“This month (so far) has been the worst for the Nasdaq since the stock market was in the throes of the Great Financial Crisis back in 2008. And it shouldn’t be hard to understand what is plaguing the Big Tech stocks that make up the bulk of this index. In addition to capital flows, macro economic trends, risk appetites and insider activity, all of which warned of the current weakness in stock prices well ahead of time, there are two major bearish forces at work.”
I wrote that six months ago and, if you change “month” in the first sentence to “year,” it is just as true today as it was back then.
Put the market caps together of Microsoft, Apple, Nvidia, Tesla and Amazon and compare that figure with their aggregate free cash flow and you get a multiple of over 50 times, down from nearly 70 at the start of the year.
This historic level of overvaluation was only made possible by massive money printing on the part of the Fed that supported both cash flows and the multiple applied to them.
Now that inflation is raging, however, the money printer has been shifted into reverse and that’s already having a visible impact (both “bearish forces,” the reversion in valuations and falling liquidity, have been consolidated into one chart this time below).
Furthermore, if the Fed follows through on its commitment to normalize the balance sheet over the next few years then this reversion in valuations has only just begun.
In fact, price-to-free cash flow ratios could still halve from their current levels. Of course, if free cash flow (the denominator in the valuation ratio) continues to grow as it has over the past decade, this process will be much less painful than if free cash flow also goes into reverse.
Worryingly, that reversal in cash flows is actually what has happened over the past year in which growth went from double digits positive to double digits negative.
As I wrote in the prior piece, “Considering the nature of the pandemic and the stimulus enacted as a result, it’s not unreasonable to think there was a significant pulling forward of demand for Big Tech products and services that will now leave a vacuum of demand for a prolonged period of time.”
We’re just now beginning to find out how much of a vacuum of demand now lies in front of us. And a Fed-induced recession resulting from the rapid rise in interest rates and draining of liquidity isn’t likely to improve things in that regard.
In Stunning Strategy Reversal, Pentagon Will No Longer Rule Out Use Of Nuclear Weapons Against Non-Nuclear Threat
Well, we’re finally there: stocks are officially trading off nuclear war headlines.
Moments ago, as part of his closely-watched speech, Vladimir Putin appeared to talk down the likelihood of a nuclear attack in Ukraine:
*PUTIN: NO POLITICAL, MILITARY REASON IN NUKE STRIKE IN UKRAINE
Which, however, is more than can be said about the US.
As Bloomberg just reported, the Pentagon’s new National Defense Strategy rejects limits on using nuclear weapons long championed by arms control advocates (and, in the not too distant past, by Joe Bide) citing burgeoning threats from Russia and China.
“By the 2030s the United States will, for the first time in its history face two major nuclear powers as strategic competitors and potential adversaries,” the Defense Department said in the long-awaited document issued Thursday. In response, the US will “maintain a very high bar for nuclear employment” without ruling out using the weapons in retaliation to a non-nuclear strategic threat to the homeland, US forces abroad or allies.
In yet another stark reversal for the senile occupant of the White House basement, in his 2020 presidential campaign Biden had pledged to declare that the US nuclear arsenal should be used only to deter or retaliate against a nuclear attack, a position blessed by progressive Democrats and reviled by defense hawks. But, like with every other position held by the pathological liar who even trumps Trump in the untruth department, this one has just been reversed as well as “the threat environment has changed dramatically since then” and the Pentagon strategy was forged in cooperation with the flip-flopping White House.
In a stunning move that should – or rather “should” – spark outrage among the so-called progressives but will at best prompt some very sternly retracted letters, the nuclear report that’s part of the broader strategy said the Biden administration reviewed its nuclear policy and concluded that “No First Use” and “Sole Purpose” policies “would result in an unacceptable level of risk in light of the range of non-nuclear capabilities being developed and fielded by competitors that could inflict strategic-level damage” to the US and allies.
meanwhile…
Putin: The only country in the world that has used nuclear weapons against a non-nuclear state is the United States of America
The nuclear strategy document doesn’t spell out what non-nuclear threats could produce a US nuclear response, but current threats include hypersonic weapons possessed by Russia and China for which the US doesn’t yet have a proven defense.
It does spell out, however, in the strongest terms, what would happen to another nuclear power, North Korea, if it launched a nuclear attack on the US, South Korea or Japan. That action “will result in the end of that regime,” it says. US nuclear weapons continue to play a role in deterring North Korean attacks.
So, the brilliant neocon minds behind the report concluded, it is better to instill the fear of a disproportionate nuclear retaliation, thus making an outright nuclear attack far more likely (if the US will nuke you anyway, may as well go all out).
In the document, which was framed well before the invasion, the Pentagon says Russia continues to “brandish its nuclear weapons in support of its revisionist security policy” while its modern arsenal is expected to grow further. In other words, the Pentagon knew what Putin would do even before he did it and that defined the dramatic revision in US nuclear posture. Almost as if the Pentagon directed the entire sequence of events…
Meanwhile, China remains the US’s “most consequential strategic competitor for coming decades,” Defense Secretary Lloyd Austin said in a letter presenting the new defense strategy. He cited China’s “increasingly coercive actions to reshape the Indo-Pacific region and the international system to fit its authoritarian preferences,” even as it rapidly modernizes and expands its military. China wants to have at least 1,000 deliverable nuclear warheads by the end of the decade, the nuclear strategy document says, saying it could use them for “coercive purposes, including military provocations against US allies and partners in the region.”
