Charts of the Week

Happy Triple Witching CPI week! It could be a bit of a roller coaster. Speaking of which, let’s talk about some of the most interesting charts I’ve found to share with you.

Do We Have the Energy for a Soft Landing?

The 10-year to 3-month Treasury yield curve is deeply inverted. We’re seeing some flattening, but it’s measured.

While many focus on the inversion, what matters more is when we steepen into positivity out of it. If you look closely at the chart below, and consider the dates involved, the steepening is when trouble started in the past.

With the Saudi Arabian and Russian oil production cuts extending until December and demand rising, there’s a deficit of crude that could keep a floor under price.

The US Strategic Petroleum Reserve is at a 40-year low while oil prices hover near 10-month highs. Any unexpected significant supply disruption could be problematic, and push prices meaningfully higher. Something to keep in mind as we enter peak hurricane season.

Meanwhile, recession probabilities have tumbled across multiple asset classes, which may just be a bit of a contrarian indicator if I’ve ever seen one.

On the other hand, energy tends to outperform during hand landings — and we are seeing that outperformance now. Whether it portends to such a scenario remains to be seen, but one trend I’ve noticed prior to some recessions is a big pop in oil prices before the hard landing.

Oil, Oil Everywhere

Speaking of oil, it goes into everything. Touching our lives in a variety of ways. If you look around anywhere you’ll see it. Whether it’s in the fuels we use, plastics, asphalt, pharmaceuticals, fabrics and other textiles, and much more. That’s why when the price of oil moves it’s important to be mindful of the downstream impacts.

We can’t talk about oil without mentioning Saudi Arabia, who has been selling down their Treasury holdings, with the largest sale during 2020 when about $65 billion of US Treasury exposure was jettisoned in part to fund the purchases of US risk assets.

Of Liquidity and Risk Re-Rating

Global liquidity has fallen by $1 trillion over the last 10 weeks, helping to drive the dollar and rates higher. The question is whether this will weigh on global equities.

Prior correlations would suggest that indeed, it should, but for now the Magnificent Seven are holding the market up, defying gravity.

Rates on the two-year note have risen to levels we haven’t seen since the Great Finance Crisis as the market continues to adjust to the notion of “high for longer”. We’re likely to get another rate hike out of the Fed, but I don’t think it will be this month. Perhaps later this year. Of course, as the Fed likes to remind us, it all depends on the data.

Nevertheless, earnings yields are thoroughly below cash yields, which often leads to a re-rating of risk lower. Something to be mindful of if we’ve yet to see the trough in earnings as valuations for the biggest gainers this year are quite stretched.

Another interesting chart that I’ve been keeping my eyes on is the divergence between the S&P 500 NTM PE and the US 10-year note real yield (inverted). The two typically enjoy a positive correlation, but we’re not seeing that of late as real yields surge and stocks move higher as well.

If there were to be a month where risk could potentially be re-rated, September is often that month, with markets falling more during Septembers since 1985 than any other month.

Will this time be different? Time will tell. The best opportunity sellers may have is after options expiration week, though, as some of the passive flows which bid up markets weaken meaningfully.

Shorts, Longs and Losses

Goldman Sachs prime book data showed a significant amount of weekly short flow last week, with cumulative short flows cresting to 2023 highs. Are we going to see some squeezes?

On the other side of the ledger, however, hedge funds are quite long regional banks. An interesting change of positioning as we are navigating through a growing wall of CRE debt maturing throughout 2023 and 2024. Regionals are also exposed to further losses on duration exposure as rates rise.

Some of those losses are visible below, as banks saw their unrealized losses grow during Q2 of 2023.

Finally, China lost the number one sp ot as the US’ largest source of exports. However, we are hearing that Mexico is importing a lot of goods from China, and some are making it over to the US. Perhaps things aren’t what they seem on the surface.

As always, I hope that you enjoyed this Charts of the Week. If you have any questions or feedback please share below.