Such a Deal?
I got to my desk at 3:30 this morning, as usual. European equities were trading higher. The U.S. dollar had softened. U.S. Treasuries had weakened a little. Maybe, just maybe, one of the many threats to global economic growth had been met head on, and successfully traversed. Nope.
What is clear is that for nearly all involved, an amicable Brexit deal matters. A highly contested, and still unratified deal was reached on Wednesday. That deal contains passages that concern Brexiteers in leadership positions. Contested parts of the deal include a continued relationship with the EU on trade, where the UK would abide by EU regulations already in place in several key areas, such as state aid and the environment, in exchange for coveted single market access. Also of concern to Brexiteers is the fact that the transition period appears to be extended indefinitely beyond the current expiration date of December 2020. That date was already two years out, gang.
Key players are already taking a walk. Earlier this morning, junior Northern Ireland minister Shailesh Vara, Brexit secretary Dominic Raab and work and pensions secretary Esther McVey have all resigned their positions. Obviously, any Brexit-related optimism that had been priced into markets overnight is now being unwound as I type out this Recon.
British banks, in particular, are trading significantly lower this morning, as all key markets outside of safe haven have now taken a hit. My thoughts on this are that I understand how difficult this is. I know what seems obviously preferable as a trader or investor. I also cannot even imagine the pain that one must feel even considering the very thought of seeing one's own flag subordinate to another. Many of you may disagree, but that pain, I would consider intolerable.
On Monday night, the Dallas Cowboys took down the defending Super Bowl champion Philadelphia Eagles. Both teams, amid sub-par seasons, appear to be clinging to playoff life support. Something far more important also came out of Dallas, Texas last night. At first there was hope. Fed Chair Jerome Powell actually seemed cognizant of changed economic conditions. Powell was quotable, saying there are "growing signs of a slowdown." Powell added that "it is concerning." Gee whiz, you don't say?
Powell even referred to coming headwinds, such as the lagged effect of monetary policy actions. Wait. He's in charge of that. Stay with me, gang. Powell also sees slowed economic growth globally and withering effects from fiscal stimulus as headwinds. Hmm. Sounds like he talked himself out of tighter monetary policy, right? Not so fast, my friends.
Toward the end of this appearance, Powell claims to have not seen much in the way of near-term impact as far as ongoing trade conflicts are concerned. On the U.S. economy, Powell simply sees the nation as "in a good place now," and "just really strong." Uh oh. If I tell you what I think, this morning note might turn into a book.
Okay... What I Think
While the negative impact of rising short-term rates has pressured the yield curve, not to mention both the housing and auto markets, every sentient being among you knows that the real threat to the U.S. economy comes from the unwind of the Fed's gigantic balance sheet. While I understand that this unwind has to be at least attempted, I do think the pace is too severe. (Hey, this is my opinion, write your own.) By now, if you read me often, you already know that I believe that an attempt to repair the yield curve should have been earnestly made prior to proceeding on a path that forced short-term rates higher while draining the economy of potential liquidity.
Unfortunately for all of us, the path that the central bank chose at the time was undeveloped and somewhat simplistic. This is not all Jerome Powell's fault. Ben Bernanke neither saw the bubble in the housing market, nor the house of cards that it was built upon, and Janet Yellen maintained a zero interest rate policy for years longer than what was appropriate, while doing nothing about that balance sheet.
All three of these players can take a bow. In fact, it may be unfair to Powell, as he is the one left cleaning up the mess created by the prior two Fed Chairs, one who seemed unprepared, and the other who consistently took the easier path at the time.
What is clear to me (and I think about this stuff a lot) is that those in leadership at the central bank had intended for the U.S. economy to hit escape velocity prior to working on these issues. Understand that three rounds of quantitative easing greatly expanded monetary conditions, artificially inflated all risk asset prices, and suppressed the market price of term credit for borrowers. Operation Twist really served no purpose in the end other than permanently damaging the slope of the yield curve.