The nuclear strategy affirmed modernization programs including the ongoing replacement of the aging US air-sea-land nuclear triad. Among them are the Navy’s Columbia-class nuclear ICBM submarine, the ground-based Minuteman III ICBM replacement, the new air-launched Long-Range Standoff Weapon and F-35 fighter jets for Europe carrying nuclear weapons.
The review confirmed previous reports that the Pentagon will retire the B83-1 gravity bomb and cancel the Sea-Launched Cruise Missile program. But the review endorses a controversial Trump-era naval weapon, the low-yield W76-2 submarine-launched nuclear warhead, which is described as providing “an important means to deter limited nuclear use.”
The broader strategy report also offered gently worded criticism of major US weapons programs, which often runs years behind plans and billions of dollars over initial budgets.
“Our current system is too slow and too focused on acquiring systems not designed to address the most critical challenges we now face,” the Pentagon said. It called for more “open systems that can rapidly incorporate cutting-edge technology” while reducing problems of “obsolescence” and high costs.
The Pentagon strategy documents were sent to Congress in classified form in March so they were considered during congressional approval of the fiscal 2023 defense budget.
* * *
So how to trade all of this? Well, the initial instinct now that nuclear war headlines are being lobbed around is that it may be time to sell… but as Art Cashin so insightfully put it some time ago, “Never bet on the end of the world, because it only happens once.”
Now thanks to the Biden admin, that “once in a lifetime” event is that much closer to taking place.
Putin Says Russia Will Never Be “Wiped Off Geopolitical Map” As West Plays “Dirty Game” In Ukraine
“Russia is not challenging the western elite. We are not trying to become the hegemon,” Russian President Vladimir Putin said early in an important speech before the Valdai Discussion Club meeting outside Moscow on Thursday. Each year the Valdai speech is a major one and closely watched by Western officials and media.
This year it was touted with the eye-catching title of “A Post-Hegemonic World: Justice and Security for Everyone.” And of course, this year’s Valdai meeting comes against the backdrop of the biggest war Europe has seen on its eastern doorstep since WWII.
Putin said in his remarks that Russia merely wants to “defend its right to exist” and “won’t let itself be destroyed and wiped off the geopolitical map.” This as nuclear rhetoric and threats of defending red lines between Moscow and the West have reached heights not seen since the Cold War.
He repeated a familiar refrain of a crisis unfolding because the Western allies are using Ukraine for their “dirty game” in an ultimate drive for world domination. “Power over the world is what the West has put at stake in the game it plays. This game is certainly dangerous, bloody and I would call it dirty,” he said according to a state media translation.
“But in the modern world, sitting aside is hardly an option. He who sows the wind will reap the whirlwind, as the proverb says,” he added. Repeating a well-known theme of his, juxtapositioning collapsing unipolar order vs. multipolarity, he said “new centers of power in the multipolar world and the West will have to start talking as equals about our common future.”
“[This game] denies the sovereignty of nations and peoples, their identity and uniqueness, and has no regard whatsoever for other countries,” Putin added.
Commenting on one segment of the talk, The New York Times said the Valdai speech sought to appeal to conservatives in Europe and the US:
Mr. Putin insisted that Russia did not fundamentally see itself as an “enemy of the West.” Rather, he said — as he has before — that it was “Western elites” that he was fighting, ones who were trying to impose their “pretty strange” values on everyone else.
“There are at least two Wests,” Mr. Putin said in his speech at the plenary session in Moscow of an annual foreign policy conference. One, he said, was the West of “traditional, mainly Christian values,” which Russia was close to.
But Putin drove home in contrast that “There’s another West — aggressive, cosmopolitan, neocolonial, acting as the weapon of the neoliberal elite.”
Ukrainian officials have been watching the speech closely, and commenting:
“Confidence in one’s infallibility is a very dangerous state, one step away from destroying those they don’t like” – Putin knows what he is talking about at Valdai. pic.twitter.com/0VRSjKlWiu
And more specifically on the Ukraine conflict, the Russian leader charged of the West’s actions, “They’re always trying to escalate…They’re fueling the war in Ukraine, organizing provocations around Taiwan, destabilizing the world food and energy markets.”
Putin warned that the West’s confidence in its “infallibility” is a “very dangerous” condition, with there only being “one step” between this self-confidence to the idea that “they can simply destroy those they do not like, or as they say, to ‘cancel’ them.”
Emphasizing that Russia is not a natural “enemy” of the West, Putin urged Western political elites to stop seeing “the hand of the Kremlin” behind all their internal problems.
On multipolarity, Putin’s message to Europe is essentially “take it or leave it”…
Putin is at it again. New Munich III speech at Valdai conference. He is laying the foundations of new multipolar world order. The message to Europe is “take it or leave it”. pic.twitter.com/oUixDO7Jmm
Western officials are also keeping a close watch on Putin’s words regarding nuclear doctrine and usage. Putin at Valdai underscored he sees “no political or military reason” to conduct a nuke strike in Ukraine. He also stressed Moscow’s nuclear doctrine is defensive in nature. “Russia has never talked about nuclear use, only replied,” he said.
