Markets kick off the week digesting the inflammatory words from Biden over the weekend, about removing Putin.
And to add to the sentiment headwind, Biden was out pushing his 2023 budget today, which includes higher taxes and disincentives for investment (by taxing UNrealized gains!!).
I suspect it’s clear to anyone, an aspiration from the West for regime change in Russia would trigger a long, messy global war. Therefore, oil prices would go UP significantly, as the supply/demand imbalance would be compounded. And gold would go UP significantly, as global capital would move to relative safety.
That said, both (oil and gold) went down significantly today.
Meanwhile, tech stocks led the way, up — from very early in the day.
Neither Biden’s reckless foreign policy actions, nor his threats to curtail wealth at the top, could keep stocks down. Perhaps the White House policy news was overwhelmed by another factor: the return to lockdowns in China.
In fact, if we can read anything into the market behavior of today, it’s that the market considers the political appetite for more lockdowns to be greater, than the political appetite for global war.
These stocks that thrive in a lockdown were big performers on the day …
Amazon was up 2.5%. Zoom was up 3%. Roku was up almost 4%. Docusign was up 4%. Doordash was up 9%.
Yesterday we talked about the prospects of a gas subsidy. On cue, the governor of California presented ideas late yesterday for a number of transportation subsidies — including a $400 a month gas card.
As we discussed, a subsidy would only sustain the demand dynamic for oil. Apply that to a world that is undersupplied and underinvested in new supply, and the price of oil would continue to rise.
But it’s unlikely to stop there. Next up: bigger government handouts in the name of broad “inflation relief.” It’s already being proposed at the state government level and on Capitol Hill.
So, here we have the Fed raising rates, and as Powell said this week, they are doing so with the explicit intent of bringing down demand. And conversely, we have governments, which have broken supply through bad policy, looking to sustain demand through subsidies (more bad policy).
If you didn’t believe the inflation problem was going to get worse, these actions (if taken) ensure it will get worse.
Let’s talk about food…
Earlier this month, we talked about a coming food crisis. It was a topic at the NATO Summit today.
Here’s an updated look at the food price index, which is now on new record highs …
If we adjust this chart for inflation, current prices are at levels are matching the record highs of 1974.
That year might sound familiar because it was the last time we had a major global food crisis.
From the looks of this chart above, it appears that some saw this coming very early. Deere has quadrupled from the pandemic lows. And continues to make new record highs.
Last week the Fed laid out a more aggressive path and destination for interest rates.
But the path they telegraphed still leaves them fueling the fire of a hot, high inflation economy through next year. With that, it didn’t sound (at all) like a Fed that was prepared to do “whatever it takes” to slay inflation.
Today Jay Powell may have corrected the mistake. In a prepared speech, he set the expectations for possible 50 bps increments (in rate hikes). And he made it made it clear that the Fed is no longer sitting back and waiting for supply disruptions to normalize. They are looking to bring demand down, to come in line with supply. This is a quite a stark contrast from the inflation-denying Fed of 2021.
In fact, all along the way, they have been telling us that the deflationary forces of the past three decades wouldn’t turn on a dime, and therefore wouldn’t expose us to a dangerous inflation scenario. That’s changed too. Today, Powell’s flip-flop was expressed like this: “it’s hard to say what the economy will look like post recent events, but no one is sitting around waiting for the old regime to come back.”
To be sure, they were (arrogantly sitting back and waiting). But hopefully not any longer.
So, what will it take to beat inflation? As we’ve discussed, in the 73-74 and early 80s inflation spikes, the Fed had to ratchet rates above the rate of inflation to finally get it under control. And if history is a guide, the past five tightening cycles (’87, ’94, ’99, ’04 and ’15), the Fed has averaged about 50 bps of hikes a quarter.
The Fed started the liftoff in interest rates today, as expected.
In normal times, an interest rate tightening cycle is intended to cool an economy that’s running hot, to safeguard against a good economy turning into an inflation problem.
