The Fog of War, The Economy, & Markets
Academy Securities
The Fog of War, The Economy, & Markets
September 1, 2024
Peter Tchir of Academy Securities, via ZeroHedge
I could be extremely lazy this weekend and just repost (with an updated chart) the Heads I’m Smart, Tails I’m Stupid report as the market continued to flip-flop around. On Friday alone, the Nasdaq 100 rose 1.2%, gave it all back, and then ended up 1.2% (with a good chunk of the gain coming in the last 10 minutes of trading). And that was somewhat “mellow” compared to the price action after some earnings reports. I continue to remain concerned that liquidity is abysmal, though maybe that will improve as we enter September.
But I won’t be totally lazy, though we will try to keep this weekend’s note short.
My First Wargame
Two weeks ago, I had the pleasure of attending and speaking at the Naval War College. I learned a lot about wargames, both from a historical perspective and regarding their current application. I did not know that Fleet Admiral Nimitz credited much of the success in the Pacific to the time they had spent wargaming (and that the main thing they had not prepared for was Kamikaze pilots).
Our wargame was centered on a theoretical blockade of Taiwan by China in 2027. It was very interesting to watch how the teams responded and how easy it was for miscommunication to occur, even in a small room, with no separation in time zones. I was part of the China team (almost as though the organizer had read a lot of T-Reports and felt that was fitting). Despite what seemed like efforts to deescalate, it was eye-opening to see how easy it was to slip into escalation as one nation’s “deterrence” was another’s “provocation.” The organizers of the wargame did admit that earlier in the month they had run the same wargame, mostly with economists, and it very rapidly descended into calling in aircraft carriers (the one I participated in had a mix of people, including many veterans).
There were a few recurring themes, none of which were a major surprise, but still warrant just a couple of moments:
• Military competition with China. From ships, where China is rapidly outbuilding the U.S., to “efficient systems” (expensive missiles vs. drones), to technologies that we’ve “shelved” (like hypersonic weapons to some extent), adversaries have advanced significantly, and there were a lot of warnings. Not necessarily alarming, but certainly a potential “wakeup call” if we continue on the current path of increased competition.
• Chips. The importance of chips and manufacturing technology came up over and over again, and it was touched on during every part of the symposium. The most informative part of the symposium (for me) was that one of the heads of the “foundry” effort for a major U.S. chip company spoke. The scale and size of what “we” need to do is enormous – the CHIPS Act is just a starting point in terms of funding. It is encouraging that there is support from D.C. for the chip industry that seems highly likely to remain in place regardless of who wins the election. On a personal note, I did get some confirmation of Academy’s theory that the “traditional industrial areas” of the U.S. will benefit as we get more serious about reshoring manufacturing.
• Water. The availability of water for any type of manufacturing activity is likely to be key, and much of the traditional manufacturing base has an abundance of water (as well as students graduating from technical programs). Companies need to be thinking about the possibility that at least some portion of the demographic shift that we’ve seen over the last decade will slow (if not reverse) as we re-industrialize the nation. Maybe the rising inventory in homes for sale in Florida and Texas is a sign that this “pet theory” is starting to occur?
Whether we need a “Man on the Moon” or “Manhattan Project” type of moment to rapidly grow our capabilities remains unclear. That sort of “national agenda” might not be necessary, but it would go a long way and seems to create a lot of potential for the next president to act.
The Fog of War and the Economy
The “Fog of War” describes uncertainty (and to some extent confusion) in military planning and decision making. It seems to apply incredibly well to the economy (and markets) at the moment.
• Inflation. We are done arguing that inflation is coming down and that the spike in the first quarter was a statistical anomaly. We continue to stick to our simple “COVID Bump” model where goods had a sharp spike that has largely declined already, and that the services sector took longer to ramp up to “peak” inflation, but is also coming down. The real question now (since so many seem to finally have given up on inflation resurgence fears) is what is the floor on inflation? We have argued that Geopolitical Inflation will provide a floor on how low inflation can go. The process of “securing” supply chains, in a variety of forms, will be inflationary. The geopolitical risks to commodities will provide a floor to inflation. I’m starting to question that assumption, as the efforts so far to reshore, reindustrialize, and expand both traditional and nontraditional energy sources have been slower than I’ve expected. While I’m not there yet, I’m starting to think that the 2.5% crowd (which I’ve been in) might be too high and that we could see further reductions in inflation as more products become deflationary.
