We talked yesterday about Biden's impending decision on who will lead the Fed for the next four years.
As we discussed, the incumbent, Jay Powell, doesn't seem to fit the mold of what the administration wants – though he's the consensus favorite. The highest probable candidate that could replace him, does fit the mold (Brainard).
The "mold," in this case, is (seemingly) someone that will carry the water for the White House's agenda.
With that in mind, markets seem to be pricing in some uncertainty about the situation.
We are living in a world of policymaker intervention. The Fed's involvement in the Treasury, mortgage and corporate bond markets over the past year is intervention. The pandemic response from Congress (stimulus, rent moratoriums, direct checks, etc.) is intervention.
But the Fed has now telegraphed a path where they could be out of the intervention business by June. And if the infrastructure package is the last bullet fired by Congress, they could be nearing the end of the pandemic-response intervention business too.
But this Fed appointment, and actions Biden took today on the oil and gas market, suggest we may get more intervention, not less.
What are two markets that create problems for the economic recovery? Runaway oil prices, and runaway interest rates.
On the former, we have an administration (and global initiative) that has restricted domestic oil supply, and given the control of prices to foreign producers. And now we have a threat of runaway oil prices.
On the latter, we have the hottest inflation we've seen in thirty years, following continued massive deficit spending. That's a recipe for higher rates, maybe runaway rates.
Will there be intervention?
Today, Biden launched an investigation into domestic oil producers, claiming producers were price gouging. This claim sounds a lot like the claim that resulted in the Nixon-era gas price controls. It led to much higher, not lower, prices.
On rates: Brainard has been an advocate for yield curve control (managing market interest rates to stated target levels). Just as the Fed is exiting the intervention business, they could be right back in it. This would keep market interest rates from running away, and choking off economic activity — but market interest rates are a market mechanism to curtail inflation. Inflation could run wild.
From a headline this afternoon, it sounds like Biden will announce his nominee for Fed Chair on Friday.
This is an important announcement, for markets and the economy.
If we take the actions of the Biden administration as a guide on how they would like to see the Fed behave, we would deduce that they would like to see a Fed that: 1) supports the social and climate agenda, and will maintain monetary policy to support the fiscal spending plans, 2) is willing to clamp down on the banking sector, and 3) is in favor of a central bank-backed digital dollar.
If we evaluate the history of Jay Powell's tenure as Chair, he
doesn't seem to fit the mold. This is a guy that raised rates into a low inflation, slow recovering post-great financial crisis economy – even as stocks were collapsing in 2018. This is a guy that has, no his watch, eased some of the bank regulations that were put in place in response to the financial crisis. And this is a guy that has carefully avoided taking a position on the digital dollar concept.
That said, it does seem like he has made a concerted effort to keep himself in the running for another term, through his maneuvering of the past year. Among those maneuvers, sticking to the "transitory inflation" talking point far longer than he should have.
Now, on the other hand, the top candidate in the running to replace Powell, ticks all of the boxes. Lael Brainard is one of the most dovish Fed Governors. And w
ith Brainard, you get a Fed that would support the move to a central-bank backed digital currency. And she will execute on the Biden social and climate agenda (which includes tougher positions on bank regulation, "looking out for Main Street").
So, how do things look? The betting markets still see a Powell reappointment, though the odds are tightening — a 64% chance for Powell vs. 90% chance back in September.
Not only would a removal of Powell be disruptive for markets from a continuity standpoint, it would imply an even more dangerous inflation outlook from a policy standpoint.
Biden signed into law the infrastructure bill today.
The question is: Will this be the final fiscal bullet fired?
If it is, with monetary policy now pointing in the direction of a tightening cycle (maybe to start by next June), we have to keep an eye on the "bubble" markets – the most vulnerable.
On that note, perhaps the biggest bubble/manifestation of excess money and a mania surrounding the expectations of a global energy transformation is Tesla — a company that has exploded in value, from $78 billion to $1.2 trillion in just twenty-months. Over a trillion dollars of global capital has plowed into this stock.
