Daily Economic Update: March 7, 2024

Powell stayed on his talking point that the Fed needs to see more evidence that inflation will get to and stay at 2% target before cutting rates.  The market seemed to cheer on the fact that Powell at least doesn’t think the Fed will need to hike again. Even NYCB couldn’t derail a bit of a relief rally (looks like maybe some crony capitalism with the Mnuchin deal, who knows). The 10Y yield fell to 4.10% while the 2Y fell to 4.56%.

ADP comes in less than expected at 140K vs. 150K est.  As an observer the correlation between ADP and the Non-farm payrolls is weak at best, so I'm not sure how much stock markets place in the ADP number as a predictor.

The JOLTS data showed job openings falling slightly but beating consensus forecast.  Quits and hiring both fell slightly but remain robust.  Speaking of job openings there are plenty of post on LinkedIn where people are complaining that job post on LinkedIn are not really for jobs that exist, theorizing that many posting are made by companies simply to create the impression that the company posting is growing rapidly. This has lead some LinkedIn candidates to ponder whether anyone has actually been hired from a job posting on LinkedIn.

There have been a few interesting Fed related post on inflation and the level of interest rate policy.  One of the post was by the St. Louis Fed and seeks to analyze the output gap, how closely the economy is functioning to it's long-run production capability, and concludes that a a Taylor Rule would imply that interest rates should be at around 5% to react to the current output gap.   A second post was from the NY Fed discussing inflation expectations and completing the 'last mile' of returning inflation to target.  That post looks at New Keynesian models and concludes that bringing inflation down is dependent upon expectations for labor market conditions driven by macroeconomic policy.  What I find interesting in this post is the author's conclusions, which show scenarios where inflation doesn't return to the 2% target until 2025 at the earliest:

"The model predicts that further disinflation—the final mile—is likely to be gradual. It bears emphasizing that these are our model-based forecasts and not official projections.

What affects the speed of disinflation? In the chart below, the left panel presents three forecast scenarios for inflation based on possible future paths of the unemployment rate, shown in the right panel. When the unemployment rate rises faster than the baseline forecast, then underlying inflation reaches its long-run trend (red line) by the end of 2025 (gold line). However, when the unemployment rate moves sideways, then the pace of disinflation is slower (blue line)."

On the day ahead it's jobless claims and moar Powell. 

 XTOD: This guy put $260 into a meme coin named “Jeo Boden” 3 days ago…It’s now worth $433,000. I love this country.

XTOD: This. Emphasis on the years of upcoming capital spend needed to make up for 4 decades of outsourcing/asset light businesses/ "financialization" of returns. The US corporate pendulum will swing back from extreme Wall Steet efficiency closer to Main Street efficacy.

XTOD: The yen extended gains against the dollar to as much as 0.5% on news that the Bank of Japan has tacit approval from some government officials to end its negative interest rate policy in the near term: BBG

XTOD: Can’t get this chart out of my head. It points to a culture that is not just stuck but dead. 

If you abdicate your attention to addiction, you cease being 'you.' You’ve stepped into the pod, made yourself comfortable, said thank you.  https://pbs.twimg.com/media/GH_zVKeXoAERIrz?format=png&name=medium

XTOD: The modern HF industry went vertical on AUM when $SPY did nothing from the tech bubble top in 2000 until post the GFC in 2010.  The modern HF industry was destroyed when the $SPY went vertical from the GFC lows of 666 to 5000+ as it wasn’t needed anymore.    It was never about limiting vol and always about total return.

XTOD (John Cochrane gets into with MMTers): Easy. 27% rise in nominal GDP (Q1 2021-now) = 27% rise in real GDP, not 9% rise in real GDP and 18% rise in prices. MMT said "there is always slack," so printing money won't cause inflation. The experiment was just run.

XTOD: “How inexplicable it seems.   "If one sets aside time for a business appointment, a trip to the hairdresser, a social engagement or a shopping expedition, that time is accepted as inviolable.  

"But if one says: I cannot come because that is my hour to be alone, one is considered rude, egotistical or strange.”  ― Anne Morrow Lindbergh, Gift from the Sea

Daily Economic Update: March 6, 2024

A tough day for equities as major indexes fell more than 1%. Yields also fell 5-8 bps as investors reassessed their risk appetites, or at least that sounds plausible.  

Yesterday's ISM showed the service sector expanded for the 14th straight month with strength in activity and new orders and some softening in employment and prices.  The softening seemed to dominate the market’s sentiment, despite the fact that comments that ISM highlighted from respondents read fairly optimistic. 

