The Wall of Money

A brief follow up to yesterday's post

In yesterday’s post, I laid out how the Fed’s dovish pivot likely provides much fuel to a nascent industrial recovery, which lead me to increase my exposure to commodities in its wake, which sit at the nexus of an early cycle economy and dovish central bank policies

With some feedback questioning the relevance of said Fed decision, I want to share a few more charts with you to follow up. These speak a simple story:

• As we know, over Covid-19, the US printed trillions of new US dollars. Subsequently, the Fed raised interest rates sharply to corral these into savings rather than spending that drives up assets prices and fans inflation. That effort was successful, recent core inflation tracks around 2-3% and is bound to drift lower

• In response, the Fed has indicated its policy pivot and guided to several rate cuts in ‘24

Now, if you give the market a hand it will take the whole arm. Bond yields collapsed and the $5.5 trillion US Dollars parked in short-term Money Market Funds yielding 5.3% sits on a ticking clock. Its owners will try to front run this policy change by rotating into higher risk assets with presumably higher returns

• NB: There is no cash “on the sidelines”. If someone retires a MMF cash holding to buy bonds, stocks or real estate, someone else will receive that cash. It is about the change in people’s intentions. If there are more bidders for the same amount of available assets, their prices will go up

As discussed yesterday, I think US residential housing will be a key beneficiary of said search for assets. Indeed, even before the FOMC’s Wednesday seminal news conference we saw a spike in mortgage refinance applications, which is bound to continue with the meltdown in yields

With its actions, the FOMC has significantly diminished the recession risk for ‘24

• US consumer spending is highly correlated to the stock market, which has been on a tear due to lower bond yields. The odds are high it continues. Housing is a key swing sector that will bring much adjacent goods activity with it, from washing machines to pick up trucks. Fiscal spend will continue to be supportive

Even for Q4, real-time GDP estimate now look rosier as strong November retail sales (likely in response to higher stock prices) push the AtlantaFed’s growth measure back up to 2.6% (real)

Thus, a re-acceleration of inflation seems more likely to me than a recession, but that will take time. First early input prices need to rise (commodities!), to translate into higher corporate cost and eventually higher consumer prices. This is a multi-quarter process, and as with anything around the economy, it could also not happen, there is no certainty

• Until inflation ticks up again, it is likely that the Fed sticks with its plan and cut rates as otherwise policy would be too restrictive in their view. After all, today’s CPI prints originate from an economic context 1-2 quarters ago, so softer readings are likely still ahead

Conclusion - Trillions of Dollars parked in MMFs looking for a new home and a US recovery well supported by lower bond yields make it likely that any dips in asset markets get bought, either until:

• The boat is entirely full - the most likely case in my view, with a blow-off top in the near future, say between now and January 19 Vix expiry

• Inflation readings increase - not likely any time soon, unless oil prices go parabolic (>$90-100bbl+)

• Policy changes - low likelihood unless inflation readings increase

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What does this mean for markets?

The following section is for professional investors only. It reflects my own views in a strictly personal capacity and is shared with other likeminded investors for the exchange of views and informational purposes only. Please see the disclaimer at the bottom for more details and always note, I may be entirely wrong and/or may change my mind at any time. This is not investment advice, please do your own due diligence

As mentioned yesterday, I have shifted my exposure mostly to commodities and related equities in the FOMC’s wake. Further:

• I added some levered consumer discretionary names which should benefit from an improved consumer outlook

• I bought some exposure to a certain automaker with AI capabilities that has been lagging its large cap Tech peers significantly and in the past often caught retail attention

• I bought some out-of-the-money S&P 500 call spreads for Spring expiry

• Finally, I have left some cash to buy dips, should the market provide them, and look to onload some equity exposure again should we indeed see a blow-off top moment before the mid-January options expiry, until which flows should broadly remain supportive

Thank you for reading my work, it makes my day. It is free, so if you find it useful, please share it!

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