Market Outlook

This transcript is a market outlook for the week. The speaker discusses recent events in the market and provides insights into what to expect in the future.

Recent Events

• There was a live Q&A session for the applied series that went on for two and a half hours.

• Over the course of last week, Equity Market is up 1.4 percent.

• The FED meeting resulted in an increase of 25 basis points on Wednesday, with the two-year delivering a cut of five basis points in response.

• The bond market is anticipating a recession as it believes that while they believe what FED says, they don't think they will be able to do it.

Capital Market Curve

• The Capital Market curve has been inverted for 263 days now but is expected to uninvert soon.

• When the two-year starts signaling a recession and drops quickly, we can expect Capital Market inversions to steepen while other curves will deepen their inversion.

• Money market inversions are getting deeper in their inversion, but Capital Market rates will begin to uninvert.

Next Meeting

• The next meeting is May 3rd, which is 38 days away. There are five risk factors before that.

Economic Risk Events and Fed Speak

The speaker discusses upcoming economic risk events, including CPI and PCE reports, as well as Fed speak. They also mention the Fed's concern about core services inflation.

Upcoming Economic Risk Events

• One more CPI report for March will be released in mid-April.

• Two more PCE reports are coming up: one at the end of this week and another at the end of April.

• May 13th will see the release of minutes from the March 23rd meeting.

Fed Speak

• The speaker notes that we will have most of the information from Fed speak before reading the minutes.

• Powell expressed concern about core Services X housing inflation, which is wage-driven.

• This week's Fed speak includes Jefferson on Monday, Bar on Tuesday (testimony on Capitol Hill), Barkin and Waller on Thursday, and Williams and Cook on Friday.

Interest Rates and Market Response

The speaker discusses interest rates and their impact on unemployment claims. They also talk about how a 25 basis point hike did not affect Capital Market rates or tighten credit conditions.

Interest Rates

• High interest rates do not cause unemployment; initial claims tend to fall as interest rates rise.

• The FED is paying 4.83% on deposits but only paying 4.80% on its reverse repo facility.

Market Response

• A 25 basis point hike did nothing to affect Capital Market rates or tighten credit conditions; it only affected FED funds rate and sulfur rate.

• Mortgage rates dropped 18 basis points on the back of a 25 basis point hike, suggesting that the market is not going along with this.

Fed Hike and May Meeting

The speaker discusses the possibility of a Fed hike and how it may not affect Capital markets. They also talk about what to expect at the May meeting.

Fed Hike

• The FED could hike wherever they want to, but it's not finding its way into Capital markets.

May Meeting

• If there is no good reason for the FED to pause after four upcoming reports, they may go for a 25 basis point hike.

• However, if these reports come in lighter than expected, there may be no need for a rate hike.

Interest Rates and Market Volatility

The speaker discusses the probability of interest rates remaining at 5, with a small chance of reaching 5.25. They also discuss the possibility of a rate cut in the future, but only if there is a clear recession.

Interest Rate Forecast

• There is a 72% probability that interest rates will remain at 5.

• There is a small chance that interest rates will reach 5.25.

• A rate cut is unlikely unless there is a clear recession.

Probability of Rate Cuts

The speaker discusses the likelihood of rate cuts and how they are affected by economic indicators such as jobless claims.

Likelihood of Rate Cuts

• A rate cut is unlikely unless there is a clear recession.

• Initial jobless claims typically start to climb before a recession.

• If something big breaks in the economy, such as another event like SVB, then rate cuts may occur.

Real Rates and Cash Flow

The speaker discusses real rates and their impact on cash flow in the equity market.

Real Rates and Cash Flow

• Lower real rates are supportive of higher present values of cash flow.

• The present value of cash flows has two components: numerator (cash flows) and discount rate (real rate).

• If there is a recession, real cash flows will suffer.

• The market seems to be pricing in lower real discount rates and ignoring cash flows for now.

Earnings Reports and Guidance

The speaker discusses upcoming earnings reports from banks and how guidance may be affected by recent events.

Earnings Reports and Guidance

• First Republic Bank will report earnings soon.

• Guidance will be important following recent events.

• Cash flows may need to come down.

• The market is pricing in a nice lower real discount rate and ignoring cash flows for now.

Fed Funds Futures

The speaker discusses Fed Funds Futures and how they are affected by market volatility.

Fed Funds Futures

• Nominal rates have dropped, but Breakeven rates have increased.

• The implied rate for May has increased slightly, while the implied rate for December has increased more significantly.

• Negative basis points suggest that the market is pricing in recession rather than fighting the FED.

Rolling Up Puts on TLT

In this section, the speaker discusses their plan to roll up their puts on TLT from 102 Aprils to 104 Mays. They also mention that they are waiting for Friday's PCE report to see how the bond market responds before making any moves.

