Is Your Portfolio Ready for the Next Big Market Shift?

Darius sat down with Cem Karsan on 42 Macro’s Pro to Pro Live last week to discuss corporate profits, inflation, recession, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. The Treasury Continues To Starve The Market Of Coupon Supply  

After analyzing the composition of the Treasury’s Net Marketable Borrowing, we found only 27% of the total issuance consists of coupons.

Treasury Secretary Yellen continues to meet the excess demand for T bills in the RRP Balance, which currently stands at approximately $600 billion.

This marks the lowest TTM Coupons to Net Marketable Borrowing ratio since the first quarter of 2018.

2. Corporate Profitability Is Broadly Improving, Reducing The Need For Corporations to Shed Costs And/Or Pass On Price Increases to Consumers

Our Corporate Profitability model, which tracks the spread between Gross Domestic Income growth minus the spread between Unit Labor Cost growth and Productivity growth, shows that Corporate Profits bottomed a few quarters ago and have improved since. 

We believe corporate profitability will perform better than consensus expectations over the next one to two quarters.

As a result, we believe this may increase the potential for stock buybacks, providing a buffer against any potential downturn in asset markets.

3. Although We Believe Stagflation Is The Most Probable Outcome In The Long Term, Markets Do Not Have to Price That Outcome In Now Or All The Time

Last fall, our team performed an empirical deep dive on the Fourth Turning and its implications for investor portfolios. 

Our findings indicate that real GDP growth is usually weak during fourth turnings, while inflation tends to be higher. 

From a long-term perspective, we believe stagflation is the most probable outcome. However, markets do not have to price in stagflation immediately or all the time. Right now, asset markets are pricing in a soft landing. That will change at some point over the medium term.

We advise investors to avoid pigeonholing themselves to ‘one camp’ and instead align their positioning with the camp that will make them money for as long as it remains the modal outcome.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Is It Time To Get Risky in Crypto?

Darius sat down with  Paul Barron on the Paul Barron Network last week to discuss the “soft” vs. “hard” vs. “no” landing debate, Bitcoin ETF, earnings, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. Near Textbook Disinflation in The Super Core PCE Deflator Suggests That The Fed May Safely Land The Inflation Plane At 2% In The Coming Quarters

The likelihood of a soft landing for the economy has increased, as highlighted by last week’s PCE report. 

Notably, the 3-month annualized rate of inflation change stands at 2.1%, and the 6-month rate is at 1.9% – figures that align closely with the Federal Reserve’s target inflation rate of 2%. 

These readings suggest that year-over-year inflation is set to decline towards 2% in the upcoming quarters.

This downward trend in inflation is reinforcing the soft landing scenario currently being priced into asset markets.

2. We Believe Upcoming Earnings Reports Will Outperform Recent Quarters 

Signs of enhancement in corporate profitability are already evident. 

Our Corporate Profitability model, which tracks the spread between Gross Domestic Income growth minus the spread between Unit Labor Cost and Productivity, shows that Corporate Profits bottomed a few quarters ago and have improved since. 

According to the model, earnings are expected to continue improving. 

Should this trend persist, it will act as a tailwind for asset markets.

3. The Impact of The Bitcoin ETF Will Take Time to Materialize

The approval of a Bitcoin ETF is likely to have a long-term positive impact on BTC, as it will introduce structural inflows into the asset class. 

However, it is important to note that these benefits will not be fully captured immediately upon the ETF’s approval. 

We believe that much of the anticipated impact is already factored into current prices, due to market participants front running the event. 

That said, the ETF is not the sole influencer of Bitcoin’s price. Factors such as inflation, economic growth, policy changes, and liquidity also play crucial roles in determining Bitcoin price trends. 

Investors aiming to stay informed about Bitcoin’s future trajectory should monitor these metrics closely.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Did the Fed Just Take a Victory Lap?

Darius recently sat down with Maggie Lake on Real Vision‘s Daily Briefing to discuss the labor market, the Fed, corporate profits, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. Labor Hoarding Has Spared The Business Cycle So Far… How Long Will It Persist?

