As we noted in last weeks letter, the equity markets looked locked and loaded to test their crucial supports and they did just that. The SP500 tested the 2550 level and the Nasdaq the all-important 6495 level, both markets saw minor follow through. All eyes are dependent upon what the FED does on Wednesday as the markets still see around a 68% chance of another 25bp hike. We read in the WSJ on Monday an Op-ed from Stan Drunkenmiller and Kevin Warsh and it can be summed up via this quote, “the central bank should pause its double-barreled blitz of higher interest rates and tighter liquidity.” As much as we respect the both of them, we disagree whole heartedly.
One of the things we pride ourselves in is the fact that we do not take public information for face value, nor do we even contemplate the sources very much. That seems risky right, but in realty what we are being sold and who’s selling it are about as trustworthy as a 3 year old holding an ice cream cone without giving it a lick. In fact, we are inundated with various reports from all over the World Wide Web, main stream media, etc.
Welcome everyone to another edition of the weekly global macro roundup. I struggled a bit this week with my thesis as it seems as if there is a plethora of narratives to choose from.
As my long-time readers know, I just don’t write to write, it has to have meaning, has to have substance and above all else engagement for you, the reader. So, I decided that I would touch briefly on various things and not go too far into any singular issue.
What I want to do first if give you the trading, investment and economic thoughts and then move onto a few other topics that I think are important for you guys to dig further into on your own.
Many studies have shown that by actively engaging in reading and research, you build a cognitive process and this process aides in the development of memory and understanding. That is why I encourage you to be inspired by what I write in hopes you end up doing a bit more reading on the very topics I bring up. Anyway, let’s get to it…
Ok, what’s been circling around the financial sphere’s lately? What seems very obvious to me is that there has been an extreme focus upon the flattening of the U.S. yield curve. As a long time, fixed income basis arb, this outcome is purely fundamental from a hawkish and tightening Federal Reserve.
Yield Curve flattening, which is nothing more than short rates moving faster than long rates for a given interest rate shift and is usually attributed to an expected higher interest rate environment. Now this doesn’t mean the yield curve can’t flatten if interest rates fall, they certainly can, but generally they are of the bear market form.
What do we mean by bear market in interest rates? It means that the prices of bonds are falling and the corresponding interest rate is rising, price and rate are inverse. I have chosen the following chart to display this visually:
The black line represents the current U.S. Treasury yield curve and it is obviously flat, which should seem strange to any investor because it doesn’t make sense to loan someone money for a longer period of time and receive the same interest rate does it?
No, it doesn’t and it shouldn’t, but many forces are in play, wait till we go inverted that will really blow your mind! The blue line represents a “normal” yield curve where the interest rate (%) rises as time (years) rises. This makes more sense, right? Then the red line is clearly an “inverted” yield curve, the alleged holy grail predictor of recessionary times.
I am not sold on that idea of its predictability, rather I believe the inverted curve to be a highly central bank driven construct that is less deterministic and more intrinsic based purely on raising the cost of funding in a highly leveraged system.
So, for me it’s more backward looking than forward. Meaning recessions form because money becomes tight and capital is withdrawn and was exacerbated by the artificial support of interest rates by central banks in the first place.
Any novice can look at the slope of the red line and say, that doesn’t make sense, why would the demand for an interest rates be greater for a shorter period of time? I could simply borrow money at the long end and sell the higher rate at the shorter end and lock in profit! Yes, you could and you would then be an expert bond arb like myself, however, it is not that easy trust me, but the fundamentals of that arbitrage are what eventually brings it back into line!
One thing that most people don’t think of is, counterparty risk, at least they don’t think of it till it’s too late. What risk does the U.S. treasury bond have…plenty and there are reasons why peripheral EU countries pay less for borrowing money then our very own “safety net” U.S. treasury bond!
Those fundamentals however are for another day, a day in the future I am sure, but this should peak your interest as to why and how the cost of money truly affects things. You have been sold the fact that lower interest rates are good for you, they lower the cost of money.
What they haven’t told you is the very fact that investments that come from borrowing are exponentially different from investments that are made with savings.
As a saver would you rather earn 8% on your 1-year T-bill or be able to borrow more money at 1%? The answer should be quite obvious if it isn’t and if it isn’t we highly suggest you continue to watch the U.S. debt pile up and then ask yourself, can the U.S. taxpayer continue to expand their debt obligations while interest rates rise?
Every investor I talk to knows equities, but they rarely follow bonds, which is a mistake. In a debt and fiat monetary system, interest rates and their flip side credit determine aggregate nominal prices.
