Hey everyone! I hope that your week is off to a great start. I’ve moved Charts of the Week to Mondays, but rest assured the content will be just as good if not better than it was before.
Debt is a Costly Habit These Days
Interest payments are on the rise for US government debt, rising to $969.9B in Q2 from $923.3B in Q1. Up over 50% from Q4 2021, when payments were $600.4B.
These rising payments are adding pressure to the government to either raise taxes or reduce spending — though in the short-term changing issuance composition will help to reduce total interest costs.
Some of that newly added US government debt helped to fund a positive fiscal impulse from the Inflation Reduction Act and the CHIPS Act.
This spending contributed to the largest manufacturing construction percentage to US GDP in Q2 since 1981. That spend may be set to fall, however, as we are traversing the fiscal peak from all of this aggressive spending now.
The federal government collected $4.9T of tax receipts in 2022 and has collected $3.69T so far in fiscal year 2023 (which ends at the end of September). Some of these tax receipts are deferred, but there may also be some signs of a slowing economy underneath the surface as tax receipts fall about 10% year-over-year.
As the Treasury contends with interest higher payments and lower tax income, it is beginning to shift issuance to longer duration beginning in August, just as total issuance is also upscaled.
This is likely to begin to pull some liquidity out of the broader market. Bill issuance was largely soaked up by RRP, but note and bond issuance won’t be.
Glancing over at global commercial debt, there’s a sizable maturity wall in fixed income approaching as we navigate towards 2024 and the next several years beyond it. There will be a significant increase in a variety of refinancing requirements, where rates are likely to be elevated vs what was experienced in the last several years.
Energy Despised, Memes and Tech Energized
Hedge funds remain quite net short of energy exposure, per Goldman Sachs Prime Book data. We still feel there are selective opportunities available in the space over the long run, particularly within energy services.
Oil prices have been resilient and natural gas seems to be trying to put in a bottom as demand rises into a sweltering summer. Most of the US power grid relies on natural gas to some degree in order to fulfill baseline requirements.
Squeeze sentiment is cresting at an extreme level, showing just how back we are as traders pile into short squeeze plays, sending them, in some cases, to the moon. These extremes often portend to a meaningful reversal—but the question is from what point? We’ll be watching.
Flows into tech accelerated again recently, buoying some of the largest companies in the world ever higher on already lofty valuations. A small bit of good news, however, is NASDAQ companies have had a relatively decent earnings season vs the S&P, clocking in some growth in Q2 while the S&P continues to see shrinking earnings for the third quarter in a row.
The concentration of tech outperfoming the broader market is the most extreme we’ve seen in over 20 years, and quite a departure from the long-term median since 2001.
Yet underneath the surface, some of the biggest players in tech are seeing revenue growth rates decelerate meaningfully, and expected to stay rather slow. Seen below is Amazon and Apple, but the situation with them isn’t in isolation. Other mega caps are slowing as well.
Positioning is Stretched
Positioning, by many accounts, is the most stretched it’s been in years. CTAs are back to levels we haven’t seen since the COVID crash when looking at an aggregate CTA portfolio across global positioning.
When we look at global systematic macro positioning, which is a combination of CTA, risk parity and volatility control funds, it was recently at levels not seen since late 2021. Another extreme, and one that suggests some level of left tail fattening in the event of a de-risking in equities. In that momentum shifting lower could add to selling pressure as these funds reduce their long exposure.
Options are the Market
S&P 500 0DTE options volume has recently hit 53%, meaning it accounts for the majority of volume across all expirations. This surge has to do with the increased number of expirations (now one for every day of the week), with most of the trading taken on by automated execution platforms operated by institutional players.
This surge in 0DTE trading has suppressed volatility by changing the composition of options trading, as well as seeing a large amount of trading happening with near dated, close to the money options. This means participants are expressing less price uncertainty, and because implied volatility is a measure of forward looking price uncertainty this short-dated trading helps to limit volatility.
Current options positioning suggests that dealers are short gamma, which creates a chase dynamic, where dips are sold and rips are bought.
This all increases the potential for upsized volatility as we approach VIXperation (or the day that VIX contracts expire for August) this Wednesday. An added bonus is the Federal Reserve minutes come out that same day, which may further heighten volatility as we close out the week.
Systemic stress is quite low, though beginning to move slightly higher of late. Currency and equity volatility tend to move higher in August until October as a part of seasonality, and we’re seeing some signs of that in leading currency pairs, like USDJPY.
Of Extremes and Seasonality
Another catalyst for volatility, outside of seasonality, is a lack of participation. Often is the case that we go through a period of lower market participation starting in mid-August. That can add to outsize moves, both up and down, as it takes less volume to move price during lighter trading conditions.
The seasonality of volatility over the last 40+ years has favored a resumption of equity market volatility in August, and so far this month has not disappointed, with the intraday trading range widening to the widest levels that we’ve seen since June recently.
As we move throughout the third quarter of the year, it’s important to consider that this tends to be a volatile time in the stock market. Sizing down positioning or hedging it can be helpful to govern risk during a period that may be more choppy, with larger overall price moves.
10-year real yields have surged to levels we haven’t seen since 2009 recently. This often exerts downward pressure on long duration risk assets, but lately that correlation has not held. At least not yet.
Rising yields on the 10-year along with rising equity prices has left risk premium at the lowest level in over two decades, making high quality fixed income more attractive than US index-level equity exposure. Particularly Treasury bills and AAA corporate debt seem like reasonable allocations here.
This is the third quarter in a row of negative earnings growth for the S&P 500
10-year yields may rise further from here as economy and (core) inflation remain somewhat resilient
The correlation between the S&P 500 and 10-year yields is the most negative that it has been since 2000, suggesting that perhaps there is an extreme with the lack of concern that stocks have for rates, despite a very low risk premium and S&P 500 earnings in three quarters of negative growth.
