Charts of the Week
A look at Disinflation, Credit, Divergences and China's Economy
What a week it’s been! Inflation is showing signs of slowing, at least for the moment, and that’s given equity markets reason to keep rising while rates have taken a breather.
Disinflation Prevails in the US and EU, but not Argentina
October’s CPI (and PPI) data showed a continuation of a theme from earlier in 2023: disinflation. That means inflation is still happening, but the rate at which prices are increasing has slowed. It does not, however, mean that prices are dropping in many key areas.
Across the pond in the EU we’re seeing disinflation and some actual deflation as well. A positive sign overall in the fight against inflation, but much of this is the result of demand destruction that may lead the economic zone into a recessionary environment.
Argentina, however, is showing signs of inflation accelerating. With estimates of inflation hitting over 180% in 2024, the Latin American nation is in trouble and remains one of the world’s hardest hit.
Slowing Lending, Slowing Spending
US bank lending is contracting for the first time since 2012, which could cause some economic headwinds given how much of the US economy is reliant on cheap and abundant capital to remain buoyant. Illustrating that point, we can see in the chart below from SocGen, that when banks even slow lending there’s a heightened risk of recession.
As credit becomes more expensive and scarce, and after such an enormous pull forward of demand at a time when supply chains were also constrained, we’re now seeing the other side of the extreme here as supply chain pressure is falling to lows we haven’t seen in decades. Just as the inflation surprise index begins to tilt into negative territory. These are often events that occur when there is growing underlying weakness in the global economy.
Dramatic Flows as Divergences Grow
Hedge funds went into November very short single stocks and the Russell 2000, with those same favored shorts outperforming the broader market this month as many were likely forced to cover with the sheer magnitude of some of the moves to the upside that we’ve seen recently.
Large caps have been massive outperformers this year, with a rally that has been broadening out of late, but overall has been rather narrow. With the S&P 500 and magnificent 7 handily outperforming small caps or the equal weighted S&P 500 index, unlike other bull runs going back 40 years.
We have seen the Russell outperforming of late, though. The question is whether it’s all short-term excitement, as seen by the record level of IWM call buying below, combined with short covering. Or instead, something more substantial. Time will tell.
Meanwhile, the S&P 500 is handily outperforming an aggregate index of major central bank liquidity. One could argue the fiscal impulse and cessation of US government debt for almost half of this year combined with a stimulative impulse from the BoJ and BoC going into 2023 could have helped. The question is whether or not gravity catches up now that those are in the background and conditions have tightened globally again.
If we weigh the S&P 500 NTM PE against the 10-year note yield (inverted), it does suggest that stocks may be a bit expensive here. Particularly within the magnificent 7.
How the Mighty Have Fallen
The dollar had a nasty swoon lower recently, falling below key support as sellers took control of the greenback post-CPI data release, betting that the Fed is done with their hiking cycle and cuts are to come earlier next year than suspected. This may be a bit too much excitement, but we can’t ignore the price action here. It sets up some potential trading opportunities in other currencies, as Ayesha wrote about recently in her article covering CPI.
Will Black Gold Shine Again?
Oil may be showing signs of bottoming as we see Saudi stocks stabilize and start to rise. WTI has a potentially solid area of support just above $74 that we discussed in our Dashboard, among other analysis and trading ideas.
Speaking of petrochemicals, oil-based lubricants are seeing the lowest demand in more than four decades. Part of this has to do with increasing usage of EVs, but it’s also another sign that manufacturing and the industrial economy may be slowing further this year.
Corporate Debt Liquidated
The rush out of corporate debt is rather extreme when it comes to the flows from Japan. This was the largest selling event in history, by a lot. It suggests that appetites are changing, but why the urgency here and now?
The Basis Trade is the Basis for Concern
Record short positioning reflects one side of a larger trade, which hedge funds have put on in record size. The idea behind this trade is buying Treasury paper while selling futures with the hope on capitalizing on the difference. But it can go very wrong given the amount of leverage being employed.
A Rotation into Duration
Investors are selling shorter tenors and buying longer-dated maturities, as we see many begin to suspect that not only is the Fed done but also that the economy may be beginning to slow. Locking in current rates as they see them as a long-term opportunity. We still believe we may see further bear steepening (long end leading the yield curve higher), but we are watching the data and markets closely.
Treasury borrowing is likely to grow beyond what has been estimated by the most recent Quarterly Refunding Announcement, which stated $776B. We’ve seen that trend over the last several quarters where the size of borrowing is increased later, often by $150-200B. This may come shortly after any 2024 budget is passed.
Checking in on China
The value of China’s US Treasury holdings i s the lowest it’s been since 2009. A leading driver of this is Treasuries losing their value as rates rise, but China has been selling as well. Particularly this year.
Chinese tech stocks have had rather remarkable underperformance vs their US counterparts. Whether or not that trend reverses anytime soon probably has a lot to do with whether Xi releases his stranglehold on the business sector and follows through with promises of stimulus as well.
We are seeing some potential green chutes with Chinese consumers, who seem to be starting to borrow again. Whether this is the start of a broader trend of consumption, however, remains to be seen.
If it is, we could see Chinese PPI begin to rise again, and with it we may begin to import some inflation in the US as Chinese PPI tends to lead US CPI.
Three Very Different Companies
Microsoft is easily the most diversified of the mega cap magnificent 7. A business that operates in a number of different industries and verticals, where they either lead or are at least number two at most of their key areas of operation.
Costco is a different sort of beast. A leader in retail, to be sure, but being a discounter means narrow margins and very, very agile management to succeed. Adding to that, the culture at Costco is quite good. Employee retention is high as compensation is more fair than, say, Wal-Mart. Happy employees mean better productivity, and it shows in the returns this company delivers almost $800,000 of revenue per employee.
Meanwhile, WeWork has become WeBroke as the company seeks bankruptcy as a combination of mismanagement, working from home, and a problematic business model led a once $47B company to be essentially worthless now.
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