THANK YOU!

Many readers took advantage of the first ever Edge And Odds Black Friday Event. Sincere thanks to Richard T., John M., Constantin Z., Richard B., Robert K., Joseph T., Joshua F., Jasec, Donald M., David M., Massimo B., Lawrence M., Stephen C., Bill C., Jack H. and Brian T. I hope I forgot nobody. You and other regular donators are truly helping this blog survive during this not so transitory inflation period.

All donations are reinvested in research. Helping the blog actually helps you.

It is thus natural, and very important to me and to all readers for that matter, to try to find ways to thank donators with special exclusive features.

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Fed’s Williams Says Inflation Fight Could Last Into 2024 The New York Fed president points to signs that price pressures are easing, but sees inflation remaining above 3% in a year.

(…) “I hope [a recession] is not the case, but that’s clearly a risk out there given all of the uncertainty in the global economic outlook,” he told reporters during a videoconference following a Monday speech to the Economic Club of New York.

Mr. Williams said he expected that rates would have to rise in 2023 to somewhat higher levels than he had penciled in during projections Fed officials submitted individually at their September meeting.

“Stronger demand for labor, stronger demand in the economy than I previously thought, and then somewhat higher underlying inflation suggest a modestly higher path for policy relative to September,” he said. “Not a massive change, but somewhat higher.”

Mr. Williams, who serves as a key lieutenant to Fed Chair Jerome Powell, did nothing to push back against expectations that the central bank will lift rates by a half percentage point at its meeting next month, Dec. 13-14. That would bring the Fed’s benchmark rate to a range between 4.25% and 4.5%, continuing the most aggressive series of rate increases since the 1980s.

Mr. Williams said if inflation declines as he anticipates next year, the central bank might need to lower rates in 2024 to hold inflation-adjusted interest rates constant. (…)

The New York Fed leader said he expected the unemployment rate to rise to between 4.5% and 5% next year. A forecast where the unemployment rate peaks at around 4.5% represents a more “benign scenario,” he said. “There are scenarios of the economy slowing more sharply,” he added.

Inflation using the Fed’s preferred gauge, the personal-consumption-expenditures price index, rose 6.2% in the 12-months ended September. Mr. Williams said he expects the inflation rate to slow to between 5% and 5.5% by the end of this year, and to between 3% and 3.5% next year. (…)

He warned that bringing down underlying price pressures, including those that reflect rising domestic wages, will require further tightening of monetary policy to slow economic activity and demand. (…)

Separately, an essay published Monday by Fed Vice Chair Lael Brainard flagged the risk that central banks around the world could face more inflationary pressures than they had over recent decades if forces such as demographics and globalization turned from headwinds to tailwinds that support higher prices.

• Loretta Mester: The costs of stopping tightening too early are high
• It is time to revisit the 2% inflation target The right goal for central banks in advanced economies such as the US might be 3% a year (Olivier Blanchard)

Global Yield Curve Inverts in Signal a Recession Is Brewing The gauge inverted for the first time in at least two decades.

The average yield on sovereign debt maturing in 10 years or more has fallen below that of securities due in one-to-three years, according to Bloomberg Global Aggregate bond sub-indexes. That has never happened before based on data going back to the beginning of the millennium.

The inversion of the yield curve is typically seen to herald a recession, as investors switch money to longer-term bonds due to pessimism over the economic outlook. (…)

China blames local officials for outbreaks as Beijing sticks to zero-Covid plan Health authorities vow to boost vaccination of elderly after widespread protests against restrictions

• Sinopharm’s F61 nasal spray receives clinical trial approval for people at high risk of exposure to COVID-19 The approval is of great significance as it will be an important weapon in the fight against the rapidly spreading Omicron variant.

According to the company, the F61 monoclonal antibody showed broad-spectrum neutralizing activity against SARS-CoV-2 prototype strains and major variants against COVID-19. In particular, it maintained high activity against Omicron BA.1, BA.1, BA.2, BA.3, BA.4/5 and BF.7, which were the main strains of the current epidemic. (…)

But no specific data on actual, measured, efficacy.

