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The New Volatility Explained

All of a sudden, the market is volatile… but why?  That was one of the main topics of conversation I had with investors over the past couple of days…

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This article was originally published by Stock Investor

All of a sudden, the market is volatile… but why? 

That was one of the main topics of conversation I had with investors over the past couple of days at the Las Vegas MoneyShow. In fact, I fielded a lot of questions about why stocks wobbled last week, and that’s completely understandable.

Fortunately, I was well-equipped to answer these questions. You see, when it comes to understanding the underlying reasons why markets behave as they do, you have to think a bit deeper than just the headlines.

Indeed, that’s why I call this publication “The Deep Woods,” because it is here that we peel back the surface layers of the onion skin so that we can get deep into the real reasons why things are as they are. In doing so, we can get a much greater sense of where things might likely go in the future. That’s because when you have a good sense of why things are the way they are, you have an even better chance of being right about how things are going to be in the future. And when it comes to our money, knowing what is likely to happen going forward is essential to investing success.

Your editor at the Eagle Financial Publications booth, Las Vegas MoneyShow.

So, why did market volatility pick up last week? Well, first there were lingering concerns about the health of the economic recovery after the soft August jobs report and the increasing threat of a more “hawkish” shift at global central banks. Then there was a soft German ZEW Survey, which offset bullish Chinese export data. Politically, there was a Wall Street Journal article that warned corporate tax rates could rise before the end of the year, and that further pressured stocks.

Another reason for last week’s volatility and subsequent selling was that the Treasury Department said the federal government would hit the debt ceiling in October, which was sooner than previously thought. The market will soon have to deal with what is potentially another volatility-inspiring political battle over raising the debt ceiling. 

And while I suspect the outcome here will be as it always is, i.e., yet another raising of the debt ceiling, there will be more volatility in markets as the battle on this issue in Washington rages. Finally, last week, stocks bounced around as derivatives trading continued to influence markets ahead of this week’s options and futures “quadruple witching” expiration. 

So, last week we had 1) Confirmation of Fed and global central bank tapering, 2) Tax hike headlines, 3) Debt ceiling warnings and 4) A series of earnings warnings related to the COVID-19 spike and subsequent margin pressures.

Yet while all of these are legitimate headwinds, the first three issues we’ve known about for some time — it’s just now the market has to deal with them as they are all coming to a head (tapering, tax hike headline risk and debt ceiling drama). However, none of these got materially worse last week, it’s just investors can’t ignore them anymore as a future risk. But while these events will continue to cause volatility, they are unlikely to be bearish gamechangers unless there’s a major surprise (accelerated tapering, massive tax hikes or a debt ceiling breach).

The one headwind here that I am most concerned about is fundamental, and it is one that we have been watching closely and writing about every day in the “Eagle Eye Opener,” our daily “insider” market briefing designed to give you this type of market analysis in your inbox every morning at 8 a.m. Eastern. 

That headwind is earnings, and last week, we saw numerous businesses from multiple industries (industrials, airlines, grocery stores) issue earnings warnings on a combination of reduced demand (airlines), supply chain issues (industrials) and margin compression (grocery stores). If expected earnings growth begins to suffer at the hands of inflation, supply chain issues or margin compression, then that is something more substantial we need to consider. 

The following is an excerpt from the “Eagle Eye Opener” dated Sept. 13, and it explains in detail why earnings growth is so important to understanding what could happen in markets next.

The market is trading at 20X expected 2022 S&P 500 EPS of $220. That’s 4,400 in the S&P 500. But if expected 2022 EPS falls to $210, then the general market “ceiling” would be 20 * 210, or 4,200. That’s more than 5% lower from here. Worse still, it’s unlikely the market would trade at a 20X multiple if earnings expectations were falling, which would put a “reasonable” level of the S&P 500 even lower (around 4,000, more than 10% lower).

