by Greyson Geiler | December 19, 2022
The Federal Reserve is raising short term interest rates at a furious pace – faster than they have done in decades in an effort to stave off inflation. The discount rate – or the rate that commercial banks pay for overnight funding is currently 4.5%. This is the rate that sat at basically zero for most of a decade after the “Great Recession” of 2008 and returned to basically zero after the Covid meltdown in the spring of 2020. So this is quite an aggressive hike in rates and last week the Fed intimated that there may be more hikes coming in the new year. Don’t forget that the Fed has also backed off its blizzard of asset purchases in the bond markets. As of February of 2022 the Fed was still buying $80 Billion per month of treasury bonds and $40 Billion per month of mortgage backed securities. The removal of that support plus the rapid increase in interest rates is an All-Hands-On-Deck sort of fight against the very inflation that Fed policies caused. That makes us wonder if the Fed confused its “dual-mandate” as being both the arsonist and the fireman of inflation…
Analyzing the question of whether or not the Fed is going too far by stomping on the brakes rather than tapping them is obviously not an exact science. The financial markets are so dependent on the actions – and even verbiage of comments – of the Fed that it is disheartening. No one entity should have so much influence on the capital markets of the largest economy in the world – and then by extension the entire world’s economy. But we don’t have a choice in the matter so let’s play the hand we were dealt by our overlords… Economic numbers can certainly be lagging indicators of the financial world’s reaction to what the Fed is doing. Obviously, someone has to compile the numbers from things that have already happened, package those numbers up and publish/distribute those numbers. Historically, the employment numbers have been chronic lagging indicators as businesses are not always making knee jerk hiring/firing decisions so what the Fed does may take a while to bake into the cake. We mentioned in previous posts how there are some wildly bearish indicators (Chicago PMI and residential home starts as examples) but those are just data points within a complex matrix of economic activity. Of course, an inverted yield curve is another recession warning – but other economic indicators are also starting to take shape that make us think this highly anticipated recession may actually be coming. Notably employment data is starting to turn south and considering how much of a lagging indicator that is, the situation becomes troubling. As much as employment lags, it is probably reacting to a couple of “Fed hikes” ago when interest rates were lower. The Philadelphia Fed is now indicating that its SECOND QUARTER employment figure was overstated by possibly 1 million jobs! That could be a big problem and many employers have been announcing layoffs – notably Goldman Sachs and Cisco indicated thousands of employees will be let go. Another developing situation is a potential meltdown in the US car-financing world which could easily domino into a “hard landing” economic situation that the Fed assured us it would avoid – stay tuned on this one…
An old-school indicator of economic activity – the price of crude oil is showing a fairly negative outlook. Let’s take a look…
WTI Crude Oil
The Ukraine/Russia conflict is still raging and government suppression of crude oil production continues, yet the price of crude oil is back to pre-invasion of Ukraine prices. On one hand, one might cheer lower prices of energy, but when you look at historical correlation data it is a negative economic indicator. Overgeneralizing, higher crude oil prices generally mean that the economy is humming along. At a time that one would be expecting higher crude oil prices the weakness may be indicative of an economy that is already buckling under the pressure of the Fed raising interest rates. The silver lining of this perspective is threefold as we see it. First and foremost, lower crude oil prices permeate the entire economy and should bring inflation numbers down over time (even though the Fed removes energy from the core CPI.) Secondly, a lot of negativity is still baked into the analysis of the economic world so a lot of selling of assets has already happened and many are hanging on to cash in the meantime. People are euphoric and not cautious when things are peaking, so one might expect that surprises may be to the upside. Finally, the Fed won’t be meeting again until February and the time lag may allow for the Fed to rethink its aggressive stance. The early indicators of retail spending for the holidays are not robust at all and if that spills over into the new year, the Fed may possibly rethink things in front of the February meeting. Our fear at this point is that the Fed has tightened too much – and their track record shows no indication that they will get it right. Wall Street is disappointed over the lack of a Santa Clause rally in asset prices, but things are not falling apart. Maybe things will look up in the new year! Until then Merry Christmas, Happy Holidays and New Year and we will see you in January!
