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It’s Coming – A Huge Bond Buying Opportunity

It’s Coming… A Huge Bond Buying Opportunity

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This article was originally published by ZeroHedge.

It's Coming... A Huge Bond Buying Opportunity Tyler Durden Tue, 10/27/2020 - 08:25
Authored by Lance Roberts via RealInvestmentAdvice.com, Here we go again. After plunging to new lows, the calls for the end of the “bond bull” market mount each time rates rise. Is this time the end of the “bond bull?” Or, is there another huge bond-buying opportunity to come?  We recently reduced our exposure to bonds, the first time in years, due to the more extreme overbought condition of Treasury bonds following the pandemic’s onset. The long-term chart of yields below shows this to be the case. There are two critical points to take away from the chart above.
  1. Interest rates are currently extremely oversold (top and bottom panels), suggesting that rates could indeed rise over the next few months. Such could coincide with another stimulus package or the passage of an “infrastructure” bill that leads to short-term inflationary concerns.
  2. When rates do rise from deeply oversold levels, there is a point where high rights collide with debt levels triggering either a credit-related event, a stock-market correction, or worse. 
There are currently two significant risks from rising interest rates, which investors should heed.

Valuation Expansion

One of the primary themes used by the “Permabulls” is that “valuations are cheap due to low interest rates.” That argument has been the clarion call of a generation of investors who have ignored fundamentals and valuations to chase market returns. Since 2019, when earnings growth began to deteriorate in earnest, investors bid up shares. As such, the primary driver of returns, as shown below, has come from “multiple expansion.” The “hope” remains that earnings growth will eventually catch up with valuations. However,  despite being 3/4ths of the way through 2020, the outlook for earnings continues to deteriorate. In just the last 15-days, the estimates for 2021 have declined by almost $7 per share despite repeated statements of a recovering economy. There are two problems with the thesis that “low rates justify high valuations.”
  1. Historically, such has not ever been the case; and,
  2. When rates rise, valuations quickly become an issue.
However, since stock prices reflect economic growth, the impact of rising rates on the economy is a far more significant issue.

The Debt Problem

People don’t buy houses or cars. They buy payments. Payments are a function of interest rates, and when interest rates rise sharply, mortgage activity falls as payments rise above expectations. In an economy where roughly 70% of Americans have little or no savings, an adjustment higher in payments significantly impacts consumption. 
  1. Rising interest rates raise the debt servicing requirements, which reduces future productive investment.
  2. As stated above, rising interest rates will immediately slow the housing market taking that small contribution to the economy. People buy payments, not houses, and rising rates mean higher payments.
  3. An increase in interest rates means higher borrowing costs. Such leads to lower profit margins for corporations reducing corporate earnings and financial markets.
  4. The negative impact on the massive derivatives and credit markets is the Fed’s worst fear. 
  5. As rates increase, so does the variable rate interest payments on credit cards. With the consumer struggling with stagnant wages and increased living costs, higher credit payments lead to a contraction in spending and rising defaults.
  6. Rising defaults on debt service will negatively impact banks, which are still not adequately capitalized and still burdened by massive levels of bad debts.
  7. Many corporate share buyback plans and dividend issuances are accomplished through cheap debt, leading to increased corporate balance sheet leverage. That will end.
  8. Corporate capital expenditures are dependent on borrowing costs. Higher borrowing costs lead to lower CapEx.
  9. The deficit/GDP ratio will begin to soar as borrowing costs rise. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

Payments Matter

I could go on, but you get the idea as we discussed concerning debt-to-income ratios:
Such is also why interest rates CAN NOT rise by very much without triggering a debt-related crisis. The chart below is the interest service ratio on total consumer debt. (The graph is exceptionally optimistic as it assumes all consumer debt benchmarks to the 10-year treasury rate.)  While the media proclaims consumers are in great shape because interest service is low, it only takes small increases in rates to trigger a ‘recession’ or ‘crisis’ event.”
Am I saying rates can’t rise at all?  Absolutely not. However, there is a limit before it negatively impacts the economy, and ultimately the stock market.