Emerging market bond yields have fallen while US bond yields rise — a curious divergence that suggests markets are more concerned about inflation in the US than overseas in EMs, where many have already completed their tightening cycle and some are beginning to cut.
Inflation is on the Minds of Investors
Inflation is something that continues to haunt investors, and rising oil prices aren’t helping to calm their nerves.
We can see that there is a 0.83 positive correlation between the 5-year forward inflation rate and the spot price of WTIC, demonstrating just how important oil prices are for inflation expectations.
This concern about inflation has investors moving into TIPS for the first time since August of 2022.
Money Flows are Evolving
The thirst for yield also has investors moving more into money market funds.
Rising Prices and Debts
While a lot of attention has been paid to credit card debt hitting $1 trillion for the f irst time ever, I think the bigger area to watch is going to be auto loans, which soarted past $1.5 trillion recently. Quadruple digit monthly payments on cars are no longer rare outside of luxury vehicles.
The cost of home ownership has a big impact on inflation as shelter is about one third of CPI. Several measures of home prices are on the rise again after a brief break in the back half of 2022.
It’s not that housing is strong, though, it’s more that the amount of supply is very limited, and largely made available from builders rather than existing sellers, which is where most supply of home listings often originates.
In California high rates and home prices have created a situation where only 16% of state residents can afford to buy a home.
California isn’t even #1 in the cost of a mortgage, though, as Hawaii has the highest mortgage payment as a percentage of state per capita income at 91%.
The chart below shows just how far and how fast 30-year mortgage rates in the US have soared over the Fed’s hiking cycle, creating a large cost increase for home buyers that many aren’t able to absorb.
As a result, mortgage applications are falling appreciably. Housing market activity has slowed significantly. You wouldn’t know it looking at home prices in many areas, though.
Fun with Numbers
Non-farm payrolls have had downward revisions for every single month of 2023. That’s quite the trend, and it suggests that the labor market may be slower than what the initial data suggests.
Meanwhile, in the world of news headlines, “soft landing” mentions have surged. Will we see a soft landing, or is the consensus a bit too confident in this outcome, as has been the case in many prior end cycle environments?
Global Economic View
Around the world the highest retirement age for men is in Italy at 67 and the lowest is Indonesia at 58. This is only looking at G20 countries. Nevertheless, interesting to see the US has the fourth highest retirement age of all those surveyed.
The global economy has a GDP of $105 trillion, with the US contributing $26.9 trillion of that, and China a sizable $19.4 trillion at number two.
Things, however, aren’t going so well in China.
China’s Lack of a Real Reopening
Youth unemployment in China has reached record levels, which is a growing problem for the country’s government as this could lead to social unrest. Promises of stimulus for the last eight months have been met with little follow through and that, along with episodic job destroying industry interventions may be leaving young people a bit frustrated.
Many observers of the reopening in China expected to see growth. Instead all signs point to an economy that continues to struggle without sufficient support from the government.
Both CPI and PPI dropped, with PPI deep in negative territory. Some believe that rising PMI data may lead inflation back up again in China, but it is too early to tell.
Commodity imports have fallen significantly month-over-month in China, with paper pulp, copper ore, and plastics falling the most. Motor vehicle, pharmaceutical and natural gas imports remained buoyant.
Year-over-year copper purchases are flattening out as well, with the electrical grid and autos partially offsetting the lack of construction and other demand for copper. Because the industrial metal is such an important economic indicator, we are watching these imports carefully.
There are other signs of trouble in China, including Country Garden’s growing insolvency.
Which intensified last week, according to the FT, as they missed international bond payments and defaulted on several debts as the problems in China’s real estate sector continue to grow.
High yield credit spreads in property debts are widening again, to the highest levels since late 2022.
The Chinese equity market hasn’t come away unscathed as the CSI 300 erases more than half of the gains made since the Politburo mentioned making a move into stimulating the economy and markets again. Some rumors recently are circulating, however, that the government may be accumulating ETF exposure to try to stabilize equities.
Europe Continues to Slow
The economy in Europe continues to show signs of slowing as manufacturing slips further into contraction and services slow to near flat growth.
The housing market in the UK hasn’t been quite as resilient as the country’s economy. While bankruptcies have been on the rise, the country’s GDP has been impressive. Nevertheless, a mortgage debt composition among home owners that resets regularly and may even be tied to variable rates in the case of about 9% of debtors, has caused home prices to weaken month over month for the last four months.
Brazil’s Inflation Re-Acceleration
Inflation in Brazil came in higher this time around right after their first cut in this cycle. Probably why they discussed keeping rates sufficiently restrictive. Despite the cut, the interest rate is now 13.25% which is still restrictive.
To compare, their pre-pandemic rate was 6.25%. Brazil was the second LatAm country to cut rates after Chile surprising everyone with a 50bps cut instead of 25bps as everyone expected. Brazil was early in the hiking cycle starting in April 2021 from 2%.
They will likely cut again this year and still remain high enough to weather some resurgence in inflation. EWZ is a decent ETF for Brazil but, it has over 14.49% exposure to Petrobras and therefore, moves a lot with Oil as well. Something to keep in mind.
Unemployment is at 8% but declining. The last time unemployment was this low was at 2015. Pre-pandemic they were around 11-12%.
Last, but certainly not least, India’s stock market has been on fire. So much so that valuations are now competing with the US to see which market can become the most expensive.
As always we hope that you enjoyed this edition of Charts of the Week. We welcome your feedback and questions below.
Thanks, very insightful
Great read...thank you Aisha and Mayhem!