Here Comes Santa?
“Nobody knows nothing” – Jack Vogle, founder of the Vanguard Group
For years the macroeconomic landscape has laid waste to economists, strategists, and most importantly, macro hedge funds. The world’s central banks effectively papered over any potential anomalies or perceived pitfalls that would have raised a series of red flags in the days when markets were left to stand on their own and deal with the self-inflicted consequences.
We are all well aware now that there has been a sea-change shift in global monetary policy in 2022. Which has in turn sprung leaks across the global financial plumbing and led to outsized spikes in volatility in commodities, rates, and obviously equities. But, in reality, it’s just a return to normal, albeit at a heightened pace and with vicious consequences. This is what happens when you go from 25 to 85 all of sudden after a being used to a leisurely Sunday drive pace.
This month we were reminded of the drastic turn of events that have ensued thus far this year as we saw the BOJ spend billions to finally make a legitimate effort to defend its currency around the 150 level and maybe add some liquidity to its domestic bond markets that now literally go days without even trading. For years, the BOJ was the global, easy money poster child, and even this year the rhetoric and swift actions from the Fed, BOE, ECB, Bank of Canada have been ignored by the Japanese. Which has begun to worry market participants that maybe Japan is the black swan lurking that so many are now fearing – and trying to create in some instances.
There is no doubt the macro trader is back in vogue now; just spend 15 minutes on Twitter and you will see all the new macro experts spout all their opinions on every subject imaginable. Macro Tourists as they are called, are, if nothing else, entertaining. But we look at all this with a different lens. That being that this new wave of macro uncertainty has led to a renewal in different markets to trade and an almost daily hunt for elevated volatility levels. Something that has been abundant in 2022.
This isn’t changing anytime soon. This isn’t an “odd year” when the macro plumbing went haywire and generated some one-time anomalies. We now have a permanent change in global central bank policy, and yes, even the much-heralded “pivot” that so many are expecting (begging for) will only be a short-term respite amongst the larger reflection of change. Inflation, continuing Chinese Covid restrictions, supply chain issues, energy supply concerns, and global strife have all but assured this to be true.
The US dollar is currently the global wrecking ball that is causing chaos in other countries’ balance sheets and commodity markets. We possess the most open economy, the deepest, liquid capital markets, and are the beneficiaries of having most commodities priced in dollars.
We are the world’s funding currency and during times of stress like these, that is where the capital flows looking for safety. This flight to safety however creates pressure for emerging market currencies and countries that must use the dollar to make its payments.
Many have struggled this year with the markets overall. And in a trying environment, many like to look to past prologues to try and search for clues that will help them better understand the current lay of the land. Unfortunately, at least in our opinion, it’s a misnomer to use historical data for this current era. Why? Because regardless of historical data and patterns, seasonal or otherwise, the overriding fact remains that we are in the early innings and unwinding of the biggest financial experiment ever conducted. The Fed’s balance sheet still stands at nearly $8.5 trillion. The global debt burden is currently a mere $300 trillion. Japan alone has a 680 trillion-yen balance sheet, down from 740 trillion-yen
What we are all trying to determine now when we look at the volatile bond markets (yes, they are finally volatile now after years of sleepy action) are the following: First, are the global bond markets even still reflective of economic conditions? That may sound delusional. How could a $50+ trillion market not reflect current conditions? Well, we stand by our thesis that the massive quantitative easing campaign generated by the world’s central banks since 2008 has effectively papered over the rate markets.
Total global debt is now estimated to stand at nearly $300 trillion. These are figures that almost seem as if they are from a Monopoly game built on fantasy and chance. But, in actuality, they are burdens that must be lifted at some point. Hence, when we see historical facts being used to gauge current times, we feel like the analogies are tarnished.
One could surmise that that era is now over as 2022 has brutally exhibited. And now, for the first time in years, we are actually having conversations on how much bond prices are being influenced by inflation. Something that wasn’t much of a topic when inflation was under the magical 2% level the Fed so desperately wanted to pierce but now wants back.
So, is the 4.05% yield on the 10-year as we sit today more a reflection of an 8% CPI print or more a take on current economic conditions? The answer is yes to both. But which is weighted heavier and which is more likely to revert to its mean?
Let’s take a look at 4 catalysts that helped the Dow Jones record its best month since 1976 and try and gauge if they are still viable as we begin to zero in on the end of 2022.
