October 28, 2022
By Steve Blumenthal
“The next stage of the tightening cycle is likely to be an economic slowdown as policymakers work to bring inflation back to target.”
– Bob Prince, Co-CEO Bridgewater Associates
The Fed is in the middle of a tightening cycle. In Bridgewater Associates’ recent research and insights note, Co-CEO Bob Prince shared his and his firm’s view on where we are in the cycle now and where we’re headed. “What comes next is weak economies and tough policy choices,” he says.
Weak indeed. Retail giant Amazon disappointed after hours, forecasting slow sales growth. Its stock is down 8% today. Microsoft, Google, and Meta reported weak quarterly earnings, and their stocks are each down between 6% and 25% for the week.
Inflation data hit the tapes this morning, too. Not good. The cycle continues. So, what comes next?
Priced into the market is another 0.75% increase in the Fed Funds. We’ll get that news next week after the Fed concludes its two-day meeting on Wednesday, November 2. The speed of this tightening cycle has been the fastest we’ve seen from the Fed in 60 years, and they’re not done yet. When you drive the cost of money higher, you drive asset prices lower.
The size of government debt and funding needs are becoming visible to a few. Soon, they will be visible to all. Policymakers find themselves in a trap Prince calls a “liquidity hole.” From Prince:
“In addition to the rise in real and nominal interest rates, the Fed and other central banks are now contracting balance sheets at a time when government bond issuance remains high, withdrawing liquidity from financial markets and creating a liquidity hole. In the decade since the financial crisis, there has been excess liquidity from central banks buying assets. This buying drove assets up faster than the economy and meant that even with government debt rising, the government debt held by the private sector could stay flat. The private sector didn’t have to buy bonds; they just had to hold on. This is now reversing. For the first time in a while, the private sector must buy new bonds at a massively increasing clip in order for the market to clear. This requires a level of yields at which the private sector desires to buy them, not the yields that central banks want to create and are willing to accept in order to institute their policies.
The table below gives perspective on the magnitude of this liquidity hole. The amount of government debt that will need to be absorbed by the private sector in the coming months is larger than at any time outside of world wars (when the central bank engineered a safe risk premium on bonds) and the global financial crisis.”
What comes next?
“The impacts of the liquidity hole stretch far beyond the bond market. When a private player buys bonds, they have to either use cash (which they might have otherwise used to buy assets) or sell assets. The consequence is that the liquidity hole is showing up not just in the bond market, but in the equity market and in other assets. The chart below shows the impact we have already seen this year from the liquidity hole trickling through all assets. Looking ahead, this is getting worse, not better.
As we progress through the tightening cycle, what likely comes next is a weakening of economies. The following diagram illustrates where we are in the liquidity cycle, which is the tendency of money to move from assets to cash or from cash to assets. Starting from economic contractions in the pandemic there was an aggressive easing, then the declines in discount rates and risk premiums and rises in asset values, then the pickup in economies, which led to inflation, then the tightening and rise in discount rates in response to that. What comes next is the rise in risk premiums and the weakening of economies.”
We are HERE (black arrow):
What comes next is—no surprise here—an economic slowdown.
Grab your coffee and find your favorite chair. In the rest of the piece, you’ll find a link to the Bridgewater CIO letter along with brief commentary and thoughts on the upcoming Fed meeting from Camp Kotok fishing friend, former Fed insider, and Cumberland Advisors’ Chief Monetary Economist Bob Eisenbeis. Random Tweets and Trade Signals follow as well.
Thanks for reading.
(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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A Bridgewater Associates – Progressing Through the Tightening Cycle
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Up Next: FMOC November 2, 2022
By, Robert Eisenbeis, Ph.D. Vice Chairman & Chief Monetary Economist
I first met Bob in 2018 fishing at Camp Kotok, David Kotok’s famous annual “shadow Fed” get-together. Former Fed officials like Bob, economists, and investment professionals. Bob now serves as Cumberland Advisors’ Chief Monetary Economist. In this capacity, he advises Cumberland’s asset managers on developments in US financial markets and the domestic economy, their implications for investment, and trading strategies. Before joining Cumberland Advisors in January 2008, Bob was Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta, where he advised the bank’s president on monetary policy for FOMC deliberations and oversaw basic research and policy analysis.
