GOP Rally Stalls Due to Weak Earnings - MIDDAY MACRO - 10/27/2022
Color on Markets, Economy, Policy, and Geopolitics
Midday Macro – 10/27/2022
Overnight and Morning Recap / Market Wrap:
Price Action and Headlines:
Equities are lower, although small-caps are higher with weaker earnings weighing on large-cap sentiment as traders await Amazon and Apple after the bell
Treasuries are higher, with today’s GDP data pointing to a slowing in consumer demand, a view reinforced by weaker new orders for durable goods and a regional Fed survey contracting further
WTI is higher, reapproaching $90, despite demand concerns growing. Elsewhere, diesel and heating oil inventories are at seasonally very low levels due to refinery capacity still being problematic
Narrative Analysis:
The S&P is down, although the sector-by-sector picture is very mixed, with energy and industrials outperforming. Small-caps continue to lead, though with value-orientated names especially well-bid. The real show begins after the bell, with Apple and Amazon earnings likely determining if this rally continues. We are doubtful they will be better than the mega-cap-tech names that have already missed this week. Today’s new economic data showed slowing demand for core durable goods and inflationary pressures increasing in the KC Fed’s manufacturing survey. The GDP data surprised to the upside due to net trade being more favorable while overall PCE slowed by almost half from last quarter. Treasuries continue to rally as the Fed’s wanted narrative is increasingly signaling a pause is coming following a step down in hike levels into Q1. This is also causing the dollar to cool, although the DXY is up to 110.5 today following a more dovish ECB meeting this morning that sent the Euro back to parity. Finally, the recent rally in copper has paused on the session, with recent gains reflecting the coming supply deficits more than any perceived increase in demand.
The Russell is outperforming the S&P and Nasdaq with High Dividend Yield, Small-Cap, and Momentum factors, and Industrials, Financials, and Utilities sectors all outperforming on the day. Sectors and factors are more aligned with a more cyclical sector outperforming and less duration and dollar-sensitive factors outperformance.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 3848 while the Call Wall is 3900. A higher Vol Trigger (3805) suggests an increase in put gamma positions. Support today shows at the 3834 and 3800 strikes. To the upside, major resistance does not show until 3900 (Call Wall). Additionally, realized volatility is starting to come down, and with that, implied volatility. This is a bullish signal for markets as it invokes a vanna tailwind. Skew continues to show no sign of bearish fears, as shown by metrics like SDEX.
@spotgamma
S&P technical levels have support at 3820, then 3805, with resistance at 3850, then 3875. Last Friday, the S&P broke out from a nearly month-long inverse head and shoulders/diamond bottom base, and we subsequently went into lift-off mode. The neckline of this structure is currently in the 3765-75 area. This makes things quite simple: as long as we are above here, the October rally is alive and healthy.
@AdamMancini4
Treasuries are higher, with the 10yr yield at 3.95%, lower by 5.7 bps on the session, while the 5s30s curve is stepper by 4 bps, moving to 0 bps.
Deeper Dive:
Despite some bellwether earnings coming in broadly weaker than expected, there are still some positive macro winds behind the current rally. For starters, the Fed looks to be signaling an end to hikes is in sight, assuming inflation behaves as expected. Notable Fed channels for communication and “prominent” sell-side research shops have highlighted that a 75-50-25 step-down hike approach over the next three meetings and then “pause and assess” scenario is the most probable outcome. Second, it is increasingly likely the GOP will take both the House and Senate in the midterm elections, as once-close races are well not as close anymore. This will reduce inflation fears, rate volatility, and improve consumer and business sentiment. Finally, the global macro backdrop hasn’t material worsened. It looks like Europe can get through this winter fine, as seen in recent drops in natural gas prices. Russia continues to flail about as it loses ground around Kherson, and fears that it will resort to using a nuclear weapon have grown, but Putin has also increased efforts/rhetoric to come back to the negotiation table. It is hard to know what to think there, but Russia’s energy leverage over Europe is certainly reduced. Finally, Xi is now the undisputed head honcho, and it is all on him following a very historic and bizarre 20th National Congress meeting. In our view, this only increases the tail risks but not the modal outcome for growth and geopolitical risk. Putting it all together and we still see some hope for the current October rally, which has stalled out this week due to tech earning misses, to continue.
Recent weaker economic data and slight changes in Fed official's rhetoric have moved the terminal rate lower as future hikes have now been priced more moderately, moving the 1yr1yr OIS closer to 4%, while the M3-Z3 spread is now pricing in 1.5 cuts. This move from peak Fed “hawkishness” has helped the dollar cool while Treasuries have rallied, reducing pressure on the MOVE index (although still elevated) and helping the VIX also fall. There has also been increased call buying and put selling, flattening the skew, indicating a reduced urgency for downside protection.
