Pro Perspectives 3/17/21

March 17, 2021

The Fed held the line today, sticking with its well advertised position: “pedal to the metal” monetary policy, pumping money into the economy alongside an unimaginably huge fiscal spend, all while pretending they have no concern about troubling inflation coming down the pike.So, the Fed sees 6.5% growth this year, with 4.5% unemployment. That would be three-times 2019 growth.  And that would be what the Fed considers to be full employment.

And yet, they see inflation at a very tame 2.4%.  That’s quite a bit lower than the average long run inflation rate (of 3.1%).   Sounds great, magical.

But the Fed isn’t telling us that we are in a Goldilocks growth economy.  They are just refusing to give any indication to markets that they will take the punch bowl away.

With that, the response from markets:  risk assets go up.  Stocks hit new record highs.

But gold went up, and the dollar went down.  This is a signal that markets see through the Fed’s messaging.

Expect this direction in gold (up) and the dollar (down) to continue, as the posturing by Powell and company continues to put the Fed at risk of getting a negative surprise on inflation, and getting a late start on fighting it (i.e. behind the curve).

After today, I suspect the bond vigilantes will go to work, selling Treasuries, pushing market interest rates higher – testing the Fed.  That will tighten financial conditions, threaten a slowdown of the economy, and force the Fed to act — likely with the “Operation Twist” program we’ve been discussing.

As we discussed yesterday, this type of response from the Fed would keep the fire under growth (still fueling asset prices), but it would also mean even hotter inflation to lurking around the corner.

Pro Perspectives 3/16/21

March 16, 2021

We had some surprisingly negative economic data this morning that set the tone for stocks. 

For the first time since May, month-over-month industrial production contracted in February. 

 
After nine consecutive months of improving capacity utilization (to near pre-Pandemic levels), that also declined in February.  So, the "operating rate" of the economy declined last month.  

And the momentum in retail sales slowed in February, and with a bigger decline than expected.  

This is surprising, but with checks hitting accounts from stimulus this week, and, moreover, another $1.5 trillion in stimulus being disbursed, the March economic data will bounce back aggressively.

We talked about Fed meeting in my note yesterday.  They will begin a two-day meeting tomorrow, concluding with a press conference on Thursday afternoon. Markets will be sensitive to any signals from the Fed that they might be looking to take action against the rising 10-year yield (i.e. market interest rates, which effect mortgage and consumer rates). 

As we discussed yesterday, there has been some chatter that the Fed might consider another round of "Operation Twist," where they would sell short term bonds, and use the proceeds to buy longer term bonds (i.e. to tamp down the 10-year yield).  Former "bond king" Bill Gross said today, he suspects they might already be in the market, executing a program to keep longer term yields in check. 

What's the impact?  Ultimately, keeping rates in check will keep the economic momentum going.  That means hotter growth.  But it also means hotter inflation to come – it's a matter of when.

Pro Perspectives 3/15/21

March 15, 2021

We have a slew of major central bank meetings this week.  On that note, the theme we've been discussing for much of the year has been inflation.  Expect the performance of global markets this week to hinge on the way central banks (most importantly, the Fed) address (maybe dance around) that subject. 

And this comes as stocks sit on record highs.  

To this point, the tone from global central banks has been led by the Fed, which has been: an ultra-aggressive stance, yet with little-to-no acknowledgement of the risks of losing control on the bond market/ and inflation. 

The question: Will the Fed say anything this week to change that tone? 

Remember, we just heard from Powell two weeks ago, in an interview with the Wall Street Journal.  He was given the opportunity to more modestly position the Fed's view on inflation risks.  He declined, arrogantly saying that the long period of low inflation won't "change on a dime."

Now, if we've learned anything from the central banks over the past twelve years (post-financial crisis), it's that they are adept at maintaining control and managing market sentiment, even if it means changing the rules. And they can change the narrative (their views) on a dime, with no apologies.

With that, with the $1.9 trillion fiscal package now in deployment, we may get a change of tone from the Fed this week. This could come in the form of a discussion on "options" (to deal with the bond market), which at this point may be talk of another "Operation Twist."    

