The Week Ahead: What Follows the Unbelievable Week in Equities?

But it had a lot to do with what was going on with treasuries in the bond market. That's your domain. So I'm going to say recap for us what happened and put some context around it before we talk about the key happenings for the coming days.

Lenore Hawkins  00:38

Yeah, last week was a I think the only thing that really ended up a good bit was the VIX. Volatility was about 20%. On the week, everything else had a really tough time. And like you said, that was that was really driven by what was going on in the bond market. And ironically enough, overall, said I wouldn't say they had a great week. Powell was testifying before Congress this week, this past weekend, he told them that, while he believes that inflation remains soft, and that the our economic outlook continues to be highly uncertain bond market didn't really believe him. The day after, though

Chris Versace  01:16

No, it called total BS on what he had to say.

Lenore Hawkins  01:20

It really did. The day after that the seven year Treasury auction may have just been the worst seven year auction in history, it had the worst coverage than again, the data does to be fair only go back to 2009. But it resulted in dealers taking on more than they ever have in the past eight years. That means investors didn't want to buy the bonds. That's the exact opposite of what Powell said just the day before on Wednesday. Then he also said that rising rates were a good sign and that the economy is recovering. Now, raising rates can be a good sign, because it can mean that the economy's recovering. But when you look at Thursday's auction, and what was going on in the market this week, it really is not saying that things are great. What it's saying is that the economy, the investors are worried about inflation, not about economic acceleration. Well,

Chris Versace  02:12

Let's let's talk about that, because we got some economic data last week, that continued the trend of what we've seen for the most part, which was stronger than expected, you know, the durables, orders numbers, even though core capital goods wasn't as strong down ticked in January from December in a couple previous months, the overall headline figures, again, for the most part, were stronger than expected. And I think what you're seeing is investors getting a little worried, right, that the economy is, you know, heating up, we're gonna throw 1.9 trillion potentially in stimulus on top of that, combining with the inflationary data that we're already seeing whether it's, you know, we talked about this previously, you know, shipping costs, lumber, chips, and a variety of other things. And I think, correct me, usually this is your domain. But even alongside the personal income and spending data for January, the PC index came in a little hotter than expected.

Lenore Hawkins  03:09

Yeah. And that's let's dig into that a little bit. Because there's, there's some hard facts about what happened in 2020. That I think we need to keep in mind. Now, overall, in 2020, real GDP contracted 3.5%. Now, that's the worst the economy is performance, going all the way back to 1946. Employment dropped nearly 6%, it was the biggest crash in employment since the Great Recession, yet real personal income Rose 5.1%. Now in a normal year, that's around 2.5%. So we had the worst economic crisis we've had since World War Two. And real personal income came in twice as strong as a typical year and was the strongest we've seen in the past 20 years. What's that all about? Well, that's a real, yes, real personal transfer payments from the government rose nearly 40%. That's more than triple what we've normally seen in past recessions. So keep in mind when we're looking at this spending, this spending is because of government taking money from one part and giving it to another. Now what does that mean? That means that the US economy is super, super levered at this point. And we all know that leverage can be great on the upside and pretty nightmarish on the downside. So when we think about inflation, and you think about those rising interest rates, consider that the US economy has never been so vulnerable to changes in interest rates. At this point, every 100 basis point increase in rates is going to pull another 800 billion. That's about 4% of GDP out of the economy just to service the debt. So when we think about this inflation and growth, you can't separate the two from each other because the economy is so levered more than we've ever seen before.

Chris Versace  04:57

And I imagine that those higher rates are going to impact refinancing down the line as well. Because I mean, if we think about this kind of game it out a little bit rates, as far as we know, are probably not going to head back to where they were. Right?

Lenore Hawkins  05:13

At least, that is? Well, that is the big question. Because Powell is under the impression and the market so far has been thinking it Oh, the feds got your bet the feds got your back. But something very interesting happened in Australia this week as well. On Wednesday, Australia's central bank said Okay, enough of this with the rates rising, and they went in, and they bought as many bonds on Wednesday as they did any time during the pandemic and 2020 during March of 2020, when things are really hitting. So they went in and they did basically what we what they did when the you know, the world was falling apart because of the pandemic. And at the end of the day, their 10 year went up 11 basis points. So that means the bond market just totally imploded on itself. And Australia central bank was not able to stop raising rates by buying. So that is something to be to be watching because the Fed may not be able to have control of this.

