Israel Outraged After Erdogan Calls Hamas ‘Liberators’, Cancels Planned Trip To Mend Ties
Turkish President Tayyip Erdogan is reverting back to his hardline stance on Israel and the Palestinian question, on Wednesday in a blistering speech blasting the Jewish state’s “inhumane” war.
The most surprising moment came when he said bluntly that “Hamas is not a terror organization” but is a “liberation group” rightfully fighting to protect Palestinian lands. This is raising eyebrows, and alarm no doubt, among Turkey’s Western allies. After all, this is the head of state for NATO’s second biggest army.
“Hamas is not a terrorist organization, it is a liberation group, ‘mujahideen’ waging a battle to protect its lands and people,” he told ruling AK Party lawmakers, using an Arabic word often used to signify ‘Islamic warriors’.
Contrary to most other NATO countries as well as the European Union, Turkey has never designated Hamas as a terrorist organization.
He additionally accused Israel of “taking advantage” of Turkey’s good will, while Israeli forces ramp up airstrikes against civilians in Gaza, and announced the cancelation of a planned trip to Tel Aviv:
Erdogan said Israel had taken advantage of Turkey’s good intentions and that he wouldn’t go to Israel as previously planned due to Israel’s “inhumane” war against Hamas militants in Gaza, according to state-run news agency Anadolu.
…He said countries outside the region were “adding fuel to fire” in the name of supporting Israel.
Erdogan further called what’s happening an “intentional massacre” as the death toll in Gaza soars past 6,000 – with many of the victims being women and children.
“The perpetrators of the massacre and the destruction taking place in Gaza are those providing unlimited support for Israel,” Erdogan said. “Israel’s attacks on Gaza, for both itself and those supporting them, amount to murder and mental illness.”
Clearly, there want be any normalization effort with Israel, after years of already deteriorated relations. “I shook the hand of this man named Netanyahu one time in my life,” Erdogan said. The two had engaged in a rare handshake on the sidelines of the UN General Assembly in New York last month.
BREAKING — Erdogan says Hamas isn’t a terror group but patriotic organisation that defends its territories and people.
• “They are the warriors (mujahids)” he says. “We aren’t indebted to Israel. But the West is.”
“If he (Netanyahu) had continued with good intentions, our relations might have been different, but now unfortunately, that will not happen either because they took advantage of our good intentions,” he added.
Israel’s foreign ministry was quick to denounce Erdogan words hours after he issued them on Wednesday. Denial of Hamas terrorism is the focus of the Israeli condemnation.
“The Turkish president’s attempt to defend the terrorist organization and his inciting words will not change the horrors that the whole world has seen,” the Israeli foreign ministry said, in reference to the Oct.7 Hamas rampage across southern Israel.
Our Daily Market Commentary* provides market insight, analyzes economic and financial news, and highlights a few graphs worthy of discussion. Occasionally, we stumble upon a graph that deserves more than the paragraph or two we typically allot in the Commentary. The chart below, courtesy of SoFi and Bloomberg, is one example. It compares real rates and stock valuations.
The graph presents the inverse relationship between real interest rates and stock valuations. It shows the traditional relationship has broken down since October 2022. The recent divergence and the likelihood it reverts to normal have implications for stock prices and bond yields.
*Our Daily Commentary is a great way to start the day. In just a few minutes, you can read our latest market thoughts and brief discussions of a few timely topics of interest. Click HERE to sign up and receive it free in your inbox every morning.
Stock Valuations and Real Rates
Despite widespread misunderstanding, the dollar price of a stock doesn’t tell us how rich or cheap it is. Apple currently trades at around $175 a share. It would trade at about $2.75 trillion if only one share existed. Despite how far apart the two prices are, both prices signify the identical value proposition.
Therefore, stock valuations provide a much more genuine gauge of the actual price of a stock.
Coca-Cola (KO), for instance, is worth $260 billion. Is it rich, cheap, or fairly valued? KO’s valuation ratios compare critical fundamental data to its stock price or market cap, allowing investors to assess whether $260 billion is the right price to pay for KO’s future cash flows.
Real interest rates, the current interest rate less inflation or the expected inflation rate, perform a similar task for bonds. Is an 8% bond yield rich or cheap? The yield level is meaningless without an appreciation for inflation, economic growth trends, and Fed policies. 8% may sound fantastic, but would you think so if inflation ran at 12% and was expected to remain in double digits for a decade?
The Stock Bond Relationship
Low or negative real rates are economically stimulative as the incentive for people and companies to borrow and spend or invest is much higher than when real rates are high.
Consequently, periods of low real rates frequently accompany higher stock valuations. Conversely, high real rates restrict economic activity. They tend to weigh on corporate profits, stock prices, and valuations.
The graph we led this article with affirms the logical inverse relationship between stock valuations and real rates. However, since October 2022, the correlation has broken down. Real rates have risen sharply to fifteen-year highs over the last ten months. Despite the coming economic and financial burden of higher real rates, stock valuations have risen alongside real rates. That shouldn’t happen in theory, but theory and short-term speculative periods often disagree.
