Equities Ride the Roller Coaster: All Eyes on Rising Bond Yields

03/07/2021

Mar 08, 2021

THIS IS NOT INVESTMENT ADVICE.

Please speak with a registered investment advisor or other qualified financial professional before making any investment decisions.

Commentary

Monday saw the S&P500’s largest one-day gain since June, +2.4%. 92% of index components were up on the day as the market responded positively to global vaccine progress, a new vaccine approval for Johnson & Johnson as well as strong manufacturing PMIs and positive developments toward the passage of a new US fiscal package. What’s more, the RBA doubled their daily bond purchases to demonstrate their commitment to the 0.10% yield cap for their 3 year rate. If that had been all that happened last week, it would have been considered a busy one. But on the week, the average daily range for the S&P500 and Nasdaq was 2.3% and 2.9% respectively. On Thursday, the benchmark Nasdaq ETF (Ticker: QQQ) logged its largest single-day volume in history with 138.5mln shares. The VIX volatility index started the week at 23, peaked at 32 and closed at 24.5. Fed chair Powell stuck to the script, literally, oftentimes reading pre-written responses to questions in an interview with the Wall Street Journal. Market participants continue to see the Fed’s sanguine response to rising rates as a greenlight to sell treasuries. 10 and 30 year Treasury securities rose approximately 10 basis points in yield this past week (1.55% and 2.29%, respectively). Federal Reserve members continue to view the rise in rates as a positive development and a foreshadowing of economic strength. Members are now in their blackout period where they are not permitted to comment publicly any more until after the committee’s March 17th press release.

Chart of the Week

Fed Hikes are Being Priced In

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ECONOMIC DATA

The Atlanta Fed’s GDPNow forecast for Q1 growth is currently tracking at 8.3%, down from 8.8% last week.

The New York Fed’s Nowcast forecast for Q1 growth is currently 8.6% down from 8.7% last week.

US non-farm payrolls in February rose 379k last month, well above the 200k forecast by the street. January revised up from +49k to +166k. Unemployment rate down to 6.22% and the labor force participation rate steady at 61.4%.

Total jobs are down about 8 million from pre-pandemic levels and the primary source of weakness is within leisure and hospitality. 4 million workers have left the labor force due to the pandemic and another 4.1 million report being unemployed for more than 6 months.
February saw what may be a turning point for these COVID- sensitive serivce sectors, leisure & hospitality +355k jobs added. Specifically, restaurants accounted for most of the gain. 2.25mln people are still on temporary layoffs, we see this as low-hanging-fruit for further strong payroll gains in the months ahead as reopening continues
Construction employment fell 61k because of weather related effects.
Average hourly earnings were up 0.23%m/m and 5.26%y/y

US ADP private payrolls came in much weaker than anticipated, +117k versus +205k street forecast.

“The labor market continues to post a sluggish recovery across the board...We’re seeing large-sized companies increasingly feeling the effects of COVID-19, while job growth in the goods producing sector pauses. With the pandemic still in the driver’s seat, the service sector remains well below its pre-pandemic levels; however, this sector is one that will likely benefit the most over time with reopenings and increased consumer confidence.”

Fed’s Beige Book (Summary of Commentary on Current Economic Conditions): “Economic activity expanded modestly from January to mid-February for most Federal Reserve Districts.”

Every Fed District reported economic growth over this reporting period
Business optimism has improved over the past 6-12 months
Consumer spending is mixed and leisure/hospitality sectors still not close to normal
Employment rose “slowly” over the reporting period and that labor demand was still drastically different across industries and skill levels.
Supply chain disruptions met with strong demand continued to cause higher input costs.

US ISM manufacturing 60.8 for February, ahead of expectations of 59

New orders, production and employment all rose, with employment reaching post-COVID highs.
Prices paid surged 4 points to 86, highest level since 2008
Of the 18 manufacturing industries, 11 reported employment growth for February
- “The Employment Index grew for the third month in a row Continued strong new-order levels, low customer inventories and an expanding backlog indicate potential employment strength for the rest of the first quarter. For the sixth straight month, survey panelists’ comments indicate that significantly more companies are hiring or attempting to hire than those reducing labor forces”

Euro area January retail sales -5.9% m/m versus consensus expectations for -1.1% m/m decline

The miss was largely the result of lockdowns. Expect Europe to rebound as their vaccine distribution develops

The euro zone aggregate final manufacturing PMI in line with flash estimate at 57.9

UK manufacturing PMI to 55.1 for the final release for February
Sweden manufacturing PMI down to 61.6 in February from 62.5
- Employment component rose to a new high
Norway’s manufacturing PMI for February 56.1, the highest in two years
- Almost all subcomponents strengthened for the month

Korea’s February exports +9.5% y/y, continue to show strong global demand for their products

Auto shipments +47% y/y
Semiconductors +13.2% y/y

Australian house price growth for February was the highest monthly rate since 2003 at +2% m/m

Strong housing data has triggered discussions of macro prudential policy response from the RBA to slow down the overheating market but leverage and lending standards still look alright so our guess is that we’re a long way from any sort of response.
Australia’s 4Q GDP confirmed the strength of the economy coming in at +3.1% q/q, well ahead of expectations for +2.5%. Overall economic activity is now just 1.1% below December 2019 levels.
- Government spending added 0.3 percentage points to growth.
- Consumer spending ripped higher, +4.3% for the quarter despite a 3% fall in disposable income. The savings rate fell from 19% to 12% for the quarter.
Why it matters: Several weeks ago we pointed to significant pickups in economic activity in regions of Australia where the economy had been re-opened. We hypothesized at the time that it would serve as a good barometer of what other developed markets would look like once restrictions were lifted. These developments foreshadow significant coming strength in OECD economies.

COMMODITIES

Saudi Oil facilities were attacked via bomb equipped drones and ballistic missiles on Sunday, leading to prices jumping to over $70 a barrel for brent crude, the global benchmark.

“While Saudi Arabia’s ministry of energy said the attacks “did not result in any injury or loss of life or property”, and a person familiar with the matter said no production had been affected, the attacks have still unsettled oil markets that have rebounded strongly in recent months.”
Attacks were claimed by Yemen’s Houthi fighters, allies of Iran.
Allies such as Russia have yet to flood crude oil markets, and barring any changes we expect these elevated prices to continue.
International benchmark: Brent crude +2.9%, $71.28/barrel
US benchmark: West Texas Intermediate also up, $67.98/barrel
While there was no direct hit on oil supplies, traders and investors should still consider the market under threat. Price premiums are likely to continue as geopolitical threats loom.