Regards and good investing,
Greyson Geiler
by Greyson Geiler | December 12, 2022
The last full trading week of the year is going to be really busy! Today, the UK GDP monthly estimate is published. Tuesday will be a huge number in the CPI (Consumer Price Index) from the Bureau of Labor Statistics. Then the Federal Open Market Committee (FOMC) will announce on Wednesday their decision on interest rates. This is of course the most important information of the week, and everyone will be waiting on pins and needles. On Thursday the Bank of England and European Central Bank will be making announcements on their interest rates. The market is anticipating that all three banks will be coordinated in raising their short-term rates by .50% rather than the .75% that all three of them did at their last meetings.
The consensus is that the headline CPI number on Tuesday will print 7.3% – so any number higher than this will be bearish bonds and stocks as the anticipation will be more interest rates rises. Conversely, if the CPI print comes in lower than 7.3% asset markets should respond positively with the assumption being that the Fed won’t have to raise rates much more as inflation is abating. We don’t subscribe to the idea that the Feds interest rises are a one-to-one correlation to lower inflation. There are many supply chain issues that are still affecting the economy adversely and the basic premise of supply and demand makes prices higher when supply is lower. There are a number of deflationary forces building – so we’ll see what the Fed has to say going forward. They will probably leave the door open for a .50% interest rate hike at their February meeting – we will see.
The yield curve is still inverted and as you can see from this chart, this sort of inversion has been an indicator of a pending recession – every single time since 1980…
We are not prepared to say, “but it’s different this time” and declare that we won’t have a recession. That being said – history rhymes rather than repeats and we can’t predict what sort of economic slowdown is in the cards. If crude oil is any indicator, things are slowing down and there are certainly other similar factors going on – but there are many conflicting indicators so we will have to wait and see…
On a completely separate note, the Bank of England is supposedly going to test run a digital currency in the near future. This is just one plan among many within the world’s central banks. The BOE is stating that if/when they do this, the digital British Pound will be run alongside of the current Pound rather than replacing it. We would be surprised if any of the central banks push this digital currency strategy too hard in the very near term. However, we do expect these CBDCs to be utilized if we have any sort of a financial market crisis – so stay tuned. We are not fans of the CBDC strategy because, by our estimation this would centralize WAY too much power. Imagine a digital dollar that the originator of (The Fed) could turn on or off at their discretion – or there could be an expiration date on the digital money. The digital money could be programmed to be usable only in predefined ways. For example, maybe alcohol or cigarettes couldn’t be purchased with the digital money. All of this might start under the auspices of stopping money laundering, protecting people’s health, keeping social order, etc. Governments all around the world for all of history don’t have a good track record of not expanding any power they are granted. This could turn into quite a totalitarian control of our lives if the CBDCs are implemented. Again, we don’t see this happening anytime soon, but we need to keep it on the radar. In the meantime, let’s keep our economic freedom in-tact. We use cash only on Fridays and are suggesting everyone do the same. As long as there is the anonymity of using cash currency available to us, no one can dominate our lives from above – at least from the financial perspective.
Regards and good investing,
Greyson Geiler
by Greyson Geiler | December 5, 2022
It was a chaotic week of news headlines and most economists and investors watching economic data are expecting more inconsistencies going forward. The Federal Reserve continues to raise interest rates in order to “fight inflation” and many fear that they will take the rates too high – essentially breaking something in the economic framework. Watching the economic numbers come out over the last couple weeks and the stock and bond market reactions leave more questions than answers. Let’s take a look…
The biggest surprise was to the downside – the Chicago PMI survey just printed 37.2 (vs 47.0 expectations), plunging to its lowest level since the peak of the COVID lockdowns in 2020. This was below the lowest estimate of 25 economists surveyed. In 55 years, this level of Chicago PMI has never not failed to coincide with a recession!