The recent period of increasing real rates and valuations is not sustainable. Therefore, we must ask, how will the relationship normalize?
Lower yields?
More inflation?
Declining stock prices?
Higher earnings?
Or will some combination close the irregular gap? To help answer, let’s look at the relationship between valuations and real rates over more extended periods.
Historical Relationship of Rates and Valuations
To better appreciate the correlation over more extended periods than the initial graph, we present monthly data for real rates and stock valuations in scatter plot format. Our real rate calculation uses the Cleveland Fed’s 10-year inflation expectations estimate and the 10-year U.S. Treasury yield. We use forward price to earnings as our stock metric to remain forward-looking with stock valuations.
Interestingly, the relationship between real rates and stock valuations breaks when the real rate is below 1%. As such, the first graph shows a strong correlation when the real rate was 1.0% or greater.
Note that the correlation is good (r-squared of .4215); however, from 1998 to 2001 (orange), the relationship was inverse that which is typical. Higher rates led valuations upward in the speculative lead-up to the dot com crash. A similar environment seems to be occurring today.
Since 1985, the relationship has been statistically meaningless when real rates are below 1.0%. Yet, despite a low r-squared (.0781) for that data set, the data still trend from the top left to the bottom right, signifying that even with low or negative real yields, there is an inverse relationship.
Since the 2008 financial crisis and the ensuing easy money Fed policies, real rates below 1% have been the norm. The following scatter plot shows that, unlike 1985 to 2007, the recent relationship has a decent correlation despite real rates predominately below 1%. The orange dots represent the current deviation from the typical relationship, which started in October 2022.
How Might The Relationship Between Real Rates and Stock Valuations Normalize?
How will the divergence end: Lower yields? More inflation? Falling stock prices? Higher earnings? Or will a combination close the irregular gap?
Normalization Via Real Rates
If the relationship normalizes solely due to real rates declining, then interest rates and or inflation expectations would be lower by default. Using the data from the scatter plot (1985-present), real rates in that scenario would fall from 2.10% to approximately 1.25% to return to trend. If inflation is stable, interest rates would fall by .85% to get real rates to trend. However, if inflation returns to the 2% Fed target, bond yields would fall by about 2% to get to the trend.
To reiterate, that scenario assumes valuations do not change.
Normalization Via Valuations
The opposite approach assumes real rates do not change. Instead, valuations adjust to get the relationship back to trend.
If the relationship normalizes with stock valuations falling toward the regression trend line, we must assume stock prices drop and or earnings expectations rise. Either way, the forward P/E would fall from 19.50 to 16. If that were to occur, either stock prices fall by about 18% or forward earnings increase by 22%. The risk to that math is that weaker economic growth reduces earnings forecasts, and the corresponding correction in stock prices must be larger than 18% if the relationship normalizes.
However, if real rates fall, stock valuations do not need to correct as much as we calculate.
Summary
The relationship between real rates and stock valuations makes a lot of sense. How the Fed runs monetary policy, whether too restrictive, stimulative, or just right, significantly impacts the economy, interest rates, and corporate earnings.
The temporary disconnect between real rates and equity valuations will eventually correct. The question is how. We discussed a few possibilities, but the honest answer is that history is an imperfect guide. The last significant divergence in 2008 resulted in a sharp correction in stock valuations and much lower bond yields.
Regardless of our guess or yours, it is most important to appreciate the relationship and the recent divergence and be ready for the historical trend to reassert itself.
Boeing Stock Rises Despite 9th Consecutive Money-Losing Quarter, Missing Across The Board And Cutting 737 Delivery Guidance
Shares of Boeing jumped 3% in premarket trading Wednesday, after the company that sells airplanes that were “designed by clowns who are supervised by monkeys“, reported revenues and earnings that missed, including the company’s ninth consecutive money-losing quarter, free cash flow which came in worse than expectations (it burned through $310 million, worse than the $252 million expected) and cut its annual delivery target for 737 deliveries (again), but reaffirmed the full-year outlook for free cash flow which apparently was enough for the market to push its stock higher, if only for a few hours.
Here is a snapshot of what BA reported for Q3.
EPS loss per share of $3.26, missing the -2.96 estimate.
Revenue $18.10 billion, missing estimates of $18.16 billion
Commercial Airplanes revenue $7.88 billion, beating estimates of $7.47 billion
Defense, Space & Security revenue $5.48 billion, missing estimates of $6.05 billion, which is remarkable with not one but two wars taking place
Global Services revenue $4.81 billion, beating estimates of $4.74 billion
Operating cash flow $22 million, missing the estimate of $448.2 million
The company’s income was dented by the supplier snarls that caused 737 deliveries to plunge by a third from the previous quarter. Losses at the defense subsidiary included a charge of $482 million to kit out the next Air Force One presidential aircraft (because Biden’s handlers must travel in style).
