October 11, 2024
By Steve Blumenthal
“Bottom line, yields across the curve are at the highs of the day with the 10 yr yield now at 4.07%, the highest since late July. While the Fed’s aggressive rate cut, the China stimulus news, and the better-than-expected jobs report are likely factors in the recent lift, maybe it’s not a coincidence that it comes a day after we heard the federal government announced a $1.8 trillion budget deficit which is about 6% of GDP in its fiscal year ended September 30th.”
— Peter Boockvar, The Boock Report October 10, 2024
Tuesday’s CBO report shows that the U.S. deficit surged to $1.8 trillion in the Fiscal Year 2024, representing 6.4% of GDP—the most significant shortfall since 2021. That’s $139 billion more than the deficit of FY 2023 and nearly $400 billion more than FY 2022.
Government spending jumped 10% year over year to reach $6.8 trillion. The biggest expenditures included Social Security ($1.5 trillion), interest payments on debt ($950 billion), and Medicare ($869 billion).
Federal debt also swelled by $2.2 trillion over the past year, hitting an all-time high of $35.7 trillion this week. The trend underscores the persistent crisis of U.S. deficit spending. Channel your inner Elvis Presley and sing with me, “Suspicious Minds”:
We’re caught in a trap
I can’t walk out
Because I love you too much, baby
Why can’t you see
What you’re doing to me
In our case, the trap is debt, and we’re too in love with QE to make any changes.
The CBO also reported that tax collections are up, but spending is increasing. Why? The interest on the debt is the biggest reason. The end of a long-term debt accumulation cycle is tricky, and we’re beginning to experience the consequences. Here’s how the Tax Foundation explained the issue in yesterday’s post:
“A major source of the growing deficit is net interest on the public debt, which grew 34 percent to $950 billion in FY24. Interest on the debt is now the second largest federal expenditure after Social Security, which costs $1.5 trillion, surpassing defense spending of $826 billion and Medicare spending of $869 billion. As currently measured, interest paid on the debt in FY24 was about 3.3 percent of GDP, which (after adjustments for comparability) would be the highest since 1992 and nearly the highest in records going back to 1940. Interest on the debt as a share of GDP is set to enter unchartered territory in the new fiscal year, surpassing the high-water mark set in the early 1990s.”
Reports on the CPI and PPI came out yesterday and today. Here’s the summary:
- Core CPI inflation has increased for the first time in 18 months. Not alarming, but in the wrong direction.
- Headline PPI inflation is climbing again—the first rise since June. Last month’s PPI inflation figure was revised upward.
- Core PPI inflation has now risen for two consecutive months. Last month’s Core PPI number was also revised higher.
Since the Fed’s 50 bps cut, the 10-year Treasury yield has gone from 3.6% to 4.1%—up, not down.
So, what’s next?
The Fed’s favorite inflation measure is Personal Consumption Expenditures (PCE). We’ll get that number on October 31. Looking at this week’s CPI and PPI reports, it seems early for the Fed to claim victory over inflation. The betting markets still favor two more 25 bps rate cuts this year and more in 2025. We need to monitor the 10-year Treasury yield and inflation data. Right now, both are trending higher. The Fed’s next meeting is November 6 and 7, so we’ll learn more then.
The 2-year note yield has risen more than half a percent since the Fed reduced rates on September 18. One plausible interpretation is that the market is “pushing back” against the Fed rate cut, concerned it may overstimulate the economy and trigger higher inflation.
In that direction, next is a look at the 10-year Treasury Yield chart. I share it each week in Trade Signals. Focus on the Weekly MACD lines in the bottom section of the chart. The black line is the short-term, weekly trend line; the red line is the long-term trend line. Signals occur when the two moving average lines cross. The red arrow at the far right indicates the most recent cross, signaling that the intermediate-term trend in interest rates is up.
The yellow zone is my best guess for where interest rates may go, with 3.25% as the logical technical support target. Expect interest-rate movement to remain volatile. I’m hoping for 3.25%, but there is no guarantee we get there.
Source: StockCharts.com
It will likely take a recession to get rates to the lower half of the yellow zone. Recession remains highly probable but has yet to be evident in the broader economy. I keep writing, watching, and patiently waiting.