What happens if the massive "clean energy" bill, that has been in negotiations in Congress and already whittled down significantly in size, does not make it to the finish line?
Does the money move out of Tesla?
We're already seeing some selling from Elon Musk, and some price action that would fit the description of a blow-off top (a steep and rapid increase in a stock's price and volume, followed by a steep and rapid drop in price, on high volume).
Back in early August, we had just come out of the first half of the year, with the economy running at a better than 6% growth rate.
Personal savings were at record levels. Jobs were plentiful, and at record high wages.
But despite these hot numbers, people were living a different story on the ground, emanating from a disruptive policy agenda in Washington.
With that, when the July consumer sentiment data came in (in early August), it was a shocker. Consumer sentiment dropped to a 10-year low. Expectations about the future? 8-year low.
This, as forecasters were, at the time, looking for between 5%-7% annual rate of growth for the third quarter. The economy ended up growing at just 2% in the quarter.
Fast forward three months, and the consumer is even less optimistic.
This morning, the October numbers came in. Let's take a look …
The University of Michigan monthly survey of consumersentiment is at another 10-year low.
Next, here's how consumers surveyed feel about current business conditions. It's not good. The reading is back around pandemic lows. And as you can see in the circled areas of the chart, it doesn't share good historical economic company.
Here's how consumers feel about the future? Eight-year low. Consumers feel worse about the future than they did at the most uncertain depths of the pandemic/lockdown.
This all comes at the Atlanta Fed's GDP model is tracking 8% growth for Q4. The consensus economist community is projecting a little less than 5%. Expect adjustments, downward.
Yesterday we talked about the latest hot inflation data. The increase in prices (CPI) from September to October was 0.9%. That's the second time in the past six months that the month-over-month reading has measured that high.
Again, if we extrapolate out that 0.9% monthly inflation number to an annual rate, it would project double-digit inflation.
And keep in mind, we have plenty of drivers at work, and new drivers being introduced (like more fiscal spending), that will only increase the rate at which prices are rising.
With that, let's revisit a couple of key inflation hedges, to see how these markets are responding.
First, gold …
We've looked at gold quite a bit in my daily notes. This is the historically favored inflation hedge. But despite the hottest inflation we've seen in decades, gold is down for the year (still). As you can see in the chart, when the inflation data hit yesterday morning, gold broke out of this technical downtrend.
If we look at a longer-term chart, you can see that this technical downtrend looks more like a short-term correction in a long-term bull market. For those that appreciate the value of technical analysis, this ABC pattern (from Elliott Wave theory) projects a move to $2,700.
Now, let’s look at copper …
Unlike gold, copper is up on the year, big (+25%). It’s winning on two fronts: 1) an inflation hedge, and 2) c
opper plays a key role in renewal energy (from solar, to wind, to electric vehicles). And the upside case for copper (from here) remains very strong.
As you can see in the chart, we’ve had these types of moves in the price of copper. If this recent run is on par with the history of the past two decades, copper has at least another 25% upside.
The producers of copper, who know the supply/demand dynamics better than anyone, think prices will go well beyond the projection in my chart.
Here’s how the CEO of one of the largest copper producers in the world put it, on an earnings call earlier this year:
“China has been the driver of copper demand growth over the past two decades. Now the source of new demand is expanding…. copper is essential to the transition to a global cleaner energy future. Roughly 70% of copper is used to deliver electricity. As clean energy initiatives are implemented, copper intensity in the economy expands in a major way. The outlook for copper has never been better. Significant demand growth is inevitable. Supply to meet this growth is severely challenged. It’s going to require meaningfully higher prices to support mine investment. The combination of rising demand, scarcity of new supplies point to large impending structural deficits, supporting much higher copper prices than previously anticipated.“
We own two copper producers, and one of the world’s largest gold producers in our Billionaire’s Portfolio. This gives us leveraged exposure to the price outlook in these key metals. If you’re not a member to this subscription service, you can join us today (here), and get all of the details on these stocks.