The system is designed to always increase in price or “inflate.” This phenomenon is most unfortunate for the majority, but extremely fortuitous for a select few.
The problem with a fiat monetary system is debt must constantly expand or else the aggregate price level will collapse.
I believe the price level collapses anyway purely by the weight of the debt that is accumulated. Not only will nominal asset prices fall, but in general the purchasing power of the consumer erodes as well.
Austrian economists call this the “Minsky moment”, named after in my opinion one of the greatest American economists ever, Hyman Minsky.
Maybe I am partial to the fellow Chicagoan, or maybe it’s the fact he was highly critical of Keynes’ neoclassical interpretations, I’ll take either one as admission.
It doesn’t take a genius to figure out that debt can only be sustainable if more and more is created, this type of system is the one we unfortunately adhere to. Will this change?
I believe so and the moment everyone is so desperately trying to avoid will eventually arise, it always does. Here is a great chart from PIMCO:
Perhaps the Central Banks should consult this French poet’s quote in order to learn something:
“A person often meets his destiny on the road he took to avoid it” -Fontaine
With all this in mind, it is no wonder the equity markets have gone nowhere since January. The Federal Reserve continues to raise not because they want to, but because they have to.
They will need room to maneuver for the coming recession and they know rates were way to low causing the elites and corporations to take full leveraged advantage.
The SP500 put in a high back on January 26th at 2872.87 and we haven’t even come close since. The SP500 trades near 2725, some 5% off the highs.
The longer the market fails to even take a clean shot at new highs the greater the odds of a stronger sell off, in fact another trade below 2650 should bring in a host of new sellers.
Well, folks we finally had temps reach near 60 degrees in Chicago, a sign that maybe the cold wintry claws of winter are finally losing their grip. Chicago is a beautiful vibrant multicultural city and summers here are awesome along the expansive Lake Michigan shoreline. The winters however can be brutal, but it seems they seem to define our gritty Chicago nature.
However, it seems that if summer is getting shorter and shorter, maybe the sun has something to do with it. We have been hearing about the sun now moving into a “Maunder Minimum,” named such by John Eddy a solar scientist in 1976 and after E.W. Maunder an English scientist who first noticed a decrease in solar activity in the late 1800’s. This decrease in solar activity will lead the climate here on Earth to cool, not heat as all the “global warming” crowd has been so adamantly insistent upon. Why are we discussing this? Why does this matter? Because from the long-term viewpoint, we want our readers to know that the climate effects commodities and energy and thus a major driver of resources in the coming years. We have already heard Jeff Gundlach’s bullish opinion on commodities and we have highlighted it for quite some time now.
We think this topic of weather volatility and cooling will have a profound effect upon global productivity and resources, so we firmly believe our readers should begin to look at commodity driven investments whether it be in futures, ETFs or other various funds. Speaking of Gundlach, in his monthly webcast to clients last July, he spoke highly of commodities and his bullish outlook for the sector.
For those that don’t know, when titans like this speak of a position they like, you can bet your bottom dollar that they are already in. So, when you look at the following chart, please note the lows in June of 2017 and follow the movement from July onward. We have long considered Jeff Gundlach the EF Hutton of the modern age, we feel you should too. (For those of you too young to remember the EF Hutton commercials from the 70’s and 80’s, we have one Here) Ok let’s look at a daily chart of the PowerShares DB Commodity Index Tracking Fund (DBC):
Obviously, this is a longer-term viewpoint and in no way suggests a straight up decade long linear driven central bank style equity run up. Commodities are fickle things, subject to a plethora of supply, demand aggregates, so realize that longer term we are bullish, but shorter term, better locations to get in, may be had. Dave Wienke over at Keystone Charts gave us a few goodies to analyze, so here are his charts on the DBC:
The chart we really liked, considering we are in the alternative asset space, was the following chart which depicts the DBC vs the SPY or equity complex, it is interesting to note that despite the run up in equities, the DBC has not lost ground and we suspect the next move is setting up quite bullishly for the DBC and other commodity driven funds as well:
So, this type of analysis is indicative of the thought process we strive to convey to our readers. We try to correlate things in the short term to have a viewpoint far into the future. This type of analysis is at the very foundation of how we approach the global market place. We deem it a fundamental construct that is imperative to refining our investment and trading thesis and one by which is necessary to achieve long term success. We abide by the mantra that if you don’t know where you are headed, you may not ever get there, it’s a bit esoteric, but you get the gist of what we are saying. For further clarification we quote Sun Tzu from The Art of War, a must read for any trader, “In the midst of chaos, there is also opportunity.”
