September 23, 2022
By Steve Blumenthal
“Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks, and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets...”
– Stanley Druckenmiller, Investor, Hedge Fund Manager, and Philanthropist
A story about earthquakes. Did you remember learning about the Earth in school?
The Earth has four major layers: the inner core, outer core, mantle, and crust. The crust and the top of the mantle make up a thin skin on the surface of our planet. But this skin is not all in one piece—it’s more like a puzzle, with many pieces. We call these pieces tectonic plates. These plates aren’t static; they move around slowly, sliding past one another and occasionally bumping into each other. The plates’ edges are called plate boundaries.
The plate boundaries are made up of many faults, and most earthquakes around the world occur on these faults. Since the edges of the plates are rough, they get stuck while the rest of the plate keeps moving. When the plate has moved far enough, the edges unstick, and there is an earthquake.
Interest rates are puzzle pieces, currencies are puzzle pieces, debts are puzzle pieces, taxes are puzzle pieces, commodities are puzzle pieces, inflation is a puzzle piece, central banks are puzzle pieces, governments are puzzle pieces, peace is a puzzle piece… I could go on.
The vast majority of the time, there is relative stability on the surface of the earth and within the functioning of global economic system. Can earthquakes be predicted? No, but Caltech seismologists, by calculating probabilities, can estimate where earthquakes may be likely to strike. Can market crashes be predicted? No, but macro economologists (new word), by calculating probabilities, can estimate where financial earthquakes may be likey to strike. It’s quite easy to estimate what ten year future annualized returns may be, it’s not so easy to know when a stock market earthquake is likely to strike.
The biggest puzzle piece is the Fed. “…focus on the central banks, and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.
There is movement in the puzzle pieces. There is friction along the fault lines.
The Federal Reserve approved its third consecutive interest-rate hike of 0.75% on Wednesday, signaling additional large increases ahead. Our friends at WallachBeth recapped Thursday’s trading day, writing, “Equity markets fell once again as the S&P finished the day roughly 0.80% lower while the Nasdaq fell around 1.4% as central banks globally are joining the FOMC in hiking rates to combat persistently high inflation levels as the BOE (Bank of England) raised rates to 2.25% in a 5-4 vote and the BOJ (Bank of Japan) held rates at super low levels but intervened to stop the yen from sliding for the first time in 24 years (the central banks of South Africa and Norway also followed the Fed’s move).” Today, the S&P 500 Index closed lower by 1.72%.
Higher interest rates in the US relative to the rest of the world are driving the dollar higher and competing currencies lower. If you earn your money in Yen and buy things like oil in US dollars, your costs have skyrocketed, because your currency is down over 20%. Same if you earn your money in Euro, Pound Sterling, Swiss Franc, Chinese Renminbi, Canadian Dollars, Aussie Dollars, or Indian Rupee. This movement could be good or bad for you depending on with whom you trade and your ability to pay your bills. My point is that puzzle pieces are moving and moving a lot.
The BOJ moved for the first time in 24 years. That’s a stress point.
Higher US interest rates have driven the US Dollar higher. Everyone sits along the fault line. Europe appears most fragile due to the poor construction of the Euro, short-sighted energy policies, and Russia’s economic and kinetic war. But an earthquake could be triggered elsewhere. Emerging Market debt priced in US dollars are at risk. My Macro economologists’ spidey senses are tingling. There is reason for concern.
The 10-year US Treasury Note closed at 3.70%, one-year Treasurys are yielding more than 4%, and mortgage rates hit 6.30%. You’ll note in the following chart that the Fed has raised rates five times in 2022, and the current Fed Funds rate is higher than in the 4th quarter of 2018. The Fed is committed to hiking until something breaks. Look at the prior peaks in 2000, 2007, and 2019. Something always breaks.
“It’s not about whether you are right or wrong, but about how much you make when you are right, and how much you lose when you are wrong,” Stanley Druckenmiller said.
Additional large increases are ahead. Pieces will move; something will break. Don’t fight the Fed. Don’t fight the Fed. Don’t fight the Fed. Channel your inner Stan Druckenmiller.
Our next opportunity in both the stock and bond markets comes when something breaks. It may be nearer than we think. My “Fed pivot” target is between 3,000 and 3,200. At that point, valuations are “fair,” and forward returns for traditional index investing are good. We can’t rule out lower levels, either. I could be wrong, of course… My best advice is, until then, keep your defense on the field.
Grab your coffee and find your favorite chair. Below, you’ll find a chart that shows the size and growth of the Fed balance sheet and a bit more about the Fed. I then share a summary of some strategic thinking around Russia, Ukraine, and China. Shifting puzzle pieces.
