Barbarians at the Gate

“How do you think they got here so fast? …Shoot dammit shoot!”

—The Blob

Repeat from last week…We are now officially in blow-off territory as momentum takes the driver’s seat.

Key takeaway: There are two different concerns about becoming overwhelmed. The first is the flood of subsidized foreign goods coming onshore that kills demand for U.S. manufacturing. The second is the worry caused by the Fed cutting rates by 50 basis points, unleashing a torrent of demand thanks to cheaper financing. The danger for the economy is that the reactions to both fears risks a recession. Watch interest-sensitive markets such as autos and housing to see how this plays out. Sage advice below from Graham and Dodd as divergences and extremes abound. Chinese markets flash a warning. Do not forget about 5674 S&P 500 as the trigger below which to become defensive.

Stampede Dept: Earlier this year, Raphael Bostic surprised me in his quarterly letter as president of the Atlanta Fed when he wrote about the intentions from their region’s business owners ready to ramp up hiring and investment as soon as the Fed cut rates. That discussion never showed up in Atlanta’s contribution to the Beige Book that month, and wasn’t revisited until recently. Fed Governor Michele Bowman first brought up the possibility in her dissent to the size of the Federal Open Market Committee’s (FOMC) 50-basis point cut. Pent up demand was mentioned last week by Fed Governor Waller and Goldman Sach’s CEO David Solomon.. Richmond Fed President Barkin on October 2 also warned that the FOMC cannot say the inflation battle has been won, so he is

Paying particular attention to the potential impact of our recent rate move on pricing for houses and cars. Buyers will welcome lower rates, but there is a risk that demand is stimulated in excess of available supply. Remember, it takes time to get new houses built and move cars onto lots. Locked-in homeowners may well start to list their homes as mortgage rates drop, but these sellers will also be buyers, increasing demand while they are adding to supply.

The Problem with the Pent-Up Demand Theory is that I am operating with the view that the FOMC can drive us into a recession if it hesitates to lower rates further over a misplaced concern that the economy can overheat. Restrictive policy due to misreading weak labor demand is treacherous. Remember, the unemployment rate can move higher even if firms retain staff. It is the lack of hiring that drives the unemployment rate higher. ?

On Your Marks, Get Set…No…?

Pent-up demand is great only if there is existing supply to meet it, as Barkin explained. Existing home sales came in disappointing once more, as seen by the following chart.

The dotted line Is the inverted 30-year mortgage rate, and demand is influenced by the mortgage rate, but it is the real mortgage rate that is the true driver of demand. The real rate is defined as the nominal mortgage rate less housing inflation, meaning the annual home price rise. What is ironic is that housing’s appreciation should have improved sales because housing inflation has lowered the real mortgage rate. It appears that the price rise has gotten so out of hand that further appreciation is not an appeal, but an impediment.

This affordability issue for both new and existing homes is a brake on Building Permits, which was released Friday:

The Fed is hoping that the upward trend in permits since the GFC continues. What is needed to help the affordability issue is breaking the reluctance of existing mortgage holders to put their homes on the market. Hopefully, a mortgage with a 5-handle will be motivation to break the inertia to switch homes. Perhaps enough time has elapsed to extinguish the hope that mortgage rates will move back to their old levels.

Existing homeowners need to feel comfortable about their employment prospects to be ready to step up their monthly mortgage payments if they sell their house. I remain skeptical, and so far, so do homebuilders.

Vehicle sales

Total vehicle sales have been progressing at a steady rate for the past 18 months, and settled into a comfortable range, which is the norm. These range between an annual rate of 16-18 million vehicles over the past two decades.

Any sustained spike up in car sales would be uncharacteristic, and could motivate the Fed to back off from rate cuts.

NY Fed Survey of Consumer Expectations:

Dissaving and delinquency will hold back demand: Consumers plan to increase purchases by 5% in 2025, but expect their income to only rise by 3%, dipping further into savings. That explains why the probability of missing debt payments over the next three months increased to over 14% in September. The chart of debt delinquency expectations from the NY Fed’s Survey of Consumer Expectations is below. September’s level is over 2% above the historical average, and the highest seen since the pandemic.

The probability of not making a minimum debt payment over the next three months was in single digit record low territory from June 2020 through February 2022. That period marked the peak in pandemic savings, and since then, those checks were spent. If banks are also sensing rising defaults, it should be reflected in tighter lending standards when the Fed Senior Loan Officer Opinion Survey for October is released early next month.

