Pro Perspectives 8/24/23

 

 

 

 

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August 24, 2023

We talked yesterday about the Nvidia earnings.
 
For the second consecutive quarter, they delivered shockingly big numbers, and CEO Jensen Huang delivered an education to the analyst community on the global transition to "a new era of computing," and the related trillion-dollar retooling of the world's data centers (from CPUs to GPUs).
 
That said, the stock gave up all of the post-earnings gains by the close today.  Concerning?  For perspective, Nvidia is a trillion-dollar company now, but growing at a better than 100% annual rate, with 80% share of a new trillion-dollar market opportunity.  If we look at Amazon, they developed the (new) cloud business (AWS) over the past decade, growing it at a 50% annualized rate, and the stock went up nine-fold.
 
As we've discussed over the past quarter, this (gen AI) technological revolution is productivity enhancing for the economy.  It's a formula to grow the economic pie (and the size of the stock market).
 
With that, productivity gains create the opportunity for much needed wage gains (to restore quality of life, which has been eroded by inflation).  We're beginning to see both (productivity and wage gains).
 
We averaged just 1% productivity growth for the decade prior to the pandemic, and negative 0.7% since the fourth quarter of 2020.  The most recent productivity growth report came in at 3.7%.
 
That's huge.  Because wages have been (relatively) hot, as you can see in the far right of the chart below.  
 
 
And this wage pressure is precisely why the Fed has focused on jobs in this inflation fighting cycle. Powell has talked endlessly about the mismatch between the number of job seekers and the number of job openings.
 
The concern?  With leverage in the job market, job seekers and employees can command higher wages.  With that, the Fed has feared an upward spiral in wages, where wages feed into higher prices (inflation), which feeds into higher wages … and so the self-reinforcing cycle goes.
 
That said, we need wages to reset (higher) to the (higher) level of prices, not the other way around.  A fall in prices to restore buying power would lead to a deflationary bust (low or contracting economic activity and falling prices).  That scenario is far worse than high inflation.
 
A deflationary bust is vulnerable to a self-reinforcing spiral, and very difficult to escape (ask Japan).  And it's far more dangerous, given that we've already exhausted two deflation-fighting tools:  government spending, and expansion of the Fed balance sheet.
 
With all of the above in mind, while wages have indeed been on the move, we are already getting an offset from productivity gains.
 
The cost per unit of output last quarter was just 1.6%.  That's lower than the average unit labor cost of the 20-year period prior to the Global Financial Crisis.
 
The Fed should be very happy with the prospect of a productivity boom.
 
We'll see if that factors into the messaging tomorrow at the big St. Louis Fed economic symposium at Jackson Hole.  As I've said, this event has a history of signaling policy adjustments.  

Pro Perspectives 8/23/23

 

 

 

 

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August 23, 2023

We had a big move in the interest rate market today.  It started yesterday with a sharp drop in the vulnerable spots of the European sovereign debt market.
 
Both Spanish and Italian 10-year yields dropped significantly, even as the U.S. 10-year yield (the global anchor interest rate) traded to new 16-year highs.
 
It's important to note that the European Central Bank was forced to step in, again, and backstop these government bond markets back in June of last year, when Italian yields were trading at 4.28%.  Yesterday, the yield was 4.41%. 
 
Spanish yields were 3.21% (back in June).  Yesterday:  3.75%.
 
Today, the relief valve in the global interest rate market was pulled.  
 
European government bond yields have all reversed around 25 basis points in about 24 hours.  
 
And the U.S. 10-year yield has done this …
 
 
Is it driven by soft manufacturing data from Europe this morning?  Was it driven by the sharp slowdown in U.S. housing turnover in yesterday's data?  Does it have anything to do with what ECB President Lagarde might say at Jackson Hole on Friday afternoon?
 
Or, did the ECB simply do what they've told us they would do if yields reached levels that created (solvency or liquidity) risk to the euro zone (particularly, the weak spots)?  
 
