MIDDAY MACRO - DAILY COLOR – 11/5/2021
OVERNIGHT-MORNING RECAP / MARKET WRAP
Narratives/Price Action:
Equities are higher, but now off their morning highs as a better than expected jobs report and further Covid positive news initially continued an overnight rally
Treasuries are higher, with the positive data failing to steepen the curve and eyes turning to Biden’s Fed picks, with Powell still favored to remain chair
WTI is higher, as OPEC stuck to its original plan despite pleas from Biden to raise output as traders now look (back) to the potential for U.S. – Iran negotiations to restart
Analysis:
The S&P is bouncing around a little, giving back some of its overnight and morning gains as the better-than-expected jobs report pushed it to key technical resistance levels while concerns over Fed picks and infrastructure bill progress have cooled sentiment.
The Russell is outperforming the S&P and Nasdaq with Small-Cap, Value, and High Dividend Yield factors, and Energy, Utilities, and Communication, and Communication sectors all outperforming.
S&P optionality strike levels have the Zero-Gamma Level moved higher to 4598 while the Call Wall is at 4700. There is little gamma expiring today, and although the total market gamma position remains positive, the level of strikes at 4700 creates a significant level of gravity towards that level.
The technical levels have support at 4675, and resistance at 4710, followed by 4750 for the S&P. The RSI continues to indicate overbought on the 4hr and daily, and with 4710 being a key uptrend resistance line, a consolidation/cooling is likely needed before a push higher.
Treasuries are higher, with the 5s30s curve flatter by -2.5 bps currently. 10yr-yields are back below their 50 dma as the head-and-shoulders pattern we highlighted last week has continued to work out well.
*The recent rally has brought markets into overbought/overbullish territory by many measures, with seasonals historically weaker mid-November before a finally Santa Rally.
*Speculative call option volumes are approaching their spring levels as the Reddit brigade has been flexing their muscles again lately.
*S&P price performance this year has been broader and more even
Now that tapering is officially underway and the economic outlook is improving, we believe there is an increasing possibility real rates start to rise in the first half of 2022 as nominal yields remain range-bound while inflationary pressures subside (reducing breakeven rates) due to improving supply-side dynamics (both materials and labor availability) while rises in more structural areas also cool (stabilizing shelter costs, lower COLA wage pressures) leading small caps and value to outperform tactically in the next few months.
Powell delivered a dovish taper this week, threading the needle and stressing patience given we have yet to see a non-Covid environment. He stated the current inflationary pulse is supply-side driven, and pandemic-related factors still impair labor participation. This allowed him to refrain from commenting on market expectations for hikes next year, instead saying “the data will guide us.”
*Due to the growing inflationary pressures seen in Q3, markets increasingly believed the Fed would be forced to raise rates quickly, hurting future growth
*Despite the Fed’s dovish messaging of patience Wednesday and dovish central banker actions/rhetoric elsewhere, markets still believe the Fed will immediately begin hiking after tapering finishes
Markets are still unsure about how patient the Fed can truly be given how hot inflation is running, but we continue to believe their focus will be on the max employment mandate and look for the Fed to increasingly communicate how the pandemic has structurally lowered the achievable EPOP level but that we remain far from its new level.
*EPOP is currently at 78.3 verse 80.4 in February 2020, with further analysis showing black and Latino populations have even further to go to achieve pre-pandemic participation levels
As we stated before, our belief is (cyclical) inflationary pressures are peaking due to price increases (or lack of availability) capping/moving-forward demand. At the same time, logistical impairments are at max “logjam” levels due to holiday inventory builds (which should now begin to subside), while labor is increasingly re-entering key logistical sectors due to higher incentivization. But to be clear, improvements are not yet being reflected in the backward-looking econ data, instead appearing more mosaically in the news, earnings reports, and shipping cost indexes.
*Although we expect months of continued supply-chain “stress,” we believe the added holiday demand which exacerbated the system will begin to subside (as its almost holiday time)
Turning to the U.S. economy, today’s job report was good for two main reasons. First, it shows workers increasingly coming back, which should reduce wage pressures and as stated above, alleviate the logistical problems, helping reduce inflationary pressures and uncapping production/growth capacity.