GEOPOLITICS

US military presence in South Korea is getting a boost. A tentative deal has been reached to increase financial support for additional military presence in S. Korea following 2019’s unusual one year arrangement.

“This proposed agreement, containing a negotiated meaningful increase in host nation support contributions from the Republic of Korea, reaffirms that the US-Republic of Korea Alliance is the linchpin of peace, security and prosperity for north-east Asia and a free and open Indo-Pacific region,” - State Department
This action follows former president Donald Trump’s unpopular demands to increase the amounts S. Korea was paying to host US troops while simultaneously rebuking S. Korea for considering removal of US forces despite the growth of China’s military and the continued development of nuclear weapons in neighboring North Korea.
“The Special Measures Agreement, the cost-sharing deal between the US and South Korea, was renegotiated every five years from 1991 to 2018. … In 2019, only a one-year arrangement was reached after the two sides failed to agree on a way to meet Trump’s demands. An ad hoc arrangement was reached to cover the final period of the Trump presidency and avoid disruptions to US bases in South Korea.”

CHARTS OF NOTE

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Bond Market Volatility Spreads Across Asset Classes

02/28/2021

Mar 01, 2021

THIS IS NOT INVESTMENT ADVICE.

Please speak with a registered investment advisor or other qualified financial professional before making any investment decisions.

Commentary

It was a week to remember for global government bond markets. The US 10 year treasury yielded 1.35% at the close of business on February 19th. This past Thursday, the 7 year treasury auction results came at 4 basis points cheaper than the pre-auction fair value; this is an historically large concession (“tail”) for the auction. What’s more, participation from money managers was bleak. The weak auction prompted a crescendo of activity that saw 10 year yields spike above 1.60%. Central bankers in Australia, Europe, the UK, New Zealand, etc. have demonstrated their awareness of rising rates in the bond markets and have said that they are watching how these moves will impact financial conditions. Their counterparts in the United States however have taken a more sanguine view; Federal reserve members have been unified in the expression of their belief that rising rates are a reflection of an improving economy and brighter prospects as a result of optimism surrounding the COVID vaccine and an impending pickup in activity. After Thursday’s frenzy, bond markets settled and the 10 year closed the week at 1.46%. Stocks did not respond well to the dramatic moves in rates, the S&P500 finished the week down 2.5% while the tech-centric Nasdaq was down 5% for the week. Below, you’ll find a slightly abridged summary this week.

Chart of the Week

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ECONOMIC DATA

The Atlanta Fed’s GDPNow forecast for Q1 growth is currently tracking at 8.8%, down from 9.5% last week.

The New York Fed’s Nowcast forecast for Q1 growth is currently 8.7% up from 8.3% last week.

The share of the population having received a first COVID vaccine for various countries:

Israel: 53.1%, UK: 26.9%, US: 13.6%, Spain: 4.4%, Germany: 4.3%, Italy: 4.1%, France: 3.9%
Daily pace of new doses administered is at 1.5mln in the US.
Covid-19 cases have declined by 73% from the Jan 11 peak.
- The number of persons hospitalized is down 55% from the peak peak to 58.4k.

Job Postings on Indeed.com are 5% above Pre-COVID levels

December S&P Case-Shiller home price index rose 0.8% for the 20-City index. This is a new record and follows a 1.1% increase in November. The seasonally adjusted annualized pace for December is in the 97th percentile of all months.

All of the 20 cities surveyed posted 12-month gains, with nine showing double-digit rises.
Related data point: FHFA House Price Index for purchases rose 3.8% from Q3 to Q4, the largest quarterly gain on record. Prices rose in all 50 states.
New home sales +4.3% m/m in January, 923k-unit pace, consensus expectations was a 1.7% rise.
- December had a significant upward revision, from 1.6% m/m to 5.5% m/m
- Prior 3 months were all revised higher bringing the average to 896k annualized units from 873k.

US Durable goods orders +3.4% in January, well ahead of consensus that was looking for +1.1%.

9th consecutive monthly increase and December revised up from +0.5% m/m, to +1.2% m/m.
Orders rose broadly almost across all components, but core capital goods orders were slightly weaker than expected at +0.5% m/m, below consensus expectations of +0.8%.

German IFO business climate index up to 92.4 from 90.3.

Beat was primarily driven by the expectations component. Had the largest monthly rebound since July.
“The German economy is looking towards recovery again” -Klaus Wohlrabe, Ifo Economist
Confirms the strong forward looking sentiment for the German economy that was expressed in last week’s ZEW survey.
Bottom Line: While current conditions are poor because of lockdown effects, optimism regarding the near future is incredibly strong.

US Conference Board Consumer Confidence had an upside surprise with a boosted outlook in the current labor market and economy’s progress. The index is at a three-month high of 91.3. The highest level in 2020 was 132 pre-pandemic.

Strength was led by survey on present situation which rose 6.5 points to 92.
Jobs plentiful minus jobs hard to get improved from -2.5 to 0.7, the highest level since November. Despite the strength, keep in mind that this labor market differential figure was 32 in February 2020.
This upbeat sentiment aligns with the recent developments we have seen with the $1.9tln economic stimulus package and steady increase in vaccine distributions.

CENTRAL BANKS

Fed Chair Powell testified before the House, “the economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved.”

Regarding rising rates, “In a way, it’s a statement of confidence on the part of markets that we will have a robust and ultimately complete recovery.”
Emphasized that accommodative measures would remain in place until “substantial further progress” was achieved and that the labor market’s recovery, thus far, was insufficient toward the objective.
- The economy, “has not made substantial further progress in the last 3 months.”
Acknowledged that the Fed anticipates a pick up in inflation this year as a result of base effects and pent-up demand but does not believe “that those effects should either be large or persistent.”
- “Inflation dynamics do change over time, but they don’t change on a dime.”
- “There really hasn’t been [a strong connection between budget deficits and inflation.”
- Inflationary risks are, “[weighted to] the downside for a long time.”

ECB President Lagarde delivers keynote speech at opening plenary session of the European Parliamentary Week.