• #CHINA AIMS TO SPEED UP VACCINATION AMONG PEOPLE AGED ABOVE 80 – BBG *CHINA TO ALLOW ELDERLY TAKE BOOSTER 3 MONTHS AFTER VACCINE *CHINA TO USE BIG DATA TO TARGET SENIORS FOR COVID VACCINATION
• *ABOUT 1.2B PEOPLE FULLY VACCINATED IN CHINA: HEALTH OFFICIAL *86.42% OF 60 YEARS OLDS AND ABOVE FULLY VACCINATED IN CHINA

• From Forexlive: Here’s an interesting item that suggests China may soon dump the COVID zero policy

Crypto Lender BlockFi Follows FTX Into Bankruptcy Cryptocurrency lender BlockFi filed for bankruptcy, making it the latest major digital assets company to fail since FTX, with which BlockFi is financially intertwined.

• Crypto exchange Bitfront shuts down

• Crypto’s Final Price Could Be Zero (Andy Kessler) No sane lender would extend credit against assets lacking any underlying collateral.

There aren’t many leveraged buyouts of technology companies, and for good reason. Technology and debt, like Red Bull and milk, don’t mix. Why? Because when technology works, it commands high valuations. You can’t LBO Google. But when technology moves on to the next new thing, there isn’t much residual value in the form of assets and collateral to call on in case of debt defaults. FTX, Elon Musk and SoftBank are learning this lesson. (…)

The new poster child for the toxic cocktail of technology and debt is Sam Bankman-Fried, with his imploded FTX and Alameda empires. Sure, these companies misappropriated, to put it nicely, customers’ assets. And yes, withdrawals that acted like a bank run drove the company into Chapter 11. But the company’s original sin was to borrow against its own FTT token, which was held up by nothing but air.

This was crypto’s mass delusion. FTT was so thinly traded that FTX could set any price, but not forever. FTX and Alameda borrowed against tokens they themselves were manipulating, including Solana and others, which some called Sam Coins, now Scam Coins. The fatal conceit: They thought FTT would stay high forever, so they invested in often illiquid positions. (…)

You can’t manipulate something forever. Reality eventually replaces delusion. (…)

A cottage industry of firms emerged to lever up crypto. This is when things turned toxic. The first task was to lure customers by paying interest on their crypto holdings. The Anchor Protocol behind the spectacularly imploded Terra-Luna algorithmic tokens was paying up to 20%.

Other platforms such as Binance and Crypto.com would pay 4%, 8% or more on crypto as well, suckering in the masses who could earn only 0.01% interest from, well, real banks. But how could anyone pay interest on crypto? By turning around and lending it out to hedge funds and others who also used leverage. Insanity.

Genesis Global Capital created a lending platform to facilitate borrowing crypto. Lending against what? Again, just air. Firms such as Gemini, set up by the Winklevoss twins, were paying 8% interest, so customers could harvest yields. Why was there any yield on crypto? Good question. It worked on the way up, not so much on the way down. Crypto was lent out like a hot potato until someone got stuck with the value down 90% and everyone else left with defaulted debt. This was probably the only way the delusion could have ended. (…)

Of course, all these crypto lenders had to do was ask: What’s the underlying collateral? Where are the assets? With no good answer, no sane lender would have lent against it. But no one asked. (…)

As an aside, last June, a company asked me to help it sell coins it had received from a few clients. After exploring a few “exchange platforms”, I advised to sell as quickly as possible because it was obvious these platforms were, uh…, unusual.

An uninformed investor could easily get creamed by the trading algos. And the apparent activity on “the tape” is fake; it gives the impression of very active, sometimes hectic, trading when the actual volume traded is insignificant, when there is any. The “price charts” are likely not real.

To avoid killing the “markets” for these coins, I had to trade very gingerly against rather silly bots. It took me 5 months to liquidate the not so large positions! On most days I sold, I was 90-95% of the volume traded. Who bought? Bids were from an algo driven, totally predictable bot, but I have no clue where the money came from?

Strangely, the “exchange” I was using no longer accepts deposits to trade (sell) one of these coins. “[coin] deposits are temporarily closed and will reopen as soon as possible.” It’s been over a week now…

SPAC, CRACKEL AND POP!

Palantir Failed to Spot Pattern in SPAC Debacle The data-analysis company aimed to use deals with startups to jumpstart its non-government business. There were some misfires.

Palantir Technologies Inc.’s raison d’etre is identifying patterns hidden within mountains of data. Yet somehow it didn’t spot the risks in its own investment strategy or the danger that startups might not be able to pay their bills. (…)

Co-founded by outspoken entrepreneur Peter Thiel and known for its work with the intelligence community and the UK’s National Health Service, Palantir has spent $450 million since 2021 acquiring shares in about two dozen early-stage companies, nearly all ex-SPACs. The quid pro quo: The startups promised to purchase Palantir software and services, typically of a value that was equal or greater than its investment.

