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) Climbing the Wall of Worry
Inflation. Fed tightening. Falling earnings. Economic weakness. War.
There’s been no shortage of things for investors to worry about in recent months.
And worry they have, as evidenced by the longest streak of negativity that we’ve ever seen in the AAII sentiment poll (36 weeks and counting).
The equity market has been climbing this wall, with a 17% rally off of the October lows. As a result, the S&P 500 is back above its 200-day moving average for the first time since April.
Is this rally going to have a different ending than the previous four, which were all followed by lower lows?
The majority doesn’t seem to believe so, as evidenced by this recent poll…
2) Impending Weakness
Chief among investor concerns are signs pointing to impending weakness in the US economy.
The Chicago PMI (a measure of manufacturing activity) has only been this low in the past during recessions (last in 2020, before that in 2008-09).
And the yield curve continues to fall deeper into inverted territory, with the 3-Month Treasury bill yield now 0.83% higher than the 10-Year Treasury bond.
In the last 60 years, the only periods with equal or greater inversion:
-2000 (recession in 2001)
-1979-82 (recessions in 1980, 1981-82)
-1974 (recession in 1973-75)
3) Moderating the Pace
How is the yield curve inversion deepening?
Short-term Treasury yields (3-Month) are still trending upward while longer-term Treasury yields (10-Year, 30-Year) have been falling over the past month.
And why is that happening?
a) Markets are pricing in continued Fed hikes that will drive short-term yields higher.
b) Long-term treasuries are getting a bid (yields falling) on the expectation of slower economic growth and a lower rate of inflation.
In a speech this week, Fed chair Powell said “the time for moderating the pace of rate increases may come as soon as the December meeting.”
Translation: a smaller 50 bps hike at the December 14 meeting. This will the 7th rate hike in a row and bring the Fed Funds Rate up to a new range of 4.25%-4.50%. The last time it was that high? December 2007.
This is great news for savers, as yields on FDIC-insured savings accounts continue to rise. You can now earn 3.90% and with the upcoming rate hike we’ll soon see yields above 4%.
4) The Case For Smaller Hikes
Why would the Fed hike 50 bps this month instead of another 75 bps?
They’re seeing progress on the inflation front and a number of indicators pointing to a lower inflation rate to come.
-The PCE Price Index has moved down to 6%, its lowest level since last December. The peak was 7% in June.
-The Prices Paid component of ISM Manufacturing hit a 30-month low in November. During the inflationary spikes of the 1970s/80s, a downturn in Prices Paid was a leading indicator of lower inflation rates to come (which was also associated with US recessions in both of those periods).
-US Rents fell 1% in November, the 3rd straight monthly decline. The year-over-year % increase has now moved down for 12 consecutive months after peaking at 18.1% last November. At 4.6%, this is the smallest YoY increase since April 2021.
-Global container freight rates moved down to their lowest levels since November 2020 this week, 77% below peak 2021 prices.
-Fertilizer prices peaked in late March and are down 43% since, now at the lowest levels since August 2021.
-Gas prices in the US have moved down to $3.41/gallon (national average), 32% below their all-time high in mid-June and at their lowest levels since early February.
5) The Case For Continued Hikes
Given this backdrop, many are asking why additional hikes are necessary at all.
This is the primary reason: November was the 20th consecutive month in which the rate of inflation outpaced the growth in hourly wages, a decline in prosperity for the American worker.
When this happens, something has to give, and thus far it’s translated into rising credit card balances and lower savings rates.
The Savings Rate in the US has moved down to 2.3%, the 2nd lowest level on record with data going back to 1959 (lowest was 2.1% in July 2005).
The Fed is now acknowledging this as the serious problem that it is, and they don’t want to see it become a permanent feature in the economy. As such, they seem to be erring on the side of caution, and will risk tightening too far if it means a higher degree of certainty that the inflationary spiral will be broken.
Giving the Fed more leeway in maintaining a tightening bias is the continued strength in the labor market. Jobs increased 263k in November, the 23rd consecutive monthly gain.
The US Unemployment Rate remained at 3.7%, only 0.2% higher than the September reading (3.5%) that was tied for the lowest rate we’ve seen since 1969.
6) A Little Help From the Money Supply
Rate hikes are not the only tool in the shed when it comes to fighting inflation.
One of the primary factors driving prices higher was the unprecedent increase in the Money Supply (+40% in 2020-21), which is now moving in the opposite direction.
The US Money Supply (M2) has decreased 1.5% over the last 7 months, the largest decline over a 7-month period on record (note: M2 data goes back to 1959).
Since 1959, the US Money Supply (M2) has gone up each and every year, with the 0.3% increase in 1994 the smallest and the 25% increase in 2020 the largest.
2022 is on pace to be the first calendar year in which the Money Supply has fallen in the last 60+ years, down 0.3% YTD.
7) Tesla Flipping Is Over
Rising interest rates, increased production, and the contraction in the money supply is bringing to an end one of the strangest things we’ve ever seen in markets: car flipping.
You read that correctly. The demand for cars, particularly hot EVs like Tesla, exceeded supply by such a large extent that people were literally able to flip their new/used cars for a profit.
This was a reversal of the age-old principle in which a car was said to lose a certain % of its value the minute you drove it off a dealer’s lot.
We now seem to be reverting back to the old normal, and at a rapid pace.
The average price of a used Tesla is down nearly 15% over the last 90 days, $11.5k lower than the peak in July.
8) An Interesting Divergence
Energy has been far and away the best performing sector in 2022, driven by soaring revenues and profits.
Typically, there’s a high correlation between the direction of Energy stocks and Crude Oil. But over the past two months, we’ve seen an interesting divergence, with Energy stocks moving higher while Crude Oil has traded sideways.
9) Oscillating Volatility
The Volatility Index ($VIX) closed below 20 this week for the first time since August. It’s been a year of oscillation for the $VIX with brief periods of calm followed by a return to higher volatility with an average level of 25.9 (historical average is 19.7).
With data starting in 1990, the only years with a higher average $VIX than this year: 2008, 2009, 2020, and 2002.
10) The Housing Slowdown Continues
US Home prices fell in September for the 3rd consecutive month. The 3-month decline of -2.2% is the largest 3-month drop since 2009.
When the last housing bubble peaked in Feb 2007, prices fell 26% nationally.
The same decline today would only bring home prices back to September 2020 levels. That’s a reflection of how much US home prices went up in the last phase of the current bubble, a 40% increase in just two years.
The rate of US home price appreciation continues to slow, up 10.6% YoY nationally according to the Case Shiller Index. This is lowest YoY increase since December 2020 but is only as of September, missing the last 2 months.
Real-time data shows YoY appreciation has moved down to 2%, and will likely go negative at some point in the next few months.
Every city in the Case-Shiller 20-city index saw a decline in home prices during August and September. The last time all 20 cities were down two months in a row was in December 2008/January 2009. San Francisco is showing the largest decline in home prices thus far, -10.5% from its peak in May.
Why are prices falling?
The number one factor is a lack of affordability.
The median American household would need to spend over 46% of their income to afford payments on a median-priced home in the US, the highest % on record with data going back to 2006.
And that’s it for this week.
Have a great week everyone!
-Charlie
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