Commercial airplanes had a Q3 operating loss of $678 million, missing the estimated loss of $624.4 million
Defense, Space & Security had an even bigger operating loss at $924 million, twice as bad as the estimated loss of $461.9 million, and a -16.9% margin, which is remarkable with not one but two wars going on.
On the balance sheet, there were almost no changes, with cash dropping about half a billion as debt remained unchanged from Q2.
But despite the mixed results, the reason why the stock is higher for now is that in its 2023 projections, the company affirmed its guidance for free cash flow of $3.0 billion to $5.0 billion and for 70 to 80 787 deliveries, even as it cut its outlook for 737 deliveries to 375 to 400 from 400 to 450 due to another round of quality issues (of course) which have led to delivery delays.
Boeing’s start-stop comeback from the pandemic has frustrated investors and customers at a time when demand for new jets is booming. In a message to employees, Chief Executive Officer Dave Calhoun said “it’s on us to perform,” highlighting how the company has struggled to increase production as it struggles with quality lapses at it’s largest suppliers.
“When we set our recovery plans, we knew issues would come up along the way,” Calhoun said in the memo. “This is a complex long-cycle business and enduring change takes time.”
Investors will be looking for more details around inspections and repairs needed for the aft pressure bulkhead in some 737 Max jets, the latest production glitch uncovered at Spirit AeroSystems Holdings Inc., when Boeing hosts an earnings call later this morning.
Boeing’s stock has dropped 14.8% over the past three months through Tuesday while the Dow Jones Industrial Average has shed 6.5%. It rose as much as 3% premarket before fading gains after the open; we expect it to close red.
Israeli Attack On Southern Syria Kills 8 Troops After Hezbollah Fired Rockets On Golan Heights
There was another dangerous exchange of fire between Syria and Israel near the Golan Heights in the overnight hours, related to ongoing airstrikes on Gaza. Late Tuesday and into the overnight hours there were widespread reports that at least two rockets were fired from southern Syria, with the Israel Defense Forces (IDF) saying the pair of projectiles landed in open fields.
Israel then responded with a major attack on what it said were Syrian missile batteries in retaliation, which reportedly killed at least eight Syrian troops, according to international reports and state media, the latter which detailed, “Around 1:45am [22:45 GMT Tuesday], the Israeli enemy carried out an aerial aggression from the occupied Golan Heights.”
Regional media sources said the IDF response attack destroyed arms depots and a Syrian air defense radar, and the base that was struck included an infantry unit.
A prominent Syrian opposition monitoring group, the Syrian Observatory, said it wasn’t the Syrian Army that fired the salvo in the first place. It identified that “fighters loyal to Hezbollah” were responsible, having “launched rockets towards the occupied Syrian Golan.”
On Wednesday, the IDF issued rare confirmation of its strikes on southern Syria, saying “fighter jets struck military infrastructure and mortars belonging to the Syrian army in response to the launches towards Israel yesterday [Tuesday].”
According to sources cited in AFP, Syrian army and Palestinian factions have been issued fresh warnings this week by the IDF near the Golan. Leaflets were reportedly dropped in the region, which read: “Syrian commanders … bear full responsibility for operations … incoming from Syrian territory”… every attack “on the state of Israel will be met with an iron fist.”
Syrian Army and Hezbollah forces work in close coordination, and it’s not uncommon for Israel to attack Syrian government installations for something Hezbollah or an “Iran-linked” paramilitary group did.
🚨UPDATE: Headquarters for the 5th Armoured Division of the Syrian Army, a Radar Battalion and Weapons Depots of the Syrian Air Defense Force were targeted by the IDF airstrikes.
The Headquarters for the 5th Armored Division has been destroyed.
This month, Israel has already attacked Damascus and Aleppo international airports some two or three times. In Damascus, an airport worker died in the latest instance the runway was taken out.
A new Wednesday report in SANA indicates Aleppo airport has been struck yet again:
“Nearly at 1:25 p.m. on Wednesday, the Israeli enemy carried out an air aggression from the Mediterranean Sea, west of Lattakia, targeting Aleppo International Airport, causing material damage to the airport’s runway and it’s now out of service.” A military source stated in a statement to SANA.
Israel is on a heightened state of alert not only along the Golan Heights which it occupies, but along its northern border with Lebanon as well, where dozens and towns and villages have already been evacuated as a fight gears up with Hezbollah.
On September 7, 2021, the U.S. Department of Defense gave an award of $749,387 to Newsguard Technologies, a private service that scores media outlets on “reliability” and “trust.” According to the suit, roughly 40,000 subscribers buy Newsguard subscriptions, getting in return a system of “Nutrition Labels” supposedly emphasizing “safe” content. Importantly, Newsguard’s customers include universities and libraries, whose users are presented with labels warning you that CBS is great and Tucker Carlson is dangerous:
Consortium News was labeled a purveyor of “disinformation,” “misinformation,” and “false content,” and, worst of all, “anti-U.S.” This is despite the fact that, according to the suit, Newsguard only flagged six articles out of the tens of thousands Consortium News has published since the late award-winning reporter Robert Parry founded it in 1995. As Consortium News points out, Newsguard downgrades its entire 20,000+ library of available online articles with these flags based on the handful of edge cases, all of which involve criticism of U.S. foreign policy.
