It seems almost daily there is either new economic data or a Fed official shooting their mouth off trying to prove how ‘hawkish’ they are now after totally missing the boat for a year. Yesterday the 10 year treasury closed at 2.99% after trading as high as 3.17% on Monday. Today the 10 year treasury is down again at 2.92%.
Today we wait on the release of the April Consumer Price Index. It seems that the new theme from all the talking heads is ‘inflation has peaked’—which has contributed to falling interest rates. Obviously if we get an upside surprise to inflation today interest rates are going to spike. The expectation today is for year over year inflation of 8.1% versus 8.6% last month. On a monthly basis a .2% increase from last month is expected.
Buckle your seat belts–a significant miss on the forecast–either direction — may mean a big ride in markets today.
Barron’s The Bear Market Is Already In Its Third Inning. Stay Calm and Defensive. https://www.barrons.com/articles/the-bear-market-is-already-in-its-third-inning-stay-calm-and-defensive-51652454842?mod=Searchresults
Don’t see many interesting articles in Barron’s these days but this seemed read worthy – BTW, anyone else having trouble reaching Captcha thru Firefox? had to use Chrome to post this
The S&P 500 is on the precipice of declining 20% from the peak. The majority of its members have already done so. Wide swaths of consumer cyclical stocks and the financials are down much more than that. Debating whether we are in an “official” bear market at this point is purely a case of semantics. If it walks like a duck…
The adage that posits to know where you’re going, you must know where you’ve been certainly applies. From the end of 2018 to the end of 2021, the Fed eased monetary policy, via interest rates and the expanded balance sheet, by 850 basis points. In the process, it destroyed the equity risk premium. No wonder asset prices soared, with the stock market doubling over that time span—that’s a 2-standard deviation event right there! And who ever knew that the first global pandemic in over a century could have made so many people so wealthy? Should we try it again? But, you see, 70% of that three-year bull market was due to the expanded price-to-earnings multiple—“animal spirits”—while earnings growth was a two-bit player, accounting for the other 30%. Historically, those relative contributions are reversed: 70% earnings and 30% multiple expansion. Had that been the case, the S&P 500 would have peaked at the beginning of this year closer to 3,600 than 4,800. That is the power of the P/E multiple: Basis point for basis point, at the lofty valuation readings in recent months, the P/E multiple is five times more powerful than earnings momentum.
So, in these past four very rough months, we have started to see the mean-reversion process take hold when it comes to the multiple now contracting. As it should with the Fed tightening policy and threatening to do much more. In fact, if the Fed does all it is pledging to do, with higher rates and a shrinking balance sheet, the de facto tightening will come to around 400 basis points. This compares to 180 basis points in 2018 and 315 basis points for the entire 2015-2018 cycle—85 basis points more this time and all lumped into one year! This compares to 175 basis points of rate hikes in 1999-2000 (ahead of that recession), 300 basis points in 1994, and 313 basis points in 1988-89 (ahead of that recession). You have to go back to the early 1980s to see the last time the Fed got so aggressive in such a short timeframe.
How apropos. At the semi-annual congressional testimony in early March, in response to a comment from Sen. Richard Shelby (R, Ala.), Jay Powell responded with his view that Paul Volcker was the greatest economic public servant of all time. Well, Volcker is revered today for slaying the inflation dragon, but in the early 1980s he was reviled for creating the conditions for back-to-back recessions and a huge bear market. People today ask where the “Powell put” is. Rest assured, the “Volcker put” was an 8x multiple in August 1982. Trust me—you don’t want to do the math on that, no matter what your earnings forecast is today.
Earnings is the next shoe to drop. When it does, no one will be debating about whether or not we are in a bear market. There has never been a GDP recession without there being an earnings recession, full stop. Everyone dismisses the -1.4% annualized real GDP contraction in the first quarter as an aberration, but I am not seeing any sort of recovery in the current quarter. In fact, the monthly data has so much negative forward momentum that the handoff to the second quarter is -1%. Monthly GDP in real terms contracted 0.4% in March and was flat or down in each of the past five months. During this time span, from October to March, the “resilient” U.S. economy has declined outright at a 2.4% annual rate. And in the past, this has only happened in National Bureau of Economic Research-defined recessions. The April nonfarm payroll report appeared strong, but beneath the surface, full-time jobs plunged the most since April 2020 and small-business employment, always a reliable indicator of turning points in the cycle, has declined more than 100,000 in the past three months.
Besides, “inflation” has put real disposable personal income, close to 80% of the economy, into a recession of its own, contracting in six of the past seven months, and at a -4.5% annual rate. As sure as night follows day, consumer spending will follow suit. The Fed will do its best to reverse the situation, but the medicine won’t be tasty, as the inflation shock is replaced by an interest rate shock. The mortgage and housing markets are already responding in kind.