He went on to warn that it remains Russia will never “put up with what the West tells it to do” – and that while Russia should not be seen as a direct challenge to the West, it reserves the right to develop. With this theme established, Putin asserted that Washington has discredited international finance“by using the dollar as a weapon” – thus he posited that in the future continued moves toward “settlements in national currencies will dominate.”
Roughly 61% of Brotherhood of Railroad Signalmen’s voting members oppose deal intended to head off strike…
Count the Brotherhood of Railroad Signalmen (BRS) as another union to reject the tentative labor agreement that representatives of the rail unions and the freight railroads negotiated under pressure from the White House.
The union and the organization representing the railroads plan to return to the negotiating table, but BRS’ vote further clouds the question of whether a freight rail strike could occur — something that the tentative agreement had sought to stave off. Members of the Brotherhood of Maintenance of Way Employes Division rejected that union’s tentative agreement earlier this month.
BRS announced Wednesday that 60.57% of voting members opposed ratification, while 39.23% voted in favor.
BRS represents more than 6,000 members affected by the negotiations, which is about 5% of the 115,000 union members involved in the negotiations process.
BRS President Michael Baldwin said the percentage of members who voted — 73.18% — was the highest participation rate in BRS history.
The union was represented at the negotiating table by the Coordinated Bargaining Coalition and later by the United Rail Unions. The National Carriers Conference Committee (NCCC) represented the freight railroads.
In response to BRS’ vote, NCCC said it was “disappointed” in the outcome, saying that the failure to ratify the agreement would delay the benefits of the tentative agreement for BRS members.
Both NCCC and BRS have agreed to maintain the status quo until early December, which means any potential service disruptions by BRS members would not occur before then. Both parties will be going back to the bargaining table for further contract negotiations.
NCCC says the tentative agreement includes recommendations by the Presidential Emergency Board (PEB), a three-person independent group appointed by President Joe Biden over the summer to work with the railroads and the unions on finding ways to resolve the labor contract impasse and avert a strike. The railroads and unions have been negotiating a new contract since January 2020.
Those recommendations included the largest wage increase in nearly five decades, maintained rail employees’ platinum-level health benefits and added an extra day of paid time off, NCCC said, noting that six other unions had already voted in favor of ratifying their labor agreements.
NCCC said PEB’s recommendations “represent a carefully considered compromise of all parties’ interests.”
“BRS asserts that the tentative agreement is inadequate because it does not provide for additional paid sick time. However, the vast majority of BRS members work predictable schedules and all have access to time off,” NCCC said. “Like other rail employees, they can and do take time off for sickness and already have paid sickness benefits beginning after four days of illness-related absence and extending for up to a year.
“The structure of these benefits is a function of decades of bargaining where the unions have repeatedly agreed that short-term absences would be unpaid in favor of higher compensation for days worked and more generous sickness benefits for longer absences,” NCCC continued. “The three experienced arbitrators appointed to PEB 250 by President Biden thoroughly reviewed and rejected a union proposal to add paid sick time for short-term absences to the existing system, noting in their report that union concerns had been considered in formulating the PEB’s historic wage recommendation.”
But BRS said the vote “spoke loudly and clearly that their contributions are worth more.”
“I have expressed my disappointment throughout the process in the lack of good-faith bargaining on the part of the NCCC, as well as the part PEB 250 played in denying BRS members the basic right of paid time off for illness,” Baldwin said in a statement. “The NCCC and PEB also both failed to recognize the safety-sensitive and highly stressful job BRS members perform each day to keep the railroad running and supply chain flowing.
“Without Signalmen, the roadways and railroad crossings would be unsafe for the traveling public, and they shoulder that heavy burden each day. Additionally, the highest offices at each Carrier, as well as their stockholders, seem to forget that the rank-and-file of their employees continued to perform their job each day through an unprecedented pandemic, while the executives worked from home to keep their families safe.”
The six unions that have approved their agreements are the American Train Dispatchers Association, the International Brotherhood of Electrical Workers, the Transportation Communications Union, the Brotherhood of Railway Carmen, the National Conference of Firemen & Oilers, and the mechanical and engineering division of the International Association of Sheet Metal, Air, Rail and Transportation (SMART) Workers.
Two of the largest unions representing train engineers and conductors — the Brotherhood of Locomotive Engineers and Trainmen and SMART-Transportation Division — have yet to vote on whether to ratify their agreements.
Musk Reassures Advertisers: Twitter “Will Not Become A Free-For-All Hellscape”
As the moment of peak crisis arrives for the left, losing control of the narrative-management tool known as Twitter, there are stories (for example, here at Bloomberg) running rife citing no sources at all while claiming that advertisers are nervous of the nazi, child pron, hate-speech that will inevitably return to the social media platform now that the richest man in the world is in charge.
“There’s no commercial viability for a network that doesn’t have some level of content moderation. Advertisers and users aren’t going to show up and post during their workday alongside pornography and extremism — and Twitter is already reportedly struggling with losing its most active users. So in deciding how “free” Musk wants speech to be, he may have to alienate users to get there.”
The Wall Street Journal also warned that “Madison Avenue isn’t sold on the deal,” suggesting advertisers are anxious to be on the Musk-owned platform.
