Blain’s Morning Porridge – August 19th 2021 – Fed Minutes, Taper, Expectations and Covid bode ill for Markets
“I am not dead yet, I can dance and sing! I am not dead yet, I can do the highland fling.”
This Morning – Fed Minutes hint at Taper this year, but markets are pricing for it not happening: a slowing global economy, competitive pressures, the market’s addiction to debt and Covid will all conspire to stop Central Banks tightening. They might be right.
Yesterday’s FOMC minutes should have put the proverbial cat among the pigeons – Fed Heads were unequivocal about the looming taper of the Fed’s $120 bln bond buying programme. The question is when? Some Fed governors think the US jobs data and inflation numbers are trending towards justifiable action soon: “participants noted that if the economy were to evolve broadly as anticipated…. it could be appropriate to start reducing the pace of asset purchases this year..” Crashing major chords…
Markets wobbled but did not fall over on the Fed noise/news. Lots of investors – anyone under the age of 36 in markets – will never have worked in a financial environment that isn’t being distorted by central banks. Many will simply continue to assume the Fed et al will continue to juice markets with low interest rates, bond purchase programmes, and QE infinity in perpetuity to avoid any market instability.
For those of us who’ve been here longer and who believed post 2008 monetary mumbo-jumbo experiments were temporary; how the Fed and other central banks act rather depends on whether the ‘economy evolves as anticipated”, and around the globe there are signs it is not.
Numbers point to a swift post Covid recovery spike that’s enthused everyone, but the reality is the short-lived upswing has been followed by the economy lapsing back into the same dull sub-optimal lethargic growth that’s characterised the post-2008 global economy. There is any amount of research out there pointing out how it’s not a v shaped recovery, and there is no reason to assume continued higher post-pandemic growth. Rather than a v, it’s likely to look like a square root/function symbol: (No idea what that symbol is called… I suppose I should find out… for now let’s call it the flat-line tick.)
Part of the reason is the Global Economy just isn’t going to recover as strongly as hoped is supply chains have been stressed by the pandemic and geopolitics. Try to order seasonal furniture or construction supplies and forget it. Here in the UK the ultimate shock-horror-signal-of-economic-catastrophe is Peri-Peri Chicken Shop Nandos closing 10% of its fast-food outlets because of a Chicken supply chain crisis, largely caused by the lack of East European workers able to enter the UK to prep and pack the chooks. If our kids starve – blame Boris and Brexit.
However, I suspect the real reason behind sup-optimal, lacklustre long-term lethargic growth since the Global Financial Crisis began in 2007 (and it’s not over yet), is the consequences and effects of monetary experimentation. Toy with interest rates at your peril! Central bankers made the assumption ultra-low interest rates would stimulate investment and capex into the economy, creating legions of well-paid jobs and a stronger, better-for-all-economy. Simplistic fools.
They were wrong.
Foolishly low interest rates have behavioural consequences. Firstly, entrepreneurs stop entreping: rather than take risk on new projects when returns are low, they simply borrow cash and play financial asset markets instead because: “Financial Assets go up in price when bond yields are artificially low” (due to QE).
Second, everyone borrows. Companies make a better return and can pay executives more buying back their stock with borrowed money rather than building new factories when rates are stupidly low. Fact. It’s happened – we now have a massively overleveraged corporate sector that’s spent gazillions buying back stocks, personal debt is through the roof, and governments have spent a billion gazillions without so much as a blink… There will be consequences.
Even the rating agencies have noticed – and if they can spot corporate debt is reaching unsustainable levels… then… go figure. When even the rating agencies notice – code red.
And then there are expectations… Contrary to popular belief expectations are not cold, rationally derived snapshots of the future. Nope. They are a reflection of what players hope to see in the future. When it comes to stocks, expectations tend to be high because analysts and investors want to justify current inflated asset values.
What is likely to change expectations? John Authors piece on Bloomberg this morning is particularly interesting: “Delta Hedging is working its way into investors’ heads”. He looks at US earnings and three reports done by Goldman, Deutsche Bank and Morgan Stanley which sum up what US corporates said about Strength, Weakness, Opportunities and Threats (SWOT) in their earnings calls. Taken together they show “cost inflation” is a major concern, prices are rising, everyone remains scared of Covid and what new variants like Delta mean, and corporate margins are under pressure.
The new reports coming out the Vaccine sector on the efficacy of the vaccines makes frightening reading if you think the Pandemic is over. The AstraZeneca jab seems to give longest protection against Delta, while Pfizer diminishes quickly over time. In vaccinated nations it’s becoming increasingly likely we’re going to see booster shots required – at a time when much of the second and third world is still struggling to get vax programmes underway. That bodes ill for global recovery and supply chains.
It feels like we are into a new phase of the pandemic.
The first 18 months were about the shock, the fightback and the vaccines – we declared victory way to early, thinking we’d won the battle back in Dec 2020 when the first jabs were introduced. But now the war continues – a dull slogging match.
This second phase of the pandemic is only just beginning; it’s about staying ahead of a mutating virus and multiple variants and stopping infections, while trying to keep the global economy open and not swallowing itself in an ocean of debt.
During the first phase a couple of my chums ended up serious ill with Covid, were in hospital for weeks, and are still struggling with Long Covid. Another friend caught it and passed away over a very short-time frame. Yet, I now know more people who have caught Covid, spent a miserable 7-12 days fighting it, and were all double-vaxed. They are not dying and they are not overwhelming the hospitals, but it highlights how still infectious a new more deadly strain than Delta may be.
Phase 1 of Covid has passed – we survived it, but we definitely didn’t win.
Phase 2 of Covid will be about coping; making sure we keep the pressure off health services through boosters and covid-therapies, matching the evolution of the disease, while trying to keep the economy on track. I’m confident of the science and the medicine, it’s the likelihood of government policy mistakes that worry me more.
Covid is not going to be a “troops home by Christmas” war… this will last decades.
There is so much I don’t understand about markets. I struggle to reconcile just how blindingly stupid otherwise smart intelligent people can be. I look at the “stuff” they are buying, and can’t for the life of my figure why they think they are worth so much. Crypto, SPACs, Tech Stocks, etc – I can write pages of detailed reasoning on why they make zero investment sense… but somewhere at the back of my mind is a little voice saying… “maybe its you who is wrong, maybe you don’t know everything, maybe the market knows more than you..”
The market does not know anything. The market is not an all-seeing artificial intelligence with divine knowledge of the “correct” price of everything. It is just a massive voting machine – determining the market price based on the input of every single market participant.
If the market is dominated by idiots, then the market price is the idiots’ price.
Some folk are brave enough to stake themselves to their beliefs. My imagination was caught by a Bloomberg story y’day: “Michael Burry of “Big Short” Bets Against Cathie Wood’s ARKK”.
Burry is famous for being played by Christian Bale in the film of the excellent Michael Lewis book – “The Big Short”. Burry’s reputation as a pragmatist was secured by the $800 mm profit he garnered by betting against sub-prime mortgages back in 2007. He saw an unsustainable market fuelled by puff and noise, and put his money to play accordingly. It took time – but when the mortgage house of cards collapsed he was proved right. Courage of his convictions, and all that…
Not he’s taken a series of shorts and puts against ARKK and Tesla (which remains ARKK’s biggest position. Keep an eye on them both – I’m anticipating Musk’s repeated claims that Tesla’s autonomous driving is “just around the next corner” is going to be clobbered in the courts and cost him dear…
Five Things to Read This Morning
WSJ – Fed Signals Asset Purchases Likely to Slow This Year
Out of time, and back to the day job!
Strategist, Shard Capital