*@SpotGamma ‘s Risk Reversal metric for the S&P closed at -0.03 yesterday, which is the highest in 2 years. This is a signal that put values are low relative to calls, and this comes from increased call buying and/or put selling
*DXY has dropped below its 50dma thanks to notable improvements in the Euro and Pound, reducing future pressure on financial conditions and corporate earnings
On the data front, weaker employment readings in survey-based data and housing prices dropping the most on record while rental markets continue to signal a cooling have reduced inflationary fears. Add in the notable contraction in M2, and Fed officials can begin to look through the stickiness of the expected continued high monthly core service inflation readings into year-end.
*Consumers are becoming increasingly more worried about job security which will reduce turnover, the primary driver of wage increases
*Higher frequency data on the rental market continues to show a slowing in demand and falling prices
As a result of weaker data and changing Fed rhetoric, there has been a “press pivot,” which, as best heard from the WSJ, see’s “this bottoms-up, microeconomic view (on inflation) as rather encouraging.” Economists at JPM believe an “inflation downshift is on its way.” Their research projects headline inflation to fall from the current 8.2% level to 3.2% next September. Using a similar exercise, Economists at UBS see it hitting 2% by December of next year. Inflation-linked bonds and derivatives have reached a similar conclusion, projecting headline inflation of 2.9% a year from now, according to Intercontinental Exchange. Elsewhere, inflation readings in business surveys picked back up in October (regional Fed and S&P Service PMI) but are still generally trending lower. Finally, decreases in future wage expectations, as seen in the same regional Fed surveys, the NFIB Small Business survey, and reduced job security expectations reported in the Conference Board’s Consumer Survey, have wage-spiral fears falling. This should counter any recent increase in consumer inflation expectations.
*Although recently more mixed and picking up in regional Fed surveys, more national readings from the S&P and ISM Manufacturing PMI surveys show continued declines in prices paid and received
*Money growth is contracting, which is a headwind for inflation and financial asset values
So what does this all mean? As we are fond of saying, it is all about inflation, and it is continuing to fall despite what the official data shows. The Fed is growing nervous about the effects their tightening will have on the real economy as well as financial markets, given the unprecedented size and speed in which they occurred. They are increasingly acknowledging the lag CPI/PCE data has in capturing the true inflation story. As a result, the end of rate hiking is near despite what the next few monthly core-service CPI/PCE readings are. This leads us to believe a further rally in risk assets remains possible, given that the 800-pound gorilla (aka the Fed) in the room will be less likely to sit on it.
*Yields tend to peak shortly before the Fed changes policy course, but if the last hike is in Q1 it is likely we haven’t seen the highs yet
To keep what is being referred to as a “crash-up” rally going, we want to highlight our list of necessary things:
Labor market data continues to decelerate, reducing the perceived tightness in the market. Generally, all data needs to show reduced end demand, reducing demand-pull drivers of inflation.
More positive participation from CTAs, which are thought to become more bullish in the 3800 – 3900 range but are still negatively positioned.
Calls remain well bid on “crash-up” fears as much of the buyside is poorly positioned for any further rally. At the same time, a put-bleed environment leads to short-covering support.
Increased levels of corporate buybacks into year-end, something expected to accelerate coming out of the earnings blackout window as soon as next week after a strong Q3.
Falling volatility levels in both rates and equities allowing greater participation from vol-focused strategies such as risk-parity funds, although correlations are still hampering strategies there.
*Positioning remains extremely bearish, so increased participation may be enough to create a positive FOMO feedback loop
In conclusion, some green shoots have appeared in the macro landscape and the growing “bad is good” mentality is helping risk sentiment begin to improve. The fact that the U.S. markets were able to shrug off an epic Chinese equity drawdown and China ADR liquidation earlier in the week and significant misses in bellwether tech earnings didn’t crash indexes back down to near lows shows there is something deeper at work with the current rally. In the end, many stocks are showing attractive valuations, particularly assuming no economic armageddon scenario next year, and the macro headwinds, particularly on the policy front, are changing. We will end with the following from Dan Loeb:
“As my friend and mentor, who I will dub the “smartest man in America,” recently told me, he did not know when the market would bottom, but he knew for sure it would be when economic data looked godawful. I am reminded of this NY Post cover and headline from March 9, 2009: “Warren Buffet: The Economy Has Fallen Off a Cliff!“ I am familiar with this doom spiral trap because I fell into it too, declaring in an investor letter on March 10, 2009 that we should “brace for impact” just before markets (and our portfolio, since I changed my view only days later based on new data and had ramped exposures to banks/autos) turned around dramatically. The essential question for me at this point is whether capitulation on rates and inflation driven by Fed policy is the key or if a bottom in the real economy (based on unemployment, income, industrial spending, and broad measures of GDP) is actually what matters most. For now, while we remain respectful of the numerous well-flagged risks, we are looking to deploy capital into both world-class companies trading at bargain basement prices and event-driven situations that will be somewhat protected from market moves." - Dan Loeb
*How low can it go? Earnings estimates have continued to fall throughout this season, but with valuations in many sectors getting cheaper, will it matter if the overall economic outlook improves for 2023?