Fiscal and monetary policies can reinforce each other to address “shielding and transforming” the euro area economy during the pandemic crisis.
- “Fiscal policy can help brighten economic prospects for firms and households, thereby strengthening monetary policy transmission... people who consider government support to be more adequate display less precautionary behaviour. Those people are in turn more likely to respond to favourable financing conditions and increase their consumption.”
ECB intends to continue supporting the economy, “the overall policy mix, however, remains essential...firms and households will only be able to take full advantage of favorable financing conditions if national policy measures are deployed to help monetary policy unfold its full potential.”
“Risk-free overnight indexed swap (OIS) rates and sovereign yields are particularly important...Accordingly, the ECB is closely monitoring the evolution of longer-term nominal bond yields.”

The RBNZ leaves the monetary policy stance unchanged as expected. Their QE problem is to buy NZ$100b of bonds by the end of June 2022.

Forecasts were upgraded as expected, but unemployment rate still expected to rise again over H1 2021.
Highlighted the “unevenness” of the recovery’s significant uncertainty about the outlook.
Operationally able to take rate negative if necessary.

The Reserve Bank of Australia purchases AUD7bln of 3 year bonds in order to defend their 0.10% target rate for the maturity.

The RBA now holds more than 60% of the target April 2024 bond.

ECB Chief Economist, Lane, “We will purchase flexibly according to market conditions and with a view to preventing a tightening of financial conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation.”

BOE Chief Economist, Haldane, “There is a tangible risk inflation proves more difficult to tame, requiring monetary policy makers to act more assertively than is currently priced into financial markets.”

Richmond Fed President Barkin, “Inflation is not a one- or two-month spike in prices; inflation is a change in expectations for the medium and long term.”

“There are disinflationary pressures that are quite profound & seem to be continuing. As long as you’ve got those disinflationary headwinds, it’s just going to be hard for businesses to believe that you’re going to have the market power to increase prices.”

St. Louis Fed President, Bullard, “Growth prospects improving and inflation expectations rising; the concordant rise in the 10-year Treasury yield is appropriate.”

Federal Reserve Vice Chair Clarida, “downside risk to the outlook has diminished.”

“The settings of monetary policy are entirely appropriate not only now, but – given my outlook for the economy – for the rest of the year.”

Kansas City Fed President, George, “Most of the rise in the 10-year Treasury this year appears to reflect an increase in the real yield that is the interest rate controlling for inflation compensation. Much of this increase likely reflects growing optimism in the strength of the recovery and could be viewed as an encouraging sign of increasing growth expectations.”

EU calls on financial leaders of the G20 (the world’s top 20 economies) to be careful not to withdraw economic stimulus and accommodation too early. The message was agreed to by all EU countries.

“Fiscal policies should remain supportive as long as necessary, and not be prematurely withdrawn.”
“The fiscal response going forward should continue to be carefully calibrated and regularly reviewed, in light of the uncertainty associated with the pandemic...and the need to avoid policy cliff-edge effects.”

PUNDITRY

Goldman: “investors ask whether the level of rates is becoming a threat to equity valuations. Our answer is an emphatic ‘no’...the 300 bp gap between the S&P 500 forward EPS yield of 4.6% and the 10-year US Treasury yield ranks in the 42nd historical percentile.

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Retail Spending Up as Stimulus Checks Arrive

Weekly Macro Summary 2/21/21

Feb 22, 2021

THIS IS NOT INVESTMENT ADVICE.

Please speak with a registered investment advisor or other qualified financial professional before making any investment decisions.

What you need to know in 60 seconds

Retail spending up as stimulus checks land, and e-commerce continues it’s rapid expansion (15.5% of total consumer spend now, up from 12.9% pre-COVID)
Housing: Home renovation spending up, building permits up, prices up - the housing market shows no signs of slowing down
Central banks: Steady as she goes as we wait for inflation to kick in
Stocks: 79% of reporting stocks have had a positive earnings surprise
What we’re wondering: When will the rise in the US 10-year yield (1.35%) matter for equity markets? See FIXED INCOME, CURRENCIES, COMMODITIES, & EQUITIES in this weeks issue for what seems to be a reasonable guesstimate.

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ECONOMIC DATA

The Atlanta Fed’s GDPNow forecast for Q1 growth is currently 9.5%

The New York Fed’s Nowcast forecast for Q1 growth is currently 8.3%

US Industrial Production +0.9% m/m in January, beats consensus expectation of +0.4%

Another strong month after December’s +1.3%m/m change
Manufacturing accounts for 75% of industrial production and was up 1%m/m. This is all a catch up to make up for lost production during COVID. Spending on goods has been above pre-COVID levels for several months (+5% as of December) but manufacturing production is still 1% below February 2020 levels.

US Manufacturing PMI 58.5, in line with expectations

Output to 57.7 from 60.5, new orders down to 57.3 from 59.9
Employment up slightly
Supplier deliveries index at a record low of 26.8, indicating slow delivery times
Input and output price indices are at all time highs

US Producer Price Index (PPI) big upside surprise for January at +1.3% m/m vs. consensus +0.4%

Core +1.2%m/m versus +0.2% expected

US retail sales in January, +5.3% m/m, the largest monthly percentage rise in 9 months and well above the consensus. Stimulus checks began to be delivered in January and it looks like they had the desired impact

Every store type reporting gains and e-commerce saw an 11% rise, “Of every dollar spent at U.S. retailers in January, 15.5 cents was spent online; before the pandemic that share was 12.9 cents.”
Building materials & garden equipment +4.3% monthly gain. This is a proxy for home renovation spending. Now 20% higher than pre-COVID levels!

US Housing starts -6.0% m/m (1.58mln unit pace). Single-family starts -12.2% m/m, reverses a +12%m/m gain in December. Probable cause of the fall in single family was due to good weather in December that pushed starts forward, this was likely a reversion of that effect

December starts were revised up to 8.2% from 5.8% was upwardly revised from 5.8%, to 8.2%.
Building permits +10.4% m/m, to a 1.881mn unit pace vs. +4.2% in December.
Bottom Line: Building permits are now at their highest level since June 2006, that’s a better indication of what’s to come versus the housing starts data which can be noisy month-to-month. See home sales below.