In this case, the Fed is just beginning to normalize policy, from emergency/crisis levels (i.e. zero interest rates, plus QE). Ideally, coming out of crisis, they would want to get rates back to the “neutral level” (which means neither accommodative nor restrictive … 2.5%-3.5%, historically), before having to deal with the challenge of cooling an economy.
But they’ve waited too long, in this case. They are already dealing with a hot economy and an inflation problem.
With that, for the first time ever the Fed is starting 8 percentage points in the hole, against inflation.
As we discussed in these notes, if we look back at the inflation bouts of the 70s and early 80s, both times the Fed had to ratchet up the Fed Funds rate, to above the rate of inflation to finally win the battle.
They have a long way to go.
With that, the Fed started making steps today, setting expectations for a more aggressive path, with a higher ending point (now projecting close to 3%). That puts the Fed closer to what the interest rate market expects for the path of rates.
What does that mean? The market was pricing in seven, quarter point rate hikes this year. Now the Fed is too.
So, if the difference between the Fed projections (coming into today) and the market projections represented the market’s view that the Fed was making a policy mistake — then the closing of this gap, should represent a reduced risk of a policy mistake.
Is that why stocks rallied this afternoon? Maybe.
As we discussed yesterday, coming into this big Fed meeting things were setting up for a “sell the rumor (assume the worst), buy the fact (rational)” scenario. This appears to be playing out.
But, we also had a very big catalyst for markets this morning: China.
Remember, late last year, the Chinese government waged a war against its own technology giants, and (maybe more so) against U.S. regulators of U.S.-listed Chinese stocks.
It started with the Chinese ride hailing company, Didi. It went public last June, as one of the biggest Chinese share offerings in the U.S., ever. Immediately, the Chinese government started harassing the company for a number of alleged violations.
But with over $1 trillion of Chinese companies on U.S. exchanges, it seemed to be more of a “shot across the bow,” related to the U.S. SEC’s new effort to crackdown on the lack of reporting accountability from Chinese companies.
By November, Didi asked to delist from the NYSE (with plans to move the listing to Hong Kong). Coincidently, the tech-heavy Nasdaq topped just three days prior …
The future of Chinese companies trading on U.S. exchanges has since been in question. That includes some of the hottest technology stocks in the world (Alibaba, JD.com …).
But overnight, we had some news out of China that may have marked an end to the Chinese government saber-rattling. China “vowed to keep its stock market stable and support overseas share listings.” Alibaba ended the day up 36%.
We entered the year with an outlook for the Fed to become “inflation fighters” for the first time in a long time. It didn’t take long, with the turn of the calendar for the regime shift (from easy money to tighter money) to become evident in markets.
This has translated into a deflation of the “companies of the future” bubble.
And for those spots, particularly the no earnings companies, the air continues to come out. The portfolio managers with long-term 30-year visions for these companies, are finding out that the term of their vision doesn’t match the term of the capital they are managing (i.e. redemptions).
With that, we see constant selling pressure in the small cap indices, since the start of the year, that looks consistent with forced liquidations. In these cases of forced liquidation, investors tend to sell what they can, not what they want to. And that can carry over to other segments and asset classes in markets.
In these environments, there will be the “baby thrown out with the bath water” situations. It presents an opportunity to buy quality, cash flowing companies at a discount.
They had already guided to an end of QE by March. And given that Jay Powell told us back in December that they wouldn’t start the liftoff on rates until they concluded their bond buying program, we could deduce that March could be the earliest they would move on rates.
On that note, the markets in the past month have priced in that scenario (a March hike). Powell confirmed that today. The other piece of the “tightening” plan, shrinking the balance sheet, has been telegraphed to come in the summer. Nothing was said today to change that course (probably June).
So, if no surprises, why the violent reaction in markets?