Tariff Flight or Fight

PIMCO’s global fixed income CIO Andrew Balls is quite worried, seeing a 50% chance of a global trade war that would raise recessionary risks, particularly for Europe. Many sell side firms are projecting stagflationary drags in U.S. real GDP growth of -1.5%, and PCE increases approaching 1% in 2025 and 2026. Because capital goods and intermediate goods constitute over half our import volume, tariffs raises production costs through their Cost of Goods Sold.

The move toward increased tariffs has increasing backing from the electorate, which was revealed by the latest University of Michigan survey. The proportion of those polled who believe that increased trade is good for the economy has fallen from 70% to just over half. The issue of "de-risking" from China in critical technology areas sensitive to national security has strong Congressional support. Both administrations have continued to expand that classification to include more industries under trade restrictions.

With a 1.5% potential reduction in GDP, we must not forget that in 2018-2019 when the tariffs began having an impact, unemployment in those affected industries rose significantly. It seems hard to believe that we can avoid a recession if the move toward a protectionist stance spanning the last two administrations accelerates.

Inflation and Margins

In the NY Fed’s survey, median one-year ahead inflation expectations were flat at 3%. Although three- and five-year ahead expectations rose in September. The chart below shows the distribution of the one-year inflation outcomes for each month of the survey since it began in 2014. It shows an interesting rise to 23% of those surveyed expecting deflation in 2025 (see far right arrow):

I have some serious issues with their graphics department, but the yellow bars represent the percentage of those polled who expect inflation to drop below zero next year. The only other readings in the past ten years that expected deflation are March and April 2020 (see arrow). I will look at this category in the survey into the end of the year to see if this blip is also temporary.

This dynamic of rising deflationary expectations supports the underlying trend I observed recently where PCE components that are experiencing y/y price drops have been rising of late. While this drags the overall inflation indices lower, it is proof of a lack of pricing power, and that is problematic, especially with stocks at all-time highs.

MS Analyst Coverage Warning

Morgan Stanley compiles a monthly index of their analysts’ views from their universe of companies. The MSBCI Composite Index is a diffusion index, and for October, it fell into contraction territory at 43 from September’s bullish 54. There were declines in Advance Bookings, Credit conditions, and Business Conditions. I have mentioned my preference for Final Demand core PPI less Trade Services because it nets out producers’ margins which have been falling lately, and their survey supports my view: Prices Received and Prices Paid both fell but prices paid is above received, revealing the margin compression these companies are experiencing.

Additionally, Hiring and Hiring Plans fell as seen in the chart below. (Their gauge for 6-month forward expectations fell but is still in expansion territory, so that series is worth watching to see if the Fed’s easing campaign helps labor demand.)

At the risk of repeating myself, and as I mentioned last week, if firms are not hiring, even if they do not lay off employees, unemployment will rise.

The Hiring Plans Index and its 3-month moving average have fallen below the levels recorded during the 2020 pandemic. Without a turn in hiring, the FOMC will need to adopt an aggressive rate cutting stance in 2025. The Fed’s new fascination with potential pent-up demand is coming at exactly the wrong time.

Excesses Abound

1. ? Short term: Andy Constan shows that professional long only managers are highly geared up in both stocks and bonds in a chart spanning the last five years:

2. ? Long term retail holdings: proportion of household balance sheets in equity exceed the levels at the 2000 top.

3. ? Long term Valuation: John Hussman calculates a valuation measure that just exceeded the 1929, 2000, and 2022 extremes this week. Hussman’s metric is the market cap of U.S. nonfinancial companies divided by gross value-added including income from abroad.

This chart puts the extremes displayed in the two prior charts in perspective.

Hussman found that since the January 2022 peak in his indicator, all excess returns over T-Bills came between August 5 and now. This fits with the Pave model factor scoring that earnings and price momentum have turned up recently.

We are looking at the market as vulnerable but not necessarily a sale today.

What matters to us is to categorize the drivers of this rally and look for defensive factors to begin to percolate higher before cutting risk down dramatically. It is paramount now to use the technical guidelines discussed in the Markets section below to guide hedging behavior. ?

