Pro Perspectives 7/24/23

 

 

 

 

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July 24, 2023

It's a big week.  We'll get Q2 earnings from Google (Alphabet), Microsoft and Facebook (META) over the next 48 hours.
 
We'll hear from the Fed on Wednesday, the ECB Thursday morning, and the Bank of Japan Thursday night (the most important meeting this week, as we discussed here).  
 
As for earnings, by Friday afternoon we will have heard from about half of the S&P 500 on Q2 performance.  Remember, we came into this earnings season with a low expectations bar already set.  In fact, this quarter was expected to be the trough in earnings growth, of this tightening cycle.  
 
With that, low expectations for earnings create the opportunity for positive surprises.  And positive surprises become more probable when you consider that the consensus view on the economy for Q2 was at just 1% (annual rate), when economists were polled in the middle of the quarter.  
That view has since been ratcheted up to 1.7%. 
 
We'll get a "preliminary" GDP report on Thursday.  Keep in mind, the Atlanta Fed model, which is still incorporating Q2 data, is at 2.4% (much higher than the economist community has been). 
 
This, too, is set up for a positive surprise. 
 
All of this, as the Fed should be ending the tightening cycle on Wednesday, with one final "insurance" hike.  Meanwhile, China is stepping up support for its economy.  This combination should serve as a positive catalyst for confidence and manufacturing activity, both of which have drags on the economic outlook.
 
Now, a final note on the "big three" earnings this week …
 
This is the first time we'll hear from the "big tech" oligopoly (in an earnings call), since Nvidia declared generative AI to be "the beginning of a major technology era" in its May earnings call.
 
All three (GOOG, META and MSFT) have invested heavily in generative AI, and have huge roles to play.  The moat is wide.
 
PS:  I'd like to invite you to join my new subscription service, the AI-Innovation Portfolio.  We've added four exciting stocks that will play key roles in the technological transformation of the world's data centers. Join here, and I’ll send you all of the details.  

Pro Perspectives 7/21/23

 

 

 

 

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July 21, 2023

As we end the week, let's take a look at a couple of key commodities.
 
First, oil …
 
 
Despite the globally coordinated anti-oil policies, which have ensured a structural supply deficit for the foreseeable future, oil prices have as much as halved over the past year.
 
But as we know, we can attribute plenty of this decline to the Biden administration's drawdown of the Strategic Petroleum Reserves (SPR, chart below) …
 
We can also attribute the oil price decline to the recession fears that the Fed explicitly induced over the past sixteen months.
 
And make no mistake, it's taken every bit of the above to reverse the 9% headline inflation of a year ago. 
 
This chart from the BLS says it all …
 
 
But the tide is turning.  Not only has the Fed backed off with the constant threats to the economy, they are near the end of this iteration of tightening.  The petrodollar has been challenged, recently (which puts upward pressure on dollar-denominated oil).  And it's time to restock the SPR (the U.S. government will be taking supply out of the market).
 
With these forces at work, as you can see in the first chart, oil has broken out of the downtrend of the past year. 
 
Let's take a look at copper …
 
Similarly, copper is structural supply deficit, but also with tailwinds of a structural demand boom from a very well funded, and globally coordinated electric vehicle/renewable energy agenda. 
 
And yet, copper prices have crashed as much as 35% over the past year, for reasons one can only assume are related to Fed-induced (and global rising interest rate-induced) recession fears. 
 
 
With the above in mind, here's what Freeport McMoran's CEO (the second largest copper producer in the world) said about the copper market this past week:  "The ability of the copper industry to meet this rising demand is a major challenge …  we believe prices will need to rise to incentivize new supplies of copper."
 
On the latter, he has said in the past that even if prices doubled overnight, "we couldn't add new production of significance for a number of years … because permitting alone on new projects is six to eight years out, due to the ramp in environmental hurdles."
 
We have significant weighting in our Billionaire's Portfolio, in cash flow-rich copper and oil producers, which gives us leveraged performance to rising prices in the underlying commodities.  You can learn more about joining us here. 

Pro Perspectives 7/20/23

 

 
 

 

 

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July 20, 2023

As we’ve discussed here in my daily notes, while most of the world has been fighting to get inflation down, the Bank of Japan (BOJ) has been fighting to get inflation UP.

The Western world has faced multi-decade high inflation, and has harmonized a policy response that has included the exit of QE, and key short-term interest rates that are settling in around 5%.

They have done so at a record rate-of-change in policy, and in the face of record high indebtedness.  And in the case of the U.S., with a government that has poured even more fiscal fuel on the fire.