Probably the latter.  Nonetheless, the pressure in the interest rate market may be abating.  We will see. 
 
Let's talk about Nvidia …
 
In my Monday note, we talked about the significance of this Nvidia earnings report for markets, as "even more important than Friday's Fed event."
 
Remember, it was three months ago that Nvidia's CEO shocked the world, declaring "the beginning of a major technology era."  He told us there was a "rebirth of the computer industry" underway, where "AI has reinvented computing from the ground up."
 
And he told us there was a "retooling" going on across the economy, the beginning of a 10-year transition of the world's $1 trillion data center, to accelerated computing.
 
And he had the numbers to back it up.  They grew revenues by 19% in Q1 compared to the prior quarter, and they guided to 52% growth for Q2 (shockingly huge).  From the "steep" data center demand, they expected revenues to jump from $7.2 billion to $11 billion in just one quarter.  
 
That brings us to today.  So how did they do in Q2?
 
It was another jaw-dropper.  They did $13.5 billion in revenue for the second quarter.  It was driven by the data center (which more than doubled from Q1).  Moreover, they guided revenue of $16 trillion for Q3.  
 
As I said after the May earnings report, it's a "big wake-up call on the massive technological transformation underway (and just in the early stages)."
 
For those that weren't awakened last quarter, this report should do the trick.
 
As you can see in the graphic below, the explosive growth is indeed coming from this data center "retooling."
 
  
And keep in mind, Huang has continually been asked how long this demand might last, and he continues to reference this trillion-dollar transition from traditional to accelerated computing. 
 
Nvidia has 80% of the market on the GPU chips that power this "retooling."  So, even at a $10 billion quarter (in data center revenue), the numbers will get much, much bigger. 
 
It's very early.
 
With that, today, even after an 8% move in the stock on earnings, Nvidia became cheaper than it was prior to the report, and cheaper than it was prior to the Q1 report, on a multiple of revenue (price/sales).
 
As I said going into that May Nvidia earnings report:

The automobile is to mobility, as AI is to productivity.

 

A productivity boom is coming, and it is well needed.

 

Productivity growth is the key to improving living standards.  As ChatGPT says, "sustained productivity growth of around 2% per year has historically been associated with positive economic outcomes and improvements in living standards." 

 

We averaged just 1% for the decade prior to the pandemic, and negative 0.7% since the fourth quarter of 2020.

 

Just as the 1920s were defined by innovation (the automobile and widespread access to electricity), we have the formula here for another "roaring 20s." 

Huang said today that he expects companies to realize trillions of dollars of productivity gains, from generative AI.  

Pro Perspectives 8/22/23

 

 

 

 

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August 22, 2023

Nvidia will report earnings after the close tomorrow.
 
As we've discussed here in my daily notes, Nvidia will need to deliver on what was a huge promise made in its Q1 earnings event.  That set the expectation for an $11 billion revenue quarter in Q2.  And that's a better than 50% jump from Q1.  
 
What if they miss? 
 
If they miss, the AI-heavy Nasdaq would probably trade into this technical support (the yellow line in the chart below) over the following days.  This is the trendline from the year's low – about 4% lower than current levels. 
 
But it would be a buying opportunity, likely even considered a gift for those that haven't participated in this AI revolution, to get involved.
 
 
Regardless of the numbers tomorrow, we should expect Jensen Huang, CEO of Nvidia, to reveal the rapid innovation in the industry, of just the past quarter.  That includes the deal they announced today with VMWare, where they will be working together to deliver generative AI applications for companies, enabling these companies to deploy large language models (like a ChatGPT) using their own proprietary data (keeping that data private and protected).
 
Speaking of "rapid innovation," billionaire activist investor, Dan Loeb, recently said this about the generative AI opportunity in his investment letter:  "We believe generative and other forms of AI could compare to the Industrial Revolution but compressed into a period of months and years, rather than decades."
 
