

With this, all eyes should now be on Georgia, where the re-opening of the economy kicked off on April 24th.  We are now eighteen days in.  As you can see in the chart below, the curve peaked in mid April with 925 cases, and has been on the decline.  The number reported yesterday was just nine.  

Still, with the economy open for more than two weeks, we are in the early days of when symptomatic people would be tested and might show in the new infections/new case data. 

What’s the difference between now and two months ago, that might give us more confidence about the path?  Symptomatic people can get tested (much more easily) and quarantine.  There are behavior and process changes (both from consumers and businesses).  There are treatment options. 

So Georgia will be the spot to watch over the coming two weeks, to gauge how optimistic (or not) we should that the bottom is in for the economy. 

Pro Perspectives 5/8/20

May 8, 2020

No one should have been surprised by the magnitude of the losses in the jobs report this morning. 
 

In fact, the numbers are even worse.  There are states that haven’t processed applications that have been sitting with them for a full month now.   

That said, about 70% of the unemployed represent furloughed workers, which remain attached to employers.  By design, that makes for a quick and seamless return to employment, which would make the bounceback in the data as historic as the decline.

Now, the one spot we discussed yesterday to keep your eye on (wage inflation), did indeed deliver.  When I say deliver, I mean delivered a warning shot. 

The market was looking for 3.3% wage growth (already among the hottest number we’ve seen since pre-Global Financial Crisis days — i.e. more than a decade), but as I said, the high estimate of those surveyed in the Reuters poll was +7.9%.  That was the number — up 7.9% (year over year). 

So everyone will be looking at the spike in joblessness today and over the weekend (which will rapidly adjust with the opening of the economy), but they should be looking at this chart.   

Again, the crisis-time wage increases won’t be temporary.  It will be very difficult to take back pay increases given to essential workers.  And for those in the lower wage range that have been collecting unemployment, they have been sent a message by the government (through the federal subsidy) that a living wage is higher than they’ve been earning.   

With that, this chart from the Economic Policy Institute comes to mind …

You can see in the chart when productivity and hourly compensation decoupled leading to four decades of wage stagnation.  Productivity has grown 6x more than pay since 1979. 

The question is, will there be REAL wage growth, or just nominal?

Mostly nominal – meaning a reset of wages against a reset of prices.  As we’ve discussed, the brew for inflation is here.  We have a deluge of money flooding the world from global policymakers, and pent-up demand beginning to enter an opening economy, with a supply chain that will take a while to catch up. 

With this inflation picture, commodities were the movers of the week.  Of course gold continues to look good, as the historic inflation hedge.  And hedge fund legend, Paul Tudor Jones, was said to be buying Bitcoin this week as an inflation hedge.

What’s the commodity most levered to rising inflation?  Copper.  That looks like it’s breaking out.  

Pro Perspectives 5/7/20

May 7, 2020

Yesterday we looked at the big spike in inflation back in the early 70s.  Inflation spiked from under 3% to almost 12%.  The trigger:  an oil supply shock. 

With that in mind, as the Covid-torn economy reopens this month, I suspect it will be the trigger for a severe supply shock, and inflation — where a disrupted supply chain will prove to be out of synch with a resurgence of demand, driving prices higher. 

Add to this, as we get the jobs numbers tomorrow, the media will focus on the big and ugly payroll and unemployment rate.  But keep an eye on wage inflation.  Those that have been working (many essential workers) have been receiving pay increases. 

So, in the wake of historic joblessness, wages are ticking higher, not lower. The consensus view is for a 16% unemployment rate, 22 million jobs lost, and wage growth of 3.3%.  That wage growth figure has only been exceeded three times in the past decade (and that was last year).  And we may very well see the highest wage growth since before the Global Financial Crisis.  The high estimate of those surveyed in the Reuters poll on wage growth was +7.9%.

Now, some of these wage increases have been sold as temporary, but remember, the unemployment package including the Federal supplement gives a two member unemployed household, the annual equivalent of better than $80,000 a year.  That's 1.3 times the median household income.  With that, these wage increases will have to stick, to compete with the government. 

