An all-in Fed covers a lot of potential worries and issues.
As per dictionary.com, Shangri-la is an imaginary paradise on earth, an especially remote and exotic utopia, a faraway haven or hideaway of idyllic beauty and tranquility, described in the 1933 novel “Lost Horizon” by British author James Hilton. This week’s action in the stock market would fit in Shangri La as the S&P 500 flirted with its all-time record high. Stocks marked their strongest 100-day run in history—paradise! Another string of generally upside surprises helped (more below), as risk aversion further dampened here and abroad. But the uptrend mostly is about money. Global money supply is exploding, led by the U.S. M2 (a broad measure including cash, checking, money markets and easily convertible time deposits) has shot up 23% year-over-year (y/y) and is rising at a much faster pace of late. The Fed’s not going to let yields rise, leaving investors few liquid options outside of stocks. Deutsche Bank associates every $1 trillion expansion in central bank liquidity with an additional 2% acceleration in y/y global money supply growth. JP Morgan expects the Fed, European Central Bank, Bank of Japan and Bank of London to grow their combined balance sheets by another $6 trillion through 2021. If the current apparent V-shaped recovery peters out into something slower, more excess liquidity likely will find its way into financial assets, making risky asset markets look even stronger relative to the real economy. Money can cure, or at least cover up, a lot of ills.
As the yield gap with other countries narrows, the dollar continues to weaken. It’s fallen almost 9% since late March against a basket of developed-market currencies, and Applied Global Research expects an additional 5% decline over the next six to nine months. This would further support housing, gold, commodities and other hard assets, with ultralow rates keeping real returns negative on short and long-term bond instruments. Nearer term, the dollar is oversold and gold is as stretched relative to its 200-day average as it’s been in years, making each vulnerable to consolidation, Strategas Research says. The biggest tactical threat it sees to equities is the recent run of remarkably low put/call ratios, particularly given resistance at the February highs (3,394) and the August/September seasonality overhang. There’s good support in the 3,125-3,175 range and, importantly, credit conditions continue to improve with BB spreads at multi-month lows. P/E multiples were little-changed as earnings season brought better-than-expected results (earnings exceeded estimates by 22.1% in aggregate so far, with 80% of reporting companies beating lowered projections) while markets ground higher. The forward P/E climbed to 22x from 21.7x for the Russell 1000 but fell slightly to 18.2x from 18.6x for the Russell 2000. Bank of America says valuations remain expensive—P/Es are in the 99th percentile for mid-caps. But if real yields are going to stay negative long into the recovery phase, as the Fed appears committed to doing, these apparently expensive valuations arguably are still cheap. An upward earnings revision cycle could lower multiples but analysts are still making more cuts than increases to estimates within small caps, while the opposite is true in large. Meanwhile, at 0.83x, the relative P/E of small vs. large caps remains near two-decade lows. Evercore ISI says this suggests a 20% relative upside for small caps if they were to mean-revert to 1.03x.
The risks of no near-term Phase 4 fiscal action are climbing on better-than-expected jobs numbers, White House executive actions that make for good political messaging even if their effectiveness is questionable, and political conventions set to take place over the next two weeks. Plus, Congress just left D.C. for August recess. Neither party is going to want to legislate during their conventions. Trump’s opinion polling is starting to recover, particularly in battleground states. A major Trump comeback could increase global policy uncertainty, with the dollar bouncing on near-term geopolitical risks and U.S. equity performance relative to global stocks rising on higher odds of more protectionism and trade conflicts. By contrast, if Congress fails on stimulus, the stock market corrects, Covid-19 reaccelerates with the school year and the “law and order” theme flops, then Trump’s polling will see a dead-cat bounce, ISI believes. Get your popcorn ready—you’ll want it in the next several months. Although the disease has proven more deadly for them, boomers have been doing better than younger generations during the Covid crisis, both psychologically and financially. About 90% of boomers (56-74) and the silent generation (75 and up) report doing very well or somewhat well dealing with the pandemic, compared with 76% of millennials (24-39) and Gen Zers (18-23), according to an Edward Jones-Harris Poll study. Indeed, the Mister and I have fashioned our own Shangri-la on the deck of our suburban home, surrounded by a forest of trees with sun, shade, fan, firepit, fountain, flowers, music, television and puppy. The Mister is an outstanding cook and we are still way behind on our Netflix list. He is suffering my personality quite nicely. I hope you and your loved ones are happy and healthy. Not to worry about me, though, I’m here in Shangri-La.
- Jobs will determine recovery’s shape Weekly jobless claims fell below 1 million and have fallen 33% the past two weeks. Strategas thinks they could be back to “normal” in three weeks, although seasonal employment fluctuations associated with back-to-school issues may slow the trend. Stronger withheld income tax collections in August confirm the improvements—tax revenues are just 3.4% below their record high set in March.
- The ‘V’ continues for factories July industrial production rose a third straight month, led by a 3.4% increase in manufacturing activity as most industries reported gains. Second-quarter productivity jumped 7.3%, laying the groundwork for earnings improvements later in the year.
- Tame inflation keeps Fed friendly Import prices rose a third straight month in July, although on a y/y basis, prices were still down 3.3% on a Covid-related collapse in demand. In the U.S., both headline and core consumer and producer prices rose, further reversing their declines at the height of pandemic weakness. But y/y figures remain extremely low.
- Consumers want more stimulus July retail sales rose at half the expected pace and well below outsized gains the prior two months. While still a third straight monthly rise after falling off the map in March and April, the moderate increase signals the spending recovery may be losing steam, as reflected in more recent Redbook weekly data. The initial Michigan read on consumer sentiment remained near pandemic lows on worries about the virus and a slowing recovery, and Bloomberg’s weekly consumer comfort gauge fell to a 5-week low.
- Covid hasn’t been kind to CRE The Real Estate Roundtable Sentiment Index ticked up in the third quarter but remains below breakeven 50 as conditions in the commercial real estate market remained broadly unfavorable. The current conditions component rose eight points to 21, still the second worst reading since Q2 2009.
- I do miss eating out Data from online reservation app OpenTable indicate American restaurants lag far behind counterparts in Europe. In the U.S., seated diners at restaurants are off nearly 60% while Germany is up 11%. Of course, the virus is now spreading more rapidly across Western Europe and there is some chance restaurant consumption slows there and picks up here in coming weeks.
Bond vigilantes are so yesterday 5-year inflation expectations are approaching early 2019 levels and recent consumer inflation expectations climbed to 2.9%, almost triple the headline CPI rate. So wither the bond vigilantes, Renaissance Macro wonders. With the Fed dutifully purchasing Treasuries, those vigilantes seem a lot less menacing to the political elite than when Democrats and Republicans relied on market forces and prices to finance the public debt. Are inflation expectations a problem? Not here.
The Covid Wall of Worry Investor sentiment remains exceptionally negative. Only 38% of investors in the American Association of Individual Investors bull-bear survey think the next 10% move in stocks will be higher.
Did you know? Bank of America’s weekly feature shares that more than 340 million people came online for the first time ever in the past year, more than entire population of the U.S. The world’s oceans are warming at a rate of five Hiroshima bombs every second … that’s nearly 4 billion nuclear bombs worth of heat absorbed in the past 25 years. And China now has more companies in the Fortune 500 than the U.S.A.