Moving on to other news before we check the technical charts of other markets, this week Wells Fargo announced the largest settlement levied by that Liz Warren pet project known as the Consumer Financial Protection Bureau as well as the OCC. The fine was marked at $1 billion, which is nothing more than a slap on the wrist, once again nobody goes to jail, just another subsidized fine for the bank so beloved by Warren Buffett himself. Who cares about duping customers or opening millions of fraudulent accounts, sounds like too big to fail, is too big to punish now also.
WSJ reporting that the Trump tax cut boosted major banks earnings collectively by more than $2.5 billion (subsidy) in Q1 alone, Goldman was an outlier as trading income grew by 23%, and who says volatility isn’t good!
The Justice Debt approved the $62.5 billon Bayer acquisition of Monsanto, combining pharma, chemicals, pesticides and crop gene technology – So let us get this straight, we are combining drought resistant seeds, with pesticides to kill the bugs that eat the seeds, which then contaminates our food, which we eat, because they say its all safe, then provide the drugs for us when we get bowel pains and other diseases – yep makes sense, cover all the bases from table to deathbed…wait that’s too harsh.
The Federal Reserve is proposing to lower capital requirements for the GSIBs (man do they love their acronyms) or Globally Significant Banks – What they really mean is the Banks and their lobbyists are trying to figure out how to capture wider credit spreads so they have more loans to charge consumers more interest or in layman’s terms, INCREASE their profits via higher interest charges, while increasing their own internal LEVERAGE and RISK and when they fail again, its tax payer bailout time, can’t lose strategy!
Locally, according to CBRE local Chicago retail vacancy rates hit an 8-year high jumping to 11.4% up from 9.5% in Q1 – landlords always amaze us on their resiliency to lower rates, they’d rather sit vacant as per square foot charge sits at $18.66 a 10 year high according to Crain’s Business
Ok let’s move onto the technical charts and we will focus on the US 10-year treasury note which is in spitting distance of the all eyes on level of 3%:
What we are looking for here is a spike above and rejection back below. We all know interest rates can’t rise too far, as the math would destroy the US from within and force nearly a trillion dollars in interest payments per year. So, we should expect the yield curve to bounce as the long rates rally, but to resume their flattening bias as the US yield curve marches closer and closer toward inversion.
The next chart is the yield spread between the US 10-year and US 2-year treasury notes. As the Federal Reserve continues to hike, which we believe to be just 2 more times this year and then done, this yield spread should continue to fall. Danielle DiMartino Booth and Mark Yusko were on Anthony Crudele’s podcast this past week and they agree with the 2 and done thesis. Anyway, here is the chart of the US 2s10 yield curve spread, which depicts the recent up move because of the long end sector selling off, but we expect the down trend to continue shortly:
As far as the long end, depicted by the US 30-year, we can see that 3.25% seems to be logical and would coincide nicely with a rejection of the 3% 10-year yield level:
Moving over to the US Equity index arena we can see the SP 500 future has backed away from the low 2700 area we targeted and is now rotating lower again 2607 is yuuggee:
We talked last week of the German Dax index possibly dragging US indexes higher as it reached for the 200-day moving average, well it did and it has since been rejected:
Apple Inc. has been hit hard lately as peak smart phone has found their price ceiling, we noted our bearish outlook on Apple back in Q4 2017 as fundamentals were not in line with the firm’s rosy expectations. We noted peak ceiling price would see insufficient demand as well as highlighted their sole reliance on the Iphone itself as its main income generator. Without new tech, we find Apple will continue to struggle. Yes, we know they have a ton of cash, on net probably around $200 billion, but considering their costs, R&D of $10 billion a quarter, it goes fast. Competition is fierce and only gets harder as you fail to innovate. The SNB (Swiss National Bank) owns 19.14 million shares and counting, so keep an eye out on this one, should get interesting…Let’s see if the Iphone 8 Red edition helps, we highly doubt it, but it looks cool, but will the followers, follow through with buying, we doubt it?
Here is the chart of Apple Inc., $147/150 seems logical here, but $125 ultimately:
Finally, our last chart is of Bitcoin, which has risen quite steadily and something we have alerted our readers to over the last 2 weeks. If you don’t read our CryptoCorner you should, because Crypto is going to be a force in terms of alternative asset classes and we will educate you on this subject. Ok here is the chart of Bitcoin which is up over 46% from its lows a few weeks ago trading $9393:
That’s it, we leave you with the weekly settlements from trade date Friday April 20th. You can see equities had a nice bounce and US treasuries were hit, Crude continues to shine up nearly 14% on the year, further advancing our commodity bull stance, cheers!
commodities and his bullish outlook for the sector.