#162: Close Relationship without Substance

S2N Spotlight

I came across a similar chart to the one below and it stimulated some thought. I had never looked at nominal GDP year-on-year growth and the 10-year Treasury yield. On face value, there looks like a close relationship I thought maybe I had discovered a new tool for my tool shed.

I said to myself surely the 10-year yield should explain the path the nominal GDP takes. The obvious way to look for an explanatory relationship is to do a regression and calculate the R-squared, which puts a number to the relationship. Not so fast—the 10 year explains a massive 0.2% of the nominal GDP growth. I hope you picked up the sarcasm.

The next obvious explanation is perhaps there is a lag effect. So I lag the nominal GDP by 1 year from the 10-year yield. Lets see if there is a closer relationship. The result is an increase by the same; there is no relationship whatsoever.

Please don’t take this as an exhaustive analysis; there are many different ways I could still approach it. I could, for example, do a regression through the 10-year yields above, say, 6% and below 6%. If you want to know the answer, hit reply, and I will do the analysis 😎.

S2N Observations

I was going through some of my central bank analysis, and the REPO activity on the 30th September and 1 October caught my eye. I cannot believe I never saw one word written about it at the time. I know I was travelling a lot, but 2.5 trillion borrowed from the bank of last resort looks like news to me. Clearly, the market makers were nowhere to be seen. That usually reflects a liquidity crisis in the system. I am far from an expert on this subject, so will keep watching this space.

Producer Price Inflation came down again.

Core Producer Price Inflation went up again.

I have shared this chart often and will continue to share it often, as I think it is one of those really powerful relationships. If you look at the green line that measures the gap between the 2-year yield and the Fed Funds rate, it hit the previous all-time high gap that preceded the 2008 global financial crisis. The 2-year will dictate the glide path of the Fed, so it is worth our attention.

Probably the greatest salesman of all-time is Elon Musk. Before I say anything negative about this guy, I will first acknowledge he is a genius and he is one of the most impressive get stuff done guys. His appetite for innovation and perfection is incomparable, and so is his ability to promise and deflect with another exciting promise. You have to deliver big from time to time to keep reality from eventually imploding. He has promised FSD (full self-driving) every year since 2017 and has never delivered.

It seems like even Elon’s die-hards are finding it harder and harder to support the current valuation. An almost -9% in this stock doesn’t seem to make people too worried. We are starting to get pretty close to a 50% drawdown from its all-time high many days ago. I will do the analysis also if someone wants to see how many days the current drawdown is in length. I suspect we are at a record.

Who am I to talk against the amazing accomplishments he has achieved? I am just calling it as I see it. Valuation is a huge burden to carry when it grows in size. Speaking of which, Chris Bumstead won his 6th Mr Olympia yesterday, for those of you who like to carry a lot.

Gee, there is more; even I am getting tired writing this. Money supply numbers came out 2 weeks ago and I missed it. M2 is nearly at the levels we got to with all the COVID stimulus. Its clear that there is still a lot of money being pushed into circulation.

I will press this point further with one more chart. The velocity of the money in circulation is also picking up. This chart represents the velocity of this money circulating through the economy. What we saw for decades was that more and more money was required to achieve normal levels of economic activity, so the velocity kept dropping. With all the stimulus that came with COVID velocity picked up, but it will be very interesting to see if this continues. I don’t think so, as inflation is likely to put further constraints on people’s spending as they struggle to keep up with the cost of living.

And now finally, in conclusion. Fund flows into China equity funds hit a massive all-time record. It must be all the readers of this newsletter putting on my trade 🤫.