Positively, a few earnings warnings don’t mean we’re going to see the overall EPS target for the S&P 500 materially cut. But this is a risk we need to watch closely, and you can be assured we will do just that.

In sum, the declines in stocks last week weren’t because the outlook turned materially worse, it did not. However, at these levels and these valuations the S&P 500 has essentially zero room for error. And as investors are forced to digest tapering headlines, tax hike threats, debt ceiling earnings and other issues, we should expect more volatility and the chance of a quick 5%-10% “air pocket” remains very real.

The bottom line here is that we all should expect to see more volatility in the coming weeks; however, more volatility doesn’t mean the end of the broader market rally.

And with the help of this publication, and with the daily analysis subscribers get in the “Eagle Eye Opener,” we can help you focus on making sure you can quickly differentiate between market “noise” and real, legitimate bearish gamechangers as we move towards Q4 and into the year’s end — and what can be better than that? 

***************************************************************

A Simple Formula 

“Sitting Alone is better than walking with the wrong people.”

— A.P.J. Abdul Kalam

What’s the secret to a happy life? Well, “happy” is different for everyone, but as humans, we generally share some basic characteristics and desires. Yet whatever our differences, there is one simple formula we can follow to enhance our existence. 

First, we can look at our interactions with others as a way for both participants to win, and not as a way for one party to defeat the other. Second, we should look to laugh along with everyone, and not laugh at anyone. Finally, we can employ the wisdom of former president of India, rocket scientist, writer and Renaissance Man, A.P.J. Abdul Kalam, by choosing to surround ourselves with the right people, and by not engaging in futile relationships with the wrong people. Do these three things and watch your life improve immediately.

Wisdom about money, investing and life can be found anywhere. If you have a good quote that you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.

The post The New Volatility Explained appeared first on Stock Investor.

Economics

China Is Responsible For More Than A Third Of World GDP Growth – This Is A Problem

China Is Responsible For More Than A Third Of World GDP Growth – This Is A Problem

As Deutsche Bank’s FX strategist George Saravelos writes…

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China Is Responsible For More Than A Third Of World GDP Growth - This Is A Problem

As Deutsche Bank's FX strategist George Saravelos writes in a recent research report he has been "on the pessimistic side of the reflation narrative for some time now."

In the note titled "three charts for pessimists", he admits that there are many more things happening to the global economy than easy fiscal and monetary policy, including a large negative supply-shock, in turn leading to sizeable demand destruction; stronger than expected precautionary saving behavior from consumers pushing down r*; and massive structural economic change on the back of COVID-led digitization across multiple sectors. And now we have to add China to the mix.

His first chart below highlights a simple observation: China has been acting as a massive global growth turbocharge since the start of the century, and is responsible for more than a third of world GDP growth. As Saravelos gloomily notes, "systemic risks of the unfolding property developer crisis aside, if the last few months experience are signaling a regime break in Chinese tolerance for what authorities have termed "low quality" growth, the world should take notice."

Back to the developed world, Saravelos' second chart shows there is still a massive hole in the UK labor market. Total hours worked are a whopping near-10% below trend compared to pre-COVID. Yet the market is now fully pricing a Bank of England rate hike early next year. For sure, wages are rising, but as a recent IFS study showed there are still massive disruptions in the UK labor market. It will take a brave central bank to hike in to such a hole. Even if it does, it is hardly positive for the currency.

Finally, there are two parallel universes. The global goods sector is overheated. Look no further than US consumption, which is half a trillion dollars above trend. But the US services sector is twice as large and half a trillion below trend. The analytical value of aggregate GDP metrics is severely lessened in the presence of such massive sectoral dislocations. In recent months, the goods sector has started decelerating faster than the services sector has quickened. How the consumer rebalances spending in coming months will be very important.

We are only at the very beginning of trying to understand the true post-COVID steady state, it will be a long ride.

Tyler Durden Fri, 09/24/2021 - 20:20
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Economics

Finally The Taper Tantrum, Or What’s Wrong With August?

