The Weekly Random Walk – October 2, 2023 From Stephen Colavito
An Aggregation of Various Economic, Market Research, and Data
As you can see over the last few weeks, we are getting creative with our content titles (sarcasm). Actually, this week, we wanted to give you some fun facts about October (no Earth, Wind, and Fire didn’t write a song about the 21st day) that you may not know about. We are not sure how it ties into the economy and markets, if we are being honest; our creative juices are just not flowing all that well right now (hence why we are taking next week off).
If you remember back in the days of Latin classes (do kids even have to take that anymore), the Latin term “Octo” means eight because it was the eighth month of the early Roman calendar. The early Roman calendar only had ten months, and it wasn’t until about 713 B.C. that King Numa Pompilius added January (Ianuarius) and February (Februarius) to the calendar (thus making it 12 months).
So, we just helped you when playing the home version of Jeopardy.
Other non-useful information about the month are these:
October 9th is:
Leif Eriksson Day (the Viking, not the pop singer because that was Leif Garrett)
Canadian Thanksgiving (“Eh”)
Columbus Day and Indigenous People’s Day (to balance things out)
October 24th is:
United Nations Day (because they’ve done so much for the world)
October 31st is:
All Hallow’s Eve or “Cavity Day” (for the kids who overeat candy)
The month is also known for the “October Effect,” which is the psychological anticipation that financial declines and stock market crashes are more likely to occur this month than any other month. We are not saying this will happen; however, the Bank Panic of 1907, the Stock Market Crash of 1929, and Black Monday 1987 happened in October.
Fed Projecting and Cycle Highs
The most profound takeaway from last month's FOMC meeting is that the median dot plot in 2024 moved from a rate cut of 100 bps down to only 50 bps. This was, at least in part, an attempt to push back market pricing cuts away from the first half of next year. We have been saying “higher for longer” and believe the Fed needed to clarify that message because some on Wall Street were not listening.
This messaging has set yields upward over the last ten trading days, and nominal and real bond yields are higher across the curve. The dot plot left the possibility of another hike in November, and the market pushed back the time of the first cut. With real yields at the highest level in 10+ years, investors have a growing incentive to shun risk assets. Riskier assets seem less attractive when you can buy a five-year government bond with yields of plus 2.25% real return.
Moving In The Same Direction
Generally, good news for equities is terrible news for bonds (and vice versa). However, over the last few months, equity and bond prices have decreased (similar to 2022), sending a 60-day correlation between the SPY and TLT to the highest level since 2005. Equity prices are reacting to higher longer-term rates and higher valuations, which puts that asset class under pressure. Bond prices go down as rates increase; thus, they are also under pressure.
We maintain our bias towards fixed income right now, particularly at the front end of the belly (4-5 years). We want to see equities return to a reasonable valuation or rates start to decline before we add weighting to that asset class (we think rates could begin to decline by Q2 next year). Until then, we hold our positions and wait.
Trading Places
Billy Ray Valentine and Louis Winthorpe III are at it again by going long-frozen concentrated OJ. In all seriousness, orange juice futures have surged to record highs as stockpiles in the US tumble to a half-century low due to Florida citrus groves battered by weather and restrictions on fertilizer and pesticides (thanks to “Green” regulations from DC). It’s a perfect storm (but not a hurricane…you’re welcome) hitting the OJ market as supermarket prices have risen this year.
As a result, OJ futures have tripled in the last several years (buy, buy, buy), nearing three dollars per pound. Also, suppliers are ramping up imports from Brazil to mitigate sliding inventories where regulation by the government isn’t as restrictive. As a result, Brazil is at historic highs in exports of the pulpy goodness called OJ.
This, like many other items bought at grocery stores these days, continues to increase in price. Inflation is alive and well, and the Fed has difficulty controlling the price increases.
Plot Twist
It has become a running joke within the “Economist Community” that robust economic data from DC always seems to have an expiration date (about 30 days). Our community believes this to be true because 2023 payrolls have been revised lower following the “big announcement of great job growth” the month before. This is a (wait for it) 12-sigma probability and virtually impossible unless there was political pressure to massage the data higher and then revise it lower when the MSM goes to bed.
And now, for the rest of the story… the BLS will likely continue to revise lower because the traditional one-month lookback revisions will extend gradually to the annual benchmark for years to come.
But that’s not all; the data with US consumption is also being revised lower according to the National Economics Account (NEA) and National Income and Product Accounts (NIPA). Per the NEA and NIPA, the growth last year has been revised from 2.1% down to 1.9% and all of the GDP components were weaker than initially reported.
All of this makes our job very difficult when our Government data is being manipulated (yes, that is the word we are using), and the health of our economy is hard to diagnose.
If the revisions are accurate, it may make more sense why workers are more inclined to strike. It seems pretty clear that workers are not participating in the “prosperity” (aka bogus numbers) that is being spun of DC. Beyond the UAW, the Culinary and Bartenders Union authorized a Vegas-wide strike across 22 casinos and resorts last week.
This union represents 60,000 hospitality workers across Nevada, of which 53,000 are based on the strip. The potential strike is interesting as Vegas will likely have a record-breaking month when the F1 race comes to Vegas in November.
