MAGGIE LAKE: Hi, everyone. Welcome to the Daily Briefing. I'm Maggie Lake. And here with me today is Peter Boockvar, the Chief Investment Officer at Bleakley Advisory Group and our own Weston Nakamura. And we have another choppy market. US stocks pared the worst of their losses of the day here in the afternoon but weren't really able to get into positive territory. And things definitely feel shaky with some big cap names hitting their 52-week lows.

Treasury yields fell. The 10Y now at about 2.8%. Weston, let's start with you. There's a tendency to trace everything back to the Fed, but you've been tweeting that it's more complex than that. What are you watching?

WESTON NAKAMURA: Yeah, sure. Given the bloodbath in markets, I just want to give a broad base quick overview of what's also been driving markets. I'm not brushing aside the Fed by any means, but just from a macro level that I feel are being overlooked by especially US base investors. And it really comes down to currency markets that are leaving the equity, the bond, even the commodity and crypto markets, and specifically the Chinese yuan, or USD/CNH cross rate as well as the Japanese yen.

Just take a look at risk assets, like stocks and crypto, Bitcoin is a proxy for crypto. Chart one, this is just S&P e-minis, as well as Bitcoin. And overlaid on that is the yuan. And I've inverted USD/CNH for this chart so that you can see the white line going down, that's the yuan going down, and vice versa. Before April 20, which is that red line, USD/CNH was stable, risk assets weren't being driven by yuan prior to that.

After that point, though, it's just been slammed, and risk assets have been highly correlated and driven by that downside move. Next chart on Chart 2, this is just the intraday over the past two days, including the bloodbath from yesterday. And you can see that's basically been nearly tick for tick, especially with Bitcoin. That's just basically China COVID Zero is really taking a toll, the macro data from this week has just been abysmal beyond already super pessimistic expectations from the lockdowns heading in.

Industrial production, retail sales, worst reading since March 2020. The retail sales came in at like minus 11% versus 6% expectations. Shanghai, not one car was sold in a city of 25 million, because they're under lockdown for two months.

MAGGIE LAKE: That's incredible. When you're talking about all this week, Chinese and you're putting the yuan up, this is because what? Because people were thinking that, okay, China's going to save the day here, their economic engine is going to kick into gear and help? Or that the authorities are going to recognize the weakness, and they're going to come to the rescue, so even though we have the Fed hiking, we're going to have China accommodating. Was that the line of thinking?

WESTON NAKAMURA: Yeah. The reason I showed that line is because prior to that, it was obviously things like the Fed tightening and all that, and the various other macro factors, the geopolitical factors and all that. But at that point, there's been a huge selloff in equity markets and all that and who is still left not selling at this point? It's people that are basically hinging on or depending on the policy response from China to come, which they verbally come, but never really come to fruition.

And then you start seeing horrendous data, and you don't really see any follow through on the policy front. That's what's getting that last bit of hope from any major global central bank policy accommodation to come through, and it's just not coming through. There's been nothing to offset that, the weakness. And we saw the latest SEC filings data this week just showing that everyone had already sold, or a lot of people had sold. The people who are still left are the people who are counting on the policy support that just hasn't been coming.

MAGGIE LAKE: What about bond yields? This is the other area that-- and this is an excellent point you bring up, Weston, that we have to look at the full global picture, because it is very layered here. What about bonds? Because you hear traditional headlines here in the US and you're like, oh, it's a safe haven trade. And you get the idea that it's just people leaving stocks and going into bonds, which may be true. Is there any dynamic that we're not paying attention to that you're seeing that we need to know about?

WESTON NAKAMURA: Yeah, absolutely. Over the bonds, namely the long end of the Treasury curve, this is, again, the Treasury market, there's many participants globally, there's a thousand reasons for people to buy and sell. There's not one single driver.

That said, I'm looking at the Japan flow. This is the long-awaited Japan flow that had been absent from its seasonal pattern. That's been behind both the selloff from March and the recent cap in yields. If you look at Chart 3, starting at the beginning of March when 10Y US Treasury yield was at 1.7%, dollar/yen was at 114 which seems like ages ago.

From March to the first week of May, if you look at Japan foreign bond investment, Japan had been net sellers of over 6 trillion yen in foreign bonds for nearly 10 weeks straight, half of which came in the last three weeks prior to this latest reading. And then just yesterday, we got last week's reading. And from May 9th, after returning from Japan Golden week holidays, Japan finally became a net buyer of 370 billion yen.

And over that same time period, we saw Treasury yields top out at 3.2% and down to 2.8% current and then dollar/yen down to whatever it is, a 1.27 handle. Now, you can see that in the chart after that as well that's more a zoomed in picture. But you can really see this stark clear division of when the accelerated selling going into Golden week happened from Japan and when yields start to fall back down when they returned from Golden Week because Japan is very underweight.