Realized and unrealized losses on the SPAC portfolio reached 75% at the end of September, or about $333 million, according to my analysis of Palantir’s latest accounts. The red ink may have increased since then. Because many of these startups now face a cash squeeze, Palantir may also be overestimating how much revenue it will receive from them. (…)

Though backing a bunch of SPACs seems hubristic in hindsight, it’s the kind of thing that happens when the stock market is awash in liquidity and rewards growth above profits. (…)

At the peak in 2021, Palantir was valued at $68 billion, or around 35 times sales. (…)

Palantir’s stock has crashed more than 80% from the high as its revenue growth slowed and the SPAC investments plummeted. (…)

In February 2021, I wrote: “BTW, Palantir has never made a profit in 17 years, despite dealing almost exclusively with governments…” FYI, it reported a $1.2B loss in 2020 and another $520M loss in 2021. Current market cap is $13.7B.

Black Friday Lured Shoppers Back, in Holiday Spending Test Stores on average welcomed more consumers compared with last year, industry data show.

(…) Store traffic rose 7% this Black Friday compared with last, said RetailNext, a firm that tracks shopper counts in thousands of stores with cameras and sensors. In-store sales rose 0.1%, and the average shopper spent less per visit than last year, according to the firm. Sensormatic Solutions, another firm that analyzes store traffic, said Black Friday traffic rose 2.9% compared with 2021. (…)

Sales on Black Friday rose 12% from last year, according to Mastercard SpendingPulse, which measures in-store and online retail sales across all forms of payment. (…) “Apparel, electronics and restaurants were strong-performing sectors as consumers turned holiday shopping into a full-day experience,” he said. (…)

It has been “kind of a lukewarm Black Friday,” said David Bassuk, global co-leader of the retail practice at AlixPartners, a consulting firm. “It’s more of an experience than it is a purchasing moment,” he added. (…)

Online sales on Black Friday rose 2.3% to $9.12 billion from last year, according to Adobe Analytics, which tracks spending on websites. On Thanksgiving people spent $5.3 billion online, up 2.9% from the holiday last year, according to Adobe. (…)

• Restaurants, Grocery Stores Battle Over Consumers’ Stretched Dollars Supermarket chains are carrying more low-price staples and promoting prepared food while restaurants including Wendy’s and Papa John’s are offering discounts.
• Inflationary pressures continue to weigh on consumer wallets in the U.S., with 46% of people saying they plan to spend less this holiday season, according to a recent Goldman Sachs Research. Nearly 80% of survey respondents expect to adjust their behavior as a result of higher prices. Roughly 55% of respondents plan to buy fewer items this year, with some also planning to trade down to cheaper price points and quality levels.

Protests Spread Over China’s Covid Restrictions People took to the streets in Beijing, Shanghai and other cities amid the growing economic and social costs of lockdowns and other restrictions.

Axios:

“Down with the Chinese Communist Party! Down with Xi Jinping!”

• Those chants — reported today in Shanghai, China’s most populous city — are very rare public protests against the country’s leadership.
• Protests are flaring across China, including in Beijing, against arduous COVID restrictions.

The wave of civil disobedience is unprecedented in mainland China since Xi Jinping assumed power a decade ago, Reuters reports. (…)

Frustration boiled over after a fire Thursday that killed 10 people in a high-rise building in Urumqi, capital of the Xinjiang region, where some residents have been locked down for 100 days. Internet messages assert residents weren’t able to escape because the building was partially locked down. City officials deny that.

@Sino_Market

• Apple to Lose 6 Million iPhone Pros From Tumult at China Plant
• Oil Plunges to Lowest Since 2021 as China Unrest Rattles Market

The S&P 500 is Not the Economy

My old friend Freddy linked me to a last Friday post by Ben Carlson discussing a point I made a few weeks ago.

(…) Sam Ro shared a great chart this past week on his Substack that shows the difference in composition between the S&P 500 and the U.S. economy in the form of earnings and economic growth:

Sam notes, “The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.”

The stock market is mostly corporations that make and sell things.

The economy is mostly the stuff we do with those things.

Most of the time the stock market and the economy are moving in the same direction but they also diverge on occasion.