*Service sector and logistic orientated jobs both saw solid gains in October and in prior month revisions
Second, the lack of positive momentum in the participation rate allows the Fed to continue to claim it is far from its full employment mandate. The perception of a “patient” Fed limits any extreme tightening in financial conditions. We do see financial conditions tightening slightly (given the extremely easy levels currently) but expect measured rises in real rates throughout Q1 as breakeven come off elevated levels while nominals are more range-bound.
*Slight improvement in the Prime Age participation rate but still “further progress” needed
*Real rates have some room to rise before they drive financial conditions meaningfully tighter, which are near their easiest levels ever, to become overly restrictive to risk assets
Coupling the jobs report with this week’s ISM manufacturing and Service PMIs (as well as recent data elsewhere), which showed demand continuing to be strong despite the known supply-side problems, the outlook on the overall economy into year-end, and Q1 is increasingly looking more positive.
*Despite high reading due to supply-side disruption driven inputs (Delivery Times, Prices Paid, Backlog of Orders), future demand indicators continue to grow while the overall outlook is still positive
The current pickup in growth should lead to a more positive narrative that markets should increasingly adopt as key metrics continue to improve. The Atlanta Fed’s GDPNow’s 4th qtr estimate has moved higher to 8.5% this week while the Citi Economic Surprise Index is now approaching positive territory as forecasters have underestimated the current growth pulse.
*GDPNow forecasts for Q4 GDP moved to 8.5% after this week’s ISM data releases
To sum it up, we believe that supply-push and wage-spiral inflationary pressures will increasingly subside into the first half of next year despite demand/growth remaining strong. At the same time, financial conditions will not overly tighten despite real rates beginning to rise. This sets a more supportive backdrop for risk assets generally, with our expectations for small-caps and value to outperform.
*GS Financial Condition Index continues to base at historic lows
As far as current risks, we continue to have concerns regarding energy prices resuming their parabolic rise if we experience extreme weather this winter, which would significantly affect the consumer. Further, the current rally is overextended, and we expect some consolidation before a further melt-up. We are less worried about high valuation levels due to the discount small caps current have to large caps.
*As quarterly earnings growth comparisons get harder and lower liquidity compresses multiples, valuations may become increasingly important
The bottom line is we continue to have conviction in our long Russell position, put on Oct 7th, and now higher by +8%, as growth and aggregate demand will continue to beat expectations while supply-side inflationary pressures (both materials and wages) increasingly ease, reducing profitability concerns for more at-risk smaller firms with weaker pricing power and higher variable costs.
*Small-caps are more likely to outperform when growth is picking up faster than expected
Econ Data:
Non-Farm Payrolls increased by 531K jobs in October, the most in 3 months and above market forecasts of 450K. In addition, payroll gains in the prior two months were revised 235,000 higher (+220,000 in private payrolls). The biggest job gains occurred in leisure and hospitality (164K), professional and business services (100K), manufacturing (60K), and transportation and warehousing (54K), while employment in public education declined (-65K). On the aggregate, employment in service-orientated sectors increased by 496K. The unemployment rate fell to 4.6% from 4.8% (3.5% in February 2020), the participation rate held at 61.6% (63.3% pre-Covid), and the U6 underemployment rate fell to 8.3% from 8.5% (7.0% pre-Covid). Average hourly earnings rose 0.4% MoM, increasing 4.9% YoY. Wage growth for production and nonsupervisory workers in leisure and hospitality remained strong, rising 12.4% YoY. The average workweek for all decreased by 0.1 hours to 34.7 hours. The number of long-term unemployed (those jobless for 27 weeks or more) decreased by 357K to 2.3 million but is 1.2 million higher than in February 2020.
