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.

Let’s Start Here

 It’s been over a week since my last comments, and the correction I’ve been waiting patiently for has arrived and taken the broad indexes in more interesting territory. Namely, the said indexes are no longer over bought, but they also aren’t yet oversold, but they’re getting there. So, what happened?

 Economics

In the past two weeks the economic data showed an economy stronger than the Federal Reserve probably wants. Starting with both inflation indicators (CPI, PPI) came in slightly higher than estimates, and that started to rattle some nerves. Then this week, Retail Sales came in for the month up .07%, higher when previous months were revised higher, and all over estimates. Housing Starts came in for the month up 3.9%, bringing the year to 5.9%. And this week the Federal Reserved released their opinions of economic growth and theses numbers prove their concern of a strong economy, and subsequent concern over the potential impact over inflation.

 Markets

The first change came from the long end of the Treasury Bond market. Starting last week, the 10yr Treasury was 3.98%, this week it currently trades at 4.31%, these are moves that our AI buddies don’t miss, and the natural move for the broad indexes is to move lower in response. Naturally, all this has been helped along by the pundit narrative. As of today, the technical condition of the indexes has improved to the point that reasons to buy are becoming plausible.

 Outcomes

The reason come in two packages. First, is that economic growth will always have a degree of inflation following it.  For the last 60 years inflation has moved around a lot, but on average has been around 3%. This, in my opinion is a far better goal than the 2% pushed by the Fed. But the point is that inflation has improved, will continue to show improvement as the Fed continues to raise interest rates and even if the economy at worst, slows down and avoids recession, which is also a plausible argument in my opinion, these are events that the markets like.

 Bears will continue to battle Bulls, but the current correction has exceeded 5% for the NASDAQ and that’s typical. As new data is released, comments from the Fed voters become public, Washington stays out of trouble and interest rates get tired of moving higher, the markets will pay attention to the clues of the future. That’s because markets are forward looking, and from my point view, the horizon looks more promising each day.

Snapshot of This Week

 Most weekends, I confess to engaging in self-composed homework. It’s usually updating my technical analysis research platforms, putting the puzzle of economic data into perspective, and researching the globe for new ideas and any connection those ideas may have to our investing interests. This is what I stumbled on.

 Last week earnings results continued to surprise on the upside. Some narratives indicated it proves that higher rates have not been hurting the bottom line as much as expected. However, in my opinion, the result of what was “expected” is a subtle reference to the analysts who lowered their expectations due to the previous three quarters of earning results providing weak guidance on future earnings. Worth noting, S&P earnings are down -5.2% for the year, however recent surprises have taken them up from down -7.0% in June, and in my opinion, this suggests the coming months could further reduce the year over year number, and that will be good for the market.

 As far as the technical condition of the broad indexes are concerned, the market is no longer over bought, but still not yet oversold. For now, uncertainties such as last week’s downgrade of the US debt by Fitch Ratings Inc. from AAA to AA+, first meant nothing to the market and then, in my opinion, was responsible in bringing a robust market on Friday to a loss. These are the kind of events, that when more fully analyzed render a more adequate judgment, rather than a simple, no big deal. I was pleased however, with Fitch’s comments regarding “erosion of governance” behind their decision. Personally, I would be more focused if the downgrade were brought by S&P Global Ratings, which happened in 2011 and resulted in a market downturn, albeit a temporary one.

 Ideas that have come out of the weekend are further research on the new addition to the models that focus on renewable energy production in general, and storage in particular. I’m also interested in the growing innovations in semiconductor technology. And as to be expected, the growing number of companies that are adapting to AI and machine learning technologies to their businesses, such as Salesforce (CRM), Amazon (AMZN), JP Morgan (JPM), and one that is curiously interesting to me, the move of Pfizer  (PFE) into what is described as AI Pharma.

 This week will see further earnings releases, many from less followed companies, but two from the industrial sector, that we’re invested in. As earnings settle down, the economy will come into focus as this week will see both Consumer (CPI) and Producer (PPI) inflation data released. The outcome could keep the market at bay, as the biggest inflation move could come from the energy sector, which, as I write this, shows US West Texas Oil trading at $82.25, nearly $10 dollars higher than a month ago. Perhaps to be expected, as there is a seasonal component to the rise. As that data rolls out, and interest rates remain at their lofty levels (10yr Treasury 4.08%) in time for quarterly refunding auctions this month, the markets will have time to digest and hopefully reach the moment of opportunity I’ve been waiting for. Therefore, I’m optimistic, because the markets are forward looking and valuations, in my opinion, aren’t as overextended as the narrative would like us to believe.

Residual Uncertainties

 This week saw the release of inflation data, both production prices and consumer prices. Both showed modestly lower results than the consensus expected. Good news for the markets, to be sure, but I welcome doubt as a crucial endeavor in researching a predictable outcome. That’s because the markets are never finished, the evidence of inflation moving lower is persuasive, but my preferred approach is as written about often, what are the residual uncertainties? My top three are, in my opinion, the same the markets will listen to.

Economic Data

The data is evident of the present, but is it evidence of the future? One economist that I follow with respect has pointed to the year over year inflation data which is currently being compared to June 2022, when the data show the highest level Consumer Inflation (CPI) reached, 8.93%. By October, the level was 7.76% and has slowly dropped in line with the decline in Money Supply which has been modestly rising since April 2023. This raises an uncertainty, will the year over year data be less visually persuasive as year over year inflation data narrows? And will the rise in M2 along with recent seasonal increases in energy prices further stall the good news? In my opinion, inflation is coming down, but the Fed is the final word on that, and I’m not convinced they’re finished.