About a dozen of GroupM’s clients, which own an array of well-known consumer brands, have told the agency to pause all their ads on Twitter if Mr. Trump’s account is reinstated, Kieley Taylor, global head of partnerships at GroupM, said.
Others are in wait-and-see mode. Ms. Taylor said she expects to hear from many more clients if Mr. Trump’s account returns.
“That doesn’t mean that we won’t be entertaining lots of emails and phone calls as soon as a transaction goes through,” Ms. Taylor said. “I anticipate we’ll be busy.”
Ad agency Omnicom Media Group evaluates the major social-media platforms’ progress on brand-safety tools every quarter. In July, Omnicom rated Twitter’s progress behind that of YouTube, Facebook, Instagram, TikTok and Reddit, according to a document reviewed by the Journal. Robert Pearsall, managing director of social activation at Omnicom Media Group, said Twitter has made agreements to improve its brand-safety controls to meet Omnicom’s standards, but it hasn’t introduced those changes to the market yet.
“There are significant concerns about the implications of a possible change to content moderation policy,” he said.
Twitter has said it is working on tools to give advertisers a better idea of where their ads appear.
Advertising provided 89% of Twitter’s $5.08 billion revenue in 2021.
I wanted to reach out personally to share my motivation in acquiring Twitter. There has been much speculation about why I bought Twitter and what I think about advertising. Most of it has been wrong.
The reason I acquired Twitter is because it is important to the future of civilization to have a common digital town square, where a wide range of beliefs can be debated in a healthy manner, without resorting to violence. There is currently great danger that social media will splinter into far right wing and far left wing echo chambers that generate more hate and divide our society.
In the relentless pursuit of clicks, much of traditional media has fueled and catered to those polarized extremes, as they believe that is what brings in the money, but, in doing so, the opportunity for dialogue is lost.
That is why I bought Twitter. I didn’t do it because it would be easy.
I didn’t do it to make more money. I did it to try to help humanity, whom I love.
And I do so with humility, recognizing that failure in pursuing this goal, despite our best efforts, is a very real possibility.
That said, Twitter obviously cannot become a free-for-all hellscape, where anything can be said with no consequences!
In addition to adhering to the laws of the land, our platform must be warm and welcoming to all, where you can choose your desired experience according to your preferences, just as you can choose, for example, to see movies or play video games ranging from all ages to mature.
I also very much believe that advertising, when done right, can delight, entertain and inform you; it can show you a service or product or medical treatment that you never knew existed, but is right for you.
For this to be true, it is essential to show Twitter users advertising that is as relevant as possible to their needs. Low relevancy ads are spam, but highly relevant ads are actually content!
Fundamentally, Twitter aspires to be the most respected advertising platform in the world that strengthens your brand and grows your enterprise.
To everyone who has partnered with us, I thank you. Let us build something extraordinary together.
Remember his words from yesterday:
“A beautiful thing about Twitter is how it empowers citizen journalism – people are able to disseminate news without an establishment bias.”
And Peter Schiff thinks the central bank has folded with a soft pivot. He explained why on his podcast.
I’m going to go out on a limb here and predict that we’ve already seen the Fed pivot. Now, it wasn’t a pivot in the sense that the Fed has gone from hiking interest rates to cutting interest rates. It hasn’t gone from quantitative easing to quantitative tightening. But it is a pivot in rhetoric. And what it amounts to is an easing of monetary conditions. Because what the Fed is going to be doing going forward is starting to walk back just how aggressive its rate-hiking campaign is going to be.”
The shift may be subtle, but it will be significant. Instead of talking about the urgency of the inflation fight, Peter said he thinks the central bankers at the Fed will start talking about how much progress they have made.
Since they’ve made progress, maybe not completely declaring victory, but indicating they’re seeing the light at the end of the tunnel — that maybe they don’t have to raise interest rates as high as they thought, or maybe leave them as high for as long as they thought. And so the path back down to 2% inflation may not require as aggressive a rate-hiking campaign as they may have previously thought before they started to see the evidence of their success.”
What led Peter to this conclusion?
Last Thursday (Oct. 20), the bond market looked close to a complete collapse. That morning, the yield on the 30-year Treasury nearly rose to 4.4%. Meanwhile, the curve between the 10-year and the 30-year moved positive out of inversion. This was a sign investors were beginning to price in prolonged inflation. Meanwhile, the stock market was also under pressure due to the weakness in the bond market.
The Achilles heel of this bubble economy is interest rates because we’ve got so much debt. And if interest rates rise high enough, the whole thing is going to collapse.”
Consider this tweet Peter sent last Friday.
The 10-year Treasury yield hit 4.33%, its highest since Nov. 2007, when the Nation Debt was under $9 trillion. Today it’s over $31.2 trillion. At 4.33%, annual interest on the National Debt would exceed $1.35 trillion, more than is spent on National Defense or Social Security.
That would make the interest on the debt the biggest US government expense. (You can read a more in-depth analysis of the national debt HERE.)
Do you see the problem here? Debt is spiraling out of control and is going to crowd out all of the other government spending.
At the rate the National Debt and interest rates are rising, before the decade ends interest on the National Debt will exceed 100% of federal tax revenue. The entire Federal Government would then consist of the Treasury Department, which would just collect taxes and pay interest.
