After The Winter (excerpt)
And we will seek the quiet hill
Where towers the cotton tree
An leaps the laughing crystal rill
And works the droning bee
And we will build a cottage there
Beside an open glade
With black-robbed blue-bells blowing near
And ferns that never fade
- Claude McKay (2003)
I think, maybe that it was not just me. Financial markets are reaching for an inflection point... changing rapidly while equity markets for the most part stood in place last week. Don't get me wrong. Equity markets feel as if there is a need to sell off in response to what we see in both debt and commodities markets. Equity index futures reflect that yearning instinct overnight, right now as I type. Yet, there is also a fear that reigns in instinct. Fear of missing out? Perhaps. Fear of taking profits ahead of a fiscally fueled melt-up? Oh, we have all thought of that. If this has not crossed your mind every single time you have taken such profit over the past few weeks even as one name or another has breached and held your own target prices, then perhaps you are better at compartmentalizing, separating emotion and impulse from action than even the hardest of individuals.
The S&P 500 enters this new week on a current four day losing streak. You'll recall that last Monday was a holiday in the U.S., so the S&P 500 closed lower for each and every single day of the week, yet closed the entire period down just 0.71%. Our broadest of large cap indices barely moved. I have talked of "rounding"... well the S&P 500 closed on Monday, February 8th at 3915, which was the high of that session. The low on the 8th was 3892. The index closed this past Friday, February 19th at 3906. Two weeks of nothing but sideways. The Nasdaq Composite gave up some ground last week (-1.57%), after a 1.73% increase the week prior, so while more volatile than the S&P 500, really just doing it's own version of the "sideways dance." Two statistics of note? Sure. One... Aggregate trading volume across the S&P 500 as an index finally exceeded its own trading volume 50 day SMA on Friday, indicating that more professionals are becoming comfortable with the idea of reducing some equity exposure. Two... On the other hand, the Nasdaq Composite (value not volume) bounced off of it's own 21 day EMA on Thursday to build a decent "up" day on Friday. That line stands at 13,711 this morning, and if not defended, will open a door to potentially testing the Composite's 50 day SMA (currently 13,204), a line that has not been kissed since early November.
Some will point to three consecutive "up" weeks for the Dow Transports and they would not be wrong. Clearly some capital moved out of small to mid-cap stocks at least last week in order to keep that index "rolling"... get it... rolling? Even the man in the blackened window thought that one was bad.
There Comes a Time...
...When a man or a woman realizes that he or she is on their own. That first night at Parris Island, was for me, that time. A seventeen year old, who had been the "cool guy" just about a day earlier, met with the realization that I had to do this, and get it done all my own. There was to be no reaching out for parental guidance. The kids who had all wished me well a day earlier were just starting to enjoy their last summer vacation prior to college. I was getting screamed at by a very tough looking man from a few millimeters away with the brim of his "Smokey Bear" cover repetitively smacking me in the forehead. Scared? Confused? Disoriented? All of the above, and that was by design. You either figure out your new reality or you do not.
That first night truly on your own, comes for everyone at some point. When does it come for these markets? That is where we are right now? No. Equity markets are not on their own, not even close, but perhaps we reach a point where something like that must be factored in? When the buds will grow on the trees, the worker bees will pollinate, and the hatchlings will take our place. In the nest.
For it is no secret that what has taken shape at this point is the product of a suppressed economy that has been coddled intentionally by a federal government and a central bank that have done all a federal government and central bank could have done, while signaling overwhelmingly that more, much more is yet to come. No, I do not fault the federal government, nor the central bank for what they have done in response to pandemic economic conditions. While I do blame the central bank broadly for what it has done since 1913 and more specifically in between the "Great Financial Crisis" and this pandemic, and I do blame a federal government that never understands fiscal restraint even in better times, the path ahead is clear, or at least I think it is.
Earnings continue to impress. According to FactSet, 83% of the S&P 500 has reported with the blended rate of earnings growth up to an impressive 3.2%, and revenue growth up to 3.0%. Expectations for Q1 2021 are now for earnings growth of 21.2% on revenue growth of 5.7%, with full year 2021 expectations now for earnings growth of 23.6% on revenue growth of 9.2%. With the truly spectacular corporate performance, the S&P 500 now trades at 22.1 times these forward looking (12 months) earnings, meaning that either shares are probably overvalued, or that earnings expectations, as fine as they appear, are under appreciated. Perhaps a little of both.
