Economic Commentary from Crista Huff: April 17, 2023
The following is an excerpt from correspondence that I wrote for my hedge fund clients on April 17. I’ll start making economic comments on Substack more regularly.
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Amidst high inflation, rising interest rates, falling corporate earnings, bank failures, credit contraction, and instability in other investment markets (bonds, bitcoin, oil, natural gas), the U.S. stock market continues to ratchet upward since October. I feel like Michael Burry in The Big Short: the guy who foresaw the collapse of the subprime mortgage market but had to wait until the rest of the financial world caught up with him before greatly profiting from that market's downturn.
Today, JPMorgan commented in correspondence with clients that the stock market rally is "irrational" and "likely running out of steam". Michael Wilson, chief U.S. equity strategist at Morgan Stanley, concurred in comments today as well, "If there is one thing that can throw cold water on the large mega-cap rally, it’s higher yields due to a Fed that can’t stop hiking." He forewarned of "more negative surprises in the coming months." And Jonathan Baird says that the U.S. equity risk premium is down to levels last seen before the 2008 financial crisis, "which reflects the highest level of implied bullish sentiment in many years". Baird says that the most likely way that extreme situation can correct itself is via "a sharp decline in stock prices."
The volume of corporate bankruptcy filings last peaked in mid-2020 when government-mandated lockdowns caused hundreds of thousands of U.S. businesses to fail. The pace of business bankruptcies and closures then subsided, only to be re-triggered in late 2022 by the costs of persistently-high inflation and rising interest rates. (When it costs more to buy products for a business, and costs more to borrow money, not all businesses will have extra cash flow available to accommodate those expenses.) Monthly corporate bankruptcy filings are now above pre-pandemic levels and approaching pandemic peaks. Read more here.
The recent surge in job layoffs continues. On April 4, two large companies made headlines with new job reductions. General Motors announced that 5,000 salaried workers will take buyouts, which will generate a $1 billion charge against first quarter 2023 results. CNBC reports, "the headcount reduction was part of the company’s plans to cut $2 billion in structural costs over the next two years." UBS Group AG bought Credit Suisse Bank for $3.3 billion after Credit Suisse's recent financial troubles. UBS is now cutting 40,000 jobs, which represents 32% of the merged company's workforce.
People are wondering whether there will be more bank failures. My guess is that additional bank failures are inevitable due to interest rate risk affecting bond values. (Can credit risk be far behind?) Investment personality Kevin O'Leary stated on April 16, "Liquidity for loans has completely dried up in the past few weeks, you cannot get any capital." What are the odds that the majority of banking fixed income portfolio managers across the country knew how to handle the surge in inflation and the ensuing increase in interest rates? While I was prepared for this sad situation to worsen, here's what I wasn't prepared for. Earlier this month, JPMorgan Chase Chairman Jamie Dimon remarked that the Fed's annual stress test for banks never incorporated interest rates at higher levels. Whoa.
On April 2, OPEC (led largely by Saudi Arabia and Russia) surprised the world by announcing a production cut of one million barrels of oil per day. Oil prices immediately jumped, with West Texas light crude oil up 8.5% and rising since the announcement. Be aware that recent improvements in inflation numbers were heavily influenced by falling energy commodity prices in March, and that trend has completely reversed.
The March consumer price index (CPI) report seemed, initially, to bring good news. The "all items" index rose 5.0% in March vs. an increase of 6.0% in February. However, the "all Items" index will likely rise again in the April report as a rebound in energy commodity prices and ongoing interest rate increases should negatively affect the cost of goods and services.
Additionally, the March "all items less food and energy" index rose a bit to 5.6%. That's the CPI number that the Fed pays closer attention to. One of the components of this index is "shelter" - think "rent" - which is up 8.2% year-over-year and relentlessly rising month after month. For many Americans, rent is their largest monthly expense. Very few of those Americans received an 8.2% salary increase in the last year, which means that their budget now covers less of their basic expenses than it did in 2022. As a result, people have less money to spend, which was reflected in the weaker-than-expected retail sales report on April 14.
People contact me almost daily, asking about a pending "currency war with China". I'm not an expert in this area. However, I can state with fair certainty that if major global countries, such as China, Russia, Iran and/or India, forego trading in U.S. dollars, that can't be a good thing for U.S. investment markets, the value of the dollar, and our economy.
There is no identifiable good news that would logically cause U.S. stock markets to rise, and I therefore cannot responsibly buy stocks for the upside. I am maintaining a bearish position on U.S. stocks, against the tide. When U.S. markets finally fall, reflecting very poor economic realities, Freedom Investment Partners LP should theoretically deliver strong performance.
The Freedom Investment Partners LP portfolio, which changes daily, is currently allocated as follows:
21.5% money market fund (yield approx. 4.3%)
9.0% U.S. Treasury bills & notes (maturities 3-14 months; yields 4.6-5.2%)
3.0% AAA-corporate bonds (maturities 1-14 months; 4.3-5.3%)
7.3% Dow Jones Industrial index ETF (bearish)
8.6% S&P 500 index ETF (bearish)
6.3% Russell 2000 index ETF (bearish)
15.2% U.S. Treasury bond ETFs (bearish)
5.0% Energy sector ETF (bullish)
3.4% Financial sector ETF (bearish)
0.9% Financial sector stocks (bullish)
7.4% Real Estate sector ETF (bearish)
9.1% Technology sector ETFs (bearish)
3.3% VIX volatility index ETF
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Crista Huff is a hedge fund portfolio manager who writes on many topics, including politics, economics, investment markets, healthcare, child-rearing, gardening, Christianity, sociology and psychology.