That, in the short term, could apply some breaks on the global asset price boom, to the extent that the Fed would be flattening the yield curve, and NOT expanding the balance sheet. 

What they also need, is to slow the rise in inflation expectations. 

This chart below shows what market participants expect inflation to be in the next five years.    

Three observations, here: 1) At 2.51%, it's above the Fed's target (of 2%), 2) it's at the highest level since 2008, and 3) when this measure reached 2.45% back in 2011, the Fed started putting out trial balloons on a policy action called "Operation Twist" – which they executed a few months later, to tamp down longer term market interest rates.  Yields and inflation expectations went lower. 
 

Pro Perspectives 3/11/21

March 11, 2021

U.S. stocks hit new record highs today (indicies tracking small caps, blue chips, broad market … all of it). 

Before that, the European Central Bank ramped up the efforts in Europe this morning, with a  promise to "significantly" increase the pace of QE in the next quarter. And like the Fed, and White House economic voices, the ECB too downplays any inflationary expectation of aggressive policies, as short-term. 

Without question, they will continue to press the accelerator in Europe on stimulus (fiscal and monetary).  It's important to remember, the ECB had already re-started QE before the Pandemic (now ramped up to about $2.2 trillion).  And in response to the Pandemic, they've relaxed fiscal constraints in the European Union, allowing for fiscal stimulus from some of the weaker member-states.  That has been extended to 2023.    

Given this backdrop, and given the record highs in U.S. stocks, we've talked about the opportunities in European equities, which have lagged.

On that note, Italy continues to be one of the most interesting opportunities.  Remember, the former ECB head and architect of the global financial crisis recovery in Europe, Mario Draghi, is now the Prime Minister of Italy.  His "whatever it takes" strategy, as ECB chief back in 2012, saved the euro zone from a sovereign debt crisis.  

He's still getting his feet wet as leader of Italy.  But a bet on Italy here, is a bet on Draghi, his experience and his connections to the ECB and European Commission leaders.  It's a good bet, especially when you consider this chart above, which tracks Italian equities.   This breakout (in the chart) is just getting underway. 

Pro Perspectives 3/10/21

March 10, 2021

If you questioned whether or not pouring another $1.9 trillion onto an economy, that was already on track to do better than 5% growth this year, would be inflationary, the White House is now discussing plans for another $2.5 trillion in deficit spending. 

This, they say will address "infrastructure."  That's code for the clean energy transformation.  And if that (clean energy plan) spending requirement will come in this next package, then where exactly is the trillion dollars going, of the $1.9 trillion, that is not associated with covid relief?

Logic would tell us that rapidly increasing the money supply, as our policymakers have done, will create inflation.  

With that, for perspective on money supply growth, here's the latest look at M1 (the most highly liquid assets, cash and coins in circulation + demand deposits …).  This is before this next wave of money hits …

The average year-over-year growth in M1, dating back to 1995 is a little better than 5%.  The growth in M1 over the past year has been about 350%. 

With that, the deluge of money, in the hands of people, should finally get this chart moving higher. 
This is the velocity of money.  This is the rate at which money circulates through the economy.  And you can see to the far right of the chart, it hasn’t been fast over the past decade (therefore, no inflation). 

We get inflation, only if the recipients of the money, spend it (if it circulates).  That didn't happen coming out of the global financial crisis.  Banks used cheap/free money from the Fed to recapitalize, not to lend. 

In the current case, by design, money is being dropped directly into the hands of consumers.  This money will inevitably translate into hot demand for stuff (it already has in many cases).  And based on the surveys from manufacturers, it will be met with "a scarcity of supply chain goods."  Logic tells us prices will go up. 

But the Fed has told us, inflation is not a concern (it will go up, but will be short-lived).  Powell says, arrogantly, that the long period of low inflation won't "change on a dime."  On a related note, I've just looked through an academic paper that concluded that inflation and money supply growth were positively correlated prior to 1990, but no longer — "inflation is no longer a monetary phenomenon; it is a wealth allocation phenomenon."  Why? Because in wealthy countries "commodity supply is abundant" (they say).