This week, CMG’s Brian Schriener shared with our clients the next chart plotting three recession indicators, including the yield curve inversion, unemployment rise, and leading economic index drawdown. It looks at recessions and soft landings since 1949, showing how many indicators were triggered during each one. As the chart shows, recessions occurred every time two or three of the recession indicators were triggered. The current reading is 3.
Source: Lantern Capital LLC, Bloomberg
Grab a coffee and settle into your favorite chair. In today’s (short!) post, we’ll examine one of my favorite economic indicators, which uses price activity and underlying technical strength in the small-cap market as an early warning signal for both the high-yield bond market and the economy in general. Because small companies are generally more sensitive to economic changes, they function as a “canary in the coal mine” for the broader economy and equity markets. Let’s take a look.
On My Radar:
- Junk Bonds
- Random Tweets
- Personal Note: Northern Lights, Dana Point, California, and Denver, Colorado
See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.
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Junk Bonds
Many investors use junk bonds as an alternative to stocks, sometimes viewing them as less risky due to the cash flow they generate. Junk bonds, also known as high-yield bonds, offer higher interest rates than bonds from financially stable companies. Small-cap companies are defined as businesses with annual revenues under $250 million. Because of their smaller size, growth spurts can significantly impact their earnings and stock prices. I’ve traded the high-yield junk bond market since the early 1990s and have found the junk bond market to be an effective leading indicator for the equity markets and the broader economy in general. I keep it on my recession watch radar.
The following chart illustrates the relationship between the Barclays High Yield Price Index at the top, the Standard & Poor’s 600 Index with a 36-day smoothing in the middle, and the NDR Small-Cap Advance/Decline Line with a 40-day smoothing at the bottom. The trend analysis indicates that junk bond prices often rise when small-cap trends are positive. Conversely, when small-cap trends decline, junk bond prices typically fall.
I believe this relationship exists for two reasons: both assets react similarly to changes in monetary policy, and both face similar liquidity and trading challenges. Therefore, multi-asset managers should not view junk bonds and small-cap stocks as entirely separate asset classes.
The direction of the junk bond market can be a useful leading indicator for the stock market and the overall economy, but it’s not foolproof. When junk bond prices rise, it often signals investor confidence, suggesting that economic conditions are improving and that companies with lower credit ratings are less likely to default. This optimism can translate to gains in the stock market, especially for small-cap and more volatile stocks, as investors are willing to take on higher risk.
Conversely, falling junk bond prices may indicate growing economic uncertainty or tightening financial conditions. Investors might expect higher default rates among riskier companies, which can precede broader market declines or signal a slowdown in economic activity.
However, while junk bonds can provide early clues, they should be used alongside other indicators like interest rates, credit spreads, and broader economic data to get a more comprehensive picture.
Chart B172 signals caution. I’ve highlighted the two moving average lines with red/yellow squares. Currently, the small-cap index (S&P 600 Index) just turned down below its 36-day smoothed moving average line (dotted black), and the S&P 600 Small Cap Advance Decline Line has fallen below its moving average line.
Corresponding data back to 1995 is in the lower left data box, while data since 12-27-2022 is plotted in the right data box. This is not a perfect process, and there are many false signals.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Random Tweets
Tweet 1: Food for thought from @APompliano:
Tweet 2: Schwab’s Liz Ann Sonders. A reminder that valuations remain extremely high:
Source: @LizAnnSonders
Tweet 3: Rising inflation with rising unemployment:
Source: @KobeissiLetter
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
In Trade Signals, we combine a fundamental view with our arsenal of technical indicators to help with investment entry points and risk management.
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TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
The views expressed herein are solely those of Steve Blumenthal as of the date of this report and are subject to change without notice. Not a recommendation to buy or sell any security.
Personal Note: Northern Lights, Dana Point, California, and Denver, Colorado
Courtesy: Adam Agosti
Courtesy: Amy and Wendy, State College, PA
It will be sunny and in the low 70s in Phila this weekend. The trees are changing, and some golf is in the forecast. Fall golf. My favorite time of year.
For my Jewish friends, I wish you a meaningful and peaceful Yom Kippur. May the day bring you reflection, renewal, and the opportunity to start the new year with a light heart and a spirit full of hope.
Thanks, all, for reading. I wish you love, strength, peace, and the joy of many sweet moments.
With kind regards,
Steve
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Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Private Wealth Client Website – www.cmgprivatewealth.com
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Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”Please take note of the following text:
“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”