Chris Versace  06:06

So when you hear Powell say during his testimony in front of Congress this weekend, this is a direct quote, by the way, the Fed will continue to increase our holdings of Treasury securities and agency mortgage backed securities, at least at their current pace, until substantial further progress has been made toward our goals, that tells you they're not backing off.

Lenore Hawkins  06:27

Now, they're definitely not backing off, but isn't going to be enough. I mean, at some point, all of his buying, you start getting diminishing returns. For example, the US Treasury now owns about 25% of all outstanding tips. Those are the inflation protected bonds. That's up from about 8% at the beginning of the year, when the Federal Reserve owns a quarter. Wait a minute, wait a minute, wait a minute, that's telling you anything,

Chris Versace  06:51

Wait a minute back up 25% compared to 8%, at the beginning of the year,

Lenore Hawkins  06:57

At the beginning of 2020.

Chris Versace  06:59

Okay, okay. I mean, still high. Don't get me wrong.

Lenore Hawkins  07:05

I mean, that's there's there's no market. So So I think what, you know, wrapping it all up, what we're seeing is that the Fed as we saw with Australia, the belief that the Fed can advantage can manipulate can control the yield curve and rates that started to come into question today. It did during the crisis in March, April of 2020. It's happening again, right now, this is something to very much pay attention to. Now, every time that this has been questioned before and things have gotten wobbly, the feds been able to come in and just wall up and we returned back to you. Yeah, Feds got your back. At some point they won't be able to and every time that they have to do these wallets, it's getting closer and closer to that point, because each wallet becomes marginally less effective, right because they've already got so much that they own. So this is something to definitely be keeping an eye on. But if we look over all at the market, pretty much every other major indicee ended the week down lower. The Dow which has been kind of grinding higher since November, it swung again wildly on Friday, close near the lows, trading just around its 50 day moving average. The risk of a pullback here and for the NASDAQ as well is is definitely on the rise. The Nasdaq pulled back to IT support and the march up from the the march uptrend that both intermediate and short term momentum rolling over for the NASDAQ composite. So all of these guys are starting to look wobbly, which is not not unsurprising given how overbought things have been.

Chris Versace  08:40

So when you look at that, I think a lot of people have been pointing towards the impact of higher rates headwind for the market, and taking maybe a little more than the froth out of technology companies and the thinking is that they continue to borrow in order to finance their growth. It'll be incrementally more expensive for them. But what are your thoughts about homebuilders? automotive companies, because mortgages and auto loans are also based off the 10 year and the 10 year is popped up. And again, you've done this better than I something like you know 50 Bips just in 2021 alone. Does that kind of cool off those markets as well.

Lenore Hawkins  09:16

I think it cools off those markets. The question is, is this going to be is the is inflation a real concern now in the beginning of the year, first first quarter second quarter, we're going to have some really bad bass effects because everything crashed last year right so compared to last year, everything this year if it's just barely okay is going to look like it's, it's going gangbusters. The the real question is, can you get inflation going when you have a massive output gap, right? So our ability to produce stuff is still way above the amount of stuff that we need to produce when you've got such high levels of unemployment. And when you've got potentially some really solid, long term unemployment problems, right? Because we've seen so much shifting to automation. And when all of this growth and I'm doing a little air quotes on that that growth has been because we've been borrowing money, just to put money into people's pockets and not to build anything that would then become your investment that produces things going forward. We've just basically the government has been putting money on the credit card to go spend today. And that all that debt does pull growth from the future. And as the economy starts to keep going, and those rates start to come popping up, like we said, it's so such a levered economy, does that then basically slam the brakes on the economy and we don't really get the growth and you don't get the inflation because you just start you everything just comes to a grinding halt again. So those are the two schools of thought. One is that there is so much debt that getting that inflation, the one thing you would like, right? Because when you have massive amounts of debt, you love inflation, makes that debt cheaper, that that may be the one thing we can't get.

Chris Versace  10:59

Okay, and just circling back to that personal income and spending report. Yeah, I was shocked that the savings rate popped to like 20% and we saw a huge pump in January in disposable income. Does that get you a little excited? Perhaps the consumer can has more money to spend in the next couple months.

Lenore Hawkins  11:21

Not when you've got employment where you've got it and not when so much of what we see in the economy has really been perverted meaning moratoriums put on evictions for renters and foreclosures for mortgage holders. Right We don't really know how bad the carnage has been. And all of these transfers have been hiding and and you're not knocking it this was this was clearly something people are are struggling in. We needed people to really eat and stay in a home. But we don't really know how bad the carnage has been from the lockdowns and how much damage long term right? How many restaurants are never coming back. How many small retail locations are never coming back. That all dictates what the growth trajectory is going to be going forward. We have no playbook for this. We've never seen anything like this. And I think the optimism is perhaps a bit overzealous.