(Reminder, this is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only).
The Fed’s $9 Trillion Balance Sheet
In last week’s piece, I shared Ray Dalio’s thoughts on how inflation, interest rates, markets, and economic growth relate to each other, and what that means for what’s ahead. Dalio is the founder, co-Chief Investment Officer, and member of the Bridgewater Board. Ranked by assets under management, Bridgewater Associates is the world’s largest asset manager at $235 billion. Imagine what it would be like to have a seat at the Bridgewater investment table. When you read Dalio’s work, you do.
Dalio concludes, “The upshot is that it looks likely to me that the inflation rate will stay significantly above what people and the Fed want it to be (while the year-over-year inflation rate will fall), that interest rates will go up, that other markets will go down, and that the economy will be weaker than expected, and that is without consideration given to the worsening trends in internal and external conflicts and their effects.” You can follow Ray on LinkedIn by clicking here.
It was a big week for the Fed, and Powell remained firm in his conviction to fight inflation. Following is a good summary of the state of play from Axios Markets.
The worst year for stocks since 2008 could still get uglier, as the Fed’s effort to pull potentially trillions of dollars out of financial markets hits full steam.
Driving the news: The Fed opened up the second front in its war against inflation in recent months, moving to shrink its stockpile of nearly $9 trillion worth of U.S. government bonds — a process known as quantitative tightening.
- In September, it upped the rate at which it’s cutting its holdings, to nearly $100 billion a month.
- The Fed also continues to lift short-term interest rates, delivering its third consecutive hike of 0.75 percentage points yesterday.
Why it matters: The only previous attempt by the Fed to simultaneously raise rates and decrease its holdings of government bonds coincided with an ugly 20% stock market sell-off in late 2018.
- The S&P 500 is already down 21% from its peak early this year, after the Fed launched its effort to crush inflation by lifting short-term interest rates.
- The big question: With quantitative tightening just ramping up, is the other shoe about to drop on the market?
The big picture: When the economy went into a COVID-related nosedive in early 2020, the Fed started pumping newly created dollars into financial markets as part of its efforts to make sure the economy didn’t become a smoldering crater.
- It did this by buying more than $4 trillion worth of Treasury bonds and government-backed mortgage bonds.
- Buying those bonds lowers long-term interest rates, which in turn lowers mortgage and auto loan rates, coaxing Americans into spending their cash instead of clinging to it in scary times.
- The plan largely worked, and auto and home sales surged during the crisis. (Some also blame it for adding to the current inflation issues.)
Between the lines: A side effect of the plan was the stock market’s record growth, as the flood of newly created money sloshed through the system.
- The stock market rose 114% between March 2020, when the Fed announced its quantitative easing program and its peak in January 2022.
- Some analysts think that the impact of the Fed’s money printing and bond buying programs might have influenced the manic mood of the markets — meme stocks! SPACs! crypto! NFTs! — over the last couple of years, in which every slight downturn for stocks was met with traders who rushed to “buy the dip.”
The bottom line: Now that the Fed is shrinking its balance sheet — effectively pulling a cool $100 billion out of financial markets every month — some expect the massive pandemic-era tailwind to turn into a massive headwind for an already troubled stock market.
“Do not, do NOT invest in the present; the present is not what moves stock prices, change does.”
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Russia – Ukraine – China
From Renè Javier Aninao at CORBŪ:
RE KEY CONTEXT:
First, Putin’s speech made three very important points — that:
- The West threatens to “dismember” the Russian state and “enslave” the Russian people
- The West has “crossed all lines” by “pushing Ukraine into war” and is now “preventing peace” by threatening the Russian state with “nuclear blackmail”
- Most importantly— that Russia now “confronts the entire military machine of the collective West” [ie, not just Ukraine]
Secondly, these actions by Putin came only ~72 hours after the Shanghai Cooperation Organisation Summit [SCO] (The SCO is the successor to the Shanghai Five, formed in 1996 between the People’s Republic of China, Kazakhstan, Kyrgyzstan, Russia, and Tajikistan) and 121-point Samarkand Declaration [a must-read here] where:
- Topic of discussion during the much vaunted Xi-Putin meeting was RE increasing “trade” / circumventing sanctions / and backfilling the RF military-industrial complex [see Putin Q&A here]
- All the GCC countries in the Middle East (GCC is the Gulf Cooperation Council, a political and economic alliance of six Middle Eastern countries—Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain, and Oman) were accorded a formal status within the SCO [note: this is very important for energy/commodity prices in the belly and back end of the curve]
- Xi Jinping upgraded the relationship with Belarus President Lukashenko to an “all-weather comprehensive strategic partnership” [which is very important diplomatic language, see Peoples Republic of China (PRC) MoFA readout here]
- Maybe the most important signal — Putin’s #1 closest insider Nikolai Patrushev met with PRC Politburo member and Party-State rep Yang Jiechi to “fully implement the consensus” reached in Samarkand with “further cooperation bewteen the military departments” [see must-read official readouts here and here]
TAKEAWAYS / IMPLICATIONS:
Strategically, it’s clear that:
- Putin has powerful allies behind him — and whether they are formally declared or not is, ultimately, besides the point for both policy and market outcomes
- Putin and Xi — conspicuously the only two major heads of state NOT addressing the UN General Assembly this week — intent is to destabilize the status quo
- Putin’s strategic political objectives dominate any military or operational deficiencies
- Putin therefore, cannot be deterred— even when facing POTUS’ “full force of American power” and the “entire military machine” of the NATO+ alliance
- Putin’s escalation proves that the current Western policy mix — of exercising restraint + demonstrated deterrence capabilities — has failed to achieve any deconfliction objectives
- That said, this escalatory cycle led by Russia et al will continue into Q4 / 2023 — as the US-NATO+ response will always “lag” — particularly since the alliance will not [and should not] be the aggressor in “sparking World War III”
SB Here: Contact Rene below via email if you’d like to be added to the email list. Let him know you read my letter and are interested in being added to his email list.