US, existing home sales +0.6% m/m in January, beats expectations. This was the highest sales rate for January since 2005! Housing market continues to be one of the strongest ever

The median existing-home sales price: $303,900, +14.1% from a year ago
Housing inventory down to 1.04mln units -25% y/y
At the current pace there is just 1.9 months supply of homes down from 3.1 a year ago

UK CPI inflation +0.7% y/y in January slightly higher than consensus of +0.6 % y/y

Core stays steady at +1.4% y/y

Euro area PMIs 48.1, in line with expectations and still below 50 which indicates contraction in activity

Manufacturing at 58 is now at a 3 year high, the weakness is being driven by service sector that is being held back because of COVID related restrictions.
Given the divergence we think manufacturing is the better indicator of what’s to come when restrictions are lifted. Expect there to be a significant catch up in services over the coming months
“One concern is the further intensification of supply shortages, which have pushed raw material prices higher. Supply delays have risen to near-record levels, leading to near-decade high producer input cost inflation. At the moment, weak consumer demand – notably for services – is limiting overall price pressures, but it seems likely that inflation will pick up in coming months.” -IHS

The February German ZEW economic sentiment survey up to 71 from 62 and beats expectations for 60.

“The financial market experts are optimistic about the future. They are confident that the German economy will be back on the growth track within the next six months...Consumption and retail trade in particular are expected to recover significantly, accompanied by higher inflation expectations” -ZEW

Australian monthly employment +29k, driven by 59k addition of full time jobs

Jobs are now just 64k (0.5%) below February 2020 pre-COVID levels 0.5%

CENTRAL BANKS

US Fed released minutes for last meeting and there were no surprises in the release

In line with Chair Powell’s press conference responses after the meeting
Regarding fiscal support, participants at the meeting said that it had, “led them to judge that the medium term outlook had improved”

San Francisco Fed President Daly: “I am not thinking we have unwanted inflation right around the corner”

Boston Fed President Rosengren, “would be very surprised if we see a sustained inflation rate at 2% in the next year or two with labor markets as disrupted as they have been”

“[asset purchases] will continue until there is substantially more progress in lowering unemployment and raising inflation”

Richmond Fed President Barkin, “we plan to stay the course on asset purchases until substantial further progress is made to our goals”

New York Fed PresidentWilliams, “wait and see mode” + “not concerned about stimulus being excessive right now”

ECB released minutes for their last meeting, “some Governing Council members thought the intensification of the pandemic posed some downside risks to output in the first quarter of 2021”

Measures put in place in December were appropriate in view of the current outlook. General council reiterated its commitment to maintain a steady presence in markets to ensure accommodative financial conditions. also highlighted the commitment to maintain a steady
Regarding the euro’s recent strength, the GC noted that the nominal effective exchange rate was at historically high levels and had already had a negative impact on inflation

FIXED INCOME, CURRENCIES, COMMODITIES, & EQUITIES

10 Year US Treasury yields have risen approximately 40 basis points year to date and are 1.35%. Despite the rising rate environment, the S&P500 is up 4%, the Nasdaq is up 5.5% and the Russell 2000 is up nearly 15%. This leads us to wonder, at what level of 10 year rates will the stock market begin to react? Strategists from Citi and Bank of America have tackled the question over the past several weeks using different methodologies. Each of these thought experiments independently arrived at a similar rate, approximately 1.70%.

In 2018, it was an approximate 50 basis point rise in real yields, from their trough, that triggered equity markets. Assuming a 2.25% breakeven inflation rate, that would get us to approximately 1.7% on the 10 year in 2021
As of February 8th, 70% of S&P 500 stocks sported a dividend yield above the 10 year yield. 1.70% is the approximately the rate at which less than half of S&P components’ yields would be higher than the 10 year.
Since 2008 periods of sustained market turbulence have coincided with the nominal 10 year yield rising above the blended cost of the US’s debt. The relationship is not immediate but it has served as a rough warning signal for when things start to get tricky for equities. Today’s blended cost of debt: 1.7%.

Via Factset: 83% of the S&P 500 components have reported earnings for Q4'2020

79% of companies have reported a positive EPS surprise thus far, and the overall growth rate for earnings has been 3.2%. Of companies that have provided earnings guidance, 63% have issued positive guidance. This compares favorably versus a 5-year average of 33% issuing positive guidance.
77% have reported a positive revenue surprise with an aggregate revenue growth figure of 3%

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Weekly Macro Summary 2/14/21

02/14/2021

Feb 16, 2021

THIS IS NOT INVESTMENT ADVICE.

Please speak with a registered investment advisor or other qualified financial professional before making any investment decisions.

Quote of the Week

“Good morning, Jamie. Just very quickly, I just want to say that the most interesting thing that's happening is the rate at which demand has increased. We've never seen an increase in demand happened as quickly. And that combined with COVID and the pandemic has really stretched the supply chain. Mark mentioned, we did have elevated freight costs in the fourth quarter of last year. And as he said, we expect those to continue through the first half. We are working with all of our suppliers. The supply base is generally tight, not just semiconductors, which has gotten a lot of press, but many of our components, are on longer lead times. Our suppliers and we are struggling with absenteeism due to COVID. And we are working very closely with our customers to remain connected and to continue to supply them as best we can. We are working through all of these issues on a daily basis, and the cost that we expect are included in our guidance. And we expect to be able to supply what we believe our market forecast is that Mark said earlier.”

-Tony Satterthwaite, President and Chief Operating Officer of Cummins Inc.

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ECONOMIC DATA

“Healthy jump in indeed.com US job postings: +2.4% above pre-pandemic baseline as of Feb 5. Was +0.7% one week earlier, on Jan 29. Accelerating improvement! 1.7 %pt weekly gain is similar to last summer's recovery pace.”

-Jed Kolko, Chief Economist, indeed.com

In the United States, as of February 14, 38.3mln people had received at least one dose of the COVID-19 Vaccine.

Daily doses averaged 1.7mln per day. At the current pace, approximately 75% of the 16 & older population would be fully vaccinated by early September.
To date, approximately 36% of the 65 & older population have received at least one dose, an 8 percentage point increase week-over-week. At the current rate, more than 50% of the 65+ population will have received at least one dose by the end of Feb.
New daily confirmed cases of COVID-19 are down 22% versus a week ago and 60% from their peak while the positive test rate has halved in the past 6 months.