Earnings

Earnings begin this week and will bring their customary bundle of uncertainties. The goal of the Fed has been to slow the economy and the recent strength of the broad indexes has suggested strengthening growth in earnings. I’ve often found this to be a curious dilemma, this is because over the past 5 years analysts have consistently taken both sides to the outcome. Namely, downgrade a stock from a buy, but raise the target price. This leaves the companies reporting to deliver numbers that will have little comparison to analyst predictions. Where the analysts have no prediction is what the CEO’s future guidance contains, which for the last three quarters has been cautious. This is what I’ll be watching for.

 External Events

In the past few weeks two events have caught my attention. The first is the Supreme Court decision to  deny the administration student debt relief package, estimated to cost the government $30 Billion a year, for ten years. Worth noting is student debt is currently on a Loan Freeze, begun during the pandemic and set to expire in October 2023. At that time, watching the changes in consumer spending, which could affect the outcome of discretionary capital by going to the government instead of the Mall. Consumer spending has seen slight moderation since 2021, and as school starts, post labor day work normalcy arrives, travel seasonally slows, the economy could see further signs of slowing that have been stubbornly elusive. Lastly, I found the addition of Sweden into NATO, and the suggestion that Ukraine is next, is probably sending a strong picture to those outside the tribe. No reason to draw conclusions, but worth paying attention to.

Some may suggest I’m being contrarian, not the first time, I was somewhat contrarian last October too. But, the current technical condition of the broad indexes, especially the Nasdaq, are overbought. This doesn’t mean the broad indexes can’t move higher, it only means, in my experience, that when markets reach this level of overbought conditions, they never stay there. What’s the trigger? I’ don’t know, I just stay the course, don’t chase the markets, and remain ready to respond when the markets come to us.

Expecting the Expected

“If you do not speak English, I am at your disposal with 187 other languages along with their various dialects and sub-tongues...”

 -Robby the Robot from the Sci-Fi movie Forbidden Planet 1956

 I was asked last week about my reference to a Holodeck. Basically, the reference to the Star Trek phenomenon and the sudden emergence of Augmented Reality and its coincidental connection. In my opinion, there was nothing coincidental about it, nor most of the technological advances we take for granted that aren’t as original as suggested. Science Fiction has fed many a geek focused on changing the world.

 I bring this up because I read a couple of articles this week and curiously none referred to the obvious, non-coincidental, technically overbought condition of the capital markets. Technical indicators, such as RSI, are one of the few resources that can’t be interfered with by either Pindudes nor Algochums. When such a condition is upon us, there are two strategies on which, in my opinion, smart investors will focus on, don’t buy, but be prepared to.

 This overbought condition, arrived at by a 14 day calculation of closes, has followed market corrections for many decades. Assumptions of the occasional 5% pullback as an annual event has followed the trail of the S&P 500 resulting in such pullbacks occurring once a year, with more notable recognition during a bull market. Averages have been tracked suggesting 10% correction every two years, and so on. So, what will trigger the decline, Inflation, Economic Data, Earnings Data? 

• Inflation, specifically core inflation (ex-food & energy) is running at 5.3%, comfortably below the October 2022 high of 6.6%. Comfortable is not enough for Fed Chairman Powell, who testified in Washington this week and doubled down on the Fed’s goal to raise interest rates at least twice, before the end of the year, to reach the goal of bringing inflation down below 2%. While a number of pundits are predicting success, even going so far as to suggest reaching a level of deflation. 

• Economic Data, after a brief rise in May 2023, the U.S. ISM Manufacturing Purchasing Managers Index (PMI) above 50 (suggesting economic expansion) has remained below 50 (suggesting contraction) for the rest of the previous 8 months including June 2023. While the U.S. ISM Non-Manufacturing Purchasing Managers Index (PMI) has hovered just above 50, likely due to a stronger work force, that level has been mostly flat for the last three months. Worth noting is a less advertised piece of data referred to as the Leading Indicator, declined in May 2023. Historically, when this indicator has declined 3 months in a row, it suggests a coming economic slowdown. Curiously, as with much these days, the index has declined every month since June 2021. 

• Earnings will emerge as newsworthy when the 2^nd Quarter 2023 ends on June 30^th. Last quarter most analyst forecasts were off, due to expectations being lowered following negative guidance from CEO’s last quarter. This year the markets have moved aggressively higher and forecasts have been conveniently increased. In my opinion, this could be a set up for another disappointment, therefore worth paying attention to the CEO guidance, rather than the results.

 One last thing to note is the recovery of the broad indexes since the lows in October of last year have yet to outpace their previous 52week highs, and any correction as described above would be taking back already achieved gains. Sad, but not the worst case scenario, in my opinion. Just a condition that makes being patient easier. In the meantime, sector diversification is serving us well.

Navigating the Noise

 Ten years ago, I first read about UBI, a welfare proposal that had gained some academic, and even political interest until the pandemic introduced a better method of wealth distribution, stimulus. In my opinion the concept of the wealth effect as a tendency to spend more when an individual feels financially secure, is at the core of our current inflationary environment. I bring this up because I’ve frequently expressed my opinion that an economy designed to fuel consumer activity is always at risk of some degree of inflation. And the wealth effect has been observed through data since 1870 suggesting a close correlation between inflation and money growth. That’s why I’ve often tracked the behavior and data set called M2 that tracks the Federal Reserve’s estimate of the total money supply, such as money in consumer pockets, checking and saving accounts for example. And M2 is where I’ve followed inflation and concluded that inflation appears to have peaked in September 2022. But there’s no shortage of narrators, including Modern Monetary Theorists who question that conclusion. Hence, volatility rules.

