Alan's Alert 7-15-2021

 

Yesterday, Fed Chairman Jerome Powell sat (on zoom) before the US House Committee on Financial Services.  He was peppered with questions ranging from crypto (especially the rumored Fed-coin) to rolling back MBS purchases.  It was a marathon, but he held strong to his prepared remarks and deflected any questions that would show the Fed’s hand.  He is an expert at running out the clock on difficult questions.  There were a couple Congressmen that had very direct questions to Powell concerning inflation and what he means exactly when he says, “still a ways away” from reaching the Fed’s goals.  He was able to reiterate that the Fed won’t be removing their “accommodative” policy and would give plenty of advance warning when they would.  Mr. Powell sits in front of the Senate’s Financial Services committee today.  I expect it to be a re-run of yesterday. 

 

Unemployment stats were released this morning and initial claims continued its slow downward trend.  We are down 26k claims from last week.  This slow pace will keep the Fed in “accommodative” mode.  After yesterday’s hearing, it is strongly believed, by most of congress and the Fed, that the goal is an unemployment rate at 3.5%.  I think this is extremely foolish.

 

Here’s the full picture of the change in the unemployment rate since January of 1948:

The unemployment rate bottomed out at 4.4% at the lowest in the last cycle (March 2007) and 3.8% on the cycle before that (April 2000).  Then the rate didn’t break below 5.0% in the preceding two cycles.  To think that we’ll see an unemployment rate at or below 3.5% is ambitious at best and negligent of history at worst.  I’m of the mind that unemployment is still elevated but juicing the money supply isn’t the way to get it down.  This fact was brought up during yesterday’s hearing but nothing came of this insight.  There was no follow-up to ask who really benefits from the accommodative monetary policy if it doesn’t improve unemployment.  Our big fireworks moment was again, shelved for a different day. 

 

Looking in at the continued claims section of the unemployment report, you can see that people are still moving off the pandemic related unemployment assistance.  We have almost 10.4 million people using the assistance but every week, more are moving off.  I put together the below graph to illustrate the point:

 

The amount of people moving off the assistance is down from last week but the trend is higher.  At some point this trend will stall as all the states ending the emergency relief early will be exhausted and the rest of the states will hold out until September.

 

 

As I reflect on yesterday’s hearing, I am shocked at how flippant the Fed and Congress are at the sheer volume of money that they talk about.  Their talk is full of rosy outlooks with no worries in sight.  They have no idea of the tidal wave of inflation that could be staring them directly in the face.  Maybe some of them feel differently behind closed doors but they do a good job masking it.  As inflation is allowed to run hotter, higher interest rates will be needed to stem the tide.  If we are at 5% annual inflation, we’ll need the Fed funds rate at 6-7% to stop it.  If inflation runs at 8%, 10% or greater would be needed.  Currently, with the Fed funds rate at 0.0% to 0.25%, the Fed is a long way from even thinking there is problem.  It simply reinforces my view that we are still very early in this trend.

 

A friend and fellow subscriber mentioned to me that PBS Frontline put a documentary together called “The Power of the Fed”.  It aired on Tuesday and it’s certainly worth a watch.  The people that put the production together get some big players to sit down for interviews and ask them great questions.  It highlights the period from the 2008 crash through current day.  Its comical that some of these players (particularly Sheila Bair and Peter Fisher), have a completely different views of the Fed’s actions after they leave their cushy government posts.  A few have truly drunk the Kool-Aid.  Neel Kashkari is especially cringe-worthy.  He is a mirrored reflection of Arthur Burns and struggles to understand that the Fed’s monetary policy is reckless and exacerbates the income inequality we see today.  Neel is of the mind that printing vast sums of money is great for low-income individuals.  He is a dangerous individual because he has been given way more power than he should have and he wields it in a way that, he believes, benefits all people.  It reminds me of a C.S. Lewis quote:

 

Alan's Alert 6-29-2021

 

Things are going from hot to hotter across the board but especially in housing.  Today the S&P/Case-Shiller Index was released.  