Bond Prices Very Overbought

In June of 2013, when the cries of the “death of the bond bull market” were rampant, I made repeated calls that then was an ideal time to be a “buyer” of bonds.
“However, the recent spike in interest rates has certainly caught everyone’s attention and begs the question is whether the 30-year bond bull market has indeed seen its inevitable end.  I do not think this is the case and, from a portfolio management perspective, I believe this is a prime opportunity to increase fixed income holdings in portfolios.”
As shown in the chart below, that was the correct call and, despite repeated wrong calls by the mainstream analysts, bonds remained in an ongoing bullish trend. Since interest rates are the inverse of bond prices, we can look at a long-term chart of rates to determine when bonds are overbought or oversold. In 2019, rates began to slide slower as the realization that economic growth was weakening weighed on outlooks. As the yield curve began to invert, the Federal Reserve stepped in with expanded “repo” operations to shore up financial institutions. Rates kept going lower. In March of 2020, the economy was shut down due to the pandemic causing rates to plunge to record lows.

Huge Bond Buying Opportunity Coming

The plunge in rates and massive Fed liquidity caused stocks to surge to new highs despite an underlying recessionary economy. Currently, the plunge in interest rates pushed bonds to an extreme “overbought” condition.  Such suggests the most likely target for rates in the near term could be as high as 2.0%. While an increase of 1.2% from current levels doesn’t sound like much, that increase would push bonds back to “oversold.”  That move will provide the best opportunity to increase bond exposure in portfolios. We can confirm the same using a very long-term chart (50-years) of 10-year interest rates overlaid with a 10-year moving average. As you can see, that moving average has provided formidable resistance and denoted every peak in rates going back to 1988. Currently, with interest rates at the bottom of their long-term trend, the risk is that rates could indeed rise in the months ahead. What could cause such an increase in rates?
  1. A massive debt-funded stimulus package that sends increased amounts of funds directly to households.
  2. More debt-funded infrastructure programs.
  3. If the government further increases deficit spending programs that fail to produce economic benefits such as universal basic incomes. 
  4. An increase of economic activity as the economy reopens, and a post-recessionary recovery occurs.
  5. If there is a point where the Federal Reserve is unable or unwilling to monetize the entirety of the debt issuance
  6. A lack of demand by foreign buyers of U.S. debt over concerns on economic strength and financial stability due to debt-to-GDP ratios.
These lead to concerns over temporary inflationary spikes, which could drive interest rates back to the top of the long-term downtrend.

Where To Invest While We Wait For Bonds

While bond prices currently remain overbought, such a condition will likely not last very long. As shown below, markets and volatility have an inverse relationship with rates, hence the non-correlation for portfolios. The long-term log-chart of interest rates and the stock market tells the tale. This analysis also suggests that the correction that started in March is likely not over as of yet in the longer term. If rates rise back toward the long-term downtrend, bond prices will come under pressure as the stock market corrects. For investors, we can turn to our colleague Jeffrey Marcus of TPA AnalyticsHe recently analyzed the best places to invest during rising interest rates for our RIAPro Subscribers.
The 4 best performing sectors are:
  • Technology
  • Consumer Discretionary
  • Industrials
  • Materials
The 4 worst performing sectors are:
  • Utilities
  • Telecomm
  • REIT’s
  • Staples
The 2 best performing broad categories are:
  • Small-Cap Growth
  • Small-Cap
The 2 worst performing sectors are:
  • Large-Cap Value
  • Large-Cap
Commodities: Crude and Copper are positive over half the time. Crude is the best performing commodity, historically. Gold is the worst-performing commodity; it is only positive 14% of the time. 2 more focus items:
  • TECH beat the S&P500 100% of the time
  • Utilities underperformed the S&P500 100% of the time”

Not The End Of The Bond Bull

In the short term, we have cut our bond exposure and have begun to shift our allocations to protect portfolios for a rise in interest rates. However, as rates rise within their technical downtrend, the media will be replete with headlines about the death of the 40-year “bond bull market.”  It won’t be. 
  • The stock market will defy higher rates initially until rates start to undermine the valuation story.
  • A weaker economy will undermine the valuation story as higher interest rates impede consumption.
  • The bullishly biased media will find themselves lost as to why stocks crashed and earnings fell.
While in the very short-term, the current overbought condition suggests we could see more downside pressure in bonds over the next few months. Such would not be surprising. However, as we approach that point where the market begins to realize the impact of higher rates on economic growth and corporate profitability, bonds will again emerge as a haven for investors against market declines. In an economy that is $75 Trillion in debt, requires $5.50 of debt per $1 of growth, and running a $3 Trillion deficit, rates can’t rise much. Which is also why the Federal Reserve is now forever trapped at zero.