 Markets

The broad markets finally let off some steam this week, and while not technically oversold, neither are the primary indexes still overbought, as the volatility is keeping it all neutral. The change in conditions can be attributed, in part, to a mixed earnings season and concerns brewing over the upcoming debt ceiling debate. Interest rates resumed their rise to prepare for the upcoming Fed meeting and international markets are having their own positive year, even in the face of continued weakness of the US dollar. For now, in my opinion, there is enough left for the narrative to digest, that could push the broad indexes to a more oversold, and desirable, condition.

 Economics

Last week saw additional declines in economic activity, including Housing Starts (-0.8%) and Existing Home Sales (-2.4%), both likely to see additional declines as interest rates revert closer to their recent highs, and with a Fed rate hike around the corner. One area that is showing some increased activity is Manufacturing tracked by the Manufacturing Purchasing Managers Index, which went above 50 for the first time since October 2022, but is still down over the same period. This week saw some additional pickup in manufacturing thru New Orders, and New single Family Home Sales (different from Existing) saw an increase (9.6%), but still down 3.4% from a year ago. Today, the first release of the First Quarter 2023 GDP come in at 1.1% down from the previous quarter of 2.6%. Interesting enough was the Core Personal Consumption Expenditure (PCE), which came in at 4.9%, higher than expected and the GDP Price Index, otherwise referred to as the GDP price deflator, came in at 4%, higher than economic consensus of 3.7%. In short, all the GDP data was, in my opinion, enough to keep the Fed on track next week to increase interest rates at least .25%. Whether they see reason to continue, will be in their customary post meeting comments.

 External Events

The big headwind, in my opinion, facing the capital markets, is the debt ceiling debate. So far, the House Speaker has stated the debt ceiling will be raised when the legislation includes a pause in government spending, and the house voted in favor. The Administration says no extra deals, lots of political food for the fight to follow. And the pundits will throw a bone to our Algochums to brew up a little volatility. In the meantime, patience is still the best strategy, as markets are too efficient, in my opinion, to be predictable. So, in my future, opportunities will reach more desirable entry points and the overall picture should become ever clearer.

The Proverbial Hook

 Having spent most of my career working on the institutional and corporate side of asset management, organization and focus have been handy skills. However, since I’ve come into a more retail setting, I’ve observed another skill, monetizing the hook. The hook is the one idea to hang the direction of the capital markets on, for a single day. I’ve also observed that this skill has created a bit of a quandary lately. Strong indicators of economic growth, employment growth, wage growth and consumption growth all suggest, in my opinion, the Fed isn’t finished raising interest rates. So why have the broad indexes started the year in a rallying mode, and can it continue?

 Markets

A commonly heard narrative is the markets are overbought and need to correct. This is currently true, in my opinion, however it’s important to stay focused on what that means. At this moment in time, a welcome start to the year is where some correction is being correlated. But where is the cause of that correlation within the broad indexes, is the Dow Jones correlating, yes, the S&P500, yes, the Nasdaq, not so much? First of all, last year the most beloved stocks helped the Dow Index perform substantially better than both the S&P500 and the Nasdaq. And the S&P 500 finished last year 10% better than the Nasdaq. So, what does this mean? In my opinion it means that the Dow needs to correct more than the S&P, and the S&P needs to correct more than the Nasdaq. And because the S&P500 and the Nasdaq share a number of influential stocks in the Technology Sector, and the Nasdaq has been the best performer starting 2023, its strength won’t keep the S&P from a necessary correction, but, in my opinion, it will keep it from collapsing, the probable hook the narrative is looking for.

 Economics

The usual mixture of data that has been released recently suggests the economy is slowing, but not the entire economy. For example, the U.S. Manufacturing Purchasing Managers Index (PMI) and the U.S. Services Purchasing Managers Index both came in at 46.6 and 46.8 respectively. I focus on any number below 50, which suggests a contracting sector of the economy. In the case of these two indicators, both have been below 50 since November 2022, a condition last observed in 2008. In addition, recent releases in Retail Sales falling 1.1% and Industrial Production falling .07%, in December, there is definitely some economic moderation taking place, and this explains, to some extent, why the markets interpret inflation as having peaked already. I agree with this interpretation, but I also need more proof. Today the Unemployment data for January showed very strong growth in Non-Farm Payrolls (517K) and the Unemployment Rate declined (3.4%) and naturally this was the hook for the opening day’s narrative. And while the numbers are concerning, wage growth, Average Hourly Earnings and Average Weekly Hours all came in static from the previous month. Another interestingly favorable outcome was the U6 Unemployment Rate, which includes a wider range of the unemployed that includes underemployed and discouraged participants, which came in slightly higher (6.6%). While a number of economists view the U6 data and more comprehensive, my takeaway is, it tells us the story isn’t over.

 External Events

In the past few weeks, the new majority in Congress has engaged its political agenda and the first legislation on the docket will likely be the Debt Ceiling. For now, In my opinion, the Debt Ceiling will likely be raised, but with some concessions, namely the promise of no further spending packages that got us into this problem in the first place. This week, the Federal Reserve raised interest rates again and the speech given by Chairman Powell reiterated that inflation is moderating but still too high and the Fed is intent to keep raising rates. While he gave no hint of today’s Unemployment report, I take the Feds actions and statements at face value. And for now, that’s my proverbial hook to hang my strategy on.

The Light Is Getting Closer

“When I look at the market behavior today, I'm a pessimist … but when I look at market behavior over history, I’m an optimist”

The opening of the year has been a good one for the markets. Rallies, even modest ones, are welcome, and the reason is the focus on inflation. The problem as I see it, ignores the fact that the markets left the previous year oversold, and a rally can be expected, just as they had infrequently occurred last year. To hear a narrative the concludes that inflation is under control and the Fed will have to slow down are still, in my opinion, too premature. However, I’m also not pessimistic, and push aside those in our industry who dispense a narrative that all too easily pervades individual thought and, in my opinion, mutates doubt into blind certainty. Here’s what I’m becoming more certain about.

