September 2024 Market Update

We thought August was wild. September was even wilder. While many economists and financial analysts proclaim the U.S. economy is in great shape, at the September FOMC meeting, the Federal Reserve decided to cut interest rates by 50 basis points. The Fed cut interest rates to prevent inflation data from accelerating below the Feds 2% target. They believe that inflation is close enough to their goal and do not want to run the risk of unemployment accelerating too high.

For the month of August, the Fed's preferred inflation metric, the PCE index, rose 2.2% year over year. Headline inflation rose 2.5% year over year. The 6-month annualized CPi rate declined to 2.0% and the 3-month annualized core CPi rate declined to 2.1%. This was the evidence which caused the Fed to remove focus from the inflation side of their dual mandate and transition back toward inflation and employment together.

Since the FOMC meeting on the 18th of September, China has deployed massive stimulus measures targeted at kickstarting the entire economy. China is doing everything from cutting interest rates to handing out fiscal stimulus payments to lower income earners. These actions taken by China, in coordination with the Fed cutting interest rates 50 basis points, have a good probability of causing global inflation to reaccelerate. We will be closely monitoring commodities prices, breakeven inflation rates and purchase applications relative to refinance applications for these reasons. If inflation meaningfully reaccelerates the Fed will go back to raising interest rates.

Chart: demonstrates relationship between US CPi China CPi and Crude Oil Prices.

Handing out stimulus payments throughout China will likely cause global prices to rise in the near term, but it will also likely result in real median household income declining. While we believe inflation will receive a small bounce from these globally coordinated central banking actions, we do not believe the bounce will be sustainable and feel investors can continue to look for lower interest rates, higher unemployment and lower real economic growth in the months ahead.

MacroVex Capital believes China's recent policy actions may trigger a global debt spiral led by China and the U.S., Whereas economic growth rates drop below the rate of inflation, and any stimulative measures end up counterproductive as increased government spending increases inflation and interest rates while the economic growth rate and willingness for banks to lend declines.

Since the great financial crisis of 2008, the U.S. Government has been eager to cut interest rates, increase bank reserves and stimulate the economy via the use of debt capital to prevent the economy from falling into deflation. The irony of this policy choice is that the accumulation of government debt puts more deflationary pressure onto an already declining population. It is yet to be proven how the government can solve a debt problem by adding more debt, especially with a negative working age population growth rate. With these conditions it is not possible for the government to inflate its way out of debt. Soon it is going to become obvious that the American standard of living will continue to decline at an accelerating rate in correlation with any reacceleration in the use of debt capital to finance growth and consumption.

Chart: Demonstrates the inverse correlation between increasing federal debt and declining working age population growth rate.

As the U.S. and China once again attempt to stimulate their economies and fight off deflation with the use of interest rate cuts and debt capital, it will be interesting to watch the real interest rate and commodities markets. If oil prices, breakeven inflation rates and employment data respond negatively to this change in policy, it could sound the alarm bell that China and the U.S. have surpassed the law of diminishing returns in using debt capital to finance growth, and real interest rates could rise as the market prices in lower growth and economic deflation. This would shock the equity market and likely force a valuation reset.

Over the coming months as the Fed guides the market down to the neutral rate of 2.5-3.0 percent, the real concern is whether economic growth continues to decline amid interest rate cuts and forces the neutral rate to be adjusted lower. In our view, this is the difference between a soft and hard landing. If the Fed can hold interest rates at or above 2.5-3.0 percent, the business cycle can trough and economic growth begins to reaccelerate, then the U.S. will avoid recession and experience a soft landing. If the Fed is forced to cut interest rates well below the perceived neutral rate of 2.5-3.0 percent, demand conditions will be recessionary and the U.S. will experience a hard landing.

Our view is that the United States will experience a hard landing. We hold this view because the overuse of policy by politicians using debt capital to finance growth and consumption is backfiring and the market is recognizing it. The market understands a policy of replacing workers with an increasing monetary base to drive asset prices higher and uphold household net worth only contributes to the working age population declining even faster and results in a lower long term economic growth rate.

Chart: Demonstrates the inverse relationship between rising monetary base and a declining working age population growth rate.

Despite the last 40 years of cutting interest rates for savers and accumulating trillions in government debt to prop asset valuations, household net worth and the economy up, each preceding business cycle has resulted in a lower and lower real economic growth rate. This financialization of the economy is not working, and Americans are beginning to wake up. Even though stock and real estate values are high, the average Americans standard of living is declining. The healthcare, legal and education systems are rotting. The only thing left before fully convincing Americans of this economic reality, is for stock and real estate prices to decline and reveal that value is being destroyed and not created.

