Correlation is not Causation

 But that doesn’t stop AI from saying it is. Just a reminder that I’m back in the office and navigating the tidal wave of uncertainties that have captivated the markets recently. Earnings are adding to the volatility, stocks with favorable earnings curiously go down and unfavorable earnings, but positive guidance, they go up, and the rest are just earnings and the market seems too distracted to pay attention. Our investments that continue to represent a diverse strategy and are still good buffers to the volatility, and with little more than Fixed Income ETF exposure to 3mo Treasury Bills the sharp rise in interest rates has also had little impact. It’s nice that Treasury Bills are yielding 5% as well. There is also the potential for the uncertainties to be weaponized through our Algochums and Pindude armies’ day trading, and the huge amount of shorting being taken on by Hedge Funds. The latter I customarily refer to as Hedgefiends since most historically make more money on fees than profits.

 Markets

I’ve returned to the office with the same technical oversold condition that I left with. While there were some price increases of the broad indexes, as interest rates moved the 10yr Treasury over 5%, a level not seen in 16 years, impulsive selling ensued. That natural reaction was to sell technology, but not to necessarily buy anything else. Hence the oversold condition is diverse by sector, which I find curious. That’s because it’s obvious that investing decisions are being sourced through technology, clearly from the reactionary responses to external conditions such as rising rates, inciteful narratives and other charged uncertainties. And as said conditions reverse the interpretation is for markets to also reverse the impact. However, while some correlation can be taken from the data, such as rising rates, the rest have little correlation and virtually no historical causation. The only good side to all of this is the analysts are feeding off the AI data, lowering expectations, and when those expectations are better than expected, such as with Alphabet (GOOGL) today, the unsubstantiated causes are not correlating with the outcomes. I’m glad machine learning is part of the longer term aim of AI to improve interpretation; I hope analysts can learn as well.

 Economics

Just as I was leaving the office on October 11^th, the Consumer (CPI) and Producer (PPI) data showed higher than expected increases. However, much of the core data, that excludes energy and food, the outcome was fairly stable. Since that release of data, energy has stabilized, and the consumer, while still remaining active is faced with increasing interest rate obligations over credit cards, adjustable mortgages and resumption of the student debt commitment. And the price increase in food is finally getting some scrutiny in the press as being significantly higher than prevailing inflation, getting some political interest as well. In September, Retail Sales increased 0.7%, and Industrial Production increased 0.3%, both are higher over the past year. Housing Starts increased 7.0%, and Existing Home Sales declined 2.0%, both are lower over the past year, -7.2% and 15.4% respectively. This continues to perplex the Fed, who will meet on November 1^st to vote on rising rates. For now, the only data that matters is Unemployment, and if that shows any weakness, even marginal, the Fed objective, in my opinion, could materialize over the next few months.

 External Events   

For now, patience in the face of distressing narratives has never been more important than in recent memory. This isn’t a financial crisis looming, the economy is chugging along and banks are only moderately struggling due to rising interest rate exposure to balance sheets. But, with even the Fed potentially raising rates at their next meeting, most of the external dangers surrounding the potential of the US engaging in military confrontation, and the growing dangers of dissention in our own country, while plausible, are also historically prone to presenting shorter term perils to the markets, as the world settles into its future, and with any luck, with more anticipation than anger. For now, even in an oversold condition, it’s okay to refrain from being too optimistic.

Investing in History

I’ve frequently written about technical analysis as an important piece in my overall strategy, to buy low and sell high. The interest in this form of analysis began during my early years as a Treasury trader, and has never been more interesting, and important, than in today’s AI world. The reason is that AI both possesses information that it’s been fed externally and through machine learning internally. The result has been the clear driver for the trading crowd dependent on AI for trading signals and more broadly to a handful of investing giants such as JPMorgan Chase (JPM) and Goldman Sachs (GS), and including Hedge Funds such as Bridgewater, founded by worldwide influencer Ray Dalio. The bigger result is the welcome evidence that market based activity has shown clear correlation to traditional technical analysis. Indicators such as traditional Wells Wilder Relative Strength Index (RSI, >70% overbought, <30% oversold) a good indicator for intermediate and longer term investors, and the Stochastic Oscillator (low positive cross indicates oversold, high negative cross indicates overbought) are fueling short term excitement. In short, AI is capturing historical measures and applying them today to the benefit of active investing strategies, essentially, history is repeating itself, albeit without the suit and tie.

 Of course, everything depends on more than this technical analysis, fundamental analysis is the primary source of ideas to invest in. But what is fundamental analysis composed of, and where does one look in a world of markets that has over 8,000 publicly traded companies. This is where technical analysis can help focus in sectors of an economy, how each is performing and where indicators show weakness at the expense of strength. For example, in 2023 the Technology sector is up over 35% this year, while Utilities is down nearly 10%. Is this a good reason to look at Technology stocks or Utility stocks?