Economics

Today the Data for the Core Consumer Price Index (CPI) was released and showed a modest December decline of .01%. The overall inflation number for the full year came in at 6.5%, a clear decline from the high of 9.1% last July. Without going over the other calculations, such as removing the more volatile food and energy data, it’s worth noting that the data clearly shows a slow decline in the overall inflation rate, but a number that would still have the focus of Fed concern as well.  This is important to me because I live a reasonably simple life and can experience inflation first hand. So, the question I keep asking myself is has the linear data that is reflected in the numbers already peaked, and my answer is yes. Now, will inflation at the grocery store continue per diem, my answer is also yes. In short, the data that reflects the monthly and yearly changes in inflation will continue to slowly move lower, but my favorite Pistachio Gelato is still going to be $9 a pint.

 Markets

The markets are definitely seeing some buying that is as much about short covering as it is about genuine buying. But the volume is good, going into a holiday weekend, and the only thing to wait for is what’s next. First of all, the markets finished the year marginally oversold in the short term. Hence, the rally we’ve been experiencing in the beginning of this year. As of today, that technical condition is starting to show the market somewhat overbought. Therefore, while the overbought condition could continue into next week’s Producer Price Index (PPI) release on Wednesday, it is also the start of earnings for the fourth quarter, and that could impose some relief on the rally. I bring this up because in the recent overall rebalancing of accounts the available cash will continue to find opportunity, and the reckless interpretation of earnings from our Algochums and Analysts should prove useful. Until then, the economy and inflation suggest, in my opinion, that the bear market is nearing an end and, sorry for the redundance, patience and focus are still the best strategy at hand. 

 

A Click Bait Strategy?

 It appears that Jerome Powell has found a new strategy, joining the ranks of social media as a last resort. This week the Federal Reserve Board voted to increase interest rates another .75%, but it was his comments and the responses to a variety of trigger worthy questions that brought out the click bait. “Job gains have been robust”, ouch, “the unemployment rate has remained low”, ouch, “inflation remains elevated” run for cover! The speech from Chairman Powell is important, in my opinion more than his more aggressive, and popular, off the cuff statements.

 In response to questions regarding a pause in rate hikes the response was that “although rates could be increased less there was no reason to think a pause was near.” The intent was to maintain the track of raising rates for the foreseeable future until there was “good evidence” that a series of monthly readings show inflation was declining. Sounds like common sense, although the scarier language does have some impact, we’ll just have to see how it all effects the markets for now. As expected, after yesterday’s comments the broad indexes moved sharply lower. That was more of a reaction than simple fear.

 Inflation is the story of the consumer. In the 1970’s when I was out of college and working on Wall Street in various accounting jobs, I made a salary respectable for the times, and had no hesitation to spend it without regard to cost. In short, I was oblivious to rising inflation because I had little responsibility to anyone but myself. Flash forward and we find ourselves at a time where for the last two decades the country has seen clear declines in marriage and childbirth, leaving nearly two generations with more consumers that are responsible for no one but themselves, feeling the power of undisciplined spending. That is what the Fed knows they have to slow down, and that can only happen if wages stop increasing, and most troubling of all, jobs are lost.

 Which brings us to tomorrow when we’ll see the monthly release of Unemployment Data. The expectation is for Job Growth for October to increase by 200K and the Unemployment Rate to increase from 3.5% to 3.6%. On the wage side, for the year, Average Hourly Earnings is expected to decline from 5% to 4.7%. If these numbers meet the consensus, that would be good, but not great. Over the next few months, the same outcomes would need to be evident to the Fed, who are clear in understanding the lagging outcome of the data they watch.

 Spend, print money, create a deficit, keep printing more. That is the current fiscal strategy of government. I don’t need to emphasize my wish for an outcome of the election that creates gridlock. This because both sides of our government have been recklessly spending for decades and that habit running into wall might be an important piece of the solution to bring inflation down as well. Also, worth noting is preexisting capital that has been raised since the pandemic, along with overall budget parameters, in my opinion, could see spending moving toward infrastructure, technological and industrial manufacturing, and away from the pockets of the voters

 

For now, the markets are working off an overbought technical condition created by the rally in October. When that said condition reverses, additional buys, and sales will ensue. Cash will remain plentiful and without sounding too redundant, so will patience.

Hot or Not

Yesterday and today current data for the Producer Price Index (PPI) and the Consumer Price Index (CPI) was released, the outcome year over year showed 8.5% vs 8.7% for the previous month and 8.2% vs 8.3% respectively. So why all the fuss? Unfortunately, the financial narrative is broken, no longer engaged with a strategy to inform, but instead with a motive to influence.

The consensus numbers, namely the expected outcome of the inflation data, were too optimistic and easily beat by the actual data. This has been surprising given the recent track record, but the focus unfortunately was on the consensus rather than the difference between the current level of inflation and the past data levels. In my opinion, the focus is missing the point, namely, that inflation may not be going down, but it’s also not going up. What does that mean?

 Well, it doesn’t mean the Federal reserve isn’t going to stop raising rates. In fact, the Chairman has doubled down on the goal to beat inflation, which can only be accomplished if the economy goes into recession. Moving forward the likelihood of some softer employment data and the ongoing rise in the dollar, which is economically unfavorable to inflation are the only positives in our focus. The strong dollar also bringing up the thought that there has been a strong increase, post pandemic of course, in international tourism. Afterall, with comparatively weak local currencies buying strong dollars, the incentive is to travel and spend. So, one asks, inflation is the outcome of consumption versus demand, but is there a difference if that consumption isn’t coming from here, but rather from over there? Either way, the aggressiveness of the Fed and the likelihood of another .75% increase in rates on Nov 2^nd and another .75% by year end will increase the realization of economic slowing and should set the new year up as a when, not an if the economy goes into recession. What does that mean?

