Notes:
-I have a new channel on YouTube where I share my latest thoughts on markets and investing. You can view the most recent video here.
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The charts and themes from the past week that tell an interesting story in markets and investing…
1) Tomorrow’s News Today
I can’t predict the future, but I can predict Fed policy actions with pinpoint accuracy a day in advance.
No, I don’t have a crystal ball. It’s just pattern recognition. In every meeting since 2009, the Fed has done exactly what the market has expected it to do.
And last week was no exception…
The Fed increased interest rates by 50 bps, the 7th rate hike this year. That brings the Fed Funds Rate up to a new range of 4.25-4.50%, its highest level since December 2007.
Both stocks and bonds have been hit hard by this rapid adjustment in the “risk-free” rate, with a US 60/40 portfolio on pace for its worst year since 2008.
On the other side of the coin, this has been a sea change for savers. The top yields on FDIC-insured savings accounts are up to 4.35% and will likely continue rising as we approach the next FOMC meeting.
Here’s an incredible stat. In 2021, risky Junk Bonds had a lower yield (3.92%) than risk-free savings accounts are offering today. What you had to reach for a year ago you can now obtain with no risk.
2) 7 Down, 2 to Go?
All eyes are now focused on what the Fed will do in 2023.
What is the market expecting?
Just 2 more hikes: a 25 bps increase in February 2023 (to 4.50-4.75%) and another 25 bps in March 2023 (to 4.75-5.00%). After that, a pause is anticipated followed by rate cuts starting in November 2023.
A recent poll I ran showed that the majority (54.6%) does not believe the Fed will hike rates above 5%. As for the rest of the respondents, most do not see rates rising above 6%.
3) Nearing the End of the Hiking Cycle?
Why does the collective market believe the Fed is nearing the end of its rate-hiking cycle?
Three reasons.
First, the slowing US economy, which the vast majority (85%) believe is either already in a recession or will enter a recession in 2023.
Second, the US national debt continues to grow (current deficit is $1.3 trillion) and the interest expense on that debt is rising rapidly. Further rate hikes will only add to this problem. In theory, the Fed is supposed to be an impendent body that does not insert itself into fiscal matters, but their actions in 2020/2021 proved otherwise.
Third, all signs are pointing to lower inflation ahead.
Last week’s CPI report confirmed this, showing the 5th consecutive decline in the year-over-year inflation rate. At 7.1%, this is now 2% below the peak inflation rate from June.
With the exception of Shelter (which is lagging the real-time decline in rents & home prices), all of the major CPI components showed a lower YoY % increase in November than October.
Shelter CPI is still playing catch up to reality as it had been wildly understating the actual increases in housing costs. That gap remains but is narrowing fast as rents are now falling while Shelter CPI continues to move higher.
In additional to CPI, other inflation readings continue to moderate:
- US Import Prices increased 2.7% over last year, the 8th consecutive decline in the YoY rate-of-change and the lowest level since January 2021.
- US Producer Prices (PPI) increased 7.40% over the last year, the smallest YoY increase since May 2021. PPI peaked at 11.66% back in March.
- Market-based inflation expectations (10-year breakevens) are at a 22-month low, approaching their historical average of roughly 2%.
4) Grumpy Consumers
Inflation may be moderating, but that’s little consolation to US workers who have now experienced 20 consecutive months of prices rising faster than their wages.
To combat this trend, workers continue to seek new jobs that offer higher pay. Those that have made the switch have been rewarded, receiving pay increases of 7.7% over the last year vs. 5.5% for those who stayed at their jobs. With data going back to 1997, this is the widest gap we’ve ever seen.
Still, for many workers switching jobs is not an option, and US consumers have not been happy with their loss in purchasing power.
The evidence: an all-time low this year in the University of Michigan’s confidence index and 8 consecutive months below 60. That’s the longest run of extreme negative consumer sentiment that we’ve ever seen with data going back to 1952. The prior record was 4 straight months during the 1980 recession.
This negative sentiment is just starting to translate into changing consumer behavior. US Retail Sales rose 5.4% over the last year, the slowest increase since March. And inflation-adjusted sales declined on a year-over-year basis for the 3rd consecutive month.
5) A Christmas Miracle
Gas prices in the US are now 16 cents lower than they were a year ago, down 37% from their peak in June. This unexpected surprise is leaving more money in the pockets of consumers at a time when they need it the most.
Incredibly, gasoline future are now down 3% on the year after being up over 90% at their peak in June.
This is a stunning reversal that resembles the 2nd half of 2008 when commodity prices plummeted as the global recession deepened.
On that point, Global PMI Output hit a 29-month low in November, with manufacturing output and service sector business activity falling at the fastest rates since June 2020.
Global growth rates have already slowed significantly in most countries, with a deeper slowdown expected in 2023.
6) Timberrrrr!
Lumber prices are at their lowest levels since June 2020, down 79% from the peak in May 2021.
Why the crash?
The housing recession and collapse in demand.
-The US Housing Market Index (measure of homebuilder confidence) fell for the 12th consecutive month to its lowest level since April 2020. Before April 2020 (which was a short-lived decline during the pandemic shutdowns), this is the lowest we’ve seen since June 2012.
-US Building Permits hit a 29-month low in November, down 22% year-over-year.
-US home prices are now close to flat on a YoY basis and down over 10% from their peak in June.
7) Blame the Fed or FOMO?
Tesla is now down over 66% from its peak in November 2021, the largest drawdown in the company’s history.
Elon Musk is laying the blame squarely on the Fed and rising interest rates.
While that’s certainly been a factor, this ignores what happened in 2020: a FOMO-induced mania that drove Tesla’s stock priced up 743% while its revenues increased just 28% that year.
That pushed Tesla’s price to sales ratio to over 30x, a valuation nearly impossible to sustain. As I wrote back then: “when expectations are this high, investors would be wise to understand what that means: the odds are increasingly stacked against them. For even if the company executes flawlessly in the years to come, its share price performance will ultimately be dependent on future investors maintaining their lofty expectations.”
8) Where’s the Holiday Cheer?
The ratio of equity puts (bearish bets) to calls (bullish bets) over the last 30 trading days has only been this high a few times in the past: April 2008 and Oct/Nov 2008 (note: data goes back to 2003).
At the same time, Wall Street strategists (a perennially optimistic bunch) are predicting a down year in 2023 for the first time in decades.
And that’s it for this week.
Have a Merry Christmas/Happy Hannukah!
-Charlie
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