Private Wealth

Weekly Research Briefing: Caught in a Loop

September 13, 2022

Just like it used to say on the back of the shampoo bottle: Wash, rinse, repeat. The shampoo algorithm. That is what the current market feels like. Investors buy, the markets rise, and the Fed says 'Stop'. Investors sell, the markets fall, and the Fed says 'Go'. This is the endless loop that we seem to be caught inside until the Fed gets the inflation data that it wants to see. They don't want financial conditions to ease enough to cause a surge in the markets. And they do not want a break in financial conditions to cause a credit crisis or collapse in financing abilities. So we sit, watch and wait while trying to be invested in the assets and company exposures that will do best once the Fed unleashes the economy and markets.

September is a big month for industry conferences and analyst meetings. During week one, there were very few negative pre-announcements which was a bit unusual given that the market is on alert for cautionary comments. To the contrary, United Airlines, Marriott and American Express were actually talking positively about their Q3 business levels. Maybe during this week's big list of conferences we will get some signs of a slowdown. Should hear much from the banking and technology industries. Oracle and Adobe will report this week and should have good commentary given the size of their customer bases.

This is a massive week for economic data. CPI, PPI, Philly Fed, retail sales, industrial production and the University of Michigan surveys. The Fed will be watching everything, but they have already telegraphed a +75 basis point move to the markets (via the WSJ). Time to start talking about the November 2nd FOMC meeting and whether +50 bps is the right increase.

The weekend news out of the Ukraine was a positive surprise. It looks like Russia is putting up little resistance as Ukraine takes back their territory. What will this mean if the Russians leave, and the war is over? European gas prices have already fallen quickly from their peaks, but could it continue? The Euro, European equities and credit like the news. Could Ukraine be one big step closer to the end? It sure seems like this was a big weekend.

Finally, congrats to all NY Giants fans. Brian Daboll went for the two-point conversion for the win in his first NFL coached game. Who would have thought it would have taken a Canadian-born football coach to fire up the NFL on its first Sunday? Awesome.

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All eyes on the CPI on Tuesday. Expecting prices to fall due to gasoline, used car and travel prices...

Looking ahead to a government inflation report to be released on Tuesday, many Wall Street analysts estimate the Labor Department’s overall consumer-price index was unchanged or dropped in August from July. If so, it would mark the second straight month of slower inflation since annual inflation surged to a four-decade high in June.

“We are experiencing a slowdown driven by the decline in fuel prices, but there is still significant upward pressure in such important categories as food, household items and healthcare products,” said Alberto Cavallo, a Harvard Business School professor who in 2008 created a “billion price” index that tracked dollar amounts of online consumer transactions. “We are not out of the woods yet.”

Called PriceStats, the price index—which is managed by State Street Global Markets and generally tracks the CPI—fell in August. The year-over-year increase in the CPI reached 9.1% in June, the highest annual inflation rate since 1981, and ticked down to 8.5% in July.


J.P. Morgan expects future CPI reads to confirm that we are on the downhill run of this pricing cycle...

J.P. Morgan

The financial markets continue to push inflation expectations back toward a 2 handle...

The bond market is signaling that in the matter of the Federal Reserve versus inflation, its money is on the US central bank.

Demand for inflation protection -- as measured by yields on inflation-protected Treasury debt -- keeps falling. The five-year expected inflation rate implied by those yields is back below 2.6%, down from a March peak of 3.76%. Meanwhile the market’s expected peak in the Fed’s policy rate remains below 4%, and long-dated Treasury yields have rebounded from levels that suggested a recession was in the cards.

“If inflation comes down to what breakevens are pricing today, then a soft landing is possible,” said Rick Rieder, the chief investment officer of global fixed income at BlackRock Inc., the world’s biggest asset manager.

Breakeven rates for Treasury inflation-protected securities, or TIPS, represent the market’s expectation for the annual inflation rate for the maturity of the debt.


Consumer inflation expectations are also retreating quickly as data on Monday showed...