Also weighing on risk appetite, apparently Apple and Tesla have sales problems in China.  How much of that is economic weakness in China vs. consumer preferences being influenced by nationalism vs. increased domestic Chinese competition (I saw that 60 minutes on China's EV industry and their robotics a few weeks ago).  

Crypto doesn't care about China (or maybe it does as it generally doesn't like authoritarian regimes and Chinese can use crypto to get wealth out of China).  I've written about crypto lately, but a bit more quietly Gold has hit new record highs.  Perhaps Bitcoin and Gold are driven by similar factors, both of which are driven by political economy questions.  True Bitcoiners are libertarian and techy who want a way to make uncensored payments with some assurance that no one will hyperinflate away the digital coin (though while Bitcoin is fixed quantity, nothing stops the proliferation of a thousand other cryptocoins).  Gold bugs generally believe that fiat currencies should be redeemable into a physical commodity, gold, which serves as a "medium of account" under a general premise that gold monetary units provide a more stable currency than fiat and are less prone to the political will to inflate (though a gold standard still requires political cooperation, especially if governments control the mints).

Speaking of gold and Bitcoin, Larry White of George Mason, was speaking about his book Better Money: Gold, Fiat, or Bitcoin? on MacroMusings back in August 2023 in his talk he mentioned the following as to why he believes Gold has characteristics that make it a better money than Bitcoin, specifically how gold supply expands as money demand grows, while Bitcoin supply does not:

That's the biggest point the book makes that in the long run, under a gold standard, the quantity of money grows as demand grows. And so you get this mean reverting characteristic that we talked about earlier where the purchasing power is pretty stable and predictable, not perfectly, but pretty stable and predictable, more stable and predictable than Bitcoin would be, more stable and predictable than fiat monies have turned out to be in practice.

...... But because the quantity of Bitcoin at any point in time is a vertical supply curve, over time, the supply curve shifts to the right slowly with the programmed increase in the supply, but the quantity doesn't respond at all to increases in the demand. All of the increase in demand goes into the price and none into the quantity. And so that makes it more volatile than a gold standard, both in the immediate run where the gold standard supply curve is not perfectly vertical, because you can convert non-monetary gold into monetary gold, but it's especially dramatically different in the long run where the supply curve for monetary gold is basically flat and the supply curve for Bitcoin is basically vertical, meaning you get a lot of volatility in the price and no volatility in the quantity. Whereas with a gold standard, it's the reverse. You get response in the quantity and stability in the purchasing power.

....So if fiat monies break down and people are looking for a better money, and to go back to the beginning of the book, as they had to do in Venezuela during the hyperinflation, it seems to me that gold is a better candidate. People would find it a better candidate.

On the day ahead it's ADP Employment, JOLTS, Beige Book and Day 1 of Powell.

XTOD: New Commentary The most important topic for Professional Investors is "The Cost of Carry" - what it costs to hold a position over time.  Today I detail this concept in layman's terms for civilians. 

https://convexitymaven.com/wp-content/uploads/2024/03/Convexity-Maven-The-Cost-of-Carry.pdf

XTOD: Is private equity actually worth it? https://t.co/kdAR1K89A8

XTOD: Berkshire Hathaway director Chris Davis on The Knowledge Project podcast:             

"Berkshire is run with the idea, from the very beginning, that the people that were invested in Berkshire had 100% of their net worth in Berkshire. 

That really does shape the culture there.  

It's not that [Berkshire] is afraid of risk, but the sort of risks it takes are risks that are manageable on the income statement. 

The idea of Berkshire really, really being built to last — that is profoundly true."

XTOD: When gold rises in your currency DESPITE positive real rates, the gold market is saying “Your government will have a debt spiral if real rates remain positive.” 

Gold began warning of this in late 2022; numerous other markets have since begun playing by this "new set of rules."

XTOD: Janet Yellen gives an important update regarding crypto  https://twitter.com/i/status/1764830154780717335

XTOD: Worth the read  The Loser’s Game   By Charles D Ellis  https://twitter.com/F_Compounders/status/1765091631370248200/photo/3

Daily Economic Update: March 5, 2024

Yields rose and stocks fell hit then fell from record highs to start the U.S. trading week.  Like most weeks, the narrative is that investors are awaiting word from Powell and economic data, this week being the Jobs report on Friday.  There are some other narratives about Chinese stimulus and how draining the RRP is de facto QE, etc. but for now the focus remains on U.S. growth and inflation expectations with many pundits continuing to push their equity calls higher and some moving to the no rate cuts for 24 camp.

Crypto and shitcoins don't need any excuses to rally, I mean we're buying a coins called "Dog Wif Hat and Frog Wif Hat", a coin called "Retardio" is up like 50%....sure, the technology, the spot etfs, the halving, the correlation of all-time highs with the release of Dune movies, etc....looks up definition of money...looks up definition of asset, closes books, burns CFA Charter. 

