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The Bank of England surprised market participants yesterday morning when they raised the Official Bank Rate by a full half point to 5.00%. The move caught traders off guard as the BOE had chosen to raise rates by only a quarter percentage point at each of the two meetings prior.

After yesterday’s testimony by Fed Chair Jerome Powell to the US House of Representatives I analyzed its sentiment on key issues compared to his previous four FOMC policy statements, using ChatGPT. The table below shows the results.

Today the minutes of the April 27-28, 2023, Bank of Japan meeting were released. Below in italics are the top ten highlights generated by our AI engine.

To recap, we tested the following metrics, drawn from each company’s fiscal year-end reports and stated in USD, and correlated them with the percent price return in local currency over the past five years.

While the Euro Area reported inflation of 6.1% in May, the US was able to post 6% year-over-year as of February. In this framework, a hike, and potentially two more to follow, was to be expected before a pause could occur.

Going into the Fed meeting today it seemed like the consensus was toward a skip, pause, or possibly a full-on stop in raising interest rates going forward. Indeed, there are reasons to be optimistic about inflation coming down despite currently sticky “core numbers.”

Using our AI engine, we prompted a description of the Atlanta Fed’s Flexible CPI. What we got was a pretty decent explanation.

The Euro Stoxx 50 Index is up about 13% year-to-date. Not a bad return for a region whose largest economy is in recession, and whose second largest is facing one of the worst inflation fights in decades.

Investor activism in Japanese companies has been the subject of a fair amount of recent conjecture. Specifically, foreign investors have been concerned about the relative prevalence of minority interest, the ghosts of fading Keiretsus on Japanese companies’ financial statements.

Of course, over 300,000 people getting new jobs is good in itself, particularly for those with newfound opportunities. But, for the last several years, as the “great resignation” took hold, there were not many new workers coming into the workforce, leading to falling unemployment.

Two weeks ago, we noted that Congress would soon raise the debt ceiling, but that this could set up unexpected consequences for investors. Now that the debt ceiling is raised until 2025, the US Treasury is free to fund the government’s liabilities since January.

In the United States, Core PCE Inflation is still 5.0% after a recent reversal in disinflation. This measure is followed by the Fed and excludes volatile food and energy inflation.

Leading into the weekend, when the debt ceiling had not been settled, markets were exhibiting very interesting positioning.

In 2011, markets were relatively flat during the year before Congress and the White House (temporarily) buried the hatchet with the passage of the Budget Control Act on August 2, 2011.

One metric I look at fairly often for various countries is the relationship between the performance of stocks vs. bonds. The idea is straightforward enough: when stocks are outperforming bonds, it tends to be associated with a growing economy.

Credit conditions are tightening in both Europe and the United States. Our analysis follows in our mid-quarter update, Tightening Credit.

It would appear that the decline in European natural gas prices has contributed to an increase in Eurozone GDP estimates for the year. Once prices crossed below $50, GDP estimates began to rise, and now the consensus expects .6% GDP growth from the Eurozone this year.

China reported year-over-year inflation last night at just 0.1%, 0.2% lower than expectations. Clearly, China’s reopening is not creating price pressures, which brings the strength of the reopening into question.

Yesterday JP Morgan introduced a new model to quantify the last 20 years of Federal Reserve statements and speeches. While we aren’t privy to the details of the AI model, we will just assume that the model properly captures dovish and hawkish language.

The University of Michigan’s Consumer Sentiment Survey will give us more information on US consumers’ inflation expectations. The survey respondents’ inflation expectations, as other analysts have pointed out, are highly correlated with gasoline prices, which rose in March by 3.7%.

With the European Market’s earning season fully upon us, let’s look at expectations for the month ahead. According to our proprietary analytics, the European energy and real estate sectors have experienced the highest level of downward revision to sales of all sectors on both a one- and three-month basis.

While Asian financial companies have by no means been safe from the recent banking turmoil scything through other developed economies, regional banks have had a far less punishing month in terms of sales and earnings estimates than their peers in other markets.

This week as regional banks start reporting earnings we will get a better look at the lasting effects of the bank crisis kicked off by the failure of Silicon Valley Bank last month. Looking at recent earnings forecast revisions, regional banks appear particularly exposed to short- and longer-term headwinds.

The Fed’s concern about U.S. banks dominated last month’s FOMC meeting. According to today’s release of the March 21-22 meeting minutes, the Fed was apparently so concerned over banking problems and the potential for an ensuing credit crunch that officials tempered calls for rate hikes...

Lost in the Good Friday holiday and the jobs report was the weekly report on bank lending, deposits and securities holdings. Keeping in mind this data is always a week old, it shows the retreat from banks continues.

As banks back away from credit creation, we think certain assets could reassert their leadership. In our Quarterly Strategy Report, we analyze the Credit Crunch.

The failures of Silvergate Bank, Silicon Valley Bank, Signature Bank, and the current struggles of First Republic and Pacific Western Bank have seen bank deposits flee to the perceived safety of large banks.

The Federal Reserve’s balance sheet grew by $394B in the past two weeks.

Yields on 10-Year Japanese Government Bonds have fallen by about a third over the past two weeks, as shown in the chart below.

Yields on 10-Year Japanese Government Bonds have fallen by about a third over the past two weeks, as shown in the chart below.

To shore up Silicon Valley Bank and the other failed banks, the Federal Reserve extended an open-ended line of credit via its Bank Term Funding Program (BTFP) and discount window borrowings.

Credit Suisse’s problems revealed today stem from issues the company discussed last June in a profit warning.

Headline CPI came in today as expected at 0.4%, however core inflation (ex food and energy) came in slightly higher at 0.5% versus the estimated 0.4% increase.

We just experienced the fastest bank run in history with the closure of Silicon Valley Bank.

For decades since the end of the Cold War there have been very limited restrictions on foreign investments by US investors compared to those of other countries.

North American developed market large-mid stocks (United States and Canada) bottomed simultaneously with other developed markets on 10/12/22, recovering over 10% since then.

Investor concerns over the potential for poor European growth in the foreseeable future have eased thanks to the flurry of economic data coming out stronger than expected this year.

The Japanese Government Bond 10-year breakeven inflation has run contra to recent worldwide trends as one of the few sovereign rates of its kind to decline year to date.

The common narrative is that we’ve (the US) been enjoying a long period of globalization and now that it is going into reverse, it will upend many of the benefits brought by globalization, to the US in particular.

The common narrative is that we’ve (the US) been enjoying a long period of globalization and now that it is going into reverse, it will upend many of the benefits brought by globalization, to the US in particular.

Last week, I dissected developed markets EMEA (DM EMEA) stock performance by sector and found that the consumer discretionary sector was driving upward performance.

Last week I looked at how Canadian stocks underperformed US stocks this year, decomposing North American Performance.

As inflation fears have receded somewhat—though we’ll see in next week’s US CPI report how much they really have receded—European stocks have had a good start to the year.

With Caixin China PMI numbers today broadly confirming Monday’s official CCP data, the outlook for China and its neighbors remains bright.

On Monday, Germany’s GDP print for the final quarter of 2022 came out below expectations of 0.0% by -2%.

In anticipation of tomorrow’s rate decision, we saw another indicator today that the Federal Reserve has been successful in stemming the tide of inflation.

The Atlanta Fed Flexible CPI is a price series developed by the Atlanta Fed to capture the price of items that change the most frequently.

Yesterday, we got our first look at December’s economic data for Europe, in the form of PMIs.

The US Purchasing Managers Composite Index (PMI) increased in January to 46.6 from 45 in December, representing a slowing economy but slightly less pessimistic than expected and better than the month before.

We got consumer price reports for many European countries this week.

Overnight, traders pressed the Bank of Japan again on its Yield Curve Control (YCC).

With winter not fully upon us, European industrial production has benefitted from lower energy prices.

In our Quarterly Strategy Report, we illustrate the relative attractiveness of select developed international sectors.

In a recent San Francisco Federal Reserve Publication titled “Monetary Policy Stance is Tighter Than Fed Funds Rate,” the authors argue that the “all in” policy rate is actually higher than the Fed Funds rate would suggest.

While many seemed to focus on the basics of the employment report like average hourly earnings (which don’t take into consideration industry mix shifts among the employed) and the payroll job beat for the month, there is one very important variable that revealed the weakness in last month’s jobs report.

There are many ways to decompose the bond market to identify the component pieces to infer what the market is pricing in.

We believe highly innovative companies, when accounted for properly, are cheaper than their non-innovative peers in all regions of the world.

The Federal Reserve has been raising rates at an extremely aggressive manner in 2022, taking the federal funds rate from 25bps to 4%.

In recent reports, we’ve been highlighting that innovation—as a factor represented by R&D as % of sales—has stopped underperforming and it is selling for an attractive valuation.