(US) NY Fed Survey of Consumer Expectations: August one year ahead expected inflation 5.7% v 6.2% m/m

- Median one- and three-year-ahead inflation expectations both posted steep declines in August, from 6.2 percent and 3.2 percent in July to 5.7 percent and 2.8 percent, respectively.

- Median five-year-ahead inflation expectations, which have been elicited in the monthly SCE core survey on an ad-hoc basis since the beginning of this year and were first published in July, also declined to 2.0 percent from 2.3 percent.

- Expectations about year-ahead price increases for gas also continued to decline, with households now expecting gas prices to be roughly unchanged a year from now.


NY Fed

"Less than $3" is now replacing last month's "Less than $4"...

And tomorrow we will hit 90 days in a row...

@lisaabramowicz1: U.S. gasoline prices have fallen now for 89 consecutive days, the longest streak of declines since 2015.

Of course, as less money goes towards gasoline, spending shifts elsewhere...

And consumers are feeling better about the outlook for the economy...

“While consumer sentiment is still fairly low by historic standards, we’re starting to see pretty dramatic improvements,” said Joanne W. Hsu, an economist at the University of Michigan and director of its closely watched consumer surveys. “It’s very much being driven by a slowdown in inflation, particularly with the decline in gas prices.”...

“When gas prices go down at the pump, people immediately feel better,” said Diane Swonk, chief economist at accounting giant KPMG. “Inflation is still high, but the fact that gas prices have come off record highs makes a huge difference in how much people are spending and their expectations for the future.”

In Omaha, Nils Haaland says he’s feeling much better about the economy now that filling up his Honda pickup costs $65 instead of $95. Haaland teaches theater at a community college and sometimes works as a handyman. He says soaring prices for fuel and food this summer forced him and his wife to stop dining out, postpone summer travel and buy less meat. Although prices are still relatively high, he says he feels less worried that inflation will continue to spiral out of control.

“For a long time, I was making sure I wasn’t just indiscriminately filling up my cart at the grocery store, but now a lot of that behavior has loosened up a bit,” the 58-year-old said. “When gas went back to $3.50 a gallon, all of a sudden it was like, ‘Oh, we know how to make this work. Things are going to be okay.’”

Washington Post

Even companies are feeling better about their business outlooks...

On Tuesday, the ISM services index topped expectations. The index registered a robust 56.9 reading, and the subcomponents were equally encouraging. Both the business activity and new orders components were the strongest readings of 2022, while the prices paid component ticked lower. The index has come off its record highs reached in 2021, but it remains well above the key 50 level that separates expansion from contraction, and it is about a point higher than the average over the 2010s. This week's ISM release provides further support for the belief that the U.S. economy has decelerated but has not yet fallen into a recession.

Wells Fargo

Meanwhile, government stimulus hard at work...

In the last two weeks: MU in Idaho, INTC in Ohio and now WOLF in North Carolina. Thank you, CHIPS legislation.

Plenty of hawkish commentary from the many Fed speakers last week. Here is the Chairman reiterating what he said at Jackson Hole...

(US) Fed Chair Powell: The longer long run inflation remains above target the higher the cost; History cautions against prematurely loosening policy

- None of the high inflation we're seeing around the world now would have happened without the pandemic

- Will keep at it until job on inflation is done

- Point of my historically short Jackson Hole speech was to narrowly focus on inflation

- Public expectations of inflation will play import role in our policy framework

- Our job is to make sure short run inflation expectations do not become anchored

- Labor market demand remains very strong and wages are running at elevated levels

- Notes the welcome increase seen in labor force participation in the Aug jobs report


Here is the Fed's Waller calling for higher sooner...

