Charts of the Week

Happy Friday! What a week it has been, with Nvidia’s earnings and guidance reaction sparking an AI-themed rally, the debt ceiling Kabuki theater keeping some on edge, and the hotter inflation reading from PCE for April.

Debt priced in dollars within emerging markets is shrinking at the fastest rate since the Great Financial Crisis, and is the second largest decline in percentage terms that we’ve seen.

As global interest rates and borrowing costs rose, we saw Latin American debt issuance fall to $64B in 2022, down 57% from 2021. This was the lowest issuance since 2008. Asia EM debt issuance also fell during the same period.

The debt ceiling Kabuki theater continued to jar the markets this week, with T-bills maturing within the first week of June seeing yields rise to over 7.47%. The last time the T-bill had an average yield around that was 1990 at 7.89%. While this was just a peak during a time of stress, it’s still remarkable.

It’s also noteworthy that the debt ceiling looks a lot more like an elevator over time, with debt readily surging rather than being contained as a ‘ceiling’ would suggest. Perhaps illustrating that the entire construct deserves to be reexamined.

Nervousness around a potential default surged over the last week, only to retreat as we closed it out. The US 1-year credit default swap hit the highest levels we’ve ever seen, with the five-year credit default swap getting back to levels we haven’t seen since 2011, the last major debt ceiling crisis.

Small business optimism is continuing to tumble, which is a concern as small businesses are the largest creators of new jobs. I expect that the relative resilience in the labor market will begin to unravel in the back half of this year as we see more pressure to save on OpEx.

We can already see signs that small business payments volume is falling this year as the economic environment becomes more challenging. This fall in revenue puts even more pressure on business owners, particularly as their cost of capital has surged and credit is less available.

The money that small businesses are sending to hiring firms is also slowing, just as JOLTS falls. Showing that the largest creator of new jobs is already showing signs of pulling back on hiring Unfortunately the next step is firing and it's likely that picks up steam soon.

Tightening credit conditions do no favors to small businesses who already face the difficulty of largely being dependent on revolving lines of credit, where businesses are at the whims of Fed Funds + the bank's markup in terms of what they are paying on their debt

Firms with fewer than 500 employees create 1.5 million job per year and account for 64% of new jobs in the U.S.

In summary, small businesses are key to economic growth and job creation As they struggle, it is likely we see more pressure on the overall economy as well. This is important to consider as rising unemployment and a deteriorating economy tends to put pressure on risk assets.

The NASDAQ 100 QQQ ETF and 20+ Year Treasury Bond TLT ETF as seeing one of their largest divergences in the last year, as big tech is increasingly ambivalent about rising rates and tightening credit conditions.

There is a reasonably strong chance that a mean reversion occurs here, but the question is when. With $1.2T of new debt issuance to occur after the debt ceiling is raised, it is likely that will push rates even higher (meaning TLT may indeed drop further).

The number of S&P 500 components outperforming the index recently hit 29%, the lowest reading since the height of the Dot Com bubble. This extremely narrow upside breadth is a concern, as it often does not portend to ideal outcomes for the market.

While there is some chance that ‘this time is different’, caution is still warranted with exuberant long positioning in concentrated parts of the market in our view.

Commercial banks continue to replace their deposit liabilities with borrowings, another sign that the deposit exodus has created additional strain within the banking system.

Current estimates have over 50% of US banks liabilities exceeding their assets, which could become a larger problem in the back half of 2023 as we begin to see more debt coming due in office building loans and other struggling areas.

We see the most stress occurring with small banks, as reserves drop as a source of funding for loans. This becomes a key concern as we head towards the back half of this year, and further tightens credit conditions which is likely to slow consumer and business spending.

In addition to tightening credit, we do see money supply going negative year-over-year. This is certainly an ominous looking trend, though it does appear that money supply as measured in aggregate rather than percentage growth terms, is reverting back to a larger, less parabolic, longer-term uptrend. So it will be worth watching to see if this trend of dropping money supply does continue.

As credit tightens and money supply falls, we also see a fall in commercial real estate transaction volume. Office space is also showing the lowest utilization levels in history, and this is before we likely see many companies decide to shrink space or not renew leases when due.

Rents in the NYC area continue to rise, as rentflation is a trend that continues to show resilience in some areas of the country, and particularly larger cities.

The AI stock surge is being classified as a “baby bubble” by Bank of America right now. But it is not too different than the Japan bubble back in the late 80s to early 90s in scale, which was still a rather sizable bubble at the time.

Similarly it appears to resemble the biotech bubble of 2013 to 2016. We’ll see how it all winds up, but I do think that AI has a lot of potential. I’m just not convinced that all of the returns we’ve seen lately are justified by the current capabilities. I will be more amiable to that idea when we see the pass-through impacts throughout a large breadth of corporate margins expanding due to productivity enhancements powered by AI.

The probability of a recession within the next 12 months is at 68% based on the New York Fed model that models Treasury spreads. The last time probabilities were this high were during the 1980s when we had back-to-back recessions.

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