And all-around, a very nice man.
To get an insider’s take on what might happen inside the Eccles Federal Reserve Board Building next week, the following is from Bob,
The FOMC will be meeting November 1–2, but there will be no projection materials to inform the public if there are significant changes in the Committee’s outlook. Thus, the Beige Book and a first reading on Q3 GDP will be the major sources of current information on the state of the economy and key industry segments across the country. Just released on October 19, the Beige Book covers information collected through October 7, which was too soon to include the impacts of Hurricane Ian. Even these data will be nearly a month old by the time of the meeting. As we parse the information in the Beige Book, we need to keep in mind that four of the 12 districts – San Francisco, Dallas, New York, and Atlanta – account for a significant portion of the country’s output because one state in each of those districts is so large in terms of GDP. The four states – California, Texas, New York, and Florida – together account for 36% of the country’s GDP, so the Beige Book entries for the four districts containing those states provide key pieces of information on how the economy is faring.
The table below provides the terms used in the Beige Book to describe the overall changes in the economy since the last Beige Book. San Francisco, Dallas, and Atlanta all showed slight increases in activity, while New York indicated a modest slowing. Other districts that showed some slight increases were Boston, Minneapolis, and Kansas City. Three districts indicated little change – Cleveland, Richmond, and Chicago – while St Louis declined slightly and Philadelphia held steady. The picture that emerges is that the economy clearly is not in recession, but neither is it growing significantly. This conclusion is bolstered by recent corporate earning reports of declining sales and earnings. (SB Here: bold emphasis mine)
While these overall assessments are informative, the devil is in the details. The table highlights some of the key common sectors and what is happening in terms of how the previous rate hikes may be impacting the economy. In some instances, not all districts discussed some of the indicated areas, and in other cases a limited number of areas were mentioned, for instance agriculture and energy.
All the districts commented on prices, indicating some continued upward pressure. At the same time, virtually all the districts reported continued and/or modest growth in the labor market while at the same time noting that the market remained tight. Where some differences showed up were in some of the other categories, such as real estate and manufacturing. For example, all the districts reported slowing and weak retail real estate markets, and 9 of the 11 districts that reported on commercial real estate noted slowing or, at best, flat markets. Cleveland, Atlanta, Minneapolis, and San Francisco reported some improvement in manufacturing, while New York, Philadelphia, Chicago, Kansas City, and Dallas noted deceleration and declines. Tourism was mixed, with New York and Richmond citing declines, while Kansas City, Philadelphia, and San Francisco reported improvement while Boston noted robust activity.
The overall picture that emerges is that prices are still a problem, labor markets remain tight, and the districts show little sign of a recession. The most common observation was on weakening real estate markets, which is not surprising given the general increase in mortgage rates. Clearly, the stage is set for at least one more 75-basis-point increase in the target range for federal funds, but the key question that may emerge from Chairman Powell’s post-meeting press conference concerning the future path for rates will be how inclined with the Committee be to slow the pace and size of future rate increases.
The views above are Bob and Cumberlands’ views. I believe we have had a light recession, are still in it, and a hard landing lies ahead. Understanding the liquidy picture is important, and Bridgewater did an excellent job quantifying the current state.
Chart of the day: The “Liquidity Cycle.” We are here (red arrow) – We’d be better off here (green arrow):
Risk remains high. More defense than offense. Ever forward!
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Random Tweets
Had to sneak this one in. Philadelphia Eagles starting center Jason Kelcy and the Phillies Phanatic jumping with joy. The World Series begins this evening.
And some not-so-good news is that since 1929, every time the Phillies won the world series, the stock market crashed. The last time was in 2008. As a die-hard Philadelphia fan, I’m going with “correlation is not causation.” As we say in the finance business.