While many perceive the S&P 500 Index to be a broad innovation-heavy index, in a way it is and in a way it isn’t.

A couple of weeks ago, in our quarterly strategy report, I argued that it appeared that innovation had bottomed.

Digging in a little deeper, we sifted through this first quintile of the S&P 500 for other insights. 

A couple weeks ago, in our quarterly strategy report (see: QSR-Has Innovation Bottomed?), I argued that it appeared that innovation had bottomed.

Irvine, California-based Masimo makes non-invasive patient monitoring, measuring and sensing technologies that improve patient care in the hospital, the home, and on the go.

Last night, the Reserve Bank of Australia stopped short of another 50bps hike to its overnight cash rate.

It appears to us that global innovation has bottomed and offers attractive value.

Innovation was the market darling thematic for many years leading up to COVID.

Using our proprietary point-and-figure-based charting system, I review a couple thousand charts per week in an attempt to identify interesting buy or sale candidates.

Shopify is a leader in commerce solutions that allow merchants to set up online stores and sell their products.

Last week, the combined dollar value of hedge positions on the S&P 500, NASDAQ 100 and Dow Jones Industrial indexes was $121.43 billion, not far from the August 16 peak of $160.02 billion.

The most significant element going into the June low was positioning.

This the name of a recent research piece from the San Francisco Federal Reserve written by Adam Shapiro.

Given all the confusion in the world around COVID, supply chains, inflation dynamics and war, there are lots of potential externalities that could resolve themselves unexpectedly.

Pinterest is a virtual bulletin board for finding and sharing ideas for food, home, style, inspiration, and more.

Over the weekend, we got a slew of data showing a generally weak economy.

Take-Two Interactive Software makes games for consoles, computers, and phones

Across US indexes, growth has experienced a resurgence relative to value off the June 17, 2022 low. 

OneSpan makes digital authentication software for corporate cybersecurity.

Since the COVID low in US Treasury rates and subsequent rise, the Japanese Yen has tracked the yield differential between the US and Japan.

After the June 17, 2022 low, stocks have jumped higher, taking out the 50-day moving average yesterday in the S&P 500. Many are debating whether this is a bear market rally or the reversal of the bruising 6-month decline.

Headquartered in Brookfield, Connecticut, Photronics is a world leader in the critical photomasks used to manufacture semiconductor wafers.

The Smart Money Index was constructed by Don Hays and measures the market action in the first half hour of trading and the last hour of trading.

We think we could see a bullish back half of the year for equity markets. Our analysis follows in our Quarterly Strategy Report.

The President today asked Congress for a gasoline tax holiday to alleviate the cost of gasoline and diesel in the country.

Headquartered in Melbourne, Australia, Incitec Pivot is a global leader in the materials sector with an unrelenting focus on Zero Harm, the expectation that its operations should never expose staff to harm or cause environmental incidents.

Crude oil and energy equities have been on a tear for the last two years.

We have a very precise methodology for dissecting the world’s equity markets.

Linde is the largest industrial gas company worldwide and an innovator in the highly engineered technologies used to deliver gas to customers.

As everyone knows, the labor market has been quite strong, with expectations for the unemployment rate to fall further next week.

All year inflation has been the narrative driving markets.

Dover Corporation is a diversified holding company serving more than 200 product categories in the industrial, energy and manufacturing industries.

The template of 1929 and 1987 is coming into focus in recent trading days.

Just today, as US inflation came in a touch hotter than expected, the Chinese Yuan is pulling lower, testing the lows of May 9, 2022.

Tractor Supply Company is the largest rural lifestyle retailer in the US, offering a range of products for home, land, pets, and animals—everything except tractors.

Today the Federal Open Market Committee raised the fed funds rate (upper bound) to 1% from 50bps.

Sensient is a leading global maker of colors, flavors and specialty ingredients for the cosmetic, food, and pharmaceutical industries.

With France’s polls closing yesterday Emmanuel Macron will now serve a second consecutive term as the president of France, the first to do so since Jacques Chirac in 2002.

The clear and present danger to the global economy is inflation because global central banks are starting to take aggressive actions to deal with what they now believe to be non-transitory inflation.

The Fed is tightening into a growth slowdown

For a confluence of reasons ranging from COVID to property sector problems, China has been experiencing slower growth. Many cross-asset relationships suggest that a devaluation in China could help spur growth.

Headquartered in Basel, Switzerland, Roche is one of the largest biotech companies in the world, providing state-of-the-art diagnostics and treatments for serious diseases, including COVID-19.

Sanofi is one of the largest pharmaceutical companies in the world.

In a year when the US is experiencing massive fiscal austerity, monetary tightening, war, inflation and a pandemic, there are many drags to stock performance.

The third largest homebuilder in the US, PulteGroup builds and sells homes in 40 cities across the country.

Known for its status as one of the top three US credit bureaus, Equifax is a global data analytics company with a goal of “helping people live their financial best.”

For more than 100 years, Belden has been a leader in designing and manufacturing the cables and wires connecting the infrastructure that controls our roads, buildings, factories, energy supplies and homes.

The Federal Reserve has all but cemented expectations for a 25bps rate hike next week. But, events have changed a lot in the last couple weeks that raise a faint hint that the Fed may not hike, despite elevated, persistent inflation.

2022 has been a tough year so far for risk management.

Headquartered in Spring, Texas, with offices around the world, Hewlett Packard Enterprise helps businesses realize the power of their enterprise data.

After President Biden’s speech, the consensus seemed to coalesce around the idea that the sanctions put forth were not as strong as they possibly could have been.

Headquartered in Brisbane, Australia, TechnologyOne is Australia’s leading enterprise software company.

Of course, the backdrop right now is Russia—a large petroleum-producing country—threatening to invade Ukraine.

Recruit Group delivers the digital meeting spaces of choice for matching individuals and business clients.

Tomorrow we get the consumer price index year-over-year for January, with expectations for 7.25%.

Headquartered in Japan, Ulvac makes vacuum devices and instruments for manufacturers in the semiconductor, electronics, chemical, pharmaceutical and food industries.

Since May 2020, the Chinese Yuan has defied the path of other emerging market currencies, strengthening by almost 12%.

Headquartered in Japan, Sysmex is the No. 1 provider of blood diagnostics equipment in the world.

Based in Tokyo, Japan, Kurita Water is a global leader in water management and water treatment chemicals.

We highlight a few takeaways from Fed Chair Jerome Powell’s confirmation hearing today before the Senate Banking Committee, broken down by topic.

This quarter’s strategy report, Forward Thinking 2022.

This Friday we’ll see where the US CPI comes out. We recently got the November print for the Eurozone CPI, and it came in hot, hitting 4.9% year over year.

Since its founding in 1963, Tokyo Electron has been accumulating the technological expertise it builds on to deliver industry-leading production equipment in two product categories: semiconductors and flat panel displays.

Since its founding in 1963, Tokyo Electron has been accumulating the technological expertise it builds on to deliver industry-leading production equipment in two product categories: semiconductors and flat panel displays.

For years preceding the COVID-19 pandemic, call option volume averaged about 15% of daily NYSE volume. This was a normal level of speculation that investors were used to.

A definite feature of the last decade has been the persistent underperformance of European and Asian stocks vs US stocks. Foreign stocks have underperformed with such consistency that it’s almost expected at this point.

A prominent feature of the post-Great Financial Crisis period has been the persistent decline in velocity, which is why the Fed has had to pump so much money into the system for so long. Absent an increase in the money supply, the drop in the velocity, all else equal, would have likely been the backdrop for a long recession.

It’s no secret that pandemic-related government policy is driving at least some of the inflation currently being experienced in the United States. Indeed, real disposable income per capita has deviated from a linear trend in a meaningful way since 2020.

This week Jerome Powell tossed the market a bone by hinting that the Fed would be patient in raising short-term interest rates due to the continued slack in the US labor market and inflation that would likely be “transitory”.

We find compelling evidence that seasonal factors exist, historically leading November and December to be the highest 2-month combined returns all year. In our allocation portfolios, we have increased our equity exposure significantly in an effort to capitalize on these year-end trends.

By now investors are quite aware of the consequences of financial repression via negative real interest rate policies. Since interest rates on “risk free” government debt are too low to even compensate for inflation, it pushes investors out the risk spectrum in an effort to achieve a positive rate of return after inflation.

New projections of the labor force growth rate by the US Bureau of Labor Statistics show the US labor force growth accelerating in the 2020s for the first time since the 1970s.

Fed funds futures for 2022 and 2023 have broken out to new highs, likely on the back of rising inflation expectations. As things stand now, the market is looking for three hikes by the end of 2023, with the effective fed funds moving from 8bps today to 85bps.

GEA is one of the largest global suppliers of food processing technology, building the machinery, plants, processes and systems that help producers deliver food to people.

