Confusing markets and multiple narratives – test them all!

Blain’s Morning Porridge – Sept 12 2023 – Confusing markets and multiple narratives – test them all!

“The most dangerous words in finance? “I want to tell you a story””

Markets are treading water trying to figure out directions – some of the underlying narratives look alluring, but they are not all they seem. In confused, uncertain markets, the trick is to remain suspicious of what others are following.

As is normal… I am fairly confused this morning. No matter. Think it through….

• As tighter credit conditions trigger rising defaults, and yet another clutch of busted businesses exit the high street, the screen headlines scream Softbank’s ARM IPO is five times oversubscribed. The deal will close a day early and maybe price higher around $60. (Bubble?)
• US numbers show consumers are close to broke and have spent their pandemic savings. The cost of living crisis in UK and Europe is accelerating, but not single analyst following LVMH has a sell recommendation on the luxury stock. (Consumption crash?)
• US July inflation rose 0.2%, but that’s pre rising energy costs. (Inflation is not beaten.)
• Jamie Dimon (head of JPMorgan) is lambasting US regulators for imposing “unnecessary” new capital requirements on US banks which will make them uncompetitive, while Kyle Bass, a chap who did rather well when the banks churned and burned in 2008 on housing losses, warns commercial capital losses are set to eat 10% of US bank equity this year. (Potential bank wobbles?)
• There is a comment on Bberg about why the UK is un-investible – but after watching Laura Doomsberg on the BBC last night on chaotic UK politics… am I surprised? (Rising political risk in UK; stocks, bonds and currency?)
• This morning an austere central banker in the FT is telling me UK rates are going to stay elevated for longer in face of the uncertain inflation outlook, while the ECB is expected to keep rates on hold this week as the cogs of European commerce and industry grind to a halt, but few within the Bank believe inflation is really beaten. (Bond markets still vulnerable.)
• Analysts increasingly accept inflation is more sticky and embedded than central banks expected – rediscovering the pivotal role volatile energy costs have on inflationary expectations and how wage inflation becomes increasingly entrenched. Someone in the Fed apparently wrote transitory on an outlook. (Central Bank credibility at risk?)

The questions in italics are my initial thoughts on each news cluster – and there are many others I’ve missed above. In other words…. Just another day figuring it out in this market paradise.

I’m nervous about recession (even stagflation), on stock valuations on the back of the AI bubble, rising defaults, rising consumer pressures – but no reason for panic. The promised soft Landing might be a little harder and bouncier than anticipated, but heck.. how much higher can rates go? I’d be shy stocks except on a fundamentals basis, and looking for bond returns based on recession proof security. As always – happy to talk ideas.

But…. the bottom line is we are all guessing.

From the most august Central Banker to the most foolish meme-stock trader we are all guilty. Luck? I have spent £4 per week on the same lottery numbers since my first kid was born – what does it prove? Absolutely nothing in life is certain, except hope and expectations are not a particularly effective strategy. (I’m agnostic on the power of prayer.)

I suspect everyone is a gambler and wants to believe in winners. Belief in the power of winning narratives is a key component of FOMO (fear of missing out). Narratives can therefore be a dangerous thing – any stock or bond story is basically marketing! The trick is to dig around and behind them to see how likely and how deeply they are embedded, (and how shallow they are founded), to try and figure out the reality. Be suspicious.

For instance, I believe in EVs – that non-polluting EVs will become the dominant transport mode, but its still a innovation sector in development. Its too early to pick the ultimate winner – new battery tech (light, more energy dense, longer range) will trigger a second EV revolution, more efficient vehicles, and leave some the current incumbents stranded.

When it comes to inflation and rates, it’s becoming increasingly clear the narrative of falling inflation and a swift easing of monetary conditions was premature. It’s what central banks would like, but not what we get. Rates are unlikely to fall until its clear the inflationary impulse is over, and that’s unlikely to happen with gas remaining tight on supply fears – not just because of Ukraine/Russia. Saudi retains undue influence on oil prices– hence the expectation of reengagement with MBS. We need to see clearer signs of slowdown before Central Banks can confidently ease.

The main narrative driving stock markets is how AI is going to change everything, creating boundless profits, productivity gains, and market upside. It seems to miss a rather obvious flaw: If AI applications are about to replace every single well playing middle class job, turning every information based roll into a series of 1s and Zeros, then who is actually going to be left earning money to actually drive economic growth through consumption? Just asking?

The power of AI explains the apparent success of the ARM IPO – CEO Rene Hass is telling potential investors ARM is going to at the core of all AI chip design. (Its not designs that are scarce – it’s the Chips…) I am not a buyer of ARM at $60 bln valuation, or half that.

One logical conclusion to the current AI boom; how AI will boost productivity by replacing workers, is that the very owners of the ultimate AI winners will become exceedingly rich on the sum of all returns, while the hoi-polloi will be reduced to mere helots (citizen slaves) making zero economic contribution, and we all know how that plays out in a dystopian future run by AI or in revolution.

That machines will inevitably make honourable labour obsolete, redundant, and surplus to need, has been a theme of society since the earliest time. Saboteurs would stick their wooden clogs in machines to break them, while technophobic luddites have been burning down mills to stop industrial innovation ever since young cross-dressing Ned Ludd took a sledge hammer to a loom in the 1800s. Even the Matrix is broadly about how AI creates an efficient society.

The reality has been technological innovation tends to result in a rising tide of economic growth lifting all boats – usually. Side issues such as how industrialisation poisoned the earth are additional costs – to be addressed through government wisely allocating these costs through taxation. Where it breaks down is where the owners of the plant causing such externalities decline to pay these costs – tax avoidance – and try to make joe public pay for their enrichment! But how to reform polluter pays taxation is a rant for another day.

How likely is AI to totally change the world? Yes it will replace some roles, and probably create others and ever germinate wider possibilities in areas like the creative aspects of society. There will be winners and losers. And read or watch any old SciFi to realise how little really changes.

That leads to another dominant market narrative – rising political discontent. Its impossible to ignore extreme voter dissatisfaction across the US, UK and Europe created not just be the current economic reality, but a succession of populist events leading to the impression government gets worse rather than better. Rising costs and declining public service standards have fed Populist themes – notably blame someone else: Brexit, immigration, and Trump.

Politics matters in markets.. and no doubt much more to be said about it.

Out of time and back to the day job

Bill Blain

Strategist – Shard Capital