We've talked throughout the year about the likelihood of seeing double digit inflation, given how the monthly change in prices were coming in.
If we extrapolate out today's (October) number, we get a 10.8% annual rate.
Now, consider this: As of mid September, there was still $550 billion of the $1.9 trillion stimulus passed earlier this year, that has yet to be disbursed. Now we have another $1.2 trillion spend coming down the pike.
All of this, and the Fed is still buying $105 billion bonds a month (i.e. injecting $105 billion into the economy).
So the Fed is still running emergency policies, just for the wrong emergency (in the wrong direction).
This is the most dangerous inflation we've seen since the Volcker era.
On that note, remember back in August we talked about some comments Jay Powell made in a townhall meeting, about Volcker. He admiringly called him "the most distinguished public servant, in economies, in [Powell's] lifetime." And he said he admires him because of his courage to take on the unpopular, but necessary path of beating what Powell calls The Great Inflation.
Volcker beat double-digit inflation with short-term interest rates that approached 20% — and in doing so, he took the economy into recession. But he also set the stage for a long and very good period of development for the U.S. economy.
That said, if we had a sense that Powell is prepared to become an inflation fighter, we also have a sense that the Biden administration doesn't want an inflation fighter.
On Friday, Biden interviewed one of the most dovish Fed Governors, as a candidate to replace Powell.
With Brainard, you get a Fed that would fall even farther behind on inflation. She will support the move to a central-bank backed digital currency. And she will execute on the Biden social and climate agenda (which includes tougher positions on bank regulation).
This candidate only makes sense if you (the Biden administration) think this agenda of America transformation (social, energy, health care, financial) will become such a drag on the economy, that inflation will naturally fall back from demand disruption — and require Fed life support.
We talked about the mixed signals in markets on Friday.
Yields going down, despite the Fed taking the first step in a policy reversal last week.
Yields going down today, despite the house passing a $1.2 trillion spending package over the weekend.
The Vix going up, and gold going up (finally) despite stocks closing the past week on record highs. That continues this week. These are all signals of risk hedging.
So, we ended last week, asking if perhaps the official change in direction from the Fed, and an ending of the pandemic could be setting the stage of an unwind of some very bubbly growth "disrupter/stocks of the future."
And this chart came to mind …
Fast foward a few days, and we have another "turning point indicator" in that view: Congress may have fired its final fiscal bullets, passing the infrastructure spend over the weekend.
Add to that, over the weekend, after becoming the richest man in the world, thanks to the chart above, Elon Musk suggested he might be inclined to sell 10% of his stock.
Now we have this chart …
The great macro trader, Paul Tudor Jones, has describes the euphoric stage of bull markets like this: "there's typically no logic to it, and irrationality reigns supreme."
Tesla, while ebitda has increased 3x from the pre-pandemic quarter, the value of the company has increased almost 15x. And, as you can see in the chart above, Tesla, one of the biggest companies in the world, increased in value by 39% in just nine days. Irrationality reigning supreme?
Last week, the Fed Chair told us that "maximum employment" was the condition for a liftoff in rates.
What's happened since?
> Two days later we had a booming jobs report, with an unemployment rate that dropped to 4.6%, on 5% wage growth.
> And then another effective oral covid treatment option was introduced.
> And then Biden's vaccine mandate for businesses was blocked by a federal court.
> And then the House passed the $1.2 trillion infrastructure bill.
> And today, the foreign travel ban was lifted.
This is a cocktail for employment ("maximum employment"), which adds to the inflation pressures, which should speed up interest rate liftoff.
With that, the Fed ran out a slew of speakers today (a total of six) to ensure that they maintain a grip on consumer psychology. As we've discussed, the Fed is far more concerned about inflation expectations, than they are about inflation.
