Weekly Research Briefing: Hawk Eye

June 22, 2021

The market didn't see that coming. "Price stability is half of our mandate" led Wednesday's playlist as Jerome Powell and the Fed took the stage to a sold-out crowd of market participants. Unfortunately, the equity longs and curve steepeners were positioned to dance to Prince's "When Doves Cry." So, by the time the not-so-special-effect dot plots exploded on stage, the traders were running for the exits sending some markets toward their biggest moves since COVID played the venue.

But seriously, the markets were lined up for a counter move and we got it. Bets on a steeper yield curve, higher interest rates, and cyclical equity outperformance have been working well, and there were likely some leveraged positions in many of the economic strengthening and reflation trades. So, when a few dots shifted and the Fed turned its attention toward near-term inflation, some unwinding was inevitable. While most of us view the current inflation spikes as transitory, the fact that the Fed shifted toward inflation sent a shiver through many portfolios last week. What if inflation is not transitory? What if the Fed decides to pull the taper and rate hike levers sooner? What if they miss and overcorrect? These are all valid questions that only point out that financial market risks are rising due to the uncertainties. Sure, the economy is great and the recovery is solid, but the financial markets are their own beast and will move due to many other factors.

My thoughts are that last week was a good gut check for the markets. Now both the Fed and China are paying close attention to global commodity prices and both are willing to act to keep inflation under control. As we discussed last week, soaring prices are beginning to cool demand in many areas as buyers delay purchases or switch to substitute goods or services. Lumber is a great example of how soaring prices led to all sawmills opening for multiple shifts, which has led to a collapse in prices. Wood will be easier to price correct than oil and copper, which have many other factors to consider to increase production. Hopefully most areas of inflation can remain in transitory mode and recede once the economy moves from high single-digit growth to low single digit. Of course, the Fed still needs to put the "liquidity genie" back into the bottle at some point so that they can use it in another crisis. This is when we will find out which financial assets investors really love the most.

I'll be watching to see how last week's oversold cyclical and high dividend stocks act this week. A bounce would indicate to me that last week's correction was mostly some leveraged trades and positioning coming out of the system. I will also be eyeing how the yield curve trades after last week's big move. The long bond was looking quite overbought on Friday and, while I do not think runaway inflation is a worry, I also do not see credit worries on the horizon to justify a sub 1.5% 10-year Treasury yield. This week's economic data could also give us some new insight into how high prices are affecting the economy. Not much on corporate earnings news for three weeks. Enjoy the week and size up those Fourth of July plans.

Fed's Bullard is just a watcher this year, but a voter next year...

“We’re expecting a good year, a good reopening. But this is a bigger year than we were expecting, more inflation than we were expecting,” the central bank official said on “Squawk Box.” “I think it’s natural that we’ve tilted a little bit more hawkish here to contain inflationary pressures.”...

“Overall, it’s very good news,” Bullard said of the economic trajectory during the reopening. “You love to have an economy growing as fast as this one, you love to have a labor market improving the way this one has improved.”

However, he cautioned that the growth is bringing faster-than-expected inflation, adding that “you could even see some upside risks” to price pressures that by some measures are running at their highest levels since the early 1980s.

That’s why he thinks it would be prudent to start raising interest rates as soon as next year.


Fed members see increasing inflation uncertainty and risks, which help to explain their growing talons...

FOMC participants' assessments of uncertainty and risk


Fed dots jump up while inflation forecasts are up, then down...

FOMC Dot Plot


Markets wasted no time in moving to a 50% chance of two rate hikes in 2022...

@SoberLook: The futures market now sees roughly even odds of two rate hikes next year.

Probability of Fed rate hikes

So how did the bigger market participants shift after the meeting?

We expect a hawkish Fed during Q3 with risks of higher dots and taper in September.

A more hawkish than expected Fed message paves the way for U.S. nominal yields to break from the Mar-Jun bearish consolidation patterns and real yields to release from their bearish base pattern formations. The S&P 500 Value/Growth ratio has had a loose correlation to yield levels yield trends since 2018. Provided the UST curve does not transition to an aggressive bear flattening regime, we expect higher yields to extend the Value, Cyclicals, and Small Cap outperformance trends that started in 2020.

The June FOMC meeting delivered a hawkish surprise with a shift up in the median dot in 2023 to two hikes, from none in March and against our expectation of an unchanged flat path. The discussion of tapering was largely in line with our expectations. Chair Powell acknowledged committee discussion but made clear that “reaching the standard of substantial further progress is still a ways off.” We continue to expect the first hint about tapering in August or September, followed by a formal announcement in December that would begin the tapering process at the start of next year, though the risks lean toward an earlier start.