US consumer price index (CPI) for January +0.26%, y/y +1.37%.

Excluding food and energy, core CPI came +0.03% and +1.4% y/y.
Rent and owners' equivalent rent measures +0.11% m/m, in line with it's December increase.
Core goods prices +0.14% on the month.
Core services prices were flat on the month. Many of these are categories that remain weighed down by COVID developments (recreation services, airfares, and hotels) and we can expect an acceleration once broader vaccine distribution has been achieved.
Bottom Line: While market’s expect rising inflation rates over the course of this year, it’s still too soon to see signs of sustainably higher inflation.

China’s headline CPI for January -0.3% y/y versus unchanged expected.

Core CPI printed negative, -0.3%, for the first time since 2009.
Cause of the low print is weak travel activity and softness in healthcare and family services consumption.

US JOLTS Job Openings 6.64mln at the end of December, higher than consensus and up from 6.572mln for November.

Job openings were led by a pop in professional and business services (+296k).
The quits rate rose to to 2.3%, the highest level since the pandemic started.

The NFIB Small Business Optimism Index at 95, down 1 point from December.

The 47-year average is 98.
“Owners expecting better business conditions over the next six months declined seven points to a net negative 23%, the lowest level since November 2013.”
“The net percent of owners expecting better business conditions has fallen 55 points over the past four months.”
Percent of owners thinking it’s a good time to expand, 8%.
Sales expectations over the next three months declined 14 points to a net negative 4%.
Despite some fall in sentiment and expectations, the employment measures remained strong

German industrial production was lower than expected +0.0% m/m (0.3%exp). Lockdown measures are weighing on industrial activity.

UK GDP +1.2% m/m for December, ahead of expectations of +1.0% and grew 1% q/q for Q4’20.

The UK economy is now around 7% below pre-COVID levels.
Manufacturing remained resilient while services saw a solid bounce back.
Household spending contracted in the quarter but was offset by government consumption and investment.

Mexico’s January CPI print above consensus +0.86% m/m (+0.77% m/m expected).

Annual rate is now +3.54% y/y but core inflation remains broadly unchanged.

CENTRAL BANKS

ECB President Lagarde spoke at the at the plenary session of the European Parliament.

“In this environment, an accommodative monetary policy stance remains essential.”

People’s Bank of China (PBOC) published their Q4’20 monetary policy implementation report.

Will prioritize policy stability with no sharp turns.
Will adhere to normal monetary policy, stable central bank balance sheet along with lower leverage and credit growth compared to the post-2009 period.

Fed Chair Powell: “We are a long way from a strong labor market.”

“Achieving and sustaining maximum employment will require more supportive monetary policy.”
Called for, “society wide commitment” to maximum employment.

Cleveland Fed President Loretta Mester said the Fed is, “going to be accommodative for a very long time.”

Dallas Fed President Kaplan:

Mass vaccination and additional fiscal stimulus will increase output, put downward pressure on unemployment, and temporarily lift inflation but the upward price pressures will not be persistent.

Sweden’s Riksbank kept policy unchanged and projects no changes in rates through 2024.

Reiterated that rate cuts are still possible if needed.
Expects the economy to return to normal levels in Q3’21, a quarter earlier than previously forecast.
Pace of bond purchases will slow to SEK100bn in Q2 (from SEK 120bln currently).

EQUITIES

Alibaba (Ticker: BABA), reported 3Q earnings in early February, the stock is up roughly 21% from a year ago and 18% ytd.

Sales rose 37% in 3Q, with cloud computing, retail and commerce leading. Cloud computing saw its first positive EBITA margin.
Alibaba reported 779 million active consumers in Q3.

Pfizer (Ticker: PFE), announced it will grow revenue 6% in 2021, excluding Covid-19 vaccine sales.

Sales were 3.3% lower than the consensus and EPS missed by 18%.
2021 Sales guidance of $59.4 - 61.4 billion was above expectations, but the midpoint EPS goal of $3.15 was below consensus due to much lower gross margin, decreased profit from the BioNTech profit share agreement and higher R&D costs.

Amazon (Ticker: AMZN), reported strong fourth quarter results on the back of increased online shopping and additional stimulus checks.

Q4 Sales rose 44%; online stores +46% and third-party seller services increasing 54% following strong holiday demand and moving Prime Day to the fourth quarter.
Amazon Web Services jumped 28% q/q.
Q1’21 revenue guidance of $100-106 billion, which is above consensus.
Management expects Covid-19 related costs to decline 50% to $2 billion q/q.

Google (Ticker: GOOGL), reported Q4 results in early February. The stock is up 21% ytd and 38% from a year ago.

Revenue surprised estimates by 5%, coming in at $46.4 billion, Adj. EPS for the quarter was 15.5 vs the consensus of 17.6. GAAP+ EPS was 19.24, a 23% positive surprise from the consensus.
Analysts believe YouTube Ads may benefit from a secular shift in brand advertising from traditional TV spending.
Cloud segment could see accelerated revenue growth in 2021 with increased enterprise usage.

Twitter (Ticker: TWTR), shares are up nearly 25% for the week after reporting strong Q4 earnings.

Analysts expect top-line growth to accelerate in 2021, mostly driven by increased advertisement spending as live events resume.
Revenue growth beat expectations by 8%, ending the quarter at $1.29 billion. GAAP EPS came in at 0.27 vs the consensus of 0.163, a 65% positive surprise.
Ad revenue gained 31% y/y driven by impression growth and price stabilization.
Monetizable daily active users grew by 1 million to 37 million in Q4.

Uber (Ticker: UBER) Q4 earnings highlighted a slow demand recovery for ridesharing and continued reliance on subsidies for an expanding delivery segment.

The company continues to cut costs and will divest from its unprofitable Freight business in an attempt to increase cost saving measures.
Revenue was $3.16 billion for the quarter which was 1.59% below expectations. Uber reported a net loss of $1.034 billion in the Q4, a 50% negative surprise from analysts.

Lyft (Ticker: Lyft) Q4 Revenue and Net Income beat consensus.

Q4 revenue of $569 million vs an estimated $561 million. Net Loss for the quarter was $180 million, beating estimates by 19%.
Ride volume continues its slow recovery, which may be down 40-50% in Q1. Lower driver incentives and continuous reduction in fixed costs could help the company achieve its goal of breakeven EBITDA in the second half of the year.

