Fed Fund Futures’ Reaction To CPI
The Fed fund futures for the March meeting show the chance of at least one rate hike went up from 68% before the data released to 73.7% after the data was released. Even though this is a small change, getting above the 70% threshold is pivotal because the Fed almost never raises rates when the chance is below 70%. As I said, the core CPI will determine if the Fed hikes in March. This is the last report until the January 31st rate decision. Because January’s meeting doesn’t have a press conference, there’s less room to signal a hawkish tone. Even if there was a statement, it wouldn’t matter much because Powell is taking the helm soon afterwards. It would be interesting to see if core inflation went up causing Powell to start out hawkish. Then some investors would think he was a hawkish Fed chair even though the data created the situation. That could spook the market.
The Second Longest Bull Market
Before I get into the details on the recent action in stocks, let’s take a step back and admire the bull market. As you can see, this is the 2nd longest bull market since 1945. In one year, it will be the longest which makes sense because this will be the longest expansion around then as well. It’s also the 3rdlargest rally. Breaking down how this rally came to be, 46% of returns came from earnings growth, 21% came from dividends, and 32% came from multiple expansion. This is interesting because many value investors claim that stocks can’t increase their multiple in the next few years; they say price appreciation needs to come from earnings growth. I disagree with that statement for two reasons. The first is that multiples depend on inflation. If inflation stays low, I wouldn’t be surprised to see more expansion. Secondly, this market isn’t always rational. Euphoria is not a logical reaction. Therefore, momentum can take the market to unbelievable levels.
Near-term Momentum Is Strong
Speaking of unbelievable levels, this entire year has been shocking. The S&P 500 was up 0.67% on Friday. Remarkably, the S&P 500 is already up 4.21% for the year. That would be a spectacular month, but the month is only half way done. This has been the best start to a year since 2003. In the first 10 days in 2003, stocks were up 5.9%. If you are curious, stocks were up 28.68% in 2003, so this rally is a great sign. The CNN fear and greed index is at 79/100 signaling extreme greed. As you can see, the chart below shows the S&P 500 is the furthest above its 200 day moving average since May 2013. My bearishness on the near-term market performance is about as high as it can be, but I was wrong this week.
Euphoria Returns In Cryptocurrencies
My viewpoint on stocks is broken into 3 points: short term, medium term, and long term. In the short term, I’m very bearish because stocks have gone vertical. In the medium term, I am bullish because the economy and earnings look good. In the long term, I am bearish because valuations are too high. I view cryptocurrency speculation as an example which shows we are near the end of the sentiment cycle where things get ridiculous. I’m not sure if cryptos are able to make it to the end of the cycle in a couple years or if they’ll crash before then. The latest size of the crypto market is $737 billion. It peaked at $836 billion, then fell to $628 billion, and has rebounded since then.
Considering the size of some of the tech stocks in the late 1990s, which saw market caps for the biggest ones get larger than the cryptos of today, the rally in cryptos might not be close to over. If you add up the top 4 tech stocks at the peak on March 10th, 2000, the market cap comes to $633.7 billion. That’s before inflation adjusting the market caps. After inflation adjusting them, the total is $912.51 billion. The current total market cap of the top 4 cryptos is $491.8 billion meaning the cryptos of total are about 54% of the tech stocks in 2000. In terms of timing, given how quickly these cryptos have rallied, we could easily see them double in 6 months which means the end of this mania might occur before the end of the bull market.
The housing bubble peaked in 2006 which was 2 years before the financial crisis. Obviously, that’s not a perfect comparison to cryptos because cryptos won’t crash the economy. However, it shows how the nucleus of the speculation can burst before the overall market tops. The table below shows how speculation has gotten out of hand. The companies listed have added the blockchain to their operations. As a result, they all have seen massive rallies. The joke is that if you add the blockchain to a company’s name without doing anything, it can add billions to its market cap. That’s close to the reality, which is disconcerting.
Food At Home Pushing Up Inflation
I discussed in a previous article how food inflation was up 0.2% in December and flat the two months before. I’ve also talked about how grocery inflation has been increasing recently after having fallen because of the Amazon effect. The chart below shows the CPI for food at home which is related to grocery inflation. As you can see, the food at home deflation bottomed in October 2016. The deflation transitioned to inflation in July 2017. If this trend stays in tact for a few more months, the two year stack will become positive again. Increasing food prices is bad for the consumer, but we’re far from reaching that point. We need to see the 2 year stack go from the -1% it’s at now to above 4%. That could occur in the next 1-2 years. That lines up perfectly with my call for increasing inflation in the next 1-2 years before a recession occurs sometime between 2019 and 2020.
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