#165 -Re-emergence of Demographic Envy, The Case For A Stock Market Bottom, and The Canadian Real Estate Bubble
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How Markets Bottom
Tensions between the USA and China Heats Up
Gregory Allen at CSIS
Generational Envy and how this affects politics and society
Software engineers cant wait their turn
Why the liberal party cant win the next Canadian election
Europe turns to Africa in bid to replace Russian Natural Gas
Associated Press Article - Krista Larson
Books of the week
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Is the current rally in stocks similar to the June- August move where the S&P had a 17 percent upside rally off the lows?
Some of the setup is the same (a low, and a quick retest), and some of it is very different (interest rates).
But the only way this can happen is if the 2- and 10-year Treasury yields stabilize/decline. That was the backdrop for the June – August rally, and a repeat would require markets to believe that future Fed policy is now entirely baked into bond prices.
DATA to Consider:
1: The S&P has been experiencing unusually large 100-day negative returns this year, most noticeably ended in June and again last Friday. History shows only a clear change in monetary/fiscal policy ends such streaks.
2: US office occupancy is edging up to 50 pct, a sign that employers finally have some negotiating power over workers. This should also help reduce wage inflation over time.
3: A NY Fed analysis released today using 2020 Census data shows WFH employees tended to work less and play/sleep more.
The question of the hour is “can we trust this rally?”, so let’s go through the numbers using S&P 500 performance and levels as our guide:
The index recently hit two similar low points for the YTD, one on September 30th at 3,586 and the other on October 14th (last Friday) at 3,583.
Both put the S&P down 25 percent on the year.
As of today’s close we are up 3.8 percent over the last 2 sessions and since last Friday’s lows.
The setup here is reminiscent of the June 16/20 lows, when the S&P “double bottomed” at 3,667/3,675 and then went on to rally 6 percent over the next week and 17 percent through the August 16th highs. That is a big reason why there is so much buzz about a similar rally now. A decent start to Q3 earnings season is helping as well.
Recall, however, that the mid-June to mid-August rally took place against a backdrop of stabilizing interest rates. The chart below shows 2-year and 10-year Treasury yields for the year to date. As noted, 2- and 10-year yields made a spike high on June 13th, at 3.5 percent for both maturities after starting the year at 0.7/1.5 percent. Once they stopped rising after that high water mark, the S&P had its June – August rally. But … Once yields started to rise again, the rally faded and we made new lows in late September/early October.
The rightmost part of the graph shows that 2- and 10-year yields have not yet started to decline very much. The 2022 YTD high on 2-year yields was on October 14th at 4.51 percent, and they are 4.43 pct today. The YTD high for 10-year yields was yesterday, October 17th, at 4.02 pct; they closed at 4.01 pct today.
The other way in which the recent lows are dissimilar to the June lows is the degree to which the S&P was abnormally oversold. We use rolling 50-day price returns (about a calendar quarter) to assess this factor. Here is the math:
Over any 50 trading days since 2005 the S&P has averaged a 1.6 percent positive price return. The standard deviation of those returns is 7.0 points.
That puts the 2-standard deviation band of expected 50-day S&P 500 returns at -12.4 percent to +15.6 pct.
The S&P did post a +2 standard deviation negative 50-day price return on October 14th, at -13.7 percent.
However, the index has been more oversold this year on two other occasions. The first was around the May 19th lows (-18.3 pct) and second was at the June 16th lows (-16.9 pct). The bounce off the May lows was short (2 weeks) and relatively small (+7.1 pct). The move off the June lows was longer (2 months) and stronger (+17 pct) because of the rate picture we described above.
Takeaway: the S&P was not as oversold going into the current rally as past bounces this year, so in our view it is critical that interest rates decline from here to support any further sustainable move higher for US large caps. That feels like a tall order given that the Fed remains hawkish and yields seem stuck at near-YTD high levels. On the plus side, corporate earnings season may help investor confidence somewhat, just given current oversold conditions and reduced expectations. That should help equities keep their footing, but until we see 2-year and 10-year yields start to decline we think traders and investors should remain wary of expecting too much from this rally.
