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 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)

Alan's Alert 6-21-2021

 

The FED is going on tour.  After last week’s FOMC meeting, and the market’s subsequent reaction, the Fed is putting on a show for us this week.  The highlight of the week will be J. Powell’s testimony tomorrow at the House select subcommittee on the Covid crisis, although it’s doubtful he’ll say anything about the FOMC meeting or future Fed policy.  Today Bullard and Kaplan discussed the economic outlook and Williams speaks at a banking conference later today.  Tomorrow is Powell but before him SF’s Daly and Cleveland’s Mester will be speaking at separate events.  Wednesday, we hear from Bowman, Atlanta Pres Bostic, and Boston Pres Rosengren.

 

This is quite a line-up for the week.  Usually, we’re lucky to get a couple speeches but it looks like the Fed is going all out.  What gives?  Do you think the hot inflation numbers coming out and the market’s reaction to “talking about, talking about tapering” have anything to do with it?  The Fed did a good job last time calming fears over the high CPI print 6 weeks ago.  They are likely trying to play the same song again this week.

 

Below is a look at interest rates on the 1-year, 5-year, 10-year, and 30-year treasuries.

You can see in the left-hand third that the spreads were wide, meaning the banks were making a lot of money by loaning long and borrowing short.  Then in the middle-third, rates compressed, banks struggled, it looked like rates were going to rise.  There was a lot of talk in the financial news of an impending recession.  When banks stop lending, new money doesn’t make it into the system, causing the economy to tighten.  In the right-third, the shutdown had the effect of money looking for safety.  All the rates were bid down because everyone wanted the safety of a treasury.  Coming out of the lockdown, rates started to spread again, giving banks another opportunity to lend long and borrow short.  Since the FOMC meeting, however, rates have started to move the other way.  Is this just a breather before they resume their rise?  The Fed sure hopes so!  Otherwise, this tour they are going on will be for naught as no tapering of asset purchases will happen.

Important and Potential Market Moving Events This Week

Tuesday, June 22
6am Existing Home Sales (May)
7am Fed Daly Speech
9am H.6 Money Stock
10am Fed Chair Powell Testimony
12.30pm API Crude Oil Stock Change
 
Wednesday, June 23
5.10am Fed Bowman Speech
5.45am PMI Flash (Jun)
6am New Home Sales (May)
6.30am EIA Crude & Gas Stocks Change
7am Fed Bostic Speech
 
Thursday, June 24
7am Fed Williams Speech
 
Friday, June 25
4.30am Personal Income & Spending (May)
4.30am PCE Price Index (May)
6am Michigan Inflation Expectations