PS:  If you know someone that might like to receive my daily notes, they can sign up by clicking below …    

Pro Perspectives 8/18/23

 

 

 

 

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August 18, 2023

We revisited the chart of U.S. 10-year yields yesterday, and the episodes of stress to the global financial system, over the past twelve months, when yields spent some time above 4%.
 
If we look back to the beginning of the Fed's tightening cycle, we are now in the longest stretch without a stress event (five months), and with yields now sitting near the highest levels since the inception of zero interest and QE policies of the past fifteen years.
 
That said, the major central banks of the world have been able to successfully exit zero interest rates (and QE) with an historically fast normalization of rates, all in the face of one of the most complicated global financial, economic and political environments in history — and without losing control of the bond markets.
 
And if history (of the past 15 years) is our guide, we have no reason to believe they will lose control this time either.
 
Remember, it's a "managed" normalization.  As we've discussed often in my daily notes, in the post-GFC era of no-rules central banking, they are in the practice of "fixing and manipulating."  And as long as it's done in cooperation (very important) with their global central bank counterparts, there are no penalties (not to the currency, not to the bond market, not to equity markets, not to foreign investment).
 
With that in mind, we should expect more rate sensitive vulnerabilities to be revealed in markets and/or the global economy.  But we should also expect central banks to continue to do "whatever it takes" to maintain stability.
 
Now, let's take a look at stocks …
 
This looks like a modest correction.  We're down 5% since Fitch came in after the close of the market on August 1st with a downgrade of U.S. debt.
 
 
After a 45% run from the January lows, a 10% correction for the Nasdaq is just two percentage points away (at the trendline).
 
On that note, we have the big Nvidia earnings next Wednesday, where they will need to hit the very big guidance upgrade from last quarter.  If we look across recent earnings reports from the AI infrastructure stocks, we should expect Nvidia to deliver.  
 
The 10-year yield was under 4% before the Fitch downgrade.  It has traded up to 4.32% since.  And part of the case for the downgrade was their expectation that the Fed will go another 25 basis points in September.
 
We should get a good view on that next Friday morning, when Jerome Powell speaks at Jackson Hole.  Contrary to the Fitch view, Powell may signal the end of the tightening cycle.  We will see. 

Pro Perspectives 8/17/23

 

 

 

 

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August 17, 2023

The U.S. 10-year yield traded up to 4.32% today.  Let's revisit the events that have occurred over the past year, when the 10-year has traded above 4%.  
 
We've stepped through each of these events many times in my notes.  Suffice to say that this level of the U.S. 10-year yield, the world's most important interest rate (the anchor for global rates), has revealed vulnerabilities in the global financial system — vulnerabilities that were created from the zero interest rate and QE world (of much of the past 15 years).
 
For perspective, the last time the 10-year yield traded above 4.30% was last October — on the day the Bank of Japan intervened to both defend the yen, and relieve the pressure in global interest rate markets.
 
The time before that was 2007. 
 
At that time, the U.S. government debt load was 62% of GDP.  Today is more than double that burden.  And the Fed's balance sheet was $800 billion.  Today it's over $8 trillion.
 
Clearly, we're in uncharted territory.  Will China's highly-indebted property developers be next?  It's looking more likely.  What has been a slow moving crisis (over years), stemmed by Chinese government intervention along the way, has accelerated over the past week.  The dominos appear to be lining up.  
 

Pro Perspectives 8/16/23

 

 

 

 

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August 16, 2023

We had the Fed minutes today.
 
If left to the headline summary on the newswires, one would get a hawkish impression.  The markets responded as such (lower stocks, higher yields).
 
Remember, the Fed told us after the July meeting that they would be completely "data dependent" in determining the path forward for monetary policy.
 
With that in mind, today's headlines from the meeting minutes pointed to two areas they saw as "necessary" to "restore economic balance":  1) below trend growth, and 2) a softer labor market.
 
