I’ve adopted a demonstrably bearish cadence over the past several days. But not on purpose.
I go where the data and news flow takes me. There’s no editorial “agenda.”
On Friday evening, after climbing back out of the DeFi rabbit hole where I’ve been digging around for triple-digit yield-farming opportunities, I wrote that something just feels wrong.
In that linked article, I highlighted the latest musings from Larry Summers, who’s been right a lot lately. Maybe that’s why the vibes are bad. When Larry’s right, something’s wrong.
Jokes aside, it’s not difficult to summarize the problem. The Fed is about to embark on an aggressive tightening push just as evidence is mounting that the economy might be rolling over and earnings growth is falling back to trend on the way to what at least one analyst suggested may be a profit recession.
An astute reader asked whether it makes sense to cheer falling retail sales and other evidence that demand may be waning given the read-through for inflation. If demand slows on its own, that’ll help suppliers catch up, and if supply chain disruptions work themselves out as consumption slows, things might come back into balance on their own.
That’s a good hypothesis. The vexing quandary for the Fed, though, is that having stayed deliberately behind the curve, they don’t have the luxury of going slow. Hindsight is 20/20, but it’s now fairly obvious that the Committee should’ve started tightening months ago. Had they ended asset purchases and squeezed in a hike or two, they could easily justify a slower pace of incremental tightening (after all, uncertainty has never been higher) and the political pressure would be much less acute (if you tighten policy and inflation still doesn’t abate, you can tell angry politicians you tried).
Instead, Jerome Powell is pot committed. There’s no not hiking in March. It’s a foregone conclusion. Even if equities sell off ~20% and credit spreads widen out, there simply isn’t enough incoming data between now and the March meeting for policymakers to devise a data-driven excuse for a dovish pivot.
There’s no chance (none) that inflation cools down materially over the next two months and it’s highly unlikely that the labor market is going to give Powell any plausible deniability either. Indeed, it’s not even clear what plausible deniability would look like at this point. The Fed has made it clear they aren’t going to wait for the participation rate to rise back to the pre-pandemic demographic trend before hiking and two large downside misses on the headline NFP print were wholly insufficient to dissuade Powell and his colleagues from leaning overtly hawkish since the November meeting.
In the simplest possible terms: The Fed is now virtually destined to hike rates into a slowdown, with inflation running the highest in four decades, 10-year yields completely disconnected from macro fundamentals (figure on the left, below) and equity multiples perched at dot-com levels (figure on the right).
That stocks are relying on low rates to excuse their own richness at a time when the bond bubble is now manifesting in wholly bizarre disconnects between yields and macro inputs is a potentially disastrous setup.
Writing on Friday afternoon, Goldman’s David Kostin noted that “equities have historically performed well alongside rising expectations for Fed hikes.” He called that “surprising.”
Going back to 2004, the bank looked at six-month periods when OIS pricing of the five-year-ahead funds rate rose by 25bps. They excluded periods during which the Fed was cutting rates. On average, nominal benchmark yields rose around 50bps during such periods, with breakevens and reals chipping in roughly the same amount. “Despite this, the S&P 500 returned 9% versus its unconditional six-month average of 5%,” Kostin noted.
What accounts for that? Well, that’s the problem. “Higher earnings expectations drove these rallies as increases in fed funds pricing usually coincided with improving expectations for economic growth,” Kostin went on to say. Arguably, those conditions won’t hold in 2022. Even Kostin conceded that “the current inflation-led hiking cycle may prove more challenging for equities.”
Goldman expects 10 hikes over the next half-decade (figure on the right, above). Their target for the S&P is 5,100 for year-end 2022 (figure on the left).
The bank seems to understand that the path ahead is perilous. The title of Kostin’s Friday note was, “Navigating through the Scylla of imminent Fed tightening and the Charybdis of pricing future rate hikes.”
As a reminder, the only way to avoid losing the whole ship in the whirlpool is to accept the loss of six sailors to a giant, angry sea serpent.
No longer a gamblers stock market, FED being the house and changing the odds.
The economy has long Covid .
This reminds me of my thinking a few years back.. The need to simplify led to confirmation bias and that led to denial which led t the H …. sight and then gradually redemption . Could be these things happen to almost everyone on occasion . Now , to not repeat the same mistake and maybe try to alert others of that Virus , that’s fodder for long weekend musings.!! Real good post credit to The H…………..
Now I get those Police lyrics.
H-Man, we definitely have some rough sailing ahead. Is there another route other than through the Straits of Messina?
Lend USDC on chain for 8% š
Never thought I’d hear the day you talk about lending crypto.
I’m going to write a few things on it over the next few months. It’s really more a DeFi story for me than it is crypto specifically. I did feel compelled to own some Bitcoin and Ether, but beyond that token allocation (see what I did there?), I started looking into the automated market makers, and that’s what intrigues me. I still think there’s a very good chance I’ll lose most of my investment in Bitcoin and, perhaps to a lesser extent, Ether. And I’m fine with that. Just like I’m fine with my gold allocation doing absolutely nothing for an entire year while headline US inflation surged to 7%. However, I don’t expect to lose what I’ve staked and otherwise lent out via AMMs and DEXs. And it’s not just going to sit around and do nothing. That’s where the story is. From my perspective, anyway.