 Well, today the broad indexes have moved from a frightening drop to a respectable rally. And with the exception of the technical conditions that have been slightly oversold there has been no other reason than perhaps investors have come to their senses. Today, that may be true, but the idea that this morning’s inflation was called out to be hot, but as described above, that wasn’t actually true. Also, the idea that inflation is going away anytime soon is also an uncertainty that can’t be ignored. The Fed will keep on being aggressive until they reach their goal and that’s a good reason to be cautious. Adding to existing positions when the market is down makes sense to me, because there is a reason and we all know it, and when the market is up it pays to look for a reason before acting. The broad indexes have come down a lot this year, balance sheets have been rattled, familiar measures and ratios have compressed and there will be a time when the Fed begins to play nice. When that happens the markets will rally for what I call the first stage. What I prefer to focus on as well are the longer dated technical conditions that persist and until those conditions are reversed, we remain in a bear market. But when the reversal happens, we begin to experience stage two and there is plenty of time to be prepared. And as experience has taught me, being prepared for the future is better than playing pinball with the present. 

What’s Obvious

 The markets have been especially volatile this week as buying was met almost immediately with selling and selling with buying, leaving the sellers with a slight edge.  All on the back of the Feds strategy to bring inflation down. Yesterday the Fed Board voted to raise rates an additional .75% taking the rate to 3.25%, a level not seen since 2008 and the third time applied this year. This by itself is a clear message, raising interest rates impacts the economy in a variety of ways, from mortgage rates, auto rates all the way to credit cards. But, this is all happening at the same time employment appears stable and the consumer is still consuming unfazed. So, what is the intent of the strategy and why do I think it’s obvious?

 Markets

Because of Fed is raising rates, the treasury bond market is forecasting where rates may go. This created a dilemma for the stock market that, in my opinion, is exactly what the Fed is comfortable with. The reason is dilute the amount of capital in the systems, and you dilute the amount of capital to consume with. In the meantime, the increase in interest rates are being sold as the coming preferred investment opportunity. I agree, but when bond yields have reached their high, they will rally, but stocks will too and that’s why we stay invested.

 Economics

Housing is having a bad year, sales of existing homes are declining, and new homes are on hold. The former because of rising interest rates and the latter because of rising commodity prices. Employment has been steady, unemployment claims are steady, unemployment as a percentage of participating workers went up a little in August, not enough for the Fed to be happy. However, since last month the number of firms that have mentioned cutting back on hiring and in many cases initiating layoffs of some exiting employees, as part of their recent earnings guidance. Should employment data show further deterioration in the workplace, declines in wages and hours worked, the outcome is once again the aim of the Fed who are aware that workers in peril spend less, leaving inflation in a lonely place.  None of the economic conditions mentioned were in yesterday’s talking points of Fed Chairman Powell, who reiterated the goal to bring inflation down, but forgot to mention the obvious intent to bring the economy down with it.

 External Events

Many of the comments that have come from the corporate community have come in two parts, the first is the present concerns of the economy and challenges to the balance sheets from inflation and the second, the future looks bright. Good news for the Fed, but good news for the markets as well, that is if the markets stop going down long enough to pay attention. Washington is still hunting for further mischief with little regard to mentioning anything about inflation nor the economy, unless it can be positively spun. Worth noting, at the outcome of the upcoming elections, if even one house is lost to an opposing party, the result would be gridlock, and the markets love gridlock.

 

Solutions are boring, problems can always be exploited, that’s why some problems never go away. It seems obvious that the Fed has one goal, deplete discretionary and corporate capital and inflation has nowhere to go but down. When that even begins to happen, the markets will react favorably. In the meantime, as always, be patient and, in my opinion, it will happen.

The Greed Component

The markets responded angrily this week to unexpected outcomes of the Consumer (CPI) and Producer (PPI) data, missing the consensus expectations. Other mixed data was released over the week and the continued decline in the broad indexes has now erased much of he rally that begin in June. The reason is simple, inflation is still a problem, and the market is listening too closely to the bullish narratives. Basically, no matter how much insight and understanding there exists, in my opinion, the rational brain is too often impotent to taking the emotional brain out of the conversation.  What’s missing from the narrative, everything?

Markets

The current decline is predicting the action of the Fed next week as they are expected to increase interest rates .75%. But some interpret the derivative (Federal Funds futures contract) that track the same rate and suggest the possibility of 1.00%. The outcome of the Fed meeting is less important to me than the fact that they are raising rates and have stated in numerous interviews that they will continue to do so. The general reaction from the body of players is the Pindudes are day trading, the Algochums sell aggressively and the investors are sitting on their cash. This is because the stock market will eventually find a bottom and begin the first stage of its future rise, but first has to see the proof to buy. In the interim, the markets will go down, the markets will go up and only a defined buying strategy is worth pursuing.

Economics

The economy is definitely slowing, and the deeper economic moderation of Europe and China are adding to the problem. Retail Sales data this week showed a slight increase (+.3%) for the month of August. But customary activity slows into the early fall as consumers build cash for the holiday season. So just as Manufacturing is showed a slight rebound as the consumer slows, the reverse is likely in the late fall, all in keeping the economy at odds with itself. All this will have some impact on the inflation data, even as one overlooked aspect of the data was that CPI and PPI didn’t go lower as expected, but they didn’t go higher either. Therefore, in my opinion, it’s worth standing by to see if inflation may have already peaked. I admit it’s a huge call, but if the economy slows, and the consumer becomes more watchful, the part of inflation that I refer to as the greed component will also slow down and a more natural level of prices will likely stick around, even when the index’s finally decrease.  This is when economies, like the US, move on. 