A particular irony is that Parry, a decorated AP and Newsweek reporter, founded Consortium News specifically to address topics suppressed by mainstream editors. Now Parry’s old site is being downgraded for dissenting reports on subjects like the 2014 Ukrainian coup and neo-Nazism in Ukraine, coincidentally topics that are “the subject of NewsGuard’s ‘Misinformation Fingerprints’ project that is under contract with the Cyber Command,” as the suit reads.
Newsguard denies it’s influenced by the government. In fact, its denials are part of the reason for the suit. When Michael Shellenberger and I testified before Congress in March, we mentioned Newsguard as a “government-funded” ratings service. I was quickly contacted by email by co-CEO Gordon Crovitz, who hastened to correct me: Newsguard isn’t government-funded, but merely an organization that receives government funds. He wrote:
As is public, our work for the Pentagon’s Cyber Command is focused on the identification and analysis of information operations targeting the US and its allies conducted by hostile governments, including Russia and China.
Our analysts alert officials in the US and in other democracies, including Ukraine, about new false narratives targeting America and its allies, and we provide an understanding of how this disinformation spreads online. We are proud of our work countering Russian and Chinese disinformation on behalf of Western democracies.
Crovitz added that “contrary to claims made in the hearings, we oppose any government involvement in rating news sources,” saying Newsguard “is entirely independent and free of any outside influence, including from the U.S. or any other government.”
The letter, CC’ed to co-CEO and editor Stephen Brill, was subject-lined “Inaccuracies relating to NewsGuard.” I immediately wrote back:
Crovitz didn’t answer at the time, but Newsguard did simultaneously release the letter to the UK-based Press-Gazette. When I reached out for comment again after the filing of this litigation this week, asking once again how “government-funded” could be inaccurate, Crovitz finally answered, writing:
“We are ‘government funded’ in the same way that Verizon is ‘government funded: We have licensed data to the government for a fee, just as Verizon has provided telco services for a fee.”
He added:
The government pays us both for our commercial offerings. Our Pentagon contract is a single-digit percent of our revenues.
So, they are government-funded, just not wholly government-funded. These are the people rating others on accuracy, remember.
The conceit about funding isn’t complicated, but it works. Because Newsguard has other customers, it can claim to be an “independent” news service that just happens to downgrade news reports that contradict and/or criticize the policy of its major client, the Department of Defense. It’s censorship, but through a silencer. As the Consortium News suit reads:
NewsGuard and the United States in violation of the First Amendment are carrying out a governmental program under the “Misinformation Fingerprints” contract to publicly label, target and stigmatize news organizations as disfavored, unreliable, as journalistically not responsible… where said organizations differ or dissent from U.S. policy.
The suitalso details what I think is the more insidious part of the system. In the guise of an independent news service, Newsguard contacts outlets and interrogates them about disputed content, not-so-subtly pressing for retractions. Again, from the suit:
In the course of the government contract, NewsGuard and the United States have acted to retaliate against those news entities and media organizations that refuse to retract or correct their articles; such retaliation consists of the “false content” warnings, the red flag and associated content described in this Amended Complaint…
Racket received one of these irritating queries this year. Call it what you want, but it comes down to Pentagon Cyber Command giving a big check to “analysts” who happen to slap red revenue-sapping warning tags on outlets that report on controversial topics like war or government censorship.
As I wrote to Newsguard when they contacted me, “media outlets should gain and lose trust based on how they are evaluated by audiences, not paid services.” This system allows institutions like the Department of Defense that have no legal remit to meddle in the domestic news landscape to pressure private media outlets.
That’s over and above the DoD’s already hugest-on-earth-by-far public relations budget. Think of the scale of petty determination one must have to spend over $500 million a year on messaging and be so dissatisfied with the results that you feel the need to spend more on private services that downgrade independent news critics. It’s particularly grating that your tax dollars are spent hiring private services that label news outlets using terms like “anti-US.” State-sponsored impugning of patriotism is a bold stroke, even by the low moral standards of the anti-disinformation era.
“When media groups are condemned by the government as ‘anti-U.S.’,” said Bruce Afran, attorney for Consortium News, “the result is self-censorship and a destruction of the public debate intended by the First Amendment.”
I was remiss in not getting this story up before, but will have more as the case goes on.
Consortium News is seeking “a permanent injunction… barring the government and NewsGuard from continuing such practices” and “more than $13 million in damages for defamation and civil rights violations.” You can read their coverage here.