Looking forward to these pieces.
From my own experience, getting a share of the automated market makers’ profits for staking/funding them is pretty cool. But there are more complex operations going on in DeFi where you are ‘promised’ a 100% yield and there I can’t figure out what’s going on…
Also – when a coin or token or exchange states that its yield is around 20% a year but the token/coin itself move 10-15% in a week or two… well, your capital gains/losses may easily overwhelm your income…
First off, I’m not trying to sound like I’m braver than I am. I play with my own moola. By EOY, the traditional 60/40 was in the rear view mirror. What is left of bonds where I control allocation have been duration adjusted down pretty aggressively. Single-stock risk amassed back in 3/2020 has been sold away at more than fair values at LTCG rates ;). HY has been getting slowly reallocated to floating rate, cash, ultra short-term bonds, etc. Can’t complain, but, sometimes I still do. That said. The fat lady ain’t sung yet.
I’m not that worried about a recession yet (of course, de-risking has made it easier to nod off at night). Any of the composite leading indicators flashing even yellow yet? Perfectly content to miss yet another S&P500 all time high (wasn’t the last one just a week or so ago?) if it means I’m loaded and ready for bears, but, let’s face it, an all time high in the main US indices hasn’t exactly been a bad sign for the past decade.
rant Didn’t old Buffett once wait over four years before any equities were worth buying? What that is meant to suggest is merely that private investors reading this news-educational service have the powerful advantage of being able to exercise Patience, whereas, H moves in more professional circles with shorter timeframes and different task-masters most likely. Not complaining mind you, and, why would I as long as the subject matter interests me? I find their frenetic pace and need to fin-splain every wiggle with narratives both entertaining and often educational about more than just the Market. Which brings to mind something else I sense, and like, about heisenbergreport.com so far. H can follow a news-thread, whereas, the Bloomberg presentation feels like such a disorganized firehose/cacophony of different voices at times. (Yeah, yeah, I’ve organized bookmarks by authors and use keyword-topic searches to apply a more useful structure to the flow ;-), and so forth.) I get the distinct impression that many of the seemingly ever rotating financial-journalists don’t really understand what their sources are saying, if only because, they are unable to restate the quotes, which they unquestioningly copied-and-pasted, from potentially self-serving argot into plain English that serves them and their readers. If I wanted to mainline hyperbole I could just go to the salesman’s website. Many financial-journalists seem to lack, or have lost, a key characteristic any investor must have: the insatiable desire, egos be damned, to pull on threads. Lacking that, Bloomberg.com subscription fees or not, they’re a waste of time to read. /rant
Household balance sheets are strong. Plenty of capacity for debt.
Has the unemployment rate (U3) multi-month moving average of your preference been crossed from below by the current U3?
The early bird (which strike a special terror in my two-chambered heart) big-banks reporting earnings so far are not signaling doom yet. WFC popped nicely. Still need to wait for more earnings to come in for a few weeks before prognosticating what the BEA corporate profits quarterly chart squiggles will do. Factset weekly corporate profits updates not exactly predicting doom yet. Aren’t the banks being profitable supposed to be a reasonably positive indicator for the ‘real’ economy (which ultimately gets reflected in the indices)?
The retail number jitters inspired me to buy a small amount of MSFT that morning. Short of a tsunami (oops! scratch that) I’ll take the odds it’ll be worth a few percent more in the next 2 to 6 months.
The GPN (is it considered a “defi”?) I snatched up when it poked it’s head out of the small/mid cap tech-software rabbit-hole, because it had growing earnings estimates, is up ~20+%. So if it goes to sh*t in Feb I’ll probably still get out green since I’ve a got a pretty tight grip on it’s ears. My point really is, I’d be paying more attention to numbers like that, than one month’s retail numbers in a Pandemic year with a less lethal variant (as I’ve read is the typical progression of these things as they gradually fade) spiking before I de-risk/re-allocate much more.
The Chinese PPI may have begun a synchronized “rolled-over”, I know one swallow does not Spring make, but, maybe that will feed into the US CPI slowly? Or maybe their first PPI reversal was just a knock-on from shutting down the factories so the Olympians could breathe the air without chewing it first? IDK.
Time to wind this down and test Akismet’s character counting skills. Yes, the central bankers clearly spend as much time reading poll results as balance sheets. Sure, I’ll be as gobsmacked as anyone else if Powell gets historical credit for a soft-landing (no draw downs >29.99991% in less than 30 trading days?), but, if not, barring more one-offs like Global Pandemics, or something like Putin/Xi losing their power-mad minds, the next gut-wrenching bear market probably won’t be all that bad. It’s not like humanity has anything much else it really wants to do besides making and chasing after money.
These columns are worth reading because H is a natural synthesizer. He has access to expert sources most us can’t or won’t afford, and the time and inclination to digest them and synthesize the information into true insight. I subscribe to the WSJ and have since 1966. I have subscribed to Business Week for a couple of years more but I will be letting this subscription lapse because I get all the best bits from this source right here on these illustrious pages. Few guys can do what H does and I will pay to read him as long as he keeps it up.
My feeling is the next really large move is down. BUT, the real question is when. It could start 10 or 15% higher or more from here Or more. To make money then you have to nail 2 trades….that said the prudent move is to take a few chips off the table.