Maybe the definition of money that is in play for crypto comes from Aesop's Fables story of the miser [substitute 'crypto' for 'gold' in the story] which concludes that "The worth of money is not in its possession but in its use."   I still haven't seen any cryptocurrency that has a legitimate use case.  And don't say, 'but I can sell my alt-coin and use the money', that seems to imply what you sold wasn't money.  

Speaking of money, every couple of months a debate pops up on X/Twitter where someone claims that banks are not intermediaries as they create their own money.  The modern view is that banks don't need deposits to make loans, in fact it is making a loan that creates their own deposits.  I don't dispute that view, but where the debate seems to really heat up is essentially around the topic of how those loans are funded, which is the key to whether or not there is any intermediation going on when banks lend.  One person who gets really fired up on this topic is economist/professor George Selgin.   "A bank that is constrained by the “cost of funds” is an intermediary _ipso facto_. Banks that dob’t need to borrow from others to finance their own lending face no such cost. In this respect the 2014 BofE article is self-contradictory."...."Claiming that a bank "funds" its lending by taking advantage of its ability to create exchange media, is not much better than claiming that anyone with a blank check can fund her shopping by taking advantage of her ability to fill out the check for some positive amount. In the second case, the blank check isn't enough: the real "funds" available consist of the shoppers deposit balance. In the first, they consist of the resources the bank has to make good on the loan when the fact that it is drawn upon results in claims against it."  Feel free to follow @GeorgeSelgin on X as he'll probably be pissed off about this topic for at least another few days.

I've already spent too much time on Money today, guess we'll have to save the distinction between "inside" and "outside" money until another date.

Look on the bright side, I could have written about R-Star again, but fortunately the BIS did it for me https://www.bis.org/publ/qtrpdf/r_qt2403b.htm   They even threwin a Knut Wicksell reference.

XTOD: me explaining to my parents that I make a living by rearranging logos on powerpoint and doing basic math on excel  https://pbs.twimg.com/media/GHyjjq-WMAA9tg5?format=jpg&name=medium

XTOD [Andy Constan replies to some dude who lost money following his trades]: Lots of lessons here for everyone including me 

1) Most importantly.  Hold assets for long term passively with low fees

2) market timing is hard and most people can't do it.

3) Following others trades particularly when you cherry pick is silly

4) follow people you can learn from. 

5) big concern for 

@kevin_jawn that after all those lessons he has decided to follow only bullish accounts. If that's for market timing reasons review 1-3 and the remind your self about 4.  For me I am here to learn and teach and hold myself accountable by detailing my trades and performance.  The last 3 months have been bad. The career good.  I want follows from people on the same journey.  Don't be stupid.  I give my opinion on stuff. In the end it's not investment advice and you need to decide for yourself and do your own research.  Again review 1-5   Thanks for your tweet Kevin and the comments within.   I see flaws in your logic and worry about your ongoing process but proud of you that you are reflecting and thinking deeply about what works for you

XTOD: We have that policy now. The American Opportunity Tax Credit (AOTC) is usually described as a $2,500 tax credit per child in college. But it is mathematically identical to giving every household $5,000 but then assessing a penalty on non-college ones. The thought experiment does not answer the question of whether the AOTC is a good policy. But it is a useful way to reframe the question to ask yourself because every benefit sounds good but all of them are effectively a penalty on others. (This was inspired by the Wendy's "debate" where you had people saying that it is fine to give discounts in slow periods but unfair to have surcharges in busy periods--when those two are identical pricing policies just framed differently.)

XTOD: I grabbed coffee with a former colleague over the weekend. He works for a multifamily GP. They have (had?) a $100M fund with a family office. However, the fund can veto any deal. If they do, the GP can syndicate the deal. The fund was smart and declined to participate in most of the 2022 deals. So, what did the GP do? Everything you’ve been reading about in TRD, Bisnow, etc. Purchased properties in the Sun Belt with max leverage and floating rate debt. They raised the remaining capital from retail LPs. 

The acquisitions team was having a hard time getting deals to pencil. Luckily, the CIO was able to solve the problem! He increased the rent growth assumption and lowered the exit cap. Magically, they had a bunch of home runs on their hands. They bought 10 properties in 2022. Fast forward to today- most of the properties are bleeding cash. Even worse, their interest rate caps begin to expire in a few months. The situation is clearly spiraling out of control. I asked my former colleague, “Why haven’t you approached the lender yet to start discussions?” His response was that the CEO and CIO are afraid they’ll have to pay a “wider spread” in the future if they have a loan modification on their records.