In light of what we learned today, we have changed our forecast of the timing of the first hike to 2023Q3, from 2024Q1 previously. However, we see the odds of a hike by the end of 2023 as only modestly better than 50% because liftoff could easily be derailed by lower-than-expected inflation or a sharper deceleration in growth as fiscal support fades.
(Goldman Sachs)

Ray Dalio is still more focused on removing liquidity from the system...

“It’s easy to say that the Fed should tighten, and I think that they should,” said Dalio, the founder of Bridgewater Associates, the world’s biggest hedge fund. “But I think you’ll see a very sensitive market, and a very sensitive economy because the duration of assets has gone very, very long. Just the slightest touching on those brakes has the effect of hurting markets because of where they’re priced, and also passing through to the economy.”


When the Fed decides to taper and remove liquidity from the system, will we tantrum like in 2013?

If the sharp rise in real yields that started this year really was the post-pandemic version of the tantrum, then everyone has got off lightly. In the following chart, I aligned the beginning of this year — when the tantrum began to take hold — with May 2013, when Bernanke made his fateful comments. With the exception of the brief and dramatic head fake when the bond market broke down in March last year, the 12 months leading up to the two incidents looks very similar, with real yields declining, and then wobbling at a low for months.

But the increase in 2013 was vastly greater than anything we have seen so far. Indeed, even after Wednesday’s market reaction, the real 10-year yield remains lower than its trough from 2012 and 2013. It’s possible that the last few months have seen the bond market try to come to terms with a likely bout of inflation and the Fed’s probable response, creating an opportunity for the central bank to begin its retreat; but there is also an argument that we ain’t seen nothin’ yet.

There is one other factor to take into account. U.S. GDP growth for 2013 was 2.6%, rising to 2.9% the following year. (Remarkably, and sadly, this remains the best calendar year for growth since the crisis). The Fed’s prediction for this year is 7%, to be followed by 3.3% in 2022. That provides quite a strong tail wind for yields, as does the risk of persistent inflation.

Market conditions may well make this as good a time as any to start the descent. Extraordinary low yields mean the Fed has to embark on the journey soon. But risks of a tantrum remain.

Tantrums Compared


It seems like we read and hear a lot from the permanent 'Inflationistas', but in reality, they look to only be a quarter of the market...

@RobinWigg: Investors pretty confident that the recent inflation spurt is transitory, according to BofA’s latest survey.

Do you think inflation is transitory?

China has gone on the offensive to fight the 'Inflationistas'...

China said it would begin to sell major industrial metals from state stockpiles, an effort to squelch factory-gate price increases that have hit a 13-year high and are stoking fears of global inflation.

As the world’s biggest buyer of a range of industrial commodities, China is using its market heft to try to quell the sharp rise in global metal prices over the past 12 months, including a 67% surge in copper, a bellwether for macroeconomic health. Economic stimulus measures and a broad resumption of global economic activity from pandemic lows have spurred a spree of buying in China and elsewhere.

China’s latest move targets copper, aluminum and zinc, among other metals, and outlines a program of public auctions to domestic metal processors and manufacturers, the National Food and Strategic Reserves Administration said Wednesday. Still, Beijing’s move comes as some metal prices, including copper, had already begun to decline in recent weeks, amid market sentiment that global supply levels didn’t warrant such rallies.


The best cure for higher prices is higher prices...

It’s a dance of supply and demand that has reassured many experts and the Federal Reserve in their belief that painful price spikes for everything from airline tickets to used cars will abate as the economy gets back to normal.

“Many of the extreme price spikes we’ve seen in recent months are likely to reverse for Econ 101 reasons,” said Jan Hatzius, chief economist at Goldman Sachs.

Lumber prices in the futures market, for example, are down more than 45 percent from their peak, slipping below $1,000 for the first time in months. That’s still high — between 2009 and 2019, prices averaged less than $400 per thousand board feet — but the sell-off has been gaining momentum over the last few weeks. The price has fallen in 11 of the last 12 trading sessions, including a 0.5 percent drop to settle at $900.80 on Friday, according to FactSet data.

Why have prices fallen so fast? It’s partly because they set off a surge of production at the country’s roughly 3,000 sawmills...

In the meantime, while the price declines filter into the consumer market, demand has cooled down.