In early 2022, the gap between labor demand and supply reached a peak of approximately 6 million. 

Since then, it has steadily decreased to around 2.4 million – this is significant because it helps alleviate wage pressure in the labor market. 

Additionally, for the first time in the time series, a significant divergence has emerged between the JOLTS Total Job Openings and the Household Survey Total Employment figures. 

The slack in the labor market being created for almost two years now is coming from an abundance of job openings rather than a decrease in total employment. 

This could pave the way to a soft landing, because the high number of unfilled jobs will likely reduce the upward pressure on wages, helping to moderate inflation without drastically increasing unemployment rates.

2. Surging Productivity Growth Is Supporting Rising Expectations of A Soft Landing 

In late October, productivity growth came in at approximately 5% on a quarterly basis and 2% year-over-year, and these figures have since been revised upwards.

Corporate profits, which bottomed a few quarters ago, are now returning to more normalized levels. 

This recovery in corporate profitability suggests that there is less pressure on corporations to reduce labor costs or to pass on price increases to customers, supporting the expectations of a soft landing.

3. Investing Is Not About Predicting Outcomes. It Is About Being Positioned to Take Advantage of What Happens In Asset Markets.

The Federal Reserve is aware that the effects of monetary policy are subject to long and variable longs. 

As a result of the positive inflation, labor market, and productivity outcomes we have seen, we believe the Fed recognizes there is no need for further tightening.

Returning to 2% inflation without disrupting the labor market would be a highly favorable outcome – especially in a general election year that features an incumbent president.

However, as an investor, it should not matter whether the economy “soft”, “hard”, or “no” lands. 

Instead, what is important is the trajectory that asset markets take to the ultimate outcome, and being positioned accordingly. 

Over the past six weeks, 42 Macro clients have made a ton of money being positioned for, first, the pain trade higher in stocks and bonds, and, second, the eventual market regime transition to GOLDILOCKS. Our models will signal in real-time when it’s time to book these “soft landing” trades and begin betting on either the “hard” or “no” landing scenario. 

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Immaculate Disinflation?

Darius sat down with Maggie Lake last week on Real Vision’s Daily Briefing to discuss Immaculate Disinflation, Soft Landing, the Consumer, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. There Is A High Probability That We Continue to Experience Downward Momentum in Inflation Over The Coming Months And Quarters

The Core PCE Deflator, which is the Federal Reserve’s preferred gauge for inflation, alongside the Supercore PCE, are both showing clear signs of deceleration. 

The deceleration is evident as the 3-month annualized rate of change is below the 6-month rate, which in turn is lower than the year-over-year rate. 

Additionally, the 3-month SAAR of Core PCE inflation is hovering around 2 to 2.5%, a range that aligns with what the Federal Reserve is comfortable with. 

Given these trends, there is a high likelihood that we will see continued downward momentum in inflation in the upcoming months and quarters.

2. Asset Markets Recently Transitioned to A Goldilocks Regime That May Prove Easy To Sustain Into 1H24

Our research indicates that the economy transitioned to a “Goldilocks” regime approximately two weeks ago.

We believe the economy can remain in the Goldilocks regime over the next few quarters, provided we avoid slowing to a below-trend pace in real GDP growth.

Current consensus estimates forecast a growth of 1% quarter-over-quarter (QoQ) annualized for the fourth quarter and a more modest 0-0.5% QoQ annualized for the first and second quarters of the coming year. 

If GDP growth aligns with these dovish projections in the forthcoming quarters, it could heighten investor expectations for a soft landing of the economy.

3. Recent Data Show The Consumer is Stable

Last week, we received updated Personal Consumption Expenditures and Income data that show the consumer is holding up well:

• Real PCE growth slowed to 2.1% on a 3-month annualized basis, a figure slightly below trend pace
• Good consumption decreased to a below-trend 1.9% on a three-month annualized basis
• Services consumption decreased to an at-trend 2.1% on a three-month annualized basis
• Real personal income increased slightly to a below-trend 1.2% on a three-month annualized basis

If the labor market remains stable, consumers should continue to fare well.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Is Goldilocks Going to End Soon?