Topic #2: Checking in on European periphery countries’ sovereign debt yields. These can be useful coalmine canaries, showing how much investor risk tolerances are rising/falling. Here are current yields for 3 such countries and how they compare to high quality German bunds:
Italian 10-years: hovering around their 2022 highs, at 4.68 percent
Spanish 10-years: also stable around their 2022 highs, at 3.46 pct
Greek 10-years: breaking out to fresh 2022 highs today, at 5.01 pct
The spreads above German 10-year bunds for each: Italy: 237 basis points, Spain: 118 bp, Greece: 2.74 bp. All are wider than the end of Q2: Italy + 24 pts, Spain +8 pts, Greece +48 pts.
Takeaway: despite the ECB’s efforts to support the sovereign debt of peripheral nations, spreads have been widening since the end of Q2. Part of this is no doubt due to the recent turmoil in the UK gilt market; 10-years there still yield 3.93 percent today, up from 2.22 pct at the end of June. Even still, it is hard to see the euro staging a sustainable rally without periphery countries’ bond spreads versus German bunds also tightening. This matters to all investors, because every real bottom for US stocks since the Financial Crisis has come with non-US currencies rallying versus the dollar.
💸Reformed Millennials - Post of The Week
The Obama Doctrine: "Russia will always have escalatory dominance in situations like this."
Sleep Walking Into WW3
A really interesting conversation between objectively small people about the risks we all face.
High Risk of Nuclear War in Ukraine w Naval, Friedberg & Sacks.
Points from the Pod:
Putin has an escalation incentive to use nukes
We are not fighting a nuclear war for Ukraine and Zelenskyy Needs to know that
Senate needs to vote on adding Ukraine to Nuclear Umbrella (treaty ratification)
Give Putin a Small Victory
The Hope for Diplomacy
Ukraine is free to do what they want and the group is pro-Ukraine
How to look at the Fed Minutes:
Going Into the Meeting - Fed Minutes
On Wednesday, the Fed released the minutes of the FOMC meeting held on September 20–21, 2022. The minutes for each regularly scheduled meeting of the Committee ordinarily are made available three weeks after the day of the policy decision and subsequently are published in the Board’s Annual Report.
The descriptions of economic and financial conditions contained in these minutes are based solely on the information that was available to the Committee at the time of the meeting.
During this meeting, the Fed acknowledged that their rate hike path will weigh on economic activity in the coming months and years. According to the minutes, they "generally anticipated that the U.S. economy would grow at a below-trend pace in this and the coming few years, with the labor market becoming less tight."
When it came to the labour market, boy was this wrong. It remained tight which is why we saw such a retreat after the NFP numbers.Reflecting the central bank's decisively hawkish tone, the word "restrictive" appeared 13 times in the September minutes, as opposed to 0 times in the July meeting's minutes. Inflation showed up 89 times in the most recent meeting's account vs. 7 times in the previous meeting's minutes.
Overall, a very cautious approach, so now we have the market digesting minutes the day before the CPI print came in…
By The Numbers - Expectations, Print
Going into the meeting, expectations were for core CPI (excludes food and energy) to come in at 6.5%, while overall CPI expectations were for 8.1%. The numbers came for Core at 6.6% and CPI at 8.2%, respectively.
All headlines initially blasted out as “HOTTER THAN EXPECTED”, hell is coming.
And markets responded, opening down ~3%. However, we saw a huge reversal mid-day as markets made a massive rally and short sellers panicked to cover.
By the numbers…
Now let’s dive into these segments.Inflation Segments - Energy, Housing, Food, Autos
Shelter, food, and medical care indexes were the largest of many contributors to the high print while prices for gasoline and used cars declined MoM.
Food prices kept soaring in September as a large contributor to the worse-than-expected print. Food costs rose 0.8% MoM and 11.2% YoY.
Grocery prices were up 13% YoY as eating at home got expensive for every item on the grocery list from flour, cookies, turkey, canned fruits, and vegetables all rising by the most ever.
Struggling supply chains continue to squeeze the average consumer on the food front.
Shelter costs make up the largest component of services when it comes to the print and 1/3rd of the overall CPI index.
Shelter costs rose 0.7% MoM, representing a 6.6% increase on a YoY basis. To me, this still seems low and there is still much to go when it comes to house prices.