• The Consumer. The consumer will have a great say in the inflation story, but it is incredibly difficult to figure out where the consumer stands. For every good data point on the consumer, I’m pretty sure that we can come up with a weak data point. The data has been mixed. The consumer credit side of things seems the weakest. The current spending seems the strongest. I’m still leaning towards a slowdown in consumer spending, largely based on the view that the recent sales pulled forward demand and this caused the strong spending so far this summer, which will slow as we enter the autumn.
• Jobs. What to do with Friday’s NFP? One of the favorite activities of the T-Report (and hopefully a useful one) is examining the data for consistency. Are headline numbers consistent with the internal details? What things (like birth/death) seem off? Are we seeing consistencies between a variety of metrics, all purporting to measure the same thing, like JOLTS, AFP, and the Household and Establishment surveys (let alone the “employment components” of various other surveys)? The market is going to have to digest the preponderance of evidence on jobs this week! Will the market still react to the headline NFP data on Friday? Sure (and I will be on Yahoo Finance with a longtime friend and excellent economist to give our instant reaction), but for how long? Not only has the bias been towards downward revisions on a monthly basis, but also the annual revisions were quite high. The estimates (on Bloomberg) ran from a high of 208k to a low of 100k (ignoring 2 “outliers” the low is 125k). The average is 162k, with a median of 165k. But how do we react to a number when the “doubters” (I won’t call us conspiracy theorists) turned out to have a valid case? My order of importance on jobs this month will be:
o Unemployment Rate. While this number is fraught with so many issues, it will likely be the biggest driver. If it improves, does that take the Fed off the table, and maybe reduce the flood of “Sahm Rule” hot takes? If it gets worse, but only due to an increase in labor participation, is it that bad? Not my favorite metric by any stretch of the imagination, but probably the most important.
o JOLTS Quit and Hires rate. To some extent, I view this as “crowdsourcing” the labor market. People have a good sense of how easy it is to find a job and how likely their company is to let them go (long before the company lets them go). So given all of the uncertainty, I will overweight the importance of this data in my analysis on jobs.
o ADP. I often wonder, given their dominance in the payroll business, why their data isn’t the “gold standard,” but it just isn’t (or hasn’t been). The fact that they didn’t publish for a period of time while changing their methodology isn’t particularly helpful either. But, I will spend more time than usual on ADP and suspect that the market will react more than usual as well (jobs are clearly the main Fed concern) and with the big revisions to NFP, more people will look to this data than usual.
• Don’t chart any economic data from January 2020 until September 2023. That is probably a bit extreme, but I find ignoring economic data from January 2020 until at least December 2022 is quite useful. We had a reasonably “normal” economy in 2018 and 2019. I want data that goes back at least a year (hence September 2023, though we could go back as far as January 2023). This analysis gives me a better comparison between “steady states” and is more helpful than including data that includes COVID and all the COVID responses/repercussions. It also makes smaller moves in the current data stand out more, as they aren’t dwarfed by the moves in 2020.
Understanding the current state of the economy is difficult enough with the data we have, let alone when we really start to question the accuracy and timeliness of the data.
Given all the uncertainties, I’m still in the “bumpy” landing camp. Not a hard landing, but an economy where the data, over time, shows that both the job market and the consumer are slowing. Not necessarily to recession levels, but to levels that make current valuations questionable.
Bottom Line
8 rate cuts in 8 meetings is too aggressive, unless the data slips to worse than “bumpy.”
• “Normal Yield” curves. I have to assume that every major news outlet has their finger hovering above the send button on a story about how the yield curve is no longer inverted, and I expect they will get to use that soon. 2s vs 10s closed at -2 bps on Friday, and I think that should drift towards 20 as we near the election (if not sooner). The 10-year yield has remained stubbornly below 4%, but the fact that we sold off on Friday, despite good inflation data and the normal “month-end extension” that typically helps bonds, means we can see that get back above 4%.
“Rotation” trades should continue in the equity space. The setup seems similar to last November where we developed consistent outperformance rather than the “crazy” moves we had for a couple of days last month.
Credit. I remain comfortable with credit as my concerns are far more about “valuations” than they are about any deep cuts to earnings and growth (bumpy isn’t the same as recession).
Liquidity remains my number one fear and I think it continues to create asymmetric risk, where moves to the upside are bigger than normal, and moves to the downside will be bigger than normal on steroids!
Normally, we’d be welcoming everyone back to “normality” after a “slow summer,” but this summer was anything but slow.
Trust but verify might be the best motto for all data in the coming weeks!
Bonus: ING on Oil
