As many states are reducing the frequency of COVID-19 reports, we will only publish COVID-19 updates on Thursday.
Beginning this week, as COVID-19 data frequency has declined, we are modifying our publication schedule to publish three times per week.
Monday
SKIP TUESDAY
Wednesday
SKIP THURSDAY
Friday
STRATEGY: Stocks “whispering” bottom but curve inversion credible. Inflation backwardation signal.
Yield curve inverted yesterday aka Economic Dim Mak (“death touch”)
The yield curve most watched by Street consensus (10Y less 2Y) inverted. Historically and reliably, this inversion is a precursor to a recession:
– inverted curve means monetary tightening of short-term capital = economic weakness ahead
– aka economic Dim Mak (“death touch”)
– see Jean Claude Van Dam’s demonstration below from Bloodsport
…even if fleeting, the Dim Mak happened
Even if this inversion was fleeting yesterday (less than 1 minute), the curve inverted. And is consistent with several economist forecasts, including that of Goldman Sachs Economics team — we highlighted that last week. GS expected an inversion before mid-2022. So it arrived on schedule.
– from a macro perspective, there are real challenges to this expansion
– inflation, supply chain shortages, overly strong demand, tight labor markets and now war
– so this is not some aberrant development
Hence, doomsayers are proclaiming the end…
This is why doomsayers are emboldened. Let’s face it.
– more arguments in favor of economic calamity
– hence, bears have far more conviction
TIME TO PANIC? 3 reasons we think stocks are still “whispering” bottom
In any era, and in most market historical timeframes, this curve inversion would indeed be a signal to get cautious. After all, this is the economic Dim Mak. But at the same time, we see 3 reasons to ameliorate our concern:
– “real” interest rate curve is still in normal slope
– in 2006 and 2019, when nominal curve inverted, “real” curve also deeply inverted
– variant development vs other curve inversions
– inflation curves are in deep backwardation (spot far higher than future inflation)
– implies market seeing “episodic” inflation
– leading indicators like Cass Freight Index, port backup volumes, car inventories rolling
– “real” cost of 10-year money is still negative
– supportive of risk assets, as real borrowing costs essentially “free”
– what asset benefits from negative “real” rates? equities
– argues P/E can expand
In short, the 3 reasons above seem to be supporting the rationale for why stocks are still “whispering” bottom. I am not trying to dismiss the economic risks — those are real. And the future is uncertain.
In this note, we explain why we believe stocks are still able to rise despite these very challenging macro headwinds. Just an apology in advance. This is a longer form analysis note. But the breakdown of why inflation backwardation matters is difficult to explain in short form.
COUNTERPOINT: BUT, we think inflation “Backwardation” is messing up the yield curve
But we think the inversion of the yield curve is due to inflation “backwardation” — meaning, the “real” yield curve did not invert. This requires some explanation:
– the nominal interest rate, or yield on a bond
– has two components
– “real” cost of money
– inflation rate
Therefore, at any point on the term structure, aka yield curve, there are two parts to the interest rate.
– Our view is that the “real” rate needs to invert to be a recession signal
– if the “inflation forecast” is the reason for the inversion (backwardation of inflation)
– this arguably is not a signal
…the “real” yield curve is still positively sloped = not economic Dim Mak
The simplest way to see the market-based “real” yield is using the TIPS market. These are inflation-protected bonds and measures the market’s expectation for the “real” return of any US gov’t bond, based on term structure and the prevailing interest rate for those bonds. The curves below were created by our data science team, led by tireless Ken, using the TIPS (Treasury Inflation Protected Securities) at varying maturities:
– the current “real” yield curve is normally shaped
– in 2006, the “real” curve was sharply inverted coincident with nominal curve inversion
– in 2019, the “real” curve was sharply inverted coincident with nominal curve inversion
In other words, the “real” cost of money tightened in the shorter term (shorter maturities) in 2006 and 2019. And these tightenings of credit conditions also contributed to a recession.
…fortunately, US financial conditions are still easy
The good news is that in 2022, we have not seen the severe tightening of financial conditions that presaged calamity in 2006 and 2019. As you can see, at the moment, US financial conditions are improving:
– this is dynamic
– so it can get worse at any time
– meaning, we can’t rule out financial conditions will worsen in the future
– as our team likes to say –> “the future is uncertain”
…inflation in backwardation is the real message of the inverted yield curve, in our view
To better illustrate the inflation component of interest rates, take a look at US yield curve below:
– the nominal rate is the line
– the composition at each maturity is shown below
– inflation is red columns
– “real” yield blue
– notice how the inflation expected is lower as maturities move outwards?
