Cycle Compression in Germany

QI TAKEAWAY —  The disconnect between ex-energy commodities, the dollar and the real global economy is becoming more apparent as signs of a spreading slowdown proliferate. The lack of Fed tools to address stagflation should cap long-maturity rates as policy errors, plural, get priced into risky asset prices.

  1. Per the ifo Institute, at -4.6 points, German business expectations were decidedly below trend in October after running an above average 13.4 points in June; the 18-point swing in 4 months has historical comparisons only to the pandemic’s onset and Great Financial Crisis
  2. ifo’s Business Cycle Clock, which tracks German business conditions and expectations, was in the “slowdown” quadrant for a second straight month in October; this is the first year that has seen all four quadrants traversed on account of the pandemic’s cycle hyper-compression
  3. China’s manufacturing New Orders-Inventories spread has slowed, helping temper German business expectations; a continued slowdown in activity could lead ECB policymakers to turn dovish just as the Fed begins its tapering efforts, piling onto euro bearishness

The Bottleneck Recession

QI TAKEAWAY —  The disconnect between ex-energy commodities, the dollar and the real global economy is becoming more apparent as signs of a spreading slowdown proliferate. The lack of Fed tools to address stagflation should cap long-maturity rates as policy errors, plural, get priced into risky asset prices.

  1. Though Australia’s Supplier Deliveries are at record highs, they remain below the rest of the developed world; in the U.S., should there be strike threats at the ports of Long Beach and LA following the 90-day surge, regional delivery time expectations should remain elevated
  2. Production-related factors contributed just +0.11 to the Chicago Fed’s National Activity Indicator in August vs. +0.40 in July; though the Fed may be forced to accelerate tapering should the supply chain push up prices, tightening into a slowdown could prove devastating
  3. Despite low supplies, copper’s drop last week was the largest in four months, validating the fast-spreading industrial slowdown; meanwhile, bottlenecks continue to threaten earnings prospects, as only two of eleven S&P 500 sectors have seen EPS forecasts rise in October

What Leads is Bleeding

QI TAKEAWAY —  Absent a post-Ida surge of auto sales, big ticket discretionary and housing remain at risk of continued weakness. We reiterate our overweight bias in Staples and add that the long-delayed household credit downturn may finally be upon us.


  1. Since peaking in July 2020 at a 11.5 million SAAR, U.S. Light Vehicle Production has fallen to a 7.5 million pace, the worst since March 2020; meanwhile, October is set to mark a 6th consecutive month of falling Light Vehicle Sales, not seen since the height of the GFC
  2. At 0.96, the Inventories-to-Shipments Ratio for Autos is at its highest since May 2020, while the same ratio for Non-Autos has slipped from 2.4 in April to 2.0; the latest prints of the Empire State and Philly Fed Mfg. surveys confirm a rise in inventories and urge to stockpile
  3. Though Deloitte projects a 5% rise in holiday spending vs. 2020, the higher-income cohort plans to spend 15% more vs. 22% less by the lower-income cohort; absent a further stimulus injection, the threat of continued weakness remains due to demand being pulled forward

Bear Flattening Getting Crowded

QI TAKEAWAY —  Changing narratives pit inflation against deflation (i.e., China). The former is squarely on investors’ radar screens, while the latter has faded. This pivot by fund managers reinforces the bear flattener trade.

  1. The top four concerns in August & September’s BofA’s Global Fund Manager survey were Inflation, Tantrum, Bubble and COVID-19 – none of which got more than 25% of responses; clarity on risks emerged in October, with Inflation the clear winner at 48% and China at 23%
  2. At 31%, investors view inflation and the Fed as the primary drivers of 2022 asset markets; with China at a distant fifth place with 8% of responses, deflation is an underpriced risk reflected in the yuan’s appreciation to 6.3930, which defies the deflation narrative
  3. Per BofA, the net percent of investors expecting a steeper yield curve fell to 23% in October, the lowest since June 2019 and well below September’s 48%; though deflation is not the consensus view, opportunities exist should China tail risk probability grow in importance

Sell with the Wind at Your Back

QI TAKEAWAY —  Home selling conditions usually track home builder sentiment, but home buying conditions have taken the reins in a post-pandemic world. The persistence of rising home prices should keep builders building as fleeting labor market strength quells any concerns that the recent slowing is a sign of what’s to come macroeconomically. Take the ride in the sector but know it won’t last.

  1. The median price of a single-family new home rose to a record $390,900 in August, an unprecedented 26% jump from April 2020; as a result of affordability challenges, UMich’s consumer home buying conditions index has held at record levels of negativity since May
  2. Since 1993, the National Association of Home Builders’ sentiment index has had a 0.92 correlation with UMich home selling conditions vs. 0.08 with buying conditions; in the last 12 months, that correlation has flipped to -0.77 and 0.81 for selling and buying conditions
  3. Historically, the MBA’s average home purchase loan size has tracked with single family building permits; loan size appears to have stalled around $400,000, while single family permits fell back in September to July 2020 levels in the face of retracting demand

Risk of Dimming Growth Rising

QI TAKEAWAY —  The yield curve is flattening. The Outlook Gap is turning. Rate vol is rising. Tightening financial conditions would clinch an M&A top. This confluence sets up a bigger correction for risk assets in coming months.