The S&P 500 also receives roughly 40% of revenues from overseas. For technology stocks, that number is closer to 60%. (…)

True, the S&P 500 is not the economy, being more than twice more heavily weighted to goods vs services.

Correlation between S&P 500 revenues, earnings and index prices with manufacturing data is indeed very high:

So, should investors care about the service economy, 60% of GDP, when assessing the outlook for the S&P 500 index or simply focus on the goods side?

Probably not so much when looking at S&P 500 earnings…

…but very much so when rising inflation is impacting the multiple these earnings carry on the index.

The S&P 500 index is earnings x earnings multiple and the multiple is highly sensitive to inflation/interest rates, themselves being highly sensitive to wage trends, themselves being very sensitive to the services economy which supplies 86% of all jobs in the USA.

All Ed Yardeni charts above cover the period 1995 to 2022 when inflation (blue below), for all 25 years, was never really a factor, remaining below 2.5% (average: 2.1%) with wages (red) never growing more than 4% yearly (average: 3.0%).

Quite a difference with the previous 30 years when inflation very rarely dipped below 4% (average: 5.4%, wages: 5.1%).

Sustained high inflation rates destroyed earnings multiples between 1972 and 1990.

S&P 500 EPS almost quadrupled between 1972 and 1989 but real equity prices cratered 60% to July 1982 and only returned to their 1972 level in September 1989, seventeen years later.

S&P 500 Inflation Adjusted

(Nasdaq Data)

Inflation can therefore matter a lot. It so happens that inflation has a lot more to do with the service economy than with the goods economy.

Over the last 25 years, the correlation between Core-CPI and CPI-Services was 71%. With CPI-Durables: -7%, with CPI-Nondurables: 10%.

As we know, correlation is not causation. The cause here is wages, the largest cost component for most service providers. Services inflation (black line below) is intimately correlated with wage trends (red). Services are 73% of Core CPI.

The recent widening gap between equity prices and the manufacturing PMI reflects a downward multiples revision, happening when inflation is accelerating owing to rising services inflation owing to rising wages owing to tight employment.

Historically, rising wage trends were only broken by recessions…

…which generally happen because consumers retrench. Hence the current hope that Americans will spend more on services to offset the likely decline in goods consumption.

Until inflation is back under control, the S&P 500 is the economy.

BTW, from the November Flash U.S. PMI:

• “increasingly steep downturns in demand”
• “the decrease in total new sales was the sharpest since 2009”
• “new export orders contracted at a sharper pace”

FYI:

PC heavyweight HP is slashing its workforce by up to 10%, saying it expects a sharp slump in demand to stretch into next year. The WSJ’s Denny Jacob reports the payroll reduction of up to 6,000 employees is part of a broader overhaul aimed at achieving $1.4 billion in annualized cost savings. It came after rival Dell Technologies reported sales in its unit that includes laptops and desktops fell 17% last quarter and said the decline would accelerate this quarter. The slump in PC sales, along with declining demand for related high-value goods like semiconductors, is hitting transportation demand. The International Air Transport Association says global airfreight traffic fell 10.6% in September. Gartner says global PC shipments fell at the fastest pace in more than two decades, and the manufacturers’ outlooks suggest things are getting worse.

• Freight forwarder DB Schenker is reducing its chartered flights because of declining airfreight demand. (Air Cargo World)

Powell to Set Stage for Slowing Fed Rate Hikes Amid Hawkish Tone Powell is scheduled to deliver a speech, nominally focused on the labor market, at an event on Wednesday hosted by the Brookings Institution in Washington. It will be one of the last from policymakers before the start of a quiet period ahead of their Dec. 13-14 gathering.

EARNINGS WATCH

From Refinitiv/IBES:

Through Nov. 25, 485 companies in the S&P 500 Index have reported earnings for Q3 2022. Of these companies, 70.7% reported earnings above analyst expectations and 24.9% reported earnings below analyst expectations. In a typical quarter (since 1994), 66% of companies beat estimates and 20% miss estimates. Over the past four quarters, 78% of companies beat the estimates and 18% missed estimates.

In aggregate, companies are reporting earnings that are 3.4% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.1% and the average surprise factor over the prior four quarters of 7.0%.

Of these companies, 70.1% reported revenue above analyst expectations and 29.9% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 74% of companies beat the estimates and 26% missed estimates.

In aggregate, companies are reporting revenues that are 2.3% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.2% and the average surprise factor over the prior four quarters of 2.7%.