“The do-it-yourself sector, it’s not as robust as it was a year ago when homeowners were locked down and using stimulus and travel money to do a lot of home improvement,” said Shawn Church, editor of Fastmarkets Random Lengths, a trade publication that covers the industry.

The professional homebuilding industry, the largest source of demand for lumber, is also decelerating from a breakneck pace, with some builders citing high prices for wood as a reason to hold off on construction.

Those decisions by consumers and companies are a major reason some analysts think the recent rise in inflation is the result of temporary mismatches in supply and demand, rather than a harbinger of runaway price increases stoked by all the money pouring into the economy.


Recent Philly Fed data suggests that higher prices have led to an economic slowing...

JPMORGAN: Philly Fed prices paid “continued their march upward last month... But declines on the month in unfilled orders, delivery times, and the workweek suggest that bottleneck pressures may be starting to ease.”

Price measures from Philadelphia Fed manufacturing survey

Likely an overshoot given how the Fed caught most investors off guard last week...

@SoberLook: Last week’s tightening in the 30yr – 5yr Treasury spread was the fastest in years.

US 30yr-5yr Government Bond Spread

The U.S. Dollar enjoyed last week's Fed meeting...

Seismic Change


Many S&P 500 stocks moved to short/near-term oversold levels last week...

S&P 500 Members Above 50d MA

Hardest hit were the Cyclical names positioned to benefit from a stronger economy and higher interest rates...


Away from the Fed, S&P 500 earnings estimates continue to grind higher...

Important to note that although there are few earnings results happening this month, there are many conferences where companies are appearing and giving guidance. So, companies must be feeling okay about Q3 so far.

Tweet from @EarningsScout


Tweet from @conorsen

Imagine being a homebuilder right now...

There was a sigh of relief on Wall Street and in the White House as lumber prices on the commodities exchanges fell about $600 in the past two weeks. The price is still about three times higher than pre-pandemic norms, but it is trending down.

But home builder Jerry Konter in Savannah, Ga., says reality on the ground is a lot different than charts on a Wall Street trading terminal. Sky-high prices for lumber remain at stores and many suppliers because they still have to sell all the wood they bought at the top. Konter doesn’t expect retail prices to change until August or September.

For the first time in his 44-year career building homes, Konter altered his standard contract to no longer guarantee a firm date or price. He has to explain to buyers that the price could jump and items like cabinets that used to arrive in 10 days now take four months. While hopeful for improvement, he’s preparing for high prices and supply bottlenecks to last. His expectations — and behaviors — have shifted.

“I personally believe we are about to kill the golden goose in the economy with these supply issues,” Konter said, adding, “There are so many people that are being left out of getting a home because of the additional input costs. It’s almost impossible to build an entry-level home.”


May be time to put off the purchase and rent for the next 6-12 months?

Monthly House Price Appreciation

(Goldman Sachs)

Tough time to flip homes when you have to cash buy versus 10 other bidders!

Tweet from @LizAnnSonders

Follow the yellow peak...

Demographic curves working in favor of new starter home builders.

Total US Population by Age and Generation


So, Retail stock buying is replacing mutual funds and ETFs?

@RobinWigg: Goldman Sachs forecasts that US retail investors will buy $400bn of stocks this year, driven by the paucity of other investment alternatives and the trading frenzy.

Goldman Sachs forecast of 2021 US equity demand

These household equity investment spikes tend to not bode well for future returns...

Equities account for a record % of assets


And not just excesses in Retail investing. These two were caused by an Institutional investing orgy...

@bespokeinvest: The blowup of Archegos Capital Management is a distant memory roughly three months in the rearview. Two stocks that were the main victims of the saga, ViacomCBS (VIAC) and Discovery (DISCA), are down over 60% from their highs:

Discovery Past Year

ViacomCBS Past Year

I am taking note that Discovery, Viacom and Bitcoin all launched in the Q4 of 2020...


Why do I even try and advocate for European Public Equities?

As a lifelong public market investor, I am always comparing securities, industries and indexes around the world. Currently, the European equity markets look undervalued as compared to the major U.S. markets which is why I allocate to them. But then I come across performance charts like the two below and I wonder why I am even spending any of my time on the public equity markets.

Below is a 15-year performance chart showing the returns of private market assets versus their public market geographic indexes. I find the outperformance of privates as impressive across all categories, but the Western Europe performance is shocking to me. Is it a function of the public markets being so dreadful or the GPs in Europe being so good? Probably a good bit of both. Anyway, I thought this was very worthwhile in spending time on.

