Alan's Alert 8-2-2021

 

Over the weekend I dove head-first into what the odds of another lockdown truly are and what it would actually look like.  I came to the realization that it is probably going to happen.  The government is trapped in an echo chamber.  They are desperate to keep a stranglehold on the power that they got from the first round of lockdowns.  In fact, roughly an hour ago, Posobiec tweeted again:

 

What will be interesting this time around will be the public’s reaction.  The first round of lockdowns worked because the public had been whipped into a frenzy about covid.  It was a completely unknown disease and the media pounded the “novel” portion into the public’s head.  It was constantly repeated that this wasn’t the flu.  The reports out of China looked dire.  Anybody remember seeing the videos of people falling down face first in the streets of China?
 
This time around, things are different.  We have several vaccines available, some people now have had the virus and have natural immunity, and the public has witnessed the devastation that a lockdown has on the economy.  To be able to pull off a repeat of the March 2020 lockdown, looks like a tall task.  If it happens, I believe we will have a bifurcation.  Blue states will jump at the chance to lockdown once more.  Red states will be leery.
 
There is a chance that this is completely overblown and there will be no lockdown.  The administration could authorize some other kind of emergency measure and avoid a shutdown of the economy. 
 
Ultimately, my job as an investor isn’t to decide what policy is best, it is to see through the smoke and mirrors to understand what the market’s reaction will be.  Unfortunately, we have only one instance of data on what a lockdown does to the stock market and that data isn’t good.  The last lockdown saw a deep drawdown of the all the general market indices.  Even silver crashed by 30%.  Oil by 68%.  However, had you bought at the end of March, you would be sitting on terrific gains.  Since this lockdown could look different, it is anyone’s guess how the market will react.

 

 

 

 

 

 

Construction spending continues to decline from its pre-shutdown peak.  This is bad news for the continued expansion of the economy.

 

Construction spending is split into two categories, residential and non-residential.  A closer look reveals a big slowdown in non-residential construction.  This tells me that businesses reliant on providing services to construction companies will begin to contract.  This should worry anyone who believes in the skyscraper effect.  The theory was put forth by a British economist named Andrew Lawrence in 1999.  It has been refined over the years by Dr. Mark Thornton.  Dr. Thornton has a book named, “The Skyscraper Curse” which you can read for free on Mises.org.  I’ve not read it but I’ve listened to several of Mark’s interviews and read a few of his articles on the subject.  These two stand out to me in particular; Skyscrapers and Business Cycles and this interview with the Mises Institute.  The takeaway, when the construction of new skyscrapers stops, economic hardship is not far behind. 

 

 

The Federal Reserve posted new data for the assets and liabilities of commercial banks in the US on Friday.  The decline of commercial and industrial loans continues while non-commercial loans and leases saw a small increase.

 

 

 

It looks like the economy is running out of steam.  How will the economy continue its expansion phase without new loans and business expansion?  Where will new growth come from?  Meanwhile, deposits at banks continue to run above trend.

 

 

Consumers are now sitting on a stockpile of cash in the bank.  Ironically, the banks don’t want it.  They’ve been furiously sending it back to the Fed in hopes of achieving any sort of return.  Even if that return is 0.05%

 

 

Earlier this year, New York Fed President John Williams had indicated that the repo markets were working as expected.  The Fed has spilled liquidity into the banks, now the Fed is mopping up the excess through these facilities.

 

 

Finally, I wanted to take a quick look at interest rates.

 

The 10-year minus the 2-year treasury is still in positive territory.  The spread has come down sharply since the peak at the end of March. 

 

Looking at the big picture, rates appear to be flatlining.

Typically, this is great news for investors.  Flat/declining rates mean that investors should go long growth vs value stocks.  Fixed income is also a good buy.  Emerging markets and commodities would struggle.  The trouble is that the rates at starting so low that they don’t have far to fall.  This could be a very short rally for this trend.