Chris Versace  12:20

Okay, so Was there anything else that caught your eye for setting context and setting the table what we're going to focus on in the coming week?

Lenore Hawkins  12:28

Yes, I think one other one to keep an eye on in the coming week. And going forward. One of the big concerns as we look at future growth is the likelihood of increased taxes. And this week, Yellen, Janet Yellen had a she had a real banner week for me. She told the G 20 finance ministers that the DC is going to drop a contentious part of her proposal for reforming global digital taxation. And what that basically has been is the US has said, we're not playing game with putting taxes on the operating profits of our big tech companies. and Europe was not happy about that, obviously, they want to put more taxation. So that's been a big battle back and forth, the Trump administration was not really willing to work with the G 20. Looks like this administration is going to be so here we go with, okay. The US is clearing away for taxes, which means that's another expense for these big tech companies. And that's just one more example of taxes, because at some point, all this debt is going to mean we have to increase taxes somewhere. And that's going to mean lower profits. And that means lower future growth.

Chris Versace  13:39

Now, there was something else you were telling me about Janet Yellen, I think you were kind of, you know, saying like Janet, what are you thinking?

Lenore Hawkins  13:46

Yeah, about something. Last week. So Wednesday, it was really interesting Wednesday, she said that the US fiscal position is in great shape. And as evidence of that, she said that the interest payments on the national debt as a percent of GDP are below where they were back in 2007. Well, that sounds fantastic, great. Like we've put massive amount of debt. And it's fine because interest payments as a percentage of GDP are much smaller. Okay, so I heard this and I thought, Wow, that sounds an awful lot. When Bernanke he assured us that the subprime mortgage crisis was contained, right, frankly, with all due respect, what the hell's she thinking, if you include not just the interest payment on the debt, but those portions of payments that the government has to make entitlements, we're talking Social Security, we're talking Medicare, these are things that you cannot really cut. Those are, those are kind of like debt like obligations, we can't stop paying them. If you put those two together, US payments, interest payments are already past the point of no return there. Roughly 100% of tax receipts, so 100% of what the government's taking in through taxes is already going out to either service the debt or payments for things that you really can't cut Medicare, Social Security and so on. And for those people who want to get a visual of this,

Chris Versace  15:06

I suspect they can go to what I call the scariest page on the internet, the US debt clock.org. And it kind of kind of lays it all out for you. guts. Yep. So it sounds to me that, you know, for the week ahead, where we're gonna get, you know, some key economic data, we'll talk about that in a second, we got, you know, additional earnings as well. But it sounds like the real headwind for the market, the real focal point possibly is going to be the balance between equities, stock prices, and continued movement in the 10. year Treasury.

Lenore Hawkins  15:40

Yep. And really, what this boils down to is, how much can the Fed control, manipulate and dominate the bond market? Well, you know, what, which has basically been the same question we've been asking since like, 2007.

Chris Versace  15:56

But what's different about it this time, and I just thought of this is that historically, there have been points in time, where Bernanke, Yellen, even Powell, had been able to jump on the market to get them where it's to get the market where it wants it. And as you talked about earlier, he did not work.

Lenore Hawkins  16:14

Yeah, exactly. And and there have been times like that, was it December 2019. When Powell was saying, No, no, we got this, we got this. And the bond market said, Oh, hell no. And they had to cut rates. Right. So this is the the Fed likes to stay on top of it. But are they going to be able to? Well, we're we're pushing up against their ability. Again, I'll see in the coming weeks, that is something to really watch, watch what the Fed is saying. And watch how the bond market is reacting, what's going on with yields.