The stock market has done a lot of work to price in a recession, but is so far discounting one-in-three odds. More to do still. The inflation shock is largely exogenous. What few talk about is how fiscal-policy contraction alone is going to help take care of the demand side by the end of the year. Is it well-understood that if items like food and energy inflation don’t come down, then the Fed, in its quest to return to 2% inflation, would have to drive a big hole in the other 80% of the pricing pie? The Fed would have to create the demand conditions that would bring the core inflation rate to -1.8%—which has never happened before! To get to 2% inflation, with the supply curve so inelastic, would require a recession that would take real GDP down by more than 3% and the unemployment rate back toward 7%. This is the sort of demand destruction that would be needed for the Fed to win the battle against this supply-side inflation, caused principally by the never-ending Chinese lockdowns and the Russian-waged war in Ukraine.
We ran models to see how financial conditions have to tighten if the Fed is, indeed, serious about its 2% inflation target. You won’t like the answer if you are still trading risk assets from the long side: 700 basis point spreads on high yield bonds (another 250 basis points to go) and call it 3,100 on the S&P 500 (another 20% downside). This makes perfect sense since the S&P 500, historically, has gone down 30% in recession bear markets. The first 10% before the recession as the downturn gets discounted, and then the next 20% through the first three-quarters of the recession. Keep in mind, however, that there is wide dispersion around that “average.” We have to acknowledge that we’re entering a prolonged period of heightened uncertainty between the ongoing pandemic and the war abroad, together with this very hawkish Fed. The earnings recession could bump against a further compression in the market multiple. So, my hope is that the 3,100 “trough” doesn’t end up proving to be overly optimistic. Yes, you read that right.
Finally, we have to play the probabilities. The Fed has embarked on 14 tightening cycles since 1950, and 11 landed the economy in a recession and the stock market in a bear phase. That’s a nearly 80% probability right there.
We can certainly hope for a “soft landing” this time around, but in my 35 years in this business, hope is rarely an effective investment strategy. The backdrop is one of a peak in the liquidity and economic cycle, and what follows is the natural expunging of the excesses (meme stocks, cryptocurrencies, speculative Nasdaq 100, even residential real estate, which is in a huge price bubble of its own) and then… the rebirth. There is no sense in being in denial. This is all part of the cycle, and the turning point was turned in several months ago. In baseball parlance, we’re very likely in the third inning of the ball game when it comes to this bear market. My advice: Ignore the promoters, shills, and mountebanks. Stay calm, disciplined, and defensive in your investment strategy. And that includes beaten-up long-term Treasuries, cash, gold, and only areas of the equity market that have low correlations with economic activity.
I didn’t see a tax free municipal bonds category, so here are my thoughts. This maybe a decent time to put one’s toe in the municipal bond water. I created a nice municipal bond maturity ladder and many of the bonds were called last year and early this year. I have been sitting on the cash just waiting for a bit higher yield and better opportunities. This muni was on Vanguards muni bond page and bought (20) South Broward Hospital 4% due 5/1/44 rated AA/AA3 CUSIP 1381953625 @$96.41 so current tax free yield 4.253% with YTM higher. These bonds traded at $103+ late last month and the higher quality muni’s have gotten trashed with the rest of the market. Twain said, “When you find yourself on the side of the majority, it is time to pause and reflect”, Azure
Azure – Or if you want to keep the maturity date short-term, drop the grade, and go corps. I picked up these various sectors among others between May 2-6:
–Royal Bk of Scotland Grp (12/19/23) 4.01% YTM (BB+/Baa2)
–Lennar (12/15/23) 3.696% YTM (BBB-/Baa3)
–PAA 11/1/24 3.923% YTM (BBB-/Baa3)
–Kilroy Realty 12/15/24 at 3.929% YTM (BBB/Baa2)
–Boeing 5/1/25 4.45% YTM (BBB-/Baa2)
Basically IG corps maturing in 2023 at 3.5%, 2024 at 4.00%, and 2025 at 4.5% YTM’s.
As like many others in III, inflation is largely tangential for me, and so these are cash place-holders-plus to make something while we ride this bear market on down.
Cash, quality preferreds, short-term IG debt, and blue-chip equities with covered calls are the key to riding this one out.
I’ve also placed a slew of Jan_23 puts on blue-chip dividend champs with an average strike price of 70% off the 52-wk high with an average premium of $120 per put. While I was seduced into a few buy/writes where the blue-chip underlying dropped 35-40%, I’ve got be disciplined and remember what happened in 2008 when the SPY dropped 50%, but many quality equities dropped 70%.