 

 

Alan's Alert 7-26-2021

 

Someone is shining a laser at the housing market.  Recently the price of lumber had skyrocketed and now it has crashed back down.  This caused headaches for builders as many projects had to be re-bid or had escalation clauses inserted to cover lumber market volatility.  Now that the price is quickly plunging to pre-shutdown levels, home sales data has turned weak.  The mad scramble to buy a house is beginning to fade.  Last week I had touched on housing starts and building permits.  Not included in that data was that mortgage applications had declined 4%.  I felt this was a normal reaction after they had surged 16% in the previous week.  This morning the US Census Bureau released their New Home Sales report.  It came in at -6.6%.  This is in stark contrast to the consensus estimate of +3.5%.  

This is the third consecutive decline.  You can see from the chart; it has quickly reverted to the trend-line of the past ten years.  Also, the median sales price has decrease from $374,400 to $361,800.  More houses are starting to hit the market pushing inventories up to 6.3 months’ worth of supply.  This puts it in line with where it was prior to the government shutdowns. 

 

Home prices and sales are an important indicator.  Just like the stock market, the housing market is powerfully impacted by the Fed’s money pump.  These markets require ever increasing amounts of new money to continue to breakout to dizzying new heights.  Tomorrow we’ll get a look at the Fed’s money pump when they release their H.6 money supply data.

 

 

The banking picture continues to look rough.

Lending has run out of steam.  New business loans are not being created. 

 

On the consumer side:

Savings is up and credit card use is down.  When everyone was locked down by the government, did they go on a Dave Ramsey reading spree?  The “financial guru” emphasizes paying off debt and saving 3-6 months’ worth of expenses.  That looks exactly like what is going on here.  If this trend were to reverse, inflation would be roaring into the market.  Currently it is trickling in, here and there.

 

 

This is a big week for market moving events.  The Federal Reserve Open Market Committee (FOMC) meets for 2 days starting tomorrow.  A summary press conference will be given on Wednesday.  Tomorrow, the Fed also releases the money supply data and Friday, their favorite inflation indicator (Personal Consumption Expenditure) is posted.

Important and Potential Market Moving Events This Week

 

Tuesday, July 27
5.30am Durable Goods Orders (June)
6am S&P/Case-Shiller Home Prices (May)
6am House Price Index (May)
7am CB Consumer Confidence (July)
9am H.6 M2 Money Supply
 
Wednesday, July 28
5.30am Wholesale Inventories (June)
11am Fed Interest Rate Decision
11.30am Fed Press Conference
 
Thursday, July 29
5.30am Initial and Continuing Jobless Claims
5.30am GDP (2^nd Quarter)
7am Pending Home Sales (June)
 
Friday, July 30
5.30am Personal Saving Rate (July)
5.30am Personal Consumption Expenditures (July)
 
 

Alan's Alert 7-19-2021

 

On Friday afternoon, the Fed released the H.8 Assets and Liabilities of Commercial Banks data. The numbers look terrible. The Fed has flooded the banks with funds and the banks have pushed it back to the Fed.

Commercial and Industrial loan figures continue their downfall.

Loans and leases have flatlined.

This signals to me that the Fed has failed to spur the banks to lend. The Fed printed absurd amounts of money and gave it to the banks, yet the banks have pushed the funds back to the Fed through the reverse repurchase (repo) market.

This has caused the repo market use to skyrocket. Its use continues to be at elevated levels.

Quality collateral is becoming scarce. Banks want short-dated treasuries, not dollars. They participate in the repo market to get their needs met. These are the charts that the Fed doesn’t want to look at.

Not only are the banks not spending money, consumers are stuffing the banks with their cash as well.

Bank of America had anticipated that these funds would be spent when a “sunny day” came along. I’m wondering now when that sunny day will arrive. These additional funds are reflected in the numbers as elevated personal saving rates. After hovering around 7% for a decade, American’s personal saving rates have risen considerably.

This is nightmare fuel for the Fed. Try as they might, they will be powerless to stop the downturn that is coming. What the Fed fails to realize is that they have created a failure of epic proportions.

They’ve suppressed interest rates for so long that they have distorted the banks’ incentives. Now they’ve printed a ridiculous amount of money and flooded the system with it. Banks are starved for yield yet, the banks know that if they borrow short and lend long, they will earn a negative return. This is because “real” interest rates are negative. What is the “real” interest rate? That would be the market rate minus the inflation rate. Below I’ve plotted the 10yr and 30yr treasury rates minus the CPI to give us an idea of what the “real” return for a bank would be.

