MIDDAY MACRO - DAILY COLOR – 11/11/2021
OVERNIGHT-MORNING RECAP / MARKET WRAP
Narratives/Price Action:
Equities are higher, as a more risk-on tone started overnight in China with Evergrande making coupon payments and U.S.-China relations improving over COP26 pledges
Treasuries are on holiday, as trading is closed today due to the Veterans Day holiday
WTI is higher, with OPEC releasing updated demand/supply projections while the Biden Administration continues to weigh its options to reduce the price at the pump
Analysis:
Equities are higher, helped by a more positive tone out of China as policy support for the real estate sector and reports of strong Singles Day shopping there, as well as Evergrande still making payments, all helped global risk assets bounce after yesterday higher than expected CPI driven sell-off. A lack of new U.S. data and the absence of Treasury market price action today is also helping settle sentiment more generally
The Russell is outperforming the Nasdaq and S&P with Small-Cap, Growth, and Momentum factors, and Materials, Energy, and Technology sectors all outperforming.
S&P optionality strike levels have the Zero-Gamma Level moved lower to 4618 while the Call Wall is at 4700. Despite the S&P being 60+ points off recent highs, the market holds a fair amount of gamma and should remain well supported, with 4700 strikes holding the most total gamma (large magnet).
The technical levels have support at 4630 and resistance at 4675, followed by 4690 for the S&P. Seasonality favors higher volatility for a few more sessions. Still, little support under 4630 increases the risk of a larger pullback before a more favorable end-of-year melt-up.
Treasuries markets are closed - Thank you to all that serve
*The various phases of the pandemic/recovery have seen clear leadership accept for the current phase, which is more even in returns except for energy
*As liquidity conditions begin to tighten next year and earning comps get harder to meet valuations should increasingly matter
*The growing breadth of inflation is what is increasingly worrying the market as it is no longer specific to pandemic phased goods/service demand cycles, although supply-side disruptions are clearly still affected by Covid elsewhere
*Despite the breadth and fact almost 40% of CPI components are higher by 4% annually, we continue to believe we are at peak inflation given the rises we have already seen
*Don’t look now, but Bitcoin and Gold are becoming increasingly correlated thanks to the growing inflationary fears, although they have a long way to go to be in sync
Given the holiday weekend and fast-approaching year-end, it is a good time to review a few key ratios that will help shed light on changing sector/factor leadership in equities. We continue to favor small-caps and value despite persistent/growing worries that inflationary headwinds will pressure future profit margins due to our belief supply-side (materials and labor) shortages will meaningfully subside in the first half of 2022 and growth will become increasingly uncapped.
After underperforming since March, the Russell has been stabilizing and now looks ready to outperform the Nasdaq, with the Russell/Nasdaq Ratio starting to push through the upper bounds of its longer-term down-channel.
*IWM/QQQ Ratio has been in a well-defined down-channel for most of the year until recently as the Russell had been range-bound until its recent breakout
*After an impressive rally from November ‘20 to March ‘21, the Russell consolidated for most of the year. It has recently broken out, helped by the renewed re-opening and increased activity from the Reddit Brigade
Further, the Russell 2000 Value Index has also been outperforming the S&P recently, with the IWN/SPY ratio pushing to the top of its post-March downtrend channel after dipping in October. We believe this will continue to outperform as the re-opening and holiday season remain strong, as well as energy and financials regaining momentum.
*The IWN/SPY ratio is pushing on the top of its multi-month down channel even with the pure value factor not performing as well (IWD/SPY)
Elsewhere, the semiconductor index had a nice run higher in October, notably outperforming the S&P. It is now cooling as the RSI reached extreme overbought conditions following a strong earnings season. We remain neutral on the sector at current levels but bullish longer-term as increased capacity has yet to weaken pricing power. We would wait for a further pullback to enter any new positions.
*The SOXX/SPY ratio reached highs seen at the beginning of 2021 after Nvidia’s Q3 earnings report and has been cooling since, still in a broader longer-term uptrend
REITs have underperformed the general market since June, with the VNQ/SPY ratio now in the middle of its multi-month downtrend channel. We believe REITs more generally will begin to outperform as investors will become increasingly hungry for dividend yield while commercial real estate fundamentals and valuations continue to improve as we further enter a world of work redundancies (home and office).
