A deep-pocketed industry began seeing government as a barrier, and started investing some of its abundant capital in political influence. It worked, too. Washington adopted a more laissez-faire attitude, allowing today’s tech giants to carve out highly profitable niches in which they face little competition. This spilled over to other industries. The result was what I called Capitalism without Competition in a 2019 letter. Quoting Jonathan Tepper’s then-new book:

“’Free to Choose’ sounds great. Yet Americans are not free to choose.

“In industry after industry, they can only purchase from local monopolies or oligopolies that can tacitly collude. The US now has many industries with only three or four competitors controlling entire markets. Since the early 1980s, market concentration has increased severely. We’ve already described the airline industry. Here are other examples:

  • Two corporations control 90 percent of the beer Americans drink.
  • Five banks control about half of the nation’s banking assets.
  • Many states have health insurance markets where the top two insurers have an 80 percent to 90 percent market share. For example, in Alabama one company, Blue Cross Blue Shield, has an 84 percent market share and in Hawaii it has 65 percent market share.
  • When it comes to high-speed internet access, almost all markets are local monopolies; over 75 percent of households have no choice with only one provider.
  • Four players control the entire US beef market and have carved up the country.
  • After two mergers this year, three companies will control 70 percent of the world’s pesticide market and 80 percent of the US corn-seed market.”

It gets worse. My friend and extraordinarily successful venture capitalist Joe Lonsdale wrote a Wall Street Journal op-ed this last week. Joe is as pro-capitalist as one can possibly get, but he points out that Amazon’s cloud service business plus its advertising business is extraordinarily profitable and lets their online product sales operate a multibillion dollar loss. No new competitors can afford to complete with someone willing to lose billions of dollars to maintain market share.

It’s not “healthy competition” when a handful of large firms control the vast majority of commerce. It’s actually unhealthy because innovation typically comes from small businesses. But low rates favor the large and the large are squeezing all they can from this advantage.

 

The Fed

 

Bonds on Thursday got battered by another jump in inflation, which sped up to 7.5% in January to mark a fresh four-decade record, or the highest pace seen since the early 1980s. That led the benchmark 10-year Treasury yield to cross the 2% level, ending the session 6 bps higher, while the two-year yield jumped the most since 2009. While yields are still low by historical standards, the speed of the recent Treasury movement is highlighting a meaningful shift for borrowing costs across the economy, or an input that investors use to value stocks and other assets. It was only a month ago that the 10-year yield was hovering around 1.5%.

Bigger picture: For those doubting recent signals from the Fed, it’s pretty clear that the hawkish monetary era has arrived. St. Louis Fed Chair James Bullard, a voter on the FOMC this year, said he now favors a half-point interest rate hike in March, the first increase of that magnitude since 2000. While he is on the more hawkish side of the central bank, other policymakers have also expressed urgency about rate increases and reducing the size of the Fed’s balance sheet, which could put further upward pressure on yields.

In fact, Fed-funds futures now point to a more than 70% chance the Fed will raise short-term rates from their current level (near zero) to at least 1.75% by the end of the year, according to data from CME Group. That was up from a 22% probability on Wednesday and 1% a month ago. Economists also keep lifting the pace of their forecasts, with Goldman Sachs (joining Bank of America) in raising rate hike expectations to seven times for 2022, up from five projected earlier.

Outlook: Equities, especially tech and growth stocks, came under pressure after the explosive inflation data, and many are warning that the recent volatility could rise across all asset classes in case of a policy mistake (acting too late, too strong, or not strong enough). However, should the rate hikes successfully put a lid on price pressures this year, early losses could be followed by strong gains for equities. In terms of the 10-year Treasury yield, the rate is likely to settle into a range between 2% and 2.5%, according to strategists at Morningstar and Neuberger Berman.

With inflation surging, we got some very hawkish comments from the Fed’s James Bullard, suggesting a full 100 bps rate increase before the start of July.

 

 

Source: Bloomberg   Read full article

Many Fed officials now see the central bank being well “behind the curve” and would like to move faster.

Bullard: – There was a time when the committee would have reacted to something like this to having a meeting right now and doing 25 basis points right now. … I think we should be nimble and considering that kind of thing.

Moving on rates before the March meeting is challenging since taper is not yet complete (makes no sense to raise rates while still buying bonds). It’s unfortunate that the Fed didn’t give itself more room by starting to taper earlier.

 

Inflation

 

Here is the problem. For the average American family, prices didn’t get any cheaper. They got more expensive, particularly in the areas that impact them the most, from energy to food. As we noted previously, for most, housing and healthcare costs get contractually fixed for a set period. Therefore, if we look at the inflation households deal with every month, the rate is closer to 10%.