With the S&P 500 up nearly 20% and international developed stocks up 13% year-to-date, the markets are having a banner year so far.

Today Straumann leads the market with a full portfolio of prosthetics and products for restoring and regenerating teeth and dental tissue. Over the last 30 years, it has enabled millions of people to regain tooth function and improve the appearance of their teeth.

Mid-Quarter Update: what does transitory mean?

Based in Brussels, Belgium, with offices in Luxembourg and Singapore, Sofina is a family-run investment company with equity holdings in Europe, the U.S. and Asia.

Carl Zeiss Meditec was formed in 2002 when the medical device business was spun off from the larger Zeiss Group, a leader in optical, semiconductor and electronics manufacturing equipment founded in 1846 in Germany.

Just when everyone thought we had COVID-19 whipped, the delta variant came along and US cases inflected higher.

The United States is just at the beginning of a housing boom that could last for the next five years.

This week US CPI inflation for June rose at a stunning 0.9% MoM, or 11% annualized, placing it among the highest sequential inflation readings in the past 40 years.

Known globally for its charm bracelets, Pandora is the world’s largest jewelry brand.

The ever-important payroll report came in ahead of expectations for June, but will ultimately do little to sway policy in toward the hawkish faction of the Federal Reserve Board.

Headquartered in London, UK, Associated British Foods is a diversified food ingredients and retail group and owner of the global brands Twinings, Ovaltine and Mazola.

Last week the 10-year to 2-year US Treasury yield curve spread narrowed from 133bps to 119bps in just three trading days.

For the second month in a row, the US payroll employment report has come in below expectations.

During the pandemic, Brussels, Belgium-based materials manufacturer Solvay provided hydrogen peroxide, hand sanitizer, face shields and financial assistance to families in distress.

Based in Stockholm, Sweden, Dometic makes accessories for mobile living, including in RVs, boats, campers and outdoor life.

Today the US employment report for April was released and it took the markets by surprise. Estimates were for net job gains of 1 million. Instead, the US economy added 218K private sector jobs. This compares to 708K private sector jobs in March. 

10 year Treasury rates peaked at the end of March at 1.74% after having risen from low of just 0.56% back in the summer of 2020. Now, the rate stands at 1.57% even as economic data continues to come in smoking hot and policy remains incredibly accommodative.

This is our Q1 2021 slide presentation of our quarterly strategy report.

LVMH Moët Hennessy Louis Vuitton is a leading global luxury brands group.

Pronounced “D-N-A,” this Knowledge Leader was founded in 1999 by three Tokyo entrepreneurs seeking to establish an online auction site.

Headquartered in Melbourne, Australia, BHP is the world’s No. 1 mining company.

Belgian holding company Groupe Bruxelles Lambert invests in European industry leaders with two key strategies in place.

Australian metals miner South32 is a 2015 BHP Billiton spinoff named to reflect the southern latitude where most of its assets are located.

Sweden’s Investor AB was founded in 1916 by the Wallenberg family with the aim of making long-term investments in high-quality global companies, a business philosophy it has maintained through booms, depressions, recessions, and global trends.

AngloAmerican was founded in 1917 by Ernest Oppenheimer, who moved from Germany to Johannesburg, South Africa, and secured financial backing from J.P. Morgan to start a gold mining business.

What a week for price data! We have been writing about the possibility of higher inflation for months now, most recently here. We have also highlighted the most likely assets to benefit from higher inflation like copper, oil and energy stocks.

To say the market is bubblelicious is a bit of an understatement given that retail “investment” in call options and penny stocks is quite literally off the charts, dwarfing numbers we saw in 1998-2000.

There are a few ways to measure productivity. One simple way to measure productivity at the company level is to calculate sales per employee. Higher sales for the same number of employees obviously means each employee is pulling more weight. Profits are a byproduct.

In this Q4 2020 slide presentation of our quarterly strategy report, we discuss: Bob Farrell’s Rules for Trading (#5 and #7 especially resonate with us right now). What the retail trading frenzy, recent IPOs and speculation can tell us...

We’re going to keep this post short and sweet because the charts speak for themselves. Today, preliminary Markit PMIs were released for January. Headline numbers ticked up, which is great and shows a continued expansion into the new year.

This week investors learned of president-elect Joe Biden’s initial bid for the next round of covid-19 relief. The number came in at $1.9tn. Importantly, included in this figure is mainly covid relief as opposed to a longer-term fiscal package that will be heavily weighted to infrastructure.

This week we were privy to both new inflation and initial unemployment claims data. The CPI data revealed a rather mundane inflation scenario. Meanwhile, the weekly initial claims number came in at a whopping 853K and missed estimates by the largest amount since June.

Inflation expectations as priced by the Treasury market are hitting 18 month highs just now. As the reader can see, inflation expectations across all treasury maturities are at cycle highs.

Since early August the “barbarous relic” has corrected some 9% while many other assets have ascended to all-time highs. This has no doubt caused a bit of consternation for holders of gold who have been using the metal not as a hedge, but as a capital appreciation vehicle unto itself.

As election results continue to trickle in suggesting Joe Biden will be the next president, there still remains a bit of uncertainty with respect the final electoral vote tally as well as any legal challenges that will emerge in the coming days.

In this presentation, we outline our argument for gold entering a new structural bull market.

In the last few weeks stock market sentiment as expressed in options has come full circle. Back in August we were noting a rather amazing level of outright speculation in stock options, mostly by small traders that were buying short-dated out of the money calls on the FAAMGs.

In recent weeks the market has been notably broader in terms of the upside participation from stocks other than FAANMGs. Typically, this type of action in the early stages of a business cycle would be strongly associated with the “value” style working, since “value” companies skew considerably smaller than “growth” companies in aggregate.

We’ve been writing for the last month about the risks, and then the corrective activity in the stock market. Even as the market didn’t peak until the first few days of September, it “feels” like this pause has lasted longer than that.

Franco-Nevada is the world’s largest gold royalty and streaming company. This means the firm invests in gold and mines, but indirectly, the idea being to provide investors with exposure to gold prices and gold exploration while limiting the risks of investing directly in mining companies.

Last week we put out a succinct mid-quarter update in which we highlighted 9 negative inputs into a tactical equity framework. This post builds upon that by calling out 7 rather conspicuous divergences that are developing in the financial markets.

The bank stocks are at it again as they make another new 52-week relative performance low compared to the broad market. It’s a perennial issue. Over the last year the KBW Bank Index, an index of 24 of the largest US banks, has underperformed the S&P 500 by 30%.

We believe the risks of an intermediate decline are higher than average and would advocate a more cautious stance toward equities right now.

When it comes down to it, there are a few key macro variables that are highly correlated with the relative performance of value vs growth – most of them measuring the reflationary impulse in the system in different ways.

Over the weekend the world learned of the Senate Republican’s “opening bid” for the next round of fiscal stimulus in the United States. That number came in at a nice, round $1tn. Now, as large as that number is, it still pales in comparison to the $3.5tn House bill that already passed.

Here we are in the dog days of summer, and the hot weather is not the only thing making us a little queasy. The darling stock market group since 2011, the Nasdaq 100 stock index, has soared a cool 20% this year and well into all-time high territory. Indeed, the height is making us queasy from vertigo.

With the US dollar index recently having completed a so called “death cross”, we thought it would be a good opportunity to review the investment implications of a potential trend change in the USD.

How does a Knowledge Leader handle a global pandemic? By adapting.

Regular readers of our content know that we have been building the case for several years now on why gold deserves a place in diversified portfolios.

As funding strains appeared in March, the USD surged. Then the Fed stepped in with massive foreign exchange swaps as a way to lend USD to foreign central banks, intended to ultimately be lent to borrowers in need of USD.

The returns of the 2009-2020 bull market were nothing short of extraordinary. From the 2009 low in the S&P 500 to the 2020 high, stocks gained a massive 488%, or nearly 18% on an annualized basis.

Even as the stock market chugs up the wall of worry, we were reminded today that the economic fundamentals remain mired in simply unprecedented territory.

Since the March 23, 2020 low, when the Federal Reserve announced basically unlimited liquidity via a variety of programs, corporate spreads have narrowed, and the stock market has risen substantially. In the chart below, I overlay US investment grade spreads over the S&P 500 Index.

As I write this note on a dreary Friday afternoon from Boulder, CO I am reminded of my town’s origin. Its first non-native settlers established the town 1858 as a base camp for gold and silver miners.

Given the surge in unemployment claims over the last month the US unemployment rate is expected to rise to 16% in April from just 4.4% in March. Shocking as that number is, we have no problem with that forecast.

We are beginning to see some important divergences develop between the stock market and other data that suggest we are not out of the woods yet.

While not 100% correlated, there tends to be a pretty good relationship between movements in the S&P 500 and credit spreads, both investment grade (IG) and high-yield (HY).