How have they pulled it off, without strangling economies and sending sovereign debt markets into a tailspin (and government borrowing rates soaring)?

Japan.

In cooperation, the Bank of Japan has buffered the effects of Western world tightening by keeping the liquidity pumping from a part of the world that has the most severe structural deflation problem, and the biggest government debt load in the world (Japan).

So rates are still negative in Japan.

And the Bank of Japan is still in full quantitative easing (QE) mode.  In fact, they are in unlimited QE mode.

By the design of their “yield curve control” program, in order to defend the upper limit of the 10-year Japanese government bond yield (which they’ve set at 0.50%), they are forced to buy Japanese bonds in unlimited amounts.  That’s freshly printed money that finds its way into foreign asset markets (like U.S. Treasuries and U.S. stocks).

With that, it’s worth noting that U.S. stocks have done well, in periods over the past year, when this upper limit of the BOJ’s yield curve has been tested.

As you can see in this chart, it’s being tested again …

And this comes as the latest inflation reading in Japan just came in well above their 2% target for the fifteenth consecutive month — which should sustain the upward pressure on the Japanese 10-year yield.

 

  

So, given the inflation picture and the pressure that rising global rates are putting on the Japanese bond market, might the BOJ adjust policy at next week’s meeting?

The Prime Minister appears to have quashed that notion today, saying they would “ensure a sustained exit from deflation.”

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Pro Perspectives 7/19/23

 

 

 

 

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July 19, 2023

The interest rate market is fully pricing in another quarter point rate hike by the Fed next week, and then done.
 
And by the middle of next year, market participants are largely looking for rate CUTS.
 
But what would induce rate cuts by next year?
 
It would have to be sluggish economic growth, if not negative growth. 
 
What would cause that, to the extent that the market would position with such consensus for rate cuts?  
 
This is a bet that the Fed went too far, too fast, in "normalizing" policy.  And it's a bet that the lag effects of tightening will ultimately strangle the economy.
 
Keep in mind, the media reports from late last year said "most economists" saw recession coming early this year.  They've been wrong.  The economy has grown at a better than 2% rate.
 
Moreover, we now have a significant growth catalyst to consider, in generative AI.
 
Remember, on May 24th, not only did Nvidia have blow-out earnings and incredible growth forecasts, the Founder/CEO (Jensen Huang) of the leading provider of technology that powers AI, proclaimed "the beginning of a major technology era."
 
PS:  I'd like to invite you to join my new subscription service, the AI-Innovation Portfolio.  We've added four exciting stocks that will play key roles in the technological transformation of the world's data centers. Join here, and I’ll send you all of the details. 

Pro Perspectives 7/18/23

 

 

 

 

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July 18, 2023

As we discussed last week, we headed into Q2 earnings season with a market that had low expectations — looking for a 7% contraction in S&P 500 earnings.  That sets up for positive surprises.
 
That's what we're getting.  And positive surprises are fuel for stocks. 
 
JP Morgan, the biggest bank in the country, kicked off Q2 earnings with record revenues and record earnings.  And the message was positive on the health of the consumers and businesses. 
 
Bank of America delivered one of the strongest revenue and net income quarters in the company's history.
 
And Wells Fargo and Citi, the other two of the big four banks, both beat on revenues and earnings.
 
Still, all of the big banks continue to manufacture down earnings, to the extent they can.  How?  They continue to set aside money for future credit losses — to the tune of about $2 billion in Q2, between the four banks. 
 
This, even though, in the case of Bank of America, the loan loss rate is running below pre-pandemic levels.  
 
And this reserve build only adds to a warchest, which now nears $60 billion (between the big four), set aside as "allowances for credit losses."  That's 44% bigger than prior to the  pre-pandemic era.
 
As we've discussed in the past, the banks are "heads they win, tails they win" businesses.  
 
When times are unstable over the past fifteen years, they've been backstopped by the Fed (de-risked), and incentivized to fuel credit creation to help the economy — from which they make money in loan origination, investment banking and trading.
 
When times are more stable, their customer account balances balloon (as they have now), from which they get to earn a very healthy interest rate spread from the rising interest rate environment.
 
PS:  I'd like to invite you to join my new subscription service, the AI-Innovation Portfolio.  We've added four exciting stocks that will play key roles in the technological transformation of the world's data centers. Join here, and I’ll send you all of the details. 

Pro Perspectives 7/17/23

 

 

 

 

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July 17, 2023

Second quarter earnings ramp up this week.  As we discussed Friday, JP Morgan kicked off the earnings season with another very favorable view toward the strength of consumer and business activity.
 
Today, let's take a look at an anomaly that has emerged in the bond market. 
 