"First, inflation is far too high, and it is too soon to say whether inflation is moving meaningfully and persistently downward -- The second takeaway is that the fears of a recession starting in the first half of this year have faded away and the robust U.S. labor market is giving us the flexibility to be aggressive in our fight against inflation. For that reason, I support continued increases in the FOMC's policy rate and, based on what I know today, I support a significant increase at our next meeting on September 20 and 21 to get the policy rate to a setting that is clearly restricting demand.” - US Federal Reserve Governor Christopher Waller

The Transcript

Here is the Fed's Evans talking up the potential for the economy to weather the fight on inflation...

(US) Fed's Evans (non-voter): Labor markets are tight; Inflation remains high

- Labor market is going to slow down

- We are increasing rates expeditiously; Job is to get inflation back to 2%

- Job one is to get inflation back to our goal

- Should not be complacent about US prospects given global slowdown, also worry about inflation expectations getting out of hand, expects inflation will come down

- Bringing job openings down usually means a recession, but it is different this time, possible job openings can decline without big rise in unemployment

- Inflationary pressures have broadened, particularly because of wages

- Expecting this year inflation to be high with core PCE in 4-5% range

- We do expect a lot of things to improve, like supply chains

- Reiterates expectation to top out rates at 4% next year, this is a forcefall path of rate hikes

- Optimistic we will be able to keep unemployment below 4.5% by the time we are done

- There is a decent chance of avoiding a recession but you have to be nervous something might break

- Expects rates to be 3.25-3.5% by year end, could very well do 75bps in Sep, my mind is not made up on Sep, we do need to increase rates

- Does worry a little bit that increase rates too quickly might take dependence off the table, we got to get demand right sized with supply


If Nick Timiraos says September is going to be a 75-basis point hike, then it is time to move on and debate the November FOMC meeting...

The Federal Reserve appears to be on a path to raise interest rates by another 0.75 percentage point this month in the wake of Chairman Jerome Powell’s public pledge to reduce inflation even if it increases unemployment.

Fed officials have done little to push back against market expectations of a third consecutive 0.75-point rate rise in recent public statements and interviews ahead of their Sept. 20-21 policy meeting.


Fed watchers moved quickly last week to support a September hike of 75 basis points...

We are raising our Fed forecast to include a 75bp rate hike in September (vs. 50bp previously) and a 50bp hike in November (vs. 25bp previously). We continue to expect a 25bp hike in December, which would take the funds rate to 3.75-4% by the end of 2022…

While the economy has been making progress toward a soft landing, we see suggestions in comments from Fed officials that this progress has not been quite uniform or rapid enough to satisfy them. Fed officials have expressed concern that an unwelcome easing in financial conditions like that in August could derail below-trend growth, have noted that while job openings have come down they are still very high and hiring is still very strong, and have downplayed the better inflation news from the goods sector. And today, the Wall Street Journal reported that the FOMC “appears to be on a path to raise interest rates by another 0.75 percentage point this month,” a likely hint from the Fed leadership that a 75bp hike is coming at the September meeting.

S&P 500

Goldman Sachs

The Fed will continue to be tough on any surging equity or credit markets...

S&P 500

The CEO of Restoration Hardware says housing market is in a recession...

"I mean it's so funny because we're -- I don't know, people keep saying, are we going to be in a recession? We're in a recession. Anybody who thinks we're not in a recession is crazy. The housing market is in a recession, and it's just getting started. So it's probably going to be a difficult 12 to 18 months in our industry. But these are the times where you can really capitalize." - RH CEO Gary Friedman

The Transcript

UAL is having a great third quarter...

UAL raised its Q3 revenue growth outlook, citing continued "strong" demand exiting a "robust" summer; now expects revenue to be about 12% above the same period in pre-pandemic 2019, compared with previous growth guidance of about 11%; sees capacity to be down 10% to 11%, compared with previous expectations of down about 11%.

Hammerstone Markets

VISA sees spending strong across the board...