External Events

I’ve spent little time over the last few weeks addressing the ongoing external events, unending China lockdowns, continuing war in Ukraine, with some light on the horizon, and the recent challenges faced by the EU regarding their inflation and the contribution made to it from their energy consumption and troubling reliance on unreliable resources. Although the EU appears to be using its problems to better navigate its ambition to manage consumption of fossil fuels in total, the UK on the other hand has moved in a countering direction. This, in my opinion, doesn’t ignore the need to discipline the consumption of fossil fuels but introduces a picture that will be better viewed through a transitional lens. The uncertainties will have to take shape as well as take on resolve, this way the future can become something the markets can predict.

 

A Slightly Clearer Picture

 Monthly Unemployment data was released today showing August job growth of 315k, which is strong enough to maintain an expanding economy, but with the previous months being revised down, the number was softer than it appeared. Another good sign was the small drop in wage growth, which has been a big contributor to more discretionary cash and therefore more inflation. The markets liked the data and were focused more on the overall Unemployment Rate, which moved from a historic low of 3.5% to 3.7%. These are the areas the Fed wants to see constructive news in line with recent statements from Fed Chairman Powell, who referred to the “pain that would be felt in household and businesses” that would be needed to bring inflation down. Not a pretty scenario, increasing unemployment could likely push the Fed to raise rates less aggressively than the markets seems to have been suggesting. But, in my opinion, it’s the impact on consumer sentiment that I’m going to focus on, because if the labor market participants are even slightly concerned about job stability, that will directly impact spending, and less spending is the true enemy of inflation.

The rest of the data suggested continued expansion as well as the recent release of ISM Manufacturing PMI remained at 52.8 (above 50 is expansionary), and worth noting, Manufacturing Employment showed a healthy increase in August as well to support that assumption. Although the overall economy is still sector sensitive, the notion that a recession is upon us is, in my opinion, premature, and the unemployment data supports that notion. Overall, I would say that the Fed sees this number and remains content with its aim to aggressively raise rates, content, but not happy yet. That would be necessary to slow the Fed down.

By the end of the day the broad indexes started to give up early gains and move lower, leaving the week, a weak one. It’s worth noting that many of the technicals that I use to track positive and negative momentum have declined to nearly oversold. This is leaving me constructively neutral, and numerous changes to the portfolios have usually consisted of some profit taking and adding to new names. I’m more inclined to pay attention to less defensive sectors, as the economy may not be in a recession, but the markets, exercising their predictive nature, will likely, as through history, begin their rise when that happens, not after.

On September 14th the Consumer (CPI) and Producer (PPI) prices data will give a better picture of where inflation is. The recent increase in the yield of the 10yr Treasury to over 3.25%, not seen since 2018, gives room to the Fed to be aggressive if the inflation data doesn’t move lower. This is why the markets will still be captive to uncertain volatility for much of the month. Add to this the disruptions that continue to occur in the energy markets and vigilance is the key to patience.

Full Circle?

     The key focus of managing investments is to take on risk when the markets decline and lighten up on risk when the markets rise. The ensuing changes historically favor a rising markets, but when the two changes become interchangeable, such as they have since the beginning of the pandemic, volatility takes over because of the increase in uncertainty surrounding the facts that are necessary for the markets to self-predict the future.

    The pandemic began with a sharp decline in the markets when governments around the world chose to lockdown their economies in an action that no living person has ever had to experience. The extreme

moves began what, in my opinion, have been an extreme series of outcomes, all to fueling the volatility and the resultant uncertainties of the future. Once the lockdowns began the various medical and geopolitical institutions that become the voice of the narrative, woke a world up to entities we all knew about but never thought about how they impacted the worlds dialogue. The distraction created a headwind that caused careful interactive behavior resulting in remote working, and careful management of businesses, especially those of services and hospitality. The outcome resulted in the first of three broad stimulus packages amounting to roughly $2.3 trillion dollars and the resulting spike in the M2 money supply to the highest level in over 30yrs. Welcome inflation.

    In 30yrs of managing money I’ve used the beginning of my career to measure the historical commonalities that have occurred over time and on the side those commonalities that prevailed humanity throughout history. Inflation has really been a problem, but the blame is never short of narratives, the first being the war in Ukraine. The uncertainty of war, and war with China are is topic of speculation although, in my opinion, with lower probability. But I mention this because so many aspects of our post pandemic world have turned nearly everything into a war; trade, politics, economics (sanctions), and each carries its own unique uncertainty. Wars and their impact on economics have had many precedents in history, including the impact on inflation. 

    So, while no person or entity can stop the reality of economic cycles, letting the markets technical behavior and fundamental vacillations define the right time to take on risk, it’s important to avoid the narratives that want to keep us eternally doubting.  I’ve never been more aware of this reality then when the pandemic struck and various extremities that rose out, massive market decline, massive market rise, historic printing of money to fuel stimulus, business disruption, supply chain disruption and while all occurred, changes in the world that would make a conspiracy theorist melt with glee. Now, the war in Ukraine is moving on, China has enough problems then going to war with the US, traveling is nearly higher than before the pandemic, and the consumer is defying the call of recession. As a well followed economist named Brian Westbury, recently wrote “These aren’t macro-related developments; they are a realignment of economic activity from a distorted world to a more normal one”. I couldn’t have said it better, and if full circle isn’t here yet, in my opinion, it’s definitely around the corner.

Revisiting Uncertainties

 This week saw the perfect response from the markets when an uncertainty such as inflation, is resolved. Although the broad indexes are clearly overbought, right now my only concern is the uncertainty isn’t so much resolved than merely being a little diluted. It’s a first step, and a great one, but it may be too early to say inflation has peaked. When CPI declines from 9.1% and PPI declines from 11.3% to 8.5% and 9.8% respectively it’s worth exploring the reasons and not ignoring that the numbers are still historically high. Let’s dig a little deeper into our favorite trio.