Walt Disney Company (Ticker: DIS) closed the week at a new all-time high $190.91. The company has experienced remarkable strength in their streaming platform.

Q1’21 EBITDA beat the consensus of $878 million by 148%, coming in at $2.2 billion.
The recent rise in the stock price can be attributed to Disney+, which shows no signs of slowing. The first quarter of fiscal year 2021 saw 21.2 million new users bringing the total number of subscribers to 94.9 million. The upcoming price increases may boost top line growth.
The Disney Parks operating income fell an additional $2.6 billion on limited capacity and extended closure in Paris and California. This news did not come as a surprise and with the vaccine rollout and pent up demand, analyst expect demand to pick up in the 2H.

Canopy Growth Corp (Ticker: CGC), reported strong Q3 earnings on Tuesday the 9th. Shares ended the week down 6.5% but not after being up 25% at one point. News organizations have dubbed this week's volatility a “reddit” fueled mania.

Net revenue has beat expectations for the third straight quarter, increasing 23% from the prior year, ending the quarter at $152 million

Recreational marijuana usage saw gross revenue increase 15% in Q3 from the prior year to $70 million and Medical marijuana usage saw an increase of 10% at the end of the third quarter from a year ago to $45 million
Non-GAAP Gross Profit was $40 million and EBITDA was -$68.4 million, a 3.8 percent positive surprise

GEOPOLITICS

The United States Senate has voted to acquit former President Donald Trump in his second impeachment trial on Saturday. With a vote of 57 yays and 43 nos, the final steps in the impeachment process have fallen short of the two-thirds required for conviction.

Former President Trump was charged with inciting the January 6th riot at the Capitol. Seven Republican Senators joined the Democrats in finding Trump guilty this time compared to just one in the first impeachment trial.
The second impeachment vote has the most Senate support since president Andrew Johnson’s 1869 impeachment trial.
The acquittal leaves the door open for Trump to make a 2024 presidential run. After already promising retribution in 2022 against Republicans who crossed him, polls show him damaged but still the front-runner among republicans.

Nobel prize winner and State Counselor Aung San Suu Kyi was arrested on Feb 1 by the Myanmar (aka: Burma) military (aka: Tatmadaw), citing alleged fraud surrounding the elections held in November of last year.

The coup came abruptly to most observers, seeing as Aung San Suu Kyi was somewhat of an ally to the military despite tensions, even personally defending the military mass killings of the predominantly Islamic Rohingya minorities during her International Court of Justice appearance in late 2019.
“The international community has repeatedly gotten Myanmar wrong … We got it wrong in the late 2000s when we thought the military had no intention to transfer authority to a civilian government; we got it wrong when it came to Aung San Suu Kyi and her authoritarian tendencies and attitudes toward ethnic minorities; and it seems we got it wrong when it came to this, too.” - Aaron Connelly, South-east Asia specialist, International Institute for Strategic Studies.
Approximately 384 of those in favor of the National League for Democracy Party have been arrested since and continue to be arrested in the face of mass amnesties of ex-convicts in Yangon. It is believed the move is to empty jail cells in preparation of further opponent crackdown.
In similar fashion to the 80’s and 90’s, protests have erupted, and civilians continue to resist despite being met with warning shots, water cannons, and largely unpredictable night time arrests.
The United States has issued sanctions, targeting a number of military generals, limiting US assets benefitting the Myanmar military as well as strong export controls and preventing access to the $1bln in Myanmar government funds being held in the US.

Mario Draghi has officially been sworn in as Italy’s next Prime Minister. Taking the oath on Saturday Feb 13, along with his 23 Cabinet ministers which consist of economic experts and various other career politicians spanning the political spectrum.

Draghi, 73, an MIT trained economist who led the European Central Bank from 2011 to 2019. Most famously known for leading the ECB through the euro-zone crisis in 2012.
The former Prime Minister, Giuseppe Conte lost control of the party after mis-handling the Covid-19 response.
Italy’s tourism accounts for roughly 13% of the country's gross domestic product, as the pandemic has taken a significant chuck from the economy. Draghi’s government will appoint a tourism Ministry from the previous culture ministry.

PUNDITRY

Marko Kolanovic, JP Morgan's head of quant and derivatives strategy,: "Commodity Supercycle and Related Equity Flows"

4 Commodity supercycles in the past 100 years. The last one started in 1996 and peaked in 2008.
- The most important driver of that cycle was the rise of China and emerging markets.
- During the period, USD weakened and commodities were more widely financialized. As a result, institutional investors embraced it as a new asset class that could diversify portfolio exposures.
JPM believes that 2020 marked the end of the commodity contraction and that we have now entered a new commodity super cycle. “Mostly it will be the story of a post- pandemic recovery (‘roaring 20s’), ultra-loose monetary and fiscal policies, weak USD, stronger inflation, and unintended consequences of environmental policies and their friction with physical constraints related to energy consumption and production.”
Inflation hedging characteristics: For the past decade, the global economy has experienced low growth and low inflation. The result was a bull market in bonds, bond proxies and secular growth stocks.
- As inflation dynamics change and the theme of a resurgence in inflation becomes more widely accepted, JPM expects multi-asset portfolios to turn to commodities as a diversifying solution.
There are two drivers of the equity-bond correlation: volatility and inflation. All else equal, a regime of lower volatility and higher inflation weakens this correlation. This is what appears to be occurring as the world recovers from the COVID shock.
“In the period from 2010 to 2015, the Energy sector had a 10.6% allocation in equity portfolios. This has steadily declined to a 3.1% weight currently”.
- During this period active managers reduced their allocation from 7% to 1.5%. The current US equity fund asset base is approximately $14trln. A re-allocation towards the energy sector would result in significant inflows and re-pricing.

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Weekly Macro: The Re-Return of Commodities

02/07/2021

Feb 07, 2021

THIS IS NOT INVESTMENT ADVICE.

Please speak with a registered investment advisor or other qualified financial professional before making any investment decisions.