 The answer, in today’s market, is both.  However, the question is why is Technology going up and Utilities going down. Historically, the economy is resilient to innovation, vital to an inclusive economy, hence every revelation from fire to the internet has seen a tidal wave of consumers. But the innovation that gains traction is more often met with deference and therefore the consideration to bring to the table in today’s market, is technology going through one of its most impactive historical periods? Yes, history is repeating itself, albeit most employees might be computers.

 Utilities are a sector that isn’t void of innovation, but most of it isn’t disruptive, a key component of technologic gain. Because most people are consumers of utilities such as water and electricity, utilities are also consistent in their flow of revenue, as demand tends to remain steady in strong or weak economies. Therefore, most investors hungry for risk will ignore utilities in favor of technology. To combat this challenge utilities have shared much revenue in the form of dividends, attracting those investors seeking defense over risk. However, in my opinion, we’re at a curious time for utilities, that is the challenge of climate change, and the steady growth of solar and wind electric generators. In the last few years, we’ve invested in companies that follow this trend, but as with any innovation, it has been wrought with problems, such as over use and harsh weather induced grid crashes. Therefore, it has been my aim to seek utility exposure that is both defensive, and innovative, but a different innovation, that is nuclear fusion. The total transformation from historical nuclear fission, it brings total renewal obligation and the potential for both steady income and growth. That combination is welcome, and when history repeats itself, the outcome is far more manageable.

This week the broad indexes traded lower on the back of the Federal Reserve, who decided to refrain from raising interest rates, but not from talking up future aggressive hikes should they be warranted. In my opinion, as inflation is slowly dropping, oil and gas are not. Also, unemployment is still very low and the consumer is spending and complaining about high prices simultaneously. A correction was necessary for the indexes and they’re getting what they deserve, until earnings suggest otherwise. Therefore, as the quarter ends, I’m expecting to see a more positive close to the year, and welcome a responsible Fed.     

Soft Enough?

 Markets & The Economy

This week the markets began with a bang, cleaning up much of August losses. After last week’s comments by Fed Chairman Powell at the Jackson Hole annual meeting, the markets appear to be responding to a speech, that In my opinion, seemed a bit hawkish, as suggested below.

 “Although inflation has moved down from its peak—a welcome development—it remains too high. We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective”

Not exactly a reason to buy. But the recent rally in the broad indexes have taken the markets away from being oversold, and for now we’re invested and I’m content to be neutral. That said, with so much technology, AI and our friendly Algochums, and some pundit narratives, the impact has been void of much economic data. And what data has come out for July, Existing Home Sales fell 2.2%, Durable Goods fell 5.2%, New Home Sales increased 4.4% and Real GDP Growth for the Second Quarter was revised lower to a 2.1% annual rate, presents a softer mix. And today the monthly Unemployment data was released and Total Nonfarm Payroll increased by 187,000 in August, and the Unemployment Rate increased to 3.8 percent. At first glance the payroll rise appears strong, however, previous months were revised down and added to today’s data suggesting a weaker number than presented. And any rise in the unemployment rate will be favorably received by the markets. Also worth noting, Average Hourly Earnings declined, consistent with yesterday’s release of data showing a month over month increase in Continuing Jobless Claims. All of this is good news, suggesting economic growth while softening but, in my opinion, still in a transition that needs more evidence. For now, the markets want to rally on slow growth data and decline on strong growth data. Hence, I’m not surprised by this week’s rally, and we did take advantage of the recent decline.

 Considerations

The future of employment is a focus of both the Fed and our portfolios. AI and robotics are being used by large hybrid (Land and Internet) retailers as warehouses are being automated with robotic movers and conveyor belt personnel. This will likely be the first noticeable impact of many corporate robotic transformations to come.

 Autonomous vehicles will be a real addition to the roads, not necessarily for consumer drivers, but more certainly for commercial drivers. The current technology is focused on Trucks, Trains and Ships, and all will have a significant impact on employment, especially Union workers.

 Inflation was an outgrowth of huge pandemic spending limits. Why, is because the United States has the largest (60% of GDP as of 01/01/23) and busiest consumers in the world, retail, leisure, hospitality sees the most activity and the largest users of natural resources. Is it coming down sooner rather than later? If we’re referring to the aggregate data (CPI, PPI) I think so, but slowly. If we’re referring to our rent, housing prices, travel, leisure, grocery’s…I don’t think so.

 Resumption of student debt payments finds a dismissive narrative as the most likely victims are the wealthier families. I disagree. The broad impact across all colleges of growing a diverse body of students serves to cover that many of those students have qualified and taken student debt. This has been especially  notable in the 19% rise in graduate school masters students and 18% doctoral students since 2010. That’s a lot of debt to assign only to the “wealthy”. Worth watching, as any slowdown in consumer spending, along with rising unemployment, the economy will soften further, keep an eye on the Fed narrative. The markets can remain strong, but a genuine second wave bull markets need a passive Fed. In the meantime, the continued cloud of uncertainty suggests to me that the markets will remain volatile, and when overbought I’ll trim and when oversold, I’ll buy.