As my wife and I have walked around the neighborhood the past week or so, we get mixed messages. Some houses are decorated for Thanksgiving which is just around the corner. Some are already fully onto Christmas decorations, with elaborate displays in full light. One perfectly reflected my sense as I walked around, and I truly love Christmas decorations. It was the inflatable above that said, “Not so fast, Santa”. Clearly some mixed holiday messages on this walk.
Strolling through my Bloomberg to see how the markets are doing this week, I also see a number of mixed messages. US stocks are still near all-time highs. Global stocks, particularly emerging markets, are not faring nearly as well. US 10-year yields, upon which everything is priced, are consolidating right now but at a level that may suggest trouble ahead. Gold is coming off the highs with outflows, while Bitcoin and other crypto are moving into uncharted territory on the upside. For someone who really relies on intermarket analysis like me, it is difficult to know what to think. Thus, I thought I might explore that a bit this week.
My first stop at the start of the analysis is often to turn to the relative rotation graph. This allows me to plot different assets or countries or sectors or styles against a range of benchmarks. I use it to see how money is flowing around the world and where signs of emerging strength or weakness may be. It isn’t perfect, as no chart or model is, but it does tell a story. Above is a chart of broad bond indices (US, EM and Global aggregates), US, EM and Global stocks, Gold, Crypto, and Commodities. I compare them all on a total return basis to a 3-month cash benchmark (SOFR in this case). We see that stocks are still leading, all bond indices are in the weakening category. This may not come as a surprise. It is interesting to now see gold, which had been so strong, is in the weakening category. This is a dangerous place for all of these assets, as relative to cash, they are starting to look unattractive. On the flipside Crypto has gone from the lagging asset 12 weeks ago to now solidly leading. Even commodities are moving from lagging into the improving category, a sign of hope and promise. Are broad asset classes telling us we need to worry about inflation, as we see in weakening bonds and strengthening commodities? Is this driving crypto too (outside of the MSTR noise)? Are equities oblivious to this risk, or think this is the ‘benign inflation’ that drives revenues higher but not margins lower? This is the mixed message of the market.
Within the commodity market, though, we might be getting a different message. I wrote about it this week on LinkedIn:
Chart of the Day - copper vs. gold
Yesterday I looked at SPX priced in gold to take out the FX debasement effects. I also looked at other assets priced in gold for the same reason
I have shown copper in gold terms before. Many bond aficionados like to look at copper vs. gold as a measure of global growth, given copper is a commodity levered to global growth while gold is a store of value within the commodity market
No less than Bill Gross when he was at PIMCO or Jeffrey Gundlach at Doubleline have said they look at copper vs. gold to give them a perspective of the US 10yr Treasury yields
Of course, US yields are impacted not just by US growth prospects but also by global growth prospects given the heavy intl interest in US bonds. Thus, we should not be surprised that looking back in time, the copper v gold and 10yr yields move in the same direction
In fact, in 2020-21, copper v gold moved and yields lagged, held down by the Fed effect. However, bond gurus like Gundlach called for higher yields. They were correct as once the Fed released the beachball, it rose to the top of the water
Now, bond vigilantes are worried about higher inflation coming from US govt spending. However, the commodity mkt is telling everyone that they should be worried about slowing global growth, led by both China and Europe, both of which are struggling
It is easy to say that equity mkts are not worried about either of those, with SPX heading above 6000. However, the US equity mkt is one of the least cyclical in the world, so in times of slowing global growth, investors tend to rotate into the US and away from the rest of world
The US has outperformed the rest of world equity mkts for some time and continue to do so
The mkt that may be the outlier is the bond mkt. However, there is an argument to be made for why all of the mkts can be correct. That is if we have stagflation, the condition where prices are high enough that they impact growth. Is that what investors are betting?
My hunch is that is not the current mkt base case (though it is the base case for my students in my Applied Portfolio Management class, whose models are telling them that)
For now, this stands out to me that either copper v gold should head higher or Treasury yields should head lower. The catalyst? Economic data in the coming months
I mentioned how US stocks are holding up better than the rest of the world. That has been a relentless grind for 14 years now. Michael Hartnett from BAML had a chart about that this week, showing that US stocks are not just at a 14-year relative high vis a vis the rest of the world, they are at a 75-year high. What will it take for this to change? Relative valuation is beyond favorable for the rest of the world vs. the US; however, over a 12-month period, valuation has no statistical significance. That said, over a 10-year horizon, that is all that matters. 10 years ago, though, we were already near 1 standard deviation of outperformance and have only accelerated since.
Well, for one, for a long-range change that might meaningfully change asset allocations, the EU economy will need to catch back up to the US. These two economies were about the same size back in 2010. Into the GFC, many thought the EU and the EUR would easily surpass the US before long. Here we are 15 years later, and the EU is only 2/3 the size of the US. Negative demographics and oppressive regulation are to blame for this performance. This does not really suggest the EU will catch up with the US any time soon.
There might be a shorter-term catalyst. The above chart, courtesy of Mr. Risk with whom I did a podcast a few weeks ago (if you haven’t listened, you really should). This chart shows the EUR vs USD at a local minimum of the last two years. The Dollar has been on a mission since the US election. Is there reason to think this may change from a technical standpoint, and this could be a catalyst for a relative move into stocks outside the US?