Why it Matters: A significantly positive report with the level of payrolls rising 766K higher than September’s original reported level. So far this year, monthly job growth has averaged 582K and is now 4.2 million below February 2020, with much of that shortfall likely due to retirements. However, the household survey shows no sign of a significant pickup in reentrants to the labor force, with the participation rate flat both versus September and a year ago and with the labor force rising only 37,000 per month on average over the last three months. There are also still seasonal adjustment issues going on as the decrease in government educational workers is a head-scratcher. Prime working-age employment is on pace to return to its pre-pandemic peak in eight months' time if gains continue at last October’s pace. But October was uneven along racial and ethnic lines, with employment for White Americans advancing and that for Black Americans slipping. The bottom line, this was a good report as it was growth positive, reduced wage-spiral inflationary pressures, while also not moving the Fed closer to their EPOP driven full employment mandate.
*Gains of +400K to +600K a month would put us on pace to reach pre-Covid employment levels by the summer of 2022
*The ratio of prime-age EPOP for Black to White Americans decreased to 91.6%, which is well below the September 2018 peak of 94.9% leaving plenty of ground to cover to achieve a broad-based and inclusive labor market
*A drop in UER will be less impactful to policymakers if the participation rate doesn’t improve
Labor productivity dropped -5% YoY in the third quarter, more than market expectations of a -3% drop. Output increased 1.7% (vs 8.5% in Q2), and hours worked jumped 7% (vs 5.9%). Unit labor costs rose 8.3% on an annualized basis in the third quarter, more than the 7% rate the market forecasted. It reflects a 2.9% increase in hourly compensation and a -5% drop in productivity.
Why it Matters: The economy slowed last quarter due to continued supply-side disruption and weaker consumer activity due to the Delta uptick. As a result, productivity fell as many firms faced shortages of materials, capping output while raising wages to retain and grow their workforce due to continued strong demand. We believe that labor will more meaningfully enter back into the workforce as pandemic-induced reasons subside and savings diminish, uncapping growth potential and alleviating logistical impairments. We also believe productivity, despite last quarter's setback, is set to improve due to the growing levels of Capex investment firms have been undertaking, all be it mainly at a digital level vs. fixed asset.
*Supply-side disruptions drove quarterly productivity growth to its lowest level since 1981
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the week but down on the day as lower yields are not helping it outperform thanks to stronger jobs data
Chinese Iron Ore Future Price: Iron Ore futures are lower on the week, falling sharply again today as fundamentals are still negative for steel demand and growth generally
5yr-30yr Treasury Spread: The curve is steeper on the week, but flatter today as a better growth picture from today’s job report has yet to material increase term premium demand
EUR/JPY FX Cross: The Yen is stronger on the week, with Lagarde’s dovish messaging playing out better in FX crosses than rates markets
ARTICLES BY MACRO THEMES
MEDIUM-TERM THEMES:
Real Supply-Side Constraints:
Moving Production?: Mattel nearshores manufacturing to bypass port bottlenecks during peak – Supply Chain Dive
Mattel is relying more on nearshoring and contracting ocean freight capacity further in advance to ensure toys make it on shelves in time for the holiday season. "We leveraged our scale, our diverse manufacturing footprint to optimize nearshoring of production," CEO Kreiz said. "We are ready for a strong holiday season." Still, Mattel hasn't been entirely immune to disruption, and the company sees significant costs tied to the ongoing resin shortage and the soaring demand for ocean freight.
Why it Matters:
According to the American Toy Association, more than 85% of toys sold in the U.S. are manufactured overseas, leaving toymakers highly exposed to port congestion and escalated ocean freight costs on the Transpacific. However, toy sales increased 11% YoY in Q3, according to NPD Group, and that high demand has allowed companies to raise prices and offset rising costs. Mattel and Hasbro have moved to hike prices over the past year, according to earnings reports.
China Macroprudential and Political Tightening:
Credit Reg: China’s Regulatory Wave Hits the Credit Reporting Industry – Caixin
The Administrative Guideline for Credit Reporting Business released on Sept. 30 by Beijing and effective from Jan. 1 next year, states that only licensed institutions can conduct credit reporting business. The guidance also lays out detailed principles governing each and every stage of the credit reporting process in terms of data management.
Why it Matters:
China’s credit reporting industry has mushroomed in recent years, driven by the boom in online lending platforms. It is estimated that more than 1,000 companies nationwide are engaged in the business of credit reporting. But many of them are yet to be properly supervised, leading to rampant data abuse, especially in the collection, analysis and application of “alternative data,” which cover a wide range of non-traditional credit information such as social network activity, mobile texts and e-commerce. This is exactly the type of data Beijing wants to control and is now taking steps to have access to it.