Well, as we discussed yesterday, the Atlanta Fed model, thus far, is projecting a 5% annualized growth economy in the third quarter (well above trend).
 
So, condition number one is far from being met.  Another headline said participants said the labor market is still "very tight."  That sounds like a vote against condition number two.
 
Moreover, another headline that stuck out:  Most participants saw continued "significant" upside inflation risks.
 
Sounds like a Fed hell-bent on delivering more rate hikes, no?
 
More likely, we've just seen another example of Fed public perception manipulation (or as they call it, "guidance").
 
Remember, the Fed doesn't want to signal "mission accomplished" to consumers, businesses and investors.  It would be the equivalent of pressing the gas pedal on the economy.
 
So, to be sure, those few headlines on the wires today were carefully curated by the Fed.
 
With a little context, the same paragraph within the minutes that said "most" participants saw "significant" upside risks to inflation, also said that "some" participants saw downside risks, from the lag effects of policy.  And "a number" saw the risks as two-sided.
 
This doesn't sound like the unanimity we've seen on the rate decisions.
 
And remember, the July hike was indeed a unanimous decision (among the 11 voting members), despite a headline inflation rate that had fallen to 3% — a full percentage point lower than the inflation data available to them the month prior, within which they chose to hold rates steady (unanimously).
 
With that in mind, it appears, from reading the minutes, that there was indeed some dissension.
 
"Almost" all participants agreed raising rates at the July meeting.  "A couple" favored leaving rates unchanged. Clearly these dissenters were among the six non-voting Fed district presidents.
 
But it's probably a good proxy on where the Fed really is — far less hawkish than they present themselves to be.
 
With that, we're a little more than a week away from the Kansas City Fed's economic symposium in Jackson Hole.
 
This annual event is well attended by the world's most powerful central bankers and finance officials, and has a history of signaling policy adjustments.  As we discussed last week, perhaps this will be an "end of the tightening cycle" theme.
 
Deflation in China, and a technical correction in stocks (perhaps underway) would give them the cover to do so. 

Pro Perspectives 8/15/23

 

 
 

 

 

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August 15, 2023

As we’ve discussed often here in my daily notes, we need a period of hot economic growth, rising wages (to restore the standard of living), and stable, but higher than average inflation to inflate away debt — not just domestically, but globally.

And indeed, if we look at the policy moves by the Western world, since the covid lockdowns, that seems to have been the plan.  Inflate asset prices.  Inflate the nominal size of the economy.  Inflate away debt.

On that note, the Atlanta Fed’s GDP model now has the U.S. economy running at a 5% growth rate for Q3.  If we add in the inflation rate, that’s over 8% nominal growth.  That’s better than double the nominal GDP growth for the decade prior to the pandemic.  And with that, as you can see in the chart, the debt burden has been shrinking from the pandemic policy-response driven peak.

With that, let’s revisit an excerpt from my June 21 note from last year (2022):   “If there is one common word we hear spoken from policymakers around the world (from the Great Financial Crisis era, through the pandemic and post-pandemic period) it’s coordination.

They have resolved that in a world of global interconnectedness, the only way to avert the spiral of global economic crises into an apocalyptic outcome is to coordinate policies.

With that, the top finance ministers from G7 countries recently met in Germany.  It’s safe to say, they all know that the only way the world can start reversing emergency level monetary policy, while simultaneously running record level debt and deficits, is if the Bank of Japan is running wide-open-throttle, unlimited QE.”

You keep the liquidity pumping from a part of the world that has a long-term structural deflation problem, and that has the biggest government debt load in the world.

The world gives Japan the greenlight to devalue the yen, inflate away debt and increase export competitiveness (through a weaker currency).  They hit the reset button on an unsustainable, debt-laden economy. This script continues to play out.  

