"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity."
-Charles Dickens, "A Tale of Two Cities"
It might be an understatement to say 2022 has been a tale of two markets. In the first half of 2022, the SP500 was down -20% and in QTD the SP500 is up +13.1%. In the first half of 2022, Treasuries were down -14.6% and in the QTD they are up +2%. Then of course there is the real squeeze . . . in the first half of 2022 the most heavily shorted stocks were down -38%, while in the quarter-to-date they are up +39%!
I could go on, but you know the score as well as I do. To those of us that were positioned correctly for the first half of the year, the last month and half has been frustrating. Even if you aren't losing money, missing a big move definitely induces some emotion induced FOMO.
As always, though, our jobs are to invest in the future. So, what happens from here? Obviously, we've been pretty clear about our view. We expect both growth and inflation to decelerate into Q2 of 2023. The setup is for four straight #Quad4s, which historically has not been the best environment for taking risk.
The treasury market seems to agree with us on slowing growth. This morning the yield curve is inverted by -42 basis points, which is the most since 2000. Meanwhile, Fed Fund futures continue to point to almost 5 more hikes through the end of 2022, which is half a hike more than the last Fed policy announcement. In other words, there doesn’t appear to be any meaningful policy pivot in the cards in the intermediate term.
Intuitively, that last point makes sense because while CPI did decelerate in July, for the full year we will still be at near 40-year highs even with continued deceleration. In addition, as the CPI report showed last week, inflation remains pervasive throughout the economy with literally every major subcomponent up versus the prior year. And despite the policy pivot narratives that are emerging, the commentary from members of the Federal Reserve has remained consistently hawkish since the last policy announcement.
Back to the Global Macro Grind…
The caveat to the points above is that inflation in theory could decelerate much quicker than we are expecting, which would primarily be driven in the short term by commodities declining. To be fair, we are getting some of that this morning with both WTI and Brent Oil getting pounded for -4.7% declines and giving up all of their gains, and then some, from last week.
The catalyst for commodities falling quicker and more meaningfully than expected is slowing economic growth. And from China this morning, we are getting a healthy dose of just that:
- China July Industrial Production came in at +3.8% Y/Y, which was below consensus of +4.6% Y/Y and slower than June;
- China July Retail Sales decelerated to +2.7% Y/Y, which was well below consensus of +5.0% and the prior report of +3.1%;
- Real Estate investment fell -6.4% Y/Y for the first 7 months of the year and overall fixed asset investment decelerated into July; and
- The China housing market is absolutely cratering with sales down some -29% Y/Y in July.
Meanwhile, China lending data also came in much weaker than expected this morning as well with new loans for July at CNY679 billion, which was well below both consensus estimates of CNY1.01 trillion and a deceleration from June’s loans of CNY2.81 trillion. This slowing loan growth comes despite the PBOC easing monetary policy, which they did again this morning by lowering one-year policy loans by 10 basis points to 2.75% and the seven-day reverse repo rate from 2.1% to 2.0%.
Now in part, the zero COVID policy is not helping China as the year has been characterized by rolling lockdowns, but there is more to it than just that. In a Bloomberg survey this weekend of export managers from Chinese factories, the commentary was downright bleak as it related to international demand. According to the survey:
“Makers of Christmas decorations to clothing and tents say orders from overseas customers are drying up, with some predicting the best they can aim for is flat demand versus last year.”
Making matters worse, China COVID cases are back up to near three-month highs as of this weekend!
All of that is a long way of saying, that inflation could certainly slow more than we expect, but that would come on the back of economic growth slowing much more than expected as it is this morning in China.
Practically speaking, inflation has a long way to go before it normalizes. Consider today’s Chart of the Day of price measures in Germany. On one hand, the chart does show some deceleration from recent highs, which we also saw today in Germany July Wholesale prices slowing to +19.5% from +21.2% in June. The bigger picture though remains, which is that many key measures of inflation in the Eurozone remain near 40-to-50-year highs. Just as electricity prices in most of Europe are about to re-set higher . . .
In conclusion, while missing some epic short squeeze moves in certain stocks can make you feel frustrated, ultimately data, wisdom, and reason should prevail with global inflation pinned to decade highs and growth rolling over.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 30yr Yield 2.90-3.16% (bullish)
UST 10yr Yield 2.65-2.95% (neutral)
UST 2yr Yield 2.95-3.36% (bullish)
SPX 4016-4299 (bearish)
NASDAQ 11,886-13,109 (bearish)
VIX 19.07-24.05 (bullish)
USD 104.76-107.24 (bullish)
Oil (WTI) 87.16-95.36 (bearish)
Gold 1 (bullish)
Bitcoin 21,508-24,727 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