And Japan, frankly, will buy US Treasurys, even with hedging costs that take out a lot of that US/Japan yield spread, that gap essentially, even though hedging costs might be astronomically high for Japan, it's still better than the 25-basis point cap that the Bank of Japan is doing. And either way, Japan, it's in need of yield period and so they don't really care what gasoline costs are doing in the United States. It's going to be almost an unconditional buyer of US Treasurys, and hence it being the largest creditor to the United States.

MAGGIE LAKE: Weston, do these charts have predictive ability? What do you think happens from here? Does this suggest that if Japan's going to keep buying that we could see yields keep moving lower, or at least a cap on them now?

WESTON NAKAMURA: If they have predictive ability, I certainly haven't figured out how to predict from them. But I guess yeah, my view for the last week has been-- so Brian, if you put up the chart, the last chart, that Chart 5. My view has been long yen. Prior to this, I've had this like straddle trade on, if you will. I've been basically short yen, long US Treasurys via options.

But that short yen I flipped to a long yen position because my view is that nothing really needs to happen. But there is a massive, massive, overcrowded position in the short yen position, as you can see on futures from the asset management community. Net short yen is like the highest on record. And also at the same time, you also have Japan retail that is most net long USD are also on record.

You just need to get an old fashioned classic short squeeze in the yen, and you can get a face ripping yen rally. And my point with that, too, is that I don't want people however to confuse that with the yen has been rediscovered as a safe haven asset or anything like that. It's not and this is just huge, like massive overpositioning that is just being covered. Let's not conflate the two either.

MAGGIE LAKE: It's so important. And I actually heard that recently, Weston, so important to point that out. Face ripping rally. That's enough to make everybody stand up and pay attention. I think. Weston, great stuff. Thank you so much for pointing all of this out. That's why I love these conversations, and the ability to bring folks like you in to the conversation so that we can be smart and look beyond the headlines that are being fed to us. Thank you so much for that.

And I know you're going to be continuing to dig into it, so if you want more information or to follow this line of conversation in terms of, of course, follow Weston on Twitter, but he's going to have it in his next West On Trading Update on our YouTube channel. That's right, correct, West?

WESTON NAKAMURA: Indeed. Yes.

MAGGIE LAKE: Awesome. Okay, great. We'll check that out. Weston, thank you so much.

WESTON NAKAMURA: Thanks, Maggie. Thanks, Peter.

MAGGIE LAKE: Great stuff. Peter, that was a lot to take in, curious about your thoughts about that. But I do think it underscores the fact that we're in a really tricky environment now, where there were all these crosscurrents that we need to be aware of?

PETER BOOCKVAR: Well, I'll start with what Western said about Japan because I think it's really interesting and the inflection points that we're reaching with the yen and yield curve control and Japanese buying of US Treasurys. We saw the Treasury International Capital Flow data this week and it reflected Japanese holdings of US Treasurys through March. It is somewhat dated, obviously not including April and the few weeks into May, but through March, their holdings hit the lowest level since January of 2020. They're down about 100 billion off their highs.

And I think that's important because foreign flows generally into US Treasurys, so foreign holdings of US Treasurys as a percent of US marketable securities is at the lowest level in 20 years. And this is happening at the same time the Fed is not only ending their purchases, but obviously shrinking the holdings of US Treasurys by 60 billion a month starting in a few months.

QT will start in a few weeks, but it will gradually get to 60. Banks as a percent of bank assets of Treasurys and agency MBS, it's now at about 20%, which is at a high, so it then begs the question of, okay, how much more can banks buy, foreigners are not going to increase their purchases, and can actually start selling as is China, and the Fed has backed away. We need other buyers to step in to keep rates from going much higher from here and at what level attracts other buyers like pension funds, individuals, institutions, and so on.

I think that that's a really important thing to watch. And also, with respect to the weakness in the yen, we know it exaggerates the cost of Japan importing energy among other things. It has less of a boost to their exports, because Japan has done a lot of offshoring of their production closer to where their customers are, so they don't get the beneficiary of that weaker yen. And we know that the Japanese consumer is getting squeezed just as everybody else with higher inflation, and how much yen weakness will the Ministry of Finance tolerate at the same time the Bank of Japan continues to be full speed ahead with their yield curve control.

How this plays out will be really important to watch. And with respect to China, obviously, with a European recession likely, the world can't afford a China shutdown with respect to supply chains, and with respect to their own economy. We need China to get out of this approach and we need China to grow. We need a smooth transition of goods throughout not only their side of the economy, but what they export to the rest of us.

It's crucial that China strives to grow again. Irrespective of what you think about Xi and the authoritarian government that he has, and everything going on, we need Chinese growth to help the rest of the world.

MAGGIE LAKE: Yeah, absolutely. That was an incredible data point from Weston, not one car sold in a city of 25 million. It gives you a sense of the enormity of what we're dealing with. That's just remarkable. I want to jump into some questions. And welcome to the conversation, everyone. JP W., Mason, John, Ross. This is from JP W. on The Exchange, Peter, what market or economic factors could cause a deeper dip for equities? And I know margins are something that you're paying really close attention to?

