QI PORTFOLIO STANCE

Politics has defied our expectations in the critical role it’s playing in economics. Absent the $6.7 trillion FY in federal outlays, amidst declining revenues, the U.S. economy would be in a brutal recession. At its pandemic peak, FY outlays were $7.6 trillion. The debt-ceiling depletion of the Treasury General Account alongside wartime fiscal spending has cushioned the bite of the Federal Reserve’s Quantitative Tightening. As the calendar closes in on Election Day, the actions of a chastened Freedom Caucus will be akin to soldiers fighting to regain their honor. Aside from the Employee Retention Act and federally subsidized green industrial initiatives, the U.S. economy will be increasingly cash-flow constrained. With Jerome Powell determined to maintain a High for Longer stance and the GOP equally resolved to withhold fresh fiscal stimulus, the pre-pandemic rot in corporate and real estate credit will continue to be expunged. The combination of spreading joblessness and the exposure via Airbnbust of shadow housing inventory will collide with deteriorating demographics and plummeting household formation. A global recession will amplify domestic strains as the lag effects of the Fed’s tightening peak and plateau at a high level as Powell tries to deliver on his mission to kill the Fed Put. [8/1/2023]

Intelligence Briefing Takeaway — 12.2.23

In late January 2019, the number of Americans collecting unemployment benefits hit 1.897 million, a cycle high before all hell broke loose forcibly closing the economy. On Thursday, we learned the number of continuing jobless claimants had hit 1.927 million, a post-reopening high. Meanwhile, DailyJobCuts.com reported 280 Closings of businesses of all sizes in November, twice that of the 139 in the same month in 2022. In the last three days alone, we’ve seen 54 Closings, one of which was a Remington gun factory employing 270 union workers in upstate New York that had been in operation since 1816. After a brief respite in October, Mergers & Acquisitions activity collapsed anew last month amidst a continued contraction in Other Deposits in commercial banks’ Liabilities. Outside the pandemic, there have been four recorded instances of synchronized contractions in S&P Global Manufacturing and Services Employment Indexes; November 2023 marked the fifth such month. Friday’s release of last month’s ISM Manufacturing survey validated shrinking factory payrolls while the surest indicator of future labor demand – Backlogs -- sickeningly slipped to 39.3.

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QI QUICK QUILL CALLS

• Long High Yield and/or Investment Grade Credit Default Swap Indexes — As Powell warned on the podium on July 26th, 2023, credit is only beginning to tighten. Sentiment indicators from both credit managers & high-income earners, pockets that have a front-row seat to the lagged effects of Fed policy, challenge to soft landing narrative. [7/31/2023]
• Long Fixed Income Volatility — While the Bull steepener call in treasuries is still in play, Powell’s resoluteness to raise 25-50 more bps increases the odds of a more profound inversion first. Assuming Bureau of Labor Statistics data remains ‘resilient’ on the surface, Powell could press forward with continued rate hikes, inverting the Treasury 2s/10s even deeper, breaking -150 bps and pressing the 1980s record of -199 bps. Long, long-duration Treasuries remains a cornerstone forecast at QI as we believe an official recession will be called, but hedge those positions with instruments like the MOVE index until the Markets realize the depth of recession we are in & the FOMC’s potential overreach. [7/3/2023]
• Short Transports – Stocks in the freight sector have largely priced in the resurgence in homebuilding and lagged effect of green federal spending. As the industry’s data improve, look to the “sell the news” effect to combine with increasing signs that a sugar high will be followed by a renewed slowdown in the U.S. economy into the fourth quarter.  [Weekly Quill, 5/17/2023] updated view here 8/1/2023]
• Bull Steepener in Treasuries. The Great Flattening we first forecasted in June 2021 has run its course. We see the slope of the yield facing steepening pressure going forward as Fed rate hikes are removed from short-term yield upside and recession pressures down long-maturity rates. Powell has the latitude to maintain his tight stance, including QT continuing to run ‘in the background.’ [3/20/2023]
• Maximize Cash. The bear market we have predicting Q4 2021 is here and only mid-innings at best. We missed October's bounce, but the macroeconomic fundamentals are even more visible now. The recession we have been predicting since Q1 is increasingly accepted. Politics could catch anyone flat-footed, but not likely in a divided congress; a defensive path is the most prudent. [9/23/2022]
• Overweight the U.S. Dollar. Foreign economies are far more brittle than the U.S. Overweight domestic Utilities within U.S. equity portfolios and underweight companies and sectors with high international exposure, namely Technology, Materials, and Consumer Staples. The U.S. Dollar will likely stay stronger for longer as the world realizes no pivot is coming. [9/19/2022]
• Short Consumer Discretionary. Shorting the most discretionary of the Durable spending sub-sector, namely recreational boats, recreational vehicles, and autos. [8/31/2022]
• Short Travel & Leisure. As the impulse from the Employee Retention Credit fades and recession bites, a pair trade of long Telecom Services & short Travel & Leisure is appropriate. [8/30/2022 – we were early – reiterating 5/8/2023]
• Short High-CRE exposed Banks. Shorting a basket of small-to-mid-cap banks with high exposure to Commercial Real Estate makes much sense to QI. Rates are rising, which is good for net interest margins, but CRE defaults are just starting. [7/26/2022]
• Short Inflation Breakevens. With recession in the books, we reference the duration of the last two occurrences of 2s/10s yield curve inversions — the 9 months in 1999-2000 and the 7 months in 2006. Because deflation in shelter will filter through with a lag, short inflation breakevens. (i.e., long TLT, short TIPS) [5/3/22 updated 7/6/22]
• Long Volatility. As the Fed tightens, weak liquidity gets tighter, and asset price volatility rises. The VIX looks increasingly inexpensive. Look to build VIX entry points when stocks are in blind rally mode. [4/5/22]
• Short Autos. Macro fundamentals suggest a downside for the auto sector. Auto Retailers, in particular, who’ve reaped huge gains are likely to see those go into reverse. [3/24/22]
• Short/Sell Commercial Real Estate. With record low cap rates pushing 2%, half of 2007's prior record, if you own anything in CRE, even Industrial, sell and sell now.

ON QI'S RADAR

• Be mindful of rampant corporate credit creation in a higher-cost environment. More credit spread widening is likely on offer.
• Avoid China; their stimulus is all hat and no cattle. As more of their private sector is consumed by the government, until they start directly injecting money into the hands of consumers, China will be a global source of deflation, not growth.
• Desalinization will be one of the biggest domestic and global plays in the next decade to go long opportunistically