If you’re fortunate to be able to do this long enough, you’re absolutely assured to get caught with your pants down and almost certainly more than once….

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If you’re fortunate to be able to do this long enough, you’re absolutely assured to get caught with your pants down and almost certainly more than once. In the short run, it’s all a crapshoot anyway. Markets fluctuate and never, ever go in a straight line. And just when you claim to be right on top, they yank the rug right out from under your conceit(s).

I’ve spent the past few weeks, really months pointing out how Federal Reserve policymakers via their compliant media hasn’t been able to provoke anything out of bonds. Not for lack of trying. Zilch. Nada. Forget tantrum, a whole lot of nothing even though taper – we’re always told – would spell the death of the bond “bull.” I’ve been almost gleefully highlighting how this policy farce has been greeted as a complete non-issue across all of those markets.

Until yesterday.

Finally, yields backed up both then and today in a notable selloff. Is this the long-awaited tantrum? Could it be something else?

For the former, start with Fed Governor Christopher Waller. Recall on August 2nd how Mr. Waller had appeared on CNBC and became the first voting FOMC member to encourage not just taper but a very quick one so as to clear enough calendar for a hard 2022 liftoff in rates.

Just two days later, it might appear his “go early, go fast” mantra caught on with at least some parts of the yield curve. From August 5 forward, the long end of the Treasury curve has been backing up from that recent mid-year low. August 4 was the last time before what is now a multi-week somewhat modest possibly reflationary action.

Before crowning Waller’s confidence, that particular date – August 4 – should ring a bell. Wasn’t it just last year, 2020, that longer-term bond yields had likewise bottomed out on this same day?

Yes, yes it was:



Obviously, the past two years began under very different circumstances; 2020 taking over from 2019 already close if not in recession (especially outside the US) and then the COVID errors. This year, 2021, opened in nearly opposite fashion with allegedly the whole world picking itself back up from all that damage and doing so boosted by every “stimulus” means known to man. Not just rebound, a fiery inflation-filled recovery. 

Yet, in the middle of both there’s more the same than different – questions about the initial “V” shaped recovery (which did not pan out) last year and then a pretty conspicuous “growth scare” this year many are plain hoping they can blame on delta COVID for the “unexpected” soft patch.

You probably also remember how that same label “growth scare” was also thrown around quite liberally in 2019, too. Back then, the only part of the yield curve anyone is told to pay attention to had inverted, not just provoking rate cuts out of a befuddled Jay Powell but raising mainstream alarms as to impending recession (which may actually have happened, but we’ll never know for sure given the timing of the coronavirus pandemic).

Wouldn’t you know it, the low point for LT UST’s in 2019 turned out to have been…August 28!



If twice could be random coincidence, yet three times is a pattern, what is four or five? Believe it or not, this same calendar shape can be found inside every one of the last five years – even 2018 when yields were more distorted as they neared their Reflation #3 peak. That year, the same sort of mid-year downward drift reaching its floor by August 20, 2018.

And the year before, during globally synchronized growth’s reported arrival, UST rates were, for the most part, moving lower (curve flattening) as the market kept rejecting the idea that there was some legitimately inflationary recovery taking shape. The low in yields for 2017? September 5 (OK, so not August but more than close enough).



Even 2015 and 2016 were pretty close in matching this seasonality; during the latter, yields bottomed out early July and then went up (a lot) later in the Autumn. The year before, 2015, as Euro$ #3 “matured”, again a mid-year low on August 24 (following CNY’s big theatrics) which had been the same day as the eurodollar shortage striking Wall Street equities (flash crash).

While there were a couple days later on in 2015 when the 10-year yield dropped a few bps lower than August 24, still the same general trend overall.

And that trend seems to have become intriguingly normal, manifested as a regular uptick in yields especially during September and October and then lasting through the end of each year (2018 the obvious exception given the eruption of Euro$ #4’s landmine). Quite simple enough, LT yields go up after August

Given this clear regularity, could any of these annual BOND ROUTs!!!! be considered reflationary?