Add to this, if we do indeed feel the pain from supply shortages, the resulting rise in prices will put even more upward pressure on wages and wage demands.   
 

Pro Perspectives 5/6/20

May 6, 2020

Last week stocks were approaching two big areas of technical resistance on the charts.  And we talked about the prospects that the top of a range would be marked there, for a while, until we are able to get some visibility on what the world looks like with economies reopening. 

That seems to be playing out.  

Now we have areas of the country slowly reopening. And we have two things to watch closely: 1) any rise in hospitalization rates, and 2) the effects of a sharp bounceback in demand. These two wouldn’t be mutual exclusive in the near term.  But the latter of which, may expose, very quickly, the supply chain disruption.  

In this case, unlike the aftermath of the global financial crisis, it’s easy to turn demand back on (removing stay-at-home orders), but it’s not as easy to turn production back on (re-staffing, manufacturing, inventory building/ new order fulfillment).  This will create a lag between demand, and when supply can satisfy that demand. That tends to be a formula for higher prices. 

We’re already beginning to see it in food prices. Just wait until the pent-up demand for a host of other products and services hits the economy. 

Let’s take a look at what the early 70’s supply shock in America did to prices.

This 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.  You can see in the chart above consumer price inflation (excluding food and energy) spiked from under 3% to nearly 12% in two years.  
 

Pro Perspectives 5/5/20

May 5, 2020

Warren Buffett spoke for over four hours over the weekend, as he hosted his virtual annual meeting for Berkshire Hathaway.

Although his message "bet on America" remained consistent, as it has over time, his lack of buying in this stock market decline suggests he's not comfortable betting, just yet. At least that's the signal that has been taken.

 
Is it the right signal?

Don't forget, Buffett runs the biggest hedge fund in the world, dressed up like an insurance company.  It takes premiums and invests those premiums, primarily in stocks (the value of which have been marked down with this broad market decline).  But they have been sitting on an unusually high amount of cash — $120 billion worth. 

Why isn’t he putting it to work?

 

A possible reason:  In this ongoing extraordinary event, the insurance business has unknown liabilities.  As an industry overall, he said "the amount of litigation that is going to be generated out of what's already happened, let alone what may happen, is going to be huge … just the cost of defending litigation will be a huge, enormous expense."

On that note, I had heard over the past of month, anecdotally, that a portfolio manager at a big insurer was forced to sit on his hands, unable to make new investments in this environment, by mandate.  I've yet to see any industry-wide regulatory policy that would spell that out, but with Berkshire's lack of action, perhaps there is truth to it.  

What's another reason Buffett hasn't swooped in with a “deal of the century,” as he did in the financial crisis?  The Fed and the U.S. Government, in this case, through quick and decisive intervention, have curtailed if not eliminated the opportunities.  They squeezed out the vultures, by becoming the lender of last resort (with the deepest pockets of them all). 

Pro Perspectives 5/4/20

May 4, 2020

Throughout the pandemic, Trump and his administration have been clearly positioning to punish (or retaliate against) the Chinese government for either 1) neglect and cover up, or 2) a deliberate attack.

In either case, Trump has said there will be "consequences."

This rhetoric has been slowly building over the past two months, but now is beginning to look like (more, bigger) conflict with China is ahead.  

Pompeo has been the stern voice all along, against China, and over the weekend said there is a "significant amount of evidence that this came from the lab in Wuhan….that it's manmade."

At best, this means the Chinese government lied about it, and covered it up. 

The early signals on this bubbling conflict may be found in Bitcoin (yes, Bitcoin). 

As you can see in this chart below, Bitcoin spiked by as much as 23% in just two days, last week.  

What does this tell us?
 
As we've discussed throughout the rise of Bitcoin, it has everything to do with money moving out of China, and less to do with Silicon Valley genius/ global monetary system disruption. 

Bitcoin futures and off-exchange (peer-to-peer) trading are liquidity sources for Chinese citizens, allowing them to circumvent government capital controls, which restrict individuals from moving more than $50,000 out of the country a year.  In short, it has been a way for Chinese (especially the wealthy) to get money out of China. 