I bought BBN and GBAB in April 2020 after the big melt down thinking they might be a “safer” place to put some fixed income $$. As a CDN it didn’t matter to me if they were taxable as they were in my tax sheltered retirement plan. Sold them last summer as they started selling off with prospect of higher rates. Thoughts from group about now being a time to reenter this market?
ATLCP down 3.37% today and over 5.4%+ past 5 days! Anyone know why?
the parent ATLC announced earnings yesterday and shares did drop big – from $40 to $30-ish. But preferreds should continue with the nice dividends, now approaching 7.9% at these prices…
ATLC up 8+% @ 11 am EDT Fidelity.com. Fido analysts neutral now. Schwab.com C on the common. Board has approved dividends to Preferreds B shares (our ATLCP?).
from Fidelity.com:
REUTERS – 05/10/2022
Atlanticus Holdings Corp (ATLC): * ATLANTICUS REPORTS FIRST QUARTER 2022 FINANCIAL RESULTS. * Q1 EARNINGS PER SHARE $1.96. * QTRLY TOTAL OPERATING REVENUE INCREASED 59.7% TO $229.8 MILLION, 6.1% OVER Q4 2021 Source text for Eikon: Further company coverage:
Oh well. At least our dividends should be safe. It seems that the street is hunting for witches with SP down so much in response to Fed’s announced rate hikes.
GBAB at over 8% looks good – I put a small order in. Thanks for mentioning.
Markets are forward looking. Except when these reports come out telling us what happened a month ago. I always thought if you invest based on these reports you are late to the party. May be better to wait for kneejerk reaction then play the opposite side.
As for inflation numbers, the number is the comparison of prices of this month to that month one year ago. The big number came suddenly about 7 months ago. Therefore, in about 5 months, the prices of that month, November, will be compared to last November which was high. Therefore the inflation number should come down drastically like it rose being the denominator doe the calculation being must larger. Just a thought.
bogiefree – Excellent point! Additionally it should be noted that the upcoming April, May and June CPI numbers this year will benefit in comparison with the 2021 monthly numbers due to a jump up in CPI for those months last year. That benefit will disappear in the July, August and September monthly measurements, due to lower increases in those months in 2021. That all changed in October 2021, when the month to month CPI reading more than doubled from September 2021 reading. When the October 2022 reading comes out in November of this year, the Fed will be significantly benefited by the October 2021 vs October 2022 comparison. Let’s hope it’s all downhill from there! (my numbers based on Consumer Price Index: Total All Items for the United States – St. Louis Fed)
Consumer Price Index Summary
Transmission of material in this release is embargoed until
8:30 a.m. (ET) May 11, 2022 USDL-22-0835
Technical information: (202) 691-7000 * cpi_info@bls.gov * http://www.bls.gov/cpi
Media Contact: (202) 691-5902 * PressOffice@bls.gov
CONSUMER PRICE INDEX – APRIL 2022
The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in April on a
seasonally adjusted basis after rising 1.2 percent in March, the U.S. Bureau of Labor Statistics
reported today. Over the last 12 months, the all items index increased 8.3 percent before
seasonal adjustment.
Increases in the indexes for shelter, food, airline fares, and new vehicles were the largest
contributors to the seasonally adjusted all items increase. The food index rose 0.9 percent over
the month as the food at home index rose 1.0 percent. The energy index declined in April after
rising in recent months. The index for gasoline fell 6.1 percent over the month, offsetting
increases in the indexes for natural gas and electricity.
The index for all items less food and energy rose 0.6 percent in April following a 0.3-percent
advance in March. Along with indexes for shelter, airline fares, and new vehicles, the indexes
for medical care, recreation, and household furnishings and operations all increased in April.
The indexes for apparel, communication, and used cars and trucks all declined over the month.
The all items index increased 8.3 percent for the 12 months ending April, a smaller increase
than the 8.5-percent figure for the period ending in March. The all items less food and energy
index rose 6.2 percent over the last 12 months. The energy index rose 30.3 percent over the last
year, and the food index increased 9.4 percent, the largest 12-month increase since the period
ending April 1981.
https://www.bls.gov/news.release/cpi.nr0.htm
Is the CPI-U increase of .3% a month increase of April 2021 or an increase over the 1982-84 base year or some other base year?
Its month over month. So if you used April CPI as baseline and annualized inflation is running a little under 4%. But, core CPI which excludes food and energy was rather hot last month at .6%.
CPI came in higher than expected…..market crashed again….but it does that everyday now….so nothing new to see here…..except maybe that 75 raise just got put back on the table.