This is an index that is based on the work of Karl Case and Robert Shiller.  These indices are calculated by using repeat sales of the same homes in an effort to study home pricing trends.  Robert Shiller used the index in his book Irrational Exuberance to analyze long term trends in home prices.  He came to the conclusion that the pattern of changes in home prices had no relation to changes in construction costs, interest rates, or population but that the difference in prices can be explained by inflation.  There’s a strong perception that house prices are continuously increasing and this can fuel bubbles in real estate.  Shiller went on to define irrational exuberance by stating, "Irrational exuberance is the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to it partly through envy of others’ successes and partly through a gambler's excitement.”

Shiller’s insights are spot on and I highly recommend his book and the YouTube of his courses at Yale.  It’s a good reminder to get into position to take advantage of the trends in the market before the amplification process takes hold.  We’ve seen this most recently with “meme” stocks such as AMC and Gamestop.  Once the enthusiasm of these stocks was picked up by the news media, they spiraled outside the bounds of any basis in fundamentals, even if those fundamentals are based on the idea of a short-squeeze.

In staying with the housing news, the US Federal Housing Finance Agency posted the house price index.

I’ve adjusted the chart to reflect the percentage change from the previous quarter.  As you can see, similar to the Case-Shiller index, we are moving higher in prices for homes.  If we annualize the data and look at it as a percentage change it gives us this:

If Robert Shiller’s insights into the housing market are to be trusted, looking at the house price index in this fashion should give us the best picture of what inflation actually looks like.  Unfortunately, we only get a small peek into the latter part of the 1970s but that small window speaks volumes.

 

Overlaying annualized CPI data, we see that it tracks really well until 1998.

1998 is when the BLS made a “revision” to the way the CPI was calculated.  You can find more info on that here.  In short, they changed the way that the housing index influenced the CPI.  I touched on this topic yesterday with Stephen Roach’s article on Chairman Arthur Burns adjusting the CPI.  Now we see that it had happened again in 1998.  Even though the Fed has stated that they will tolerate higher inflation in the present to make up for the low inflation in the past, I would not put it past the Fed or BLS to “adjust” the CPI to downplay the tidal wave that is coming.

 

 

In other hot news items, the Consumer Confidence Index was posted by the Conference Board.

They revised last month’s reading up to 120.0 and posted the June reading at 127.3.  This was a complete about-face to the consensus estimate of 119.  Neither rises in prices, nor back-orders, nor shortages, nor bottlenecks stay consumers from their swift purchases of goods and services.  According to Senior Director of Economic Indicators at The Conference Board, Lynn Franco, “Consumer confidence increased in June and is currently at its highest-level sine the onset of the pandemic’s first surge in March 2020.  Consumers’ short-term optimism rebounded, buoyed by expectations that business conditions and their own financial prospect will continue improving in the months ahead.  While short-term inflation expectations increased, this had little impact on consumers’ confidence or purchasing intentions.  In fact, the proportion of consumers planning to purchase homes, automobiles, and major appliances all rose – a sign that consumer spending will continue to support economic growth in the short-term.  Vacation intentions also rose, reflecting a continued increase in spending on services.”

 

With consumers not discouraged by rising prices, the “transitory” story that the Fed is touting looks less and less believable.

Alan's Alert 6-28-2021

 

I re-watched The Big Short recently.  The movie was based on the book by Michael Lewis which follows the accounts of several people who predicted the housing market collapse.  Now I don’t think the book was Mr. Lewis’s best (see Flash Boys or The Undoing Project), and I don’t even think that it was the best movie based on one of his books (see Moneyball) but it holds a special place in my movie library.  This is mainly due to the movie’s portrayal of Dr Michael Burry.  

Dr Burry had accurately predicted that subprime mortgages (especially those with “teaser” rates such as 3/1, 5/1, 7/1, & pay-option ARMs) would adjust to higher rates causing homeowners to be unable to afford their mortgage.  This in turn would cause the bonds built on top of these mortgages to fall in value.  To trade this thesis, Dr Burry purchased credit default swaps against these subprime deals.  Between the time of his purchasing of the swaps and the eventual collapse of the subprime market, Dr Burry was under extreme pressure from the investors in his fund.  Many worried that his predictions were inaccurate and demanded to withdraw their capital.