Getting back to the original question, there’s quite a lot of evidence for something(s) other than Governor Waller’s melodramatic CNBC interview – or even the taper announcement and dots this week – which seems more likely to account for the bond market’s longer end behavior over the past five weeks. And this would also encompass the “big” selloff yesterday and today.

These last two days, then, have not been some unusual, tantrum-y eruption (look above at how far yields jumped in early September 2019 even as recession moved into the global forefront). Quite to the contrary, what’s happened so far over the past two months is entirely consistent with what seems to happen every year. Taper doesn’t. 

This could even mean I’m actually off-the-hook, my britches still fashioned tightly right where they need to be. The Fed’s people will continue trying to provoke a bond tantrum because of their need for the public to believe taper is in charge of interest rates, yet right at this moment there’s only evidence that bonds are just doing what they normally do without regard for dots and QE’s.

This only raises the question, of course, what the hell must be going on during the month of August? Sorry for the cliffhanger, but that I’ll save for another day. Feel free, however, to tweet or comment your theories and hopefully during next week’s podcast Emil Kalinowski and I will be able to discuss them.

 



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Precious Metals

Your cash will lose at least 5% of its purchasing power in the next year

Earlier this week, Fed Chair Jerome Powell announced that the real yield on dollar cash and cash equivalents is likely to be -5% or less over the next…

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Earlier this week, Fed Chair Jerome Powell announced that the real yield on dollar cash and cash equivalents is likely to be -5% or less over the next 12 months. Yes, your cash balances will lose at least 5% of their purchasing power over the next year, and that's virtually guaranteed. So what are you—and others—going to do about it?

Assumptions: This forecast of mine optimistically assumes that 1) the first Fed rate hike of 25 bps comes, as the market now expects, about a year from now, and 2) the rate of inflation slows over the next 12 months to 5% from its year-to-date rate of 5.9%. Personally, I think inflation next year likely will be higher, if only because of the delayed effect of soaring home prices on Owner's Equivalent Rent (about one-third of the CPI), the recent end of the eviction moratorium on rents, and the continued, unprecedented expansion of the M2 money supply.

I'm a supply-sider, and that means I believe in the power of incentives. Tax something less and you will get more of it. Tax something more and you will get less of it. Erode the value of the dollar at a 5% annual rate and people will almost certainly want to hold fewer dollars than they do today.

I'm also a monetarist, and that means I believe that if the supply of dollars (e.g., M2) increases by more than the demand for dollars, higher inflation will be the result. We've already seen this play out over the past year: the M2 money supply has grown by more than 25% (by far an all-time record) and inflation has accelerated from less than 2% to 6-8%. Massive fiscal deficits have played an important role in this, but so has an accommodative Fed. Between the Fed and the banking system, 3 to 4 trillion dollars of extra cash were created over the past 18 months. At first that was necessary to supply the huge demand for cash the followed in the wake of the Covid shutdowns. But now that things are returning to normal, people don't need or want that much cash. Yet the Fed continues to expand its balance sheet, and they won't finish "tapering" their purchases of notes and bonds until the middle of next year. That means that there will be trillions of dollars of cash sitting in retail bank accounts (checking, demand deposits and savings accounts) that people will be trying to unload.

If we're lucky, the inept and feckless Biden administration will be unable to pass its $1.5 trillion infrastructure and $3.5 trillion reconciliation bills in the next several weeks. This will lessen the pressure on the Fed to remain accommodative, but it's not clear at all whether it will encourage the Fed to reverse course before we have a huge inflation problem on our hands. Non-supply-siders (like Powell) view an additional $5 trillion of deficit-financed spending as an unalloyed stimulus for the economy. Supply-siders view it as a virtually guaranteed way to increase government control over the economy and thereby destroy growth incentives and productivity.