15-Year Asset Class Risk-Adjusted Performance

Source: Hamilton Lane Data via Cobalt, Bloomberg (March 2021)

And for a look at the short-term performance results...

3-Year Asset Class Risk-Adjusted Performance

Source: Hamilton Lane Data via Cobalt, Bloomberg (March 2021)

Keep in mind that the Private Market Asset performances have a slug of Credit and Real Asset exposure in them. These are not 100% equity-based portfolios.

Market Composition

Source: Hamilton Lane Data via Cobalt, Preqin, PEI (March 2021) Fundraising data excludes secondary funds and fund-of-funds.
Note: Trailing 3-Year Fundraising calculation begins at the year-end of the vintage year shown

Talk about a Prime Day bargain!

An Amazon Prime subscription in the U.S. costs $119 per year. J.P.Morgan calculates the value of a subscription to now be worth more than $1,000 per year.

Unpacking Prime


Why the Tokyo Olympics track and field events will be a Swoosh-fest...

The shoe-technology revolution Nike unleashed on the marathon-running world five years ago with mysterious prototypes has veered onto the track, where a growing army of “super spikes” from the swoosh and other brands is shredding records.

Debate rages about the degree of advantage conferred by the new spikes, which feature soles with a rigid plate and superlight, energy-returning foam. But the near-universal belief that they help has prompted a radical move ahead of the U.S. Olympic Track & Field trials that start June 18 in Eugene, Ore.:

Brands that pay elite athletes to endorse their shoes are granting them permission to wear a competitor’s product. For many runners, that’s Nike…

In less than a year, Nike super spikes have been used to set world bests in the men’s and women’s 5,000 and 10,000. Just this month, Dutch runner Sifan Hassan smashed the women’s 10,000-meter record by 10 seconds.

Her record lasted two days.

Last week, Ethiopia’s Letesenbet Gidey broke the record by five seconds. Guess which shoes she wore.


Nike shoe

(The Nike Air Zoom Victory NIKE)

If there was ever a long-term study to show why kids need healthy daily meals at school, this is it...

Our two most important findings concern lifetime income. We first show that the programme generated substantial long-term benefits: pupils exposed during their entire primary school period have 3% greater lifetime income compared to unexposed pupils (see Figure 1). Second, we find interesting heterogeneity in the effects: children from poor households benefit the most, although children from all households benefit to some extent. While pupils from poor households have 6% greater lifetime income compared to unexposed pupils, those from the other households still benefitted and have about 2% greater lifetime income (see Figure 2). Hence, applying the reform to all pupils led to universal effects.

The effect year of exposure to school lunches on height, schooling, and total income

The return to nine years of school lunches by household income quartiles


Should we blame The Graduate?

@LizAnnSonders: A global tragedy: single-use plastic bags accounted for highest share of garbage items documented across 7 aquatic ecosystems at 14.1%; plastic bottles were 2nd most common item at 11.9%, while food containers & cutlery followed with 9.4% @StatistaCharts

Plastic Items Dominate Ocean Garbage

And finally, big arena sold-out concerts returned to the United States this weekend...

NEW YORK—Whether you were down in the pit or up in the nosebleed seats at Madison Square Garden on Sunday, social distancing was out. Singing along with a roaring, maskless crowd to Foo Fighters hits like “Learn to Fly” was in.

Fans of the post-grunge arena rockers filled the roughly 20,000-person venue for its first full-capacity show in more than 15 months. The sold-out concert required proof of full vaccination, complying with current state mandates. Children under 16 were permitted if they provided proof of a negative Covid-19 test or full vaccination and were accompanied by a vaccinated adult.

“Did you miss it?” frontman Dave Grohl asked early in the night, referring to concerts and eliciting a forceful “yeah” from the audience. “Me too,” he said.

Rock and Roll Returns to the Garden Tonight



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Endnotes: Strategy Definitions

Credit – This strategy focuses on providing debt capital.

Growth Equity – Any PM fund that focuses on providing growth capital through an equity investment.

Infrastructure – An investment strategy that invests in physical systems involved in the distribution of people, goods, and resources.

Mega/Large Buyout – Any buyout fund larger than a certain fund size that depends on the vintage year.

Natural Resources – An investment strategy that invests in companies involved in the extraction, refinement, or distribution of natural resources.

Real Estate – Any closed-end fund that primarily invests in non-core real estate, excluding separate accounts and joint ventures.

Venture Capital – Venture Capital incudes any PM fund focused on any stages of venture capital investing, including seed, early-stage, mid-stage, and late-stage investments.

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