These guys are living in an alternative reality.

XTOD: Worth reading, but I think this emphasizes “clock speed” a bit too much. The more fundamental issue for Google, as @bgurley  and  @altcap  pointed out in their excellent new pod, is that LLM-generated answers cost a LOT more to serve than a handful of blue links. And it’s not clear at all that the revenue will sufficiently offset those costs. The days of the search cash cow might be over.

XTOD [full Tweet from Marc Andreessen is very long]: The conclusion is obvious: OpenAI must be immediately nationalized.

XTOD: Check out this *beautiful* chart of consensus US growth forecasts for 2024. Not even a soft landing, just a brief refuelling.  https://ft.com/content/0d58cb77-c771-4b05-8e7b-fca2a53e4912

Daily Economic Update: March 4, 2024

We start the week with the Nasdaq at fresh all-time highs over 5,100.  Along with the Nasdaq strength, Bitcoin and altcoins have rallied solidly.  Weaker than expected manufacturing PMI and construction spending data, coupled with more concerns over CRE portfolios at regional and community banks helped pull down Treasury yields to end the week.  The 2Y starts the week at 4.53% and the 10Y at 4.18%.  

The latest NY Fed r-star estimates continue to show a declining estimate for r-star.  Arguably if the neutral rate of interest continues to fall and the nominal fed funds policy rate doesn't fall than Fed policy would become increasingly restrictive.   Interestingly the Fed estimates of trend growth show growth rising.  Back on August 23, 2023, I mentioned Knut Wicksell's theory that while you could not see the natural rate, you could see the impact of policies that kept rates above or below this rate by looking at trend growth rates.  So it's interesting to see a directional divergence between the Fed's trend growth estimates and neutral rate estimates at the same time that monetary policy is unchanged.  Admittedly I haven't dug into the data or the estimates, perhaps its a short-run vs. long-run difference, or perhaps r-star will follow trend growth higher.  Both Atlanta Fed and NY Fed 1Q2024 GDP forecast continue to show a 2-handle.  As readers of Scott Sumner might already know his opinion on the restrictiveness of Fed policy, which he stated again recently:  

"At no time in the past few years has monetary policy been “tight”. Indeed it’s been generally expansionary, which is why NGDP growth remains excessive."

On the week ahead we get the man in the orange hat from the Grateful Dead concert, AKA Jerome Powell testifying to Congress in his semi-annual Humphrey Hawkins address.  Powell's testimony will be to the House on Wednesday and Senate on Thursday.  Ahead of the testimony, the Fed already released their report which provides no new information.   We also get a JOBS Day Friday.

Today: No major data and only Harker on the Fed slate

Tue: Factory Orders, ISM Services

Wed: ADP, JOLTS, Fed Beige Book, Powell

Thur: Jobless Claims, moar Powell

Fri: JOBS Day in 'merica

XTOD: Cutting interest rates will not help $NYCB.  Fade STIR!  These guys paid the wrong price for Signature and then botched the booking of the loans either hiding their bad acquisition price or just being bad at booking/pricng stuff.  The 10K delay stinks of an accounting firm unwilling to provide their audit letter to the 10K. This sort of thing doesn't get resolved in 15 days despite the extension announcement.

XTOD (talking about Liz Warren): Just when you think her economics can’t get worse.  What percent was it last Thursday? Is 100% too much but 41% just right, or still too much? Maybe you should just set all prices? Please note that isn’t serious (though you’d like to I know).  When do corporations, or in fact mom and pop businesses, not charge what the market will bear? Is that gouging? What is gouging btw except progressive babbling? You want a new iPhone you pay apple the price it asks or you don’t. I know this is complicated.  Btw, you guys like to make fun of Trump’s populism, and I often share that opinion, but what you do all the time is utter populist nonsense. Just with a slightly more left wing spin (not that different actually as you both embody ends of the horseshoe).

XTOD:  “You’re born…you take sht…”   The best description about the difference between working and school I have ever heard…VP in my banking group:  “99% is Dean’s list at your overpriced college…it might even be an academic scholarship…welcome to the real world where 99% is simply 1% wrong…”  You want to complain about the hamster wheel…live in finance circles long enough and you meet people who make $2+ a year, have 1-2 kids and negative cash flow with a “middle class manhattan” lifestyle.  How many people commute 3 hours a day and miss all their kid’s stuff?    The socials have convinced everyone that it’s easy.  One of the hedge fund founders I worked for took just 10 vacation days in the first 10+ years of the fund.  The legend is that he was airborne when a major bankruptcy finally happened, landed and said to his spouse “this is why I can’t go on vacation…”  