Amidst all this potential gloom, there are some very encouraging signs, believe it or not. Chief among them: household net worth has soared to a new high in nominal, real, and per capita terms. Also, believe it or not, the soaring federal debt has not outpaced the rise in the wealth of the private sector. See the following charts for more details:

Chart #1

Chart #1 is a reminder of just how low today's interest rates are relative to inflation. Terribly low! In normal times, a 4-5% inflation rate would call for 5-yr Treasury yields to be at least 4-5%. yet today they are not even 1%. The incentives this creates are pernicious: holding cash and/or Treasuries implies steep losses in terms of purchasing power. That in turn erodes the demand for cash and that fuels more spending and higher inflation.

Chart #2

Chart #2 shows the growth of the non-currency portion of M2 (currency today is about 10% of M2). Currency in circulation—currently about $2.1 trillion—is not an inflation threat, because no one holds currency that they don't want. The rest of M2, just over $18 trillion, is held by the public (not institutions) in banks, in the form of checking, savings, and various types of demand deposits. For many, many years M2 has grown at an annual rate of 6-7%. But beginning in March of last year, M2 growth broke all prior growth records. As the chart suggests, the non-currency portion of M2 is about 25% higher than it would have been had historical trends persisted. That means there is almost $4 trillion of "extra" money in the nation's banks. This extra money has been created by the same banks that are holding it: banks, it should be noted, are the only ones that can create cash money. The Fed can only create bank reserves, which banks must hold to collateralize their deposits. Today banks hold far more reserves than they need, so that means they have a virtually unlimited ability to create more deposits. And they have been very busy doing this over the past 18 months. 

For most of the past year I have been predicting that this huge expansion of the money supply would result in rising inflation, and so far that looks exactly like what has happened. People don't need to hold so much of their wealth in the form of cash, so they are trying to spend it. But if the Fed and the banks don't take steps to reduce the amount of cash, then the public's attempts to get rid of unwanted cash can only result in higher prices, and perhaps some extra spending-related growth. It's a classic case of too much money chasing too few goods and services. And Fed Chair Powell has just added some incentives for people to try to reduce their cash balances. He's fanning the flames of inflation at a time when there is plenty of dry fuel lying around.

Chart #3

Now for some good news. Chart #3 shows the evolution of household balance sheets in the form of four major categories. The one thing that is not soaring is debt, which has increased by a mere 20% since just prior to the 2008-09 Great Recession. 

Chart #4

With private sector debt having grown far less than total assets, households' leverage has declined by 45% from its all-time peak in mid-2008. The public hasn't had such a healthy balance sheet since the early 1970s (which was about the time that inflation started accelerating). Hmmm....

Chart #5

In inflation-adjusted terms, household net worth is at another all-time high: $142 trillion. 

Chart #6

On a per capita and inflation-adjusted basis, the story is the same (see Chart #6). We've never been richer as a society.

Chart #7

Total federal debt owed to the public is now about $22 trillion, or about the same as annual GDP. It hasn't been that high since WWII. So it's amazing that, as Chart #8 shows, federal debt has not exploded relative to the net worth of the private sector. As I've shown in previous posts, the burden of all that debt is historically quite low, thanks to extraordinarily low interest rates. 

Chart #8

Chart #8 adds some color to my prior post, "What's wrong with gold?" What it suggests is that gold prices are weak today because the market is anticipating higher short-term interest rates. The red line shows the yield on 3-yr forward Eurodollar futures contracts (inverted), which is a good proxy for where the market thinks the federal funds rate will be in three years' time. Gold peaked when forward interest rate expectations were at an all-time low. Why? Because super-low interest rates pose the risk of higher inflation. With the Fed now talking about raising rates (albeit sometime next year, and very slowly thereafter), gold doesn't make as much sense because forward-looking investors are judging the risk of future inflation to be somewhat less than it was a few years ago.

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