We’re bullish on MedTech, and so are Goldman Sachs conference attendees. There’s a backlog of over 500,000 hip, knee and other joint replacements that is likely to be worked through in the years ahead.
QT is still happening, and while we’ve enjoyed a reprieve from January through June, we are beginning to see liquidity tighten again as measured by global central bank balance sheets, global M2 money supply, and of course, the balance sheet of the most important central bank in the world: The Federal Reserve.
Continuing on this theme for a moment, we can see that net Fed liquidity is falling, but markets seem to content to ignore that. At least for now. Net Fed liquidity is defined as the balance sheet of the Federal Reserve subtracted by the sum of the Treasury General Account and Reverse Repo Program added together.
Large cap growth has massively outperformed large cap value over the last 14 years. We believe that value will have its day in the sun again, though. It’s likely to be an outperformer during the next credit cycle — and there may be some interesting pair trade opportunities here as well which we will keep our members apprised of as they emerge.
Zooming in to the last year and a quarter, we can see the significant outperformance of cyclicals vs defensives. We’re back to the extreme that we saw earlier this year before the regional banking kerfuffle played out and spooked markets, creating more demand for defensive positioning and an exodus from cyclicals. The question now becomes, with risk appetites back to recent highs, is there a greater risk of a tail event?
With hedge fund gross positioning at 265.2% (according to data from JP Morgan) I would suggest that risk is elevated. It’s important to clarify what this means. When gross leverage is this high it indicates that hedge funds have sizable long and short books, with a long bias (as evidenced by net leverage).
However, funds often do not take a delta neutral approach. They often have different factors, sectors, and even asset classes as shorts vs longs. That means that both sides of their book can go against them simultaneously, causing erratic and disorderly deleveraging pressure.
Shifting over to international data, we can see that the Bank of Japan’s enormous bond purchases over the last year equal 24% of the country’s GDP.
The central bank already owns more than half of Japan’s government debt and about 60% of the domestic ETF market. The amount of liquidity that the Bank of Japan is pushed into global markets as a result of attempting to control the yield curve of sovereign debt in the nation is extraordinary and has helped to buoy risk assets.
In China, the Great Reopening that wasn’t theme continues to play out. Manufacturing is in contraction, services are slowing, and consumers really aren’t participating as was hoped by optimistic projections.
The second largest economy in the world is struggling to start its new credit cycle, and this will likely have global ramifications. After all, the hope was a decoupling from a largely slowing global economic situation.
Unfortunately it seems that same slowdown is dragging China down, a country that relies on export demand for much of its domestic production. In addition, with construction and real estate mired by an overhang of bad debts and defunct projects, the former pillars of growth for the country seem challenged.
We also see weaker growth in the Euro Area, and particularly in Germany. The country’s economy is in a recession and that’s worth watching as Germany is the most vibrant Euro Area economy, and it is heavily reliant on exports into a global economy that is showing signs of falling demand.
Zooming out to a global view, income distribution remains problematic in Russia, the United States and China while in the Euro Area distribution is somewhat more balanced.
The US central bank’s views on the economy have shifted between the March and June meetings, with inflation, growth, and the ultimate terminal rate revised higher and unemployment revised lower.
The notion of “higher for longer” until the Fed breaks something big enough that it turns about is a theme I’ve discussed for over a year now, because the problems of inflation have become more structural in nature. More on that coming soon in a video I am making about the shift from abundance to scarcity.
Within the US middle-class, wealth has dropped by $33.5K over the past year. In part due to the fall in the stock market, regions with falling real estate prices, and excess savings being drawn down.
We’ve also seen a slide in the average workweek over the same time period, falling from a peak of 35 hours to 34.3, a decrease that suggests that there are some signs of the labor market beginning to soften.
Budgets have been rising for US households, which is one reason we see a drawdown of excess savings, increased credit card debt, and more falling behind on bill payments. While wage growth has helped to offset this, it hasn’t been enough. Real wages remain largely flat to negative over the last several years. That means that inflation is eroding people’s purchasing power faster than they can earn enough more money to offset it.
Household budgets have realized significantly higher monthly costs as a result of all this upward price pressure over the last two and a half years. This is, in part, what happens when we have a stunning lack of investment on the supply side, lock down the global economy, and then flood the world with cheap credit.
What we like to call “rentflation” is on the rise again, as we see prices perking up in multiple regions. Causing the averages to follow along. This is likely to put a floor under how far inflation readings can fall as housing is a sizable component, particularly within CPI.
Additionally, as some of the base effects of last year’s Ukraine-Russia conflict wear off, we’re likely to see data that isn’t as ideal year-over-year. This all puts pressure on the Fed, who focuses on lagging data, to keep rates higher for longer.