Mortgage rates have more than doubled since the beginning of the year, as the average contract on a 30-year fixed-rate mortgage ballooned to 6.81%, the highest level since 2006.
Energy saw a retreat by 2.1% on a MoM basis but is still up 19.8% YoY. The most notable decline within the energy column was gasoline, down 4.9% MoM, which makes sense when you look at the WTI chart:
We are far from out of the woods yet in the energy complex when it comes to further politicization of critical energy infrastructure.
Autos are a bit of an interesting one and really tell a story here. For used cars, the print was down 1.1% MoM while new cars increased 0.7% MoM. My takeaway from this is that commodity prices and supply chain squeezes continue to pressure new vehicle costs, driving prices up. On the other hand, the purchasing power of individuals is now getting squeezed, so used vehicle sales are coming down.
Where to Go From Here - Can We Get a Bottom Drawn In?
It seems like the market is still trying to determine just how deep and long this bear market will be.
The main takeaway I will say from this is that the market never bottoms during a rate hiking cycle.
We need to see the end of the hiking cycle for a bottom to get drawn in which is why the inflation and labour market picture are still so important.
Soon, we will be lapping comps where inflation will come down. Just how responsive the Fed will be to any improving data is anyone’s guess.
So we continue to be the kid in the backseat during a long family vacation asking, “are we there yet?”
Invest Like the Best - Paul Orfalea - It’s About the Money -- Paul founded Kinkos, the popular copy chain, in 1970. He started with a single photocopy shop in California and grew the business into a $2 billion multinational operation over the course of his 30 years in charge. Paul is a non-traditional leader in the best sense and we discuss his philosophy of business building, from why your subordinates should frustrate you, why you shouldn’t love your business and tips he learned on hiring well. Please enjoy this conversation with Paul Orfalea.
🔮Best Links of The Week🔮
China’s domestic chip industry, helping manufacturers develop new chips to catch up with foreign rivals. Now, those workers are in limbo under new U.S. export control rules that prohibit U.S. citizens from supporting China’s advanced chip development." Source: WSJ
"President Xi Jinping has called on the Chinese Communist party’s 97mn members to steel themselves for a “critical time” in the country’s history, as he opened a congress that will solidify his status as its most powerful ruler since revolutionary hero Mao Zedong. In an almost two-hour speech in the Great Hall of the People in Beijing on Sunday, Xi said the party’s “mission is glorious beyond compare” as he outlined goals ranging from an “all-out people’s war” against the pandemic to realising the unification of China and Taiwan." Source: FT
"NFLX beat third-quarter expectations on the top and bottom lines Tuesday. The company said it added 2.41 million net subscribers during the quarter, higher than the 1 million it had forecast. NFLX will begin to crack down on password sharing next year." Source: CNBC
"Amazon employees at a warehouse outside Albany, New York voted nearly two-to-one to reject the formation of a union, dashing hopes that a grassroots effort to organise workers would spread across the e-commerce giant’s facilities." Source: FT
"One of Wall Street’s go-to safety plays isn’t shielding investors from market turmoil anymore. Earlier this year, utility stocks were among the best-performing segments of the market as investors turned to defensive sectors to weather the financial storm. Utility stocks are typically thought of as more stable than overall equity markets as providers collect steady checks from customers even when the economy slows. At its 2022 high in mid-September, the S&P 500 utilities sector was up more than 8% year to date. That trade has unraveled. Over the past month, utility stocks have been the worst-performing sector of the S&P 500, down 13% versus the broad benchmark’s 4% decline." Source: WSJ
"More than 300 U.S. buyers have already put down deposits for Rolls-Royce’s first electric vehicle prior to its unveiling on Tuesday, the luxury automaker’s CEO told CNBC. Rolls-Royce CEO Torsten Muller-Otvos told CNBC that the buyers visited the company’s headquarters in Goodwood, England over the past two weeks to get a sneak peak at the Spectre, which was publicly revealed Tuesday and comes with a starting price tag of $413,000. The two-door coupe, which is sleeker than a typical Rolls, has a range of about 320 miles and can go from 0-60 miles per hour in 4.4 seconds. Rolls-Royce has said its entire product line will be fully electric by 2030. Muller-Otvos said the buyers put down deposits before they even saw the car." Source: CNBC