Energy companies are facing a life or death moment in 2020 with the price of WTI crude oil falling to $13.64/barrel as of this writing. Indeed the collapse in energy prices combined with poor fundamentals leading into the COVID crisis make most of the oil…

Back in the good ole’ days of mid-January, asset allocators could look to long-duration US government bonds as a refuge for stormy weather. Those days are no longer.

Despite the relief rally yesterday, financial conditions have tightened significantly in the last couple of weeks. This likely explains why the Fed just made an emergency 50bps cut to the fed funds rate.

Anyone reading this post already knows that palpable panic has set into equity markets over recent days. We present these charts to highlight the extreme nature of the selloff so far, and as a reminder of the rarity of these events. In times like this, it’s important to remind oneself that these kind of extremes are transient and often present, at the very least, unique tactical opportunities.

Watching while the largest equity market in the world falls by a whopping 8% in four trading days brings us back to the 2008-2009 meltdown period of the financial crisis. Normally an 8% drop in such a short time frame would present an interesting intermediate-term buying or rebalancing opportunity outside of a recessionary environment.

Fed funds futures are on the move today, with longer dated futures now pricing in now two 25bps rate cuts by the end of the year. However, the market does not seem to be pricing in, yet, any material chance that the Fed cuts at its March meeting.

This week’s breakout in gold is an epic expression of our times in which potential economic problems are quickly followed by massive actual and expected responses by central banks and governments. The problem de jour (for both markets and the public) is of course the real and scary health and economic consequences of a further spread COVID-19.

This morning the monthly job openings and labor turnover (JOLTS) report was released, and it came in significantly shy of expectations. While Bloomberg’s consensus estimate was for 6.925 million job openings, the actual number came in at 6.423. It is important to keep in mind that this is December data, so it doesn’t yet reflect the impact of the coronavirus on business operations.

Regular readers of this blog and of our other commentary know that we have been looking for some kind of cyclical rebound in economic activity starting in the first quarter of 2020.

As dangerous as the virus is, we believe financial markets face a larger risk from the impending economic slowdown the virus will create due to the massive quarantine effort of China underway.

Sell-offs can start for any number of endogenous or exogenous events. A mentor used to tell me, “There are a million reasons to sell a stock, but one reason to buy.” What he meant was that there are always personal reasons to sell...

10-Year US Treasury yields are down about 30bps so far this year, continuing the trend of lower rates that began in the fall of 2018 and confounding investor expectations for rising rates which would validate a turn up in economic activity.

There are a number of factors that have us tactically concerned about a period of over-exuberance among equity investors. Those include record low put/call ratios and extreme inflows into equity ETFs. But among the more troubling facts of late is the breakdown in breadth we are witnessing even as the equity markets rally to new cycle or all-time highs.

Unless something dramatically changes in the final few days of 2019, the 4th quarter for equity market performance will be one to write home about. The S&P 500 is currently on track to deliver about a 9% price return, which would be the second best quarterly performance in the last five and a half years.

For the last several months we’ve been talking about the distinct possibility of a period of foreign equity outperformance that investors would be remiss to miss.

US corporate profits are down from the 2014 peak. In this mid-quarter special report, we dive deep into corporate profits, taxes, profit margins and the increasing government debt levels that have propelled stock and bond prices higher, in our view, leading to rising equity and government bond valuations.

As hopes for a trade deal fade, similar to May and August, the CNY is devaluating against the USD again. In our work there are a handful of fairly mechanical relationships that should follow if the CNY continues to devalue.

Even as left tail risks to US and global economic growth seem to have been mitigated over recent weeks (more accommodate financial conditions, rising of some PMI data, worst case trade outcome seemingly a lower probability now), incoming data continue to suggest the nadir of this slowdown cycle has not yet been reached.

Investors were unfortunately treated to a rather disappointing package of October Chinese economic data. Three of the most important hard data series were reported: fixed asset investment, industrial production and retail sales.

As each day passes and more evidence of some sort of bottom in economic activity emerges, the chances of market rotation into the more beaten down areas of the global equity market would seem to be rising.

I wrote a week ago about how international equities may be finally getting the help they need to break the back of a long-term underperformance trend. It’s a trend that has caused international stocks to underperform US stocks in eight of the last eleven years.

EAFE stocks, those in the developed Europe and Asia regions, have underperformed US stocks in eight of the last eleven years. That batting average might be decent if you are a professional baseball player, but not so much if you are a professional investor.

Last week the Federal Reserve announced the re-commencement of large scale asset purchases in order to alleviate funding pressures that had been bubbling for several months.

United States and indeed global economic data have been weak – at least that is the unabated message from the PMI data that were released this week on both manufacturing and services. At this stage everyone knows the survey data, or “soft” data, are weak.

At some point the global economy will get a dose of reflation. Whether that comes from the current central bank easing cycle, fiscal policy response, coordinated fiscal-monetary action, or a détente in the US-Sino trade dispute is not yet known.

In our mid-quarter update, we highlighted the plunge in the University of Michigan’s consumer confidence indicator, suggesting that “good feelings” among consumers were starting to fade. Often surveys offer a leading glimpse into economic activity. A more confident consumer is more likely to make those big-ticket purchases, like homes and cars, as well as consuming more services.

With interest rates on the 10-year US treasury bond having moved nearly 50bps higher over the last 10 days it is certainly worth asking the question if we’ve seen the low in interest rates or whether this is more of a correction in an ongoing downtrend in rates.

In this mid-quarter special report, we do a deep dive into the University of Michigan survey and discern what it may mean for the vigor of the consumer moving forward, prospects for a recession and consequences for asset allocation.

Over the last few days investors have been given a good amount of information to digest from incoming economic data, Federal Reserve meting minutes, and Fed speakers opining about monetary policy at the annual Jackson Hole conference. Even still, everyone is waiting on THE speech from Fed Chairman Powell tomorrow to set to the expectations for the Fed’s upcoming meeting in mid-September.

How in the heck can the 30 year Treasury bond yield be trading at just 1.97%, an all-time low, when just 10 months ago it was up at 3.46% and “breaking out” to the upside?

Germany’s second largest bank, Commerzbank, reported a fourth straight quarter of falling revenue and projected lower profit for the year, suggesting clients have been impacted by trade tensions.

Today’s news of 10% tariffs on the remaining $300bn of imports from China took markets by storm today with US stocks moving from a 1% gain to almost a 1% loss on the day. Meanwhile, gold closed at a 6-year high of $1445.

When the US government gets near its statutory debt limit, congress must lift the debt limit in order for the Treasury to continue to issue debt to pay for government expenses. Simple enough.

We have been surprised over recent weeks to read a slue of commentary proclaiming that the economy is in great shape and Fed Chairman Powell is just pandering to markets by signaling rate cut(s) in July and beyond.

On January 3, 2019, Chinese stocks made a v-shaped bottom and surged into a peak on April 19, 2019. Since then, stocks have corrected by about 7%, dropping, recouping about 6% of the peak to trough decline that ended on June 6, 2019.

Yesterday BASF, the largest chemical company in the world, announced its earnings would fall well short of analyst estimates in the second quarter. Earnings season in the US begins in a few weeks. So, we ran through our charts to harvest any insights about how corporate earnings may play out.

In this post we’ll highlight how this payroll report could either beat or miss expectations and what each case could mean for bonds, stocks, the USD and gold.

To cut or not to cut is no longer the question. Now the question is the quantity, magnitude and timing of rate cuts for the rest of the year.

A few days of trading certainly does not make a trend, but we have our eyes on the nuanced message coming from the market – a message that has yet to give us an all clear signal.

Tomorrow will obviously be one of the most important news days of the year for financial markets with the Fed expected at the very least to signal that a rate cutting cycle is in the offing.

As expectations for a Fed easing cycle have gained momentum, we’ve seen an abundance of comparisons between the current period and the late 1990s.

In this mid-quarter update, entitled “Escalation,” we discuss the backdrop of escalating trade wars and our belief that the environment is more favorable for US Treasury bonds relative to stocks.

In today’s report, we will address one of the asset allocation implications of those factors, namely that long-term US Treasury bonds could have a substantial downside in yield even from these levels.

As we look into the second half of the year and into 2020, we are left with a fleeting feeling about the prospects for a cyclical uptick in growth and therefore earnings. The problem is not so much with the current pace of growth or incoming data (which by the way hasn’t been very good).

Despite the S&P 500 having made a new all-time high just a few weeks ago, many of the supposed market leaders have not kept pace.

The announced tariffs have come at a rather inopportune time, economically speaking.

The relationship between the performance of emerging market stocks and the US dollar is one of the tightest macro relationships that exists in investing.

Last week we wrote how the US dollar could be in for a major move when it breaks up or down out of the major consolidation it has been in for the better part of six months.