*If you believe commercial real estate will recover further and inflation will remain structurally stronger, the REIT sector is likely to outperform with $VNQ only 10% higher than its pre-pandemic highs
Finally, financials have come under pressure as the Treasury curve flattened and earnings season, although positive, failed to break the XLF/SPY ratio out of its multi-month uptrend channel. We believe that improving fundamentals and a stabilization in the yield curve will support financials to outperform tactically again.
*The XLF/SPY ratio is trying to bounce off the bottom of a well-defined tactical up-channel inside a wider longer-term up-channel
Policy Talk:
San Francisco Federal Reserve President Daly spoke with Bloomberg yesterday, noting it was still too early to tell if inflation was becoming a problem that required a faster pace of tightening. Instead, as was heard from Chicago Fed President Evans early in the week, she cited the persistence of Covid as still being a primary problem. “Right now, it would be premature to start changing our calculations about raising rates… Right now, uncertainty requires us to wait and watch with vigilance.” Daly attributed the supply bottlenecks and “extreme demand for goods” are the main contributors to the high levels of inflation.
Why it Matters: Daly is an FOMC voter this year but will not be next year. She can also not be ruled out as a potential successor to Powell, so listening to what she says is important. Daly’s views nicely summarize where the dovish members of the committee stand. The data is still muddied from the pandemic, and patience is still warranted because the core belief is that normalization in prices and labor will occur as the economy fully reopens, all be it at a slower pace than initially expected.
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the week although growth is outperforming today, all be it on a quieter holiday session
Chinese Iron Ore Future Price: Iron Ore futures are lower on the week, but higher today thanks to a more risk-on tone domestically in China
5yr-30yr Treasury Spread: The curve is flatter on the week, but no changes today due to the holiday
EUR/JPY FX Cross: The Yen is stronger on the week and the day with the Euro continuing to be tactically weaker against most major FX pairs recently
ARTICLES BY MACRO THEMES
MEDIUM-TERM THEMES:
China Macroprudential and Political Tightening:
老板: Chinese Communist party clears the way for Xi to tighten grip on power – FT
The Chinese Communist party has passed its first “historical resolution” in 40 years, in a development likely to pave the way for President Xi Jinping to stay in office until at least 2028. Communist China’s two most revered leaders, Mao Zedong and Deng Xiaoping used similar resolutions to secure their grip on power in 1945 and 1981, respectively.
Why it Matters:
The central committee typically holds one plenum a year, attended by its 370 full and alternate members at a military hotel on the western outskirts of Beijing. This week’s plenum opened on Monday and is particularly significant because it comes just a year before a party congress will appoint a new leadership team to serve until 2027. Xi is expected to dispense with the traditional two-term limit and secure a third five-year term as the party’s general secretary late next year.
Support: China Weighs Moderating Property Curbs to Help Troubled Developers Unload Assets – WSJ
Chinese regulators are considering easing the rules to let struggling developers sell off assets to avoid defaults. Currently, rules put in place late last year to restrict how much property firms can borrow, dubbed the “three red lines” on leverage ratios, are so strict that they have hurt the ability of developers like China Evergrande Group to sell assets to repay debts.
Why it Matters:
The potential move would represent a calibration, rather than a change, of the broader policy aimed at reining in real estate speculation and reducing the economy’s reliance on the sector. The article also highlights other actions being taken or at least activities out of Beijing that show a growing concern that the clampdown on the real estate sector may have gone too far.
LONGER-TERM THEMES:
National Security Assets in a Multipolar World:
Supplying Food: Wheat Jumps as Russian Export-Tax Talk Fuels Supply Worries – Bloomberg
Russia could revise the formula behind its floating grain-export tax if there is a significant increase in global prices, Agriculture Minister Dmitry Patrushev said at a government meeting Wednesday. The tax has been in place since mid-year to slow sales abroad and cool domestic food inflation. He said that Russia also plans to set a grain-export quota again in the first half of next year.
Why it Matters:
Wheat prices in Chicago reached the highest since 2012 earlier this month, and Paris futures hit a record after crops worldwide were hit by droughts, frost, and heavy rain. Food security will continue to come into focus moving forward if weather changes continue to stress production. As a result, and in a similar fashion to energy, food producers will wield increasing power, prioritizing stable domestic inflation verse gaining export-driven soft-power, as Russia is currently doing.
