Expansion, Contraction and Return

    Once again, we’re facing a market that seems content to lure buyers on the notion that if the economy is growing that’s a reason to buy, and if an economy is slowing, the Federal Reserve will lower interest rates and that’s a reason to buy. When economies grow businesses invest, GDP stays firm, consumer spending rises, and optimism prevails. When an economy peaks, it’s usually because wages and prices are rising too quickly, consumers and businesses are cutting back on spending. When the economy slows, economic data show signs of slowing, which brings GDP down. Businesses reducing spending may include a reduction in hiring as well, putting upward pressure on the Unemployment rate. In presenting the economic cycle this way it is better understood that markets shouldn’t react favorably to slowing economies, not until the Federal Reserve lowers rates, but when that action produces results.

 

    In the meantime, on the back of today’s Bureau of Labor release of downward revisions of previous months of payroll growth, the likelihood of the Fed lowering rates is making traders and their AI buddies happy. But, tomorrow and Thursday, data for the Producer Price Index (PPI) and the Consumer Price Index will be released. This is important, because last month showed PPI above 3% year over year and is expected to remain at that level. CPI, which came in last month at 2.7% is expected to increase to 2.9%. This outcome would likely cause the Fed some pause as both indexes are moving away from their much publicized goal of 2%. A level, which everyone knows, makes little sense to me. Add to that, oil remains near a level not seen since 2021, when oil spiked and inflation spiked with it. This week the Organization of the Petroleum Exporting Countries (OPEC) raised output, which should place some stability on prices, especially as the West enters the colder seasons. Non- Manufacturing industries, which provide services such as Healthcare, Finance and Hospitality, has remained above 50 at 52, which suggests expansion over contraction. Personal Income rose in July to 5% year over year along with Spending which increased 4.7% for the same period. Enough to keep prices rising, or can the moderation seen in Manufacturing data be the stabilizer I think it will be?

 

    A lot for the Fed to take in at next week’s meeting. Pressure from the Administration doesn’t, or shouldn’t, matter. Likewise, the impact on the economy of lower rates should have less effect on current economic growth, credit card debt may get some relief, as may mortgage rates. Housing might see a rise as debt is the primary financing for that industry. And let’s not forget the Fed has also used other forms of stimulus in the past such as Quantitative Easing. But, in my experience the Fed has only used that tool if rates are significantly lower than they are expected to be by the end of the year.

 

    Which leave us to my final opinion, the economy is showing some slowing and some growth. Payroll growth, while still in the positive range, is under pressure less from companies pulling back on hiring and maybe more on immigration deportation and government employee reduction policies, the former of which is still progressing and latter of which has lost its luster, for now. Overall, the Fed will lower rates sooner rather than later, and while the markets can remain volatile, the bond markets can raise rates without the Fed, if necessary, and if economic growth shows any sign of resuming, the markets will love it, and so will we.

Correlation is not Causation

 But that doesn’t stop AI from saying it is. Just a reminder that I’m back in the office and navigating the tidal wave of uncertainties that have captivated the markets recently. Earnings are adding to the volatility, stocks with favorable earnings curiously go down and unfavorable earnings, but positive guidance, they go up, and the rest are just earnings and the market seems too distracted to pay attention. Our investments that continue to represent a diverse strategy and are still good buffers to the volatility, and with little more than Fixed Income ETF exposure to 3mo Treasury Bills the sharp rise in interest rates has also had little impact. It’s nice that Treasury Bills are yielding 5% as well. There is also the potential for the uncertainties to be weaponized through our Algochums and Pindude armies’ day trading, and the huge amount of shorting being taken on by Hedge Funds. The latter I customarily refer to as Hedgefiends since most historically make more money on fees than profits.

 Markets

I’ve returned to the office with the same technical oversold condition that I left with. While there were some price increases of the broad indexes, as interest rates moved the 10yr Treasury over 5%, a level not seen in 16 years, impulsive selling ensued. That natural reaction was to sell technology, but not to necessarily buy anything else. Hence the oversold condition is diverse by sector, which I find curious. That’s because it’s obvious that investing decisions are being sourced through technology, clearly from the reactionary responses to external conditions such as rising rates, inciteful narratives and other charged uncertainties. And as said conditions reverse the interpretation is for markets to also reverse the impact. However, while some correlation can be taken from the data, such as rising rates, the rest have little correlation and virtually no historical causation. The only good side to all of this is the analysts are feeding off the AI data, lowering expectations, and when those expectations are better than expected, such as with Alphabet (GOOGL) today, the unsubstantiated causes are not correlating with the outcomes. I’m glad machine learning is part of the longer term aim of AI to improve interpretation; I hope analysts can learn as well.