Another negative economic number came in with regard to the residential real estate market. This isn’t a huge surprise considering mortgage rates are higher than they have been in 20 years. After plunging by the most since COVID lockdowns in September, analysts expected U.S. pending home sales to tumble once again in October and they did, dropping 4.6% MoM (September was revised slightly higher from -10.2% MoM to -8.7% MoM). This the 5th straight month of sales declines (and 11th of the last 12 months) leaving the YoY drop down over 36% – the biggest annual drop ever. Absent the COVID collapse, this is the weakest level for the Pending Home Sales Index since June 2010!
A big surprise back to the upside was the report of employment statistics. The jobs report was hot with the monthly job gains rising to 263k from the prior 261k despite expectations for a slowdown to 200k. The unemployment rate was maintained at 3.7% while the wages were very hot: M/M rose 0.6% (exp. 0.3%) and Y/Y rose 5.1% (exp. 4.6%) This was considerably better than Wall Street was expecting. We can argue about some of the details of the report (full-time employment down and part-time employment up) – but we will save that for a later post. The basic point was that the numbers were way better than expected.
All of this up and down in economic numbers causes corresponding ups and downs in financial markets. Throw in the fact that everyone is on the edge of their seat waiting for any clues out of the Federal Reserve whether interest rate rises will slow down or not and we get some erratic markets. Erratic as the markets may be, the end result is the S&P 500 rallying back above its 200-day moving average!
On top of this move higher in stocks, the 10-year treasury note yield has come all the way back down to about 3.5%! That is quite a move higher in bond prices…
Of course, the question now is where do markets go from here? Some of the bearish traders on Wall Street have finally given up on their short positions and bought back – and some investors sitting in cash have finally given up on waiting for a pullback in stocks – they have pushed some excess cash back in the market. Is that an indicator that the up move is now done? Time will tell, but we get more nervous as the market goes higher. All eyes will be on the Federal Reserve meeting next week. Stay tuned…
Regards and good investing,
Greyson Geiler
by Greyson Geiler | November 28, 2022
For most of 2022 the economic numbers haven’t been so great. We had two consecutive quarters of declining GDP which is, by definition, a recession. Although we haven’t had the sort of slow down we had in 2020, many people have been at least somewhat hesitant to make big economic decisions because we keep hearing that a recession is right around the corner. Inflation is bad – no matter how it has come to pass – and the Federal Reserve has been raising rates to combat it. Strangely the negativity continues to be overdone and things have just not fallen into a serious recession. This is even with some international socio-economic stuff going that is positively wild.
Hopefully that is not about to change but economic numbers are coming in continually worse. Some of the highlights (lowlights) recently look like this…
Kansas City Fed Manufacturing Index was -7 in October and -6 in November. Industrial production was down in October and capacity utilization was down to 79.9 which is one of the worst numbers out there. The Philadelphia Fed number maybe challenges it, although coming in much lower than expected for the October numbers. All in all, things are looking tepid but not at all a trainwreck. One thing that does skew the numbers – especially on the retail sales side – is inflation. People are spending more money, but they aren’t getting more goods because of higher prices. That isn’t perfectly baked into the numbers and adds to the fact that things just aren’t that great.
Of course, the big remaining question is all about the Federal Reserve. What is the future of interest rate hikes? That is the most important question – and no one can answer it without a crystal ball. The inflation numbers still don’t look good, but all it takes is one comment from one of the Fed governors that is less-than-hawkish and the stock and bond markets rocket higher. Our guess is that the Fed will slow down – but the market is guessing that too.
One of the big indicators that we keep referring to that may turn into the catalyst for the world economy to really take a tumble is the value of the Japanese Yen. Take a look at a chart of the price action…
As you can see, the Yen is holding together reasonably well near a several month high after its beating earlier this year. So that is some good news, but now the bad news. The situation in China is always difficult to follow because of the CCPs control and manipulation of the information that hits news wires. Keep in mind that since the 2008 economic disaster, the Chinese have built a debt bubble that makes that of the west pale in comparison. With all of the debt they issued, the Chinese were a very large part of the economic growth in the world over the last decade. Now things on the social front appear to be breaking down to a degree. Of course, we are not predicting all out revolution, but the Chinese have some big problems on their hands. Remember, this is the second largest economy in the world, and we have to pay attention if their downturn accelerates.