 Inflation

In my opinion, the Fed is unlikely to divert from its aggressive goal to bring inflation down. That’s because the economy is doing exactly what feeds that goal by moderating. For example, there is a data set called the Leading Economic Indicator (LEI), which tracks business, markets and the economy from different sectors and is historically focused on by economists as a measure of broad economic stability. It is released monthly and when three month over month changes show a decline that is considered a strong sign of moderation in the broad economy. The inversion of the yield curve, customarily predictive, although on a wide timeline, of a recession, has inverted multiple times since the end of last year. Which brings us to inflation, where even this week’s modest declines are consistent with a moderating economy as well. The data is still choppy, so it still pays to be patient.

 Ukraine & China

I’ve previously viewed the war in Ukraine and the economic challenges of China as mutually exclusive. Although the war in Ukraine has recently been joined by the tenuous military exercises near Taiwan that China has used to change its narrative. One narrative is the fragile condition of the Chinese economy, and another is the 13th National People's Congress of the People's Republic of China elections in 2023. Any material changes in the outcome are harder to predict than Russia’s Putin, who isn’t likely going anywhere, but the threat of military actions based on perceived sovereign rights has as much chance of escalating than deescalating. On a constructive note, McDonald’s announced the company would be reopening restaurants Ukraine. Could this be a source of uncertainty dilution in the future?

 Everything Else

Most comments regarding the recent introduction of the Inflation Reduction legislation suggests that the impact of the 15% minimum corporate tax will be centered on a number of large tech companies, who’ve historically had access to favorable taxable conditions. The 1% tax meant to discourage stock buybacks, might have a constructive impact on dividend growth. And spending on other familiar projects is, well, just spending. In my opinion it will have little overall impact on the broad markets, but it also won’t likely reduce inflation. The last point worth noting is the recent sharp declines in energy prices, which were the primary catalysts for the recent declines in inflation. This week’s data was met with new increases that at this time shows WTI Oil (domestic) approaching $95. Should oil touch or exceed $100 that would have direct impact on inflation data. Likewise, Natural Gas, currently at $8.80 is high and could move higher as the summer season moves into fall. All of these observations suggest the inflation uncertainty is currently a little diluted, but it’s too early to predict neither how aggressive the Fed will be next month, nor if the Fed will ease rates in 2023. There is historic precedent for such quick Fed turnarounds, but that just defines the narrative, it doesn’t confirm it.

Everybody Got it Wrong

Friday, August 5, 2022

Event                                                               Actual   Forecast   Previous

Nonfarm Payrolls (Jul)                                   528K     250K         398K

Unemployment Rate (Jul)                               3.5%     3.6%         3.6%                 

Average Hourly Earnings (YoY) (Jul)            5.2%      4.9%         5.2%

I’ve often quipped that I would listen to one chartist over ten economists, any day. Case in point was today’s Unemployment data showing a string of miscalculations that caught the economists and the markets by surprise. But not me.

The markets are overbought, and not just a little overbought. And much of the rally was based on growing optimism that the economy was slowing and that would force the Fed to cease raising interest rates. This followed the debate on whether or not the economy was in a recession, which I dismissed as irrelevant at this time. The reason is, in my opinion, if today’s number serves to have influence on next week’s Consumer Price data (CPI) and Producer Price data (PPI) the Fed will not only increase interest rates but will have to focus on slowing the economy overall, the only strategy that has ever worked in in the history of Federal Reserve actions.

For now, the economic data has shown definite moderation in some sectors. An example is this week’s ISM data that showed Non-Manufacturing increased in July, while Manufacturing data decreased in July. Housing has been under pressure, mostly New & Existing Home Sales. But the consumer has been busy, as usual, mostly in the restaurant and leisure space, less so in the durables (utilities, autos, etc.).  On top of this certain sectors, such as Tech, have announced hiring freezes and in some cases layoffs. This is an environment that has fed the slowdown narrative. 

When I say the broad indexes are over bought, it is a condition that can occur in bear or bull market. But because, in my opinion, there is the potential for a recession, perhaps not this year, the overhanging dark cloud needs no new uncertainties. Today’s employment data added to the uncertainties and the strength should not be ignored. Since the pandemic became the source of newfound corporate responsibility, companies have been increasingly servicing the employee over the shareholder, even in some cases executives taking salary cuts to preserve the balance sheet without laying off workers. In this respect the strength in employment that is at odds with much of the rest of the economy questions the strategy the Fed will have to initiate, which in my opinion, will be more aggressive than the markets currently expect.  

On a final note, I’m not confident that this condition will end anytime soon. Legislation in Washington is still spending (printing) money, increasing capital in the consumer pocket, raising taxes, and taking it out at the same time. Not an economically friendly move to make at this time of economic uncertainty. Will this make a difference? Will changes from the November elections make a difference? Will the economy continue to moderate while employment continues to be strong? Will the Fed have any choice but to be so aggressive that the markets become convinced that a recession in imminent? A lot of questions, the answer lies in the behavior of the investor. If overall equity price action can work off some of the recent rally, the buying, in my opinion, will come back, and the strength of that comeback will determine the future direction of the markets. I’ll continue to wait, be cautious and be ready.

 

Anyone Paying Attention?

