Groucho Marxism

Tech Leading the Way: The bulk of the Mag 7 report earnings this week and will go a long way toward determining the market’s path into year end. The Republican sweep trade has gained momentum among investors, which favors tech, but also introduces accelerating inflation, and that has pushed rates higher across the yield curve. The next seven trading days will dramatically shape the market. Historically, stocks are impartial to which party occupies the Oval Office, with the major difference being tax plans that benefit one group at the expense of another. Keep some dry powder–it could get bumpy on any surprise to the consensus view.

Does Membership Have Its Privileges?

Saudi Arabia took the hint from Groucho Marx’s famous “I don’t want to belong to any club that would have me as a member” when they declined to join the BRICS (Brazil, Russia, India, China, and South Africa) alliance Thursday. The importance of their trade ties to the West drove the decision. Invitations were extended to many countries at last year’s summit, but Saudi was the prize sought after by China and Russia, thanks to what they would have brought to the group. While no new permanent voting members were announced, Thailand, Vietnam, and Malaysia in China’s circle and Turkey, Belarus, Uzbekistan, Kazakhstan, and Cuba in Russia’s sphere of influence were listed as new BRICS partners.

BRICS is defined by contradictions, perhaps the biggest being China, whose fragile economy is reliant upon international economic stability. Yet, they are pushing for a break from the Western dominated trade system.

One example of conflicting policy is that last month, Uzbekistan declined to enter the Eurasian Economic Union (EAEU), disappointing Moscow, but is now part of BRICS. It is possible Uzbekistan felt that BRICS was not solely a Moscow-controlled entity, unlike the EAEU. Their government remembers the U.S. hitting EAEU member Kazakhstan with economic sanctions when Kazakhstan supplied drone parts to Russia.

Unfortunately, those very sanctions against large trading countries such as Russia, China, and Iran will drive many countries into BRICS, with promises of independent payment systems and increased trade benefits. Thankfully for the West, major reforms won’t be enacted soon because Brazil and India are still heavily connected to the U.S. and Europe. Importantly, Putin admitted there are no plans for an alternative to the SWIFT payment system. While there was a mock-up BRICS currency presented, we believe this is nothing more than a mockery because the rising nationalism that is disrupting globalization is also upsetting harmony within the BRICS universe.

We fear tearing global trade in two could become more of a reality under an anti-trade agenda from the U.S., a result that seems inevitable under either administration next year. Markets welcome the fact that global membership has its benefits. The new order into which the world could devolve must be avoided because it carries an excessive cost—one that is not just economic.

We Are From the Government, and We Are Here to Help

The unemployment rate was flattered by an 800,000 increase in government payrolls that represented a 3.6 standard deviation event, which means a number this large happens once every 55 years. What we found interesting was that excluding government hiring, jobs fell by 355,000. Hurricanes and the election created a surge in government jobs and may fool the Fed into thinking labor demand is back. However, last month’s bump was caused by three temporary factors:

·   An unusually strong number of teachers hired even for September.

·   The enormous pile of cash raised for the election generated strong hiring.

·   The need for government responders to deal with hurricane emergencies.

Because local and state financial conditions are stretched to the limit, there is little appetite to continue education hiring. The election is over in two weeks, and the U.S. hurricane season also ends in November. Pantheon Macro believes the snapback increase in education hiring was the result of rehiring teachers who were temporarily laid off when pandemic stimulus programs ended in July. The Fed may incorrectly view unemployment going from 4.30% in July to 4.05% in September as a resurgence in hiring. The distortions involved could be turning the Fed in the wrong direction once again.

Trouble Might Be Spelled S-O-F-R

Sometimes, the markets are driven by esoteric events at the margin, so let’s delve into the scintillating topic of financial plumbing. This is important because there are signs pointing to a major cash drain in the banking system that could lead to a liquidity shortage. At the end of Q3 2024, there was a big spike in the Secured Overnight Financing Rate (SOFR), which measures the cost of collateralized Treasury overnight borrowing. This is the backbone of all funding markets, and spikes are business as usual at quarter and year end. The problem is that the September 30 spike was enormous, the largest since the dislocations during the pandemic chaos.

When Quantitative Easing ballooned the Fed’s balance sheet from $4 trillion in January 2020 to $9 trillion two years later, the Fed resorted to tools such as interest on overnight reserves to manage money markets. However, with the rollout of Quantitative Tightening, the Fed has shrunk its balance sheet to $7 trillion. This SOFR spike may be signaling that reserves have dropped too fast, and the Fed must address it by adding reserves back into the system. Otherwise, the central bank could be risking a money market crisis like the September 2019 repo market instability that was followed by a two-week 5% drop in stocks. Any problem in the funding markets creates enormous volatility in the bond and stock markets, and it could coincide with the Treasury roll out of its Quarterly Refunding Announcement, so the markets may need to brace themselves.

What to Look for This Week

1. Tuesday, October 29 at 10:00 a.m. E.D.T. September Jobs and Labor Turnover Survey (JOLTS). Although it is a stale report because it is September data, JOLTS is important since the Federal Reserve watches Openings, Hires, Quits, and Layoffs closely. Since the September Nonfarm Payrolls data reversed a weakening trend, any strength in JOLTS could alter expectations for rate cuts at the November and December FOMC meetings.

2. Thursday, October 31 at 8:30 a.m. E.D.T. September Personal Consumption Expenditure Price Index. May, June, and July core PCE was 2.6%, and August ticked up to 2.7%. September is expected to be unchanged, but the Philadelphia Fed forecasts it at 2.62%. The Q3 Employment Cost Index is released at the same time and has fallen from 1.4% to 0.9% over the last two years. An unchanged or lower reading could shift Fed sentiment to stay on its path of easing 50 basis points in 2024 and another 100 in 2025.

3. Friday, November 1 at 8:30 a.m. E.D.T. October Nonfarm Payroll Report. All eyes will be on any revisions from September’s +254,000 number. July and August were revised up as well, so it will be critical to see if the back months are altered, too. As for changes to the expected +147,000 print for October, there may not be an impact from Helene based on technical factors (if you work one hour you are employed) in the reporting reference week. However, Continuing Claims was so high that it could point to a weaker non-hurricane-related payroll number.

EPS announcements: Alphabet on Tuesday, Meta and Microsoft on Wednesday, and Amazon and Apple on Thursday, all after the market close.