Potemkin Markets – Reasons to be cheerful or fearful

Blain’s Morning Porridge – July 25th 2023: Potemkin Markets – Reasons to be cheerful or fearful

“Hubris is only hubris when it fails. When hubris pays off, we call these people geniuses.”

Stocks are looking forward to a double dose of joy from strong tech earnings and the Fed close to end of the tightening phase, but these may be Potemkin Markets.. foundations in the sand and little behind the façade… says the grumpy bond trader…

Short comment this morning as I’m taking clients off sailing for the day….

The weather in the UK is pretty awful, but its still notionally summer… which means markets are supposed to be kind of relaxed, on a bit a slowdown. Apparently not. My stock picking chums are delighted by the current apparently unlimited market upside. What bear market they ask as last year’s wobble is corrected. This week they expect a combo of superb Tech earnings and dovish hikes (yep get yer head round that one) from central banks close to the top of the tightening cycle, will drive stocks yet higher.

They might be right.

Bah humbug I say… Market commentators are highly predictable. We say things are cheap when the rest of the market judges they aren’t, and then call them too expensive just as the head stratospheric. We then excuse our mistakes and make convoluted excuses to explain why we were right being bearish when the market was not because, ultimately any bull market is part of a bear phase of a zero-hedge game.. or something like that… Being a self-appointed market intellectual reading the market runes is nowhere near as rewarding as being a decent trader divining market sentiment.

This morning, yet again I find myself sitting Billy-No-Mates in the corner in a grumpy strop – unconvinced by the increasingly euphoric market mood, overly worried about things like debt and dither. I can’t help but feel the market is missing something about the value of stocks and the underlying economic turmoil… or maybe it’s just me caught on the wrong side of a bull market? Again.

Whatever the US Federal Reserve does to US rates this week – the market will remain divided about what it ultimately means. (Consensus is for a 25 bp hike on Wednesday to 5.5%.) What they do and say after this week’s FOMC meeting will then become the next critical thing. The market is expecting the Fed to then hold or maybe one more hike – but it depends on the data.. it always does.

The markets are currently split into two camps:

• Reasons to be cheerful: an increasing number of folk are convinced slowing US inflation and the economy’s resilience means the Fed has achieved the improbable holy grail of central banking – a soft landing. That’s got to be good news for stocks – er, maybe.
• Reasons to be fearful: Others are delving deeply into the detail of rising credit card defaults, earnings problems, a property bust, and global slowdown (particularly in China and Europe) for proofs of how unsustainable the current happy-clappy market is.

As we all know the market can remain irrational longer than holdouts against the narrative can remain solvent…. But ultimately (remember my Mantra No 1):  The market has but one objective – to inflict the maximum amount of pain on the maximum number of participants.  

I was listening to a well known market guru last night describe his current strategy as: “Tactically, risk on. Strategically – cautious.” Not entirely sure how you do that (short-term bonds and liquid stocks) but I guess it’s all about to trying to time the next top to sell liquid stocks, and then wait for the next bottom to re-engage. That’s the kind of irrational behaviour that entraps investors – they miss the bottom and then wait for the market to go their way before they try to play catch up… finally getting sucked in just as it tops.. Remember, markets are driven by envy – the force which ‘forces’ late investors into tottering upside on the basis of FOMO (envy by another name).

I’m intrigued by the other analysts also looking at markets with a sense of disbelief. They point to multiple reasons its unsustainable. Some say the market still ain’t figured how rising rates and QT replacing QE (ie central banks pulling cash from the market) has removed much of the free cash that was sloshing around fuelling market upside, thus rendering the current multiples unsustainable. Others rail about bubbles in new tech and the mismatch between consumer disposable incomes and earnings expectations. Apparently, the Bank of America survey says 60% of investors are bearish on stocks – which in not reflected in current markets!

Let’s try to figure it out…

Things to smile about include…

• Economic resilience – consumers continue to consume and the market has new drivers like digitalisation and AI driving investment themes.
• Bond rates are close to top
• Dovish Fed – many commentators predict the Fed will swing behind a looser tone.
• Russia interests becoming more isolated from those of the Global South re-establishing global geopolitical harmony as links between the West and South are reforged.
• ECB likely to continue hiking – accelerating dollar weakness – deflationary, but great for US jobs (less so in Europe.)
• Global Investors still awash with cash

And why to remain glum:

• Global investors fear global recession – look at China and European PMIs.
• Debt: (delete where applicable…)
  • Unsustainable consumer debt
  • Unsustainable corporate debt
  • Unsustainable sovereign debt
• Sticky inflation – inflation aint beat yet.
• Potential global food inflation from closed Odessa grain exports.
• Saudi oil production cuts are having an impact – oil upside will be inflationary
• Hawkish Fed – the Fed may remain uber-cautious, and remain on tightening mode.
• Commercial Real Estate crisis
• Regional Banking crisis revisited
• Bank of Japan set to change the dynamic and hike
• Rising political risks in USA, UK and Europe
• Rising inequality risks
• Elevated no-see-um risk (and because they are no-see-ums I simply can’t explain why the risks are rising!)

Please add futher +ve or -ve reasons below in the comment section. As always, (Blain’s Market Mantra No 2) Things are never as bad as we fear, but seldom as good as we hope.

So, what is the right strategy for the moment? I can’t think we are in a Potemkin market – where the actual supports are nothing like as real as we think they are. It all looks rather rosy, but behind the false façade a whole series of issues are still to be revealed.. Not all of them will positive.

No time for five things today…

Out of time and back to the day job.. if taking clients out for the day counts as a job rather than a pleasure..

Bill Blain

Strategist – Shard Capital