…the point being…not only is the world so competitive that “lesser people” than you can beat you by outworking you…the truly scary thing is when people “greater than you” are willing to pay a price you are not.    Bill Gates’s dad ask him and Buffett to write down on a piece of paper what explained their success:  “focus” they both responded.  This life isn’t for everyone, and nor should it be… but the lie people tell themselves is that they can live in the “best” places and not pay the price…someone always has to pay…be if you, or the person you inherited your trust fund from.   The “facts of life…” from Layer Cake

XTOD: There are a few things I re-read every year. One is “Self Reliance” by Emerson. Here’s what stood out to me this time:   

There is a time in every man's education when he arrives at the conviction that envy is ignorance; that imitation is suicide; that he must take himself for better for worse as his portion; that though the wide universe is full of good, no kernel of nourishing corn can come to him but through his toil bestowed on that plot of ground which is given to him to till.  

A man should learn to detect and watch that gleam of light which flashes across his mind from within, more than the lustre of the firmament of bards and sages. Yet he dismisses without notice his thought, because it is his. In every work of genius we recognize our own rejected thoughts; they come back to us with a certain alienated majesty.  We lie in the lap of immense intelligence, which makes us receivers of its truth and organs of its activity. When we discern justice, when we discern truth, we do nothing of ourselves, but allow a passage to its beams. 

I must be myself. I cannot break myself any longer for you, or you. If you can love me for what I am, we shall be the happier. If you cannot, I will still seek to deserve that you should. 

Insist on yourself; never imitate. Your own gift you can present every moment with the cumulative force of a whole life's cultivation; but of the adopted talent of another you have only an extemporaneous half possession. 

The force of character is cumulative.

XTOD: To attain knowledge, add things every day.  To attain wisdom, subtract things every day.  - Lao-tzu 

Daily Economic Update: March 1, 2024

The much awaited Leap Year PCE data came in slightly above consensus estimates on the core MoM and YoY numbers at 0.42% and 2.85% respectively, the headline numbers were largely in-line. The data shows core services inflation continuing to outpace goods, as that trend/shift continues.  Perhaps the outlier was Personal Income at 1.0% for January vs. consensus of just 0.3%.  Seems hard to believe inflation will slow if incomes are hanging in there.  After all inflation is so under control we're worried about Wendy's "surge-pricing".

Stocks ended the month of February higher while bond yields rose on the month, as the market decreased the timing and amount of 2024 rate cuts.  The 2Y is around 4.60% and the 10Y around 4.25%. Remember 10Y under 4% and the 2Y around 4.20% to start the month???, me either.... It doesn't matter just buy Bitcoin.  

"..the failure to investigate, after all, everyone was happy.  The factories here and there in various cities that turned out the pieces [shitcoins], they made their profits. The wholesalers passed them on, and the dealers displayed and advertised them [all the new ETF players].  The collectors shelled out their money and carried their purchases [virtual wallets] happily home to impress their associates, friends, and mistresses [ex. Crypto Bros and Have Fun Staying Poor]."

"...it was fine until questioned. Nobody was hurt--until the day of reckoning. And then everyone, equally, would be ruined [especially Michael Saylor].  But meanwhile no one talked about it [about how they still can't explain a legitimate use for the coins]...they shut their mind to what they made, kept their attention on mere technical problems [the halving and whatnot]."

    - Frank Frink in Philip K. Dick's, The Man in the High Castle on Bitcoin (or on forgeries of pre-war artifacts and Gresham's Law - bad driving out the good and how normative/accepted fraudulent items became)

Speaking of bubbles, a little over a month ago I wrote about "Bubbles" here. As with all of my esteemed content, it tends to go mainstream in due time.  Like yesterday when Ray Dalio posted an article titled "Are We in a Stock Market Bubble?"  So let's see what Mr. Metrics had to say on the topic, he's never been accused of rigging those metrics anyway, right?

• Dalio defines a bubble as having: (a) high prices relative to fundamentals, (b) unsustainable business conditions, (c) hot money - people buying just because something went up (d) broad bullishness, (e) leveraged purchasers (f) speculative betting on the future by businesses via large forward expenditures.
• He decides that Mag-7 is frothy but not bubbly - and states the obvious that if AI doesn't live up to the hype those valuations could face significant correction.
• Of his aforementioned metrics he mentions that he doesn't believe we are in a bubble because current conditions lack: a broad bullish sentiment, purchases financed with high leverage and  buyers/businesses with extended forward purchases.

So there you have it, no bubble. We'll check in with Jim Cramer in a few weeks just to double check.

One stock that definitely wasn't in a bubble yesterday was Chemours, the chemical giant placed their CEO and CFO on leave over accounting concerns and associated concerns about 'tone at the top', that never sounds good.