Renè Javier Aninao | Managing Partner, CORBŪ email@example.com
Trade Signals: FedEx, Mortgage Rates, Housing and Jerome Powell – 09-21-2022
September 21, 2022
S&P 500 Index — 3,856
Notable this week:
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizons, and risk tolerances.
Personal Note: Fall is Here
Two back-to-back wins and the Malvern Prep Friars find themselves at 5 and 3. The team is young, with some non-soccer athletes hitting the field. Stepson Tyler is home and has joined me on the sidelines. He calls the non-soccer athletes “Lacrosse Grinders.” Good hands, but not so good with a ball at their feet. But surprisingly effective. We are both part-time assistant coaches to Susan. Tyler is a 2015 graduate of MP. Susan took over the head coaching job in 2018. We provide encouragement, help out when a player gets injured, and share what we are seeing on the field. Formations, strong players, weak players, etc. Mostly we say, “Yes coach.”
Both the veteran players and the Grinders are getting it done. It was a good week, and Coach Sue is smiling. For some reason, a cold Hazy IPA just tastes better after a win.
Fall is here, and college football season is in full swing. I hope your favorite team is doing well. A heartfelt ugh to my Notre Dame friends. It’s been a rough start. Adam A and Bob M, good luck against UNC this weekend!
And if you don’t have a favorite team, join me by putting on some blue and white and rooting for Penn State. There is optimism in the air. Let’s go! “We are!” PSU plays Michigan on October 15 and Ohio State on October 29.
Here is a look at the top 15:
The travel calendar is light, and that’s good news, as my team, and I are working on a number of initiatives in the private equity space. One involves oil and natural gas. The hard reality is the grid system is not yet built to be able to power the world in a carbon-free way. I think we will get there, but it is a number of years away. Look at the tough spot Germany, and much of Europe is in with the closure of the Nord Stream Pipeline. This from Forbes: “When, at some point in the distant future, we are all able to pause to catch our breath and reflect on the causes of the expanding energy crisis, it seems likely that this past week will be seen as a key moment when reality about the crisis facing the world began to set in. It was a week that saw the reversal of a national fracking ban (in the UK), an extraordinary speech by the leader of the United Nations, and some very frank statements by two high-profile CEOs.” One of those statements came from JPMorgan CEO Jamie Dimon. More from Forbes: “Dimon informed congressional inquisitors at another show-trial-style hearing staged on Capitol Hill this week that his bank would not refrain from making new investments in major oil and gas development projects, telling the members when asked that question, “Absolutely not, and that would be the road to hell for America.”
When asked for his thoughts about the progress of the energy transition, Dimon was just as clear. “We are not getting this right,” he said bluntly. “The world needs effectively 100 million barrels of oil and gas every day, and we need it for ten years. To do that, we need proper investing in the oil and gas complex.” I concur, thus our interest in the space.
CMG’s Luis Medina has recently presented at a family office event the case that oil and gas and nuclear energy are needed to reduce CO2. Shutting them down has increased the cost of oil and gas and driven both poor and wealthy nations to revert to coal. There is a cause and effect for everything. That’s the point Jamie Dimon is making. The next On My Radar Spotify audio post will be out this Sunday. Look for the post on Spotify, Twitter @SBlumenthalCMG, and LinkedIn this Sunday.
Wishing you and your family the very best!
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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