Gimme three steps
January 23, 2022
Gimme three steps, gimme three steps, mister
Gimme three steps toward the door?
Gimme three steps, gimme three steps, mister
And you’ll never see me no more. Lynyrd Skynyrd
I was running down the road and the classic Lynyrd Skynyrd song came on, which I of course cranked up, and it reminded me of the old Wall Street adage, ‘Three Steps and a Stumble’. This pithy rule says that when the Fed hikes three times, stocks are likely to suffer a serious setback. Given the Fed’s enormous transformation from an institution that had previously relied on changes in the Federal Funds rate to calibrate the economy, into an Oz-like entity that has stretched its dual mandate of price stability and full employment to encompass financial conditions, climate risks, and a healthy dollop of input on economic and social equality, ‘three steps and a stumble’ has headed out toward the door.
Anyway, as I was driving along, I once again thought I had stumbled upon a novel and entertaining tie-in between Fed policy and classic Southern Rock. As I surfed on Saturday morning, I was highly disappointed to see that Liz Ann Sonders had already stolen my idea in 2017, with her Gimme Three Steps and a Stumble article from 2017 (linked at bottom). Had I not been listening to the Allman’s Midnight Rider in the background I might have been a bit deflated and abandoned the idea, but I’m bound to keep on riding.
The fact is, the short end of the market had already priced four hikes before this week’s stumble (EDH2/EDH3 spread only moved from 105 to 104 bps from Friday to Friday). A greater concern is likely balance sheet drawdown (which will never happen). There are other looming challenges for the US economy which I will mention below.
The US is dependent on financial asset prices in the same way China was dependent on property development. It’s a slo-mo train wreck in China, with a new low in the ten year yield to 2.70%. That low equates with other stressful periods as shown in the chart below. I know nothing about China’s monetary policy, but I think I know when a market is telling me all is NOT well. The Beijing Olympics run through February 20, but after that I would think China will take steps to weaken its currency.
Broad markets in the US are also sending the signal that all is not well. This week CCMP (Nasdaq Comp) decisively closed below the 200 DMA and is just below the 0.618 retrace from the March 2021 low to the Nov 2021 high. Anyone who bought this index in Q3 or Q4 is under water. Nasdaq 100 likewise closed decisively below the 200 DMA, but is not quite below the Oct 2021 low. SPX closed just under the 200 DMA, and RTY, which went sideways throughout 2021 ended the week at 1988, the lowest level of all of 2021 except for the first two sessions of the year. Remember that total market cap to GDP started the year over 200%, so a 10% drop in market cap equates to around 20% of a year’s income.
And then there’s this from Credit Bubble Bulletin:
Sinking 10.0%, the Bank Index actually suffered larger losses this week than the Nasdaq100 (down 7.5%). Goldman Sachs fell 9.7%, JPMorgan 8.1%, Bank of America 6.2% and Citigroup 5.5%. Robinhood sank 14.3%, Wisdom Tree 9.7%, Interactive Brokers 7.3%, and Charles Schwab 6.6%.
The Bank Index is symbol BKX and a 10% loss in a week is quite rare. Looking back, there’s another interesting note: this index had topped in February 2007, just prior to the Bear Stearns mortgage fund blow-up that preceded the GFC. SPX didn’t ultimately top until October 2007.
So, what is the US looking forward to? An April tax date with the prospect of large cap gains taxes due because of the cash-infused gains of 2021. An election that is going to mean NO MORE fiscal stimulus. A President who is inviting the Russians to waltz into Ukraine with the State Dept preparing to evacuate US diplomats from the embassy. One other factor to keep in mind is that PPP loans from the Cares Act of March 2020 had two-year terms. I would imagine almost all of these loans either have been or will be forgiven. However, a friend (thanks DK) mentioned that commercial real estate may come under added stress, and that banks will have to start writing down asset values. Finally, the Atlanta Fed’s GDP Now estimate for Q4 has declined from about 9.8% at the start of December to 5.1% now. The US is clearly looking at decelerating growth ahead.
What’s the easiest way to ameliorate damage to bank balance sheets and make sure lending continues? Through a steep yield curve. What are BKX and a new low in 5/30 at 51.5 bps telling us? That a BBG article titled “Goldman Sees Risk Fed Will Tighten at Every Meeting from March” is simply ludicrous. This week’s FOMC on January 26 is unlikely to emphasize a hawkish tilt. More likely is that it will signal a steady and slow adjustment (one hike per quarter) in the FF target to gently lean against inflationary pressure.
Bonus chart below shows the ratio of SPX to BCOM, the Bloomberg Commodity Index. New low this week as commodities outperformed stocks. I only show the past five years, but as recently as 2013 this ratio was 10. It hit 50 in 2020 and is now 42. Another possible signal of deflation in financial assets ahead.
OTHER MARKET THOUGHTS/TRADES
Friday’s risk-off treasury rally saw large declines in futures open interest: FV -51k, TY -34.5k, UXY -33.7k, US -16k and WN -1k. While there was notable selling in TYH 127 puts which have massive open interest, the decline there was only 10k to 323k. (18/64s with -0.24d vs 128-10). TYH 126 puts saw new buying, with OI +26k, settled 8/64 with -0.12 delta. There was a new seller of some 75k FVH 120 call which settled 17.5/64 delta 0.35, OI +63k, vs FVH2 119-180. Underlying sentiment in treasuries continues to be bearish, but moves in risk assets are causing a pare-back of positions.
There was a buyer last week of about 75k EDM2 9925/9937.5/9950 call fly at 2.25 with futures around 9920.5. EDM2 settled 9923.5 and the fly at 2.25. This trade should work out on one 25 hike at both March and June FOMC meetings.
| 1/14/2022 | 1/21/2022 | chg | ||
| UST 2Y | 96.5 | 99.1 | 2.6 | w/I 103.2 |
| UST 5Y | 154.4 | 154.4 | 0.0 | w/I 155.7 |
| UST 10Y | 177.0 | 174.4 | -2.6 | |
| UST 30Y | 211.3 | 206.0 | -5.3 | |
| GERM 2Y | -58.3 | -61.8 | -3.5 | |
| GERM 10Y | -4.5 | -6.5 | -2.0 | |
| JPN 30Y | 71.7 | 70.8 | -0.9 | |
| CHINA 10Y | 279.2 | 270.7 | -8.5 | |
| EURO$ H2/H3 | 105.0 | 104.0 | -1.0 | |
| EURO$ H3/H4 | 48.0 | 45.5 | -2.5 | |
| EURO$ H4/H5 | 5.5 | 6.5 | 1.0 | |
| EUR | 114.16 | 113.44 | -0.72 | |
| CRUDE (active) | 83.30 | 85.14 | 1.84 | |
| SPX | 4662.85 | 4397.94 | -264.91 | -5.7% |
| VIX | 19.19 | 28.85 | 9.66 | |
https://www.advisorperspectives.com/commentaries/2017/05/23/gimme-three-steps-and-a-stumble