 

 

With real wages not adjusting for rising prices, the ability to consume gets reduced, and economic growth slows.

 

 

While mathematically, we are witnessing “peak inflation,” the cost of living will likely remain more expensive for quite some time.

Such will weigh on consumption, the economy, and ultimately profit margins.

Is The Fed Behind The Curve?

The Fed remains set to tighten monetary policy in March. Expectations run the gamut from a 25-50bps increase in rates to a rapid winddown of quantitative easing.

However, if we are correct that inflation and economic growth will slow in the months ahead, such an aggressive policy tightening will likely create unwanted financial instability. The last time the Fed hiked by 50bps was in March of 2000. While that more aggressive hike didn’t immediately break the market, it signaled the end of the bull market advance.

 

 

Recently, the market seems to be frontrunning the Fed’s policy action by selling off in advance. Such was a point from Marketwatch, noting that the recent market turmoil resulted from an already tighter monetary policy. To wit:

“Their shadow rate, a model first introduced in 2019 that maps the signals from the yield curve into a fed funds equivalent rate, rose 85 basis points over the past three months. That would rank in the top 5% of historical moves, say the Deutsche Bank economists.

‘The recent rise moved the shadow rate into positive territory for the first time since the onset of the pandemic. This movement can be interpreted as the yield curve’s signal about how the monetary policy stance has adjusted in recent months,’ say economists led by Matthew Luzzetti, chief U.S. economist.”

 

 

Notably, the yield curve is rapidly declining, suggesting peak inflation and slowing economic growth. If the Fed tightens aggressively, such will exacerbate the slowdown of activity.

 

 

For investors, the considerations are essential because earnings expectations are currently at a record deviation from long-term growth trends. Reversions of those estimates to intersect with economic realities do not support overly bullish expectations.

 

 

US Economy

 

  • Economists knew that the January payrolls figures were going to be a bit of a wild card, with many expecting a decline due to omicron.
  • But this report was well above any of the forecasts, showing nearly half a million jobs created.
  • Payrolls are approaching pre-COVID levels.
  • Perhaps of greater importance for the Fed and the market was stronger than expected wage growth (including an upward revision).
  • Labor force participation is rebounding as some older Americans return to work.
  • Long-term unemployment continues to fall.
  • The 2yr Treasury yield is nearing pre-COVID levels,  as the yield curve keeps flattening
  • Mortgage rates keep moving higher with Treasury yields.
  • Housing affordability has deteriorated.
  • But demand for homes is expected to remain robust due to demographics.
  • Homebuilder sentiment points to stronger residential construction.
  • Due to supply shortages, building homes takes nine weeks longer on average than before the pandemic.
  • Existing home prices have increased much more than new home prices over the past few years.
  • Small business sentiment continues to move lower.

 

 

  • Inflation remains a key concern.

 

 

  • The share of companies raising selling prices hit a multi-decade high.

 

 

  • COVID cases are falling quickly.

 

 

  • COVID has not been the reason for the recent weakness in the U. Michigan consumer sentiment indicator. Instead, it’s been about inflation.
  • Multi-year highs in gasoline prices will continue to weigh on household confidence.
  • The January CPI is expected to hit 7.3% on a year-over-year basis. But we are nearing the peak.
  • US exports hit a record high in 2021, driven by agricultural sales.
  • The 10yr Treasury yield is approaching 2% for the first time since mid-2019, pushing the 30yr mortgage rate toward 4%.
  • The decline in dry bulk shipping costs points to slower global trade.

 

 

  • The Atlanta Fed’s GDP tracker for the current quarter is holding below 1% (annualized).

 

 

  • Various macro indicators are pointing to slower economic growth ahead.
  • The CPI report surprised to the upside, with inflation hitting multi-decade highs.

 

 

  • The core inflation also topped forecasts.

 

 

Market Data

 

  • Here is Bloomberg’s agriculture index.

 

 

  • Will we hit $100/bbl before the week is over?

 

 

  • The S&P 500 valuations remain elevated.

 

 

  • Traders are very short the Russell 2000 (small-cap) futures.
  • The proportion of S&P 500 companies beating on sales is still relatively high.
  • But the proportion of companies beating on margins has fallen below the historical average, as higher costs cut into profit margins.
  • The 10yr Treasury (above 2%):

 

 

  • Hit by surging bond yields, defensive/high-dividend, REITs, Utilities and Housing stocks aren’t offering protection. Just Financials and Commodities.

 

Thought of the week

 

Do good and good will come to you.

 

Pictures of the Week

 

 

 

All content is the opinion of Brian J. Decker