Basically, the US government would become a conduit from taxpayers to bondholders. Now obviously, this can’t happen. At some point, something has to give. And I think that something already gave. I think it gave on Friday morning, and that’s why I think the Fed folded with this ‘soft’ pivot. The reason I’m saying a soft pivot and not a hard pivot is because the Fed is still on the trajectory of hiking rates. I just think it shifted into a lower gear. So that, in and of itself, constitutes an easing. Even if the Fed is tightening, if it’s tightening less aggressively than the markets had thought, then it’s an easing. It’s a forward guidance that is easing conditions a little bit and telling the markets, ‘Hey, you’re too tight. You’re pricing in too many rate hikes. Because we’re probably not going to have to hike as many times as you think. The terminal rate is not going to be as high as you think because we’re already making good progress.’”
The soft pivot was telegraphed to the markets by a Wall Street Journal report saying some Fed members were expressing “unease” and were concerned about overtightening. The story reported that San Francisco Fed President Mary Daly said, “The time is now to start planning for stepping down.”
Peter went on to detail some of the bad economic data the Fed will also have to reckon with including contractionary October PMI, tanking consumer confidence, and rising shelter costs (even though housing prices are falling).
U.S. energy executives told Jennifer Granholm that shuttered crude oil refineries won’t restart, Valero’s Chief Executive Joe Gorder said on Tuesday.
The comments were made to the U.S. Energy Secretary at a recent White House meeting with energy executives, Reuters reported on Tuesday.
“The one interesting thing that came out of it, too, was there was consideration for the ability to restart refining capacity that had been shut down, and I think the general sentiment was that wasn’t going to happen,” Gorder said.
Limited U.S. refinery capacity – and perhaps more critically, refinery capacity in specific U.S. geographic areas, known as PADDs – has spared worry in the United States over high gasoline prices and energy security.
US refinery run rates were north of 90% for much of the summer, according to the EIA’s Weekly Petroleum Status Report.
Shuttered refineries unlikely to start back up are the latest nail in the U.S. refinery coffin.
“Building a refinery is a multi-billion dollar investment. It may take a decade. We haven’t had a refinery built in the United States since the 1970s. My personal view is that there will never be another refinery built in the United States,” Wirth said at the time.
Oil and gas companies would have to weigh the benefits of committing capital ten years out that will need decades to offer a return to shareholders “in a policy environment where governments around the world are saying ‘we don’t want these products to be used in the future,’” Wirth added.
Refinery utilization in the United States for the week ending October 14 was 89.5% of their operable capacity, the most recent EIA data shows.
ECB Rate Hike Preview And Three Things Traders Will Be Watching For
The ECB policy announcement is due at 13:15BST/08:15EDT, with the follow up press conference starting at 13:45BST/08:45EDT; both consensus and market pricing look for a 75bps hike, taking the deposit rate to 1.5%, and according to Newsquawk, markets will also be focusing on discussions around the balance sheet and measures to address excess liquidity.
OVERVIEW: With headline Y/Y HICP in September advancing to 9.9% from 9.1%, policymakers are set to deliver another outsized rate hike following a 75bps increase in September. In terms of market pricing, a 75bps hike is priced at around 80% and a 50bps increase at 20%. Beyond inflationary developments, growth concerns are continuing to mount in the Eurozone with the composite PMI metric declining to 47.1 in October from 48.1 in September. Nonetheless, with the ECB’s 5y5y inflation expectations measure rising to around 2.3% from circa 2.2% at the time of the prior meeting, policymakers will be forced to raise rates again this month. In terms of other measures to be mindful of, source reporting on 13th October suggested that the GC discussed the timeline for the balance sheet reduction at the Cyprus meeting earlier this month. The report noted that the language regarding reinvestments could be tweaked at the October meeting, before outlining plans for a balance sheet reduction in December or February and then commencing QT sometime in Q2 2023. Elsewhere, the upcoming meeting could see policymakers alter the terms of its TLTROs given that banks can currently park cash from operations at the ECB and earn a risk-free profit following recent rate hikes.
PRIOR MEETING: In-fitting with market pricing and against a split consensus amongst analysts, the ECB opted to pull the trigger on a 75bps hike, taking the deposit rate to 0.75%. The statement noted that the GC expects to raise rates further over the next “several” meetings, whilst taking a data-dependent and meeting-by-meeting approach. The ECB opted to continue with its current reinvestment policy whilst suspending its two-tier system by setting the multiplier to zero. The accompanying staff forecasts saw 2022, 2023 and 2024 inflation projections revised higher with the 2024 forecast of 2.3% indicating that further policy tightening is required. On the growth front, 2022 GDP was revised a touch higher, however, 2023 was slashed to 0.9% from 2.1% with the downside scenario touting the possibility of negative growth. With regards to the magnitude of hikes going forward, Lagarde noted that 75bps increments are not the norm, but moves will not necessarily get smaller as the ECB heads towards the terminal rate. Despite guidance that the GC will be following a meeting-by-meeting approach, Lagarde stated that hikes will probably take place at more than two meetings, but fewer than five, so markets will be looking to see if such a viewpoint was alluded to in the account of the meeting.