Chart: annualized real GDP growth rate has remained below 3%, excluding post covid since 2005. The same time period in which U.S. federal debt began rapidly accumulating and the working age population growth rate accelerated its decline.

When the Fed begins cutting interest rates, savers and producers in the economy lose interest income because jobs are being lost. This alone can cause a behavioral shift in the way businesses and consumers feel about their personal finances. In part, this is one reason why when the yield curve dis-inverts and the Fed is forced to cut interest rates to prevent deflation from accelerating, recessions begin.

The 10-year minus 2-year yield spread has finally dis-inverted. In our March 2023 Market Update, https://www.macrovex.com/post/march-2023-market-update, we recommended this position for the fixed income portion of a portfolio built for recession. The spread fell to as low as -107 and is currently +20, we feel the spread will continue rising until closer to +100 basis points. As the unemployment rate begins rising with the Fed beginning to cut rates, we feel now is a great time to begin focusing on the 10-year minus 3-month yield spread. After bottoming around -180 basis points in May 2023 and holding higher lows throughout 2024, the spread appears the be breaking out, suggesting recession and lower short term interest rates in the months ahead.

The entire market appears to be a currency debasement trade. Everything from high valued blue-chip stocks, real estate, commodities, gold and crypto is being held or traded in case the Fed cuts interest rates and the Treasury issues more debt. This ideology has become the new dogma and is why the market is very bullish about the prospect of lower growth and lower interest rates which will need stimulation. It is also why bitcoin and gold outperform the S&P500.

As a fiduciary we have some commonsense questions to consider regarding the current psychology of the market. If the price of bitcoin is a derivative of rising government debt and bank reserves i.e. (the total monetary base), then is the price of bitcoin inadvertently controlled by policy makers? And if policy makers are proven wrong regarding using debt to fix a growth problem caused by too much debt, then what happens to asset valuations when that policy is reversed, and deficits are traded in for a return to surplus? How do assets which rely on currency debasement to uphold their valuations react when the currency appreciates? What if the economy continues getting worse and the only way to make it better is to let the currency appreciate or implement policies which strengthen the currency? These are important questions to consider when everyone is on one side of the market.

Chart: Gold in yellow vs Surplus/Deficit in black. Golds inverse relationship with the deficit. From 1981-1997 the deficit was flat and so was gold. From 1998-present Gold has skyrocketed with the deficit.

The U.S. stock market is currently NOT at all reflective of the economy. The stock market is priced for high growth and the economy is on a path of lower growth. For the reasons mentioned above, our recommendation since January of 2023 has been to position portfolios to endure a recession, in a defensive manor, risk off and in cash, T-bills, money market funds, fixed income duration extended in September 2023 from 0-5 year to 0-30-year U.S. Treasury bills and notes, 10-year minus 2-year yield curve re-steepening, 10-year minus 3-month yield curve re-steepening added September 2024, and select low duration U.S. equities.  

Getting paid to wait for growth assets to be priced at discounts, while being positioned to benefit from bond price appreciation as interest rates decline from downward economic pressure, continues to be a profitable and rewarding strategy. We remain patient and focused on managing risk through 2024.

We encourage all Americans to take some time to decide for themselves and their families what they desire America's future to look like. The future is a policy choice. Please get out and vote!

Source: Federal Reserve Bank of St. Louis

Disclosure: Investing involves risk, including the possible loss of principal and fluctuation of value. Past performance is no guarantee of future results. This letter is not intended to be relied upon as forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date noted and may change as subsequent conditions vary. The information and opinions contained in this letter are derived from proprietary and nonproprietary sources deemed by Macrovex Capital, LLC to be reliable. The letter may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projection, and forecasts. There is no guarantee that any forecast made will materialize. Reliance upon the information in this letter is at the sole discretion of the reader. Please consult with a Macrovex Capital, LLC financial advisor to ensure that any contemplated transaction in any securities or investment strategy aligns with your overall investment goals, objectives, and tolerance for risk. Additional information about Macrovex Capital, LLC is available in its current disclosure documents, Form ADV and Form ADV Part 2A Brochure, which are accessible online via the SEC’s investment Adviser Public Disclosure (IAPD) database at www.adviserinfo.sec.gov, using CRD #300692. Macrovex Capital, LLC is neither an attorney nor an accountant, and no portion of this content should be interpreted as legal, accounting or tax advice