 

So, why do I bring all this up? Two reasons.  The first is that Dr Burry saw something going on in the market, set up a trade in his favor, and then had the patience to see it through.  This all in the face of people telling him that he was wrong and the trade moving against him.  However, his perseverance paid off.  I feel we are encountering a similar time now as the Fed has just gone on a gaslighting tour that seems to have spilled over into this week. NY Fed Presidents Williams, Vice Chair Quarles, and Pres Barkins are speaking today. Barkins is also speaking tomorrow and Wednesday.  Bostic also speaks on Wednesday, as well as Thursday.  We’ve seen the tidal wave of inflation that is coming our way with high CPI and PCE readings.  I wouldn’t put it past the Fed to change the way they look at these statistics in order to downplay their significance.  In fact, this very thing has happened before.  Stephen Roach, who served on the research staff at the Fed from ‘72 until ‘79, wrote an opinion piece last month for Project Syndicate that was picked up by MarketWatch.  You can find it here.  In it, he details how the Fed chairman at the time (Arthur Burns), would argue that the inflation that was happening was transitory (!!).  He would purposely exclude items from the CPI because he argued that these items were experiencing increases that had nothing to do with monetary policy.  Things like oil, gas, and food.  This is how we ended up with the “core” CPI/PCE indexes.  Burns even argued that an El Nino event which decimated Peruvian anchovies was the cause of rising fertilizer, which in turn raised food prices.  Burns didn’t concede that monetary policy was the issue until 1975.  Now what does Mark Twain have to say about this?

 

The second reason I bring up Dr Burry’s story is that he reopened his hedge fund in 2013.  He is required by the SEC to disclose his holdings (13F reports) because he has over $100M in assets under management.  I know that he was bullish on Gamestop (GME) in 2019, so I looked up his 13F to see what he was up to now.  Anyone can do this by going to the SEC’s Edgar search found here.  Using the search, you can lookup public companies to review their quarterly statements and hedge funds who file the 13F reports, as well as a litany of other info such as merger/acquisition announcements and insiders buying or selling their stock.  Here’s the link to Dr Burry’s latest filing.

 

What jumped out to me was this:

Dr. Burry has put on a big bet that interest rates are going up.  He has put options against TLT which is the 20+ year treasury ETF, call options on the ultra-short 20+ year treasury ETF, 300k shares of that same ultra-short ETF, and calls on the -3x 20+ year treasury ETF.  For those of you who don’t trade options, I’ll put out a primer later.  In the meantime, this is quite a position against interest rates.  Dr. Burry, like myself, believes that the Fed has painted itself into a corner and will eventually need to raise interest rates.  The Fed wants to keep interest rates low but this feeds the inflation that is coming.

 

The problem the Fed faces is that by raising interest rates, the stock market will get crushed.  Especially the growth stocks and growth stock ETF’s like the QQQ and IWO (which Dr. Burry is also betting against).  This is because growth stocks are heavily reliant on high P/E ratios which discount future earnings.  These stocks look really good when interest rates are low but when interest rates are high, future earnings aren’t valued as high.

 

So, what’s an investor to do?

Important and Potential Market Moving Events This Week

 

Monday, June 28
6am NY Fed Pres Williams speech at the BIS
7.30am Dallas Fed Manufacturing Index (June)
9am Richmond Fed Pres Barking speaks at Rotary Club of Atlanta
10am Vice Fed Chair Quarles speaks at Utah Bankers Association
 
Tuesday, June 29
6am FHFA house price index (April) & Case-Shiller index (April)
6am Richmond Fed Pres Barkin speaks at MNI event
7am Conference Board consumer confidence (June)
 
Wednesday, June 30
5am Fed Pres Bostic speaks are Buckhead Coalition event
5.15am ADP employment report (June)
7am Pending home sales (May)
10am Richmond Fed Pres Barkin speaks at Northern Virginia Hispanic American Chamber of Commerce
 
Thursday, July 1
6.45am Markit manufacturing PMI (June)
7am ISM Manufacturing Index (June)
7am Construction spending (May)
11am Atlanta Fed Pres Bostic speaks are Habitat for Humanity event
 
Friday, July 2
5.30am Nonfarm payroll employment (June)