For those of you who would prefer to listen:
I know I say it a lot, but there’s so much going on these days. The Market is a living, breathing animal which is driven by a myriad of issues and events around the world. As a discounting mechanism, it prices in expectations of various outcomes quickly. It’s the wisdom of crowds. Here’s another rapid rundown of the week’s events and implications ahead:
Inflation is still an issue. In fact, it is getting worse. The Headline CPI (Consumer Price Index) for August recorded the largest monthly increase since the Summer of 2022. It increased 3.7% from a year ago. It was sort of expected. But the source of the price increase is showing no signs of slowing. Higher oil and gas prices are driving it. We’re paying for it. And the Fed is trying to figure out what to do about it. The Fed can’t do anything about oil production. Their tool is to try to cool the Economy with rate hikes. They’ve done it a lot, as you know. The big question is how much more ahead? The Fed was starting to feel like they’ve tamed inflation and a soft-landing was ahead. That’s yet to be determined.
Energy was by far the biggest contributor to the CPI increase. It accounted for half the climb. Gasoline prices were up over 10%. Demand for fuel is strong. But it’s really supply that is driving the high prices. More on that below. West Texas Intermediate (WTI) Crude Oil broke above $80 over the Summer. The price soared 17% in just the past 3 weeks. It’s over $90 now. That increases costs on everything from transportation to manufacturing. The world still runs on crude.
Expensive energy could really slow growth across the globe, especially for China, whose economy is already under pressure from its bumpy rebound since its zero-Covid policy. OPEC+ wants higher Oil prices. Their production cuts have been aggressive. So far, it’s been working out for them. Strong demand with shrinking supply means higher prices; Pretty basic stuff. Russia is taking advantage of the higher prices big time as the G-7 seems to be snoozing on the oversight of the $60 cap on Russian Oil that was slapped on in response to the Ukraine invasion. Russian Oil traded as high as $74 in August. Accountability is an important thing. Without it, bad actors gonna act bad.
The Saudis and Russians need to be careful here. They’re trying to pull off a balancing act. Higher Oil prices pose a major risk for China as well as the rest of the world. It’s already putting a dent in Europe and there are signs of a squeeze in America too. These production cuts may end up backfiring and reduce overall demand for this Black Gold.
It’s not just the price of Oil on the rise. Food prices have tapered a bit of late. But it is hard to see this lasting heading towards the holidays. Diesel prices jumped 15% since the end of July. This will naturally bleed into grocery store prices with a lag. Energy impacts pretty much everything. Input costs are heading higher, to make things, to transport things and to sell things. Prices have stalled and look like they’re headed higher. We the Consumer always pick up the check.
You might think that the price at the pump doesn’t matter as much as the trend towards electric gains momentum. Electric vehicle sales continue to grow at a fast pace, no doubt. But they are still a low percentage of all cars on the road from coast to coast. It started from a very low base. Sure 1 in 4 cars sold in California are electric, an incredible number. And Teslas are everywhere throughout the Golden State. But the number of cars on the road across America that are electric still stands near a mere 1%. Driving in California can be misleading: and very expensive. The price at the pump still matters in America big time.
Speaking of cars, you might have heard that there’s a strike in Michigan. It started at midnight on Friday. There’s never been a simultaneous strike against the Big 3 automakers in American history. There is now. Nearly 13K auto workers went on strike at 3 factories owned by General Motors, Ford and Stellantis (the owner of Jeep and Chrysler). A 10-day strike could cost the US Economy an estimated $5.6 Billion in gross domestic product. It would push the state of Michigan into recession.
The United Auto Workers (UAW) want a wage increase. It’s become a big theme this year and they’re joining the party. Unemployment is low and wages have gone higher. Unions have been the most active in decades. American Airlines increased wages for its pilots by 40% last month. Dockworkers along the West Coast ports just got a 32% bump in pay. UPS employees just got an 18% raise. The UAW want a 40% raise. Wanting to negotiate, Ford and GM offered half that. Stellantis offered less than that. They are clearly far apart. Talks ceased as the workers walked off the job to strike.
Henry Ford faced many labor issues. Ford was a brilliant entrepreneur and a businessman. Ford is best known for the Model T and the modern assembly line. He also doubled worker pay. Ford wanted workers to stay. The car titan also believed his market share would expand by paying a wage so employees could buy his cars. That was a selling point then. That’s a point that’s being sold today.
Costs have undeniably been on the rise. Ultimately those cost increases will get sent to the consumer. Cars will be more expensive whenever this labor strike ends. Today’s motor vehicle production represents less than 3% of US GDP. UAW union workers account for about half of that. The direct impact of a one-week strike would be quite small and manageable. It could be made up quickly if a deal is soon reached. The longer it goes though, runs the risk of a much bigger issue and impact.
