Posted November 18, 2022
By Sean Ring
No, We’re Not Crazy
- Investors are smoking the hopium when it comes to the Fed.
- The bond market is warning the equity market of impending doom.
- Inflation is still here and hurting us badly.
I know. I said yesterday I’d keep it light.
But it’s just too important to get this out now.
Some super bright people advise their clients to pile back into this market.
And it won’t end well for them.
Sure, the technicals look better than they have in months.
But that doesn’t mean this mess is over with.
In today’s Rude, I will cover five reasons why I think this is just another sucker’s rally.
The Market is Wrong About the Fed
I was on a call with my paisano Mark Rossano yesterday.
I asked him, “Am I crazy? Is this market really turning around?”
He said, “Nope. I don’t know what everyone’s so happy about.”
Phew. Sanity restored.
Later, Mark tweeted this:
A voting member on the rate-setting Federal Open Market Committee, Bullard said he wants to see the Fed Funds upper band between 5.00% - 7.00%.
“Thus far, the change in the monetary policy stance appears to have had only limited effects on observed inflation, but market pricing suggests disinflation is expected in 2023,” he said.
Here’s an important point about definitions from Investopedia:
Disinflation is a temporary slowing of the pace of price inflation and is used to describe instances when the inflation rate has reduced marginally over the short term. Unlike inflation and deflation, which refer to the direction of prices, disinflation refers to the rate of change in the rate of inflation.
I’ll get to inflation later.
But currently, the Fed Funds upper band is at 4.00%.
That means the Fed isn’t done yet.
Not by a long shot.
Even if it hikes another fifty basis points (0.50%) at the December meeting, the Fed will still be hiking into early 2023, at least.
I don’t get why the market doesn’t get that.
But I think Goldman Sachs’ research team is mainly in the right:
You may see one or two more 50 bp hikes, instead of 25 bp hikes, after December. But we’re splitting hairs there.
Deutsche also sees the terminal rate at 5.00%.
This is where everyone may be making a big mistake.
I don’t think Jay Powell is worried about where he’s stopping right now.
And that may be at 6.00% or higher.
The Curve is More Inverted
As I wrote in an earlier Rude:
The yield curve is simply a plot of rates across time.
The most observed curve is the US Treasury yield curve.
The most crucial section of the UST curve is the 3m – 10y spread.
Why? Because banks tend to fund themselves for three months and loan out on average for ten years for mortgages and other loans.
The difference dictates how much profit the banks can make from their ordinary business activities.
That part of the curve has just got more inverted.
Do you notice anything about the other times we’ve inverted? Let me help you:
Every time this part of the curve inverts, a recession follows. (The gray areas on the chart above denote recessions.)
But more importantly, the recession followed once the curve returned to normal or positive territory.
We’re not even close to that happening yet.
So, the recession signal isn’t so much the inversion itself. It’s when the inverted curve returns to normal.
Keep a weather eye out for this.
The Diesel Problem Isn’t Going Away…
I remember Philosopher-Truck Driver John Ring bitching about diesel costs in the 90s. Ha!
Though diesel is off its highs for this year, the price is still elevated.
And not only is the price elevated, but the difference between gasoline and diesel is also enormous.
Even the soccer moms are noticing!
With the average gallon of gasoline costing $3.688 and the average gallon of diesel costing $5.313, the difference is a mindboggling $1.625.
That’s why diesel sellers are getting so rich right now.
Remember, every link in the supply chain is greased with diesel.
Every truck that brings raw material to a factory, a factory to a warehouse, or a warehouse to a retail outlet runs on diesel.
And every ship that brings products to your country runs on marine diesel.
So even if you’re driving a gasoline-powered car to the store to pick up your t-shirt from China, you’ve also paid for the diesel to transport it through the t-shirt retail price.
Now, it’s much easier to understand at least part of the insane price rises we’ve seen.
… And That Means We’re Not Done with Inflation Yet.
Earlier, we mentioned both disinflation and the diesel problem.
To assume we’ve got through the inflation problem is plain silly.
In fact, I received a great mail about this yesterday:
While everyone compares the YoY CPI rate increases, no one accounts for the initial year.
September 2021 CPI was 5.4%. The October 2021 CPI was 7.7%.
September 2022 CPI increase was 8.2% for a combined 2-year increase of 13.6.
October 2022 was 7.7 for a combined 2-year increase of 15.4%.
So while the October YoY print was lower than September, it was from a much higher base number.
Things aren’t getting any better, in fact they are worse.
Dan, thank you for writing. It’s an astute observation.
But it’s even worse than you think.
Using the index numbers, I will show you the math on the numbers you’ve presented. Then I’ll break them down into year-on-year and month-on-month numbers.
The first important thing to know is that the basket of goods is set to 1982-1984 prices equaling 100.
So, when the Bureau of Labor Statistics (BLS) releases the September 2021 index number of 274.214, that means prices are, on average, 2.74214 times higher than in the 1982-1984 period. Ouch!
Now let’s get to the math:
September 2021 index: 274.214
October 2021 index: 276.590
September 2022 index: 296.761
October 2022 index: 298.062
How do we get the year-on-year numbers? For September 2022 year-on-year, we simply take (Sep 2022 index/Sep 2021 index) - 1 = 296.761 / 274.214 - 1 = 8.2% (as you rightly noted above).
For October 2022, it’s 298.062/276.590 - 1 = 7.7% (again, as you already wrote).
The month-on-month math is the same: (Oct 2022 index/Sep 2022 index) - 1 = (298.062/296.761) - 1 = 0.4%.
For the two-year numbers, though, the math works like this:
(1 + Sep 2021 change) x (1 + Sep 2022 change) = (1 + two-year change)
(1 + 0.054) x (1 + 0.82) = (1 + two-year change)
1.404 - 1 = two-year change = 14.04% (higher than your estimate)
October’s 2-year number, using the same math, is a whopping 16%!
So, yes, Dan. Much, much worse, but at a slower rate.
The upshot is that we need to look at the month-on-month numbers to depict inflation accurately.
Stocks are Still Below the 200DMA
Ok, let’s look at the SPX weekly chart:
And here’s the daily:
I’m sorry, but we’re not above the 200-day moving average yet.
It still seems to be a significant barrier. And we’re turning down again.
Remember my big bull/bear SPX chart?
Depending on what we do for the rest of the month, we may be trading under the 200-day moving average in the SPX for seven straight months and eight of the last nine.
I’m just not happy about that at all.
The Nasdaq is even worse:
As I’ve said to many soon-to-have-been ex-girlfriends, “It’s not me; it’s you.”
We’re not the crazy ones here.
Mr. Market is unjustifiably euphoric, ignoring the Fed, the macro, and the charts.
Still frosty, my friend, and keep your powder dry.
The big sale may be right around the corner.
Have a great weekend!