Darius sat down with Mike Ippolito last week on the On The Margin podcast to discuss the FOMC, interest rates, inflation, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. We Believe The Projections From The September FOMC Meeting Are Wishful Thinking

In the September FOMC meeting, the FED hiked its 2024 and 2025 median dot plot estimates by 50 basis points.

• The Fed raised its median Real GDP estimates by more than double for 2023 to 2.1% and by 40bps for 2024 to 1.5%.
• The Fed lowered its median unemployment rate estimate by -30bps to 3.8% for 2023, -40bps to 4.1% for 2024-25, and sees unemployment at 4.0% in 2026. 

Despite these hawkish revisions to its growth and labor market estimates, the Fed still sees Core PCE decelerating by 3.7% by year-end, 2.6% by 2024, 2.3% by 2025, and 2.0% by 2026.

We disagree with the Fed’s projections and believe they will need to engineer a recession to bring down inflation to below-trend levels.

2. The Fed Will Likely Need to Cut Rates More Than What The Market Is Currently Pricing

The current Fed Funds futures pricing shows the expectation that the Fed will begin cutting rates mid-2024 – we believe this current pricing is misguided. 

Our research shows that a recession is the modal outcome, so we believe the Fed will need to cut by more than what is currently priced.

The 10-year three-month treasury yield curve, an indicator that has successfully predicted a recession eight out of the nine times it has inverted since its inception – and eight of the last eight – continues to be deeply inverted and supports our view.

3. Inflation Will Likely Trend Higher In The Coming Months 

Our research shows that the median Core PCE delta in the year leading up to a recession is +5 bps, suggesting Core PCE is generally ‘flat to up’ in the year preceding a recession. 

Additionally, the three-month annualized rates of the different indicators of the inflation basket have halted their downward trend. Although the headline YoY numbers may continue to decelerate, we are seeing increases in specific indicators like:

• Energy inflation increased to 25.4% on a three-month annualized basis after spending approximately one year compounding negatively. 
• Core PPI Less Food Energy and Trade Services increased to 3.3% on a three-month annualized rate in August.

We believe that many of the indicators that make up the inflation basket will trend higher in the next few months and will not decline to below-trend levels until we go through a recession. 

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.
2. RT this thread and follow @DariusDale42 and @42Macro.
3. Have a great day!

Will Inflation Come Back HOT?

Darius recently sat down with Anthony Pompliano to discuss inflation, its direction, and its effect on asset markets.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. Headline CPI Is Accelerating Again, Primarily Due to Energy

Last month, the 3-month annualized growth rate of headline inflation spiked from just under 2% to 3.9%.

A material increase in energy inflation drove the move. 

Until last month, the three-month annualized rate of energy inflation had been negative for approximately one year; the August CPI report indicated an energy inflation increase of 25.4% on a 3-month annualized basis.

We expect the increase in energy inflation to persist as Brent crude oil continues its upward momentum.
 

2. Core CPI Continues to Decelerate, Primarily Due to Shelter

While Headline CPI is increasing, Core CPI, a measure that excludes some of the most volatile components like food and energy prices and therefore provides a clearer view of the underlying trend in inflation, is decreasing.

Last Wednesday’s report showed that:

• Core CPI decelerated to 2.4% on a 3-month annualized basis – the lowest reading since 2021.
• Core Goods CPI inflected negative to -1.9% on a 3-month annualized basis.
• Shelter Inflation materially impacted Core CPI as it declined from just over 5% to 4.4% on a 3-month annualized basis.

3. Producer Price Inflation Is Back on The Rise Again And May Also Represent The Vanguard of Sticky Inflation

PPI, which measures price changes from the producer’s perspective, accelerated to 4.2% on a 3-month annualized basis – the highest value since the first half of last year.

Leading underlying measures of inflation like Super Core PPI are beginning to show upside momentum and we are starting to see the first signs that inflation is potentially bottoming out.

The return of inflation is negative for asset markets – with it comes a stronger dollar and greater bond market volatility, both of which are headwinds for any increase in global liquidity.