The Fed has a good record of managing stability through manipulating expectations on the policy path. On the latter, Powell was sloppy in his press conference (maybe on purpose). He created a gap between what the Fed has been guiding and what he expressed (in words) as a reality.
Keep in mind, the Fed continues to fuel the inflation pain through QE and zero rates, until March. Yet, Powell expressed how inflation was hurting people’s ability to afford basic needs. And he said it has gotten “slightly worse.” Add to that, he said that affordability will become more painful, as fiscal is no longer stimulative and price pressures from supply chain constraints will persist — into next year (according to Powell).
Is he setting us up for a more aggressive path? He should be. Remember, unlike the “taper tantrum” of 2013, the policy error this time isn’t removing emergency policies prematurely. It’s a Fed that has been/is too late.
Last week, we talked about the unwinding of some bubbly assets.
It got uglier today. And then it got better.
Let’s talk about what’s going on …
Remember, we have over 40% growth in money supply in less than two years. That’s a lot of excess money in an economy, chasing a relatively stable quantity of assets. When this happens, you get inflation, and you get irrationally allocated money. This can tend to result in money over flowing good assets, and being pushed to lower quality assets.
Much like the dotcom bubble, and the housing bubble, we again have seen this dynamic of irrational investment. The time of reckoning is here. In this case, it was the overly aggressive Fed and Government response to the pandemic that created the liquidity deluge, and the resulting excessive investment. And now it’s the ‘change in direction’ of those policies that is ending it.
The prospective path of rising interest rates, is already putting downward pressure on valuations. With that, some selling can quickly turn into more selling, which can turn into forced selling.
We’ve talked over the past two weeks about forced selling of overvalued, under-earning tech companies in the famed ARKK Funds. That was the “canary in the coal mine.”
Here’s the good news: After the selling today became broad, markets recovered. And value stocks led the way. This signals that money is not running away from the stock market, it’s simply moving (from overvalued, to undervalued). That’s very positive.
Still, some think the decline in stocks to start the year may influence the Fed’s current path of monetary policy. That’s highly unlikely. Back in 2016 and 2018, a falling stock market caused the Fed to do an about-face on its plans for hiking rates — but the economy was weak and fragile, and inflation was soft.
This time, the Fed is dealing with a 5%+ growth economy, and 7% inflation. They won’t be altering the path. That said, Jay Powell would be smart, in this Wednesday’s post-FOMC press conference, to make it uneventful (i.e. give markets nothing new to chew on).
Yesterday we talked about the vulnerability in bitcoin. And we looked at this big trendline.
This line broke today. Bitcoin was down 10%.
As we discussed yesterday, an unraveling of the private crypto bubble would be powerful enough to create some waves in broader markets. And we may have had a catalyst for it, with the Fed’s release of its Central Bank Backed Digital Currency report yesterday (i.e. the CBDC, a potential private digital currency killer).
On a related note, remember we looked at this chart below last week, which shows the relationship between the bets on the “companies of the future” (Cathie Woods’ ARK Funds) and the “money of the future.”
Both ARKK and Bitcoin have been investments that have been based on qualitative theories about the distant future — with valuations driven by the gush of liquidity (monetary and fiscal),rather than fundamentals. The liquidity spigot is now closed, and these trades are being unwound.
It’s probably no coincidence that the top in the Nasdaq (highly valued tech) and the top in Bitcoin came in the second week of November.
That was when it became clear that a change in the direction of both fiscal and monetary policy had arrived. Just over the course of a few days (in November), the Fed’s stated condition for rate liftoff was seemingly met (with a booming job report) and Congress passed the $1.2 trillion infrastructure bill.
This change in direction from easing to tightening is a signal for value stocks to outperform growth, which is underway. And historical studies suggest this value stock outperformance can hold for the next decade. It’s a buy the dip — on value.
The Fed released its report on a digital dollar this afternoon. Stocks had been in rebound mode for much of the day, but went south when the report hit.