 

Pro Perspectives 8/14/23

 

 

 

 

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August 14, 2023

The U.S. 10-year yield closed at 4.20% today. That makes ten consecutive days with a close above 4%.
 
As we've discussed often here in my daily notes, this 4% level has tended to bring about fireworks in the global financial system, which has tended to be countered with some form of intervention.
 
With that, the last time the 10-year yield spent this much time, at this high a level (October of 2022), the Bank of Japan was forced to intervene in the currency market. 
 
The widening spread between U.S. and Japanese yields was creating a rapid fall in the value of the yen (to 24-year lows against the dollar).  And as you can see in the chart below, the dynamic is back at work (the orange line higher represents a stronger dollar, weaker yen) …
 
This makes the Japanese inflation report later this week, maybe the most important event of the week.  A rapidly weakening yen doesn't help inflation that's running well north of the Bank of Japan's 2% target.  And that's making BOJ monetary policy, which still includes negative rates and QE, harder and harder to justify.
 
That said, Western world central banks need Japan to continue to print money, to be a buyer of global assets (which suppresses global market interest rates, and serves as a liquidity offset, to a degree, to the global tightening). 
 
It's worth noting that the intervention episodes (including BOJ intervention) of the past year, successfully resolved the pressure in the financial system created by 4%+ yields.  Yields went back down, and that resulted in a lower dollar, higher stocks and higher commodity prices (a generally better risk environment).

Pro Perspectives 8/10/23

 

 

 

 

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August 10, 2023

The July inflation report did indeed break the streak of twelve consecutive months of declining year-over-year U.S. inflation. 
 
At 3.2%, it's about a third of where it was a year ago.  But it's still some distance from the Fed's obsessed about 2% target.  And the core rate (excluding food and energy) is still in the high 4s.  
 
But let's revisit a chart that suggests the Fed should be feeling pretty good about the current level of inflation.
 
 
Relating to the above chart, it's important to remember that the Fed made an official policy change in the way they evaluate their 2% inflation target back in September of 2020. 
 
Inflation had been too low, for too long.  For the better part of the prior decade, inflation ran well below their two percent target.
 
So, Jay and company told us explicitly that they would let inflation run hot, to bring inflation back to 2% on average, over time.
 
They've done just that.  The above is the chart on the Fed's favored inflation gauge, core PCE.  They countered thirteen years of weak inflation, with two years of hot inflation, for an average of 2%. 

Pro Perspectives 8/9/23

 

 

 

 

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August 09, 2023

We get July inflation data tomorrow.
 
On a positive note, China's producer price data has been leading the trajectory of U.S. inflation on the way up, and on the way down. Last night's July report showed the tenth consecutive decline in year-over-year prices. 
 
As we discussed when Chinese PPI was at 26-year highs, and the Fed was telling us there was no inflation, this (China PPI) is the equivalent of "skating to where the puck is going."  The price of the products we will be buying in the months ahead, will be determined (in large part) by the inputs into Chinese production. 
 
  
That said, tomorrow's headline number will likely break the streak of twelve consecutive months of declining year-over-year U.S. inflation.
 
It will be higher than the barely sub 3% reading in the last report. But it will leave us with a headline number still in the 3s (good).
 
However, a powerful driver of falling inflation (the fall from over 9% to 3%) has been DEFLATION in energy prices.
 
 
 
 
That deflation was brought to us by supply manipulation from the White House (via the near halving of the Strategic Petroleum Reserves).  Now it's time to restock, just as the economy is proving to be stronger than most expected.   
 
With the above in mind, oil prices rose about 16% in July, and have continued to climb in August.
 
That said, it's unlikely to create any big waves in tomorrow's report.  The EIA's average gas price survey for July showed just a small (0.7%) rise in gas prices.
 
This is where the Fed will likely start turning everyone's attention back to, more strictly, the core inflation data for the future path of policymaking (excluding the "volatile" nature of energy prices).