Maybe, just maybe equity markets simply priced in not just a renewal of economic activity sooner than other markets, but potentially an angry or ugly consumer level inflation that other markets are just catching on to at this point. I know that Janet Yellen, the current Secretary of the Treasury, has told us, among others, that the Fed has tools to deal with inflation. No kidding. We all know what those tools are. Higher interest rates and not just a tapering of asset purchases by the central bank, but a forced outright contraction of the monetary base... of money supply. Catch my drift here? I mean no disrespect, but let's call the blue sky blue. This Treasury Secretary who assures the public that runaway inflation, if it appears... can be dealt with, happens to be the same individual who as Fed Chair, admitted quite honestly that she and her FOMC pals did not understand why the Phillips Curve did not work in real life as it had in economic modeling, despite several of us who do write on such matters repeatedly reminding the FOMC that velocity matters more than employment.
To clarify. We, as a public, are expected to believe that a Fed that could not produce consumer level inflation through extremely accommodative monetary policy would be able to tame consumer level inflation through reversing policy that could not provoke said inflation on its own in the first place. Things that make you say Hmmm. I do not criticize, though it sounds like it. I doubt I could have done better. (Publicly, privately I have never doubted for a millisecond that I could do better. Much better.) I do want to understand and interpret reality, and to help you do so as well.
Batter Up !!
Fed Chair Jerome Powell testifies this week on Tuesday and Wednesday before the Senate Banking Committee and the House Financial Services Committee. He will promise more flowers and sweet kisses because he has to, because 10% of all jobs lost to the pandemic are still unrecovered, and because the government needs to borrow in incredible size moving forward. Nothing will be said that will remind Fed watchers of Paul Volcker, the last Fed Chair put in the position of tracking down consumer level inflation and killing it in its sleep. It has been a while.
I want you to think about how quickly the long end of the US Treasury curve is moving. On Friday, the US Ten Year Note went out yielding 1.344% after kissing 1.35%, up from less than 1.16% earlier in the week. The 10 Year/3 Month spread went out at 130 basis points and the 10 Year/2 Year spread went out at 123 basis points. On Sunday night, just before I laid my greasy head upon my pillow and listened to the Vancouver Canucks play the Winnipeg Jets on the radio, that same Ten Year Note was giving up 1.36%. This morning, at zero dark-thirty, the Ten year paid 1.375%. Our two key spreads are now up to 134 and 126 basis points, respectively. Are you following? Because if you are not, you need to. Let's do this slow, no offense. but you must understand this, especially since dollar valuations are not weakening, at least not like one might expect.
Real slow... the 10yr/3Mo spread stands at 134 bps. The 50 day SMA is just 99 bps. That is fast, my friends. The 200 day SMA is just 70 bps. The math is easy. The 10Yr/2Mo spread is trading at more than a 35% premium to its own 50 day SMA. Lighting. The 10Yr/2Yr spread which for some reason still, has a few followers, stands at a 35.1% premium to its 50 day SMA, similarly. Greased Lightning.
As the vaccines continue to force new infection rates lower, and as the snows finally start to melt, economic activity will increase, probably dramatically. This will be the dawn of the kind of velocity we have been seeking and talking about for eons. Should the Johnson & Johnson (JNJ) vaccine be granted "Emergency Use Authorization" in the short term, and now with both Pfizer (PFE) and Moderna (MRNA) increasing production (After receiving some really good news regarding PFE efficacy from Israel, as well as relaxed PFE refrigeration requirements.), there really is no reason to believe that the United States will not be able to immunize two million to even three million folks a day by sometime in late spring.
What does this do to the CPI, or Core PCE. Sure, January data for consumer pricing looks calm, but Producer Prices, Import Prices and Export Prices for the month were all red hot. The FOMC seems willing to deal with above target inflation for a "spell" in order to even out the lost years of stagnant inflation. Where does such inflation force the FOMC to change course? Where do folks just getting back on their feet cry "uncle"? Is 3% consumer level inflation okay? How about 4%? The administration is going to add $1.9 trillion to already absurdly bloated supplies of debt securities. Where would these auctions price this debt if not for money creation? We'll never know. Remember, if growth does not outpace growth, the only other choices are austerity, for which there is no political will, and debasement. Good times.
Still, Fed Funds futures... remember those? Haven't looked in a while, have you? Well, there's nothing cooking for March, not yet anyway. However, my friends... There is now a market at least for a rate hike by April (4% probability), and a market for two increases by June. In fact, futures markets are now pricing in an almost 15% probability that at some point in 2021, the FOMC is forced to increase their target for the Fed Funds rate. Think you're good at this game? We'll find out. I'll be adding to my bank stocks and my metals on any dips the markets grant me. In the meantime... do not allow your pantries to become depleted just because the pandemic appears to be slowing.
Economics (All Times Eastern)
08:30 - CB Leading Indicators (Jan): Expecting 0.4% m/m, Last 0.3% m/m.
10:00 - Dallas Fed Manufacturing Index (Feb): Expecting 6.7, Last 7.0.
The Fed (All Times Eastern)
15:30 - Speaker: Reserve Board Gov. Michele Bowman.
Today's Earnings Highlights (Consensus EPS Expectations)