"In terms of spending across income levels, affluent spend is still very strong. You see that in restaurants. You see that in credit. You see that in travel, high-end hotels, high-end restaurants, and so on. And the lower-income spender is also holding up well. Maybe they're spending in somewhat different areas. For example, food and drug is holding up very well, maybe helped a little bit by inflation there and so on because we only see the nominal growth. But there's no evidence of a slowdown in spend across income cohorts nor is there any -- when you look at early bookings of travel, they seem to be holding up pretty well so far -- But when you put them together, effectively, between July and August quarter-to-date, we're indexing at about 146% to 2019." - Visa CFO Vasant Prabhu

The Transcript

Where are all the earnings pre-announcements that we were anticipating?

S&P 500

A check on the markets: 10-year Treasury yields still rising...

The U.S. dollar still rising...

The S&P 500 is following the Fed's wishes...


Meanwhile, the BofA Bull & Bear Indicator has returned to 0.0...

And the recent Deutsche Bank survey of clients expects lower U.S. stock prices ahead...

@lisaabramowicz1: An investor survey conducted by Deutsche Bank shows increasingly bearish sentiment for stocks and bonds in the U.S. and Europe. Fewer than 10% of respondents think we've seen the low in the S&P, and more of them think we'll see 5% 10-year Treasury yields before 1% yields.

But even though equity investors remain bearish in the surveys, buyers are quick to hit the green button as Friday's broad buying strength showed...

@jonathanharrier: Up-volume days of greater than 90% are significant and historically point to much better days ahead. The S&P 500, Nasdaq-100, and NYSE Comp all were 90%+ Friday, while under the 200-ma. See the summary table below for what historically happened after.

Best Year for Commodities

Today's WaPo headlines show an incredible turn of events for Russia in their war on Ukraine...

Best Year for Commodities

The Washington Post

This retreat is happening very quickly...

Over the past six days, Ukraine’s armed forces have broken through the Russian lines in the northeastern corner of the country, swept eastward, and liberated town after town in what had been occupied territory. First Balakliya, then Kupyansk, then Izium, a city that sits on major supply routes. These names won’t mean much to a foreign audience, but they are places that have been beyond reach, impossible for Ukrainians to contact for months. Now they have fallen in hours. As I write this, Ukrainian forces are said to be fighting on the outskirts of Donetsk, a city that Russia has occupied since 2014.

Many things about this advance are unexpected, especially the location: For many weeks, the Ukrainians loudly telegraphed their intention to launch a major offensive farther south. The biggest shock is not Ukraine’s tactics but Russia’s response. “What really surprises us,” Lieutenant General Yevhen Moisiuk, the deputy commander in chief of the Ukrainian armed forces, told me in Kyiv yesterday morning, “is that the Russian troops are not fighting back.”

The Atlantic

As the curtain is pulled back: Europe is less vulnerable to Russian energy weaponization than the Kremlin thinks...

An internal Russian government economic forecast described this week by Bloomberg News estimated that a full cutoff of gas to Europe would cost as much as $6.6 billion in lost tax revenues.

But with Gazprom netting a record profit of $41.75 billion in the first half of the year — $10 billion of which it passed on to the Kremlin — that is a cost Mr. Putin has calculated to be acceptable

For Russia, oil is the biggest revenue source, and Mr. Putin may be keen to use gas as a political weapon while he can, said Thomas O’Donnell, an energy expert at the Hertie School, a public policy school in Berlin.

“This is where he’s got his biggest leverage to cause the most trouble in the European Union,” Mr. O’Donnell said. He added, “It’s a lever that he knows he’s going to lose in a year — or even maybe after this winter.”

And a lot may depend on the severity of the winter.

The New York Times

European electricity prices are still higher, but retreating quickly...

Best Year for Commodities


Imagine the inflows into European equities that would occur if there was a positive resolution to the war in Ukraine...

Best Year for Commodities

And with P/E multiples half that of the U.S., imagine the potential recovery in their stock markets...

Best Year for Commodities

Goldman Sachs

Even U.S. listed stocks with high overseas sales have been punished by the U.S. dollar and the many issues affecting Europe and China...

Best Year for Commodities

Goldman Sachs

What happens to German yields if the war in Ukraine ends?