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Port Congestion Could Be Worse Than “Lehman Crash”, Flexport CEO Warns 

Port Congestion Could Be Worse Than "Lehman Crash", Flexport CEO Warns 

"The ports shutting down is worse than Lehman Brothers failing. Both can lead to catastrophic failures of all counterparties depending on them. But with Lehman, the…

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Port Congestion Could Be Worse Than "Lehman Crash", Flexport CEO Warns 

"The ports shutting down is worse than Lehman Brothers failing. Both can lead to catastrophic failures of all counterparties depending on them. But with Lehman, the government could just print tons of money to flood the banks with liquidity," Ryan Petersen, chief executive officer of logistics company Flexport, warned Friday after touring logjammed U.S. West Coast ports. 

Petersen said his firm hired a boat captain to tour Los Angeles and Long Beach ports, which account for 40% of all shipping containers entering the U.S. He said during the three-hour loop through the ports, passing every single terminal, "we saw less than a dozen containers get unloaded." 

He said the twin ports have hundreds of cranes but only "seven were even operating and those that were seemed to be going pretty slow." He said the bottleneck that everyone now agrees on is "yard space" and that "terminals are simply overflowing with containers, which means they no longer have space to take in new containers either from ships or land. It's a true traffic jam."

"The bottleneck right now is not the cranes. It's yard space at the container terminals. And it's empty chassis to come clear those containers out," he said.

The twin ports appear to be at a standstill even though President Biden issued a directive last week to keep them operating on a 24/7 basis. But that seems to be not enough because the president has weighed the use of the National Guard to alleviate constraints. 

Petersen suggested a "simple plan" for the state and federal government to partner with ports, truckers, and everyone else in the chain to create temporary container yards that stack empty ones up to six high instead of the limit of two. This would "free up tens of thousands of chassis that right now are just storing containers on wheels. Those chassis can immediately be taken to the ports to haul away the containers."

He said it was necessary to correct this bottleneck because it's a "negative feedback loop that is rapidly cycling out of control that will destroy the global economy if it continues unabated."

Goldman Sachs' Jordan Alliger agreed and told clients to monitor the ports. He said, "the most notable congestion indicator is the number of container ships anchored waiting to offload their freight returned to 70 ships anchored on October 18 after hitting a record of 73 on September 19, compared to their pre-pandemic average of 0-1 ships."

Petersen is right. The monetary wonks at the Federal Reserve are way over their heads. They can't print their way out of this shipping crisis they helped sparked by unleashing unprecedented monetary injections into capital markets over the last 19 months. The circulatory system of the global economy risks breaking as port congested worsens. 

Tyler Durden Sun, 10/24/2021 - 14:00

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At the Edge of Chaos: Market Breadth Breakout Signals Returning Uptrend as Options Market Remains Doubtful of Rally

Something’s got to give in the markets. And it may not take long before the next long term trend becomes apparent. The most reliable market indicator since 2016, the New York Stock Exchange Advance Decline line (NYAD), see below for full details, exploded

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Something's got to give in the markets. And it may not take long before the next long term trend becomes apparent.

The most reliable market indicator since 2016, the New York Stock Exchange Advance Decline line (NYAD), see below for full details, exploded to a new all time high on 10/20/21, and did not fall apart by week's end. This is signaling that for now, against all odds, despite the Fed's confirmation that the QE tapering is coming, the uptrend for stocks is back.

More interesting, as I will detail below, is the fact that even though stocks have broken out, options players remain very skeptical of the gains and bond traders are expecting the Fed's actions to slow the economy.

MELA Test Straight Ahead

The likelihood of a major move in the MELA system, where the markets (M), the economy (E), people's life decisions (L) and the algos interact (A), is approaching.