While we’ve seen an impressive rally in global equity markets year-to-date, and particularly the US, IPO volume has not been impressive, with the worst first half since 2016.
We also see an appreciable slowdown in VC fundraising activity so far in 2023 as the appetite for start-up stage risk is diminished.
Speaking of low levels, the US strategic petroleum reserve is at the lowest level since 1983. Given that the supply-demand imbalance in global energy markets is rather tight, any unexpected major disruption could create a spark that lights up the price of crude, with a very low buffer provided by the SPR.
The oil market itself is enormous, with $2.1 trillion of global production yearly. Almost everything has some connectivity to oil, whether it is agriculture, transportation, manufacturing, travel and leisure, plastics, you name it. That’s why the price is so crucial to inflation. Because as it rises, cost push inflation begins to become an issue as those increases in price are being passed down the supply chain.
Inflation tends to follow the PMI output prices index, and we are seeing some positive signs here, but the resilience within the services industry suggests that we aren’t yet out of the woods. Inflation is coming down, but core inflation is likely to remain sticky for some time. Particularly given what we’re seeing with rents and housing prices.
In the UK we can see that there’s a high correlation between PMI and GDP, suggesting that the recovery may be starting to waver. We don’t see a contraction in Q2, but we do think there’s slowing growth in the UK. Making the economy more vulnerable to the Bank of England’s renewed focus on tightening given inflationary pressure remaining robust.
Globally we see a picture that resembles that of the US: manufacturing is contracting as services growth is only slowing. The resilience in services is quite impressive, and encouraging for the industry, but it also suggests that core inflationary pressure within services may remain resilient in countries where growth is continuing.
New orders are telling two stories, depending on where we look. Within manufacturing we see contraction, but within services we only see slowing growth. New orders are a key barometer of industry health and tend to be a leading indicator. Until new orders begin to fall meaningfully below 50 (into contraction) we think services are likely to remain rather robust at a composite level.
Speaking of new orders, in China new orders for manufacturers is still in expansion territory, but not by much. Another sign that the economic recovery remains challenged. Output, meanwhile, has fallen significantly. Part of that is because export demand has slowed as the appetite for discretionary spending from the US and Euro Area remains somewhat low.
Quite the interesting divergence between the US ISM PMI numbers. Not only do we see the headline Services PMI number in expansionary vs. the Manufacturing PMI in contractionary but now we're also seeing a divergence between the employment data.
Services employment has moved into the expansionary region while manufacturing employment has slipped into contractionary territory.
The latest Core PCE forecasts from Goldman Sachs are intriguing. The Fed revised their core inflation projections from 3.6% to 3.9%, almost double their 2.4% target.
Goldman sees four reasons for a decline in inflation:
1) the 9% pullback in used car prices is only halfway done
2) negative residual seasonality in the summer for PCE prices
3) the sharp deceleration in apartment rent list prices
4) significant progress on labor market rebalancing
Global liquidity has fallen by $170B over the last two weeks, driving up bond yields. Our outlook is that this drop in liquidity continues as QT and Treasury issuance create additional gravity. In addition, Morgan Stanley estimates bank reserves will drop by as much as $500B due to the volume of Treasury issuance we’re seeing after the debt ceiling resolution was passed. This will put more downward pressure on global liquidity.
Money market funds continue to experience robust demand, and are on a trajectory for a record year in 2023. We see these funds with yields in excess of 5% as a very attractive alternative to longer duration debt or equity exposure at this juncture. These inflows will, in part, help to absorb some of the Treasury bill issuance as well.
Here's the futures markets positioning for currencies as of Jun 27. We still like short EUR, JPY and long GBP as tactical trades. The recent rally in the JPY may be an opportunity for a long GBPJPY pair. Short EURGBP also seems like a trade idea that has potential as the disparity between central bank policies is rather stark.
The high yield market has been very resilient thus far, with the default rate only rising marginally thus far. We suspect that we’ll see defaults pick up towards the end of this year and into next year as the cumulative impacts of rising rates and less availability of capital weigh on companies ability to sustain current debt loads or finance them.
Quite a few Global Yield Curves remain inverted in major markets. This is quite a reliable indicator of trouble ahead, but only when we see the steepening into positivity after such an inversion. Right now we’re still within a rather deep inversion in the US. Comparable to what we saw in 1981.
In the long run, however, markets do tend to climb higher. Crises tend to offer opportunities.
Our goal at MacroVisor is to identify strategic opportunities to allocate capital into beneficaries of where we are in the market cycle, strong fundamentals, and outperformers based on relative strength.
Stay tuned as we have much more research to share.