Electrification and Digitalization Policy:
Escape from Reality: Coinbase CEO Says NFTs Could Be ‘As Big or Bigger’ Than Crypto Trading – Bloomberg
Coinbase plans to open its own NFT marketplace, where people will be able to trade digital art and other items, in the next quarter or two. The company wants to offer a one-stop experience for users where they can make purchases and store their holdings on a platform that would provide a social media experience more similar to Instagram than a traditional marketplace such as EBay Inc.
Why it Matters:
Personally, we can’t wait to hang all our NFTs in our Metaverse office and invite reader avatars to look on in awe. That’s a joke but clearly where things seem to be heading. The growth in NFT popularity on top of the continual increase in utility coins helps explain the notable outperformance Ethereum has had over Bitcoin recently. This world really is going online quickly as AR and VR will soon be integrated into daily life.
Commodity Super Cycle Green.0:
Playing Chicken: U.S. oil refiners bet the farm Biden will back them on biofuels – Reuters
U.S. merchant oil refiners like Monroe Energy and PBF Energy are making moves in the biofuels credit market that could force them to close plants and fire union workers unless the Biden Administration bails them out by changing the rules on blending biofuels in gasoline. Behind the shift is a bet that Biden will side with refiners and their powerful union supporters. But significantly rolling back the law as they wish would anger the nation's Farm Belt.
Why it Matters:
Merchant refiners have long tried to dismantle a U.S. law requiring them to blend biofuels like ethanol into their fuel or buy credits from competitors who do. But until very recently, they largely continued to participate in the multibillion-dollar credit market by buying credits to offset their production. But now, some of these same refiners are building up record short positions in the credits. Refiners have extra leverage right now because the White House is battling rising fuel prices, which are hurting Biden's poll ratings. As a result, we expect a capitulation from the Biden Administration.
No Nukes: Ministries reject nuclear inclusion in EU taxonomy – Argus
In a joint statement issued by the environment ministers of Germany, Denmark, Luxembourg, Austria, and Portugal, the signatories warn that including nuclear in the taxonomy would permanently damage the latter's "integrity, credibility and therefore its usefulness." The EU taxonomy is to establish criteria for environmentally sustainable economic practices, steering funding towards these activities.
Why it Matters:
German caretaker environment minister Svenja Schulze said that "nuclear power is too risky, too expensive", and in any case would come too late to make a notable contribution to mitigating climate warming. The statement comes a day after French President Emmanuel Macron announced that France will build new nuclear reactors in the coming years, as part of the country's decarbonization strategy. Looking elsewhere, nuclear will have an increasing role to play in China and India if they truly want to replace coal but the EZ is still Fukushima shook.
We’re Sorry: Investors Pushed Mining Giants to Quit Coal. Now It’s Backfiring – Bloomberg
It was supposed to be a big win for climate activists: another of the world’s most powerful mining companies had caved to investor demands that it stop digging up coal. Instead, Anglo American Plc’s exit from coal has become a case study for unintended consequences, transforming mines that were scheduled for eventual closure into the engine room for a growth-hungry coal business. The article expands on how coal production is not being reduced due to ESG shareholder activism.
Why it Matters:
After years of lobbying blue-chip companies to stop mining the most-polluting fuel, there’s a growing unease among climate activists and some investors that the policy many of them championed could lead to more coal being produced for longer. “Everyone in the industry is starting to be more sophisticated, more nuanced, and more careful on the way they think these issues through,” said Nick Stansbury, head of climate solutions at Legal & General Group Plc. Unintended consequences always occur with big changes, that is what we are seeing with the current energy situation.
ESG Monetary and Fiscal Policy Expansion:
Breakthrough: U.S. and China pledge co-operation over ‘existential’ climate crisis – FT
The U.S. and China made a rare joint declaration to co-operate on climate change, which the Chinese special envoy to the UN COP26 summit described as an “existential crisis”. The U.S.’s John Kerry said the two countries had worked “in good faith” and found a shared interest in success at COP26. “Now the two largest economies in the world have agreed to work together to raise climate ambition in this decisive decade,” said Kerry.
Why it Matters:
The U.S.-China joint statement sends a political signal to other nations that the world’s two biggest emitters will push for a strong final outcome at the COP, even as negotiators are bogged down in late-night wrangling in the last days of the two-week summit. Key outstanding issues include the rules for a global carbon market, the format for countries to report their emissions, and the level of climate-related financial assistance provided by rich countries to developing countries.
Current Macro Theme Summaries:
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