China watchers/analysts are seeing last week’s 20th National Congress of the Chinese Communist Party as one of the most extraordinary meetings in CCP history. There was a higher level of secrecy and internet/news suppression leading up to it than usual, indicating it would be a different sort of meeting. However, the widely expected and unprecedented third term for Xi was one of the least surprising things, with entire political factions disappearing from leadership roles, the abolishment of the seven-up/eight-down norm, and a massive revision to the Party Charter catching most off guard. Not to mention Hu’s humiliating on-stage exit while Xi looked on with his usual smirk. Xi’s two-hour speech covered it all with high expectations for development while still expecting frugality. He focused on security over growth and showed no signs of wavering on his zero-Covid policy. The “Wolf Warrior” mentality that has been growing for a while now was also on full display as his report to the Party Congress ditched the familiar characterization that China was in a “period of important strategic opportunity” but instead warned that “dangerous storms” are approaching. As seen by market reactions earlier this week, investors read the affair as a doubling down of existing policies and a further move by China to become a one-man-driven autocracy, weighing on the growth outlook and increasing the geopolitical risk of investing there. We generally agree with the market's outlook but also acknowledge that financial assets there are now historically very cheap, and the ability to change priorities (and support growth and financial markets) to accomplish technological ambitions could occur quickly if Xi wanted it.
The most significant message from Xi's 20th Party Congress Report is that development goals have shifted to quality over quantity, especially regarding technological advancement, which is seen as critical to the country's future. The advancement of self-sufficiency and leadership in tech stands out compared to the 19th Party Congress Report, which barely mentioned tech. For decades, the most important performance metric for Chinese officials' advancement in the Party was delivering GDP growth. That era is over, and instead, now it is all about research and development to ensure critical technological advancement.
Every single official in China will hear this message, from the Politburo down to local district leaders. Instead of chasing GDP growth to advance their careers, they'll pursue tech breakthroughs. Following the Congressional meeting, the National Development and Reform Commission outlined policies for domestic firms to attract “world-class” talent and urged local authorities to support multinational companies in setting-up research and development centers and to deepen “scientific and technological openness and collaboration.” Beijing also signaled it would ease its rigid pandemic border restrictions for some foreign business executives that are seen as critical to this “collaboration.”
*While the “Made in China 2025” sought to shift China from being a low-end manufacturer to becoming a high-end producer of goods, Xi’s new ambitions will seek to see China as a leader across all tech
The increased emphasis on technology development can clearly be seen in the increased amount of STEM technocrats at higher levels. Once only concentrated at the provincial leader level, seven of the 24 new Politburo members are from “emerging tech” that China will prioritize in the next five years, while there was only one in the 19th PB. Xi stressed that its development path would still be unique, not following Western approaches based on capitalism. Instead, the party would lead the way to achieve high-quality growth while still having “common prosperity.” This means there will be no genuine private sector outside state influence/control. Certain areas of the economy will be allowed to grow if it benefits the overarching goals of tech advancement. In contrast, other areas will suffer, with service to the masses expected over profitability. Xi is basically expecting nationalistic duty and frugality, not things that have historically led to dynamic workforces that can lead to technological innovation, especially against a more greed (vs. fear) orientated West.
*Xi has surrounded himself with no real successors, as the age and backgrounds of the newly appointed are at odds with norms. Given his age and health, this could cause a massive internal fight if he could not continue suddenly
The main takeaway following the 20th Party Congress meeting is that China is continuing its long march toward personalistic autocracy, a system in which Xi ruthlessly rules the party, and the imperatives of political control and national security trump those of economic growth. History shows that when an autocratic leader takes full command of a powerful state, especially after ten years of existing leadership, the results are rarely good for anyone. However, this does not mean that Chinese equities are “uninvestable.” Xi's speech struck a more optimistic note regarding its tech sector, instructing the sector to focus on innovation and potentially reducing any further ramp-up in the “Common Prosperity” crackdown. Time will tell, and the risk-reward currently favors staying away despite attractive valuation levels and the likely revival of economic growth next year to a more on-trend level. Finally, we clearly had the long Chinese ADRs trade wrong this year, underestimating the degree to which Beijing would punish the private sector due to our belief that “Dual Circulation” goals/needs (which need a thriving if not at least functioning private sector) would outweigh zero-Covid and Common Prosperity policies. This may slowly change if Xi is serious about boosting technological innovation, but there is no need to rush in until clearer signs are seen.