Lower on less geo-political risks, supply disruptions, potential for better access to energy and demand for Euros. But resumed economic growth and UKR rebuilding potential could cause upward pressures. Hopefully we will get to see the reaction someday soon.

@lisaabramowicz1: German 2-year yields bump up against the highest levels since 2011.

Best Year for Commodities

The Red Hot Chili Peppers best hit might have been made in the summer of 2021...

Because that is the month that they sold their music library to a group of investors. At the time, U.S. interest rates were near zero. A year later, U.S. rates are looking toward a '4' handle. While we love RCHP as much as the next music fan, this library is a royalty stream with decaying attributes. (This could change subject to 'Stranger Things 4' jumping ahead 5 years and including "Under the Bridge".) A collection of music libraries can easily be valued by a DCF of the existing asset cash flows. So when rates go up, values go down. No one should be surprised that investors are willing to pay less for any fixed (or declining) stream of payments today than they were a year ago. Flea gets a bigger swimming pool in the Hollywood Hills and the Hipgnosis Song Fund falls in value. End of song and story.

Since embarking on the buying frenzy, Hipgnosis has pledged to transform popular music, for all its creativity and stardom, into a dependable asset class. The royalties from the songs it owned would be packaged into a regular income stream in the form of dividends for investors including the Church of England and Investec’s wealth management arm.

But Hipgnosis Songs Fund, which took shape in an era of rock-bottom interest rates and soaring stock markets, has since become an example of what can happen to exotic investments when the market turns.

To fuel its growth, HSF has repeatedly tapped investors for cash to make new acquisitions, but it has since burned through its funds and is unable to raise more because its stock price has fallen.

Pro forma royalty revenues from its catalogue — a measure that strips out the boost from acquisitions — have fallen for the past two years and the cost of servicing its $600mn of debt is rising. It has not bought a new song for more than a year. Some artists who had hoped to sell their catalogues to Mercuriadis are growing impatient... recent months, several artists have complained that Mercuriadis has failed to complete potential transactions that were being discussed, according to people briefed on the negotiations. One warned that the inability to complete those deals was damaging Mercuriadis’s reputation in an industry where personal relationships are highly prized. Mercuriadis blamed the delays on the US Federal Reserve’s implementation of a string of interest rate rises, the people said...

“We have a fiduciary responsibility to our investors to always ensure our underwriting is accurate,” Mercuriadis said in a statement to the Financial Times. “Changes in interest rates has meant some deals have had to be underwritten again and re-priced. This is not unique to Hipgnosis or the music industry.”

The Financial Times

For a comparison, would you rather own Intel Corporation or a music library or at the same 4.6% yield?

One cash flow stream should grow over the long-term and one will not.

Best Year for Commodities

Besides helping to save the planet, beavers are also good at football this year...

Horace Smith blew up a lot of beaver dams in his life.

A rancher here in northeastern Nevada, he waged war against the animals, frequently with dynamite. Not from meanness or cruelty; it was a struggle over water. Mr. Smith blamed beavers for flooding some parts of his property, Cottonwood Ranch, and drying out others.

But his son Agee, who eventually took over the ranch, is making peace. And he says welcoming beavers to work on the land is one of the best things he’s done.

“They’re very controversial still,” said Mr. Smith, whose father died in 2014. “But it’s getting better. People are starting to wake up.”

As global warming intensifies droughts, floods and wildfires, Mr. Smith has become one of a growing number of ranchers, scientists and other “beaver believers” who see the creatures not only as helpers, but as furry weapons of climate resilience.

Last year, when Nevada suffered one of the worst droughts on record, beaver pools kept his cattle with enough water. When rains came strangely hard and fast, the vast network of dams slowed a torrent of water raging down the mountain, protecting his hay crop. And with the beavers’ help, creeks have widened into wetlands that run through the sagebrush desert, cleaning water, birthing new meadows and creating a buffer against wildfires.

Best Year for Commodities

The New York Times

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