RECENT ECONOMIC DEVELOPMENTS: Y/Y HICP in September advanced to 9.9% from 9.1% and the core metric rose to 6.0% from 5.5%, with the headline boosted by the ongoing surge in energy and food prices as well as Germany unwinding its discounted transport ticket scheme. In terms of market gauges of inflation, the ECB’s preferred 5y5y expectations measure has risen to around 2.3% from circa 2.2% at the time of the prior meeting. On the growth front, the flash estimate of Q3 GDP is not due until October 31st. That said, the October composite PMI declined to 47.1 from 48.1 in September. Accordingly, S&P Global noted that “The eurozone economy looks set to contract in the fourth quarter given the steepening loss of output and deteriorating demand picture seen in October, adding to speculation that a recession is looking increasingly inevitable.” The Unemployment rate in August held steady at 6.6%, however, concerns about the employment outlook have triggered talks within the EU about the potential revival of the SURE scheme (aimed at mitigating unemployment risks in an emergency).
RECENT COMMUNICATIONS: Since the prior meeting, President Lagarde (14th Oct) said that inflation in the Eurozone is likely to stay above the ECB’s target for an extended period of time and the governing council expects to raise rates further over the next several meetings. Germany’s thought-leader Schnabel (30th Sept) said a robust approach to monetary policy is required given the uncertainty about the persistence of inflation. Chief Economist Lane (29th Sept) said the central bank is still trying to reach neutral, but is not yet taking a stand on whether that will be enough. He added that the exchange rate channel is not significant enough to influence monetary policy. France’s Villeroy (11th Oct) remarked that the ECB should reach the neutral rate of close to 2% by the end of the year, adding that the Bank could move more slowly after reaching a neutral rate. Elsewhere, Slovenia’s Vasle is of the view that the ECB should hike by 75bps at the next two meetings and then could start shrinking the balance sheet in 2023.
RATES: Expectations are for the ECB to hike its key three interest rates by 75bps each, taking the deposit rate to 1.5%, main refinancing rate to 2% and marginal lending to 2.25%. According to a Reuters survey, 27/36 expect the Deposit Rate to be raised by 75bps to 1.5%, 7/36 look for 50bps and just 2/36 forecast 25bps. In terms of market pricing, a 75bps hike is priced at around 80% and a 50bps increase at 20%. The decision to carry on with interest rate hikes follows on from headline Y/Y HICP in September advancing to 9.9% from 9.1% and the core metric rising to 6.0% from 5.5%. Furthermore, since the prior meeting there hasn’t been much in the way of guidance from policymakers to suggest that the Bank will be stepping up or stepping down the magnitude of rate hikes. As a reminder, at the September press conference, Lagarde stated that hikes will probably take place at more than two meetings, but fewer than five. Looking beyond this week, markets fully price in another 50bps move in December, with the deposit rate expected to peak at just below 3% around Q3 next year. In terms of guidance from policymakers, Slovenia’s Vasle believes the ECB should hike by 75bps at the next two meetings, whilst France’s Villeroy remarked the ECB should reach the neutral rate of close to 2% by the end of the year. Note, recent reporting suggesting that an ECB staff model puts the target-consistent terminal rate at 2.25%. That said, the report noted that policymakers were sceptical over the accuracy of the model.
QT: In terms of other measures to be mindful of, source reporting on 13th October suggested that the GC discussed the timeline for the balance sheet reduction at the Cyprus meeting earlier this month. The report noted that the language regarding reinvestments could be tweaked at the October meeting, before outlining plans for a balance sheet reduction in December or February and then commencing QT sometime in Q2 2023. ING takes a more cautious stance, suggesting that markets “have got ahead of themselves”, noting that “even if the discussion might have started at the ECB, with current financial stability risks, the recent UK experience and a very uncertain macro outlook, QT is still some way out”. Furthermore, guidance from President Lagarde has stated that rates would need to be taken to neutral (estimated to be around 2%, according to Villeroy) before QT could begin. In terms of a potential course of action, ING suggests that a beginning of QT would entail ending reinvestments rather than active selling of bonds, something which, under APP could start in Spring 2023 at the earliest. As such, any talk around QT at this stage is likely to be vague. SGH Macro expects that details will not be announced until February.
TLTRO: Elsewhere, the upcoming meeting could see policymakers alter the terms of its TLTROs given that banks can currently park cash from operations at the ECB and earn a risk-free profit following recent rate hikes. Source reporting via Reuters suggested that a decision on what to do about this could come as soon as the upcoming meeting. In terms of the options available, SGH Macro says the ECB could:
Reset the terms of the original TLTRO loans.
Adjusting the rates paid specifically on TLTRO-related deposits.
Instituting a blanket threshold on excess reserves above which the ECB and national central banks will not pay interest.
SGH Macro leans towards the third option by implementing a “reverse tiering” system as per the SNB. ING is also of the view that this would be the easiest system to implement as opposed to resetting TLTRO terms as this would hamper the Bank’s credibility “and would lead to reluctance of banks to ever make use of the TLTROs in the future again”. Alternatively, Rabobank suggests that “reverse tiering would impair the efficacy of the interest rate instrument”. Instead, Rabo believes “lowering the remuneration on banks’ excess reserves equal to their TLTRO use is the most feasible”, albeit it has a low conviction on this call
* * *
In its ECB preview, ING Economics writes that since nearly everyone’s expecting another 75bp hike, the market reaction will depend on
Stance on further rate rises
Changes in inflation and growth outlook
Discussion over quantitative tightening
And here is the bank’s popular reaction matrix:
* * *
Finally, courtesy of Bloomberg’s Ven Ram, here three things traders will be watching, and some of the key elements of what may be expected from the European Central Bank today and how markets may react.
