Inverted Curve, Recession Risk and Defense Plays: Market Recon

Granola Bars Several days ago, I was doing the grocery shopping for my household, which is actually one of my favorite chores. This works well, because my wife hates this specific task. Off I go, usually with my ear-phones plugged into the audio version of whatever economics text I'm currently reading, deciding what we as a family will eat this week. I come across the granola bar area. They don't have my wife's brand. Uh-oh. I have an app that upon scanning the bar code, offers up nutritional values. I find something similar to her brand (a brand that I had never purchased before) and continue on. Upon check-out, I use a credit card. End of story. Maybe. After putting away the groceries, I log onto Amazon to check an order. Big and bold, atop the web page is an ad for the granola bars that I had, less than half an hour prior, purchased for the first time. Algorithms. Sucker Punch If you've ever been victim to, or even just witnessed, a real sucker punch, then you know. Devastating. Really no recovering. Not in short order any way. Twenty-four hours ago, I wrote you. I told you that I shuddered to think what the algorithms that now run the point of sale across U.S. financial markets would do to equities should the yields of the U.S. 2-year and 10-year notes invert. This is what we've come to. Gaming those who game the market. Their advantage is their speed. That is also their downfall. Markets move faster and go further than they probably should on every move. Why? No one is minding the store. Their mission? Just make a fraction of a penny on every transaction over and over again. Whomever this benefits likely cares not whether the market moves higher or lower, and most likely has no idea which stocks that he or she is even participating in on any given day. At least, as they giggle at YouTube videos of thirteen year-olds falling off skateboards, they have, if anything, become predictable. This is also a problem, as the U.S. Treasury yield curve becomes an even bigger issue. Humans have weaknesses. They are slow. They will have biases, as well as differences in cognitive ability. They will act as individuals in their own self-interests. Yet, in aggregate, the financial marketplace should be a reflection of human response to conditions of both surplus and scarcity across any number of assets at any point in time. In aggregate, more times than not, the headline reflects a rational human response. Or it should. Don't Count On 22 Months My point here with the markets, and with the granola bars, is that most economists are pointing to a lag of 18 to 24 months, with an average of 22 months as the time the economy still has prior to the onset of outright recession after an inversion of the yields paid by the 2-year and 10-year notes. Throw out the historical data. Those decisions were made by humans. The points of sale for equities, debt securities and commodities are all governed by competing algorithms. The entire U.S. economy is now governed in such a way. How did Amazon know that I showed an interest in a new brand of granola bar? It was either the app that I used to scan the bar code, or the credit card... maybe both. No individual at Amazon gives a darn what granola bar that you or I purchase. Now multiply this aggregation of information across every transaction across this great land every day. Now you get it. Should this economy head into contraction, the move will be furious and awe inspiring. There will be no mercy shown by corporate artificial intelligence inspired algorithmic response. They only try to maximize. Is there a chance, the economy does not contract? There is. Understand though, that this path requires several trade deals, a less expensive relative U.S. currency, and a deeper understanding by those at the FOMC on what must be done to the short end of the curve when foreign money pours into the long end. All of these conditions will be difficult to meet. That last one has already proven way beyond the cognitive depth of the committee making those decisions. They have never understood that this was never about economic performance... until now. Data dependency simply means too late. The mission has to be to excel in the environment provided. The best way to excel in this environment would have been to control it. Opportunity lost. The Signs Are There There's a good reason why I tried to get the Fed ahead of the curve so to speak. Those comprising the FOMC paid little attention, and now the opportunity to stay ahead of trouble has been squandered. Yes, the inversion of the 2-year/10-year reliably predicts recession. Heck, the inversion of the 3-month/10-year does this as well, and was already inverted. There are points that need to be made, and I hear many experts in the financial media who just don't see the forest for the trees. Or maybe their employers don't want them to, publicly. Some blame the trade war, rather than the Fed, for the now-obvious global economic slowdown. Okay, really it is both. The environment of increased tariffs associated with the many conflicts over trade have slowed commerce. That said, was there going to be a better time to make a stand on these issues? No, and left unaddressed, these issues would ultimately leave the U.S. in a state of permanent economic weakness and a badly depleted domestic industrial base. The trade war had to be fought. In understanding these truths, the term complete lack of situational awareness describes FOMC policy behavior since mid-2018. Now, in August of 2019, multiple European economies exist in a state of economic contraction. The Japanese economy is not currently in contraction, but has printed negative in two of the last five quarters. No