Rolling Up Puts

• The speaker plans to roll up their puts on TLT from 102 Aprils to 104 Mays.

• They believe that TLT will be supported at the worst at 105/104 and will continue rolling up their puts as yields keep dropping.

• The speaker hopes to get some volatility when they roll up their puts.

Calculating Target Price of TLT

In this section, the speaker calculates a target price for TLT by year-end based on a target yield. They also discuss the total return and duration of TLT.

Target Price Calculation

• The speaker calculates a target price of $130 for TLT by year-end based on a target yield.

• To achieve a total return price of $130, there needs to be a price of $127.66 on TLT with distributions included.

• If the 30-year drops to three percent, we can expect the price of TLT to be around $118.58.

Total Return and Duration

• Year-to-date, TLT is up 7.56% in total return with a duration of 17.6.

• The change in yield on the portfolio is about 43 basis points, which improves the full value of the portfolio.

Thinking in Terms of Yield Target

In this section, the speaker discusses thinking in terms of a yield target on the 30-year instead of a price target on TLT. They also provide a chart showing the market yield on the U.S Treasury 30-year constant maturity.

Yield Target

• The speaker suggests thinking in terms of a yield target on the 30-year instead of a price target on TLT.

• By looking at the market yield on the U.S Treasury 30-year constant maturity, we can calculate a price target for TLT based on different yields.

TLT and OAS Analysis

The speaker discusses their perspective on TLT and OAS, including the theoretical change in price based on duration, recession levels, and credit market trends.

TLT Analysis

• The speaker is willing to roll up their puts for TLT as they don't see much more upside terrain rates.

• They believe that the highs for yields are probably in and that there is a zero percent probability for the next meeting.

• The speaker suggests a different perspective on how to look at TLT by calculating the theoretical change in price based on its duration.

OAS Analysis

• There have been interesting moves in OAS with investment grade spreads decreasing while high yield spreads are widening.

• Credit Market trends suggest that investment grade will be fine but high yield may move a little.

• The spread has stayed constant despite the 10-year dropping in price, so MBB is expected to be up 0.54.

Comparison of Yields

The speaker compares various yields such as one-year UST, one to three year investment grade, and mortgage rates.

• One-year UST is at 4.32 while one to three year investment grade sits at 5.12.

• Mortgage rates have come down by 18 basis points week over week on the back of a 25 basis point hike.

• Looking at Thursday over Thursday changes, the 10-year has dropped by 18 basis points and the 30-year fixed rate mortgage has dropped by 18 basis points.

MBS Spread Analysis

The speaker discusses the MBS spread and its relationship with the 10-year price drop.

• MBB is a good proxy for the MBS spread, which is rate and spread sensitive.

• The spread stayed constant despite the 10-year dropping in price, so MBB is expected to be up 0.54.

Mortgage Market Analysis

The speaker provides an update on mortgage applications, re-fi's, purchases, and existing home sales.

• Mortgage applications are up three percent while re-fi's are up 4.9 percent and purchases are up 2.23 percent.

• Existing home sales for February are up by 14.5 percent with a median home price that actually dropped year over year for the first time in 131 months.

The Housing Market and Home Builders

In this section, the speaker discusses the housing market and home builders.

Home Builders in the Next Expansionary Cycle

• Home builders will be front and center in the next expansionary cycle.

• Companies with a clear cost of capital advantage, such as DHI and Lennar, will have an advantage over others.

• Companies that don't require debt and have low financial leverage will also do well.

REIT Sector

• The REIT sector is not expected to do well.

• There is a significant shortage of new home construction in Canada.

Canadian Housing Market

• There are reports that Canadian banks will suffer due to their exposure to housing.

• Canada has the highest population growth on the planet due to immigration.

• There is a massive shortage of housing in Canada, so it's unlikely that there will be a significant drop in housing prices.

Initial Claims and Federal Funds Rate

In this section, the speaker discusses initial claims and federal funds rate.

Charting Initial Claims and Federal Funds Rate

• To chart initial claims and federal funds rate together, you need to multiply the effective federal funds rate by 100,000 or divide initial claims by 100,000.

High Rates and Unemployment

The speaker discusses the relationship between high rates and unemployment, using initial claims data to demonstrate that high rates do not create unemployment on their own. Instead, something must break or a random event must occur to introduce slack into the labor market.

High Rates and Initial Claims

• High rates at 5.25% for about a year did not create unemployment beyond what was already present.

• Economic and financial data tend to demonstrate volatility dependency on the level, with higher levels leading to higher volatility.

• It is not until things start breaking that initial claims start to increase, indicating that high rates are not the creator of unemployment.

Breaking Points and Slack in Labor Market

• Something endogenously has to break or exogenously has to happen for slack to be introduced into the labor market.

• The FED raising rates alone will not create slack in the labor market.