I know this sounds a bit confusing. But here's what seems to be happening. As I've noted here before, the bond market is torn between the sellers, who are afraid of inflation, and the buyers, who are betting that when the Fed tapers the economy will tumble.

Lately, the sellers have been in control of the bond market, as evidenced by the rising yield on the U.S. Ten Year note (TNX). This rise in market interest rates has put a damper on the stock market, which in true MELA fashion, has put a bit of crimp on the economy, especially areas such as home buying, as people have become cautious and slowed down their purchases. All of which has been amplified by the algos and created a choppy trading range for stocks.

Until Friday, that is, when Fed Chairman Powell noted that it was "time to taper," and TNX rolled over after running into intermediate-term resistance near the 1.7% yield area as the buyers came in.

So now we have an interesting setup. With less than a week before November, the month in which the Fed has signaled it will start its taper, bond traders are betting that the Fed's actions will hurt the economy while stock traders are betting that the bull trend in stocks has returned.

How is this possible?

Remember that the stock market is the centerpiece of MELA since it is the source of wealth for a large number of people via their 401 (k) plans and other stock trading related venues. In other words when the 401 (k) does well, as in periods when stocks rise, people feel wealthy and buy things.

And what do stocks like best? They love lower interest rates. All of which means that if the Fed tapers and things slow down, stock traders are betting that the Fed will likely have to restart QE.

In other words, it's all about the Fed and how the bond and stock markets respond because it will all play out in MELA.

It's time to buckle up.

"The edge of chaos is a transition space between order and disorder that is hypothesized to exist within a wide variety of systems. This transition zone is a region of bounded instability that engenders a constant dynamic interplay between order and disorder." Complexity Labs

I own shares in APP as of this writing. For detailed option strategies and stock picks chose a FREE trial to Joe Duarte in the Money Options.com. Click here. You can also check out my latest video which expands on these strategies here.

Why Astra Zeneca's Monoclonal COVID Antibody Gamble May Pay Off

Shares of pharmaceutical giant Astra Zeneca (AZN) have been under quiet accumulation of late and recently scored a price breakout.

The breakout is interesting for sure, mostly because AZN's COVID vaccine has been associated with rare but serious complications. At the same time, other COVID vaccines have also been associated with complications. All of which means that even though the vaccines have been useful against the pandemic, there is clearly a treatment niche that needs filling in the fight against the virus.

Certainly, AZN has a top notch research team, which is why it's no surprise that they have developed a new and very promising monoclonal antibody to treat COVID infections which may fill that niche. Of course, at first glance they seem to be getting to the party a bit late given that Eli Lilly (LLY) and Regeneron (REGN) already have very successful COVID antibodies on the market.

But here is what could be the game changer; AZN's antibody may be useful as a preventive treatment for COVID, meaning that it is a potential vaccine-like product, although not likely a replacement. At least that's what the studies suggest, and what the company is trying to convince the FDA and global health agency approval committees of.

Put another way; AZN may have an alternative or an adjunct to COVID vaccines which would not likely replace vaccines but would give physicians another treatment option based on well accepted clinical situations such as patients at high risk of vaccine reactions. In addition, the AZN antibody can be administered on an outpatient basis, reducing costs and keeping hospital beds open for emergencies.

Moreover, the stock is also attractive based on the fact that AZN has several blockbuster drugs that have been flying under the radar of late such as its diabetes treatment Forxiga and several key anti-cancer drugs which are fueling year over year sales gains above 30% and an earnings growth rate of 20%.

Technically, AZN has cleared long term resistance above $61, where it may consolidate in the short term as traders wait for approval news on the antibody. But the stock is in an excellent setup for sure as Accumulation Distribution (ADI) has flattened out which suggests that short sellers are exhausted while On Balance Volume (OBV) has been moving higher, confirming that buyers have been using recent price dips to move into the stock.

I own shares in AZN as of this writing. For detailed option strategies and stock picks chose a FREE trial to Joe Duarte in the Money Options.com. Click here.

Options Traders Just Don't Trust this Market

In what may be a bullish contrarian sign, put volume continues to outshine call volume at key strike prices on the SPY options. What's most interesting is that even as the market's breadth (see below) has improved, option traders remain skittish and continue to buy puts just below the most current market price.