Size of hike & signaling: ECB officials have been more or less consistent in telegraphing a 75-basis point increase at today’s meeting. With President Christine Lagarde herself having commented that rate hikes need to be more emphatic the further the benchmark is away from neutral, markets are well positioned for another big hike. While there is a remarkable scatter of opinion within the ECB as to what constitutes a neutral rate, few in the Governing Council seem to be thinking it would be a number less than 2%. Lagarde may stay noncommittal as to her personal opinion on the matter during the press conference, but if she hints that the ECB may no longer need 75-basis point increases, euro-area rates could find a bid tone.
TLTRO & tiering: A crucial point of discussion at the meeting will be cheap long-term loans to banks, or targeted longer-term refinancing operations (TLTROs). With the ECB having gone from a regime of extreme accommodation to one of express hawkishness to contain inflation, how the central bank remunerates the excess reserves that lenders park with it is at once a challenging and contentious issue.
The ECB may decide to opt for one or a combination of the following measures:
Alter the terms governing TLTROs to the effect that reserves parked with it aren’t remunerated at the deposit rate, especially in a context where the latter is likely to climb well above 2%;
Treat cash parked with it on a par with mandatory reserves that lenders set aside; or
Introduce tiering, with different rates applying at different thresholds. Bloomberg Economics estimates that a tiering multiplier of six would exempt about 20% of excess liquidity from remuneration altogether
Euro-area lenders will feel the pinch of the moves, so bank stocks may come under a glare after any such announcement.
Quantitative tightening: Another topic du jour will be when the central bank should start shrinking its mammoth balance sheet. While the ECB may discuss the matter, it is unlikely to get going before it is done hiking for the current cycle. Lagarde remarked after last month’s review that the ECB has “probably less than five interest-rate increases” left, suggesting that it may decide to pause in February or March if all goes to plan. (In a situation where inflation is still ebullient, it may be compelled to keep going, though that’s a discussion for another day). That means, perforce, that quantitative tightening will have to wait until then at least.
* * *
All told, euro-area bonds will take their cue from how hawkish the ECB sounds, but the euro — which has been exposed this year against the dollar by deeply negative inflation-adjusted interest-rate differentials — won’t find any quick resolution despite any short-term hullabaloo.
New SEC Rule Will See Accounting Errors Result In Loss Of Executive Bonuses
A new SEC rule is being rolled out wherein executives of firms with costly accounting errors could find their personal bonuses on the hook. The Securities and Exchange Commission approved the rule on Wednesday, the Wall Street Journal reported.
The rule, “required by the 2010 Dodd-Frank Act to discourage fraud and accounting mischief”, was approved by a 3-2 vote of commissioners at a meeting this week. Democrats approved the rule while both Republicans dissented, the report says.
The rule had been initially proposed in 2015, but was then shuttered under the Trump administration. Democratic SEC Chairman Gary Gensler has said that it will “strengthen investor confidence in corporate reporting, as well as the accountability of managers,” the Journal reported.
Gensler stated: “Corporate executives often are paid based on the performance of the companies they lead, with factors that may include revenue and business profits.”
He continued: “If the company makes a material error in preparing the financial statements required under the securities laws, however, then an executive may receive compensation for reaching a milestone that in reality was never hit.”
The original rule used to apply only to firms that found major errors and had to restate financials. The newer version of the rule is broader and can still affect executive bonuses even with smaller, recent accounting errors.
“This may result in salary increases, rather than compensation mechanisms tied to financial-reporting measures,” Republican SEC Commissioner Mark Uyeda said. He also argued that the rule “may ultimately weaken alignment of interests between shareholders and management.”
The U.S. Chamber of Commerce and Business Roundtable along with GOP lawmakers and some SEC commissioners had spoken out against the rule.
Not unlike some Sarbanes-Oxley attestations, firms will now have to include check boxes on the front page of their annual reports to confirm that an error correction or clawback analysis had been conducted before filings are submitted.
For freight companies, this year’s peak will be weak
Peak season, an annual event in the freight industry, serves as the most important season in the calendar for many transportation firms. Depending on mode, peak season kicks off at different points on the calendar, mostly based around the role in the supply chain that a freight provider plays in ensuring that retail goods are on the shelves for the holidays.
Peak season by mode:
Ocean container: July through September
Trucking and rail intermodal: October through December 15th
Parcel: Black Friday through December 24th
With the peak season already completed in ocean freight, we can say with certainty that this year’s peak season will be incredibly weak.
Back in June, FreightWaves reported that ocean container volumes were dropping quickly, based on data found in SONAR’s Container Atlas, which tracks bookings volumes at the point of origin. By tracking point of origin bookings, we get an advanced look at import volumes months before those containers hit U.S. ports. At the time of publication, we believed that the contraction in volumes would happen at U.S. ports by July, but we underestimated how long it would take to clear the backlog of containerships off major U.S. ports and then waiting to clear U.S. Customs.