FED Funds Rate and Continuing Claims

The speaker examines whether companies were laying off people during a period of no hiring by analyzing continuing claims data. They compare this data from two different periods: one with an increase in the FED funds rate, and another more recent period.

FED Funds Rate Increase Period

• During this period, participation rate hung closely around 66%, while unemployment hung around 4.5%.

• Initial claims fluctuated between 2.4 million to 2.6 million, while continuing claims fluctuated within a 200,000 person range.

Recent Period

• During this period, participation rate was much lower at 62.2% to 62.6%, while unemployment sat around 3.5% to 3.7%.

• Initial claims fluctuated between 1.3 million and 1.7 million, indicating that the FED funds rate increase did not have a significant effect on continuing claims during this period.

Labor Market and Bitcoin Analysis

In this section, the speaker discusses the relationship between labor market participation rates and unemployment rates. They also provide an analysis of Bitcoin and gold.

Labor Market Participation Rates

• 55 to 60 percent of the cost structure in labor-driven categories is wages.

• To increase the unemployment rate, more people have to lose their jobs or show up who want jobs but don't have it to introduce slack into the labor market.

• High participation rates do not create unemployment; something has to break in the economy for unemployment to increase.

• To get a 4.5% unemployment rate, something has to break in the economy.

Bitcoin and Gold Analysis

• Gold was down by 0.63% week over week, while Bitcoin was up by 2.85%.

• Money is flowing out of other assets into money market funds, not so much in gold still a little bit more into Bitcoin but not that much.

• The speaker thinks that Bitcoin is acting as a barometer of what sentiment is in the general market rather than speculative exuberance.

• The Yen got stronger while the peso got weaker, but Japan CPI had no effect on Yen.

Recession Targets and Commodities

In this section, the speaker discusses his recession targets for the peso and yen, as well as his thoughts on various commodities.

Recession Targets

• The speaker will buy the yen in anticipation of a recession with a target of 115 and 120 on the cover.

• If it is a global recession, he can see a target under 120 as an initial target. It depends on the depth and duration.

• The Yen could even get to 110 or 105 in a deeper recession. His recession target on the peso is in the range of 20 to 22. He will not step into the peso until he sees this range.

• He would sell the pair (short US, long Peso) when it's over 132. He would cover somewhere under 120 to 115.

Commodities

• Copper is up by 4.5%, West Texas Intermediate is up by 4%, Brent crude is up by 3.05%, and gasoline is up by 3.76% for the week.

• Freeport-McMoRan (FCX) is showing solid price action and is his number one pick for mining companies going into the next cycle.

• Warren Buffett seems very interested in Occidental Petroleum (OXY), so he will continue to sell puts on this stock but not sell calls.

• Copper demand will increase due to transitions to electric vehicles and green grids. There is not enough minable copper to meet all of that demand.

Predicting Recessions

In this section, the speaker discusses how events always happen and how economic conditions can cause a recession.

• Events always happen, and we have the economic conditions under which if an event happens, it can cause a recession.

• The magnitude or nature of the event will determine the magnitude of the recession.

• It's hard to predict what kind of recession will occur because it depends on the type of event that causes it.

Copper Demand

In this section, the speaker talks about copper demand in relation to electric vehicles and housing.

• Electric vehicles take triple or even four to five times as much copper as internal combustion engines.

• Copper pipe and wire go into housing, and anything electric is copper. There is not enough minable copper right now to meet all of that demand.

Copper Earnings Estimates and Market Environment

In this section, the speaker discusses copper earnings estimates and the market environment.

Copper Earnings Estimates

• The forward four-quarter estimate for earnings is 219.16.

• The earnings expected per quarter share weighted earnings for 2024 is 245.99.

• Bottom-up estimates are typically consensus or guidance-driven, and there's a lot of optimism built into these numbers.

• Morgan Stanley's estimate is around 210, while most of the market sits around 210 as opposed to the bottom-up consensus using guidance of 220.

Market Environment

• The multiple sitting at a closing of 39.71 using this four quarters we're sitting at almost 18 times forward earnings in an environment where the FED is saying we've lowered our real GDP forecast to point four percent for 2023 and looking at creating an extra one percent unemployment that you're willing to pay a forward multiple of 18 times earnings in that environment.

• Even without making much assumption just taking .87 off the multiple and taking ten dollars off the forward earnings here you are revisiting the October lows.

June Futures Contracts and Options Trading

In this section, the speaker talks about June futures contracts and options trading.

June Futures Contracts

• Junie has finished at $4010.50

• The speaker sold more June ES (E-mini S&P500 futures contract).

Options Trading

• The speaker sold September ES as well because he wants options that are just one day later than June ES.

• The speaker sold more 4000 calls with the September underlying for June 16th, which is the same day that the June contracts expire.

• The implied volatility decreased to 58 from 97 the week before.