*Mainland Chinese stocks, as measured by the MSCI China Index, have never been as cheap as they are now, but for a good reason, given the high level of uncertainty regarding growth and geopolitics
Econ Data:
GDP grew at an annualized 2.6% rate in Q3, beating forecasts of a 2.4% rise. The GDP deflator rose to 4.1%, putting nominal GDP at 6.7% for the quarter. The biggest positive contribution came from net trade (2.77 pp vs. 1.16 pp in Q2). Imports sank by -6.9% (vs. +2.2%), while exports increased by 14.4% (vs. 13.8%). Nonresidential investment jumped by 3.7% (vs. 0.1%), boosted by increases in equipment and intellectual property and offsetting declines in structures investment, which dropped by -15.3% due to decreases in residential investment, which fell for the 6th quarter by -26.4% due to the weakening housing market. Finally, consumer spending slowed but still grew by 1.4% (vs. 2%) as higher outlays on services (led by health care) offset a decrease in goods (motor vehicles and food and beverages). Real private domestic final sales edged only 0.1% higher in the quarter. Finally, the drag from private inventories was smaller this quarter at -0.7 pp (vs. -1.91 pp). The headline price index for personal consumption expenditures rose by an annualized 4.2% in the third quarter, following a 7.3% gain in the previous period. The core price index rose by an annualized 4.5%, following a 4.7% gain in the previous period.
Why it Matters: The report was better than expected at the headline level, as the growth and inflation mix were more favorable than expected. There was higher real-growth due to more favorable inflation readings in exports, government spending, and residential investment. However, the deceleration in final private domestic sales was heavily hurt by the decrease in residential investment, despite business spending on equipment and intellectual property jumping and slowing consumer spending. This means real growth is essentially flat in the quarter. As a result, it was the swing factors of trade and inventories that added 2.1% points, on balance, to GDP in the third quarter. On inflation, if there are no revisions to July and August, backing out of these quarterly numbers suggests that headline PCE price inflation will hold steady at 6.2% year-over-year in September, and core PCE price inflation will pick up further to 5.1% in September from 4.9% in August.
*Big increase in net exports with the more critical PCE component decreasing from last quarter
*Declines in residential investment are increasingly weighing on the overall Real GDP outcome
New orders for durable goods increased 0.4% in September, following an upwardly revised 0.2% gain in August and beating market expectations for a 0.2% advance. Transportation equipment, up five of the last six months, drove the increase with a 2.1% MoM gain (aircraft orders increased 5.3% and motor vehicle orders rose 2.2%). Excluding transportation, new orders decreased by -0.5%, and excluding defense, new orders increased by 1.4%. Nondefense new orders for capital goods increased by 3.5%, but excluding aircraft, was down by -0.7%. Shipments increased by 0.3% MoM, while unfilled orders increased by 0.5% MoM. Finally, inventories increased by 0.2%.
Why it Matters: Somewhat mixed bag, as outside of transports, most categories were lower on the month. The data is not adjusted for inflation, so gains in shipments, unfilled orders, inventories, and Inventory-to-Shipment ratio are hard to interpret. The September durable goods shipments and inventories data are already incorporated into today’s third-quarter GDP report. The forward-looking information is in the non-defense non-aircraft capital goods orders series, which declined by -0.7% and has risen 3.2% at an annualized rate over the last three months, which contrasts with the strong business equipment investment in the third quarter.
*The headline rise hides a weaker report as transports were the primary driver while other categories declined on the month
*Declines in Non-defense capital goods ex. aircraft foretell a decline in growth maybe coming in Q4
New home sales fell by -10.9% to an annualized rate of 603K in September, after jumping by a downwardly revised 24.7% in August and compared with market forecasts of 585K. Sales fell in the South (-20.2% to 356K) and the West (-0.7% to 135K) but rose in the Northeast (56% to 39K) and the Midwest (4.3% to 73K). The median sales price of new houses sold was $470,600, up 13.9% from a year ago, and the average sales price was $517,700. There are 462K houses for sale, corresponding to 9.2 months of supply in inventory. Building permits increased by 1.4% month-over-month to an annualized 1.564 million in September, in line with preliminary estimates. Permits rose in the Midwest (3.4% vs 4% in early estimates), the South (2.5% vs 3.1%) and the West (0.8% vs 0.3%) but fell in the Northeast (-6.5% vs -9.4%).
Why it Matters: In what is becoming a very erratic monthly data series, new home sales fell less than expected as a big jump in the Northeast helped buffer decreases in the South and West, where the bulk of activity is. With all things housing currently, there is clearly a cooling occurring, with the level of new houses selling back at more normal levels after running hot the last two years. Increases in permits show that homebuilders still have a backlog to work through, as the construction pipeline has not fallen entirely off a cliff yet.
