Author: Colin Twiggs

Posted on

Optimism bias

As humans, we are programmed to assume our solutions will work. It is an important evolutionary trait. The military solution to this optimism bias is to assert deductive reasoning and the arrangement of a reserve capacity, to compensate when systems fail, resources run out, or solutions are exhausted…..

~ Rob Johnson

Comment: The equivalent for investors, to maintaining a reserve capacity, is position-sizing: never bet so much on any one trade that an adverse outcome, or string of adverse outcomes, would affect your ability to keep investing/trading.

Posted on

Base case: global recession

The Treasury yield curve is flattening, with the 10-year/3-month yield differential plunging sharply, to a current 0.24%. Another 75 basis point rate hike at the next FOMC meeting is expected to drive the 3-month T-Bill discount rate above the 10-year yield, the negative spread warning of a deep recession in the next 6 to 18 months (subsequent reversal to a positive spread would signal that recession is imminent).

10-Year & minus 3-Month Treasury Yield

The S&P 500 is retracing to test short-term support at 4200. Breach would warn of another decline, while follow-through below 3650 would signal the second downward leg of a bear market.

S&P 500

 

21-Day Volatility troughs above 1% (red arrows) continue to warn of elevated risk.

S&P 500

Dow Jones Industrial Metals Index is in a primary down-trend, warning of a global recession.

DJ Industrial Metals Index

Supported by a similar primary down-trend on Copper, the most prescient of base metals.

Copper

Brent crude below $100 also warns of an economic contraction. Goldman Sachs project that crude oil will reach $135 per barrel this Winter, while Ed Morse at Citi says that WTI Light Crude will likely remain below $90 per barrel. Obviously, the former foresees an economic recovery, while the latter sees an extended contraction. Of the two, Morse has the best track in the industry.

Brent Crude

Natural gas prices are climbing.

Natural Gas

Especially in Europe, where Russia is attempting to choke the European economy.

Russia: EU Gas

Causing Germany’s producer price index to spike to 37.2% (year-on-year growth).

EU: PPI

Conclusion

Our base case is a global recession. A soft landing is unlikely unless the Fed does a sharp pivot, Russia stops trying to throttle European gas, and China goes all-in on its beleaguered property sector. That won’t address any of the underlying problems but would kick the can down the road for another year or two.

Posted on

In the Ways That Count, Liz Cheney Won | Frank Bruni

Liz Cheney

Extract from Frank Bruni’s piece in the New York Times:

I know what the numbers say. I can read the returns. By those hard, cold, simplistic measures, Liz Cheney was defeated overwhelmingly in her House Republican primary in Wyoming on Tuesday night, and her time in Congress is winding down.

But it’s impossible for me to say that she lost.

She got many, many fewer votes than her opponent, an unscrupulous shape shifter unfit to shine her shoes, because she chose the tough world of truth over Donald Trump’s underworld of lies. That’s a moral victory.

She was spurned by conservatives in Wyoming because she had the clear-eyed vision to see Trump for what he is and — unlike Mitch McConnell and Kevin McCarthy, whose titles perversely include the word “leader” — she wouldn’t don a blindfold. That makes her a champion in the ways that count most.

Come January, she will no longer be Representative Cheney because she represents steadfast principle in an era with a devastating deficit of it. History will smile on her for that. It will remember the likes of McConnell and McCarthy for different, darker reasons. You tell me who’s the winner in this crowd…..

Conclusion

We try to stay out of party politics but Liz Cheney’s stand is about principle — the preservation of American democracy — which should be above politics. Sadly, that is no longer the case.

Related articles

Retired Admiral James Stavridis | Setting fire to the Wells – November 19, 2020
George Orwell | The appeal of Fascism – November 11, 2020
The Threat to Global Democracy – August 18, 2022
Thomas Homer-Dixon: The American polity is cracked, and might collapse. Canada must prepare, The Globe & Mail – January 2, 2022

Posted on

CPI dips but rate hikes likely to continue

CPI dipped to 8.5% for the 12 months to July. But this still leaves the Fed way behind the curve, with a real Fed funds rate of -6.0% (8.5%-2.5%).

CPI

Monthly CPI figures, however, show a sharp slowdown, with CPI falling 0.01% in July (-0.14% annualized rate).

CPI Monthly

The primary cause is energy prices, which fell 4.53% in July (-54.7% annualized rate).

CPI Energy (Monthly Annualized)

Food CPI continues to climb, up 1.06%for July (12.75% annualized rate).

CPI: Food

CPI Shelter, heavily weighted at 32.1% of the total CPI basket, remains a major source of upward pressure on CPI. The Shelter index tends to lag home prices by up to 12 months and the Case-Shiller 20-City Composite Home Price Index grew at 20.8% for the 12 months to May.