 
That’s a wrap!


If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.
2. RT this thread and follow @42Macro and @42MacroWeather.
3. Have a great day!

Buy The Dip Until “Immaculate Disinflation” Transitions To “Sticky Inflation”

A return of inflation pressure destroys the “transitory GOLDILOCKS” narrative and potentially derails the actual GOLDILOCKS US economy that has supported risk assets for the past few quarters, paving the way for a cross-asset crash. Our qualitative research views expect that process to occur within 3-6 months. Our best guess based on the momentum in key inflation time series and the labor market is sometime around yearend or early in the new year.

Emphasis on “guess”. We deliberately never speak in certainties about the future; the only investors that do are those chasing clout on podcasts and social media platforms. Beware conviction from folks that lack the DEEP, DAILY Bayesian inference process required to understand the full distribution of probable economic and financial market outcomes.

If we are wrong on the timing of the handoff from “immaculate disinflation” to “sticky inflation” and it happens much sooner than our 3-6 months [from now] projection, our Global Macro Risk Matrix will transition from risk-on REFLATION to risk-off INFLATION early in that process. Such a shift would be your queue to shift from a buy-the-dip mentality to a sell-the-rip mentality in asset markets. It would also be your queue to pivot defensively from a factor tilt perspective. Until then, we remain constructive on risk in accordance with the “transitory GOLDILOCKS” that we co-authored with our friend Bob Elliott in January.

Evidence Of A Potential Wage-Price Spiral

The ~150,000 member United Auto Workers (UAW) union has declared “war” on Detroit’s big three auto makers GM $GM, Ford $F, and Stellantis $STLAM IM, threatening a strike by September 15 if the companies fail to acquiesce to demands that include a +46% wage increase and a decline in the work week to 32 hours. If a new collective bargaining agreement cannot be achieved by the deadline, the strike will be joined by Unifor — Canada’s largest labor union with ~315,000 total workers and ~18,000 auto workers.

Stories like this are supportive of our view that the narrative around inflation is likely to shift from “immaculate disinflation” to “sticky inflation” within 3-6 months. We have been keen to call out the elevated probability of a soft landing in the US economy. While a soft landing is not our modal outcome, we believe it is a scenario worth educating you on because a soft landing in the economy is highly likely to result in a soft landing in inflation relative to the Fed’s 2% target — which Powell went out of his way to quadruple down on last Friday at Jackson Hole.

No firm on global Wall Street has had a more accurate view on the resiliency of the US economy than @42Macro has for the past year and, as a result, a better call on bonds. We still see more fixed income volatility in the months ahead because we believe the consensus narrative surrounding inflation is likely to deteriorate before the recession hits.

Still No Recession in Sight

From a recession-signaling perspective, we have been watching three statistics that are updated with each month’s Jobs Report: Continuing Claims/Total Labor Force Ratio, Cyclical Unemployment, and Temporary Employment.

• With respect to the Continuing Claims/Total Labor Force Ratio, the 3mo annualized growth rate for July decelerated to -24.6%, well shy of the median rate observed at the start of recessions throughout the history of the time series.
• With respect to Cyclical Unemployment, the 3mo annualized growth rate for July accelerated to -3.3%, well shy of the median rate observed at the start of recessions throughout the history of the time series.
• With respect to the Temporary Employment, the 3mo annualized growth rate for July decelerated to -6.5%, narrowly shy of the median rate observed at the start of recessions throughout the history of the time series and is the only one of our “Fab 5” Recession Signaling Indicators suggesting the US economy is currently in a recession.

With the Fed nearing the end of its rate-hiking scheme, asset markets likely require a recession for the current correction to develop into a crash.

The Most Important Number In Today’s Jobs Report

The spread between Labor Demand (Household Survey Employment + JOLTS) and Labor Supply (Total Labor Force) rose to 3.7mil in July from 3.6mil in June. This statically rare phenomenon of excess labor demand is the key reason wage growth remains robust amid trending “immaculate disinflation” and improving Nonfarm Productivity (3.7% QoQ SAAR in Q2; highest since 3Q20).