Pro Perspectives 5/1/20

May 1, 2020

We talked the past few days about the significant technical levels of resistance that stocks were bumping up against.
 
Combine that with the end of month, a 36% rise in stocks over just 27 business days, AND the unknown about what the economy will look like as businesses are beginning to reopen, and it looks like the top of a new range is in, for the moment.

So, let's talk about the expectations that have been set for the reopening of the economy.

I think it's fair to say that the policymakers and the government officials have set some very conservative expectations.  If fact, I would argue that it leans more toward pessimistic. 

And just as we evaluate the probable outcomes for markets, based on the way sentiment is leaning, we can also evaluate probably outcomes for the economy. 

And after being in the business of markets for 24 years, I can tell you that the best trading opportunities are found in situations where sentiment is heavily leaning in one direction or another – and/or when the expectations bar has been set at an extreme level (either overly optimistic, or overly pessimistic).  These are opportunities to bet against sentiment, because these situations set up for the element of surprise.  And with surprise we tend to see sentiment violent swing from extreme levels. 

I think we are set up for this swing in economic sentiment.  Public officials have set the bar very low on expectations of getting back to normal life.  And they've set the game plan accordingly for the re-opening of businesses – slow, and in stages.  And the broad belief is that the behavior of people will follow this very conservative path. 

This is set up for a surprise, related to how both businesses and consumers behave.  And I suspect we're going to get it. 

Once people are out of the house, returning to some day-to-day life and interactions, I suspect the life-learned patterns and behaviors won't be changed after just two months of sitting at home.  I suspect we will all slip back into normal behaviors sooner rather than later, and possibly very soon – especially if hospitalization rates in the coming weeks are stable to lower. If that's the case, it will be a “rip the band-aid off” scenario for the economy, and a return to normalcy. 

If that’s the scenario, we may see very quickly how a big bounceback in demand will overwhelm supply, following two months of supply disruption and production stoppages.  That would be the first signal that inflation is coming.   

Pro Perspectives 4/30/20

April 30, 2020

Stocks end the month lower today, after a 36% bounce from the March 23rd lows.

Let's take a look at the chart we've been watching, which presents some key technical resistance up here …

So, we have this big technical level around here at 2,930 which represents the 61.8% retracement of the full decline in stocks.  And just above here, we have the 200 day moving average, which comes in at 3,004.

As we've discussed, this looks like a sensible area to mark the top of a range for a while.  And I suspect we may see stocks trade back and forth in a range until there's some visibility into how the world looks with economies reopening. 

What has yet to show any signs of life in a world where governments are doing cash handouts and much more?  Commodities.

We have this chart of broad commodities …
 
This chart looks like a deflationary vortex, not a world where governments are handing out cash.    

I suspect this chart of commodities will change/will be the next spot to watch. 

As we've discussed, the government and central bank response is designed to inflate the value of the economy, and deflate the value of debt. That's a recipe for a global reset of prices (and a recipe for a reset of wages), and commodity prices should soar.   
 

Pro Perspectives 4/29/20

April 29, 2020

The Fed met today.  As we discussed yesterday, they did indeed take the opportunity to recap the response of the past two months.  And it was a big one. 

If there was anything new that came from Powell's press conference, my takeaway was his remarks on protecting against long-term economic damage.

He said Fed policies to protect firms and families from "avoidable insolvencies" comes with a hefty price tag, but would avoid long term damage to the economy. 

He went on to say "now is not the time to worry about debt, but time to use the 'great fiscal power' of the U.S. to avoid deeper damage to the economy."  

With that, as we discussed yesterday, the Fed has been a buyer of corporate debt (in the secondary market), and that has greased the wheels of the market for new corporate debt issuance of the past month and half — enabling companies to stockpile cash, despite the fact that many (if not all) would be considered high risk for bankruptcy if the economic disruption were to carry on, through the time necessary to get a viable vaccine on the market. 

This should give us clues on the decisions coming from the Treasury and the White House on whether or not the domestic energy industry will be saved, or any other highly levered industry that has been crippled by the demand shock. I think the answer is "yes", they will be given government life support.