  1. The spread between the 5-year note and 30-year bond fell below 100 basis points over the last week, hitting 85 bps in yesterday’s trading session; after the 1990, 2001, and 2007-09 recessions, the 100 bps level served as a demarcation line from early to middle/late cycle
  2. As firms battle wage pressures via M&A activity, U.S. deal counts have reached successive records in Q2 and Q3; the October-to-date deal count is tracking to 2,200 by the end of the month, which would be the fourth highest on record behind September, June, and August
  3. As a z-score, the Outlook Gap, or spread between CEO and Consumer Expectations, looks to be coming down as it usually does when expansions mature; however, rising wage pressures remain an opposing headwind that is making consumers relatively more optimistic

Cyclical Head Fake

QI TAKEAWAY —  There is still more normalization to trudge through on the retail spending front despite September’s upside surprise. We maintain our staples over discretionary stance in the consumer sector.

  1. U.S. retail sales surprised to the upside in September, seeing a 0.7% MoM gain vs. the -0.2% consensus while July and August saw a combined 0.4% upward revision; in response, equities rallied led by cyclicals, while Treasuries sold off with higher yields in 10s than in 2s
  2. Real retail sales, excluding food services and deflating with the CPI for commodities, saw volume gains of 0.4% MoM in August and 0.2% in September; thus, price increases drove roughly 60% of August’s headline retail sales increase and 75% of September’s advance
  3. Little notice was given to the downside in October’s NY Fed Empire State Manufacturing report, which saw new orders, employees, and hours worked all fall; meanwhile, UMich’s Survey of Consumers saw sentiment fall to its second-lowest level since 2011 in October

Deeper Dive in Transports

QI TAKEAWAY —  Trucking and railroads are facing logistical headwinds while indicating tailwinds to pricing. As long as the slowdown proves temporary, higher inflation should continue to support long positions.

  1. Per data from the Association of American Railroads, intermodal trailer traffic, a proxy for truck output, downshifted from double-digit expansion to contraction from June to October; a driver shortage, as well as a lack of chassis at ports, are impeding trucking industry growth
  2. Every month since March has seen average weekly hours in truck transportation at or above prior record highs; despite the PPI for truck transportation posting YoY prints in the teens since April of this year, the S&P 500: Trucking continues to post elevated annual returns
  3. Rail traffic has been down YoY since September, driven by intermodal containers rather than traditional rail carloads; however, given the S&P:500 Railroads has posted double-digit YoY gains since August 2020, investors seem to view any slowdown in activity as temporary

Staples Trump Discretionary

QI TAKEAWAY —  Toy inflation is direct byproduct of the challenging supply chain environment. Industry sources pushing a buy-now mentality before the holidays equates to validating of higher inflation psychology. More broadly, inflation expectations are taking a toll on income and spending expectations. The bearish guidance, augmented by the 2011 debt ceiling standoff precedent, suggests staples are the better option if you have consumer sector exposure.

  1. The second and third quarters of 2021 saw CPI for toys post positive YoY prints for the first time since Q4 1996 and Q1 1997; California PMI Supplier Deliveries Index should continue to surge into Q4, with Chapman University expecting times to slow at a record high rate
  2. Cox Transportation recently announced that shipments have declined by nearly 5% as a result of supply chain issues; coincidentally, the only bright spot in August’s job openings data was in trade/transportation/utilities, with all other major sectors seeing declines
  3. In the NY Fed’s Survey of Consumer Expectations, household income growth and spending expectations both turned negative in August and September; this poses downside risk for real consumer spending, with the consensus at 2.1% and 4.2% for Q3 and Q4, respectively

Rate Volatility Risk on the Rise

QI TAKEAWAY —  Small and medium businesses face more earnings challenges as they’re forced to pay up for labor. To combat this, small businesses are banking on hiking prices, which raises the probability of rising rate volatility. Small cap stocks are not the relative value choice.


  1. Canada saw 157,000 jobs gained last month, more than 2.5 times the consensus and above every estimate in the Bloomberg survey; the 0.8% MoM pushed employment back to pre-pandemic levels and would have translated to a proportional 1.2 million bump in the U.S.
  2. Unlike in the U.S., Canada’s labor shock appears to have gone a full cycle, with both temporary layoffs and permanent job losers seeing a recovery; labor force participation has returned to 65.5%, and the labor progress made has led the BoC to taper three times already
  3. Per the CFIB, in the six months through September small business’ average price plans over the next year have run north of 3%; at present, CPI trim and CPI median are both above the BoC’s 2% target at 3.3% and 2.6%, respectively, risking cost pressures flowing downstream