*Single-family home sales have come off historically high levels at the start of the year and are now more aligned with multi-year average levels
*Permits and Starts remain historically high at an absolute level due to the low levels of existing inventory, but things are changing fast
*All signs point to further declines in sales and hence prices as demand continues to be hurt by higher mortgage rates on top of already poor affordability
The S&P CoreLogic Case-Shiller 20-city home price index fell by -1.6% month-over-month in August to a 13.1% year-on-year increase, the least since February of 2021, and below forecasts of 14.4%. It marks a fourth consecutive month of slowing home price growth. All 20 cities reported lower price increases. The largest monthly decreases came from San Francisco (-4.3%), Seattle (-3.9%), San Diego (-2.8%), and Los Angeles (-2.3%). Meanwhile, the National Composite Index rose by 13% in August, down from 15.6% in July, the largest deceleration on record.
Why it Matters: As a reminder, this data is severely lagged, so the -2.6% drop in the annual YoY growth rate for the National Composite Index between July and August, the “largest monthly deceleration in the history of the index,” is likely only going to increase. Given what more timely data is showing us.
*Large and sudden reversals finally being captured in the Case-Shiller data
The Conference Board’s Consumer Confidence Index decreased in October to 102.5, down from 107.8 in September. The Present Situation Index declined sharply to 138.9 from 150.2 last month. The Expectations Index declined to 78.1 from 79.5. Consumers’ assessments of current business conditions and labor markets were less favorable in October. Expectations six months ahead were more upbeat, with slight increases in business conditions and job availability, while future short-term financial prospects also improved very slightly.
Why it Matters: After back-to-back monthly gains, consumer confidence fell notably in October due to increases in gas and food prices. Vacation intentions cooled; however, intentions to purchase homes, automobiles, and big-ticket appliances all rose. “The Expectations Index is still lingering below a reading of 80—a level associated with recession—suggesting recession risks appear to be rising,” said Lynn Franco, Senior Director of Economic Indicators at the Conference Board. We will be interested to see the effects a split government will have on consumer confidence following the mid-term elections. Our expectations continue to favor a strong rebound in the present situation readings into year-end and throughout Q1 due to this and the continued decrease in inflationary pressures.
*The majority of the headline index drop was due to changes in the “Present Situation” sub-index
*Consumers’ appraisal of the labor market was also less upbeat, with a four percentage point drop in those viewing jobs as plentiful
The Richmond Manufacturing Index fell to -10 in October from 0 in in September, the lowest since May of 2022. Shipments and New Orders fell notably, while other indications of demand were more mixed, with the Backlog of Orders moving further into deep negative territory while inventory measures increased. When coupled with a fall in Capacity Utilization, fewer inflationary pressures are likely coming from those channels moving forward. However, actual measures of Price Trends, Paid and Received, both increased at the current and expected level. The employment picture also cooled slightly with the Number of Employees unchanged but Wages and Availability of Skills Needed both falling. Current and Expected Capital and Services Expenditures cooled but remained positive outside future service expenditures.
Why it Matters: A broadly negative report in the current and expected future readings. There were notable drops in several key sub-indexes that had improved in the prior month, indicating that on-the-ground conditions in October deteriorated as demand fell while cost pressures did not. There was little change in Vendor Lead Times and Backlog of Orders, indicating supply-side and logistical impairments were little changed. Finally, the overwhelming and broad downgrades in the future outlook indicated a significant increase in negative sentiment among respondents.
*Changes in current and future expectations mirrored each other in October, with most down following a September bounce
*The overall index continues to trend lower as demand falls while price trends have picked up again
*Hiring and investment expectations are rolling over hard, given the increasingly uncertain future economic landscape
Kansas Fed Composite Index decreased to -7 in October from 1 in the previous month, with Manufacturing Production Index falling to -22 from 2, both reaching their lowest levels since April of 2020. The declines were broad-based, with Shipments falling notably into negative territory after being flat in September. New Orders and the Backlog of Orders fell further into contractionary territory too. All three employment sub-indexes declined, with the Average Workweek moving into negative territory. Inflationary measures eased, with both Prices Received and Paid declining to their lowest level of the year. Inventory measures were little changed and flat, indicating no bias to being under or over-stocked. The majority of the six-month ahead sub-indexes fell, mirroring what was seen in current condition readings, although the drop in demand readings was larger than what occurred on the current side.