PETER BOOCKVAR: Yes, so if you look at the market over the past year, let's assume that February 2021 was the top for the broad market. That was the peak euphoria, because that coincided with the meme stock craze. Let's take that as the peak just as March 2000 was the peak at that bear market. And since then, through the rest of last year, we started to see this multiple compression in a lot of the high-flying stocks.

And that's all it was through the end of last year. And then we fast forward into this year, and up until about a month ago, that was still the case, it was a rolling correction in everything that had a high PE multiple. But I think we're making a transition in this bear market, where we've had the PE multiple compression which I still think will continue. It's not going to end here, it will continue.

But now, we're worried about the E part of the P E, where earnings are going to go and what we saw this week is profit margin compression is now joining this bear market and that coming off record highs of only a couple of quarters ago of very high profit margins relative to history, now you're seeing this supply problems, the inflation that's catching up to that part of the earnings story. And then I think from here on through the rest of the year, we have to start worrying about the revenue side because global growth is slowing.

We talked about China, Europe is likely in a recession, US growth is naturally going to slow as monetary tightening continues to constrict the interest rate sensitive parts of the economy, markets and so on. I wrote this morning that it's essentially a perfect storm of multiple compression, profit margin compression, and the likelihood that we're on the cusp of a revenue slowdown, which makes it tough for US stocks from here and global stocks as well, but mostly US stocks that are still expensive that's trading at, even with the selloff, 16.5 to 17 times. But times earnings estimates that I think are unrealistic. As earnings fall at the same time PE multiples are falling, that's a tough combination.

MAGGIE LAKE: Yeah, and nobody knows this better than you, Peter. Teaser, Peter was a guest for my podcast, My Life in 4 Trades, it's going to come out in the next few weeks. And in it, you'll get a sense of a real understanding of the balance sheet, Peter, which is really needed in a time like this. Crunching those numbers and saying, hang on, this doesn't add up. How much downside do you see though? How off are those expectations? And how much more of a rationalization for this new environment do you think we're in for? Is there a lot more pain ahead?

PETER BOOCKVAR: Well, let's take current earnings estimates that really haven't changed much this year. In fact, they've actually risen up until about a month ago, when they peaked out. According to my Bloomberg, we're at about $227 a share. I'm talking specifically, of course, about the S&P 500. Those earnings estimates topped $1 higher up to 28. Now, let's just say that the Fed is not able to achieve a soft landing and a hard landing is more likely, in addition to continued fall in profit margins, let's just say we clip that number by 10%.

Let's just say around $200 ends up being realized. And I'm just throwing this out there because I think it'll help instruct people of what the possibilities are on the downside since it is a bear market. Well, let's just say at the same time-- okay, so let's just say the multiple at 17 times stays where it is and let's just say $200 a share, well, that gets you to 3400 in the S&P versus stays close right on 3900.

Well, let's just say that multiple compression continues, and we go to 15 times, which is not out of the realm of possibility. It's in fact, the average of the last 100 years. And why can't multiple still compress with inflation being as high as it is, and interest rates up pretty rapidly this year? But what if it goes to 15 times? Well, 15 times 200 is 3000 in the S&P. Now, I'm not saying we necessarily go there, but I think these are the possibilities when you think about what's the multiple we're going to end up paying on what I think will be a likely EPS number.

Now, there's probably some stocks out there that have already bought it. If February 2021, as I said earlier, was the peak in this bull market from a broad stock perspective and peak euphoria, well, maybe we're a year into this, it's this bear market and bear markets last 18 months, 24 months, and now it certainly has metastasized, which is what typically happens in a bear market. Getting back to that 2000 analog, the NASDAQ topped out in March 2000. The S&P didn't top out until late August, early September, and then caught up with tech and bottomed in October 2002.

That's what happened here. We had the frothy stuff topped out February last year, and the S&P didn't top out until January this year. And now, obviously, everything is weakening, but like I said, you can argue that some stocks have already bottomed and have seen the worst of this bear market as it spreads into other things, particularly the bigger cap tech stocks, where so much money has been hiding out in and used to do so.

MAGGIE LAKE: Yeah, and you get a sense of that in some of what we've been seeing this week, certainly. Mason from the RV site has a great question. Peter, could the Fed get a soft landing in the economy, but results in hard landing in markets and still be considered successful? Are you thinking about the real economy-- can the real economy get by, but we see asset markets just in a world of pain as you were just talking thing about?

PETER BOOCKVAR: It is a great question. And my one belief in thinking that is difficult to achieve is the-- and I refer to the ancestral nature of monetary policy, asset prices and the economy. And that, when you think about the direct influence of asset prices on the economy is, let's just take the consumer and break it down. The lower end consumer is now getting crushed by inflation and falling real wages. Take the upper decile of consumers, where about 40% of retail sales or consumer spending is done by the top 20% that are going to be very sensitive to fall in asset prices.

And more so now because so much of household wealth is in equities, is in