The US dollar is on the cusp of making a major move. The question is which way will it go, higher or lower? The directional movement of the US dollar will have significant asset performance implications once the tug of war between dollar bears and bulls is resolved.

So far this week, we’ve received a few data points that reinforce the manufacturing slowdown taking place in the US. Below is a calendar of events for the last couple days.

The tale from some of the most cyclical and predictive economic indicators are telling investors two very different things at the moment. Copper, the metal with a PhD in economics is giving us the all-clear sign while lumber, which is perhaps only regarded as having a master’s or bachelor’s in economics, is saying, “be careful.”.

The IMF made news yesterday by announcing its latest updates to 2019 GDP growth around the world. It guided global growth down and made an especially large cut to Eurozone growth estimates, bringing them down 30bps since January to 1.3%.

Yesterday’s stocks reacted to a raft of overnight foreign economic data that it perceived positively. In this note, I’ll run down the data and my doubts about that reaction. The hits began with China’s Markit manufacturing PMI jumping to 50.5.

Investors have been given another slug of wanting housing data this week. First it was building permits which surprised to the downside and today it was pending home sales, which fell 4.9% YoY vs expectations of a 1.8% drop.

To the dismay of many observers, US treasury yields have been dead as a doorknob despite the 20% rally in stocks over the last three months. In fact, the US 10-year yield is on the verge of breaking below the 2.56% level it reached on January 4th when recession concerns were flaring.

Last week we were presented with a fairly cold employment report with the number of job gains being lowest in 18 months and one of the lowest readings in the last decade.

The big news of the day relates to the continuation of a trend that has been going on since 2013: the widening of the trade deficit. The trade deficit in dollar terms at $-59.8bn in December and $-622bn for the year broke down to a new 10-year low.

In Part 1 of this series we talked about the lagged effect of interest rates and money growth, AKA “financial conditions” broadly speaking, on economic growth.

With US stocks up 11% YTD and nearly 19% since the Christmas Eve low, one could surmise that the economic slowdown that occurred in the back half of 2018 both globally and in the United States was a thing of the past, or at least would be over soon.

Credit markets often move before the equity markets, and this can offer helpful information about the near-term path of equity prices. In general, I like to see credit confirming what the equity markets seem to be saying. When credit stalls, like it is now, I take notice.

Several weeks ago we did some research to find out what a typical rally looks like after a big waterfall-like decline takes place.

As many commentators have pointed out, the yield curve has developed a sort of humped form in recent months. That has led many to speculate about when the yield curve will invert, foreshadowing a recession. If, as the logic goes, the yield curve is about to invert then we all better take cover.

Knightian uncertainty is named after University of Chicago economist Frank Knight (1885–1972), who distinguished risk and uncertainty in his work Risk, Uncertainty, and Profit. The concept of a separation between risk and uncertainty is an important one right now given how severely politics are driving markets.

The “blowout” employment report, while strong in some respects, should be taken with a grain of salt. It’s important to remember that employment is a lagging indicator. Payroll employment often peaks either at the beginning or middle of recessions, so it provides virtually no warning of impending danger.

The slide in oil prices in October accounted for most of the move in 10-Year US Treasury bonds via the inflation risk component of the term premium. The two series are always highly correlated and this is a mechanism through which oil price changes are incorporated into US Treasury pricing.

As a conceptual exercise, it may be useful to frame the current episode of market volatility (both upside and downside volatility) from the perspective of the stock market declines in 1998 and 2000.

So here we are, having added 10% to the value of stocks from their Christmas Eve low when we listed a baker’s dozen reasons why stocks could tactically rally from there.

The oversold condition in stocks that has developed over the last several weeks is more than trivial. I highlighted on Christmas Eve the baker’s dozen reasons why equity markets could tactically rally from that point, showing extremes in a variety of indicators.

The S&P 500 experienced a waterfall decline in December, something rarely seen. Measuring the decline using a 30-day Wilder Relative Strength Index, it is clear the extremes recently experienced.

Stocks plunging to new lows on the year and to the lowest level since early 2017 is no way to bring in the holidays. Investors are in panic mode, with precious few precedence of this level of sustained selling outside of the 2008 meltdown.

2018 has been kind to corporate profit margins. In fact, the margin expansion we’ve seen so far in 2018 is unprecedented in a late cycle economic environment when wages are rising briskly, at least looking back over the last thirty years.

One of the more well-recognized Now-Casting data series is the GDPNow series produced by the Federal Reserve of Atlanta. Every day they incorporate economic data releases and update their estimate for GDP growth in the current quarter. GDPNow is a great source of information on the real-time performance of the US economy.

The Federal Reserve is in the midst of an historic tightening cycle, and it has begun to impact the economy.

The equity markets no doubt experienced a powerful move today on the back of Fed Chair Powell’s dovish remarks mid-day. Specifically, his comments laid the groundwork for a pause in interest rate hikes in the first quarter of 2018.

It goes without saying that the most rate sensitive areas of the economy should feel the burn from higher rates first. It’s useful, therefore, to look at the performance of those sectors to get a read on the impact that changes in the rate environment are having on the real economy.

Value investing, which is often traced back to Ben Graham in the 1940s, is among the most influential trends in finance in recent decades. Value investing is based on the idea that lots of stocks are out of investors’ favor because of a myriad of reasons, such as recent losses, management upheaval (think GE), product failures, etc.

Oil prices have swung drastically over the last couple months. The market was unprepared for the US to grant waivers amounting to nearly one million barrels/day to fill the void expected to be left by the drop in Iranian exports. Instead of Iranian exports plunging to almost zero by November...

I am not optimistic about reversing the trend of the ever-rising estimates, but I found a way of substantially improving their accuracy and reliability, thereby enhancing the usefulness of reported earnings and asset values to investors.

The selling over recent weeks has been fast and intense, providing investors almost no relief. This type of short-term selling pressure has reached fever pitch levels that is usually indicative of some sort of relief rally, even if the ultimate lows are still ahead of us.

Energy is the best performing sector in four of six market-regions. (From two market groups, Developed and Emerging, and three regions, Americas, EMEA, Asia, we get six market-regions.) Among Developed Market sectors, energy is 5^th YTD, down about 5% less than the MSCI All Country World Index.

Third quarter real GDP came in at a 3.5% QoQ annualized rate for the third quarter, above expectations for a 3.3% growth rate. The growth rate itself wasn’t much of a surprise, and frankly, neither were the drivers of growth.

Steve and Bryce dissected US Treasury bonds, discussing the message of the rates market and how this is directing asset allocation. 

Today, economy watchers were treated to more of the same from the housing market. That is, more weak numbers suggesting we may have seen the peak in housing activity for the cycle.

Everyone knows that accounting is boring (not when I teach it, though), but, at least, people think it’s factual. No fake news. After all, accounting comes from counting―counting money, units of inventory, etc. All facts. Nothing further from the truth.

Today’s story begins with the once-behemoth that is the American retail firm, Sears. In the last week of September Sears’ stock dipped below $1 a share, reducing the company’s market value below $100 million. Sears may still linger on a bit, but when a big firm falls into penny-stock territory, its outright liquidation is a foregone conclusion.

Overnight, new data released in China suggests businesses are having a tough time lately. Cheung Kong University produces an alternate PMI Business Conditions Index in association with the China Federation of Logistics and Purchasing. The latest data point plunged more than 10 points from its end of July reading and is currently sitting at 41.88, deep into contraction territory.

Is last week’s 18 basis point selloff in 10 year government bonds the start of a bond bear market or a market adjusting to the realities of the time, albeit in a somewhat disorderly way? The answer to this question has obvious implications for not just bonds, but all asset classes from equities to commodities to real estate.

The Chinese stock market is closed this week for the Golden Week holiday. On this side of the Pacific the markets have been busy this week with US Treasury bond yields breaking out and stocks selling off—especially technology—based on the revelation that China implanted devices in technology products shipped to the US.

Sooner or later, higher mortgage rates (which are keyed off of the 10-year treasury yield) were always bound to start slowing the housing market. It was more a matter of what level of rates would be necessary to take the first bites out of housing.

Among the major groups of stocks around the world that we follow, US small-cap stocks have been the best performer over the last decade as the USD experienced a strong bull market. US small caps have outperformed our mid/large group of developed companies by almost 40% over the last 10 years.

Over the summer, some groups within the global equity market sold off sharply, leading to the current trends of poor performance and weak breadth. Foreign stocks, cyclicals and value-oriented sectors were the hardest hit.

The Phillips Curve (the relationship between wages and the unemployment rate) finally awoke from its slumber with today’s unemployment report showing private sector wages rising 2.9% year-over-year and non-supervisory wages rising 2.8% year-over-year, the fastest growth rate since 2009.

