The Weekly Random Walk – September 25, 2023 From Stephen Colavito
An Aggregation of Various Economic, Market Research, and Data
September
Since we were born in this great month, one of our favorite songs is Earth, Wind, and Fire’s “September.” The lyrics go something like:
Do you remember
The 21st (now 25th) night of September?
Love was changin’ the minds of pretenders
While chasin’ the clouds away
After the Fed’s hawkish tone and some of the data we have seen this week, one has to wonder if “data was changin’ the minds of pretenders” who think the Fed will land this economy on a soft, fluffy pillow. Hey, hey, hey!
Our Hearts (and Their Wallets) Are Ringin’
Inflows into money market funds show no signs of slowing down and have reached a record high in 2023 with over 1 trillion dollars of inflows this year. While the inverted yield curve implies that money market rates are attractive and banks have lost deposits, it’s also a bearish signal that investors have found cash more attractive than other potential investments. The market has been “risk-off” for over three months.
Volatility Keeps Dancing The Night Away
Despite energy prices, long-term rates climbing, the US Dollar gaining strength, and the market correcting a little, the realized volatility of the S&P 500 has drifted lower and lower. The VIX index fell below 13 last week before bouncing during this week's equity weakness (now above 17). The low correlation of stocks within the index keeps volatility low; however, individual stock names are at “normal” intraday levels (remember last week we discussed only a few companies driving indexes like the S&P 500 higher). Even after this week’s trading, the S&P has gone more than 140 consecutive days without a 2% move in either direction, the longest streak since 2017.
Do You Remember Never a Cloudy Day (Until The Rains Come)
High-yield cash spreads in the US are south of 380 bps (3.80%+), while leverage loan spreads are now south of 500 bps (5.00%). These are the tightest levels since April 2022 despite rising default rates. Goldman Sachs predicts that US HY default rates will reach 4.6% and loan default rates will reach 6.7% net year (as higher interest rates have a more pronounced impact on floating loan issuers). With recoveries continuing to fall, losses on both loans and HY may be significant. Although it may be a bumpy market, we will start looking at this sector in mid-2024 if yields exceed 8%.
“Ba-dee-ya (dee ya, dee-ya), Golden dreams were shiny days.”
As we move into week two of the UAW negotiations, analysts at JP Morgan estimate that a 35% wage increase for auto workers would translate into a 1% increase in cost at auto dealers, some of which will likely be passed on to consumers (inflationary). With the combined weight of new and used car prices in the CPI around 7%, the total impact on overall inflation would be moderate. However, it’s still higher, making the Fed's job a little more challenging.
My thoughts (and wallet) are with you.
We are a broken record (our one pun of the day) on the energy issue, but it bears repeating. Oil prices continue climbing and are now at the highest levels since November 2022. The surge in WTI has dragged gasoline prices at the pump dramatically higher, and worse still, given the lag in the supply chain, pump prices are set to go higher.
This impacts transportation costs, which could flow through to goods in the way of higher prices. Last week, the White House acknowledged the spike in gas prices (via press statement). Yet, at almost the same time, the Biden Administration made some head-scratching announcements when they terminated oil drilling contracts in Alaska (ANWR) and New Mexico, making the US more dependent on imported oil. We are not sure what they are thinking…again.
The chart below is precisely what we have been saying for the better part of this year. The Biden administration has depleted the Strategic Petroleum Reserve (SPR), which helped keep gas prices artificially low, but now that they have stopped draining, gas prices are rising.There were rumors this week that the Biden administration once again would strip what little supply is left, but we have not been able to substantiate that rumor.
“Holdin’ hands with your heart to see you.”
EW&F may be holding hands, but it seems pretty clear that House Republicans are not. According to Bloomberg, online betting markets see a 69% chance that Speaker McCarthy cannot get consensus within his party to put a vote on the floor, and a shutdown starts on October 1st when appropriations lapse.
Bloomberg report also estimates that a month-long government shutdown could temporarily push up the unemployment rates (on top of those laid off in the UAW strike) and would negatively impact economic activity. In the chart below, if the shutdown is prolonged or extreme, the maximum hit to Q4 GDP would be a drag of 2.8% if the shutdown lasts a full quarter (we doubt that would be the case).
Ba-dee-ya (dee-ya, dee-ya), dancing in September
In the middle of last week, we saw this chart and wanted to share it. It highlights one of last week's points on the dislocation of the top 7 stocks performance from the rest of the market. As of Thursday, the S&P 493 (excluding the top 7 stocks) was only up 4% this year, while the S&P 7 was up 52%.
In other words, if you buy the S&P 500 today, you are purchasing a handful of companies driving the entire market. The seven largest stocks now account for a massive 34% of the whole index’s value. So, those chasing S&P 500-like returns, we ask two questions: 1) Are you really diversified, and 2) What happens if all the hype for AI fades?
This is a one-hit wonder, but EW&F was not.
The only bullet point this week is the broken record on equities. We continue to stay in a trading range. The markets are FINALLY coming to grips with “higher for longer,” but it’s still trying to front-run when the Fed will cut rates. We are surprised at the lack of volatility and that the markets haven’t corrected. This doesn’t mean we have complete conviction in a bull market from here but one of “wait and see.” Both our thesis and the trading range remain intact.
Have a great week. Be safe and trade well!
Stephen Colavito
Chief Investment Officer
San Blas Securities
stephen.colavito@sanblas-advisory.com
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