Random Walk

“Some things there’s no moving on from. And I think that is a good thing.”???

???????????????????????? ???? --The Banshees of Inishirin??

??

Aliens and AI may have taken control of the stock market and set the dial to Schizophrenic.??

??

Key takeaways:?

• Markets have their own individual character; we now find ourselves in a flip to a risk-on or risk-off?view based on just one Fed comment or data release. ?
• Traders are reacting to single points of economic data as if it is the most essential information they are ever going to receive. Ironically, data releases are becoming less, not more reliable due to seasonal adjustments, revisions, and lower survey response rates. ?
• Zero days to expiration options (0DTE) magnify the swings after any given data release, and that price move continues throughout the day. This reinforces the view that the news of the day is a shift of significance, but it is just being driven?by hedging activity or speculation.?
• The Fed is contributing to these swings. Some Fed members are discussing 25 basis point hikes at the same time others discuss 50 basis points. Instead of Listening to Fed Rhetoric, we think it is better to focus on their balance sheet.??
• Unexpected US Dollar strength could be the biggest danger for the markets.??

Notables:??

• Fed Trifecta—sell side firms’ consensus is for three 25 basis point hikes at the March, May, and June FOMC meetings, bringing the target rate to 5? - 5?%, In just one month, the expected funds rate for December 2023 jumped from 4.75% to 5.25%.?
• Consumer debt burdens are growing too fast and may be reaching critical levels. Consumers' average monthly debt payments were up 10 pct y/y in December, and this is occurring as real incomes are falling. As a result, non-mortgage consumer debt payments as a percent of disposable income are at the highest level since the Global Financial Crisis.??
• Nonvoting hawk Bullard brought up front-loading a 50 bp hike, something he has been proposing for quite a while to no avail. Nonvoting hawk Mester suggested she would have dissented at the last meeting, opting for a 50 bp hike. We believe voting member Harker describes the FOMC’s prevailing sentiment when he said, “I do think we need to continue above 5% in 25 bp increments for a while”.??
• Asian inflation continues to be a problem—Australian CPI continues its climb to new highs near 8% and tends to lead Japanese inflation by one quarter. Japanese wage growth has already risen to a level not seen in over 25 years.??

???

Freud et al. Dept: Schizophrenia is a disintegration of the thought process, and that is an apt description of the market, but the blame may rest with the Fed. The proper diagnosis is the Fed, and the markets are suffering from myopia. There has been a developing theme of taking a shorter and shorter window of data points to make long term forecasts:?

• A mild winter now means Europe has gone from a devastating recession where factories were expected to halt manufacturing to a new world order of sustainable growth. However, the energy story has yet to be written as the situation remains precarious.?
• China changes their lockdown policy, and capital rushes in to catch a robust growth rebound. Meanwhile, there are shockwaves going through tech and investment circles upon the disappearance of dealmaker Bao Fan and factory workers are still reluctant to return to work.??
• The Fed appears to have dropped any discussion about the long-term lags of monetary policy and replaced it with a reliance on more volatile headline inflation and one-year inflation expectations. The Fed seems to think that consumers have become myopic as well and will anchor their long-term inflation expectations to volatile food and energy prices.?

With the Debt ceiling debate looming, we can only imagine how investors will scamper from one side of the boat to the other as headlines give hope for a compromise and then just as quickly reverse as the situation points to a government shutdown and imminent debt default. It seems hard to believe that the inherent volatility in shortsighted investment horizons will not depress valuations as visibility will diminish. Considering margin pressures will continue, lower stock prices should result.?

Longer-term investors can take advantage of the random nature of market conditions by waiting for major dislocations, a scenario in which we are growing increasingly confident.?

?

A little bit of data mining in my life (apologies to Lou Bega and Mambo No. 5)?

The liquidity picture has been helped enormously by drawdowns in the Treasury’s General Account. However, that boost to the markets is ending as we approach the debt ceiling “resolution” this Summer. Therefore, we think it is appropriate to revisit the Fed’s balance sheet, Quantitative Tightening (QT), and its potential impact.??

Below is a chart of the Federal Reserve’s Total Assets annual growth over the last 5 years. The data goes back almost 20 years on the St. Louis Fed FRED database, and before June 2018, there had never been an annual contraction greater than 3.5%. The yellow highlights around Sep 2018 and Feb 2023 show both periods had a 6% annualized reduction in the Fed balance sheet.??

Here is the chart of the daily close on the S&P 500 displaying the two dates when the Fed balance sheet reached a 6% contraction:?

In both cases, the markets rallied as balance sheet growth initially turned negative. The economic outlook in 2018 was favorable but the aggressive liquidity withdrawal impacted equities negatively. But why should the balance sheet continue to shrink as it did into 2019???