Why it Matters: Mirroring what has been seen in other regional Fed surveys, the Kansas Fed Composite headline decrease hid a more negative underbelly, with a broad and notable decrease in the majority of current and future sub-indexes. Unlike other surveys, price pressures at least continued to fall. Also, unlike others, there was more of a downturn in employment readings here, with current and future sub-indexes all falling. Contacts were asked a special question on changes in their workforce and investments compared to pre-pandemic. In October, 65% of firms reported devoting significantly or slightly more resources to training workers in order to meet skill requirements, while 33% reported no change. Due to labor shortages, 36% of firms reported investing or planning to invest in labor-saving automation strategies at a faster pace than in the past. On the same questions, 28% percent of firms invested or planned to invest, similar to the past, and about 25% of firms reported not investing in labor-saving technology. Clearly, labor problems during the pandemic have increased the push to automate as much as possible, although not everyone is as eager or able as others.
*“Regional factory activity declined slightly in October,” said KC Fed Official Wilkerson. “Indexes fell considerably for production, shipments, and new orders; however, firms still reported slight gains in employment.”
*When looking at current and future sub-indexes, sentiment turned considerably more pessimistic in October verse September.
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day and the week, and Small-Cap Value is the best-performing size/factor on the day.
Chinese Iron Ore Future Price: Iron Ore futures are lower on the day and on the week.
5yr-30yr Treasury Spread: The curve is stepper on the day and on the week.
EUR/JPY FX Cross: The Euro is stronger on the day and the week.
Other Charts:
“Implied Vol stays bid in “spot up, vol up” fashion, driven by demand for “right-tails / crash-up” hedges from an underexposed buyside that is terrified of missing the “pivot” rally, which is then evident in the “greater than 2:1” magnitude of the spread on “upside” vs. “downside” day absolute returns seen over the month of October… Puts still too remain firm at the same time, as there certainly doesn't seem to be any sort of "all clear" from the market at this point, due to this persistent Rates and FX vol tension.” - Nomura Cross-Asset Research Team
Corp. client buybacks have remained elevated and above typical seasonal trends since the start of Oct., suggesting corporates may be taking advantage of valuations amid the sell-off. Following the earnings blackout period for most large caps, there should be a further increase starting next week throughout November.
“Put the market caps together of Microsoft, Apple, Nvidia, Tesla, and Amazon and compare that figure with their aggregate free cash flow, and you get a multiple of over 50 times, down from nearly 70 at the start of the year. This historic level of overvaluation was only made possible by massive money printing on the part of the Fed that supported both cash flows and the multiple applied to them.” – Felder Report
While seasonality turns bullish about right now, take caution when in a bear market. -@topdowncharts
The ten-year to three-month part of the curve has finally inverted, something that has an almost perfect record of predicting a future recession.
“Latest Investors Intelligence data show 36.9% bulls and 38.5% bears. This still fits almost perfectly with the price model for what sentiment should do. In other words, sentiment is a function of price behavior, versus the other way around.” - @McClellanOsc
“If slowing household demand is the goal, more work to be done. For the week ending Oct 18, total retail & food service spending from the BEA's payment card transactions data is up 12.2% against the pre-pandemic baseline. That's exactly where it has been for the last four weeks.” - @RenMacLLC
Inflation will remain uncomfortably high next year, especially for core service inflation, and as a result, we see some risk that the FOMC will feel obligated to keep hiking for too long in response. – GS Research
However, GS also noted that wage growth is slowing for retail sales and accommodation and food service workers, reducing wage spiral fears at the Fed.
Business confidence in Germany stabilized in October after expectations came close to levels seen at the height of the pandemic
Chinese stocks have never lagged the overall global stock market index this badly, as Xi's selection of cronies did not comfort investors that meaningful change was coming.
The offshore yuan jumped the most on record, by as much as 1.8% to 7.1917, as state banks were said to sell dollars and the greenback retreated on bets the Fed may moderate hikes.
The price of lithium in China continues to rise after a short pause over the summer. Are price controls coming to this sector soon?
Article by Macro Themes:
Medium-term Themes:
Real Supply-Side Situation:
Returning to Earth: Trucking Swerves Erratically Across the US Economy - Bloomberg
Consumer spending is cooling, and there are pockets of weakness, such as housing, that are weighing down cargo volume. United Parcel Service Inc.’s average daily package volume in the U.S. fell 1.5% in the third quarter from a year earlier and is likely to decline even more in the fourth quarter. The word is that there will be no peak holiday season for truck companies this year because warehouses are already stuffed with inventory, and those goods aren’t moving off shelves rapidly. Rates in the spot market are plummeting, down 40% from a year earlier, according to Cowen & Co.
Why it Matters:
Despite the recent slowing in demand, the freight contract market, where rates are locked in through shipper agreements that typically last a year, is still rising. Cargo tonnage in this market rose 5.5% in September from a year ago, reaching the highest level since August 2019, according to the American Trucking Association. Contract rates have risen 15% from a year earlier. Cargo strength is being bolstered by infrastructure projects, increased domestic oil drilling, and industries with large backlogs, such as aerospace and rebounding auto shipments. The cleanup and reconstruction work from Hurricane Ian in Florida has created trucking demand, and the drought that has left barges stuck on the Mississippi River also pushes some bulk demand to trucks. There is no cliff coming for the trucking industry yet.