With that, as we've also discussed, what they say and what they do (actions) are often very different. For us, having the benefit of on-the-ground/everyday observation, it's fair to expect higher rates will come sooner than they would like us to believe.
On that note, we've been talking about the opportunity in small cap and value stocks — which tend to outperform in rising interest rate environments.
The move is now underway …
We looked at this chart last Monday, as it was closing in on the highs of the year (of March). As you can see, we now have a breakout.
And this breakout should extend.
Remember, the S&P 500 is now eighteen percentage points higher than its March highs (formerly, record highs). And this outperformance comes as small caps should be outperforming large caps coming out of recession. Again, this performance gap may close quickly (i.e. much higher small caps into the end of the year).
The jobs numbers this morning confirmed what should be a reasonable assumption: When you stop paying people to stay at home, they will go find a job.
In this case, from July forward, more than half of the states have rejected the federal unemployment subsidy. And while the August and September job growth came in under expectations, those numbers have since been revised UP. And this morning's October numbers came in better than expected.
So, averaging the job growth over the past six months, we get 665k jobs added a month. That's big. And that's on an unemployment rate that came in this morning at 4.6%.
That's more than three times the job growth underway when the Fed started normalizing rates back in 2015. And a lower unemployment rate (currently), by 40 basis points.
Add to this, today the health czars are touting the trial success of another oral therapeutic against Covid.
This should all signal a sustained, strong economic recovery, which should be a greenlight for stocks, commodities and interest rates (yields).
Check, for stocks and commodities. But yields went the wrong way today, sharply.
As you can see in the chart, there was a lot of bond buying today (price goes up, yield goes down), despite the positive news on the economy and on the pandemic front. And the move in yields was global. European yields were down sharply on the day too.
Not only that, but gold had one of its best days of the year (only 12 days better) — finishing on two month highs.
And the vix was up 5% on the day, despite broadly positive stocks.
Bottom line: It looks like there is some hedging of risk going into the weekend.
Perhaps there is some fear of an ugly unwind, of some of the bubbly tech stocks that have done so well in the pandemic period. This one comes to mind …
The October jobs report comes in tomorrow morning.
As of yesterday, this report and the coming monthly job reports, will be a lot more important.
Why? Yesterday, Jay Powell tried to take the focus off of inflation, which he admitted was hot, by telling us that they (the Fed) aren't thinking about an interest rate liftoff, in response to inflation, because we aren't at "maximum employment."
Here are his words, exactly: "We don't think it's time yet to raise interest rates. There is still ground to cover to reach maximum employment both in terms of employment and in terms of participation."
Stating that a condition of maximum (or full) employment is necessary to clear the path for setting just a positive (i.e. not zero) interest rate for our economy, is hard to comprehend.
Keep in mind, the unemployment rate from last month's report dropped to 4.8%. That's very close to the long-term average unemployment rate. And it's very close to "NAIRU," which is what the Fed believes to be the "Non-Accelerating Inflation Rate of Unemployment. This is the level of unemployment, below which, inflation would be expected to rise. That's probably not a level you want to dance around, in an economy that's already producing hot inflation.
For perspective, when the Fed started raising rates in December 2015, following the financial crisis and three rounds of QE, the unemployment rate was higher than it is now. Economic growth was lower, and inflation was lower (much lower).
So, there is debate about whether the Fed has it wrong.
Knowing the history of the Fed, especially the history of the post-financial crisis environment (the past thirteen years), they aren't trying to be right, they are trying to manipulate public perception in a way that gives them, in their view, the best chance to execute on their objectives, without changing consumer confidence/behaviors and market stability.
With that, as we've discussed, we have to watch what they do, not what they say. In this case, they've just started tapering their emergency bond purchase program (QE). And they did it sooner, and are telegraphing a faster timeline than most would have expected just a couple of months ago. The liftoff for rates will likely be the same — sooner and faster.