LONGER-TERM THEMES:
National Security Assets in a Multipolar World:
Missing Dollars: Mystery of China’s Huge Dollar Surplus Baffles Global Markets – Bloomberg
Large and growing trade surpluses and record inflows into its bond market are giving China a stockpile of dollars unseen since the days when the ‘Asian savings glut’ was blamed for keeping U.S. interest rates excessively low and fueling the sub-prime mortgage crisis. But unlike then, when China aggressively recycled its dollar holdings into U.S. Treasuries, China’s giant pile of foreign exchange reserves are holding broadly stable.
Why it Matters:
While some accumulated dollars are ending up as deposits at Chinese banks, the large ‘errors and omissions’ in the nation’s balance of payments are muddying the picture to their ultimate destination. What is clear is that the dollars offer China an important cushion against any future shocks in the world economy as there would be less pressure through the balance of payment or foreign debt channels. We highlight this as a reminder that the U.S. has actively weaponized the dollar, increasingly using it in foreign policy, making it a national security asset. China’s stockpiling of dollars makes this policy channel less effective.
Commodity Super Cycle Green.0:
Strains: Vestas and Orsted warn of tough times for renewable energy - FT
Danish power group Orsted and wind turbine maker Vestas have warned of challenging conditions in renewable energy after projects in Europe suffered low wind speeds and as supply chain hold-ups and rising costs hit manufacturers. Shares in wind energy companies have suffered steep falls this year after hitting record highs in January. Shares in Vestas are down 22%, while those of rival Siemens Gamesa, which has issued several profit warnings this year, have lost 40%.
Why it Matters:
The intermittency of renewables such as wind power has come into focus in Europe in recent months. Some of the slowest wind speeds in decades have exacerbated reliance on gas and coal for electricity. We continue to believe that until renewably generated energy storage can occur at a greater scale, the world will continue to need a barbell energy portfolio, relying on fossil fuels during times of low sun, winds, and water levels. This is why we continue to believe in hydrogen and lithium-orientated firms/sectors as viable energy storage investments.
Well Bid: Global Lithium Squeeze Has One Top Producer ‘Going as Fast as We Can’ - Caixin
Albemarle, the world’s biggest lithium producer, is expanding as quickly as possible and evaluating new opportunities as buyers of the battery metal struggle to keep up with surging electric-vehicle demand. The company plans to start sales from a new plant in Chile in early 2022 and an expansion in Western Australia around the middle of the year, as it restarts another mothballed mine. At the same time, senior executives said it’s evaluating a bid for new contracts in Chile and looking out for possible acquisitions in Australia, North America, and Europe in an interview Thursday.
Why it Matters:
A sharp tightening of the lithium market has seen a benchmark index more than double in 2021, and prices in China hit records. With little or no inventory in the system right now and demand set to more than triple by 2025, buyers are snapping up all they can. This also includes state-subsidized Chinese firms as securing lithium has increasingly become a national priority to help meet future carbon reduction targets.
ESG Monetary and Fiscal Policy Expansion:
Have Your Cake: Biden’s Covid Mandate for Business Adds to Challenge of Hiring - Bloomberg
The Labor Department said Thursday that companies with 100 or more employees will need to have all staff vaccinated or regularly tested for Covid-19. It set a Jan. 4 deadline. Failure to comply could trigger fines of as much as $136,000. Manufacturers in Boston blamed the vaccine and testing rules for exacerbating worker shortages, and employers nationwide are worried about the effect on morale and payrolls, according to the Federal Reserve’s Beige Book of corporate anecdotes.
Why it Matters:
The new requirements may have an unwanted side-effect by spurring workers who oppose vaccinations to leave their jobs which would be another blow for companies already struggling to find employees. We have hope new developments by Merck and now Pfizer regarding pill solutions to mitigate spread and reduce the effects of Covid will slowly help vaccine reluctant labor to stay employed even with vax-mandates, but this will take time.
Current Portfolio Performance:
Current Macro Theme Summaries:
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