- Election certainty- the polls and PredictIt are showing an 89% chance of the Republicans taking the House and a 66% chance for the Senate. That shouldn’t be construed as an endorsement for their policies, but more so as triggering gridlock in DC, which markets have traditionally endorsed.
- A truce in Ukraine? This is likely just wishful thinking, but there have been some rumblings of some sort of agreement of land division between Russia and Ukraine. Also, this month the Washington Post reported that some Democrats are urging President Biden to shift his current Ukraine strategy and seek a “diplomatic push,” although that was quickly rescinded.
- Earnings – the earnings apocalypse that we were all promised has not materialized and in fact has been pretty supportive of further gains, especially the financial sector which will benefit the greatest. The current PE xxx
- The pivot? On October 21st, the Wall Street Journal “leaked” a story that some Fed members were becoming concerned with the effect that aggressive rate hikes were having on the financial plumbing. Then, literally a few hours later, SF Fed President Mary had this to say..
While acknowledging that high inflation made it really challenging for the central bank to step down from its rate hikes, the time is NOW to start talking about stepping down, the time is now to start planning for stepping down.”
So, let’s be real here. The Fed saw some disturbing issues in the system (think liquidity) and sent out some feelers to the markets to see how they would respond. This has happened previously, so the pattern was certainly recognizable. In response, equities shot up 4% in two days while, curiously, the fixed-income markets remained weak, but then finally saw a sustained move higher as the dollar finally weakened.
The ECB came out on the 27th and raised 75bps while hinting that their quantitative tightening campaign would begin in December. But what really gave the markets a bit of a jolt occurred on the 26th when the Bank of Canada “only” raised rates 50bps and some market watchers interpreted that as the beginning of a global “pivot.” It should be noted that the ECB is woefully behind in the tightening game.
The BOJ said on the 27th that they unanimously voted to leave their target for short-term interest rates at 0-1% or unchanged. And kept their target for yields on the 10-year JGB at 0%. Never change BOJ.
While we wait for the Fed to raise another 75bps on the 2nd, the real fireworks will occur in the press conference that follows. We would even go as far as to say this will be the most closely scrutinized 30-45 minutes a Fed chief has ever had. The world is waiting to see if the pivot feelers that were obviously leaked out on the 21st are to be validated by Chairman Powell or if he will preserve his hawkish rhetoric and keep the engines running at full steam ahead, effectively dashing all the leaks and likely sending both rate and equity markets into yet another tizzy.
How’s that for hyperbole?
Are stocks and bonds decoupling or was this just a few-days event that was triggered by other inputs such as the October option expiration that also fell on the 21st (coincidence?)
Regardless, seasonality has begun to rear its pretty face. There are some legitimate historical data that shows that bear markets tend to bottom in October and that the period following mid-terms to year-end has historically had a bullish tone to them.
We briefly touched on the fact that China was gathering its political elite in October at the National Party Congress which was seen as just a coronation for another term for President Xi. Well, that part did indeed play out. But what surprised many was the fact he was elected 7-0 and is now allowed to remain President for as long as he wishes. Which some are saying will make him the most powerful Chinese leader since Chairman Mao.
Even though the markets brushed aside this development and continued a higher trajectory, there are some concerns that emerged from this development. Specifically, the likely more aggressive stance forthcoming toward Taiwan, the continuation of a zero-Covid policy (supply chain ramifications), and a continued promise to become the world’s new superpower both militarily and financially.
These new warnings come just days after President Biden issued a national security strategy that identified China as a threat to American security. He also imposed new restrictions on sales of computer chips and machinery to China (and Russia).
Global markets took the news in stride, as we noted, but Chinese ADR’s trading on American exchanges was massacred on the following Monday. Such China bellwethers as Alibaba, JD.com, and SE Limited fell as much as 15%.
It’s obvious we are in the beginning throes of a cold war with China. Or already have been for a while now. The Pelosi-Tawain visit, coupled with the recent chip ban, has only heightened tensions between the two nations, both vying to keep, or cede world dominance.
This latest power move in China should serve as another stark warning that China is not bluffing. The Belt and Sand initiative along with repeated aggressive actions toward Taiwan are not something to dismiss. China came out this month and essentially warned the world that they are preparing for world dominance by 2049. China likely looks at our fractured political atmosphere and has also seen in real-time during Covid just how dependent we are on foreign manufacturing and supply chains and has chosen to ramp up the rhetoric.