As we've discussed often, the 4% threshold in the U.S. 10-year government bond yield (a, if not the, benchmark global interest rate), has been Kryptonite for the global financial system.
 
Time spent above 4%, in this post-pandemic world, has a short but consistent record of "breaking things" in the financial system. 
 
With that, in my July 5th note, we looked at this technical setup in the 10-year.  Once again, it looked like the 4% level would be revisited.
 
 
Indeed, it traded up to 4.09% over the next few days.
 
Guess what else happened in early July?
 
This 10-year swap spread blew out (right side of this next chart).  
 
 
This chart above represents the difference between the 10-year yield and the 10-year interest rate swap (IRS). Without getting into the mechanics, let's just look at the comparables on the chart.
 
The last time we had a severe spike like this was March 2020.  It spiked on the lockdown, and reverted the following week with the accompaniment of massive Fed intervention. 
 
Before that, it was August of 2015.  The Chinese surprised markets with a devaluation of the yuan.  It was a modest adjustment in the currency, but global markets reacted on the prospects that a big one-off devaluation may follow, to support its flagging economy.
 
Prior to that, the closest degree to which we've seen this magnitude and speed of spread expansion was following Lehman Brothers bankruptcy in October of 2008. Obviously that's not a friendly comparable. 
 
All three of these past episodes came with negative shocks in the stock market, and (related) spikes in the price of downside stock market protection (reflected in the VIX). 
 
The good news:  The 10-year yield has fallen back, aggressively — now comfortably below 4% at 3.8%. 
 
Also good news:  Stocks haven't had a negative shock.  
 
And if we look at the VIX, it's on three-year lows – the lowest in the pandemic/post-pandemic era.
 
 
The VIX tracks the implied volatility of S&P 500 index options.  This reflects the level of certainty that market makers have, or don't have, about the future.
 
To put it simply, if you are an options market maker, and you think the risk of a sharp market decline is rising, then you will charge more to sell downside protection (ex: puts on the S&P) to another market participant — just as an insurance company would charge a client more for a homeowner’s policy in an area more likely to see hurricanes.
 
An "uncertainty premium" would translate into the violent spikes in the VIX that you can see on the chart.  
 
Again, as you can see in the far right of the chart above, we haven't had it. 
 
So, what would cause this quick round trip (up and back down) in the 10-year U.S. Treasury yield, the most important bond market in the world (chart below)? 
 
 
Maybe a good inflation report is attributable to this fall back in yields. We had one last week.
 
Or maybe it was a stress event in the financial system.  If that were the case, we know, with certainty, how the Fed has responded, and will continue to respond, to shocks.  They will intervene, to plug the holes. 
 
Remember, back in 2019, when the Fed was about two years into its first attempt at quantitative tightening, this happened…
 
The Fed described this chart above as: "strains in money markets that occurred against a backdrop of a declining level of reserves, due to the Fed's balance sheet normalization and heavy issuance of Treasury securities."
 
More simply, the Fed was forced to rescue the overnight lending market (between the biggest banks in the country) because of an unforeseen consequence of balance sheet "normalization."
 
What was their response?  They quickly, but quietly, returned to expanding the balance sheet.  As Bernanke once said, QE tends to make stocks go up.  Stocks went up close to 20% over the following four months. 
 
With all of the above in mind, here's the look at the latest Fed balance sheet. 
 
 
Interestingly, in last week's report, there was a considerable slowing in quantitative tightening.  
 
We'll see in this week's report if there's any indication that trouble has been brewing in the interest rate market.
 
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Pro Perspectives 7/14/23

 

 
 

 

 

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July 14, 2023

Remember, we head into Q2 earnings season with a market that has low expectations — looking for a 7% contraction in S&P 500 earnings.

That sets up for positive surprises. 

With that, let’s take a look at JP Morgan’s report this morning.

Keep in mind, this is the biggest bank in the country.  No entity is closer to the pulse of the consumer, business and government than JP Morgan.

They reported record revenue, and record net income (if we add back the net $1.5 billion they set aside as provisions for credit losses).

Jamie Dimon said, “almost all of our lines of business saw continued growth in the quarter.”

About the economy, Dimon said it continues to be resilient.  Consumer balance sheets remain healthy. Consumers are spending.  And job growth remains strong. 

How is the business customer faring?  Commercial banking revenues grew 14%, just over the past quarter.  

All of this is taking place into the headwind, and at the tail end, of a 500 basis point Fed tightening cycle.  

Bottom line:  The activity at the country’s biggest bank is quite healthy, and that is reflective of an economy that continues to float on a decades worth of money supply growth, that was force-fed over the span of just two years (in response to the pandemic).