China Macroprudential and Political Situation:
No Go: China’s Economy Slows in October as Business Confidence Slumps - Bloomberg
China’s economy slowed in October as car and real-estate sales weakened while global trade and small business confidence contracted. Export orders still rose, but there was a contraction in activity from domestically focused companies, implying weaker demand locally. An indicator for the manufacturing sector dropped to its lowest level since February 2020, while the index for accommodation and catering was at its lowest level since at least May 2020.Housing sales in the four biggest cities in China were down almost 30% in the first three weeks of the month compared to a year earlier, and property transactions slumped almost 40% during the long holiday earlier in the month, which is usually a time of brisk sales.
Why it Matters:
Daily Covid case numbers in China have been hovering around 1,000 since early August, despite strengthened efforts to contain outbreaks and much tighter restrictions on travel and movement ahead of the just-ended Communist Party congress. Those controls have stopped exponential increases in cases at the expense of private consumption, which only grew 2.5% in September from a year earlier. There was no indication from the party congress that the government is planning any changes to the Covid Zero strategy, causing a stock market rout on Monday that was the steepest since 2008. The benchmark onshore share index has lost more than a quarter of its value this year.
“Openness”: China Signals Easing of Covid-19 Restrictions for Foreign Businesses – WSJ
China signaled it could ease its rigid pandemic border restrictions for some foreign business executives and called for technological collaboration with multinationals. In a notice that outlined policies to attract more foreign investment into its manufacturing sector, the government asked local authorities to facilitate multinational companies’ executives, technicians, and their families to travel to China. The notice, published Tuesday on the National Development and Reform Commission’s website, also encouraged bringing world-class talent into the country. It urged local authorities to support multinational companies to set up research and development centers in China and to deepen “scientific and technological openness and collaboration.”
Why it Matters:
Jointly issued by six regulators, including the Commerce Ministry and Ministry of Industry and Information Technology, the notice also specifically named the semiconductor sector, among a few others, calling on local authorities to organize international investment events for these industries. Foreign business lobbies and executives called the policies an improvement but said they would watch whether and how they get implemented. “This is essentially the gathering of existing national policies under one umbrella, the implementation of which—in terms of how and over what time frame—is yet to be clarified,” said Jörg Wuttke, the president of the European Union Chamber of Commerce in China. The bottom line is that the zero-Covid policy is getting in the way of “Dual Circulation” objectives of insulating China from foreign tech needs. Xi will have to choose which one is more important.
Longer-term Themes:
National Security Assets in a Multipolar World:
Zero-China: Japanese companies explore how to go 'zero-China' amid tensions - NikkieAsia
Japanese companies are striving to build supply chains that do not depend on China amid that country's growing conflict with the U.S. This is expected to increase the costs of all manner of products dramatically. If 80% of Japan's imports from China, about 1.4 trillion yen ($9.4 billion) worth, including raw materials and parts, were disrupted for two months, Japan would not be able to produce a wide range of products, including home appliances, cars, resins, clothing, and food products. About 53 trillion yen ($360 billion) worth of production would disappear, according to estimates by professor Yasuyuki Todo at Waseda University. That would amount to a loss of about 10% of Japan's gross domestic product.
Why it Matters:
Countries are increasingly excluding China from their supply chains. In May, the Biden administration in the U.S. created the Indo-Pacific Economic Framework (IPEF) with 14 countries, including Japan, the U.S., and India. It assumes that in a contingency, countries will share information on critical products and exchange inventories as part of their crisis response. However, much of the world continues to rely on China for goods, and with high inflation, it is not a great time to move production to potentially higher-cost places. As a result, China’s manufacturing base continues to be a national security asset as no other country can fully decouple from it yet, giving China soft power over the rest of the world.
Electrification and Digitalization Policy:
Machines: Ukraine Enters a Dark New Era of Drone Warfare – Wired
Russia has ramped up its use of Iranian-made “suicide drones” in Ukraine, which travel in groups and explode by diving at their targets, obliterating themselves in the process. On Monday, dozens of drones attacked Ukrainian cities during morning rush hour, killing at least four people when they struck an apartment building in Kyiv, the Ukrainian capital. Drone and missile attacks have also destroyed 30 percent of the country’s energy infrastructure in the past ten days, according to Ukrainian officials. Swathes of the country are now without power.
Why it Matters:
Armed drones have been involved in the fighting in Ukraine for months. Until now, both sides have mostly limited their use to the front lines, although Russia used Iranian drones to bombard the port of Odessa and military targets in the city center. But this week’s attacks by Russia mark the beginning of a dark new era for drone warfare in Ukraine. For the first time, drones are being used to target civilians and civilian infrastructure in a way that analysts say gives Russia little strategic advantage on the battleground. Instead, these attacks are designed to spread terror and crush morale.