The Fed was due to deliver this report, on the viability of a central bank-backed digital currency (CBDC), back in September. It never happened.
And throughout this period, when Jay Powell was being scrutinized for re-nomination, the Fed Chair carefully avoided taking a position on it. His talking point has since been, that it will be a decision made by all stakeholders (namely, Congress). Today’s report said the same.
On that note (a decision for Congress – those in power), we have some clear direction. They want it. And they want to kill private digital currency. Remember, back in June, Elizabeth Warren held a hearing on this. Warren made it clear that a central bank-backed digital dollar would “help drive out bogus digital private money (bitcoin, stablecoins, etc.).“
It’s not only U.S. officials that may be challenging the rise of private money. Just as the “build back better” and clean energy transformation is an agenda highly coordinated by major global economic powers, so is the concept of CBDCs. The BIS (Bank for International Settlements) consists of 63 global central banks, and nearly 90% of them are having conversations about adopting a CBDC.
With the drop of this new report today, Bitcoin swung from a positive day, to close down, and on the lows. And as you can see in the chart above, the future of bitcoin mania may hinge on this big trendline.
Why would stocks get hit on this currency report? Maybe it was just an additional catalyst in a market that has already been unwinding overvalued/bubbly tech stocks. And now we may see an unwinding of a bubble in private crypto.
The former, has been orderly, with money moving from growth to value stocks. The latter may create some waves.
Nonetheless, the technical picture in the big stock indices became considerably uglier by today’s close.
As you can see, the S&P 500 has clearly broken the big trendline from election day, and is testing the 200-day moving average (the purple line).
The support has already given way in the Nasdaq.
This brings us back to the discussion we had yesterday, on the Fed meeting next week. Through the post-financial crisis era, the Fed’s hand was forced, more than once, by instability in stocks. As we discussed yesterday, we should not expect the Fed to react, in this environment.
But, more pain in stocks from here would likely get a fiscal response. We’re already seeing some signs that “Build Back Better” will be carved up and done in pieces. I suspect we would see a deal like that, where the clean energy piece (wish list), was approved. My view: That would be the shock absorber for markets, if needed.
We are a week away from the Fed’s first meeting of the year, and as it stands, they will be contemplating a 10-year yield that has gone from 1.45% to 1.90% since they last met (a month ago!).
And that has translated into a sliding stock market: Rates up, lower valuations on the high growth (especially no EPS) stocks.
The Nasdaq index, full of the much-loved “companies of the future,” is down 8% to open the year.
The question is, what would make the Fed balk on the guidance it’s given to exit emergency policies?
It’s a question that markets have been conditioned to ask. After all, we’ve seen an about-face more than once from the Fed, in the years emerging from the financial crisis. Lower stocks has equated to a Fed response (a lifeline).
Consider this: They began rate liftoff in December of 2015, with the guidance of four rate hikes through 2016 — only to pause, and return back to damage control just a month after the first hike.
Will it happen this time? The short answer is, no.
As we discussed yesterday, the policy error from the Fed emerging from the financial crisis, was acting too soon. The policy error now, is acting too late, too slow.
We can see the difference in these two environments through the sector performance in this recent decline in stocks. In a sea of red (from the sector level), financials and energy are green on the year. Energy is up, as a result of undersupply in a hot economy with hot demand. And financials are up, as a supplier of credit, winning from a hot economy and prospects of more profitable lending. Bottom line, post-financial crisis is not an analog for post-pandemic.
Of course, an easy differentiator is the $5 trillion in new, excess liquidity added to the system over the past two years. That has slowly turned the tide in what has been a long bear market in commodities, into a young secular bull market in commodities.
With that, let’s revisit this chart we’ve looked at many times in my Pro Perspectives notes … the commodities/stocks ratio.
As you can see, commodities are coming out of a roughly 12-year period of significant underperformance, relative to stocks. In fact, commodities haven’t been this cheap, relative to stocks, in 50 years.