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Pro Perspectives 7/13/23

 

 

 

 

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July 13, 2023

Last week we stepped through the simple math that all but guaranteed a very eye-appealing 3%(ish) June inflation number.
 
And I said we shouldn't underestimate the appetite of the media and the White House to celebrate this headline number, and for it to positively influence confidence (which has been running near crisis low levels).
 
We've seen it.  Not only has the media and the White House celebrated, but Wall Street seems to be claiming victory on inflation. 
 
They are now pricing out a September rate hike.
 
With that, remember it was just two months ago that global fund managers were most bearish stocks since 2009, and leveraged futures traders were short stocks at a twenty-year extreme. 
 
This was just as stocks were breaking above this 4,200 level. 
 
 
And that market positioning, as we discussed in my note back in May,  actually creates vulnerability to a sharp move higher. Why?  
 
With some good news, the shorts (and those that are underweight equities) will be scurrying to reposition (long), which can exacerbate the move.
 
When the investment community is caught on the wrong side, where do they look to catch up?  The laggards.  
 
With that, the easy targets, in this case, are small cap value stocks and commodities.
 
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Pro Perspectives 7/12/23

 

 

 

 

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July 12, 2023

In my note last week, we talked about the return to the danger zone for the 10-year yield (as it traded back above 4%). 
 
This is the level that has triggered fireworks in the global financial system over the past year (i.e. revealing vulnerabilities).  
 
But we also discussed a likely, impending antidote to that danger zone: A very eye-appealing inflation number was coming.
 
Indeed, we got it.  Not only did the headline inflation number fall to 3% (a third of the rate of a year ago), but the core, excluding food and energy, fell below 5%.  That's the lowest since late 2021.  The core monthly change, at 0.2%, was the slowest rate of change in prices in 22 months.
 
Just like that, we now have the 10-year yield back below 4% (at 3.86%).
 
This puts stocks in a very good spot…  
 
>Suddenly the market chatter is about "soft landing" (unapologetically abandoning the recession drum beat).
 
>The 10-year yield is out of the danger zone, helped by the Bank of Japan, which seems to be implicitly executing yield curve control on our bond market.  
 
>Second quarter GDP is projecting to be above 2%.  
 
>And we head into earnings this week with a market that has dialed down expectations, expecting a 7% contraction (which sets up for positive surprises).        
 
Meanwhile, the interest rate market continues to price in one more rate hike.  That means the Fed can raise again, as insurance against persistently hotter than long-term average inflation (which will likely come in the form of higher oil prices), with seemingly little risk to stocks.
 
With all of this in mind, last month we went into the inflation number looking at the longer-term charts of the big four U.S. stock indices.
 
Both the Nasdaq and the S&P 500 had decisively broken out of the bear market trend in Q1.  The Dow and Russell had not.  
 
Those big bear market trendlines have now been broken. 
 
Most compelling, the Russell remains down 21% from the 2021 highs.  And the index has just, last month, gone through a "reconstitution"/reshuffling of constituents. 
 
 
This looks very favorable to aggressively catch-up, particularly as the underperforming energy sector (oil) may be breaking out too. 
 
 

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Pro Perspectives 7/10/23

 

 
 

 

 

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July 10, 2023

We get June inflation data on Wednesday.  And Q2 earnings will kick off later in the week with the big banks.

As we discussed on Friday, the “base effect” of the consumer price index has been telegraphing a cliff dive in this coming headline inflation number for several months.  I’m seeing a consensus view on the monthly change at 0.3%.  If that’s the case we might get a sub 3% number (like 2.95%).

Now, this is the “headline” number.  The Fed, of course, is looking at core PCE, which measures the change in prices of goods and services that people have actually paid — not just a selling price.  And “core,” of course, strips out food and energy prices.

Still, we shouldn’t underestimate the appetite of the media and the White House to celebrate this headline inflation number on Wednesday.  They will, especially if it breaches 3%.

And it may (positively) influence confidence, which has been running near crisis-low levels.

For perspective, a year ago, we were at peak inflation.  Small business optimism had plunged to nine-year lows, and consumer sentiment was on record lows.  It was all driven by 40-year high inflation, and a Fed that was talking down stocks and vowing to destroy jobs.

Now we may get an inflation print under 3% (a third of the rate of change of a year ago).  And the Fed, while continuing its chatter about an insurance hike (or two) is no longer threatening stocks and jobs.

The correlation between inflation and confidence is a tight one.

With the above in mind, the inflation data this week should be a positive catalyst for confidence (good for markets).

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