Of course, the precise nature of this development suggests that algos are hedging their bets. And while market maker algos hedge their bets based on order flow, CTA algos (quant funds) make bets on technical analysis based support and resistance levels.

It's not clear whether what we're seeing is the market makers or the CTAs. If it's the CTAs the odds may favor a rally if the market breakout continues as they will have to cover their shorts further. If the market maker algos are hedging, though, it could mean that the order flows are bearish and that this rally could be short lived.

To get the latest up to date information on options trading, check out "Options Trading for Dummies", now in its 4th Edition – Available Now!

# 1 New Release on Options Trading

Market Breadth Finally Breaks Out

After a nearly five month trading range the stock market's breadth finally broke out with the New York Stock Advance Decline line (NYAD) moving above recent and multiply times tested resistance level. Thus, until proven otherwise the uptrend has been re-established.

The S & P 500 (SPX) is hovering near its all time highs and trading above 4500 as well as its 20,50, 100, and 200 day moving averages with good confirmation from Accumulation Distribution (ADI) and On Balance Volume (OBV).

The Nasdaq 100 index (NDX) did not fare as well as SPX as it did not deliver an all time high and ended last week on a much weaker note.

Meanwhile the S & P Small Cap 600 index (SML) is knocking on the door of a potential breakout, but still remains somewhat further away from its all time highs than NDX and SPX.

Good news! I've made my NYAD-Complexity, Chaos chart (featured on my YD5 videos) and a few other favorites public. You can find them here.

Joe Duarte

In The Money Options


Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best selling Trading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com - now in its third edition, The Everything Investing in your 20s and 30s and six other trading books.

Meanwhile, the U.S. Ten Year note yield (TNX) is trading in a The Everything Investing in your 20s & 30s at Amazon and The Everything Investing in your 20s & 30s at Barnes and Noble.

A Washington Post Color of Money Book of the Month is now available.

To receive Joe's exclusive stock, option, and ETF recommendations, in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.

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Government

Weekly Market Pulse: Inflation Scare!

The S&P 500 and Dow Jones Industrial stock averages made new all time highs last week as bonds sold off, the 10 year Treasury note yield briefly breaking above 1.7% before a pretty good sized rally Friday brought the yield back to 1.65%. And thus…

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The S&P 500 and Dow Jones Industrial stock averages made new all time highs last week as bonds sold off, the 10 year Treasury note yield briefly breaking above 1.7% before a pretty good sized rally Friday brought the yield back to 1.65%. And thus we’re right back where we were at the end of March when the 10 year yield hit its high for the year. Or are we? Well, yes, the 10 year is back where it was but that doesn’t mean everything else is and, as you’ve probably guessed, they aren’t. In the early part of this year, the 10 year yield was rising as anticipation built for a surge in post vaccination economic growth. The 10 year yield rose about 85 basis points from the beginning of the year to the peak in late March. 10 year TIPS yields, meanwhile, were also rising, a little more than 50 basis points. There was agreement between the two that growth expectations were improving, inflation expectations rising a bit more than real growth expectations. The 10 year Treasury ended March right about where it was last Thursday, 1.7%. But there is considerably less agreement between the two markets now with the 10 year TIPS yield still 35 basis points lower (more negative) than the March peak.

So, no, things are not back where they were. The recent rise in nominal bond yields is much more about inflation fears than growth hopes. Markets provide us with a wealth of information that allows us, to some degree, to get inside the heads of investors. The changes in the bond markets recently show that investors have a very specific and nuanced view about the economy. They are certainly concerned about inflation and doing what people do when they are scared – trying to protect themselves. TIPS have been very popular of late for exactly that reason, as the inflation narrative gets louder and louder. But what is interesting is that, in a way, investors are taking the Fed at its word, that the inflation is transitory. The 5 year breakeven inflation rate hit 2.91% last week while the 10 year rose to 2.64%. But the 5 year, 5 year forward rate (5 year inflation expectations starting 5 years hence), has fallen over the last week to 2.37%. Investors think inflation will average nearly 3% over the next 5 years but less than 2.4% over the following 5. So investors do see inflation as transitory even if their definition of the term seems quite a bit different than the Fed’s.