As this monetary largess is unwound, bank deposit liabilities have no choice but to contract, forcing the entire monetary condition into contraction. It seems impossible to me, and perhaps irrational, that should the path of quantitative tightening continue unabated, asset prices will continue to decline and valuations will return to something closer to 10-year averages. It could get worse. For the S&P 500, that would be a rough 14x forward-looking earnings.
The Impact Of Headlines
Even under duress, there is an undercurrent of "FOMO." Investors still fear missing out on a significant year-end rally, despite earnings that appear to be at peak levels and an economy that appears to have reached peak growth.
You have noticed the German and Japanese economies mired in outright contraction, right? You have noticed even the manicured data that China makes public has slowed, right? We may be the cleanest dirty shirt in the hamper. That said, we are still a dirty shirt, and every shirt in the hamper smells.
To provide further stimulus, the fiscal imbalance already impacting the supply side in Treasury markets will only have to be exacerbated. So, why is there still a FOMO undercurrent? Easy. Hope.
Hope that a Brexit deal is agreed upon. Hope that the Fed wakes up. Hope that trade tensions ease. You get all three of those headlines, even if you just get Presidents Trump and Xi playing nice in Argentina, and you will get that year-end rally. No doubt.
I remain net-long, but long less, if you know what I mean. I will gladly expose myself to the possibility of an upward spike, but I am not going to expose myself entirely. Time has come to button down the jerseys. When the benches clear, staying on said bench is not an option.
A U.S. recession is not imminent, nor is a bear market. But only a fool would choose to miss the flashing red lights. By the way, I hope I am wrong -- and will celebrate with the rest of you if I am. I do give Jerome Powell credit for making every single policy meeting a live meeting going forward. There will surely be a need for increased agility as we navigate the coming year.
The Warren Buffett Shuffle
News of Berkshire Hathaway's (BRK.A) latest 13-F filing made the rounds last night, offering some hope to beleaguered investors as Warren Buffett, at least as of September 30, had climbed into the foxhole next to you. Of course after what markets and investors have been through over the past six weeks, this dated information may simply be that... dated.
That information acknowledged, the Oracle of Omaha's self-styled conglomerate holding company has invested a cool $4 billion in JP Morgan Chase (JPM) taking a 1% stake to add to the firm's 9% stake in Bank of America (BAC) . The firm had also increased its investment in Goldman Sachs (GS) , while paring back on Wells Fargo (WFC) .
I will not go over the entire 13-F with you, but I do think it noteworthy that Buffet thought to reduce his exposure across the airlines -- American (AAL) , United (UAL) , and Southwest (LUV) -- and completely exit his long position in Walmart (WMT) , while increasing Berkshire's stake in Apple (AAPL) to an incredible 25.8% of the entire portfolio.
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Expecting 216K, Last 214K.
08:30 - Retail Sales (Oct): Expecting 0.5% m/m, Last 0.1% m/m.
08:30 - Core Retail Sales (Oct): Expecting 0.5% m/m, Last -0.1% m/m.
08:30 - Control Group (Oct): Expecting 0.3% m/m, Last 0.5% m/m.
08:30 - Empire State Manufacturing Index (Nov): Expecting 19.5, Last 21.1.
08:30 - Philly Fed Manufacturing Index (Nov): Expecting 20.2, Last 22.2.
08:30 - Import Prices (Oct): Expecting 0.1% m/m, Last 0.5% m/m.
08:30 - Export Prices (Oct): Expecting 0.1% m/m, Last 0.0% m/m.
10:00 - Fed Speaker: Federal Reserve Gov. Randal Quarles.
10:00 - Business Inventories (Sept): Expecting 0.3% m/m, Last 0.5% m/m.
10:30 - Natural Gas Inventories (Weekly): Last +65B cf.
11:00 - Gasoline Stocks (Weekly): Last +1.852M.
11:30 - Fed Speaker: Federal Reserve Chair Jerome Powell.
13:00 - Fed Speaker: Atlanta Fed Pres. Raphael Bostic.
15:00 - Fed Speaker: Minneapolis Fed Pres. Neel Kashkari.