Learning from mistakes to call the next ones…

Blain’s Morning Porridge 5^th June 2023:  Learning from mistakes to call the next ones…

“ Never interrupt your enemy when he is making a mistake.”

The debt ceiling crisis has lifted a cloud from markets, but we’re still looking for resolution on inflation, geopolitics and a host of other issues. Maybe the real issues are about valuations – which remain over-extraordinary.

So, what are we going to get wrong this week, this month, this quarter, this year?

In there is a theme to the story of 2023 it’s been just how badly we’ve navigated the uncertain and shallow aspects of confusing and difficult markets. We’ve been assuming the worst, and been caught by surprise when something different occured. Now it feels like many of the narrative threads are approaching some kind of resolution, perhaps meaning things will become a little bit clearer. Maybe things aren’t so bleak after all – clue, they never are!

Consider the following pieces of the macro jigsaw:

The US debt ceiling proved a crisis averted – as a result of competent politics which few folk expected. One of the biggest underlying themes in current markets is how polarised and divisive Western politics have become as a source of weakness and uncertainty. No one expected such a painless resolution. Biden/McCarthy played smart game to avert a debt debacle with limited fallout.

Takeaway:       Worry less about politics.

Inflation has proved anything but “transitory”. Central banks are struggling to juggle the effects and consequences. The speed of European inflation fell last week, while the US employment report highlighted how the US economy remains resilient, almost thriving. Far from the risks of a deflationary bust – which many strategy desks had been pricing in – the Economic outlook across the West is trending towards a modest reflationary boom; long-term sticky inflation and growth… although the UK remains an outlier with stagflation as the apparent threat.

Takeaway:       Inflation remains a destabiliser, but central banks will seek accommodation to avoid recession/bust – soft landing/long term sticky inflation are the issues to solve for. Manageable inflation will whittle away the debt time-bomb – but leaves the bond markets long-term vulnerable. (Clue: bond yields are marginally positive in real terms.)

Global growth looks an issue in the face of the apparent China slowdown. This has two effects; inflationary from rising prices as supply chains remain tight, but reminding Western economies of imperatives such as maintaining strategic economic capacity – everything from energy to steel!

Takeaway:       Global trade patterns may take decades to settle (you can’t transfer iPhone production to India overnight), thus a long-term force on inflation and commodities.

Geopolitics remains a source of worry, but Saudi cutting production over the weekend highlights the inherent contradictions at the heart of the new Russian/Chinese alignment of previously non-aligned nations. (This week’s BRICS conference will chatter, but achieve little.) Russia needs to keep selling as much discounted oil to China and India as it can to fund its’ war. Saudi isn’t benefiting from higher oil prices magnifying its perception it has global clout.

Takeaway:       The geopolitical risks remain elevated, but are probably set to moderate. The less competent Russia looks on the battlefield, the less energy insecurity is an issue, and more the Chinese economy continues to underperform, the more geopolitical tensions and risks are likely to ease.

In terms of markets, we’ve already established a marvellous track record for the year in terms of the big call: Fundamental Stocks vs Big Tech. Guess what… fundamental value stocks have pretty much flatlined while stock market records are powered by belief in Big Tech! The Mega 7 has driven the entire market upside – and if they were to stumble…. Well, that really could become the defining point of 2023. (Personally, I doubt it will happen. Why? Because, where else are folk going to invest? The reason fundamental stocks are flatlining is because, fundamentally, the offer limited upside! Tech stock will thrive on the irrational exuberance of folk believing they will continue to thrive.. but, but and but again…)

But….. What if? Lots of talk on the screens this morning about how vulnerable a no-see-um shock on one or more of the Big-Seven Mega Caps could prove. Apple, Microsoft, Alphabet, Amazon, Meta plus Tesla and Nvidia are “unassailable”… really?

Let’s just remind ourselves. These are not disruptors. They are mature companies that have been around for decades (in most cases). Apple trades on 31x multiple (P/E), Microsoft on 36x, Alphabet at 28x, Amazon on 301x, Meta on 35x, while Nvidia is on 204x and Telsa on 63x. Fuelling these tremendous valuations is the believe these companies have something extraordinary still to bring us, a value multiplier so strong it will not only produce an enhanced flow of gold and growth, but justify our belief in their rosy futures….

Perhaps not. Apple makes and sells stuff, and is finally getting round to revamping its tired retail temples. However, is anyone really interested in the VR headsets which is what today’s big and mega-hyped product launch is all about. Apple is a great company making stuff… stuff I still buy.. My kids? Not so much because they simply can’t afford over-priced white shiny things…

Microsoft, Google and Nvidia are all riding the AI wave – a tsunami of FOMO and irrational exuberance on the hope something major is changing around the future and we got to be invested in it.. Maybe we do…. But could we actually see it please? Meta remains Meh – its real business is clinging on to its diminishing advertising revenue which will always, always be looking for the new new place to spend its money.

Telsa.. don’t get me started. Great car company. Kudos for starting the EV revolution. But… the EV bubble is busting; the weight of the cars, the difficulties recycling them, the carbon costs to produce and refuel them, the battery problem… etc etc etc… When Telsa is a 12x PE, call me.

What would happen to market confidence if the tech bubble bursts? What might trigger it….?

What about further banking problems in the US as banks try to exit underperforming commercial property, or maybe on the big banks experiencing something that melds the deposit flight that sank SVB with some of the hubris that felled Credit Suisse.. more than a few of my bank following chums are eying up strategies around what they see as the inherent weakness of Citibank..

As commented above, lots of the market narratives are looking better and are becoming clearer, but there is never a lack of threats out there. I’m not convinced by the current Tech Rally – it looks like bear-trap gasp on the back of the current hype, and the lack of opportunity in bonds which remain vulnerable to further rate hikes and inflation.

Personally, I’m going to stick with real assets throwing off real returns to mitigate credit risks.. and keep watching…

Five Things to Read This Morning

WSJ                 Big Banks Could Face 20% Boost to Capital Requirements

BBerg              Mystery Trader’s Debt-Ceiling Windfall Sparks Insider Concerns

WSJ                 Bearish Bets Against S&P500 Are Surging, Despite Love for Big Tech

BBerg              Private Credit is Poised for a Multi-Trillion Dollar Boom, But it Could get Ugly

FT                    US Banks prepare for losses in rush for the commercial property exit

Out of time, and back to the day job…

Bill Blain

Strategist – Shard Capital