IRS Collects $160 Million From Wealthy Taxpayers Amid ‘Increased Compliance Efforts’
The IRS has collected roughly $160 million from wealthy taxpayersYTD – or approximately 2 days worth of Ukraine aid, as part of the agency’s ‘increased compliance efforts’ that some worry could eventually target small-business owners.
This figure combines some $38 million collected by the IRS earlier this year, and $122 million the agency on Friday announced having collected. The latest collection spans 100 high-income earners, according to a statement.
The 100 taxpayers are part of the IRS’s 1,600 new high-income earners they say “owe hundreds of millions of dollars in taxes.”
The agency cited three specific cases of such taxpayers. One, who was ordered to pay $15 million last month, falsified millions of dollars of personal expenses as deductible business expenses. That amount was instead used to fund the construction of a 51,000 sqft. mansion, which included an outdoor pool, pool house, tennis, basketball and bocce courts. The individual also falsified millions of dollars of expenses for luxury vehicles, country club memberships, homes for his children, and artwork.
Another individual recently pleaded guilty to filing false tax returns and skimmed more than $670,000 from his business, according to the agency. The individual also spent $502,000 on gambling and $110,000 on personal expenses.
A third individual fraudulently obtained $5 million in COVID-19 relief loans for a sham business and then spent the money to fulfill personal needs, buying multiple cars, including a Lamborghini and a Ferrari. This person was sentenced to 54 months in federal prison. –Epoch Times
The IRS credited last year’s Inflation Reduction Act (IRA) as contributing to the tax collection efforts.
“Prior to the Inflation Reduction Act, more than a decade of budget cuts prevented the IRS from keeping pace with the increasingly complicated set of tools that the wealthiest taxpayers use to hide their income and evade paying their share,” the tax agency said. “The IRS is now taking swift and aggressive action to close this gap.”
Skeptics abound
While the IRS contends that its enhanced collections efforts are aimed at making wealthy taxpayers pay their fair share, Sen. Joni Ernst (R-IA) has questioned the Biden administration.
In an April 18 letter to IRS Commissioner Daniel Werfel, Ernst pointed out that the Inflation Reduction Act funding over 10 years was designed to “enhance collections efforts toward American taxpayers and increase the IRS workforce to over 105,000 employees by 2025.”
“President Biden has repeatedly stated that these efforts would be directed to ‘billionaires’ and wealthy taxpayers,” she wrote.
“However, the strategic plan states in Part II, Objective 3.5 that IRS will pursue increased audit rates of any business earning more than $400,000 to enhance collections efforts towards large corporations and wealthy individuals.”
Ernst cited government data showing that the average small business employing around five workers had annual receipts exceeding $424,000.
“It is abundantly clear that small businesses will bear the brunt of these enforcement efforts, not solely large corporations and the wealthiest taxpayers,” she wrote.
As the Epoch Timesnotes further, earlier this month, the IRS insisted on strengthening compliance efforts by pointing to the burgeoning tax gap—the difference between what is owed and what is actually paid to the government.
For tax year 2020, the IRS estimates the gap to be $601 billion. For 2021, it is estimated to be $688 billion, which is “a significant jump” from previous estimates, the IRS stated. The 2021 tax gap is $192 billion more than estimates from 2014 to 2016 and $138 billion more than 2017–2019.
“This increase in the tax gap underscores the importance of increased IRS compliance efforts in key areas,” Mr. Werfel said. “With the help of Inflation Reduction Act funding, we are adding focus and resources to areas of compliance concern, including high-income and high-wealth individuals, partnerships, and corporations.”
In an Aug. 16 statement, the IRS stated it was cracking down on schemes that wealthy people were using to evade taxes. One scheme involved about 100 high-income Americans who claimed benefits in Puerto Rico without meeting the rules regarding U.S. possessions.
Another scheme involves a Malta-based personal retirement program used by certain Americans to avoid U.S. taxes. At the time, the IRS said it was “working to identify taxpayers who are improperly using Malta-U.S. Treaty rules to improperly claim exemptions.”
Despite the IRS’s claims of targeting wealthy people, it has historically audited lower-income people the most, according to a January report by Syracuse University’s Transactional Records Access Clearinghouse.
“If one ignores the fiction of auditing a millionaire through simply sending a letter through the mail, the odds that millionaires received a regular audit by a revenue agent (1.1 percent) was actually less than the audit rate of the targeted lowest-income wage-earners whose audit rate was 1.27 percent,” the report stated.
The rate of income tax audits per 1,000 individuals stood at 12.7 for the lowest-income wage earners and 2.3 for everyone else.
The report authors wrote that low-income wage earners have historically been targeted by the IRS not because they account for the most underreporting but because they are seen as “easy marks in an era when IRS increasingly relies upon correspondence audits yet doesn’t have the resources to assist taxpayers or answer their questions.”
By Jessica Menton, Bloomberg markets live reporter and strategist
The pain in long-duration growth stocks, fueled in recent weeks by a relentless surge in Treasury yields, is finally on the verge of subsiding. That is, at least, if the so-called Taylor Rule is anything to go by.