As many have documented, the main channel of transmission for the Fed’s quantitative easing policy was via the term premium component of US treasuries. As the Fed’s balance sheet doubled from 2010 to 2015, the term premium embedded in US Treasuries fell from 2.5% to -75bps. The Fed is now shrinking its balance sheet, which on the surface would seem to suggest a rising term premium.

Chalk it up to strength of the US dollar, trade, policy risk, or whatever, stocks outside of the US are in bad shape. One of the ways we systematically measure the relative attractiveness of a stock in a particular sector, region or country is to calculate the percent of stocks in a group that are currently flashing a red performance alert.

We are living through a period of extremely crowded trades at the moment, as Jeff Gundlach notably quipped several days ago. The risk in crowded trades is of course that what would otherwise be relatively minor risk reversals can cause massive covering of positions resulting in large moves in the underlying.

We’re pleased to share a new white paper on the market anomaly that rose above value, size, quality, low volatility and momentum factors. Written by Bryce Coward, CFA, the study details the results of first market test of the Knowledge Effect, the tendency of highly innovative companies to deliver excess returns.

Most commodities have suffered lately with the backdrop of tariffs and China’s devaluation. But some have fared worse than others, and there is information content to the relative move in commodities. While copper catches many of the headlines (i.e. Dr. Copper, the metal with a Ph.D in economics) the most significant decline has occurred in lumber.

For several years I have argued, based on comprehensive statistical evidence, that corporate financial reports―quarterly and annual statements―have lost most of their relevance and usefulness to investors.

On a day like yesterday when more than half of the US tech sector was down more than 2%, we are reminded of the benefits of diversification. Yet, diversification would not have helped one participate in the market’s rise to the highest level since February.

Recently, fears of a slowdown in global growth brought on by a trade war have led to turbulence in cyclical assets. The US Dollar has risen while commodities and emerging markets have struggled.

We calculate statistics for all developed and emerging equity markets around the world. For our mid/large cap indexes, we take the top 85% of all stocks in a given region or country and convert all prices into US Dollars.

Stock and currency markets often take their cues from the credit markets, so we find it instructive to keep a close eye on credit spreads and credit default swaps (CDS). Looking at the credit markets in the emerging markets, we think there may be initial signs that the storm that has engulfed emerging market assets may be over.

There has been considerable discussion lately about the slowly inverting yield curve and what it may signal for growth prospects going forward. Commonly used as a proxy for the yield curve is the spread between 10-Year US Treasury yields and 2-Year US Treasury yields.

In light of Fed Chairman Powell’s congressional testimony, we thought it relevant to revisit the inflation story and provide yet more evidence that the trend in inflation continues to be higher. For now, the Fed has assessed the risks to inflation and growth as balanced in both directions, which is Fed-speak for a policy that is on auto pilot.

The US shale boom has led to a surge in the production of crude oil, and much of this production has been exported in recent years. In the chart below, I plot the gross exports of crude oil from the US. Beginning with almost nothing several years ago (in part because crude exports were banned until December 2015), US daily crude exports have eclipsed two million barrels per day.

Emerging market stocks have taken it on the chin so far in 2018, down 9% and unperperforming the MSCI World Index by about 8%. There are of course plenty of excuses for such bad performance, from trade related issues to the breakdown of the synchronized global growth story.

The Chinese Yuan has fallen precipitously in the last 10 weeks raising concerns of whether China was using the currency as a weapon to preemptively mitigate looming tariffs.

Yesterday, someone threw in the towel on EM bonds. The Van Eck JP Morgan Emerging Market Local Currency Debt ETF (EMLC) is the largest and most liquid vehicle to invest in emerging market local currency bonds.

Talk of a trade war with China has recently dominated the discussion in financial markets, overshadowing the other major story playing out in the US economy—normalization of the energy markets. I thought I would answer the question of whether trade with China or oil was a bigger economic issue.

The big three central banks (Federal Reserve, European Central Bank and the Bank of Japan) met this week to review their monetary stance. In this mid-quarter update, we share our analysis, The Monetary Policy Pitchfork.

Venezuela has experienced a collapse in oil production this year as the country sinks into chaos. Daily production is down from 1.7M barrels/day at the end of last year to just 1.44M barrels/day at the end of May. Year-over-year production declines are even larger, down about 500k barrels/day.

This week financial market participants were delivered a cogent explanation for the weakness in EM stocks, bonds and currencies by India’s central bank governor, Mr. Urjit Patel.

Last week, in Bubble-Like Stock Valuations Miss $3.4 Trillion in Hidden Assets, Bloomberg detailed how traditional accounting can make a company’s fundamentals “look a lot worse than they are.” In the article, New York University’s Professor Baruch Lev weighs in. “You get numbers which are highly inflated for some companies and are understated for other companies.”

Semiconductor and semiconductor capital equipment stocks have been stellar performers lately, a trend we have been a bit slow to recognize. So, I decided to do a deep dive on semis and semiconductor capital equipment stocks to see if there is opportunity left to capture.

Yesterday we got the latest glimpse into US corporate profitability. Depending on the series observed, corporate profits are either flat-lining or rising. Before-tax corporate profits, the blue series in the chart below, are actually net down by $32 billion from the peak in 2014.

As investors, it does feel like we are in limbo, stuck between the push of higher growth and employment and the pull of higher inflation, higher rates, and policy risk. And and the end of the day, despite quite a lot of directional volatility so far this year, the S&P 500 trades at the same level as it did back on January 4th.

Energy stock fundamentals remain appealing. Global developed market energy stocks are still trading at recessionary valuation levels with the median dividend yield of 2.5% being near the highest recorded over the last two decades.

As the Trump administration’s on-again, off-again trade war with China continues to create uncertainty for investors, we sat down with geopolitical strategist Peter Zeihan to learn more about the tariff program and what it could mean for the US economy.

John Williams, one of the newest members of the Federal Open Market Committee, wrote an article titled “The Future Fortunes of R-star: Are They Really Rising?” where he summarized his views on real neutral interest rates.

Ten-year US treasury rates broke out this week on the back of news that looks unequivocally like an inflationary boom. Earlier in the week the Atlanta wage tracker ticked back up to 3.3% year over year. Wages moving higher, check. Oil prices broke above $71/barrel. Commodity prices higher, check.

Rising oil prices, food prices and interest rates are likely to soon start taking a toll on the US consumer. Over the last year, gasoline prices are up 28%, the price of cornerstone crops like corn, soy and wheat are up between 5-16%, credit card interest rates have moved to an eight year high of 13.6% and the all important mortgage rate has risen to nearly 5%.

There are two basic drivers of the London Interback Offered Rate (LIBOR): 1) policy rates and 2) a variable premium. Starting with the policy rates component, in the chart below I compare the interest rate on excess reserves (IOR) and USD LIBOR.

With the European Central Bank dragging its feet to begin the monetary tightening cycle, the difference between US and German rates has opened up to record levels. In the chart below, I show the yield on 10 Year US Treasury Bonds and 10 Year German Bunds.

A recent report by The Wall Street Journal identified a new generation of supercomputers as the fuel behind Big Oil’s “digital arms race to find oil and trim costs.” Indeed, make a quick visit to the websites of most of the Supermajors – that’s BP, Chevron, ExxonMobil, Royal Dutch Shell, Total and Eni in oil speak...

Bitcoin made a closing high on December 18, 2017 at $18,764 and then proceeded to fall to the closing low for the year, $6,604.48 on April 6, 2018. Since then, it has rebounded almost 50% to today’s level of $9,670, having broken back through the 50-day moving average.

Price excesses have built up over a long bull market. Stocks are expensive, and the volatility shock wave is traveling the globe. This quarter, we discuss the risks correlated with the current volatility, potential new sources of instability, and the sectors that could be the performance beneficiaries of these trends.

Among yesterday’s data releases was the widely followed ‘flash’ PMI report produced by Markit, which showed that the Manufacturing PMI increased to the highest level since the 4th quarter of 2014. Unlike the final report, which gets published on the first day of the month, the advanced report lacks details on specific components.

After spending the last four months consolidating gains, crude oil is breaking higher again, and it’s taking inflation expectations with it. The break higher in crude isn’t surprising given that oil fundamentals haven’t been this good in years.

Another month and another new high in equity valuations, at least relative to sales. Indeed, the median company in our developed world index (which covers the top 85% of companies in each country) just achieved a price to sales ratio that eclipsed the 2000 peak.

Last night the China Shanghai CSI 300 index fell a bit more than 1.6%, taking out February lows and setting a new YTD low for the index. This is important since the global equity markets have a very high correlation to Chinese stocks.

Recent weak data emanating from the Eurozone has been weighing on German Bund yields. The significant drop in the Eurozone Citigroup Economic Surprise Index (CESI) has pressured German Bund yields lower.

Later this year, Rio Tinto will seek board approval to spend $2.2B to build the world’s first “intelligent” mine, a network of robots and autonomous vehicles all working together on the site of the earth’s largest iron ore complex in Western Australia.