Commentary

Underneath the headlines regarding meme-stocks and the runaway rally in the stock market has been a significant improvement in the COVID situation America. The number of people hospitalized with COVID in the US has declined rapidly to 92,880, approximately 40,000 lower than the peak hospitalization rate that was recorded on Jan 5th. As of Jan 31st, 25.2mln Americans had received at least one vaccine dose - that represents approximately 7.5% of the population. Some estimates show that approximately 22% of the 65 & older population of the country has received at least one dose, 8 points higher than the prior week. 49 out of 50 states saw a decrease in hospitalizations. The outlier, Vermont, saw a one-person increase in hospitalization

The most recent data showed that the daily dose rate was approximately ~0.4% of the population, a 60% improvement versus 2 weeks prior.
- At the current pace, more than half of the 65+ population will have received a first vaccine dose by the end of February.
- Already, high frequency data reflecting activity in the travel, leisure and hospitality industries has shown a bump in engagement and spending.

Chart of the Week

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ECONOMIC DATA

Nonfarm Payrolls Total +49k in January, weaker than consensus estimates for +105k. Revisions for past months were also disappointing at -159k. Unemployment rate fell to 6.3% from 6.7% but only because the labor force shrunk to 61.4% from 61.5% in December.

Private +6k, Goods -4k, Services +10k, Gov +43k.
- Leisure & hospitality -61k jobs in January after -536k loss in December.
Job loss relative to February 2020 stands at 9.9mln which means that the US has only regained 56% of the COVID job losses.
“The workweek lengthened by 0.3 hours. As a result, aggregate weekly payrolls, a proxy for total wage and salary income, jumped 1.1%, the fastest pace in four months.”
While the report was poor, the ADP report (below) and ISM jobs components bode well for employment figures over the coming months. As vaccine roll-out gets more traction it’s worth keeping in mind that approximately 45% of the private sector payrolls decline since February has been in the leisure & hospitality sector so the snap back could be a lot more intense than currently envisioned. Already, high frequency data is showing significant improvement (see spending chart above).

January US ADP employment +174k vs +50k expected. Previous month was revised higher by 40k jobs.

Composition: Small business +51k, Mid-size +84k and large +39k.
- Goods +19k, Services +156k.
“The labor market continues its slow recovery amid COVID-19 headwinds. Although job losses were previously concentrated among small and midsized businesses, we are now seeing signs of the prolonged impact of the pandemic on large companies as well.”

US ISM manufacturing for January 58.7 down from 60.5 in December. Of the 18 manufacturing industries, 16 reported growth in January.

New orders down to 61 from 67 drove much of the decline but still, this is a very strong print.
Employment up almost 1 point to 52.6, this is the highest level since the pandemic and the employment component only started to grow in November. US manufacturing employment still has 540k fewer people employed than February 2020.
Prices paid at 81.2, the highest reading since 2011 and it is the first time since 1978 that no firm reported lower prices.
Supplier delivery times at 68.2. Firms reported “labor shortages, strong demand and delays in supply chains.”
The US economy has been resilient despite COVID restrictions. Europe has had a more difficult time keeping the economy going. Composite and services PMIs for the Euro area were in contraction (sub-50) at 48 and 45, respectively.
- German new manufacturing orders index fell 1.9%m/m in December. First fall in 7 months. Their retail sales fell 9.6% for December and it’s the steepest monthly decline since 1994. Both are further evidence that lockdowns across Europe are starting to have an impact on industrial activity and the broader economy.

US Services PMI 58.3 in January ahead of expectations for 56 (Dec was 55).

2nd sharpest upturn in output in six years.
Strong increase in employment component to 55.2, the highest level since February 2020 reinforces strong trajectory of employment growth for services going forward. All of this was despite continued weakness in hospitality and leisure sectors that are still hampered by COVID restrictions.

US total construction spending +1.0% in December to $1.49trln, in line with street’s expectation.

Core construction spending, let by strength in single family housing, +1.1% for December in addition to upward revisions for prior months. It’s the 6th increase in the past 7th month. Total residential construction was up 21% y/y.
Since May, total construction spending has been rising an average of 1.2% per month and is now above pre-pandemic levels and the highest levels since 2002!
Bottom Line: There is still no end in sight to the housing market’s strength.

US light vehicles up to a 16.63mln annualized rate in January (estimate was 16.3mln) up from 16.2mln in December.

At the nadir, sales were 8.7mln rate in April and for context January 2020 sales were 16.9mln.

China's official manufacturing PMI prints 51.3 for January, the 11th consecutive month of expansion but down from 51.9 in December. The decline was a result of a slower expansion in large and medium-sized firms.

Official services PMI fell 4 points down to 51.1 as a result of a pickup in COVID cases and a resulting closure of hotel and entertainment sectors. Railway passenger traffic for the first 3 days of Spring Festival season was down 70% y/y.

Oxford Economics: “Businesses remain concerned over global economic prospects, despite some improvement in sentiment over the past month. Based on our latest survey of risk perceptions, almost half of respondents see activity in their business remaining below pre-pandemic levels throughout 2021.”

CENTRAL BANKS

Reserve Bank of Australia, in a surprise move, doubled its bond buying program and made clear that accommodative policy is here to stay, “Australia will need very significant monetary support for years.”

Will buy additional AUD100bln after the current 100bln program is done in April. Pace of purchases will remain at 5bln per week.
Benchmark rate and the target yield on the 3-year bonds (0.10%) left unchanged.
Governor Lowe pledged to maintain rates at the current levels until inflation has reached the 2-3% target “in a sustainable manner.”
- Their current forecasts do not see this occurring until 2024 “at the earliest.”
“In terms of what other central banks are doing, many have recently announced extensions of their bond purchase programs. This is relevant to us, because we live in an interconnected world. If we were to cease bond purchases in April, it is likely that there would be unwelcome upward pressure on the exchange rate.”

US Federal Reserve Comments:

Minneapolis Fed’s Kashkari, very dovish, ““we are not even close to being at the right time to even think about adjusting the balance sheet size.”
- “The key now is for the Fed to keep our foot on the monetary policy gas until we really have achieved maximum employment as we call it."
Cleveland Fed’s Mester, “It is now clear that the adverse effects of the pandemic have not been evenly distributed and there are wide disparities in the recovery across business sectors,geographic areas of the country, and demographic groups.”
St. Louis Fed’s Bullard, the vaccine combined with fiscal and monetary policy should lead to a “very strong” recovery and positive real GDP growth in 2021.
- Rising inflation is still in line with the Fed’s new policy framework and as inflation approaches and exceeds the 2% target, it would be a welcoming “[...] development for the FOMC, as inflation has generally been below target for many years,”.