The equation, posited by Stanford economist John Taylor in 1993, has become a way to measure how the Federal Reserve can use its overnight bank lending rate to tame inflation or stimulate the US economy. Now, it’s approaching a critical inflection point for the US equity market by signaling that the central bank has finally normalized rates.
The calculation calls for a higher terminal rate when price pressures are anticipated to be higher than usual, and — all else being equal — a lower one when economic growth is expected to be lower than usual.
The spread between the fed funds target rate and the rate implied by the Taylor Rule peaked above 10 percentage points in early 2022, suggesting the Fed was well behind the curve at the start of the current cycle, according to Gina Martin Adams, chief equity strategist at Bloomberg Intelligence.
But now, that spread has dropped to its lowest level since early 2021. So, if the consensus is correct that core inflation will continue to ease, the fed funds rate may be finally hitting its cycle peak. Naturally, the next question for investors is just how long will the central bank keep rates high?
“The Fed is pretty close to being done, particularly because the bond market is doing the work for them by also tightening financial conditions,” said Julie Biel, portfolio manager at Kayne Anderson Rudnick. “While investors can’t ignore how strong the economy is, the Fed is scared of repeating the 1970s where they misjudged the staying power of inflation, so they will likely hold rates higher for longer than needed.”
In the run-up to the Fed’s Nov. 1 policy decision, investors are looking to figures later this week on economic growth, inflation and consumer spending that will help determine the trajectory of central bank policy for the remainder of the year.
Economists expect Thursday’s GDP data to show US economic output accelerated to 4.5% on an annualized basis in the third quarter, up from 2.1% in the three-month period ended in June.
Policymakers have taken comfort from a slowdown taking hold in the US in key underlying measures of inflation, including the Fed’s preferred inflation measure. The annual core personal consumption expenditures metric, which strips out food and energy, fell below 4% in August for the first time in nearly two years.
The consensus is for core PCE to slow to 2.6% by the end of 2024, as the unemployment rate rises modestly to 4.4% by that time. These two forecast inputs to the Baseline Taylor Rule model suggest the current fed funds target rate is “spot on the level implied by the equation,” according to Gillian Wolff, senior associate analyst at Bloomberg Intelligence.
What’s more, a steep climb in bond yields since late June has coincided with an 8% reduction in the valuation premium that high-duration stocks have over their low-duration counterparts, data compiled by Bloomberg Intelligence show.
Generally speaking, Big Tech companies are particularly susceptible to fears of higher-for-longer rates because many of them are valued on projected profits delivered years in the future. The present value of those future profits are worth less as yields rise. The highest duration sector in the S&P 500 Index on average is communications services, including shares like Take-Two Interactive Software Inc., AT&T Inc. and News Corp.
In fact, the median top quintile of BI duration stocks within the benchmark equities gauge saw forward price-to-earnings multiples contract more than 13.6% as of Friday, from 3.84% on June 30. Bottom quintile stocks, meanwhile, have experienced valuation compression of just 6.3%. High-duration shares still trade at a hefty premium compared with their lower-duration peers.
“High-duration growth stocks that aren’t profitable will continue to be pressured with rates elevated, so it will be hard for investors to stomach,” Kayne Anderson Rudnick’s Biel said. “But I’m more concerned about a divergence in the companies that can continue to maintain their pricing power versus those who face further margin degradation.”
Authored by Simon White, Bloomberg macro strategist,
US households are becoming the buyer of last resort in Treasuries, meaning yields may need to rise by as much as 1.5 percentage points to meet the sector’s elevated and rising inflation expectations.
The world is once again having to acclimatize to higher rates. US 10-year yields this week rose above 5% for the first time since 2007. But they may need to climb even further to clear the market as other sectors continue reduce their Treasury exposure, leaving households as the only net buyer.
For every seller, there must be a buyer. The Federal Reserve, financial firms and the rest of the world have all been net sellers of USTs since last year, leaving the household sector (including the corporate sector it de facto owns) to pick up the slack.
Households have historically been the smallest holder of Treasuries, but in the space of less than two years they have increased their holdings by $1.7 trillion, taking them to a new high of $2.4 trillion. The way things are going, households may end up owning a lot more yet – but they’re likely to demand a greater yield than currently on offer to compensate for the risks.
In the years just before the pandemic, all sectors other than households were happily hoovering up Treasuries. But now they’re reducing their duration exposure in the face of the fastest Fed rate-hiking cycle yet seen.
Most obviously, the Fed is no longer a buyer, with its UST holdings falling $1.3 trillion from their peak as part of its quantitative-tightening program.
There is little sign the Fed won’t carry on with the current pace of QT, especially with reserves still more than $1 trillion above most estimates of their lowest comfortable level.