On the day ahead it's ISM Mfg and Construction Spending.

XTOD {the essence of the compounding equation appears in all aspects of life}: Can you evaluate my workout program?  Question 1: "Can you do it consistently & not miss more than 2 workouts a month?"  This matters more than frequency, exercises, etc. as it helps determine these and other key variables.  This applies even more when evaluating meal plans.

XTOD: In some beautiful version of this universe, @RobinWigg  and  @CliffordAsness  co-wrote this masterpiece of condescension and disgust  Crypto factor investing. Really https://t.co/SX4spIWqSq

XTOD: This 1986 CIA analysis on the Japanese government's unwillingness to consider a fiscal expansion that might, among other things, boost Japanese wages while reducing the trade surplus, is absolutely fascinating:  https://cia.gov/readingroom/docs/CIA-RDP86T01017R000605930001-7.pdf

XTOD: We also now have four years of data on the elevated share of goods spending and the corresponding decline in the services share. Many economists expected these shares to normalize, but thus far, the goods share remains elevated relative to both pre-pandemic levels and trend. We cannot yet determine whether this is bona fide structural change, or whether the shares will eventually return to their pre-pandemic levels, but either way, it’s been an important and impactful development regarding shifting consumer preferences.

XTOD: Super core PCE inflation EXPLODED higher on a MoM basis to +0.596%, or basically the HIGHEST EVER (showing the @federalreserve  is NO WHERE NEAR restrictive, & NO WHERE near its goal of +2%). Yet, the Fed is talking rate cuts, and the market is cheering today's inflation data?

XTOD:  What happened to team transitory?

Daily Economic Update: February 29, 2024

Sure, why not have an extra day every 4 years? Yesterday stocks moved lower and bond yields fell a few bps. The 4Q GDP showed a 3.2% rate, revised down a tenth.  This leap year will feature the all important PCE data, whoa!  It will be important until the next important piece of data and on it continues. Government looks to have kicked the shutdown risk out a year.

Fedspeak continued the messaging of 'it's too soon to cut rates' post-FOMC narrative.  NY Fed's Williams said: 

“While the economy has come a long way toward achieving better balance and reaching our 2 percent inflation goal, we are not there yet.”

“I am committed to fully restoring price stability in the context of a strong economy and labor market.”

“As we navigate the remainder of this journey, I will be focused on the data, the economic outlook, and the risks, in evaluating the appropriate path for monetary policy that best achieves our goals.”

Given we have an extra day, a topic that seems to be coming up frequently of late is that of diversification and more specifically the role of bonds in an investment portfolio.  Diversification works best when assets have negative correlations.

I was reminded of this in a post by Joachim Klement where he discusses how it is possible that the correlations between stocks and bonds is what he calls "regime dependent", depending upon the expectations for GDP growth, inflation and interest rates.  In his post he provides:

"But as long as stocks and bonds have a negative correlation, we can at last reduce this higher volatility in a mixed stock/bond portfolio. And bonds have a negative correlation with stocks, don’t they? Don’t they? …please tell me that stocks and bonds have a negative correlation in the long run because that is the foundation of stock/bond portfolios recommended by asset managers and banks everywhere.

 Since the 1960s, the correlation between stocks and bonds has been either very low or even negative. This is the time when modern portfolio theory was born and when stock/bond portfolios became the workhorse benchmark against which to assess all other investment approaches.

But before the 1960s, the correlation between stocks and bonds was on average 0.5 to 0.6, much higher than any investor today expects it to be going forward. If the correlation between stocks and bonds is that high, the diversification benefits from investing in stocks and bonds are much smaller as these two asset classes increasingly move in lockstep.

Note that even since the 1960s there have been large swings in the 20-year correlation between the two asset classes. Notably, in the 1970s the correlation increased, before falling again in the 1990s.

Concluding that basically the fundamental premise of asset allocations could be questionable:

 Depending on the regime you expect and the assumptions on correlation you make, the allocation to stocks and bonds will be very different going forward. In a world of high correlation between stocks and bonds, the allocation to bonds will likely be smaller, unless you also expect the equity risk premium to be smaller (which again depends on your expectations for growth, inflation, etc.). In a world of negative correlation between stocks and bonds, the allocation to bonds will be higher, unless you expect the equity risk premium to be larger.

Klement's writing reminded me of an article that turned into a book by Seb Page of T. Rowe Price called When Diversification Fails.  In the article Page cites research showing the following:

Based on a precrisis data sample ending in February 2008, Chua, Kritzman, and Page (2009) documented significant “undesirable correlation asymmetries” for a broad range of asset classes. Not only did correlations increase on the downside, but they also significantly decreased on the upside. This asymmetry is the opposite of what investors want. Indeed, who wants diversification on the upside? Upside unification (or antidiversification) would be preferable.