Commodities markets clearly haven't been given this message. 

This complacent view toward inflation sounds a lot like "this time is different."  And historically, in markets, when people say "this time is different," it doesn't end well. 

With this backdrop, gold (the historic inflation hedge) has been moving lower recently since August of last year, but it bounced perfectly into this long term trendline — a good spot to buy or add to gold, on the inflation theme.   

Pro Perspectives 3/9/21

March 9, 2021

Yesterday we looked at charts of the key "big tech" stocks.  These stocks (FB, AMZN, AAPL, TSLA) make up over 13% of the S&P 500 index.  And the recent drag from these stocks had the index in a vulnerable position at yesterday’s close. 

Today, we get a big bounce back, which bolsters the technical picture for the S&P 500 (as you can see in the chart below). 

So, this big trendline remains intact.  That's good news, because this line has plenty of significance.   

If we look back at major turning points in markets, historically, they tend to come with some form of intervention.  This past crisis was no different.  It took intervention to mark the bottom for stocks.  The Fed came in last year, on March 23rd, promising to buy unlimited Treasuries, and they announced that they would buy corporate bonds AND corporate bond ETFS.  This latter piece meant the Fed had (officially) crossed the line, and had entered the stock market.

 
That gave us everything we needed to know about how the Fed would respond to a falling stock market.
 
The Fed knows how important the stock market is in promoting confidence, stability and wealth (and therefore, economic recovery).  If stocks were to get messy (i.e. a quick and "disorderly" decline), we know exactly what they would do.  There is no doubt. They would outright buy stocks.
 
In fact, they will do anything and everything to preserve stability and to preserve the recovery — and to protect the trillions of dollars that have been spent to manufacture that recovery.  With that, any dip in the benchmark S&P 500 is a buying opportunity. 

Pro Perspectives 3/8/21

March 8, 2021

As expected, the Senate passed the $1.9 trillion spending package over the weekend.  This has been a done deal since the Georgia Senate run-off installed two democrat Senators in early January.    

As we discussed on Friday, the dollar will be key to watch as this bill officially becomes law.  The question is: Will foreign investors begin punishing this blatantly profligate deficit spending? 

The risk is that foreign investors sell our Treasuries and sell the dollar. So far, not yet.  Interest rates (bonds) were tame today. And the dollar was up. 

What is moving, is the favored "store of value" for global money over the past few years:  big tech stocks.  They are on the move, lower.  And the technical picture is looking ugly.  

Let's take a look at some charts …

First, here's a look at the S&P 500.  This yellow line represents the very clean uptrend from the March lows of last year, manufactured by government and central bank intervention.  This line broke last week, recovered today, but closes right on the big line. 

This picture of broader stocks looks vulnerable, especially when you consider the technical picture of some big constituent stocks of the index…  

Facebook is down 16% from the highs, and is trading below the 200-day moving average (bearish). 

Amazon is down 17% from the highs and trades below the 200-day moving average (bearish).  

Apple is down 20% from the highs (a technical "bear market" for Apple), and is approaching the 200-day moving average. 

And Tesla, isn't looking good — down 37% from the highs of late January and sitting on a key trendline here.  A move down to the 200-day moving average would represent a 47% drawdown, in what has been the world's investment manifestation of the global clean energy transformation.  Money is moving out. 

Where will this money (from big tech exits) go? 

So far, plenty is finding a home in value stocks.  Will some of this money plow into our Treasuries, at an attractive interest rate (1.6% on the ten-year) relative to the rest of the world?  Or will this money leave the dollar?  We will see. 

Pro Perspectives 3/5/21

March 5, 2021

The Senate may ram through the $1.9 trillion spending package over the weekend, which will likely require a tie breaking vote by the Vice President.  With that outlook, unsurprisingly, stocks reversed course from the beating of this morning.

We've talked about the dangerous inflation that is brewing under the expectations that another additional $1.9 trillion will be poured onto an economy that is already projected to run at least three times faster than pre-Pandemic levels. 