As political risk continues to escalate, we are, as always, keenly focused on risk management and the mitigation of potential losses. To those ends, we are monitoring indicators of market breadth for evidence that the worst of the shakeout is behind us.

Energy stocks are looking lively today, with energy the best performing sector in the US and second best performing sector in Europe. The likely reason for the buoyant performance is a continued improvement in fundamentals. Inventory data released yesterday showed a steady decline in crude and refined product (ex-SPR) in the United States.

As our readers ponder the implications of trade wars and the possibility for moderately higher inflation – a circular loop if we ever did see one – we thought we’d evaluate the market’s behavior to see what kind of clues it’s giving us about its health.

Today the Fed hiked the Fed Funds rate by .25% and also updated their policy statement and the so called dot plot, which is a compilation of the FOMC members projections’ for GDP growth, unemployment and prices.

As of this writing, WTI crude oil is back above $65/barrel, closing in on the recent $66.33 high on January 26. While oil and US equities have been in a “wedge” formation where, hemmed in by the January 26 high and the February 90 low, crude oil has broken out from its wedge.

Several weeks ago three professors from the Columbia and Dartmouth business schools recapped some of their work on accounting for intangible investment in a Harvard Business Review article. Their key finding, which builds on Professor Baruch Lev’s analysis in The End of Accounting, is that, “accounting earnings are practically irrelevant for digital companies”.

We recently had the opportunity to sit down with author Daniel Pink to discuss his new book, When: The Scientific Secrets of Perfect Timing, now in its 8th week on the New York Times best-seller list. 

This is the time to be alert for any signs of a failure in the S&P 500. Why? There are two really good historical precedents to the current market configuration.

Today’s unemployment that featured above trend employment growth, a tick up in the participation rate, a flat unemployment rate and a little less wage growth compared to last month is being met with applause from the equity market.

The US Dollar appears to have entered a new bear market. In this mid-quarter update, we analyze equity factors and their performance tendencies in recent USD bull and bear markets.

Counter cyclical stocks, those in the consumer staples, health care, real estate, telecom and utilities sectors, continue to have a tough go at things. In fact, as of two days ago this group of bond proxies made a new low compared to all developed market stocks, thereby continuing and reinforcing a trend that has been in place since the middle of 2016. Why is that?

As we navigate a period of market turmoil, its important to remember that non-bear corrective phases typically last six weeks to two months and almost always include several several substantial large rallies followed by selloffs back to the range of the initial low.

Year-to-date the energy sector is the worst performing sector in the developed markets. In the tables below, I highlight statistics from our Knowledge Leaders Selection Universe (KLSU) which captures the top 85% of market cap in the developed and emerging markets.

There are many different ways in which we can measure the severity of a market correction. The absolute peak-to-trough decline is one way. Duration of the drawdown is another. But we can also measure corrections by taking note of the performance of individual stocks, in what is akin to looking under the hood.

This selloff is demonstrably different than other corrections the market has endured this cycle in one important aspect: it has inflationary rather than deflationary notes to it. This is an extremely important point of context because it tells us something about market participants’ anxieties.

With a hint of volatility returning to the stock market this week, we though it good timing to review some of the market-based indicators we follow that help us judge the sturdiness of the market. This is by no means an exhaustive list, but rather a few items to consider when evaluating whether pullbacks are for buying or selling.

Oil prices have pushed through resistance and are breaking out while the US dollar has pushed through support and is breaking down. All of the major industrial commodity prices are moving in lock step, while the global economy appears to be accelerating led by the United States.

By now it’s common knowledge that the stock market is extremely overbought by nearly any measure one chooses to use. This has led many investors to infer a weaker forward return profile than usual on the logic that the normalization in the overboughtness of the market will cause a steep and lasting pullback in stocks.

Bitcoin prices have corrected severely in the last 48 hours. The newsflow suggests investors have concerns about increased regulation in China and South Korea. No doubt these headlines have spooked investors, but I think there is something else at work.

It’s no secrete that fluctuations in oil prices can lead to dramatic swings in headline price inflation, as chart 1 below shows. After all, not only does oil fuel the vast majority of transportation needs, it’s also a critical raw material used in consumer products far and wide, and much of the price swings in oil are passed on to consumers.

We recently caught up with Peter Zeihan, author of The Accidental Superpower, to ask his thoughts on the top geopolitical shifts to watch in 2018. He shared his predictions on everything from anti-trust concerns for Silicon Valley and the dire consequences for the United States if we exit NAFTA to why he expects North Korea to back down this year.

2018 has so far brought in the highest price of crude oil since late 2014 (chart 1), but we shouldn’t be surprised by the price action. Indeed, ignoring geopolitics for a moment, the fundamental picture for the crude markets haven’t been this favorable in years.

Investors were finally treated yesterday to some of the most important compromise provisions to come out of the House-Senate conference on the Tax Cuts and Jobs Act.

We expect momentum in the energy sector and resource-related currencies to continue into 2018. In this mid-quarter update to investors, we analyze what this means for the market.

Our long-time readers are familiar with the work of Professor Baruch Lev of the NYU Stern School of Business, whose research forms the basis for the Knowledge Leaders investment strategy.

The drop in the VIX to ultra-low levels in 2017 has been a point of consternation for market participants and largely misunderstood. Some market participants view the low level of the VIX as an indication of excessively positive sentiment among investors and thus a contrary indicator for the general direction of stock prices.

In a US Dollar bull market with interest rates at zero, cash is rightfully dismissed as a non-asset class. But, when the US Dollar is in a bear cycle, things change, irrespective of what US interest rates are.

Bitcoin has garnered much mainstream media coverage in recent months which is the natural reaction to its meteoric ten-fold rise this year. The digital currency’s rise to about $11,000 today was met with awe, and then it quickly fell by 20% in a matter of hours, as has been widely reported.

We’ve been arguing for the last year that US-based investors would be well served to overweight foreign versus domestic equities. In this post we’ll dig into that topic a little deeper to try to convey a few of the company specific fundamental drivers of our foreign vs domestic call, especially as they relate to one of our favorite markets: Japan.

From time to time we illustrate our analysis of highly innovative companies in a Knowledge Leader spotlight. Today we look at Microchip Technology Inc. (MCHP), a highly innovative semiconductor manufacturer that produces programmable microcontroller products used in autos, computing and lighting, among many other applications.

Over the last decade US stocks have outperformed the global equity benchmark by about 35% and have outperformed in eight of the last ten years prior to 2017. But that may all be coming to an end.

As the famous Yogi Berre once said, “You can learn a lot just by watching”. At the moment we are watching the price of oil break out of a trading range to the highest level in about 2.5 years.

The Consumer Staples sector is often viewed as a safe haven; a sector that, because of its inherent cash flow stability, market participants can turn to as a place of refuge when things get shaky. Yet, persistent fundamental decline among North American Staples companies may well be throwing a wrench in these companies’ abilities to weather a broad market downturn.

We recently met with Geopolitical Strategist Peter Zeihan to discuss three geopolitical shifts for US financial advisors to watch in the coming months.

Today’s preliminary Q3 GDP number of 3% growth at a QoQ annualized rate has been met with a mix of relief and hope. Relief that one of the most destructive hurricane seasons ever didn’t completely sap growth and hope that two consecutive quarters of 3%+ growth is evidence that trend growth has, finally in the 9th year of this recovery, accelerated above 2%.

Over the last 20 days, the US equity is showing early signs of exhaustion, and momentum is beginning to weaken. In the following charts, we’ll highlight the various technical measures we calculate each day to illustrate the early turn in momentum. Our KLSU DM Americas Index represents the top 85% market-cap of the US and Canada.

The rise in home prices from the trough in 2009 has added $8tn to home values, pushing the value of homes to a level surpassing the 2006 peak.

Since the start of this year, the US Treasury market is signaling a scenario of rising growth expectations and falling inflation expectations, as reflected by the various components that comprise interest rates.

With some exceptions, smaller-cap stocks in the US tend to pay higher taxes than their larger-cap peers. As such, speculation that corporate tax rates may be cut has stoked the performance of US small caps recently.

Employing basic bond math, we can decompose the US Treasury bond into two pieces: real rates and break-even inflation expectations. Because real rates (TIPS) and nominal rates (US Treasuries) are directly observable, break-even inflation is relatively easy to determine.

Indicators of market breadth are often useful in confirming or telegraphing important trend changes in equity markets. In simple terms, indicators of market breadth measure the level of participation of individual stocks in the general trend of the market.

Since the middle of August the S&P 500 energy sector is up 11.5% compared to just 3% for the index as a whole. Many observers have chalked this outperformance up as a reaction to a deep oversold condition or a short covering bounce, but a growing amount of evidence suggests it may be more than that.