CPI: Shelter

The Rents component of CPI shelter shows a similar lag, a long way behind the Zillow rent index which is up 14.8% over the 12 months to June.

CPI: Rent

Wages & consumer expectations

Consumer expectations for inflation were unchanged, at 5.3% in June.

University of Michigan: Inflation Expectations

While average hourly wage rates moderated slightly, growing 6.2% in the 12 months to July.

Average Hourly Earnings

Upward pressure on wages is likely to continue for as long as job openings exceed unemployment, with a current shortfall of 5 million workers.

Job Openings & Unemployment (U3)

The Fed

The real Fed funds rate (FFR adjusted for CPI) rose to a weak -6.0% after the latest rate hike, still lower than any previous trough in the past sixty years. Real FFR (red below) should be positive when unemployment (blue) is below 5%. Past lows, circled on the chart below, were in response to high unemployment — when the economy had spare capacity. We now have the opposite, with a tight labor market, and negative real rates are likely to give rise to high inflation.

Unemployment (U3) & Fed Funds Rate - CPI

Conclusion

Some are calling this “peak inflation” but the decline in CPI growth is due to a large monthly drop in energy prices. Food and shelter costs are still rising.

The energy crisis is not over, with Winter approaching in Europe while gas storage levels are at record lows and Russia is restricting pipeline flows in an attempt to create division within the European Union. Energy prices are likely to remain volatile.

The Fed is way behind the curve, with a real Fed funds rate of -6.0%. We expect them to continue hiking interest rates despite the recent fall in energy prices.

According to Larry Summers and Olivier Blanchard, the Fed will only be able to bring inflation down when unemployment is well above 5%. The danger is if the Fed is forced to halt rate hikes before it has tamed underlying inflation. We are then likely to end up with both low growth and high inflation.

Our strategy remains defensive: overweight Gold, critical materials, defensive stocks which enjoy strong pricing power, and cash.

Acknowledgements

Posted on

Fiona Hill | Putin is pushing our buttons

British-born Fiona Hill is an expert on Russia and Vladimir Putin and served as security adviser to US Presidents George W. Bush, Barack Obama and Donald Trump. Her take on Russia’s invasion of Ukraine is that Vladimir Putin still thinks he is winning. The Kremlin has a far higher tolerance for troop losses than Western governments and Putin believes that he can grind out a victory of sorts. He thinks he has the upper hand in terms of leverage, through his influence on energy markets and food shortages, and is prepared to wait out the West — waiting for them to lose patience and attempt to force a negotiated settlement.

“Putin is a contingency planner. If one thing doesn’t work, he’ll try another. If things get dire, expect more nuclear sabre-rattling. They already rhetorically deployed nuclear weapons, and used them, on national television.

Bear in mind they take a very careful read of us and how we react. Think about when they moved through the Chernobyl exclusion zone into Ukraine….People said they wouldn’t possibly do that but they did. This scares the heck out of everyone….Same thing with Zaporizhzhia nuclear power plant. They deliberately shelled it. Think about the timing. It was just when Germany and Japan were considering recommissioning their nuclear power plants. All this happens because Putin knows he can push our buttons. He knows our fears and can play to those fears.”

The West has to get ahead of this. But we always tend to do things too late. Earlier action in Ukraine — in terms of supplying weapons — may have deterred Putin.

“Putin and the Kremlin have a major advantage: continuity. They have been in power for a long time and have no effective opposition.

The West, by contrast, has no continuity. This is the main obstacle to getting ahead of the game. Democracies tend to lose focus over time…..The more domestic problems you have, the more likely you are to lose focus.

….Putin’s business is to find points of leverage.

Political donations. Corruption. Germany’s pact with the devil — it’s economy is built on reliance on cheap Russian gas. We have to wind this all back.

Posted on

Margin debt plunges 30%

Margin debt has fallen more than 30% from its October ’21 peak. That is a similar range to the 2020 contraction, during the pandemic, but far behind the +50% contractions seen during the Dotcom crash (2000-2002) and the global financial crisis (2007-2009).

S&P 500 & Margin Debt

The S&P fell 49% during the Dotcom crash and 57% during the GFC. The low point in June showed a 24% fall, from the January peak, followed by a 7.5% rally.

S&P 500

Conclusion

Plunging margin debt confirms a bear market, in line with the Fed’s plan to force deleveraging in order to shrink aggregate demand and curb inflation.

The current rally on the S&P 500 is typical of a reflexive rally in the middle of a bear market. We expect further contraction in margin debt as interest rates rise and liquidity tightens. Our target is a 50% contraction in margin debt, with a similar fall in the S&P 500, to 2400.

Acknowledgements

  • Hat tip to Advisor Perspectives for the margin debt chart
  • FINRA for the margin debt data
Powered by WordPress / WordPress Maintenance Service By Website Helper