The estimated earnings growth rate for the S&P 500 for 22Q3 is 4.3%. If the energy sector is excluded, the growth rate declines to -3.5%.

The estimated revenue growth rate for the S&P 500 for 22Q3 is 11.7%. If the energy sector is excluded, the growth rate declines to 8.4%.

The estimated earnings growth rate for the S&P 500 for 22Q4 is -0.4%. If the energy sector is excluded, the growth rate declines to -5.4%.

Some other facts:

• The +3.4% earnings surprise factor is boosted by Energy (+10.9%) and Health Care (+8.2%). Five of the 11 sectors show negative surprises with Consumer Discretionary at -2.8% and Industrials at -4.7%.
• Trailing EPS are now $222.39. Full year 2022: $220.32e. Forward 12-m: $224.98e. Full year 2023: $231.23e.

TECHNICALS WATCH

@Callum_Thomas

U.S. Expands Chinese Telecom, Surveillance Bans The Federal Communications Commission voted to ban sales of new telecom and surveillance equipment made by several Chinese companies, arguing that their ownership and practices threaten U.S. national security.

The rule change affects 10 companies already subject to other restrictions and prohibits them from marketing or importing new products. They include security-camera makers Hangzhou Hikvision Digital Technology Co., 002415 -0.96%decrease; red down pointing triangle Hytera Communications Corp. 002583 -1.43%decrease; red down pointing triangle and Zhejiang Dahua Technology Co. 002236 -0.42%decrease; red down pointing triangle and telecom equipment makers Huawei Technologies Co. and ZTE Corp.  000063 0.66%increase; green up pointing triangle

The FCC made its order public Friday. The latest order stops short of requiring U.S. equipment buyers to remove items they have previously purchased or stripping authorizations for electronics models that already exist. (…)

Russian security software maker Kaspersky Lab is also on the list of tech companies covered by the sanctions. (…)

Hikvision is the top worldwide seller of professional security equipment by revenue and ranks No. 5 in the U.S., according to market researcher Omdia. (…)

Miami clubs miss crypto high-rollers

Crypto entrepreneurs who began frequenting Miami’s clubs out of the blue have “completely disappeared,” Andrea Vimercati, director of food and beverage at Moxy Hotel group, tells the Financial Times (subscription).

“They wanted to show that they didn’t have any limits,” Vimercati recalled. “They were ordering 12 or 24 bottles of the most expensive champagne and just showering themselves without even drinking.”

On the dance floor, crypto kids acted as if there was no tomorrow, the FT notes. Turns out, they were right.

•   Leverage means contagion

The financialization of crypto made it vulnerable to the kind of contagion we’re now seeing, Axios’ Felix Salmon writes.

The big change in crypto between 2018 and today is the introduction of large-scale lending to the sector. And with lending comes a new kind of risk — counterparty risk — that crypto still hasn’t found a good way of dealing with. (…)

At the heart of the crypto project is a technological feat: The ability to create digital objects that exist only in one place and can’t be copied. If I send you a bitcoin, I can’t send that same bitcoin to someone else.

As a result, if I own a bitcoin, that bitcoin can go down in value, or even be stolen, but those losses are mine alone.

Crypto lending changes the dynamic. Companies like Celsius Network and FTX — both now in bankruptcy — paid interest on crypto deposits, and lent out crypto assets to borrowers.

• Instead of one person owning a simple asset of one coin, a depositor is owed a coin by the exchange. The borrower owns the coin, and the exchange is owed money from the borrower while also owing money to the depositor.
• Effectively, an asset of one coin has become an asset of one coin (in the hands of the borrower) plus two liabilities of one coin (at the borrower and the exchange) plus two receivables of one coin (at the exchange and the depositor).
• There are now three assets worth 1 bitcoin. If the actual coin is lost and the borrower defaults, then the borrower and the exchange and possibly even the depositor can all lend up losing 1 bitcoin.

Crypto losses have rippled across companies that engaged in such borrowing and lending activity, from Luna to 3 Arrows Capital to Celsius to Voyager Digital to Alameda Research to FTX to Genesis to Gemini.

• None of them adequately managed their counterparty risk — the risk that the trading venue you’re dealing with will go bust and not be able to pay you what you’re owed.
• In traditional finance, central banks can step in to prevent such contagion. In crypto, however, there are no such macroprudential overseers.

Iran’s Supreme Leader Orders Militias to Deal With Rioters