one on planet earth trusts data put forth by the Chinese government, yet even those numbers show an economy rapidly slowing. There are two other comparisons that traders watch as they gauge economic growth. You've heard of one. Dow Theory. Traditionalists compare recent performance of the Dow Jones industrial Average with the Dow Transports. I use the S&P 500 due to its breadth. You can use what you prefer, the Dow Industrial Average does correlate quite closely to the S&P 500 over time. Over the past 90 days, the S&P 500 has gained 0.2%, while the Dow Transports have surrendered 5.9%. Quite telling. The other comparison is made in the metals complex. Gold, where demand is often driven by safe-haven seekers, versus copper, where demand is driven by industrial use. Over these same past three months, gold futures contracts have simply run 17.6%, while similar futures contract for copper have contracted by 4.6%. Very interesting. The Bottom Line We are told that fiscal deficits don't matter. At some point they will. Remember the debt totals that I showed you the other day? At $22.5 trillion, the U.S. national debt stands at 105.6% of GDP. Now, including the debt of both state and local governments, U.S. businesses and U.S. households, this debt number blows up to just under $74 trillion. GDP, by the way, does not expand when I include the whole ball of wax, because it's all already in there -- at $21.3 trillion annualized. So, in reality, aggregate U.S. debt stands at 347% of GDP. The word untenable comes to mind. Now, we have to wonder just how long a nation will be able to fuel growth through increased deficit spending. I do not believe that indefinitely is an appropriate answer. At some point, we are pushing on a string. The consumer is our strength due to robust labor markets. Well, not in a recession, they're not, Bucko. Better start controlling fiscal policy while better managing monetary policy... like 10 minutes ago. Understand this. These folks lose their jobs, they cannot depend on the safety of Treasury securities as a haven. With the U.S. 10-year now yielding 1.56%, and headline CPI running at 1.8%, Americans already exist in a real, negative rate environment. If that does not signal the start of the last chapter of the current business cycle (barring deals and changes to policy that would prolong), then I guess nothing does. Equity Solutions I have already told you that markets will remain volatile through October due to both internal and external conditions. I have long professed the use of target prices and panic points. Following those instructions, it is likely most traders now have much narrower portfolios, and at least a decent level of dry powder at the ready. I'm not saying that you're not down. I am saying that you're not out. That all said, I did some nibbling on Wednesday afternoon. At the lows? They were when I bought them. (True, but a joke). We all know that if I ran the Fed, we would have cut the targeted Fed Funds Rate by 50 basis points without a policy meeting overnight, and made public an intention to aggressively purchase Treasury paper in maturities of under two years. The committee pays me no heed. I doubt they will at this point, though I have been ahead of them since I can remember. That said, at least for me, all new capital outlays (for now) must be in areas where cash is likely to move. You know I am a big fan of the cloud kings. Panic points are panic points and discipline is key to victory. That's still discretionary capex. The federal government must spend on defense. There is no maybe, especially in this environment. You know my favorites in that space in recent months have been Lockheed Martin , Northrop Grumman , and Mercury Systems . Others have not fared as well. I have been forced to manage Kratos Defense & Security . As these names approach their respective 50 day simple moving averages, perhaps they attract some of that rotated moolah. Corporate America must spend on cybersecurity. Either that, or they go back to using typewriters and file cabinets. My favorite in the space remains Zscaler . I grabbed a few of those on Wednesday (really did get close to the low on that one). My other name of interest here is Cisco Systems . I am long this one and the shares will open at at discount on Thursday due to lowered guidance. Still, cybersecurity is a growing part of this business. After allowing the analyst community to ratchet down their numbers, I expect to then add to this name if the shares trade below my net basis. Economics (All Times Eastern) 08:30 - Initial Jobless Claims (Weekly): Expecting 211K, Last 209K. 08:30 - Retail Sales (July): Expecting 0.3% m/m, Last 0.4% m/m. 08:30 - Core Retail Sales (July): Expecting 0.4% m/m , Last 0.4% m/m. 08:30 - Unit Labor Costs (Q2-adv): Expecting 1.8% q/q, Last -1.6% q/q. 08:30 - Non-Farm Productivity (Q2-adv): Expecting 1.5% q/q, Last 3.4% q/q. 08:30 - Philadelphia Fed Manufacturing Index (Aug): Expecting 10.4, Last 21.8. 08:30 - Empire State Manufacturing Index (Aug): Expecting 2.2, Last 4.3. 09:15 - Industrial Production (July): Expecting 0.1% m/m, Last 0.0% m/m. 09:15 - Capacity Utilization (July): Expecting 77.8% , Last 77.9%. 10:00 - NAHB Housing Market Index (Aug): Expecting 66, Last 65. 10:00 - Business Inventories (June): Expecting 0.1% m/m, Last 0.3% m/m. 10:30 - Natural Gas Inventories (Weekly): Last +55B cf. 16:00 - Net Long-Term TIC Flows (June): Last $3.5B. The Fed (All Times Eastern) No Public Events Scheduled. Today's Earnings Highlights (Consensus EPS Expectations) Before the Open: (1.46), (-0.31), (1.22) After the Close: (0.70), (0.71), (1.15), (1.05), (1.61)

Inverted Curve, Recession Risk and Defense Plays: Market Recon

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