Sticking with the manufacturing theme, Apple announced a new iPhone. There’s a new watch too. Of note, Apple kept its price unchanged. That was not expected. Early indications suggest strong demand for the new devices. It’s not clear how much is coming from China. The Chinese government reportedly banned iPhone use by state employees. The government has since denied that report. But channel checks suggest there’s something to it. Apple is an easy target. The Chinese government has been trying to retaliate against American tariffs and product boycotts. They also want the Chinese people to support Chinese companies and products. Chinese manufacturer Huawei has a new, 5G-like smartphone that is proving to be popular too. China accounts for 20% of Apple’s revenue, and the iPhone is by far the largest generator. So, this is something being watched closely. The US is by far the largest market, so sales will be tracked every which way to gauge the health of the American Consumer. We’ll learn a lot more heading into the Holidays.
AI entered Capitol Hill. Well, not quite. Congress is not that tech-savvy. Silicon Valley leaders whose companies are driving this Artificial Intelligence revolution came to Washington to discuss both the technological opportunities and threats, and how best to oversee the fast-moving, innovative process. Elon Musk was one of them. Musk is always good for a catchy quote. He told reporters: “There’s some chance – above zero – that AI will kill us all. I think it’s low but there’s some chance. The consequences of getting AI wrong are severe.” So, there’s that…
Elon Musk also said that the Congressional meeting could go down in history as one of the most important for the future of civilization. That seems like a really good thing. They plan on holding 8 more sessions. This is no small deal. All attendees, both government and Corporate America, say the goal is to be able to maximize the benefits and minimize the harm of AI. Every Tech CEO agreed that the US government should have oversight of this AI revolution. However, none of them had a clear understanding of what that role should be. Satya Nadella, the CEO of Microsoft, framed it well: “When it comes to AI, we shouldn’t be thinking about autopilot. You need to have copilots.” The problem is, the government doesn’t have a stellar track record of oversight, particularly when it comes to High-Tech. A new agency will likely be formed coming out of these series of meetings. It’s that big of a deal.
Back to the Market:
The Stock Market has been incredibly resilient in the face of so many cross currents. That’s been the way of 2023. In some cases, it’s defied logic and discipline. It’s important to remember that just 7 stocks accounted for all of the first half gains. It has not paid to be diversified. Fortunately, leadership has broadened out. That’s what corrections are designed to do; Address the excesses. But the Top 7 holdings still account for ¾ of S&P gains for the year. Friday brought some more corrective price action. Tech was for sale again.
The S&P has been pinging in a tight range since the August correction commenced. So far, it’s been hitting lower highs. It pushed back up against those levels this week. Friday sent it back down. Our read is this corrective price action is incomplete and lower levels are likely ahead near term. But the Market has a life of its own and has demonstrated time and again that it can rally in the face of negativity. And I don’t need to remind you, there’s a lot of negativity out there.
Treasury yields jumped to their highest levels on the year as inflationary pressures are proving their lasting presence. You see it in prices everywhere. This makes for a tough call for the Fed, who is likely to pause on its rate hike at its meeting next week but will almost certainly keep these elevated rates higher for longer. The Market is assigning a 99% probability of just that. Higher yields put a big dent in stocks in August. It didn’t seem to bother them much earlier in the week. Then Friday came. Yields jumped and stocks fell.
Pessimism is building again. Just 34% of Institutional Investors surveyed considered themselves bullish this week. It was 42% last week. That is generally viewed as a contrarian bullish sign. Perhaps that helps explain the rally earlier in the week. Of course, the week ended with red. The high on the year was 51% Bulls. That occurred the last week of July. That’s also where the Market topped. The correction began. You see how that works. Greed leads to Market tops.
Despite the corrective price action, volatility is actually shrinking. The VIX (Volatility Index) was down to 12 this week. That’s the lowest in years. It shows a great deal of complacency. But it happened while options traders were aggressively buying puts. Traders buy puts when they’re worried about potential declines ahead.
The ratio of “puts” to “calls” traded this week was nearing an extreme. Usually, spikes in the put/call ratio take place with heightened volatility. That’s not happening. Historically, volatility is a reflection of financial conditions. Financial conditions have tightened significantly at the hands of the Fed. The fact that volatility is contracting in a tightening cycle would historically seem preposterous, but that’s exactly what’s happening today. It’s a real headscratcher, but the Market is designed to outthink and outsmart all. It’s a master at that.
The economic data that keeps rolling in shows America is chugging along at a faster pace than people thought and still think. Low unemployment and heavy spending will prop the US Economy up until that trend stops. There are signs of such things developing. But it’s not firmly in the data yet. The Market is sniffing that out. Options expiration Friday definitely played a role in this week’s price action. Friday’s session was what’s known as “triple witching” day. That’s when single-stock equity options, equity index options, and US stock index futures for the month and the quarter, all expire on the same day. $2 Trillion of S&P index options expired Friday. That always brings heavy volume and tends to drive choppy price action.
Then there’s this: 10 of the past 11 September option expiration days saw the S&P 500 close in the red. Make that 11 out of 12. You already know about August and September being corrective months. It seems to be playing out again.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