The Federal Reserve officially signaled the beginning of its balance sheet run-off. At this point, that’s old news. But, today the Fed released the Z.1 Flow of Funds, which adds to the intrigue of the balance sheet run-off. Why?

The Federal Reserve is likely to decide next week to begin letting assets roll of its balance sheet as bonds mature, instead of reinvesting the proceeds. This means that the balance sheet will begin to shrink in size and other market participants will be forced to absorb the supply of new issuance of treasury and mortgage backed securities.

Knowledge Leaders Strategy mid-quarter update.

The upturn in global PMIs over the last year has been substantial and for the first time in years the world’s developed economies appear to be expanding in unison. As we can see in the table below, the color of the board has moved from red to green, indicating that nearly every major DM country is seeing improving PMIs.

We’ve been talking at length recently about the attractiveness of foreign, cyclical stocks. While foreign developed markets are attractive, emerging markets are especially attractive from a valuation perspective and are also benefiting from what we think is just the beginning of a persistently weak US dollar environment.

For retail investors, there are a few vehicles for exposure to gold. The SPDR Gold ETF (GLD) and the iShares Gold ETF (IAU) are the biggest, lowest cost funds for retail investors. Below are charts of the GLD and the IAU, with price and USD volume overlay to illustrate the liquidity.

Today gold is trading over $1,305, for the first time since November 4, 2016. The breakdown in the USD Index last week was a good signal telegraphing the short-term breakout in gold. Gold is notoriously difficult to value, but we have found one relationship that seems to consistently work.

We’ve been arguing since the end of 2016 that markets could be in for a sustained period of USD weakness and so far in 2017 they delivered just that.

It may be an overlooked fact that the global materials sector is the best performing sector over the last three months (up 8.6%), the second best performer over the last month (up 2.7%) and the third best performer over the last week (up 1.3%).

On a relative basis, compared to the developed world, North American stocks peaked on November 23, 2016, and have since underperformed by about 4% (in USD).

The last week has witnessed the return of multi-directional volatility in the equity markets for the first time since just before the election in the United States last November. At this point we have little reason to suspect the 2% mini correction in the S&P 500 will turn into a major downside swoon.

As the title suggests, any way we slice the data, it appears that the crude oil market is coming into balance to a greater extent than is generally recognized. This has broad asset allocation implications.

Proxy metrics for financial conditions from the US dollar, to interest rates to corporate bond spreads have been loosening since June and suggest continued moderate economic growth in the second half of 2017 and a firm equity market.

Equity allocators should take note that performance trends in North America are deteriorating while they are picking up outside the US. In the table below, I show the recent performance of the sectors within our KLSU North America index...

By most accounts the Q2 earnings reporting season has been a good one, with most companies surprising to the upside and some offering improved guidance for future numbers. In fact, according to FactSet, more companies have posted a positive sales surprise in Q2 than any quarter going back at least five years.

With energy setting records as the worst performing sector year-to-date, we were curious about Geopolitical Strategist Peter Zeihan’s thoughts on fossil fuels in the context of the United States’ continued retreat from the global theater.

The USD is off to its worst start since 1985, down about 9%. In the chart below (courtesy of Bianco Research), it appears the USD is tracing its performance in 1985 quite closely.

As our regular readers are aware, we’ve been pounding the table all year arguing that foreign stocks are in a position to structurally outperform domestic stocks. At the risk of sounding like a broken record, we thought we would – in one post – review the setup that makes foreign equities relatively attractive at this juncture.

It’s news to no one that energy has been the worst performing sector year to date with plenty of hatred of the sector to go around. Yet, as we write the price of WTI crude oil is up about 2% on news of capex cuts and OPEC’s apparent moves to reign in production and exports.

The financial sector has been getting a lot of attention recently with earnings announcements so we thought we’d weigh in on one aspect of financial stock relative performance that is making it difficult for financials to truly lead this market higher: the flattening yield curve.

This quarter, we look at two important structural changes that appear to be underway: a normalization in US and European monetary policy and a normalization in crude oil inventories.

The USD is weak again today and plunging lows not seen for 15 months. The “obvious” reasons for the USD weakness include converging foreign economic activity, more hawkish foreign monetary policies, and a general overvaluation of USD.

It’s been awhile since we’ve weighed in on the active/passive debate so we thought we’d toss our hat in the ring yet again and try to explain the asset migration that is taking the fund management industry by storm.

Highlighting the deteriorating trend in Chinese corporate financials has been an annual feature our of this blog.

Today’s payroll beat of 222,000 nonfarm jobs being added to the economy in June should be viewed in a larger context of overall slowing employment statistics that all point to the US economy remaining in its relatively weak and slowing trend.

With the euro up another 50bps today against the USD, we thought it timely to review some fundamental factors that should act to support the longer-term trend higher in the euro.

The US dollar is having another tough go today after it spent the first part of June working off an oversold condition and rallying modestly.

The last six months has seen one of the most incredible changes in investor positioning in 10-year US treasury bonds in recent history. Back in early January, around the time rates peaked, non-commercial traders (AKA speculators) were net short 10-year options and futures contracts by a whopping 17% of open interest.

To say that value is difficult to find in the global equity markets would be an understatement. In fact, when we look at all 44 of the developed market regions and regoin/sectors, what we find is that in only ten of them is the median company trading at a discount to its own 10-year average multiple.

Back in December 2016, we discussed our expectation for lower longer-term US interest rates, which we used to justify an aversion to financial stocks. This expectation played out.

The essence of diversification is choosing assets that are not perfectly correlated with each other. The logic is simple enough: when one asset zigs, another zags. Years ago, finance scholars proved that a portfolio of securities is less risky than an individual holding and the idea of diversification as a risk management tool was born.

We met with Geopolitical Strategist Peter Zeihan for a quarterly update right before the French presidential elections. In addition to calling Macron’s win, Peter outlined the three most important geopolitical shifts for US financial advisors to watch in the coming months.

We met with Geopolitical Strategist Peter Zeihan for a quarterly update right before the French presidential elections. In addition to calling Macron’s win, Peter outlined the three most important geopolitical shifts for US financial advisors to watch in the coming months.

A recent run of weaker economic data, highlighted by the Citigroup Economic Surprise Index (CESI) plunging to -32 from 58 in mid-March has caught the attention of the US Treasury bond market.

With the USD now about 5% off its January peak and having made a series of four lower lows and lower highs, it’s fair to say that the period of US dollar strength we witnessed for most of 2016 has come and gone.

From the middle of April through yesterday 10-year treasury rates rose from 2.17 to 2.40, prompting the obvious question of how high will they rise. The interesting thing about the recent slight backup in rates is that it has occurred within the context of slowing economic data.

In the table below we show the aggregate US Treasury maturity schedule. Due to stops and starts of the US Treasury issuing longer dated bonds over the last few decades, there is a huge gap in maturities available for investors.

So far in this earnings season, with over half of companies having reported, the energy sector has experienced the biggest earnings surprise. Earnings have come in almost 23% ahead of analyst estimates, nearly double the surprise of the consumer discretionary sector.

Since the beginning of 2017, the US dollar has struggled against nearly every major currency, calling into question the idea that the US dollar is still in a bull market. Indeed, since the dollar made its cyclical high on the first day of 2017 trading,

In this quarter’s Knowledge Leaders Strategy update, we discuss our work in four areas.

As investors, it’s easy to get caught up in headlines about things like Snap’s $23bn market cap or Tesla overtaking Ford and GM to become the most valuable US auto maker.

After testing and bouncing off the important 2.32% level four times so far in 2017, the US 10-year bond finally broke below that important threshold. The phenomenon has gone basically unnoticed by the financial commentators, but it occurs just as US economic data begins to wane following the bounce that started in the second half of 2016.

Last week, Intel executives took the stage in San Francisco to report to an audience of analysts, investors and media that Moore’s Law is alive and well. What does this have to do with our investment process and the Knowledge Effect? Everything.

It was shaping up to be a pretty good day for stocks until the Fed minutes dropped the balance sheet hammer on the markets this afternoon. In the minutes detailing the discussion at the March meeting, Fed officials suggested they might begin draining the balance sheet later this year.

As 1Q17 finishes with a gain in the books, the stock to bond performance ratio has also broken to a new cycle high, elevating to levels not seen since mid-2007.

With the dissolution of health care legislation barely final, murmurers out of Washington seem to suggest tax reform/cuts and infrastructure may be tackled in tandem in a way that attracts bipartisan support.

In a market experiencing the largest pullback since the election, investors are rightly looking for places to hide. At present, according to our work, the US energy sector is the only truly oversold sector.

As the first quarter nears its end there is some debate as to where Q1 GDP growth will come in. As recently as yesterday the Atlanta Fed GDPNow estimate had GDP growth of .9% and this morning the NY Fed’s Nowcast is expecting 2.8%.