From writer David Moser…
I’ve lived in China for 30 years, and I’ve never seen such a brazenly open and sustained expression of rage against the PRC govt. WeChat is exploding with protest videos and furious vitriol, and civil disobedience is becoming rampant. This is a serious test of CCP governance.
Stay tuned…
Regards and good investing!
by Greyson Geiler | November 21, 2022
In recent posts we wrote repeatedly about all of the conflicting forces acting on our asset markets as we try to transition out of the Covid disaster. A year ago, the Fed was aggressively dovish and pouring trillions of dollars onto markets that had almost ground to a halt because of Covid lockdowns effectively being sand in the gears of whole economies.
Just one year later and now we have a Fed standing on the brakes and raising interest rates faster than we have seen since the 1970s. We had wildly bearish sentiment in the financial sector in 2020 that morphed into almost a euphoria in late 2021. We have a war in Europe. We have a governor in Texas calling up military tank divisions in an attempt to shore up our southern border. We have a Chinese economy trying to pull out of a tailspin as their lockdowns appear to have finally ended.
The Fed bailed out Credit Suisse which is now going through some restructuring. The Bank of England had to bail out some of the country’s pension system as gilt pricing cratered. We have a U.S. stock market that just rocketed out of the hole over the last month or so – only to now have the most bearish expectations on record by investors as defined by the put/call ratio (investors buying insurance because they think the market is going to go down.)
Yield curves all around the globe are inverted (short term rates are higher than long term rates) and Eurodollar spreads are out of whack reminiscent of 2007 – right before the wheels came off. Some economic indicators are coming WAY down and yet we have a Federal Reserve preparing to stomp on the breaks again next month with another interest rate raise. There is an absolute meltdown in cryptocurrency world and people are literally losing billions of dollars.
We have a Japanese monetary system (and Europe for that matter) that is staring out over the edge of a dark and deep abyss – AND we have a candidate to chair the Bank of Japan who claims that he will remove BOJ emergency support measures for Japanese stock and bond markets. That is an almost comical statement as Japan is an ongoing emergency. The BOJ owns some $5.5 trillion or 60% of the government’s debt. They are the largest single stockholder in Japanese markets as well owning nearly 10% of the Japanese stock market. If the BOJ walked away there would be no bid for Japanese government bonds. No one would try to buy them at anywhere close to current prices…no one. Good luck trying to let those markets discover prices on their own from here…
You probably get the point…this is a wild ride and no one knows what to do. All this craziness is going on and yet our domestic stock and bond markets are holding together quite well. Like we said last week, we thought the negativity was overdone and weren’t nervous of a stock market about to go off of a cliff. But now that we have had a good rally and the Fed is still talking about raising rates, one has to question the valuation of the stock market right now. Overpriced? Well, most of the rally in the 2010s after the 2008 meltdown was defined by an overpriced market that got more overpriced – so staying on the sidelines because of a valuation measure can leave you out in the cold. But at least this time you can earn interest on your savings while you wait if that’s what you choose to do.
Historically speaking, if you intend to withdraw some of your savings to use as time goes on, having that money in 5% guaranteed investments blows the doors off the performance of a portfolio you are withdrawing from that is in the stock market. There is a reason that even Warren Buffett has $130 billion sitting in cash right now (I bet he is buying treasuries with it until he finds valuations in stocks that he likes.)
That is a sharp spike higher in interest rates, by the way…
The last time inflation was this high was in the late seventies – and you can see from the chart, interest rates were much higher back then. Maybe rates go up to challenge those late seventies rates, but we doubt it. There is too much bad debt in the system this time around and interest rates going that high would initiate financial meltdown in our guess. But only time will tell.
We certainly are not suggesting you run sell all of your stocks and buy 5-year treasuries, but we are getting more concerned about valuations of stocks in comparison to these higher interest rate guarantees. Of course, everyone fears that the Fed will raise rates until something breaks, but as we have said many times in the past – when everyone is sitting around fearing something it usually doesn’t happen.
Regards and good investing!