Chris Versace  16:42

And when you say watch what the Fed is saying, it's not just what Powell has to say, right? It's also what the other fed heads are in their various speeches, and other publications, like, you know, the so to speak of transitioning for next week. So next week, we also get the Beige Book. So that'll be kind of interesting to watch and see what happens. But let me let me backtrack just a little bit. So you know, we are starting off a new month, March, it is the beginning of the beginning of the final month of the current quarter, which means that we get all that usual start of the month economic data, right. So key key things to watch over the next couple days will be the February IHS Markit, manufacturing PMI, as well as the same from ESM. A couple days later, we'll get both pmis for the services part of the market both for from sorry, IHS market, as well as ITSM. And then the other big, big report to watch is going to be the February employment report now. Now, when we look at that kind of stuff, we always say it's not just the headline that matters. It's the innards of the report. And well, from my perspective, because we're going to get the PMI reports before the February employment report, we're going to obviously dig into the the labor components. But we also want to dig into two other ones, New Order components just to see what what's it looking like, for the month of March. And then the second one would be annual commentary and the written report about inflation, or delays or anything along that line. Right. Anything to add to that,

Lenore Hawkins  18:11

And also looking at productivity, because with all this talk about inflation, and inflation killer is productivity, right? If you have productivity going up, it's harder to get inflation, right, because you're able to do more with less. Right, so I'll be looking for Thursday's productivity and unit labor cost report.

Chris Versace  18:31

Okay, cool. So and as we enter into March, hallelujah, we finally see that step down in earnings reports, thank goodness. So that'll be a little bit easier to digest them, but we're still going to get a number of them. What I will tell listeners is that over the next couple of weeks, we're going to continue to transition away from earnings reports and more towards investor conferences. And that means companies will be presenting and potentially updating what they're seeing with, you know, just a handful of weeks to go on the quarter. So those will start to take center stage. But let's talk about the earnings that are on deck next week on Monday. We've got Neo which is one of the Eevee companies out of China as well as zoom video. The big question on Neo is going to be how many models and units are they actually manufacturing and delivering? What are their price points for zoom video, we know zoom has been a darling as a result of the pandemic. What do they see in terms of their outlook and profitability? Tuesday, we've got a number of retailers everybody from Kohl's to target to Nordstrom to Ross stores Urban Outfitters. In many cases, well consumer spending and given what we saw on that personal income and spending report. Did they see a pickup in January like a lot of others have talked about also to how much was online and what did they see in terms of opening up more sorry, a greater portion of their physical footprint. What are they gaining out for the rest To the year. Another company that's reporting is Lumber Liquidators. Let's hear what they have to say about lumber prices and where they think the housing market is going. Wednesday, we've got some cybersecurity companies aka Splunk. But the one that I really want to hear about is daikon. They are especially contractor. They are the ones who are responsible for building all the 5g networks, at&t, Verizon, and the like that a lot of people are talking about, they really should see an acceleration in their business subject to some potential weather disruptions that happened earlier in the quarter. So their guidance is going to be crucial. Thursday, we've got Kroger, so we know that they're going to put up some good numbers because of the shift towards dining at home. I think that also helped Costco. Costco is reporting as well. Yeah. The key for Costco, though, is the membership income, right high margin for them. And it's really dictated by the growth in their warehouse footprints, or investors will want to listen to the expected capital spending plans for additional warehouse locations. We've also got Broadcom that's a known supplier for Apple. So we want to hear them confirm the 5g ramp cycle, as well as other insights for the iPhone. And then other than that, nor any other companies you get on your radar screen.

Lenore Hawkins  21:19

Now, the other thing to be looking at is the latest developments on the Biden stimulus plan, getting that sucker passed. One of the areas of concern has been including the $15 minimum wage, and mandatory minimum wage, and if you think about the if we if they force some more minimum wages. So what we talked about today has been an increase in taxes. right that the you've got taxes going up on the tech companies, you've most likely got the by the administration, not this year, but next year, probably going to increase corporate taxes. And this you can think of this minimum wage as another way to increase as sort of a tax forcing higher wage costs. Did you see what

Chris Versace  22:01

Costco did they raised their minimum wage to $16? Yeah.

Lenore Hawkins  22:05

Good for that and pull it off. Great for them.

Chris Versace  22:07

I know. I agree. I agree. I just don't see how a lot of other companies, restaurant companies in the light can can get away with that.

Lenore Hawkins  22:16

You're gonna see more and more automation.

Chris Versace  22:18

Well, it's either gonna be automation or another reason to think that inflation picks up over the coming quarters. I mean, that will be the question. Well, I mean, think about it, right? If, if they have to have How can they contend with pyre? Sorry, how can they contend with higher input costs, it's either reduce their, you know, reduce their cost structure for for prices. Yep.

Lenore Hawkins  22:42

I think that's a wrap.

Chris Versace  22:44

I think that's the week ahead.

SUMMARY KEYWORDS

week, inflation, economy, powell, growth, point, market, report, bond market, debt, real, fed, day, year, continue, rates, march, question, hear, companies