Another big difference between now and March is the steepness of the yield curve. The 2 year note yield has been on a steep rise of late, up 140% since the beginning of September, with most of that coming in October. The 2 year rate roughly doubled in the early part of the year too but the absolute change was small because rates started so low. The recent change in the 2 year has been more rapid than the 10 and is being driven by expectations for Fed policy changes. The 10/2 curve was 1.58% at the end of March but just 1.18% today. The short term trend is still toward steeper but the climb has stalled a bit:

I interpret these changes in the obvious way. Nominal growth expectations are rising with most of the recent change focused on inflation but with some pickup in real growth expectations too. In addition, investors do not seem willing to believe yet that inflation is a long term problem. Given the high profile of the inflation narrative and the lack of much concrete evidence of a growth pickup, these changes seem perfectly rational and reasonable. I think it is important to note too that these changes in inflation expectations are small but also rapid. The 10 year breakeven rate is up about 65 basis points this year but over half of that has happened in the last month. The same is true for the 5 year breakeven rate. As for the change in real growth expectations I’d just say that it isn’t very impressive regardless of the rate of change. Unfortunately, that makes sense too since, as I discussed last week, we haven’t done anything to change the trajectory of either workforce or productivity growth. My long term expectation for growth hasn’t changed much since the first few months of COVID. We came into it with growth averaging roughly 2.2% over the previous decade. After adding a lot of debt to that economy during the pandemic my assumption is that, when things finally settle out from the virus and the response to it, economic growth will be lower. How much? I don’t know of any way to quantify that.

But that long term expectation is just that, long term. It doesn’t say anything about growth over the near term, the next 6 to 12 months. We’ll get a report on Q3 GDP next week and all indications are that it will be a pretty big fall off from the first half of the year. But anyone who’s been paying the slightest bit of attention knows that so it really won’t matter. Investors will be focused on the current quarter and the one after that. Will there be a reacceleration in growth as the delta variant fades? Will businesses be able to get goods for Christmas or will America get a lump of coal in its stocking? Or are we out of coal too? I don’t know but I do think we need to be careful about getting too negative about, at least, the immediate future. Inflation expectations can change rapidly while growth expectations take more time so TIPS and nominal yields are often on different songs, even if in the same hymnal.

I don’t generally put much emphasis on the PMIs or regional Fed surveys. They are basically sentiment surveys and rely on people’s anecdotal observations which, as we know, can be skewed for a whole host of reasons. But they can be interesting at turning points, inflection points, where sentiment does have a bearing on actions and ultimately the economy. While I don’t think we’re near a negative inflection point, the Philly Fed survey and the Markit PMIs do seem to point to a more positive near term outlook. The Philly Fed survey itself was down considerably from September but it is still higher than 3 months ago and the details hint at a near term pickup. The new orders index rose to 30.8 from 15.9, employment to 30.7 from 26.3. They also asked a special question about capital spending plans that showed expectations for increased spending in 5 of 6 categories for next year:

Of course, those expectations could change dramatically if Q4 turns out to be a bust but it is, for now, a positive indication for future growth.

The Markit PMIs also offered some near term optimism as the overall measure rose to 57.3 from 55 in September. That’s the best in 3 months with a sharp rise in service sector activity and a 3rd consecutive month of slowing in manufacturing activity (which is still at a high level). New orders in services rose at the fastest pace in 3 months. Job creation was the highest since June although companies still report having a hard time finding workers. All of this is perfectly consistent with the expectations for a growth resurgence post delta. Will those expectations be met? I don’t know obviously but if these expectations start to be met, we should see a response in the bond market with better balance between TIPS and nominal bonds.

There was also some potentially good news in the Census Bureau’s weekly household pulse survey which showed a big drop in people reporting not working.

Again, I don’t think we should put a lot of emphasis on these surveys. I’m always more interested in what people are doing rather than what they say they’re doing and especially what they say they intend to do. But these seem to be more significant changes than we’d normally see month to month.