The Russian invasion of Ukraine and our continued financial and weapon support has curiously led to China also becoming friendlier with Russia and to support them financially via crude oil purchases (at a nice market discount we may add). Is this all a coincidence? We aren’t geopolitical savvy enough to ascertain that.
But it sure seems worrisome considering the massive footprint that so many iconic American companies have in China: Nike, Apple, Starbucks, Qualcomm, Microsoft, and Wynn – to name a few.
This new trade war also shines a strengthening spotlight on TikTok. The uber-popular app that tracks our data here in the states and sends it back to China (read the user agreement, kids). There is speculation that TikTok will be banned in the US soon, and we have to believe that this latest power play by Xi only strengthens that resolve.
In case you were wondering just how popular TikTok is, here is a statistic curtesy of Crunchbase:
“In 2021 revenue almost hit $4 billion. This year it’s projected to hit $12 billion — make it bigger than Twitter and Snap combined. Its average user in the US now spends about 29 hours a month on the platform, compared to just 16 for Facebook and eight on Instagram”
Last tidbit on China. The tightening grip represented by President Xi will lead to an attempted exodus by the Chinese elite wealthy citizens (remember when Jack Ma “disappeared for a while?). We wonder if this move will help put a bid into Bitcoin as a way for these elite to transfer money out of China without much of a footprint.
Looking Forward and other Market Commentary: There are four very important events in early November that will likely set the tone for the remainder of 2022. Let’s make a list:
- FOMC meeting on November 2nd. There is currently a 95% chance that the Fed raises by another 75bps and sets the Fed Funds Rate at 3.75-4.0%. Some are saying this will be “peak Fed”. The December meeting is currently showing a 55% of another 75bps hike, but also a 43% probability of only 50bps.
- The October jobs report will be released on November 4th. The labor market remains stubbornly resilient in spite of all the Fed machinations thus far. The unemployment rate has stayed below 4% for months now, but the recent rash of layoffs across the spectrum may finally spike this number to a 4-handle.
- The mid-term elections on the 8th. We touched on this above. The general consensus is that the GOP will take back some control in DC. How much, if this prediction is accurate, is all to be determined.
Given the past few elections, it is fair to say we all view polls now with a large grain of salt. The S&P has gained an average of 60bps in the week after the midterms.
- The CPI release on November 10th. The most important gauge of inflation is set to be released and those in the “peak inflation” camp had better hope this report actually begins to validate their thesis because the last two certainly have not. This is likely the biggest market moving event of the month.
Just because it’s November doesn’t mean we can put away our pencils and forget about corporate earnings releases. We still have a solid two weeks left for some lesser known, but equally important companies. Many of which we always like to keep an eye on. They include: Airbnb, AMD, Expedia, Snowflake, MongoDB, Zscaler, Palo Alto Networks, Sofi, Datadog, Lululemon, and Moderna.
We will have an extensive earnings recap in the November Update after we pile through the remaining names.
Earnings season got off to a solid start thanks to the banks and brokerage firms such as Goldman Sachs and Morgan Stanley. Across the board we saw better than projected earnings, better than expected forecasts, and the reassurances that their balance sheets, thanks largely due to the regulations since 2008, were ample and are capable of weathering an economic downturn. It was this set of earnings that helped spark a fire into equities in mid-October and form a “bottom” in stocks? A fire that had gallons of gasoline poured into it by some curious Fed comments and some alleged tinkering in the debt markets via the Treasury.
But we digress. The feel-good financial vibes provided by the banks fizzled out quickly on the 25th when Microsoft, Google, Texas Instruments, Boeing, and Spotify all delivered clunkers of a quarter. Google in particular was most alarming; profits fell 27% from the prior year and growth slowed the most since 2013. Even You Tube’s revenue shrank for the first time since 2019.
On the consumer side, Chipotle beat their earnings by $0.32, but the stock still fell 5%. Wingstop blew out their quarter and were rewarded with a 15% surge in their stock price. Hilton beat by $0.07 but missed on revenues. However, their RevPAR was still +5% versus 2019 pre-covid comps and they guided the next quarter to +2%-6% despite the summer travel season obviously being in the books.
The blow-up dejour in the big cap tech space was, no doubt Meta. The stock dropped nearly 20% after a clunky report that is now down a whopping 73% on the year. Meta has become a classic value trap. Just turn on CNBC for 30 minutes and you will hear a plethora of fund managers with deer-in-the-headlights looks mumbling how “cheap” it is at these levels as Tik Tok continues to eat away at its users.