Bank of England Comments:

The Bank of England will give lenders six months to prepare for negative interest rates, anything sooner “would attract increased operation risks”. Banks will begin updating their IT systems to reflect the new policy. The PRA is set to ask banks for their readiness regarding negative rates in six months time, but reiterated that “such a request could be misconstrued as a signal that the MPC setting a negative Bank Rate was in prospect, or even imminent” further adding that “This was a signal that the Committee did not wish to send.”
Andrew Bailey, Governor, on negative rates:
- “Particularly when you go negative, the transmission is much less clear because it does change the whole calculus of how the banking system works. We do not know with any confidence how that would work. However, there are experiences of other countries.”
Andy Haldance, Chief Economist, is cautiously optimistic on the economic recovery following the pandemic:
- “If we get that recovery that I expect to start coming on stream, probably at the rate of knots from the second quarter, that will hopefully then eat away and improve the prospects of reemploying those million people who have lost their jobs.”
- As members look to the future, “I feel much more confident about the second half of 2021 than I do about the first quarter of 2021, which is unusual but should be encouraging.”

Does the National Debt Matter? David Andolfatto, Senior Vice President at the Federal Reserve Bank of St. Louis doesn’t seem to believe it’s a dire situation.

The national debt grew to $20.5 trillion or 105% of GDP by the middle of 2020 from only $5.3 trillion or 35% of GDP in 2008. That is a 400% increase in just 12 years. David believes it is incorrect to view the national debt through the lens of a household, where unsustainable debt will bankrupt a household, a nation doesn’t face the same constraints.
On the topic of ‘Debt Issuance’, a household has a finite lifespan whereas a government can continually refinance its debt indefinitely. Government debt is much different than household debt because it mainly consists of marketable securities issues by the U.S. Treasury as bonds. In fact, from 1862-1971, the Treasury department issued some of its securities in the form of small-denomination bills which are indistinguishable from currency issued by the Federal Reserve today.
- When interest comes due, the U.S. can print additional U.S. or Federal Reserve Notes (a legal tender), this technically means a default can only happen if the government permits it.
- This makes the U.S. Treasury securities highly desirable for investors seeking a safe haven asset.
Domestically held debt creates domestic private sector wealth. Increasing the national debt makes individuals feel wealthier. Investors value the securities that define the national debt in the same way individuals value money - a safe store of wealth. David argues if the national debt is a form of money, wherein lies the concern?
If the interest rate on the national debt was on average less than the growth rate of the economy, the government can indefinitely run a budget deficit, using the debt to finance programs designed to enhance the productivity of the nation.
Presumably there is a limit to how much the market can handle Treasury securities for any given price level or inflation rate but right now, no one knows how high the debt-to-GDP ratio can get. David argues that we will only know once we get there.
Consistent debt issuance must be met with corresponding economic growth, otherwise inflation will corrode private wealth. As long as inflation stays in check, there should be little concern to the national debt. Since the 2008-09 recession, Personal Consumption Expenditures (PCE) inflation rate has averaged around 1.5%, this reinforces the idea that inflationary pressures have stayed in check as debt-to-GDP has grown exponentially.

Source: U.S. Bureau of Economic Analysis, Federal Open Market Committee and FRED (Federal Reserve Economic Data)

To conclude, direct checks, PPP and credit market support is a necessary step to support individuals and businesses that have been affected by Covid-19 and the sharp increase in government debt may result in a one-time increase in price levels. A spike in inflation is not a signal to tighten monetary or fiscal policy as long as the spike is temporary. The higher price level that would accompany this event should be understood as the mechanism through which purchasing power is redistributed over the course of the pandemic.

FIXED INCOME, CURRENCIES, COMMODITIES

Last week we highlighted that, “Prices for commodities are surging. From aluminum (+39% since March) to scrap steel (up 60% since November) to corn (up 43% since Aug)... The cause of rising commodity prices are the COVID related supply chain disruptions that were not met with a subsequent fall in demand for many commodity intensive products.” The United Nations food agency highlights the negative aspect of this reflationary theme, food prices have now risen for 8 consecutive months and are at their highest levels since 2014.

The Food and Agriculture Organization (FAO) reported that their cereal price index rose 7.1%m/m in January, with maize rising 11.2%. Corn prices are now 42% above where they were a year ago. “China was importing unexpectedly large quantities of maize this season, which was having a significant knock-on impact on estimates for world utilization and stocks.”
- Wheat prices +6.8%, “driven by strong global demand and expectations of reduced sales by Russia when its wheat export duty doubles in March 2021.”
- Sugar +8.1%
- The vegetable oil price index +5.8% and now at the highest level since 2012 as a result of falling production in Indonesia and Malaysia.
- Dairy prices +1.6% and the meat index posted +1.0%.
- “At this level, the world stocks-to-use ratio of cereals would decline from 29.7 percent in 2019/20 to 28.3 percent in 2020/21, marking a seven-year low.”

EQUITIES

“As of end of January, 47% of S&P 500 stocks had forward P/E greater than 20; slightly off recent peak in December but still higher than any level during dotcom era” Liz Ann Sonders, Charles Schwab.

As of the end of this week, 59% of S&P 500 have reported results for Q4’20

81% have reported earning above wall street forecasts and in total earnings havec come in 15% ahead of estimates, thus far.
79% of the companies that have reported have beat revenue estimates. In aggregate total revenue has come in 3.4% above the estimates,
Bespoke Investment Group highlighted a quirky dynamic that has been going on during earnings season, ““The S&P 500 is up over 2% since earnings season began in January, but stocks that have reported earnings this season have seen an average decline of 1.15% on their earnings reaction day. So even though the broad market is trending higher, the gains are not a result of big earnings moves. We also note an absolutely fascinating result from the current reporting: companies that beat EPS estimates have underperformed names that missed EPS on their earnings reaction days! As shown below, stocks that have beaten EPS estimates have fallen 1.22% on their earnings reaction days this season. Stocks that have missed EPS estimates have only fallen 0.81%. It’s not just that investors aren’t rewarding EPS beats, it’s that they’re practically punishing them!”
77 S&P500 components will be reporting earnings in the coming week.

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