We’re going through a bit of an inflation scare right now and we can see the changes in markets. They are fairly small changes though and they can, probably will, change again in coming weeks. Growth and inflation expectations are always changing as new information enters the market. Millions of investors speculate about how the future will look and their bets on that future move markets as new consensus expectations emerge. And the market changes that come from these new expectations also affect the economy in an ongoing feedback loop that changes expectations and markets again in a never ending search for equilibrium. The ebb and flow of the markets and the economy are intertwined, one influencing the other to produce the best prediction of the future we’ll ever get. Just don’t get too attached to that future because it can – and often does – change quickly.

————————————————————————————————————————————————————————————————————————————————————————————————————————-

The economic environment is unchanged.

The trend in the nominal 10 year rate is obviously up

But we’re interested mostly in real growth expectations and TIPS yields are not in an uptrend yet:

The dollar remains in a short term uptrend but we are at a pretty obvious resistance point. In addition, the futures market shows a pretty strong preference by speculators for the long side of the dollar trade. So the short term trend may be running into some trouble and with real rates still flailing at low levels, I think that makes a lot of sense. The real long term trend of the dollar is no trend at all, still stuck in the middle of a 10% trading range that has prevailed for now 7 years:

———————————————————————————————————————————————————————————————————————————————————————————————————————

 

Despite my comments above about the Philly Fed survey and the Markit PMIs (not shown here), the economic data wasn’t that encouraging last week. Industrial production was down for the second straight month but there were a lot of caveats. Hurricane Ida is alleged to have taken 0.6% off the total and the auto industry is still flagging due to the chip shortage. Mining output (shale) was down, shocking exactly no one except maybe Joe Biden. On a more positive note, IP rose at a 4.3% annual rate in Q3, the fifth consecutive quarterly gain over 4%.

The Housing Market Index rose in September with single family especially strong. But the news on the new home front otherwise was not that great with starts and permits both down. Existing home sales did have a big rise but that was probably driven by rising mortgage rates.

 

A lot of data releases next week with GDP the highlight for most observers. The more important items will be the CFNAI to get an idea of how much we’ve slowed overall, durable goods orders and especially core capital goods orders, personal income and consumption and consumer sentiment.

 

 

We were reminded last week that US markets are still under the spell of speculators when a SPAC announced a deal with an entity associated with Donald Trump. Digital World Acquisition Corp. rose from $10 to, at one point, over $170 in two days of trading last week before settling the week up a mere 9 fold to $94.20. SPACs are Special Purpose Acquisition Corps or more commonly blank check companies. The fact that these companies with no business plan beyond a vague notion to purchase an operating company are so popular, is an indication by itself, of the speculative nature of these markets. But when a blank check company with no business plan acquires a shell company that consists of a powerpoint presentation and the stock has to come down to be up 9 fold in a couple of days, well, I think we’ve entered something beyond speculation. This is the post-modern economy where value is socially determined, reality is anything but objective, “where there are no hard distinctions between what is real and and what is unreal, nor between what is true and what is false”. It is an absurd world where the value of Donald Trump’s future social media empire is determined through the interactions of speculators on existing social media.

Back in the real world, stocks were up last week with the US continuing to outperform. Growth had a good week and the value/growth debate YTD now amounts to a draw. China rebounded last week as Evergrande made an interest payment and you may see a rebound in Chinese markets as people get comfortable with the heavier hand of the communist party. I’m going to have to miss that if it happens as I am decidedly not comfortable with China. There are other places in Asia that look a lot more attractive in my opinion, Japan prominent among them.

 

 

Real estate has recovered quickly and led last week but financials continue to perform well too. Healthcare had a good week after lagging recently.

With stocks near or at all time highs, it is easy to assume that means something about future economic growth. But stocks move based on expectations about future EPS growth which isn’t even close to the same thing. Last week’s move up in stock prices was more likely a consequence of the death of the corporate tax hike as the Biden economic plan continues to get pared down to something more manageable. The economy just isn’t the focus of stock investors right now but that could change if growth doesn’t pick up soon from the big Q3 slowdown. There is little evidence of that yet beyond the surveys I mentioned above so we won’t guess at the outcome. If real rates join nominal rates and start to rise more decisively, that will be a sign that we can be more optimistic. But we aren’t there yet.

Joe Calhoun

 

 

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