US banks, too, have been reducing their exposure to duration through Treasuries. Before the Fed started hiking, Treasury holdings of banks had reached all-time highs. But banks typically row back on their UST exposure when rates rise. As the chart below shows, they are likely to continue to shed Treasuries well into next year.
US Treasuries have also lost their allure to overseas buyers. High short-term rates and an inverted yield curve have made US yields after FX hedging costs very unattractive to erstwhile large buyers like Japan. Further, non-Western-aligned countries are becoming more reluctant to hold US government debt in case they face Russia’s fate and see their FX reserves frozen.
But where there is the greatest potential for large-scale Treasury divestment is in the non-bank financial sector. Asset managers, mutual funds and other multi-asset investors have no essential need for Treasuries. But they became increasingly attractive to them as portfolio and recession hedges as long as their correlation to stocks was negative.
However, stocks and bonds are reverting to co-moving together now that the inflation genie is out of the bottle. Investors not bound by liability-matching needs may question owning Treasuries if they are no longer enhancing risk-adjusted returns or are unlikely to work as a recession hedge.
Since 2021, non-bank financials’ UST holdings have dropped by almost $600 billion, accounting for over 60% of the net rise in the household sector’s holdings. The positive stock-bond correlation hints households may end up taking on a lot more of unwanted Treasury debt currently held in 60/40-like portfolios.
Recent rises in yields have been driven by term premium – a sign that the market is becoming increasingly wary of supply and therefore inflation risks. But cushioning the blow has been the RRP facility. The Treasury has been skewing its issuance toward bills this year, and as their yield is higher than the RRP (and as we gradually get closer to the point where the Fed will eventually cut rates), money market funds (MMFs) have been transferring funds from the RRP to bills.
But bills are now above 20% of total Federal debt outstanding, around the upper bound of where the Treasury has aimed to cap bill issuance in the past. Future auctions will increasingly skew toward bonds and away from bills.
As that trend continues, the RRP will provide less of a cushion as MMFs are unable to invest directly in longer-term debt (even if they can indirectly through repo).
The Fed, banks, multi-asset investors and overseas buyers are unlikely to provide much support, leaving the household sector as the marginal buyer and therefore the setter of the clearing price.
But what is that price? That largely depends on the outlook for inflation. The market has been remarkably sanguine in its inflation outlook this cycle, despite the highest consumer price growth seen for several decades. The 5y5y forward inflation breakeven rate has risen from around 2% in 2019 to 2.75%.
The household sector is much less optimistic. Shorter-term inflation expectations, based off the University of Michigan survey, are almost back to their pre-pandemic levels, but longer-term expectations – pivotal for bond yields – remain elevated.
As the chart below shows, the gap between households’ and the market’s inflation expectations has widened to at least 15-year highs, with a recent peak of more than 1.5 percentage points.
Heightened inflation has been with us more than two years now, and households will increasingly be growing wise to money illusion.
Regardless of whether they have as nuanced an understanding as the market of inflation-duration risks, they are likely to demand more yield compensation than the market is currently offering, with a rough-and-ready estimate – given by the excess of the household sector’s anticipated long-term inflation above breakevens – of 1-1.5 percentage points over time, or perhaps even more if bond and inflation volatility remain high.
It’s not about who’s ultimately right on inflation, but who’s left – and at the moment that’s US households.
Blackstone CEO Says Remote Staff “Don’t Work As Hard”
It has taken Wall Street – which rushed in 2020 to offer workers virtually unlimited work from home options at a time when lockdowns were the mandatory narrative and anyone who strayed was summarily canceled – almost 4 years to realize what has been obvious to modern civilization for centuries: there is a reason why employees work in offices and not at home.
Today, Blackstone billionaire CEO Steve Schwarzman shared that insight when he revealed that part of the reason workers are proving difficult to lure back to offices is because they enjoy a lighter workload at home while saving money.
The Blackstone boss, whose firm is the single largest commercial and residential landlord in the US and maybe the world, said people profited from remote work as they found “they didn’t work as hard regardless of what they tell you” and saved money on commutes, lunches and expensive work clothes.
That’s contributing to the continuing vacancies in office buildings in the US, with Schwarzman saying he expects companies to cut back on space when their leases end and some of those properties are “not survivable as economic entities.” Still, he said newer office buildings were proving resilient and demand for other categories of real estate like warehouses continued to rise.
Schwarzman was speaking on a panel at the latest edition of the Future Investment Initiative summit in Riyadh, aka Davos in the Desert. According to Bloomberg, the executive may have drawn solace from comments by Goldman Sachs CEO David Solomon, whose workers have largely returned to their desks. Solomon said on the panel that his firm is, “by and large, operating the same way now as it did before the pandemic.”
At Blackstone’s own offices, things are back to pre-covid normal with all executives and investment professionals expected to be at their desks five days a week. The good news for Blackstone is that it collects rent no matter where workers are physically located.
After U.S. officials backed Israel’s assertion of innocence in the blast, major news outlets that relied on Hamas’s version of events—like the New York Times—have been forced to issue corrections, albeit quietly and begrudgingly.
