"The pendulum of the mind oscillates between sense and nonsense, not between right and wrong."
-Carl Jung
In the last few years, the markets have regularly pivoted between sense and nonsense. Up until the last few days, we seemed to be solidly in the nonsense stage again. Take meme stock favorite Blood Bath and Beyond, or sorry Bed Bath and Beyond ($BBBY). It had an almost 400% rip to the upside in about three weeks.
Then of course, as it usually does, the market came to her senses. Ryan Cohen sold his holdings in $BBBY for a handsome profit and the reality of the financial structuring the company was likely going to undergo became more obvious. And poof . . . the party was over!
The funny thing with fundamentals is that they usually do ultimately matter. Whether it is the fundamentals of a slowing economy, the fundamentals of a company with dim prospects, or an asset with little to no value or use case... common sense is more than likely to eventually prevail.
Despite the meme driven short squeezes we’ve seen over the last couple years, a 2021 study from the Nasdaq looked at some twenty years of data. Empirically, the results were conclusive with the most heavily shorted decile of stocks underperforming the least shorted decile of stocks by some 700 basis points. In fact, by and large as short interest increases, future stock performance declines.
Another joint study from various business schools in 2013 concluded:
“One of the robust findings in the empirical investments literature is the negative cross-sectional relation between the level of short interest and future abnormal stock returns. Stocks that are heavily shorted have dismally low returns over the following months. This suggests that short sellers are informed traders … “
Now I’m not encouraging you to run out and short the most heavily shorted stocks. But conversely, make sure to check your recency biases when wading into the next Reddit driven short squeeze. Because market mechanics aside, those short sellers probably do know something.
Back to the Global Macro Grind . . .
As I woke up this morning and reviewed the most recent data, the one data point that jumped out at me was expectations for future Fed hikes in 2022. As the Chart of the Day below shows, we are at a new high for hike expectations at 5.05. Despite talk (hopes?) of a Fed pivot, expectations for rate hikes continue ticking higher.
While tighter financials conditions take time to work their way through the economy, the housing market is often a real time measure of their impact. Consider some of the data points we’ve received on housing in the last week:
- July single family housing starts down -10.1% M/M and -18.5% Y/Y;
- Home purchases that are in contract getting cancelled are at 16.1%, which is up some 60% from the post COVID trough;
- Mortgage Purchase Apps fell -0.8% W/W and -19.6% Y/Y; and
- NAHB Builder Sentiment dropped to 49 (contractionary) after eight straight months of declining.
Now some of you may still be questioning whether we are in, or will be in, an economic recession in the U.S. Perhaps that is a fair debate. But regardless, we are already in a housing recession. As NAHB Chief Economist Robert Dietz said in last week’s report:
“Tighter monetary policy from the Federal Reserve and persistently elevated construction costs have brought on a housing recession.”
Seems simple enough. And unlike narrative driven pivots, the housing market is unlikely to turn absent an actual easing of interest rates, which is currently anticipated to be sometime in late 2023.
Speaking of the recession and slowing growth debate, there isn’t much of a debate with this morning’s European PMI data. We had across the board slowing with most of the date coming in contractionary. Specifically, Eurozone August Manufacturing PMI slowed to 49.7 (contractionary) and Services slowed to 50.2, which were both 18-month lows. Within these reports, the U.K., Germany, and France printed both contractionary Services and Manufacturing numbers.
Again, the commentary within the report is worth reading:
“The latest PMI data for the eurozone point to an economy in contraction during the third quarter of the year. Cost of living pressures mean that the recovery in the service sector following the lifting of pandemic restrictions has ebbed away, while manufacturing remained mired in contraction in August, seeing another record accumulation of stocks of finished goods as firms were unable to shift products in a falling demand environment. This glut of inventories suggests little prospect of an improvement in manufacturing production any time soon.”
Even though the ECB has only tightened marginally, this report shouldn’t be a real surprise as inflation continues to accelerate in Europe. In fact, yesterday’s German power prices hit an all-time high at 700 euros / mega watt hour for the first time ever. Not to worry though, that is only some 14x the seasonal average over the past five years . . .
Perhaps the epic rally in risk assets was the beginning of the next bull market as some market prognosticators are predicting. Or maybe sense will prevail and the markets will continue to price in slowing growth, tighter financial conditions, and global inflation that is very high and in many regions accelerating.
Only time will tell, but personally I’ll be sticking with the rate of change of the data as my guide.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 3.00-3.27% (bullish)
UST 10yr Yield 2.70-3.05% (neutral)
UST 2yr Yield 3.15-3.35% (bullish)
High Yield (HYG) 75.55-78.71 (bearish)
SPX 4071-4297 (bearish)
NASDAQ 12,101-13,128 (bearish)
RUT 1 (bearish)
Tech (XLK) 140-151 (bearish)
Utilities (XLU) 74.21-78.99 (bullish)
Healthcare (PINK) 25.47-26.61 (bullish) `
Shanghai Comp 3 (bearish)
Nikkei 28,002-29,555 (bullish)
DAX 13,108-13,901 (bearish)
VIX 19.80-24.71 (bullish)
USD 104.92-109.26 (bullish)
EUR/USD 0.993-1.019 (bearish)
USD/YEN 132.58-137.99 (bullish)
GBP/USD 1.172-1.208 (bearish)
CAD/USD 0.764-0.779 (bearish)
Oil (WTI) 86.01-94.79 (bearish)
Nat Gas 8.10-10.03 (bullish)
Gold 1 (bullish)
Copper 3.48-3.72 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