Comparing Yields and Risk

In this section, the speaker compares yields of different investments and discusses the risk associated with each investment.

Yield Comparison

• The speaker is comfortable holding a holding agency as it pays a nice dividend.

• The earnings yield of equities is 5.59, which is 47 basis points higher than the one to three-year investment grade yield of 5.12.

• The six-month T-bill has no volatility or variability in return, while the one to three-year investment grade bond has some variability due to coupon payments.

• Equity has a much wider distribution of possible outcomes compared to bonds.

Risk Assessment

• The question becomes whether the difference in yield between equity and investment grade bond is enough compensation for the possibility of underperforming.

• Using shortfall risk, we can figure out what the probability of being lower than a certain point is based on what the yield is.

• There's an overlap in the tail down here that shows if there's a promise of upside, it comes with the threat of downside.

• If you're comfortable with a 43% probability of underperforming an investment grade bond, then investing in equity may make sense.

Equity Risk Premium

In this section, the speaker discusses how to calculate equity risk premium and how it relates to treasury yields.

Treasury Yields

• A long-term risk-free rate cannot use 20 because there seems to be some kind of clientele effect around it that makes it disjointed between the 10 and the 30.

• The 195 basis point difference between the 10-year and 30-year treasury yields is lower than the desired range of 400 to 450 basis points.

• To get a higher price on the market, money has to go somewhere, which justifies a higher price on the market.

Equity Risk Premium

• If you're going to have a 30-year treasury at 3.64%, you cannot be paying 18 times forward earnings on this Market.

Fear of Good News Breaking Out

In this section, the speaker discusses the put call ratio and open interest in the market. They also talk about how good news is expected to break out over the weekend, causing a rally in the market.

Put Call Ratio and Open Interest

• Put call ratio is 1.5, which is kind of low.

• Put call open interest is 2.01, and it's dropping but that's typical going into a weekend where good news might break out.

Rally in Market Due to Expected Good News

• The rally on Friday was due to more meetings being held over the weekend to possibly extend deposit or insurance to everyone.

• Implied volatility dropped to 19.3 for the week versus 22.3 last week because people didn't want to be on the wrong side of good news.

Everything Is Not Fixed

In this section, the speaker talks about how everything is not fixed despite good news being expected over the weekend. They discuss how credit will tighten up and have an effect on consumers and businesses.

Credit Tightening Up

• Powell said that tightening of credit from banks acts like a rate increase.

• Credit tightening up will have an effect on consumers and some businesses as they are hit with higher costs to service their debt.

Commercial Real Estate Loans

• There is a lot of short-term debt financing an asset that is more long-term, specifically commercial real estate loans.

• Regional banks tend to have a far greater overweighting of commercial real estate in that sector.

• If they are going to get refinanced, it's going to be at a punishing rate.

Lower Earnings for Banks

• There will be lower earnings for banks because of higher loan loss provisions.

• The speaker thinks 210 is not unrealistic and 18 times is simply too high.

Short Position on the Market

In this section, the speaker discusses their short position on the market and why they believe it will continue.

Reasons for Short Position

• The speaker believes that if the market doesn't go down, their position won't go down. If the market recovers, their position will recover.

• Earnings are too high and multiples are too high. Even if nothing breaks, 210 and 17 is not unrealistic.

• Many companies engage in speculative finance by mismatching liabilities with assets. This can lead to liquidity issues.

Portfolio Concentration

• The speaker is more concentrated in their portfolio than ever before because they don't have all these puts in place anymore.

• Every decision they make seems to be on rallies. They're just shorting the market taking bigger shorts.

• Every time they short something, they also add a call as well.

Preview of Upcoming Week

In this section, the speaker previews upcoming events for the week.

Monday

• Not much going on to change your mind.

• Dallas Fed Manufacturing Index coming out.

Tuesday

• Consumer confidence coming out.

• Bar starts two days of testimony that will probably dominate Bloomberg.

• Pending home sales coming out.

Wednesday

• Mortgage applications coming out.

• Pending home sales coming out.

Thursday

• GDP final look for Q4.

• Continuing claims will be watched.

Friday

• PCE will be the big one that we look forward to.

• Michigan consumer sentiments coming out.

Earnings Season and Financials

This section discusses the upcoming earnings season for Q1 2023, with a focus on financials. The speaker notes that this will be an interesting week, as it is also the week of CPI.

Financial Earnings Reports

• First Republic, Citigroup, JP Morgan, Wells Fargo and BlackRock are reporting in Q1 2023.

• Financials lead off the earnings season followed by Information Technology mixed in with discretionary consumer staples.

• This will be the most watched earnings season for financials.

Volatility

• The same week as the financial earnings reports is March CPI which will make it a super volatile week.

• If something completely breaks before that date or if there is an event then none of these earnings reports matter anymore.