All while the Metaverse, which they have literally changed their name to, continues to get mercifully mocked on social media. The latest being a $1,500 set of virtual reality goggles that will surely appeal to the masses.
Getting away from tech. Despite the constant negative vibes surrounding the overall economy, we did hear some good news from economic stalwarts such as Caterpillar, United Rentals, GM, Honeywell, Cameco, and Canadian Pacific.
Energy companies continue to be the strongest of bunch in 2022. Much of this is the result of the ongoing energy crisis across the globe. We came across this fascinating statistic from Goldman Sachs commodity chief Jeff Currie.
“At the end of last year, overall fossil fuels represented 81% of energy consumption. 10 years ago, they were at 82%, $3.8 trillion of investment in renewables moved fossil fuels from 82% to 81% of the overall energy consumption.”
The biggest takeaway from earnings in our opinion was the fact that in the last week of October we saw some pretty wretched numbers from Meta, Texas Instruments, Microsoft, Amazon, and Google. All reports were met with initial bouts of violent selling to the tune of 15-25% as the last group of “generals” were finally taken down in 2022.
However, the interesting fact is that after the markets closed on Friday the 28th, the NASDAQ-100 index actually finished up 2% for the week. Which tells us that the sellers have dried up, the end-of-year performance anxiety is in full bloom, and larger funds are likely underinvested or, worse, short.
Meanwhile, nuclear energy now provides 10% of world electricity and the entire sector is only worth $40B. That is a pretty mind-blowing statistic and sure makes Cameco seem like an interesting play at some juncture.
After calling Bitcoin, and crypto as a whole, essentially “dead money” for all of 2022. Bitcoin decided to get off the mat and finally attempt to push higher and escape from its mind-numbing trading range of $18,800-$20,500. The rationale – at least for the pop – was a pronounced weakening of the US dollar, and a possible flight to safety by wealthy Chinese looking to get out of a more and more restrictive China.
Newswise, it’s been a slow month. Trading volumes have stalled, as happens when assets sit in a tight band. One thing we have been watching is the hash rate. Which is simply defined as the amount of processing and computing power being given to the network through mining. A higher hash rate implies that more machines are devoted by legitimate miners to find the next block. The point here being that despite the sharp drop this year and the current lackluster environment, the hash rate has remained surprisingly strong and continues to trend above the spot price.
Which many believe (or hope) is a sign that it is why the price of Bitcoin has held the $18,000 level well, despite all the macro carnage, and more importantly, is that a clue that higher prices are coming.
We shall see about all that, but it’s an interesting subject, nonetheless. The aggregate value of all virtual currencies is back over $1 trillion for the first time in over six weeks.
The Hash Rate (blue) and Bitcoin price (black) have been steadily diverging since August.
Let’s see if price catches up to the rate as we close out the year, or if it’s another false narrative, in what has been a trying year for the crypto crowd.
Finally, the world is awash in an energy crisis, and we aren’t helping. There are only 25 days of diesel fuel supply in the US, the lowest since 1951. Germany is ripping up wind farms to build a coal mine. Gas prices in California are back over $7/gallon in some areas. The Biden administration, and Norway, want to impose windfall taxes on energy companies – which will result in less incentive to produce.
Our current energy policy has led us to practically drain the strategic petroleum reserve (graph below), a reserve that is supposed to be used in case of supply shocks or national disasters, neither of which are present.
President Biden is on record as saying that he is planning to fill back up the reserve when oil is in the $72 range (currently $88). It sounds great to buy back at lower prices and fill up the tank. But how does he know he can get those prices? What if they go to $100 first? At what point do we have to buy and fill for national security?
We don’t want to be holding an empty bag/barrel if a war really escalates or a hurricane knocks out key production areas. Some say he is doing this as a political stunt to try and lower prices at the pump before the mid-terms. We won’t go there and think it’s just another example of politicians not understanding how markets function. You don’t tell the world you need supply and where you are a buyer at. That’s what short squeezes are made of.
It sounds incredulous to think America is the victim of a global short crude squeeze. But look at the graph below and keep in mind how public this administration has been with its intentions.
Let’s all hope oil is back to the $70’s soon – for everyone’s sake. But don’t bet on it.