More Random Tweets next week. Please follow me on Twitter, where I do my best to tweet, retweet, and like what I feel is most important… @SBlumenthalCMG
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Trade Signals: Nearing Extreme Optimism
Market Commentary
October 28, 2022
S&P 500 Index — 3,666
Notable this week:
Hitting the wires at 8:30 am this morning, Core CPI rose 0.5% in September from the prior month, the Commerce Department reported — a slight slowdown from August’s month-over-month pace of 0.6%. The gauge showed a 5.1% increase year-over-year, an acceleration from the annual 4.9% seen in August. Economists surveyed by Bloomberg expected increases of 0.5% and 5.2%, respectively. Source: Yahoo Finance
Positive Apple news outweighed negative earnings from Amazon. Combined with the CPI news, stocks are up nearly 2% at the time of this posting (1 pm October 28, 2022). It’s notable that Amazon dropped ~ 9% today after the e-commerce giant issued Q4 guidance that missed Wall Street estimates and reported disappointing Q3 results.
Extreme Pessimism and the Daily MACD short-term moving average signal on the S&P 500 Index signaled a trading rally, which is continuing today. Overhead technical resistance sits at 3,900. I suspect we’re reaching a near-term recovery rally peak. For short-term traders, I’m keeping an eye on Extreme Optimism and a turndown in the MACD in the chart below to signal the end of the current rally (red arrows are sell signals, and green arrows are buy signals).
Zooming the lens out: Following is a monthly chart of the S&P 500 Index. Nothing in my mind has changed from hedge and/or sell the rallies. The downside target, in my view, remains 3,000 to 3,200.
The balance of the indicators remains in sell signals – mostly red arrows across the dashboard. High yield is back in a buy signal. Gold remains in a sell.
Click HERE to see the Dashboard of Indicators and all the updated charts in Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizons, and risk tolerances.
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Personal Note: Try To Remember
I find that living in a Zoom world really works for me. My days are filled with multiple meetings, and I love being able to connect visually with people while also seeing the sights right outside my office. If you’ve been on a call with me, you know that my office windows are floor-to-ceiling, and in the lawn outside behind me sits a beautiful tree. I love fall—September, yes, but especially October once the leaves start to change. The colors here in the Northeast have been spectacular this year, and that tree outside my window has given me quite a show. Every day, it’s a new painting. Sadly, this week marks the turn. The leaves have now all changed and their dropping approaches quickly.
Coffee in hand, view from my office couch as I write today October 28, 2022
As I write to you today, sitting on my couch with my laptop, I’m thinking about time and how fast it’s moving. I often play some peaceful music when I write, and I paused today as this oldie-but-goodie from The Brothers Four, “Try to Remember,” graced the airwaves and reminded me to take a few minutes to slow:
Penn State plays Ohio State tomorrow at noon in Happy Valley. For all you Big 10 fans who understand the enormity of the task ahead, send some love to my Blue and White. Ohio State is favored by 15.5 points and ranked #2 in the polls, and this may just be their year. It looks to me like it’s coming down to the University of Georgia and Ohio State, the Bull Dogs vs. the Buckeyes—unless the Nittany Lion roars.
Speaking of dogs—underdogs, that is—go, Phillies! Game one of the World Series is tonight.
I’m rushing to get to today’s 4 pm soccer game for Malvern Prep, so I’m sending the letter to the publishing team early. I’m really enjoying helping my wife, Susan, who’s coaching the high school’s team, and getting to know the boys. Though, it’s been another rough week for the Friars, having lost 2-1 on Tuesday. That makes for three losses in a row and a 5-10-2 season record. Susan loves a cold IPA, but it tastes much better after a win. With only three games left in the season, followed by playoffs, I’m hoping for a good-tasting IPA after the game. Go, Friars!
Tampa, Dallas, and California
John Mauldin and I are co-hosting a dinner with our partners from Skyway Capital in Tampa on Wednesday, November 9, and another in Dallas on Wednesday, November 16. We’ll talk markets, share a few investment themes, and answer your questions. John will also share his thoughts on what he calls “The Great Reset.” If you’d like to learn more, please email us at Blumenthal@cmgwealth.com.
Travel is picking up. We’ll be in southern California in December. The date and venue are to be determined.
Hoping your favorite team wins this weekend!
Click on the next photo to link to Spotify, where you can find a link to each week’s On My Radar audio recordings.
Wishing you and yours the very best.
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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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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