In other words, inflation is in backwardation. That means the “spot” inflation is above the forward rates. This is not a normal condition.
Inflation backwardation only started in 2022…
Inflation “backwardation” only started in 2022. In fact, take a look at the inflation curves for 2019, 2020 and now. We can see the evolution of inflation over time:
– in 2019 and 2020, inflation was seen at similar levels across time
– but in 2022, this went into “backwardation”
– meaning, markets see high inflation near-term and diminishing over time
This is an important consideration. After all:
– since nominal interest rates have two components
– “real” rate + inflation
– if inflation is higher for a specific period of time
– nominal rates need to be higher
– otherwise, “real” rate is too low
To an extent, this is also why the Fed needs to raise short-term rates. Because short-term “real” rates are too negative.
…Is “episodic” inflation explaining the backwardation of inflation?
Our base case is that inflationary pressures are not as durable as market expectations seem to be pricing. Brian Rauscher, Fundstrat’s Global Head of Portfolio Strategy, explains it best when he describes inflation issues as “episodic”:
– first wave was supply chain shortages
– second wave was “revenge spend”-fueled demand
– third wave is commodity parabolic surge further fueled by Ukraine war
This is illustrated below. And if this view tracks correctly, we should see inflationary pressures apex. That is:
– inflationary pressures should cool
– leading indicators like Cass Freight Index, or port delays are rolling over
– labor markets are still tight, so this needs to ease
– employed to population ratio is only 59% –> historically this is a recession low, not a sign of a tight market
– greatest risk is that consumer expectations are anchored at higher inflation
– then Fed needs to be super aggressive
…Inflation curves did not “backwardate” in 2006 or 2019
One last point. In 2006 and 2019, at the date of the yield curve inversion:
– inflation curves were normal in contango
– upward sloping
– 2022 is in “backwardation”
So this is very different, in a concrete and measurable way, from 2006 and 2019.
STRATEGY: Stock market still “whispering” (deafening actually) BOTTOM…”real” interest rate is negative = supportive of risk assets
We have advised our clients that the current macro environment is indeed quite uncertain and dangerous. And those warning of economic risks from inflation, war, shortages, supply chains and even COVID-19, have credible and well-reasoned arguments. In fact, this is the reason our base case (from December 2021) was that 1H2022 would be treacherous.
But we also cannot ignore the continued “whispers” from the stock market that a major bottom is in place. This is not confirmed technically (see work by Mark Newton, Head of Technical Strategy) but is coming from multiple vectors:
– multiple quantitative signals such as successive +1% up days (see prior notes)
– “recession” positioning by institutional investors (see BofA FMS)
– “recession” sentiment by retail investors (AAII)
– stocks priced in “recession” with > 40% stocks down 20% from highs in March –> 9 of 9 times stocks higher in 12M (assuming no recession)
See the picture? Bears have conviction:
– bear case is more convincing and it is credible
– bears therefore have conviction
– but market acting like a major bottom
We are choosing to see the market message.
Another case for staying constructive is the fact that “real” interest rates are negative. Take a look at the “real” cost of money below:
– we highlight cost of 2Y and 10Y money
– nominal rate is the same at ~2.38%
– “real” rate is -2.53% and -0.62%
– 10-year money has a negative real rate
– if one can borrow money for less than inflation
– why wouldn’t one invest in “pro-inflation” assets?
– what is a pro-inflation asset class?
EQUITIES!!!!
…History shows stocks do well when “real” rates are negative
History has shown this is the case. We have published this chart below multiple times in the past. This is looking at CPI and 10-yr treasury rates. Since 1880.
– 26% of the time, “real” rates are negative
– yup, far more common than most realize
– it tends to be “episodic”
– 1906 to 1910 <– post-1907 bank runs
– 1917 to 1928 <– Roaring 20s
– 1942 to 1958 <– Post-WWII economic boom
Hmmm… these are all periods of economic prosperity.
