“Adventure upon all the tickets in the lottery, and you lose for certain; and the greater the number of your tickets the nearer your approach to this certainty.“
- Adam Smith
The renowned Scottish philosopher is considered by many to be the Father of Capitalism. In effect, he laid the groundwork for classical free market economic theory. He expounded on the idea that rational, self-interested activity and competition can lead to economic prosperity. i.e. he invented the American Dream!
By and large most of us would probably agree that the free market capitalist system has proven its dominance. The question is, and will continue to be, what should the role of the government and regulation be within that system?
Currently the role of government is the largest it has ever been within our capitalist system. We are printing money, bailing out companies, and levitating markets. Now certainly there is merit to the idea that when a once in a life-time pandemic hits, this is exactly the role the government should take. That is the government should backstop the people in periods of extreme distress. The question we’ve been struggling with is: how does it end?
We’ve had many successful investors suggest to us that it is not the Fed, or government, that is actually sending the markets - both bond and equity- to all-time highs, but rather that the market is pricing in a quick end to this pandemic and return to normalcy due to an approved vaccine in the not so distant future.
Unfortunately, even with a vaccine, it’s likely not that simple. Duration to normality will still be lengthy, unemployment will still be high, and many corporate balance sheets will be impaired.
This doesn’t mean the market isn’t going higher and the economy won’t continue to incrementally improve. In fact, our models turned bullish on the SP500 on Nasdaq in the second half of Q2. Having a quantitative overlay is certainly helpful in times when getting long of equities beguiles common sense.
But when do we cash in our “lottery ticket” and take our cash?
Keith and I took a busload of kids up to Quebec this past February for a pee-wee hockey tournament. I “fronted” them 20 bucks for lottery tickets. They won 3 more times in a row and had a solid $200 banked. But after going all in on the last purchase, they lost it all. Just as Adam Smith would have predicted. It seems there is more than just lessons on the ice when you are on a road trip with the risk managers of Hedgeye.
Back to the Global Macro Grind…
On the topic of COVID-19 (I get that everyone and their mother has an opinion on this), the good news it that the U.S. has seen somewhat meaningful declines off its second peak and is now averaging around 50,000 new cases per day versus roughly 70,000 a few weeks ago. Conversely, the global new cases continue near all-time highs with burgeoning hot spots in Germany, Spain, and Australia.
Regardless of what you think, COVID-19 isn’t going away.
A key beneficiary of the pandemic appears to be the U.S. housing market which is hotter than a five-dollar pistol. The CEO of Zillow, Rich Barton has called this “The Great Re-shuffling”. In effect, the pandemic has, perhaps, permanently reshaped how people live and work. We need to look no further than record vacancies in New York City and record inventory in San Francisco to see short term validation of this phenomenon.
According to Barton, seventy percent of Americans report working from home some of the time and all Americans are spending on average nine hours more at home per day. As a result, people want space, a back yard, and that home corner office. This of course has inflationary implications on not only existing home prices, but also new builds. It’s no surprise then that lumber futures have more than doubled over the last six months.
This morning on our Research Call, my colleague Brian McGough highlighted a couple of interesting points about retail earnings. The first was intuitive in that companies are seeing comps slow as stimulus monies taper off. The second insight that caught me by surprise was that retailers are starting to see cost pressures build due to payroll.
It might surprise you too, but unit labor costs in the economy, based on data tracked by my colleague Darius Dale, are rising at the fastest pace since the early 1980s. We’ve highlighted this in the Chart of the Day, but needless to say we may still be only in the middle innings for that part of the labor cycle. In fact, in the latest report from the BLS, hourly -compensation was up +20.4% and unit labor costs were up 12.2%. Meanwhile, output was down -38.9%. Something doesn’t smell right in the state of Denmark!
The combination of demand driven inflation combined with monetary driven inflation has the potential to be a toxic elixir. Especially the later ingredient. And as Adam Smith also famously said:
“All money is a matter of belief.”
Indeed.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 0.49-0.73% (bearish)
SPX 3 (bullish)
RUT 1 (bearish)
NASDAQ 10,801-11,199 (bullish)
Tech (XLK) 110.41-115.96 (bullish)
REITS (XLRE) 35.36-36.79 (bullish)
Utilities (XLU) 59.54-61.79 (bullish)
Financials (XLF) 23.78-25.62 (bearish)
Shanghai Comp 3 (bullish)
Nikkei 22101-23470 (bullish)
VIX 21.00-28.47 (bearish)
USD 92.41-93.88 (bearish)
Oil (WTI) 41.14-43.23 (bullish)
Nat Gas 2.06-2.40 (bullish)
Gold 1 (bullish)
Silver 24.38-29.53 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