While the US economy has grown relative to the EU the last 15 years, it is not without its own problems. One of the outcrops of the US election is the new Department of Government Efficiency, led by Co-Chairs Elon Musk and Vivek Ramaswamy. Regardless of one’s political views, the notion of this Department, may be objectively one of the most bullish aspects of ideas thrown out there. I wrote about it this week on LinkedIn:
Chart of the Day - DOGE
I came across this link to an old Milton Friedman interview from the new DOGE. This was from probably 40-50 years ago. Even at this time, the size of govt was an issue & Friedman, a small govt advocate, had his views on what should be done
Worth a listen even if Elon Musk triggers you these days. Point being, for decades, not years, there has been concern that we couldn't control spending. On the one side it's 'raise taxes to cover it'. On the other it's 'lower taxes to grow out of it'. Neither wanted to cut spending. Both were wrong
This is the first time in my life I have heard about a legitimate attempt to cut spending. Do I think it will work? I am very doubtful. Not because I don't think Musk is capable. I just fear the bureaucracy & the fight they will put up not to lose a job
Look at the chart. A few things stand out. First, Friedman was complaining about govt at a time when revenues & spending were around $500bb & the deficit was $50-70 bb. How quaint. Now we are easily in multiple trillions
Second, regardless of the tax rate, revenues have stayed about 17.5% of GDP. Raise taxes? Activity goes lower, people pay less. Lower them, activity goes up but you take a smaller percent. Either way, taxes don't change the deficit math sorry to say
Thus, we have a spending problem. This problem has gotten blown out of proportion in the period after the Great Financial Crisis. There are two drivers to this
1st, demographics. We have a large & growing retired population of Baby Boomers. Throughout their history, whatever they were buying was going up a lot. Now, that is healthcare paid for by the govt. Not going away any time soon
2nd, desire for big govt. There is a growing percent of people that wanted the govt to solve our problems during & after the GFC & then during & after Covid. In between, we wanted the Fed to solve our problems
I am old enough to remember Reagan saying the scariest words in the English language are "I am from the govt & I am here to help" My how attitudes have changed since then
The problem with this as we can see below is that the US can ill-afford to do it. Politicians have 'kicked the can' & issued more debt. The debt is now 130% of GDP, far into crisis mode. This is why the next Treasury Sec is so important
This is also why a credible effort to reduce the size of govt is so important. We have 60,000 employees in the Social Security Admin. Should we stop sending checks to retirees? No. But can we do it better?
We have 350,000 employees in the Veterans Affairs. Should we stop helping vets? Heck no. No one thinks that. But can we get them care & service more efficiently? Worth a try
If DOGE is successful, I think it is very bullish for the economy & mkts. However, I fear that the bureaucracy (both sides) will hold him back
However, there are not many, myself included, that think that Elon can pull this off. I know that Peter Thiel says the #1 rule is to never bet against Elon. I think that is fair, and I do not really want to. However, Elon is fighting a massive bureaucracy with full intention to keep their well-paying jobs in DC. The government employees are protected by a collective bargaining agreement. So what, some say, just shut down the entire Department. While this may be the right thing to do, Congress has to do that, not two independent advisors to the President. Sure, Trump has political capital right now with Congress. However, is his number one priority the DOGE or tax breaks. After all, DOGE, tariffs etc are all there to pay for the tax breaks. I would argue that for the last 5 years, markets are seeing that politicians understand that not only won’t they do anything about budgets, but they probably can’t. With too much debt, there are four choices - grow your way out of it (tough to do with so many Boomers), default (in spite of getting close at times, most agree this is a disaster), restructure (there is little political will to do this) and inflate. Politicians and central bankers seem to be taking the last approach. While the broad commodity markets may not be able to fully embrace this, because of the potential deflationary risk from China, gold and crypto seem to sense it. I have written about these before, how the owners of each agree with more than they disagree with to me. A 50-50 index of Bitcoin and Gold (above) has moved higher almost unabated for the last 5+ years. Even when it moves into solidly overbought territory, as we are now, it just goes sideways for a period of time, before resuming its climb.
It may be time to consider this hedge against equities instead of a bond hedge. While 60-40 and risk parity have been built on negative correlation between stocks and bonds, that assumes a disinflation if not deflation. In inflation, equities and bonds are positively correlated. We got a sneak peak of this in 2022. Will we get another peak in 2025? Or is this another mixed message from the markets?
Stay Vigilant (and Happy Thanksgiving for those that celebrate)
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Happy Thanksgiving to you and your loved ones, Richard.
RE: your post and DOGE. I would not be surprised if we do get some success from Musk and Vivek in cutting the Fed budget. There is a lot of fat that can be sliced off...not saying it will be easy, but can be done. If there was a time we could do it, now is it...with all three branches of govt in alignment. I am rooting for their success. Cheers!
Once again think everyone who subscribes really appreciates all your knowledge you share with us, and I hope you and the family have a wonderful Thanksgiving.
A good read and thought provoking. Thanks
Happy Thanksgiving to you and your loved ones, Richard.
RE: your post and DOGE. I would not be surprised if we do get some success from Musk and Vivek in cutting the Fed budget. There is a lot of fat that can be sliced off...not saying it will be easy, but can be done. If there was a time we could do it, now is it...with all three branches of govt in alignment. I am rooting for their success. Cheers!
Once again think everyone who subscribes really appreciates all your knowledge you share with us, and I hope you and the family have a wonderful Thanksgiving.