In August, it appeared that FreightWaves’ warning was unwarranted, at least looking only at U.S. customs import volume data. That data showed the market was relatively stable and hadn’t contracted.
But maritime spot rates and container shipping lines’ actions told a completely different story.
Ocean spot rates and imports fell off a cliff this year
First, we saw container rates collapse – suggesting that carriers were rapidly losing pricing power. When we published our June piece, the cost to ship a 40-foot container from China to the U.S. West Coast was $9,630. Today the same container would be transported for $2,470 – 74% lower than just a few months ago. This happened in a backdrop of a significant number of “blank sailings” by container ship lines. The container lines will cancel voyages to pull capacity out of the market.
According to Sea-Intelligence, container lines have canceled more than quarter of sailings across the Pacific in recent weeks.
Freight transportation is a commodity and responds to the laws of supply and demand. The collapse in container rates reflected volumes that were quickly deteriorating.
By September, the slowdown in container import volumes was becoming too significant to dismiss, even for the most hardened skeptic. The Port of Los Angeles reported that it handled the fewest number of loaded import containers for the month of September since the Great Financial Crisis (2009). The Port of Los Angeles is the largest port in the United States.
Weak import volumes weren’t just limited to Los Angeles, but affected all the major West Coast ports. Long Beach posted the lowest September loaded imports since 2016; Seattle/ Tacoma had its worst September for loaded imports in seven years. The decline in volumes will take longer to hit East Coast ports, but it’s already starting – September was Savannah’s weakest month this year for loaded imports, down 9.8% year-over-year.
With an estimated 75% of U.S. container imports related to consumer activity, a sharp drop in volume provides an ominous warning for any mode of transportation that is further downstream and closer to the point of consumption.
How the trucking turndown materialized
The trucking industry has been struggling since the first quarter. FreightWaves predicted that a freight recession was imminent, based on the drop in truckload volumes and tender rejections in the first quarter.
The SONAR Outbound Tender Volume Index (OTVI) measures truckload load requests from shippers to carriers, moving under contract rates. From the start of February to the end of March, it dropped by 12%.
The volume drop continued in April and May, with OTVI registering another 2.5% decline, but stabilized in June in conjunction with the summer construction, beverage, and produce shipping seasons. In June, the OTVI index registered an increase of 1%.
A stable June provided some confidence to carrier executives that the slowdown in the earlier part of the year was just a cooling of volumes from the inflated levels of the COVID economy.
Unfortunately, the optimism at the end of June was short-lived and proved to be an anomaly in a disappointing year.
The OTVI index dropped by 8% in the third quarter, with the majority of this drop occurring in the last two weeks of September. The decline has continued into October, with OTVI dropping an additional 3%.
The reality of the market deterioration is starting to set in across all trucking fleets. During the publicly traded trucking companies’ third quarter conference calls executives talked about how muted they expected the peak to be.
Trucking executives are wary
Here were some of the notes (quotes and other market commentary) from the early earnings reports and calls from the trucking industry.
CFO Adam Miller: “It’s rare that you go into a fourth quarter and not see some type of seasonal uplift and projects and spot opportunities. Especially with companies of our scale, we typically get some of these large, kind of difficult projects to handle and they typically pay a premium; … none of that stuff materialized.”
CEO David Jackson: “Anecdotally, we hear from those that have receivables with small carriers, and it has turned ugly very, very quickly for them,” Jackson said. “The pressures just continue to mount. I wouldn’t be surprised if there aren’t many small carriers that were just holding out hope for a strong fourth quarter to bail them out of a tougher summer with no spot [freight].”
President and CEO Jim Gattoni on customer expectations: “Everybody’s [indicating a] flat to a soft, muted peak season. Since our July call, I would say things have clearly softened up compared to the anticipation of a better peak season.”
CEO John Roberts: “Further evidence has presented itself over the course of the quarter that requires an increased level of caution and awareness on broader demand trends and economic activity.”
Head of intermodal Darren Field: “Peak season this year just doesn’t appear to be much of an event, although the company is taking market share.”
CEO Aaron Graft on factoring (i.e., short-term trade finance): “The decline in freight rates is starting to show up at TBC. September’s gross revenue was $17.2 million, 8.2% less than a year ago. October is already tracking down 19% from a year ago.”
Retailers command trucking by the fourth quarter
In the context of understanding the trucking calendar and sharp decline in container volumes, the slowdown makes sense. Retail has an outsized impact on the fourth quarter trucking market. Even in a good year, construction, agriculture, and beverage volumes slow down in the fourth quarter significantly. Retail becomes king.
Retailers have nearly all of the products they need in their distribution networks for the holidays (and then some), which means that there won’t be a lot of freight demand as we head into the last two months of the year.
In recent quarters, retailers have talked about how much inventory they are carrying. This holiday season, they will be focused on burning that inventory down – potentially through aggressive discounting and promotions.
As firms get more nervous about the broader economy heading into 2023, there is little incentive to replenish bloated inventories. This is bad news for most freight companies as they will find far fewer load opportunities.
While the timing of when the freight recession started will be hotly debated, carriers from the weakest spot participants to the best run are starting to realize that peak will be very weak.
To borrow a phrase from Mish Shedlock, author of the macro-economics blog, Mishtalk, whether we are in a recession or headed for one, the question is moot.