It’s no wonder the banks don’t want to lend. It’s a losing proposition! This is why the repo market looks so good to them.

I was immediately curious how this compares to the 70s, lo-and-behold;

The 1970s and the early 80s both had a bout of negative “real” rates. This was a terrible time for the Nasdaq and a tremendous time for gold.

Typically, during a recession inflation will fall. This is because there is a demand to hold cash balances. This demand had been suppressed during the boom phase of the economy. Firms that have inventory will discount it to raise cash. There is low wage growth and increasing unemployment. Commodity prices drop due to reduced demand. Asset prices fall, especially the stock market and the housing market. The problem is, this will not be a deflationary recession. Businesses are hovering around all-time lows for their inventory to sales ratio. Wage growth is happening and there is a great demand for employees. Commodity prices are up and rising. Asset prices are reaching nosebleed levels. We are in the upside-down world which means we’ll see a recession and inflation. Buckle up, the ride back to the 1970s could be a bumpy one.

Important and Potential Market Moving Events

 This Week

Tuesday, July 20
5.30am Housing Starts and Building Permits (June)

Wednesday, July 21
4am Mortgage Applications (16/June)

Thursday, July 22
5.30am Initial and Continuing Jobless Claims

7am Existing Home Sales (June)

Friday, July 23
6.45am Markit Manufacturing, Composite, & Services PMI (July)

*all times Alan standard time (PST)

Alan's Alert 7-12-2021

 

The Fed released the H.8 Assets and Liabilities of Commercial Banks, Friday afternoon. Commercial and industrial loans continue to crash. They are down 2.4% month-over-month.   

You can see the spike at the beginning of the shutdowns. Many businesses drew on their lines of credit and participated in the PPP loan program. Since that time, lines are getting paid down, and new loans are not getting originated.

When you look at all loans that banks are creating and subtract the commercial and industrial portion, consumers are borrowing at a rate that is increasing at 2.3% month over month.

These loans would be mortgages, car loans, student loans, home equity and personal lines of credit.

Rothbard stated that business borrowing would expand the money supply. I’m not sure he ever thought the Fed would do what it has done to date to juice the money supply. It remains to be seen if businesses will come back to the table to borrow. I think that many are unsure of the future. When the future is difficult to predict, businesses don’t want to take a chance on borrowing money for expansions. In time, the full picture will develop. In the meantime, it will be important to keep an eye on the yield curve and the money supply.

Using Bank of America’s favorite stimulus money tracker, deposits at commercial banks are still well above the trend line.

Consumers are holding approximately $2.5 trillion above the pre-shutdown trend. Now, these “excess” holdings have come down 0.3% on a week-over-week basis. Bank of America stated that these consumers would be ready to spend when a “sunny day” arrived.

Consumers holding this much money also have high expectations of future inflation.

I don’t think we should be giving too much weight to this. It is interesting to see the up-tick in expectations. The rate increased to 4.8% in June. It’s a new high for the series and the eighth straight month of increase. I’m sure its just transitory guys. Nothing to see here. Just people who seeing rising prices in the grocery store, at the gas pump, and rent.

Important and Potential Market Moving Events 

This Week

Tuesday, July 13
5.30am CPI (June)

Wednesday, July 14
5.30am PPI (June)
9am Fed Chair Powell Testimony to Congress

Thursday, July 15
5.30am Initial Jobless Claims
5.30am Import/Export Prices (June)
6.15am Industrial & Manufacturing Production (June)

Friday, July 16
5.30am Retail Sales (June)
7am U of Michigan Consumer Sentiment (Prelim for July)

Alan's Alert 7-2-2021

 

This morning employment situation data was released including the unemployment rate and nonfarm payrolls. The unemployment rate ticked up .1% to 5.9%. This was a shock to the bank research teams who had a consensus estimate of 5.7%. Nonfarm private payrolls increased by 662k; this surpassed the consensus estimate of 600k. The labor participation rate was also released and it showed it holding steady at 61.6%.

