Comment of the Day
28th February 2023
Video Commentary for February 28th 2023
A link to today's video commentary is posted in the Subscriber's Area.
Some of the topics discussed include: quality stocks rolling over on competition with higher Treasury yields, copper, oil, gold rebound, natural gas extends rebound, carbon credits extend breakout.
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Inflating inflation fears
Thanks to a subscriber for this article from Saxo Bank which may be of interest. Here is a section:
Wage pressures are a key concern
Despite widespread news of tech layoffs, the January jobs growth of +517k sent a shockwave to the markets. Unemployment rate touched a 53-year low as service providers expanded their activities. Likewise, jobless claims data and surveys on unemployment all continue to point at hiring and wages would remain on an upward path.
With the demand and supply imbalance in the labor markets continuing, companies are feeling wage pressures eat into their margins. As the US consumer is still holding up well even in the wake of high inflation and interest rates, companies with pricing power will pass on these wage costs to the consumers, thereby creating more upside pressures to inflation and a potential wage-price spiral.
Re-acceleration of cyclical growth
Transition from a recession to a goldilocks/soft-landing narrative to the current no-landing/acceleration narrative isn’t all positive for the markets. The Atlanta Fed GDPNow model estimate for real GDP growth in Q1 is now at 2.7% from 0.7%, which is hardly a sign of recession or stagnation.
Overall, recent economic data suggests that the US economy is reheating, and the market is moving to price that in by bringing the terminal rate forecast higher and driving out the rate cuts priced in for this year to 2024. This also brings back the risk of higher inflation. The reopening of the Chinese economy also brings fears of an inflationary impulse through commodity and raw material prices.
Cleveland Fed economists Randal Verbrugge and Saeed Zaman have said that it will likely take US inflation many more years than central bankers and financial markets expect to close in on 2% without a deep recession.
Upward repricing of the Fed path
Beyond cyclical risks, inflation continues to face upside threat from structural factors such as shortage of labor, deglobalization as well as the energy supply crunch. US breakevens are signalling renewed concern that inflation will stay elevated in the shorter term, with the 2-year rate above 3% for the first time since August 2022 and the 10-year rate holding at around 2.5%.
As such, market expectations of the Fed path have seen a dramatic shift from expecting a pause/pivot to now pricing in a terminal rate of 5.4% from sub-5% a month back. Calls for 6-7% terminal rates have also picked up. But the Fed has already transitioned to a 25bps rate hike pace, and it would potentially be a credibility issue if they were to move back to 50bps rate hike increments. So, a longer tightening cycle looks like the most likely outcome.
Eoin Treacy's view
Retail sales are still strong despite a tighter interest rate environment. That is supporting the employment outlook and giving the impression of a strong economic expansion. The only way I can think of to describe that succinctly is as an inflationary boom. There is clear evidence of a more inflationary bias to consumer sentiment with people accelerating purchasing decisions.
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Applied Materials to Challenge ASML's Grip With New Machines
This article from Bloomberg may be of interest to subscribers. Here is a section:
The company’s Centura Sculpta machine — a so-called pattern shaping system — lets customers reduce the amount of time they spend on lithography, the process of using light to burn lines into silicon. Lithography has become increasingly complex and expensive, and the new approach will help streamline chip production while reducing waste, Applied Materials said Tuesday.
The move threatens to disrupt a lithography market dominated by ASML’s machines. Though Applied Materials isn’t challenging that company directly, it’s attempting to rethink the way the industry manufactures chips — the tiny electronic components that are built by depositing materials on disks of silicon.
Eoin Treacy's view
The investment case for ASML is that it is the undisputed leader in providing cutting edge equipment for the most advanced chip manufacturing factories. The company’s backlog of orders forms the basis for its high valuation. It’s also why investors have always been willing to step in and buy the big dip. The logic is that regardless of what happens in the semiconductor space, ASML’s products are essential for any company that wants to be the leader in the sector
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China Has a Debt Ceiling Problem of Its Own
This article from Bloomberg may be of interest. Here is a section:
Before Covid, regional authorities got roughly 40% of their income from local taxes, with the rest split almost evenly between land sales and subsidies from the central government.
Last year, land sales tumbled 23%, while total expenditure rose 6%. Beijing did increase its subsidy, but its support was not enough to plug municipalities’ budgetary hole. As such, local government debt has ballooned to 66% of China’s gross domestic product, from 29% in 2012, according to CLSA Ltd. estimates.
On the other hand, Beijing’s own book remains fairly pristine. The central government’s debt-to-GDP ratio stands at only 24%, versus 15% a decade ago.
Because of this power imbalance, China’s sovereign debt manages to be solidly in the investment-grade territory, even though the nation has become one of the world’s most leveraged. When investors fret about China’s elevated borrowings, they refer to those from real estate developers or municipal authorities. They do not talk about the central government’s book.
However, it is increasingly clear this fiscal arrangement is near a breaking point. According to CLSA, regional governments already spent 10.8% of their revenue on interest payments. Their expenses would have been a lot higher if the People’s Bank of China did not pump liquidity into the financial system. The average cost of borrowing for municipals fell from 5.6% in 2018 to 4.1% recently.
Eoin Treacy's view
China does not have a property tax. That means regional governments rely on land sales to pad out their coffers. Without a vibrant property market, there is no building and therefore no land sales. The simple fact is China’s regional governments are in real trouble without a property bull market.
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Eoin's personal portfolio: commodity long initiated and stock option long initiated February 14th 2023
One of the questions subscribers ask most often is how to find details of my open trades. To make it easier I will simply repost the latest summary on a daily basis until there is a change.
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© 2023 Eoin Treacy
548 Market Street PMB 72296, San Francisco, CA 94104
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