Jobs and Markets
Over the past few weeks, equity markets have been under pressure, perhaps reflecting that the Fed is reducing worker demand as US job openings are declining. The S&P 500 has traded. One hundred seven days in a row without a plus or minus move of 2.0%, leading volatility control funds to generally be “long.” A material fall could lead to a significant de-leveraging as volatility funds and dealers go from positive to negative gamma to balance their books. For those who don’t speak “derivatives,” equities would be sold, and long volatility would be bought to hedge their positions.
The chart below shows an interesting correlation between job openings and equities from 2001. This chart comes from BoA, and if this were to continue, markets would likely head lower following job openings (no guarantee of future returns).
To add to that point, looking at net leverage in the markets, the change in long/short fundamental strategies that use Goldman Sachs as their prime dealer was the most significant move since March 2020, a sign that fast money is preparing for a very choppy October.
Things Are Getting Tighter
Financial conditions in the US are now declining, which may explain why the S&P 500 is also under pressure. These conditions haven’t been this tight for about a year, and growth expectations are becoming gloomy.
There are interesting correlations between the Condition Index and the S&P 500. Although there can be a slight lag, the markets follow these conditions. Also, we highlight that this time last year, when conditions were at the same level, the S&P 500 Index was just above 4000.
We have discussed a trading range for the S&P 500 from 4200-4600. We continue to believe that is the case; however, talking to technical researchers, they are watching 4195, the 200-day moving average (DMA). In speaking with several, they agree that if the 200 DMA is breached, the 1/3/6 and 12-month equity returns historically have been well below average.
Really Tight
The inflows to money markets continue to push higher while capital keeps getting harder to find for small and midsized banks. US money market funds are now back up to record highs, and an extraordinary gap exists between money market and bank deposits (as seen in the chart below).
The challenges to bank deposits mean that the Fed’s emergency funding facility for banks remains at record highs around 108 billion dollars). We want to highlight to readers the 108 billion dollars that are being borrowed are supposed to be paid back in six months (unless the Fed extends that deadline). This could be very problematic for banks that can’t find capital.
General Thoughts
This has been a rough weekend for yours truly. We took a lousy L on the tennis court, and every one of our sports teams got a beat down. So, we apologize if we displace our frustration on our bullet points with our focus on lawmakers in Washington, DC. We have to take it out on something, and our dog is too big and cute for us to yell at him.
Yesterday, with three hours to spare, the House and Senate passed a Continuing Resolution stopgap funding bill, which stripped out funds for Ukraine, includes 16 billion for disaster relief, and will (kick the can…I mean) keep the US government running for another 45 days. Even though Hollywood has been closed due to a writer's strike, we have all the drama we need here in DC. What a joke, and lawmakers should be ashamed of themselves.
Instead of Real Wives of Atlanta, we need an A&E show called Real Lawmakers of DC. The show would be a great hit; it would be awesome to have Andy Cohen's year-end show with Democrats and Republicans in the studio yelling and screaming at each other like the wives do. The show could start with Congressman Bowman, who got caught on camera this weekend, triggering the Capitol Building fire alarm to delay the vote for the Continuing Resolution (we can’t make this up). Since Congressman Bowman was a former teacher and principal, I am sure he knows how fire alarms work, but watching the MSM cover for him is laughable.
Lack of leadership by lawmakers at the City, State, and Federal levels has led to chaos in some cities as we continue to see announced weekly store closures. Last week, Target said they are closing stores in nine cities, citing violence, theft, and organized retail crime. Stores in New York, Seattle, San Francisco, Oakland, and Portland are a few of the places Target is shutting down. We again reiterate the daisy chain effect this has on communities. These stores create local jobs, generate city and state taxes, and are essential to local shoppers.
Lastly, as the US continues to reduce its gold reserve and dilute its dollar, official global gold reserves held by Central Banks hit 38,764 tonnes in Q2 2023, breaking its previous record from 1965. Unsurprisingly, China has been the largest buyer of any Central Bank over the last twelve months as they continue to stockpile the metal. As discussed over the previous few months, the Chinese want to bring a gold-backed global currency to market soon to provide options to countries using only dollar-backed international transactions. With our lawmakers showing little fiscal responsibility, it has allowed the Chinese to potentially replace SWIFT and the dollar (note, this will take years, but if our lawmakers don’t wake up, it will happen).
We never want to get “over political” in these notes, but our economy and markets are greatly affected by DC. The drama this weekend (only to pop back up in 45 days) is unnecessary, and our economy deserves better. The lack of fiscal responsibility falls on both parties, and we hope that citizens of this great country vote for better representatives in the future.
Thanks for listening.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
stephen.colavito@sanblas-advisory.com
General Disclosures
This research is for San Blas Clients only. The opinions represented in this research are that of the CIO, not advisors or officers of San Blas Securities. This research is based on current public information that we consider reliable, but we need to represent it as accurate and complete, and it should not be relied on as such. The information, opinions, estimates, and forecasts contained herein are as of the date hereof and are subject to change without prior notification. We seek to update our research as appropriate. Some research can and will be published irregularly as appropriate in the analyst’s judgment.
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