And while this may sound confusing that unemployment would go up while jobs are being added my attention was elsewhere:

Above are the average hourly earnings of all employees. I’ve added the red trend-line to show how much above trend we are currently running. The current average hourly rate is $30.40/hour. That is approximately $0.65 above the trend. The earnings rate increased at a rate of 0.3% month-over-month. This is funneling more money into workers’ pockets and is going to continue to put upward pressure on prices. I believe it will also incentivize more workers to search for jobs.

A wild card to keep in mind;

When the government unemployment bonuses officially end in September, employers will have difficult decisions to make. Some believe that wages will be suppressed when this happens. They believe that with an influx of new people hitting the job market, that this would put downward pressure on wages. I have a hard time believing this. New workers may be started at a lower wage but once a worker has been hired at a specific wage, employers rarely reduce that wage because they worry that the time and training that the employee has received will go to waste if they leave. What happens to employers when confronted by employees that do the same job and aren’t paid the same rate? Workers discuss their wage rates. It happens. Will employers feel obligated to match wage rates? Will there be strife and contention? That surely doesn’t make for a positive work environment. This is something to ponder as we move through the summer and see more states drop the federal bonus payments.

Every Friday the Fed posts the Assets and Liabilities of Commercial Banks. According to Mises (and Rothbard), bank credit to business is what generates the boom-bust cycle of the market. When banks are lending to businesses, businesses are expanding and generating income, which then fuels the fractional reserve system. Pairing the lending data with the money supply data gives me a better picture on what is going on with the economy. Unfortunately, the shutdowns have put a real wrench in the numbers:

Businesses borrowed PPP money, drew on their lines of credit, and did anything they could to withstand the long government shutdown. You see this in the big run-up with a peak in May 2020. These actions broke the trendline and have muddy the waters. Businesses now feel unsafe borrowing money until future economic conditions are more certain. Since the Fed updates this data late on Fridays, I’ll be spending more time on Monday mornings reviewing it.

Lastly, durable goods:

Orders have rebounded after the slight drop in April. They increased 2.3% month-over-month and are close to the pre-shutdown high of 255,924. It seems to me that consumers are continuing to purchase and are making up for lost time.

As a reminder, there will be no alert on Monday, July 5^th, as the market will be closed. Hope you all enjoy the 4^th of July weekend!

Alan's Alert 6-18-2021

 

It feels like the wheels are getting a little loose.  The Fed meets, raises the rate on their reverse repo function and what happens?  We have a record in the use of the facility.

NY Fed President John Williams assured investors weeks ago that the repo facility was functioning as it was supposed to.  This was reiterated by Jerome Powell at the press conference on Wednesday.  He said that the reverse repo facility “which is to provide a floor under money-market rates and keep the federal-funds rate well within its – well within its range. So, we’re not concerned”.

 

I know that this is not an easy concept to understand.  Wall street likes to make things sound as complicated as possible so that you’ll give up trying to understand them.  The less transparent and more complicated, the more money wall street firms can make.

 

What has happened is the Fed has stuffed the banks full of cash.  They were concerned that the government shutdowns would create a crisis.  When all you have is a hammer, every problem looks like a nail.  The Fed’s hammer is to create money and push it to the big banks.  Total reserves of financial institutions have skyrocketed.

Now the banks are pushing it back to the Fed.  Banks get interest on the reserves they hold at the Fed.  While the banks and the Fed would rather find a customer to lend these funds to, the market for commercial and industrial loans is running dry.

To recap; the Fed created massive new money and shoved it into the banking system because they were nervous about a market crash due to the government shutting down the economy.  The banks couldn’t find anyone to lend the money to so they are pushing it back to the Fed.  Its like a game of hot potato.

So, where do we go from here?  The Fed has created enough money to make inflation explode.  The government gave some of that money directly to consumers in the form of relief payments.  Some made it into the system through the PPP loans to businesses.  Due to the shutdowns, many businesses have collapsed.  Banks are having a hard time finding customers to lend money to, so they are doing what they can to earn a return.  Things are looking downright frothy.  We seem to be in slow boil mode.  I’m patiently waiting for a catalyst to set inflation to warp drive.  What would the catalyst look like?  There are many but a few of the big ones would be; bank lending picking up, wage rates running high, or a change in consumer sentiment. 

The Fed updates the M2 money supply next week.  This will be an important indicator to determine if the Fed will slow down the printing presses.