There will be increased reliance on QT due to the severe inversion between short and long rates. The steep negative yield curve may be the strongest argument against a 50 bp rate hike at any of the upcoming FOMC meetings. Continuing rate hikes will compress banks’ net interest margins even further—the Fed is aware of their own Senior Loan Officer survey that warned of weakened loan demand and tighter standards. The way to alleviate more lending pressure is to stop at 5? - 5?% targeted funds but continue tightening the balance sheet.?

The markets should care about following this 2018 path, as the 2018 analog projects to 3150 in the S&P 500. A lot of negatives must align for that selloff to materialize, but it is something we are going to monitor.?

?

__________________?

?

Regarding the markets, the 4080 S&P 500 support level was respected, as the lowest close last week occurred during Friday expiration at 4079. For the upcoming week, the risk remains for a drop to 4030 on a sustained break of 4080, but the longer horizon positive tone remains intact above 3980-4000. We continue to think the market is capped at 4300.??

From last week: “We are turning friendly toward fixed income at current rates. We are looking for a confirmation signal to begin purchases and will report back.” We did not get any buy triggers because rates moved higher. We may see a good risk return trade upon further weakness, but there are no clean oversold signals yet. Still watching.?

?

Note on Yen repatriation?

On March 10 BoJ Governor Kuroda could flip the short-term policy rate to positive and bolster the expectation for yen repatriation. Capital returning to Japan will reduce global liquidity and is expected to impact assets around the world. The price of the Japanese Yen will be the gauge for the repatriation process. The chart below applies a Japanese charting technique on daily USDJPY. The arrow is placed on March 10 and shows “the cloud” resistance is broken above 135.??

USDJPY above 135 by March 10th would signal non-consensus dollar strength. Bank of America reported the latest 3-month increase in emerging market equity exposure hit record highs, and the most overcrowded trade is no longer the US Dollar, but Chinese stocks (and corporate bonds). Continued dollar strength will result in EM underperformance (EEM/SPY has already given back half of its gains since the October lows). There is a danger of heavily overweight EM positions taking disproportionately large losses in a risk-off environment that are accompanied--or triggered by--Dollar strength. Forced position reductions could kick off a sharp selloff.??

In that case, 0DTE options are problematic, but the real risk could end up being the Dollar.??

?

?

Peter Corey?

PavePro Team?

??

??

? Copyright 2023 Pave Finance, Inc. All Rights Reserved Pave is an SEC registered investment adviser. Such registration does not imply any level of expertise by the registrant. Pave provides services on a non-discretionary basis. Clients are responsible for opening a brokerage account and placing any trades in their own account. Clients will also need to input their investments positions and trading activity in our application. The enclosed material is for educational purposes only, any client subscribing to Pave’s advisory services will need to accept the Term of Service and execute, by accepting, the Investment Advisory Agreement in the Pave application. Investing is speculative and involves risk, including the possible loss of principal. The information contained herein is provided for discussion purposes only, is only a summary of key information, is not complete, and does not contain certain material information about Pave or any of Pave’s affiliates and is subject to change without notice. The distribution of the information contained herein in certain jurisdictions may be restricted, and Pave may not be available in all jurisdictions.?

??

Unless otherwise indicated, the information contained herein is believed to be accurate as of the date it was produced. No representation or warranty is made as to its continued accuracy after such date. This material is not intended to be, nor should it be construed or used as an offer to sell, or a solicitation of any offer to buy, any securities or investment advice. No offer or solicitation may be made prior to the delivery of an Investment Management Agreement, which will contain additional information about Pave, including disclosures relating to risk factors and conflicts of interest. Clients will also receive ADV Part 2A, 2B and Part III (Form CRS). You should review all the material provided about the advisor. In the event of any discrepancies between the information contained herein and the Investment Management Agreement, the Investment Management Agreement will control. You should make an independent investigation of the investment described herein, including consulting your tax, legal, accounting, or other advisors about the matters discussed herein. Pave’s non-discretionary investment methodology may not be suitable for all investors. There can be no assurance that any investment objectives will be achieved. Investment losses may occur, and investors could lose some or all of their investment. No guarantee or representation is made that Pave’s investment methodology will be successful. Nothing herein is intended to imply that Pave’s investment methodology may be considered "conservative", "safe", "risk free" or "risk averse”. Economic, market and other conditions could also cause Pave to alter the investment methodology. Certain information contained in this material may constitute "forward-looking statements," which can be identified by the use of forward-looking terminology such as "may", "will", "should", "expect", "anticipate", "target", "project", "estimate", "intend", "continue" or "believe" or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of Pave’s methodology may differ materially from those reflected or contemplated in such forward-looking statements. Pave believes that the information contained in this material to be reliable but does not warrant its accuracy or completeness.?