 Economics

Just as I was leaving the office on October 11^th, the Consumer (CPI) and Producer (PPI) data showed higher than expected increases. However, much of the core data, that excludes energy and food, the outcome was fairly stable. Since that release of data, energy has stabilized, and the consumer, while still remaining active is faced with increasing interest rate obligations over credit cards, adjustable mortgages and resumption of the student debt commitment. And the price increase in food is finally getting some scrutiny in the press as being significantly higher than prevailing inflation, getting some political interest as well. In September, Retail Sales increased 0.7%, and Industrial Production increased 0.3%, both are higher over the past year. Housing Starts increased 7.0%, and Existing Home Sales declined 2.0%, both are lower over the past year, -7.2% and 15.4% respectively. This continues to perplex the Fed, who will meet on November 1^st to vote on rising rates. For now, the only data that matters is Unemployment, and if that shows any weakness, even marginal, the Fed objective, in my opinion, could materialize over the next few months.

 External Events   

For now, patience in the face of distressing narratives has never been more important than in recent memory. This isn’t a financial crisis looming, the economy is chugging along and banks are only moderately struggling due to rising interest rate exposure to balance sheets. But, with even the Fed potentially raising rates at their next meeting, most of the external dangers surrounding the potential of the US engaging in military confrontation, and the growing dangers of dissention in our own country, while plausible, are also historically prone to presenting shorter term perils to the markets, as the world settles into its future, and with any luck, with more anticipation than anger. For now, even in an oversold condition, it’s okay to refrain from being too optimistic.

Investing in History

I’ve frequently written about technical analysis as an important piece in my overall strategy, to buy low and sell high. The interest in this form of analysis began during my early years as a Treasury trader, and has never been more interesting, and important, than in today’s AI world. The reason is that AI both possesses information that it’s been fed externally and through machine learning internally. The result has been the clear driver for the trading crowd dependent on AI for trading signals and more broadly to a handful of investing giants such as JPMorgan Chase (JPM) and Goldman Sachs (GS), and including Hedge Funds such as Bridgewater, founded by worldwide influencer Ray Dalio. The bigger result is the welcome evidence that market based activity has shown clear correlation to traditional technical analysis. Indicators such as traditional Wells Wilder Relative Strength Index (RSI, >70% overbought, <30% oversold) a good indicator for intermediate and longer term investors, and the Stochastic Oscillator (low positive cross indicates oversold, high negative cross indicates overbought) are fueling short term excitement. In short, AI is capturing historical measures and applying them today to the benefit of active investing strategies, essentially, history is repeating itself, albeit without the suit and tie.

 Of course, everything depends on more than this technical analysis, fundamental analysis is the primary source of ideas to invest in. But what is fundamental analysis composed of, and where does one look in a world of markets that has over 8,000 publicly traded companies. This is where technical analysis can help focus in sectors of an economy, how each is performing and where indicators show weakness at the expense of strength. For example, in 2023 the Technology sector is up over 35% this year, while Utilities is down nearly 10%. Is this a good reason to look at Technology stocks or Utility stocks?

 The answer, in today’s market, is both.  However, the question is why is Technology going up and Utilities going down. Historically, the economy is resilient to innovation, vital to an inclusive economy, hence every revelation from fire to the internet has seen a tidal wave of consumers. But the innovation that gains traction is more often met with deference and therefore the consideration to bring to the table in today’s market, is technology going through one of its most impactive historical periods? Yes, history is repeating itself, albeit most employees might be computers.

 Utilities are a sector that isn’t void of innovation, but most of it isn’t disruptive, a key component of technologic gain. Because most people are consumers of utilities such as water and electricity, utilities are also consistent in their flow of revenue, as demand tends to remain steady in strong or weak economies. Therefore, most investors hungry for risk will ignore utilities in favor of technology. To combat this challenge utilities have shared much revenue in the form of dividends, attracting those investors seeking defense over risk. However, in my opinion, we’re at a curious time for utilities, that is the challenge of climate change, and the steady growth of solar and wind electric generators. In the last few years, we’ve invested in companies that follow this trend, but as with any innovation, it has been wrought with problems, such as over use and harsh weather induced grid crashes. Therefore, it has been my aim to seek utility exposure that is both defensive, and innovative, but a different innovation, that is nuclear fusion. The total transformation from historical nuclear fission, it brings total renewal obligation and the potential for both steady income and growth. That combination is welcome, and when history repeats itself, the outcome is far more manageable.

This week the broad indexes traded lower on the back of the Federal Reserve, who decided to refrain from raising interest rates, but not from talking up future aggressive hikes should they be warranted. In my opinion, as inflation is slowly dropping, oil and gas are not. Also, unemployment is still very low and the consumer is spending and complaining about high prices simultaneously. A correction was necessary for the indexes and they’re getting what they deserve, until earnings suggest otherwise. Therefore, as the quarter ends, I’m expecting to see a more positive close to the year, and welcome a responsible Fed.