Market Update: June 4, 2023

This newsletter is a synopsis of a continual series of updates by a market analyst Mark Meldrum. Mark Meldrum is a CFA that provides weekly updates on the market, but they tend to be an hour long. Here is a synopsis of his video found here.

Interest Rates & the Fed

With the debt ceiling finally behind us, we see a 74 basis points (bps) drop on the 1-month Treasury since just before Memorial Day. Capital market rates have also decreased, week-over-week. The market experienced some boost on Friday, which Meldrum attributes to China announcing a stimulus and more booming AI-related hype. These all seem rather inflationary: China’s stimulus pushed industrial metal prices up and energy prices; with the debt ceiling raised, government spending is back on track; OPEC’s decision to limit its oil output will also have inflationary effects on the price of gas. With all of this inflationary action, it’s hard to understand why the Market boomed so significantly on Friday…

As predicted, the 5-year Credit Default Swap (CDS) fell 22 bps from last week down to 36.8%. Total money market funds increased by almost $32 billion. We can expect some issuance from the Treasury to replenish some of their account, but it’s doubtful that they’ll rush it all to market right away. They likely have a cash flow plan that provides allocated issuance to direct money where they need it most.

The June 14 FOMC Meeting is just over a week away. In 9 days, May CPI reports are released. And, in the last week, there’s been a reversal in the predictability of the Fed’s upcoming rate decision: last week, the likelihood of a rate hike sat at 64%, while this week the likelihood of a rate hold is at 75%. This could be attributable to the mixed interpretations of the recent Jobs reports and how the market tracks wage inflation. There may be a chance we see another shift in these predictions before the meeting.

Now let’s talk economic lags… popular media and the Market like to believe that rate increases are absorbed directly into the economy, almost instantly. Claiming the market is “resilient,” they assume households and business are “handling it,” even though neither of these will feel the effects of higher rates for weeks, usually months. The Fed knows this and academic literature know this—a rate increase and the effect of that increase are two different things. And when we’re talking a wave of 500 bps of rate increases, those effects wouldn’t be small or immediate. Consider those with credit card debt or businesses with floating rate debt: they’ve most likely felt the effects of most of the rate increases. But there are some households with no auto loans or credit card debt and only a mortgage at a lower fixed rate: that household would be feeling far less effect upfront.

Real Rates, Federal Funds Rate, and TLT

Real yields have finally pulled back, but by only a small margin.

Federal fund futures (FFF) are implying around a 5% rate by the time 2024 begins.

TLT, the major long-term bond ETF index, is still showing marginal fluctuations.

Corporate bond issuance in May 2023 is 67.7% higher than May 2022, yet rates are also significantly higher. Borrowing more at higher rates is problematic. Could this be because some businesses are hoping to replace these loans at lower rates in the next few years? Something to think about…

Housing

The Primary Mortgage Market Survey shows 30-yr. Fixed Rate Mortgages (FRM) are at 6.79% (up 22 bps from last week) and 15-yr. FRM are at 5.18% (up 21 bps from last week).

• Mortgage applications are down 3.7%
• Refinances down 6.88%
• Purchases are down 2.46%

Homebuilders are up again by an average of 3% across major developers. Housing prices are increasing again, and bidding wars have emerged again. This speaks volumes to the housing shortage because buyers are purchasing homes at elevated prices with elevated mortgage rates—not an ideal situation to purchase a home. Given the conditions that have been put on the housing market (waves of rate increases, higher housing prices, lower inventory, etc.), it’s surprising that housing prices year-over-year are only down 1.1%. These kinds of conditions should constitute a much steeper fall, but the housing market seems determined to stay up, even in the face of bad news.

US Jobs

The Labor Market isn’t as tight as it used to be because the quits rate has fallen against the openings rate, indicating workers are less likely to quit their jobs to find another one. Companies are finding it more expensive to find outside hires, since the average “job switcher” experiences an average wage increase of 6.9% vs. “job stayers” experiencing an average wage increase of 5.7%.

The Jobs Report is comprised of both the Household survey and the Establishment survey, and they both tell different stories:

Meldrum even provides an analysis of who is getting and losing jobs, broken down by age, type of work, and educational level:

Each of these data points are contained in the AHE stat (above), which is why it’s not a clear number to interpret. This is why it seems like different stories are being told depending on which survey you’re examining: the Household Survey points to a waning job market, while the Establishment Survey shows improvement in the job market.

SPY (S&P ETF Index)

The Market bias is still bullishly positive, fueled by the AI hype, the presumed end of the rate cycle (doubtful), and strong employment. Again, this upward bias means things will continue as they are until something significant breaks in the economy. Meldrum also mentions something particularly significant: “If our capital markets are so reliant on central bank and fiscal spending, then it looks like capitalism can’t stand on its own two feet. If it constantly has to be propped up by central bank intervention and government stimulus, it makes us question what’s the problem underlying capitalism itself?” And if this kind of economic relationship exists, then the profits in the economy are a result of taxpayer spending, not just consumer spending, in which case, tax rates are too low.

Wheat & Livestock

Those investors who are weary of investing in the stock market are probably in the hunt for alternative investments, especially those that aren’t correlated with the stock market. Wheat, specifically wheat futures, are one investment that has no correlation with stocks, meaning the value of these investments won’t be affected by a market downturn. Still, some may be hesitant to invest in wheat: over 40% of the global wheat supply is produced by China, India, and Russia. And Russian wheat is still on the market, despite the ongoing conflict with Ukraine.

Some years ago, the spread between cattle and hogs was quite wide, providing an opportunity to squeeze value from the difference between these two commodities. At the beginning of 2023, the spread between hogs and cattle was 84 cents, which typically isn’t enough to entice investors; most require a spread of at least 100 cents to justify trading. And like wheat futures, investing in livestock is another alternative that is uncorrelated to the stock market. But these are “spread trades,” so the difference between the gain and the loss is what matters here. Currently, cattle is moving up in value while hogs are moving down, so the spread has widened significantly creating opportunity to make money. For whatever reason, there is something in the market causing pork prices to fall and beef prices to rise and Meldrum reminds us that “it’s the beginning of barbecue season,” so these prices may not have found their way into consumer decision-making.

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