Having skin in the game has always been the best way to gage the value of present and impending risk. I’ve personally been responsible for managing billions of dollars in bonds and stocks over the last 35yrs, most of it was bonds, which require sharp focus on economics, currency and monetary policy. I bring this up because with all the jargon infested narrative claiming expertise, much of it from those with little direct experience and a few with experience, I always pay more attention to the latter. These days the latter is questioning the Fed from the perspective that the current inflationary environment we find ourselves in is 1: not the same as 40yrs ago, and 2: increasing interest rates will have little impact if spending and money printing isn’t addressed with fiscal discipline. That’s where the government comes in, and that’s where government has failed in at least the last two decades, and these days doesn’t seem to be paying attention. How did we get here?

        In the early 1980’s the economy had become more disposed to inflation, for reasons unrelated to monetary policy. During the period preceding the rise in inflation, any aggressive actions on the part of the Fed Chairman that may slow the economy was not politically advantageous. I bring this up because after Fed Chairman Paul Volker, against all predecessors, crushed inflation by raising interest rates to historic highs, he entered the economy into a severe recession. From that time during the period from the mid 1980’s to 2022, the GDP Implicit Price Deflator measure saw the lowest inflation averaging around 3.0% on an annual basis. That came at the expense of near zero interest rates and the historical printing of money (M2), all occurring during the super growth of technology, capping the half century transition to a service economy from an industrial economy. All of this fueled consumer spending, government and corporate debt growth and a weak dollar. All good for economic growth, but also all inevitably inflationary. So now, Fed Chairman Powell needs to convince the capital markets that he is in control. 

      So, what else is happening? This week both the Consumer Price Index (CPI) and Producer Price Index (PPI) showed inflation through June at 9.1% and 11.3% respectively. This week’s decline in in the broad Indexes of nearly 4% also strongly suggest in anticipation an interest rate increase of 1% at the next Fed meeting (07/27), the highest since 1994. But from an economic point of view last week saw data from June such as the ISM Manufacturing Index decline to 53.0 and the ISM Non-Manufacturing Index declined to 54.0, in each case a move below or above 50 signals economic contraction or expansion respectively. Tomorrow the Retail data is expected to rise with Friday’s Employment data showing wages rose 1.4% over the last three months, more money in the consumer’s pocket. Next week’s Housing data is expected to show negative effects of the recent mortgage rate increases and slowdown in new purchases. 

      Inflation is real, and so too should the Federal Reserve Board be real. But one piece of data that got attention this week is the ongoing inversion of the yield curve (the 10yr treasury 2.97% minus the 2yr treasury 3.0%). In my opinion an inversion is a good thing, because if we really enter a recession in the near term, the Fed would have to stop raising rates, and inflation would certainly take a hit. As long as the government doesn’t engage in its usual mischief. Luckily the 2.4 trillion dollar Build Back Better bill has so far failed reconciliation and probably would’ve made energy inflation even stronger and also give away too much newly printed money, another reckless increase in the budget deficit. But for now, Congress is doing nothing with the exception of investigating the Jan 6 riot, and Powell appears hesitant even as other members of the Fed voting board are making far more aggressive statements, in my opinion, to get Mr. Powell’s attention. Whether or not it works is key to ending the inflation dilemma. In the meantime, waiting out the markets need for certainty requires patience and focus, diversification has kept portfolios less volatile, and cash remains ample for value, when it shows up.

 

Content But Not Convinced

 In the world of investment nothing offers more false security than a crisp summary 

The Markets

The markets have been in decline this year, there is no quick answer for it, capital markets predict the future, but it’s also not as complicated as it sounds. That’s because the future is to the capital markets an uncertainty, otherwise referred to as risk. But the uncertainty becomes denser when additional challenges enter the markets. For example, inflation has been a growing problem since last summer beginning with supply chain disruptions, then we were introduced to 20th century war in the 21st century, then the world learned of the numerous products that are imported from China found a different supply chain disruption as the Chinese government locked down urban areas in the face of a variant of Covid that was failing to hinder the massive surge in international travel taking place in the West. Crisp enough? 

The Fed

It widely understood in the investment community that the Federal Reserve Board is nearly unanimous on being more aggressive in raising interest rates at their monthly meeting to vote. The troublesome area for now is the narrative that follows the vote. This week Fed Chairman Powell addressed the Congress to answer questions regarding inflation and the Fed’s strategy to bring it down. The trouble is one side of aisle is blaming the Russians, and the other side is blaming the current administration’s policies. Little time was spent discussing the post pandemic adventure as a source, given the sharp increase in GDP, sharp drop in unemployment and the numerous regulations that impede the energy industry, further exacerbated by the war in Ukraine and becoming a global problem. On top of that the working public that saw an increase nationally in wage growth over 5.5% over the last twelve months. This is important, in my opinion since the consumer makes up nearly 60% of GDP. And while Manufacturing picked up from its level of 12%, the growth was offset by the decline in Exports coming at the expense the Fed, whose activities to raise interest rates is favorable to the global value of the Dollar, which is deflationary. The Fed has more work to do, not just to battle inflation, but to convince the investing public that they are on top of the problem.

External Events

Uncertainties usually follow the global political and pop culture environment, which these days is nearly indistinguishable. The divisions in Washington are as unstable as ever as is the broad popular culture. The big change is the unintended consequence of the divisions, and that’s the dwindling interest in globalization. The focus of the current narratives, away from the pandemic conspiracies that captured the imaginations of millions of people the world over is, in my opinion, good news. First, because just as the current administration is committed to bringing Semiconductor production domestically, there is increasing agreement regarding the repatriation of other points of production areas of Capital Goods, Consumer Products, Industrial Supplies, the list goes on with nearly 20% coming from China alone. This could go a long way in softening any recessionary slowdown.

In the meantime, last week ended very oversold. However, unless the three major challenges to the Capital Markets are reasonably addressed, Inflation, War and China, the markets definitely have room to correct, but, in my opinion, less so to become a genuine Bull Market.