 Page's article focuses mainly on how diversification fails most notably at times when investors need it most, especially during crashes (i.e. "left-tail events").  His article shows that hedge funds and private assets do little to solve the diversification problem. Ultimately the article provides:

Unexpected changes to  the discount rate or inflation expectations can push the stock–bond correlation into positive territory—especially when other conditions remain constant.

 "In an apocryphal story, a statistician who had his head in the oven and his feet in the freezer exclaimed, “On average, I feel great!” Similarly, as a measure of  diversification, the full-sample correlation is an aver-age of extremes. Conditional correlations reveal that  during market crises, diversification across risk assets  almost completely disappears. Moreover, diversification seems to work remarkably well when investors  do not need it—during market rallies. This undesirable asymmetry is pervasive across markets. Our findings are not new, but we proposed a robust approach to measure left- and right-tail correlations, and we documented the extent of the failure of diversification on a large dataset of asset classes and risk factors. The good news is that tail risk– aware analytics, as well as hedging and dynamic  strategies, are now widely available to help investors manage the failure of diversification."

XTOD: I (like most people!) have been skeptical of the 6, 5, or even 4 cuts priced in for the Fed, but now that we are priced to match the DOTS, I think further upside progress in yields will be much more difficult.  First test is PCE tomorrow--I could see a scenario where we get 0.5 Core PCE and yields end lower on the day. The market understands that inflation popped in January-- we don't need PCE to tell us that.

I feel that getting to fewer cuts than the DOTS is a lot more strenuous than removing cuts in excess of the DOTS.  

XTOD: $BOXX. It's not that simple. Strongly recommend Victor's piece.  As a partner at LTCM Victor knows arbitrage and risk from the pointy end.   His company ELM is now a leader in tax optimized beta investing. https://t.co/9P8Hql12oi

XTOD: NVIDIA and now BTC going parabolic.  Incredible.  The Federal GOV really should be taxing me more.  Maybe they should start investing in equities to make up for the deficit?  Now there’s an idea.

XTOD: More on privates!  Agreed. I’ve acknowledged this many times (https://institutionalinvestor.com/article/2bstqfcskz9o72ospzlds/opinion/why-does-private-equity-get-to-play-make-believe-with-prices). My issues remain: 

A) Once you say “I’m investing in volatile things but like not being told the truth as it makes it easier to stick with” I would’ve guessed the bubble would have popped and it wouldn’t work anymore. Clearly I’m wrong. Why I’m wrong is another question. 

B) Our job (well many of our jobs) is to explain such things to people and to encourage them to do better not to simply accept “hey we do dumb false things as we are weak knee-ed panickers.” Too often the truism you describe is taken too far to become an excuse for not doing the right thing. 

C) The very act of accepting this logic (hey volatility laundering is great!) almost definitely lowers future returns on the assets that provide the volatility laundering (you get paid for bearing a bug, you pay for a feature).

https://aqr.com/Insights/Perspectives/The-Illiquidity-Discount

XTOD: Press release: Barclays Bank PLC also served as liquidity facility provider to Blackstone. 

Barclays sheds credit risk to private credit firm —> private credit firm needs bank liquidity support, gets it from Barclays.   Banks continue to re-tranche themselves.

XTOD:  How seriously should we take stats like these on secession? IMO, as seriously as we take intensifying polarization, growing acceptance of political violence, and rising expectations of civil war. More in today's post: https://demographyunplugged.com/p/what-were-following-secession-population

XTOD: “When you go back and study people producing things of real value, using their brain, they were smart, and they were dedicated, and they worked really hard, but they didn’t hustle, and they didn’t work 10-hour days, day after day. They didn’t work all-out, year-round. They didn’t push, push, push until this thing was done. It was a more natural variation. They had less on their plate at the same time, and they glued it all together by obsessing over quality.”

— Cal Newport

Daily Economic Update: February 28, 2024

I decided to write this blog entry while eating an ice cream cone.  Yesterday stocks were up slightly. In the bond market the 7Y Note auction seemed solid clearing through where WI was trading with good end-user uptake.  Durable goods fell more than expected thanks to declining airplane orders (blame Boeing) but the core component was strong.  On the Fed front, Bowman isn't sold on the idea of cutting rates yet and added that they may need to raise rates if progress on inflation stalls or reverses. The 2Y finished the day at 4.71% and the 10Y at 4.31%..  

On the day ahead it's inventories and another look at 4QGDP.