Those waiting for a heartfelt apology may be disappointed, as according to investigative journalist and author Lee Smith, the media has for years been complicit in a propaganda machine designed to “disorient and demoralize” the American public.
“For most people, actually, on the right, their first exposure to real disinformation, real information operations has been watching what’s going on in the Middle East since the beginning of the 21st Century,” Mr. Smith said on EpochTV’s “American Thought Leaders” on Oct. 20.
From the war in Iraq to the 2006 Lebanon War and now the Israel-Hamas War, Mr. Smith noted that information warfare has been a key tactic utilized by militant regimes in the Middle East to break down support for their enemies.
However, he contended that it was the Obama administration that purposefully created a media echo chamber to sell its nuclear deal with Iran to a dubious American public. And that communications infrastructure, he charged, is now being used to spread disinformation about the Israel-Hamas War.
Echoes of the Past
Mr. Smith noted that when the Obama administration struck its controversial deal with Iran in 2015, most Americans were against it.
“We know that they took our diplomats hostage in 1979,” he said. “We know that they killed Americans in Iraq. We know that they killed Americans in Lebanon back in 1982, and they’re responsible for almost all of the American deaths in Iraq. … So, most Americans are looking at this, the Iran deal, saying, ‘This looks nuts.’”
At the time, the “Joint Comprehensive Plan of Action” was promoted by the administration as a means of preventing Iran from developing nuclear weapons. But according to Mr. Smith, the true purpose of the deal was just the opposite.
“It was never designed to stop Iran from getting the bomb,” he contended. “It was designed to get Iran the bomb and legalize it in the eyes of the international community.”
To convince the public otherwise, Mr. Smith said the administration relied heavily on friendly journalists, think tanks, and so-called “experts” to regurgitate White House talking points.
“Barack Obama had behind him the strength of the media—again, that’s the communications infrastructure that was built back then. And it’s used to sell everything now, from Russiagate to the Jan. 6 insurrection.”
Revisiting the Iran Deal
Mr. Smith said the message that the echo chamber is now selling is that Israel should not be allowed to defend itself against what he called a “pathocratic” regime.
“We’re not talking about an oligarchy; we’re not talking about a democracy, a tyranny, a monarchy,” he said.
“We’re talking about rule of the pathologically evil, or rule of the pathological. And that’s what we’re seeing with Hamas and Hezbollah.”
Hamas’s use of human shields, he noted, “is abnormal—this is sick, this is pathological.” And while some have called for a ceasefire, that course, he said, would ultimately strip Israel of its right to defend itself from such a regime.
“I’m not saying that everyone knows the upshot of that argument,” he said. “But that’s where that argument goes—that Israel cannot protect its own.”
The Biden administration, for its part, has made an effort to demonstrate its support for Israel militarily, sending ammunition, aircraft, and aircraft carriers following the attack.
President Joe Biden also joined with several world leaders on Oct. 23 to reiterate his support for Israel and the nation’s right to defend itself.
However, Mr. Smith noted that the administration has downplayed the possibility of Iran’s involvement in the assault despite reports that Iranian security officials helped to plan it all.
“We have records of all sorts of meetings between high-ranking Iranian officials, and the leader of Hamas—Ismail Haniyeh—and the leader of Hezbollah—Hassan Nasrallah—training operatives specifically for this assault with hang gliders. It’s very sick,” he said.
“And the reason that the Biden administration is concealing this is because the Biden administration still wants to restore the nuclear deal with Iran,” he stated.
When former President Donald Trump took office, he withdrew from the nuclear deal, shutting out Iran and its proxies in favor of bolstering relations with existing Middle Eastern allies through the Abraham Accords.
The Biden administration, Mr. Smith contended, has undermined that agreement in hopes of “collapsing” Israeli Prime Minister Benjamin Netanyahu’s government and bringing Iran back to the table.
And those goals, he said, beg the question of why.
“Why does American and European leadership want to legalize the nuclear weapons program of a pathocratic state? We know what they are. … Why are they normalizing regimes like Hamas’s, Hezbollah’s, and like the Islamic Republic of Iran when these are sick and insane polities?”
Deteriorating Trust
While the mainstream media echo chamber may still be active, for many, its effectiveness has waned.
From the COVID-19 pandemic to concerns about election integrity and the weaponization of the federal government, many Americans no longer trust the sources they once believed credible.
And for Mr. Smith, that deep distrust presents another concern that must be addressed.
“The people who have no faith in the information they’re getting and are willing to believe everything have been made extremely, extremely vulnerable,” he said.
“And it’s a very bad sign for our country, again, because it’s an indication that people feel that they have nothing to hold on [to]. They believe] everything about our country, everything about our reality is fake,” he said. “But of course, that’s not true.”
To help those people discern truth from fiction, said Mr. Smith, society must get back to “looking at the true things and explaining the true things as they happen”—without the added spin.