…Stocks staged parabolic gains during these negative “real” rate episodes
In fact, stocks did quite well during periods of negative real rates. Take a look below:
– S&P 500/ Dow 10-year rolling returns were strong during negative “real” rate periods
– 2022 is the start of another negative “real’ rate era
….Stocks go moon? Pamp it.
STRATEGY: Stick with BEEF
Broadly, our existing strategy of BEEF remains valid. Even in war. Even with inflation. In fact, the last few weeks are strengthening the case for our “BEEF” strategy. That is, BEEF is
– Bitcoin + Bitcoin Equities BITO -1.99% GBTC -1.98% BITW 0.38%
– Energy
– FAANG FNGS 0.84% QQQ 0.97%
Combined, it can be shorted to BEEF.
Why is this making stronger BEEF?
– Energy supply is now a sovereign priority
– this helps Energy stocks
– Ukraine and Russia both want access to alternative currencies
– this strengthens case for Bitcoin and bitcoin equities
– if Global economy slows, growth stocks lead
– hence, FANG starts to lead FB AAPL 1.57% AMZN 1.41% NFLX 0.89% GOOG 1.00%
All in all, one wants to be Overweight BEEF
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33 Granny Shot Ideas: We performed our quarterly rebalance on 2/3. Full stock list here –> Click here_____________________________
DATA ON RUSSIA-UKRAINE WAR: Tracking Russia-Ukraine war statistics — 3,039 Ukrainian civilian casualties so far
Our data science team, led by tireless Ken, is scraping data from several sources to track some high level data around the Russia-Ukraine war.
– Ukrainian civilian casualties
– Ukraine population movements
– Ukraine military losses, except personnel
– Russian estimated losses of personnel and material
Ukraine has lost an estimated 80% of its tanks and 93% of its aircraft
Our data science team, led by tireless Ken, has been tracking the casualties and losses associated with the Russia-Ukraine war. And while Ukraine has staged an impressive resistance, the reported losses of equipment show that Ukraine has lost a substantial share of its equipment:
– by our team’s analysis, using reported data
– Ukraine has lost 1,738 tanks or 80% of its equipment
– Ukraine has lost 132 aircraft, or 93% of its fleet
By these measures, the armament of that army is rapidly depleting. I am not sure if this is a well known fact. But this also highlights why the nation is seeking to replenish its equipment.
With each passing day, Ukraine is experiencing further losses of critical equipment.
When we hear Russia has deployed 150,000 soldiers in Ukraine, this is not 150,000. As many military people know, for every front-line soldier, there are 4 support soldiers:
– 1 frontline soldier
– 4 support, fuel, ammo, logistics, supply lines, etc, cooks
Thus, if there are 150,000 Russian soldiers in Ukraine, about 30,000 are doing the actual fighting.
– Using data from Ukraine’s Ministry of Defence, estimates of Russian casualties are about 17,200
– Presumably these are front-line soldiers
– Unless Ukrainian soldiers are “attacking from behind” and hitting supply lines
This implies over 50% of the frontline soldiers are casualties.
The number of casualties is 64 on 3/28, and a total of 3,039 have been reported to the UN.
The flow of migrations out of Ukraine had been steady at about 100,000 to 200,000 per day, but continues to gradually decline and is now around 40,000 per day. And a total of 3.9 million have fled so far.
– 55% are entering into Poland
– curiously, 6% or 270k or so, have entered Russia
If one is wondering about reported losses of equipment, we are citing statistics provided by the opposing ministry officials.
– est. 123 Ukraine planes lost
– est. 1,738 tanks lost
– this seems like a lot of equipment
Russian losses are higher
– est. 17,200 Russian soldiers killed
– est. 597 tanks
– est. 127 aircraft
– est. 1,710 armored vehicles
Our team says this data is scraped and can be updated daily. So, we will post these figures for now. And that way, we can get a sense for the intensity of the hostilities.
Thomas Hu, of Kyber Capital, also shared this website which is a crowd sourced view of reported activities. There is a lot to the website, and I encourage you to check it out. The website URL is https://maphub.net/Cen4infoRes/russian-ukraine-monitor
For instance, if you click on one of the icons, a verified post is shown. There is geolocation and other data attached.
POINT 1: Daily COVID-19 cases
This data will be updated every Thursday.
POINT 2: Vaccination Progress
This data will be updated every Thursday.
POINT 3: Tracking the seasonality of COVID-19
This data will be updated every Thursday.