I mentioned impact of fiscal policy in yesterday's post and in this post from last week.  Claudia Sahm is never quiet and she put out a piece declaring big fiscal policy as a big win.  In it she does acknowledge the role it played in causing inflation: 

" we would have had high inflation in the US without the Rescue Plan, too, though likely somewhat less....A key lesson from this crisis is that fiscal policy is much more powerful than monetary policy. With great power comes great responsibility. It’s a lesson that macroeconomists must learn and devote more time to the nuts and bolts of fiscal policy, even though it’s inherently more tied to politics than the Fed."

XTOD:  "The last time Americans spent this much of their money on food, George H.W. Bush was in office, Terminator 2 was in theaters and C+C Music Factory was rocking the Billboard charts. Eating continues to cost more, even as overall inflation has eased..." https://wsj.com/economy/consumers/its-been-30-years-since-food-ate-up-this-much-of-your-income-2e3dd3ed?st=xce0z9cp30fihg5

XTOD: “The total cumulative easing over the past four months ranks as one of the most significant periods of relaxing financial conditions since at least 1982:” https://pbs.twimg.com/media/GHX2hv6XUAAIdQq?format=jpg&name=medium

XTOD: Full story here :-  The fund sold its 29% stake in Manhattan’s 360 Park Avenue South for $1 to one of its partners, Boston Properties Inc., which also agreed to assume CPPIB’s share of the ‘Project’s Debt’  Moreover , this deal took place in last year end : https://bloomberg.com/news/articles/

XTOD: The godson and a childhood friend of Jam Master Jay were found guilty by a jury for the 2002 murder of the Run-DMC rap pioneer, who was fatally shot at his New York City recording studio in one of the most infamous killings in rap history https://reut.rs/42Xy3xT

XTOD: The world belongs to those who can keep doing without seeing the result of their doing.

Daily Economic Update: February 27, 2024

Yields rose slightly while stocks slipped slightly as markets await PCE data this week. Sales of new homes rose, but less than expected.  The 2Y note is yielding 4.73% and 10Y note is yielding 4.29%.  I guess we're also back to worrying about government shutdowns too.

The inflation puzzle/debate continues with two good reads over the last few days.  The first by John Cochrane here.  The key takeaways from Cochrane are that "If you don’t like my little fiscal theory model, we don’t have a good model of the most basic question, how higher interest rates lower inflation, without a contemporaneous fiscal tightening." and "The news is that without such contemporaneous austerity, higher interest rates don’t lower inflation at all in standard models. Intuitively, if the Fed raises interest rates, that raises interest costs on the debt. Taxes must rise or spending must fall to pay those interest costs. If not, no reduction in inflation."  As for monetary policy, "all monetary policy can do is to shift inflation over time. With short term debt, a model can get only inflation below the nominal rate by producing higher inflation later. With long term debt, a model can only get inflation to go down by accepting higher inflation later. I call this “unpleasant interest rate arithmetic”"  He concludes with what he considers as a better way of discussing the Fiscal Theory of the Price level: "what fiscal theory is all about. Slowly inflating away long term debt = rise in primary deficits + rise in real interest costs on the debt (or, a slow windfall to long-term bond holders = rise in primary surpluses + decline in real interest costs on the debt)."

The second article is courtesy of Barry Eichengreen here.  Eichengreen's article questions whether we've learned anything from this recent inflation episode given so much disagreement on the cause of inflation and what, if any, credit the Fed deserves in bringing inflation back down.  Eichengreen argues that the supply-factors only view and the Fed hasn't caused spending to slow or unemployment to rise views are "too simple", "Along with supply shocks, demand and expectations – factors that are fully within the capacity of the Fed to influence – played a role in America’s recent bout of inflation."  Like Cochrane above, Eichengreen hits on the role fiscal policy has planned in this inflation, wondering how much the fiscal impulse exploding and waning accounts for the rise and decline of inflation, "perhaps fiscal policy both caused the inflation problem and solved it."  He closes with crediting the Fed's communication as a factor in slowing inflation, "the credibility and communication channels of central-bank policy. The Fed signaled, beyond a doubt, that if inflation failed to come down, it was prepared to do more, even at the cost of higher unemployment."

XTOD: "Most people probably shouldn't do anything other than have index funds." ~Charlie Munger

XTOD: How do we know the nice downward inflation trend isn't because of Waller's dogged determination to remain patient with a rate cut?

XTOD:  American Couple Likely Dead After Yacht Hijacked, Police Say: What We Know And Still Don’t Know https://go.forbes.com/c/3xTP

XTOD: "What's your favorite sandwich?" “The spicy chicken sandwich from Chick-fil-A.” "Wrong!" https://pbs.twimg.com/media/GHRWBXkW4AAqU8B?format=jpg&name=medium