Hussman aptly quoted from Graham and Dodd from their 1934 book, Security Analysis:

The “new era” doctrine—that “good” stocks were sound investments regardless of how high the price paid for them-was at bottom only a means of rationalizing under the title of “investment “ the well-nigh universal capitulation to the gambling fever.

Then as now,

The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd.

With the important conclusion,

…making money was now the easiest thing in the world…buy “good” stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic.

‘Nuff said.

Markets:

Equity Market: Different sized watches

Weekly Trend: Bullish

SPX Focus

120-Minute Chart: Ending diagonal formation. The circled area in the chart below is a standard throw over above the converging trendlines. Bullish above 5895-5901 resistance targets, bearish below 5845 in the shortest term.

I had mentioned last week that “A breakout above 5820 initially targets 5845 with 5880 above” and the high for the week was 5878.50. Any downtrend needs to be confirmed by a move below 5765, with the major pivot sitting at 5674.

Sentiment and internals are problematic with the S&P at all-time highs: Investors Intelligence bearish sentiment went below 30%, the 5-day put/call ratio fell below 0.7 and High Yield vs. Investment Grade spreads are not making new lows, nor has the VIX. Importantly, the NYSE Net new 52-week highs and lows measure has been falling all month.

SPX Wide Lens

1. ? ?Monthly: The longer-term chart continues to move higher, bound by the support line and the upper Bollinger band, which was the intention of my buy and hold trend positioning model.

No sustainable bear market unless and until a flip to a red bar below lower support (a flip to a monthly sell signal on my trend model).

Elliott wave objectives are also listed in the chart above: the lower target was hit at 5870, closing just below at 5864. The higher target sits at 5910, just above the aforementioned 120-minute resistance zone at 5895/5901, so a cluster is forming at various time increments.

I have been mentioning 6000 ever since the August 5 low, and I have noticed many sell side strategists are also looking for that number to be hit for year end. The contrarian in me thinks that we either blow through there toward 6100, or not reach it all.

2. ? ?Weekly: The key level is still 5674, but if the 120-minute support at 5845 is broken, given the small range last week, bulls want to keep it above 5830, 5815 and 5805 in the near term. Stops will be set below last week’s 5805 low, so on any break below, there must be a daily close back above there as the first sign of sustained demand.

5725 support also will bring in selling upon a break below.

3. ? ?QQQ weekly: small range for the week closing near the open .Selling comes in below 487.50 and intensifies below 485.50.

QQQ closed within two points of a new closing high (July 2024 high 496.16), so a move above there is a bullish signal. 497.75 is where the rally from the March 2020 low ended when measured off the October 2022 low. That is an extremely important price level that was exceeded in July 2024, but never closed above there. Bulls need to push through that level. The equivalent NASDAQ 100 level is 20,433.

China Weekly Preliminary warning

A continued reversal lower this week is dependent upon no new stimulus measures. The Chinese MOF press conference did discuss a large debt swap to help local governments. However, the red triangle (overbought momentum sell signal) triggered last week, which puts me on high alert.

The weekly MCHI (MSCI China ETF) chart did bounce nicely on Friday after better-than-expected economic data, but is on a weekly and daily trend sell to add to this potential topping signal.

Fixed Income: Failed to reach the downside target

Weekly Trend: Bearish

Weekly trend model continues bearish: The Weekly Ten-Year Note yield chart below shows an inside week maintaining its a blue bar (trend model projects higher yields).

Stay short bonds but because the daily model is stretched, yields need to stay above 3.95% to press positions next week.

Crude Oil: Overlay of USO and WTI Crude Futures

Weekly Trend: Bearish

USO crude oil ETF monthly has been consolidating with a narrowing range. Crude futures could not maintain its bullish weekly trend. WTI futures closing monthly chart overlaid in black line. The chart is noisy, but the signal is clear:

USO’s triangulation diverges from crude due to the negative carry that gets taken out. USO closed at 71.50, and trendline support is at 67.50. Crude closing chart shows that the market must avoid a close below the 2021 and 2023 monthly closing lows.

The daily 9-month forward spread chart bounced in September and early October near the 2021 extremes but is now failing again:

I noted last week that “A break above $78 is needed to continue the trend reversal that has occurred this week.” Crude opened at $75 and that was the high for the week and it later reversed back below the $71.50 pivot, closing at support near $68.50.

Upcoming $67.50 trendline support for next week is key. $69.50 is the first sign of a reversal within this bearish environment.

.

Best,

Peter Corey

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