Watch the Wires: French police probe multiple cuts of major internet cables - WaPo
French police said Friday they’re investigating multiple cuts to fiber-optic cables in France’s second-largest city. Operators said the cables link Marseille to other cities in France and Europe and that internet and phone services were severely disrupted. The damage in the city in southern France also appeared to resemble suspected acts of sabotage to other cables in the country earlier this year.
Why it Matters:
Cybersecurity company Zscaler said the severed cables link Marseille to Milan, Barcelona, and the French city of Lyon. It said the cuts “impacted major cables with connectivity to Asia, Europe, U.S., and potentially other parts of the world.” The disruptions in Marseille were a taste of what analysts warn could be far larger problems in other cases if cables are systematically attacked. The vulnerability of fiber-optic cables, especially underwater and other key infrastructure, was highlighted by Russia's sabotage last month in the Baltic Sea of natural gas pipelines.
Hardware: Chipmakers in ‘Unprecedented’ Slump Rule Out Quick Turnaround - Bloomberg
Texas Instruments Inc. and SK Hynix Inc. offered a gloomy view of the chip market in their latest quarterly reports, dashing hopes of a quick rebound for the $550 billion industry. Investors have been trying to pinpoint when flagging demand for chips would begin to ease. TI missed earnings while said memory prices fell 20% over the last quarter and warned of “unprecedented deterioration in market conditions.” Some welcomed Hynix’s action to stem oversupply and whittle down production of lower-margin products.“The South Korean chipmaker’s dramatic capital expenditure cut is a bold statement demonstrating their determination to confront the escalated uncertainties,” said Hebe Chen, an analyst at IG Markets Ltd.
Why it Matters:
Texas Instruments rekindled fears that the slowdown is spreading, saying sluggish demand had affected chips for industrial equipment, an area that had been seen as more immune to the slump. Elsewhere, memory maker Kioxia is cutting output by 30% and also said the market is in a severe condition, and there’s little certainty of when sentiment will improve. The Japanese firm said that demand for NAND memory is weakening across the board. The Biden administration’s effort to rein in China’s chipmaking power has also cast a cloud over the industry. Hynix warned that its DRAM production plant near Shanghai might be forced to close in an extreme scenario where U.S. sanctions prevent it from importing the equipment it needs to sustain and expand production. It is still unclear if the current slump is customers cutting back to reduce inventory or if a deeper economic concern is at play.
Commodity Super Cycle Green.0:
Micro-Grids: Long-duration batteries could free the grid from fossil fuels - Protocol
Form Energy signed a partnership with Georgia Power, its first with an investor-owned utility, earlier this year to deploy up to 15 megawatts of energy storage capacityusing its new iron-air technology. CEO and co-founder Mateo Jaramillo told Protocol that Form Energy will announce more contracts in the near future and that the company is targeting late 2024 for commercial production of its batteries. The article details the technology and the company's voyage to this point in starting to commercialize it.
Why it Matters:
So far, utilities have primarily used lithium-ion batteries to store renewable energy when the sun sets, or the wind stops blowing. However, existing utility-scale storage can only discharge energy for up to four hours at a time, meaning that systems can falter when the grid needs to provide widespread power for a long period of time, such as during a heat wave or major storm.Instead, the iron-air technology is only now being commercialized because the technology is particularly well-suited to the demands of today’s grid. We highlight the use of Iron-air technology, as well as potentially sodium-based storage in the future, as something worth keeping on your radar given the shortages of lithium likely to come.
ESG Monetary and Fiscal Policy Expansion:
New Norm: Biden’s Student-Loan Forgiveness Program Temporarily Halted by Appeals Court – WSJ
A federal appeals court Friday temporarily stopped the Biden administration from moving forward with its plan to forgive up to $20,000 in student-loan debt for millions of Americans. The Eighth U.S. Circuit Court of Appeals issued the halt in a one-page order that will remain in place for a short period while it considers a request by Republican leaders in six states to block the implementation of the program. The Biden administration has said in court filings that it wouldn’t discharge any student-loan debt before Oct. 23.
Why it Matters:
The Biden administration estimates the debt relief would cost $379 billion over 30 years, while the nonpartisan Congressional Budget Office released a similar estimate of around $400 billion that assumed 90% of eligible borrowers would apply. Friday’s decision by the appeals court comes one day after a federal judge in Missouri denied a request by the group of Republican state leaders to block the program. The appeals court, which is hearing an appeal of the Missouri judge’s order, set a briefing schedule with deadlines early next week. We also highlight this legal tactic given the likely coming divided government where the Biden administration will need to use more executive orders.
Appendix:
Current Macro Theme Summaries:
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