Macro Monitor February 12 2023
Broken Record
I have been a faithful devotee to the belief that bonds and stocks will remain positively correlated.
Over two weeks, we have seen two year Treasuries jump 50 basis points to settle Friday at 4.71%. The bond guys now essentially believe that it is most probable overnight rates go to 5% by summer and stay there through a good part of 2024.
To borrow a phrase from the Brits, the stock guys “just can’t be bothered.” The S&P is positive for the same period, and with this Monday morning’s rally, it has appreciated over 1% in the face of much higher rates.
If Shakespeare were a stock trader: “Out, damned rates!”
Reaching into the Wall Street bard’s bag of narratives, this price action is thus explained:
While there are signs of economic slowdown, momentum from the job market minimizes the possibility of the dreaded hard landing. Relative strong economic growth traditionally means that equities appreciate and bond yields rise.
End of story?
There is nothing more boring and even intellectually reprehensible than the inability to change one’s mind. Call me boring and reprehensible. I will not be offended.
Instead re-pontificating on the risks of the no-landing scenario, I would like to offer two choices to maximize your time:
Read about no-landing risks in the article published this weekend by the Wall Street Journal’s formidable Fed-watcher Nick Timiraos.
Here is a highlight, with the use of an exceptionally fine macro metaphor:
Ethan Harris, head of global economics research at Bank of America, said he is deeply skeptical that inflation will fall if growth quickens. “The longer this plane circles at 30,000 feet, the bigger the risk of running out of fuel,” he said. “A more plausible scenario is that it is simply going to take more time and tightening to cool off the labor market.”
Read what the reprehensible David Wolf wrote about these risks in December.
Here is a highlight:
A new school of thought is developing, which is that of a “no landing.” Inflation trends down but remains “sticky.” Instead of ending 2023 at the Fed’s projection of 3%, it hovers at 4%. Corporate profits grow slightly, GDP growth remains positive…but the Fed is forced to choose between accepting higher structural inflation or raising rates well over 5%. Meanwhile, the Fed cannot (I hope) stop reducing its balance sheet (QT) while it is also raising rates…
… At its heart, uncertainty make this scenario negative. Every bear market rally since April has been predicated on the hope that the Fed is close to pivoting, that is, turning its back to raising rates and embracing looser monetary policy. The no landing scenario means a no pivot scenario…”
This view has proven spot-on in for a short in the Treasury market. However, my short position in the S&P is still on the books with not so insignificant losses.
Bank of America analyst Mike Wilson is also a stubborn bear. In this article published last week, Wilson highlights two trends in corporate earnings.
The current level of the S&P is at odds with these negative earnings trends and the a possible new narrative surfacing, (you heard it here first), “dis-dis-inflation.” Perhaps the immense liquidity of the two trillion dollar Reserve Repo facility at the Fed, where money-market funds park their cash, or liquidity increases generated by Janet Yellen’s emergency measures to keep the government running until the debt limit is raised, are two factors that have made the flow into stocks positive. But money should be flowing to bonds too, right?
Perhaps the advent of a New Year has resuscitated the “Buy the F**king Dip” mentality of yesteryear.
Or perhaps this is the Mother of all bear market rallies, and Mike Wilson’s 3000-3300 S&P prognostication is just a month away.
I admit to and apologize for being a broken record vis a vis the risk-off effect on higher interest rates on stocks. I am putting my money where my mouth is, and run the risk of going from a broken record, to a broke record.
Just kidding, the against-the trend-bear position is in options, with downside limited, so I will have plenty of time and capital to improve my broker record.
Have a nice CPI tomorrow!
Here is this week’s Macro Monitor, which shows little change from last week’s.