On that note, we had more evidence this morning that the hot economic recovery is already underway, thanks to the over $3 trillion of aid and stimulus rolled out last year.  The jobs number from February came in hot — twice what economists expected. And average hourly weekly earnings were up almost 6% compared to the February of last year (pre-Pandemic).  

And these numbers are coming with parts of the country still burdened by varying levels of government imposed constraints on their respective economies.  Any subjective economist would tell you the economy does not need another penny of stimulus, especially given that the constraints are being lifted. 

But it's coming.  And that's why yields have been running UP, and asset prices have been running UP.

So what happens when that next tranche of money gets the official stamp from Congress?  

We may find that foreign investors start voting on our policy decisions on Capitol Hill, with their feet.  That would mean, exiting the bond market, and selling the dollar.  This weaker dollar scenario is the typical and rational counter-balance to the rise global commodities prices (which are mostly priced and traded in dollars).  

With that, this will be the chart to watch next week …

Pro Perspectives 3/4/21

March 4, 2021

We talked about the 10-year yield yesterday, as the spot to watch for market stability.

On cue, yields did this today …  

And stocks did this …
As we discussed yesterday, the sharp rise in yields, since the beginning of the year, may be a signal that the Fed has it very wrong on the inflation outlook.  

On that note, the Fed Chair, Jay Powell, had a perfect opportunity to atone for any mis-positioning on the inflation outlook today, in a scheduled interview with the Wall Street Journal.  He declined that opportunity, and stumbled through excuses.  The markets didn't like it. 

As we discussed a couple of weeks ago, we should all know that Powell's intent is to signal to markets that rates will stay ultra-low and QE will continue as far as the eye can see.  This is meant to set the expectations (for markets, consumers and businesses), that the Fed will be providing maximum support for years. The intent is to keep any possible impediments to the economic recovery (like behavioral changes from fears of rising prices) out of the picture, to best secure the recovery.  

Market participants are smart enough to see through it.  And I suspect they will continue to push the interest rate market in the direction of reality (up, and stocks lower), up to the point that the Fed will have to respond (probably very soon). 

On that note, as we also discussed yesterday, history shows us that the Fed will easily regain control of the bond market (to keep rates low, to continue unbridled fuel for the recovery).  But subverting market interest rates, at this stage in the recovery, will only create far bigger challenges when they are forced to deal with rapid inflation. 

Pro Perspectives 3/3/21

March 3, 2021

At the highs of last week, the ten-year U.S. Treasury yield had nearly doubled since the beginning of the year (in two months). 

The Fed Funds Rate (the target rate which is set by the Fed) hasn't moved.  But the market interest rate (the rate determined by market participants) nearly doubled. 

This is creating concern for markets and the Fed. 

The concern is not that the economy is too fragile to survive on a 10-year interest rate of less than 1.5%. It's the idea that rates have moved fast, and may continue to rise, and to rise fast.  That would be trouble. 

Aside from the abrupt slowdown effect it would have on the economic recovery, it would represent either 1) a market that thinks the Fed has it very wrong on the inflation outlook, or 2) a market that is taking the cue of recklessly extravagant U.S. government spending, and political and social instability, to dump their long-term investments in our Treasury market (the historically safest and most liquid investments in the world).   Or it could mean both.

And both may be right.  But the Fed has been in control of the bond market.  And recent history (the past 12 or so years) suggest that they will maintain control of the bond market.  That means, we should expect the Fed respond to this sharp rise in market interest rates.  We've already heard them try to talk it down, with promises of keeping rates low, and assurances that they see little-to-no inflation risks.  That hasn't worked.     

Now there is speculation that the Fed will revisit the "Operation Twist" strategy.  They did this in 2011, selling shorted dated Treasuries, and buying longer dated Treasuries.  This flattens the yield curve, bringing down longer term rates (without having to buy more bonds … i.e. without having to increase the money supply).

Let's take a look at what happened to stocks when they did this in 2011.  

As you can see, stocks were already in bear market territory, due to an unraveling European debt crisis at the time.  And following the Fed's actions, stocks continued to fall another 7%, but bottomed within a couple of weeks.

With the 10-year trading at 1.47% today, the Treasury market continues to be the spot to watch.