Blain’s Morning Porridge, June 16th 2022: Prepare for Upside – but find it first!
“People tend to sell winners and hang onto losers. The psychology behind such behaviour is simple.”
This morning: The Fed just aggressively hiked 75 bp in the midst of the first major correction since 2009, making clear the game has changed, and we’re into a whole new cycle. While the market correction remains ongoing, when it flips, it will flip swiftly. Already there are positive signals to be seen – but only if you look outside the box.
Apologies for lack of Porridge y’day, but I was “entrained”. Being stuck on the Southampton to London line gives one a chance to think – and consider opportunities and threats. Success in markets is about using headology to understand groupthink. The market is just a voting machine, and it is not necessarily logical.
While the Fed feels confident enough to aggressively hike, the ECB was forced to make defensive vague promises about saving “fragmenting” Euro bond markets. It tells me the Western World is increasing split between the US, which is energy and food secure and will thus shrug off recession, while Europe, which is neither, will really struggle with looming stagflation and debt wobbles.
Place your chips accordingly.
Surprisingly, my general conclusion is things might be bad, but probably not as bad as the headlines suggest. There is nothing the market media like as much as good old-fashioned market catastrophe to talk-up and gloat over.
Yet, over nearly 40 years of investment banking, I’ve never seen markets this fraxious on the back of the uncertainty, multiple threats, storm fronts and potential bear-traps in play. Its pandemonium out there. I can’t help but think our attention is 100% focused on the mayhem on the field, rather than seeking to understand what’s happening off it, out of sight.
One of my market mentors called me earlier this week. While he agreed markets are tortuous, he bluntly told me I should get my head out the box.
He reminded me of a story he’s told many times: As a young analyst, he presented his boss with a bullish write-up on some stock. The boss read it and handed it back, saying: “Young man, everything you say is right but I would not buy this stock. The players are all on the field for everyone to see. You do not make money buying stocks when the players are all on the field. You make money when there is a hidden player whom no one knows about ready to trot down the tunnel and join the game.”
A punch between the eyes to remind me; the trick about markets is not to follow the same narrative track as everyone else. The trick is to spot what others aren’t seeing. That is particularly true in times of enormous market stress – as we are facing now.
The current generally accepted market narrative is profoundly negative. Everyone – apparently everyone – agrees rampant inflation, geopolitical instability, Russia, China, dollar strength, fractured domestic politics, rising interest rates, the apparent inability of Central Banks to impose stability, and overvalued markets means we’re shaping up for something much, much worse. That’s been reinforced by rising fears we’re about to see a dismal Q2 earnings season as wage demands, declining consumption and rising inflation cut corporate outlooks.
High levels of fear are not surprising.
The market’s underlying psyche is still dominated by the events and consequences of the 2008 Global Financial Crisis (“GFC”). Basically, the market has a bad case of PTSD. As a result, the way markets behave today has fundamentally changed.
The GFC saw the risk-appetite of banks fundamentally neutered to avoid a repeat of politically embarrassing bank bail-outs. In its’ wake, market participants today are dominated by onerous (and often seemingly pointless) reporting requirements, the rise of internal bureaucracies, crushing regulatory oversight, and formulaic risk tolerance – rules put in place to ensure we never experience 2008 again. The good old days when risk taking was encouraged and we played solely to win – look so over.
Careful what you wish for. While the regulatory response to the GFC should ensure that particular crisis doesn’t happen again – something else will undoubtedly surpass it! The next crisis will be different, and will likely be in part a consequence of the measures we took to resolve the GFC. For the last 12 years young market participants have come to believe Central Banks are there to shore up markets. They are not.
Old fashioned risk is making a comeback. It’s fascinating some of the top performing funds in this market include Crispin Odey’s 110% contrarian gain this year – betting against Gilts, while reversing his 68% loss betting against stocks since 2015! Odey still thinks things will be bleak: “Outages, shortages, strikes and war will come along”, he wrote in May!
While everyone is focused on the worst possible outcomes, it’s difficult to think through to more positive outcomes. You can read any number of dystopian market outcomes at present. For instance; ZeroHedge is one of my favourite sites – there are often very interesting financial and market insights buried among the legion of Joe Biden-ate-my-hamster stories, but a frightening number of readers seem to be loading up on guns and ammo, preparing their shacks in the mountains to defend themselves from the coming collapse of everything.
The global economy goes up. It goes down. It wobbles, but like weebles it doesn’t fall down.
As I’ve discussed through this week, I’m convinced markets are well into a major overdue correction. The last 12 years of zero-interest rates and QE created a liquidity fuelled boom. Now it’s over. With the US stock market officially in bear territory, we’re already about 40% done on the way down to the fair value of Mean Reversion. You get the same number if you look at the Buffet Indicator, or earnings vs P/E.
Most stocks are going lower, and bond yields will rise. It’s going to happen – get used to it. Accept it. It’s part of rationalisation, normalisation, mean reversion – call it what you will. There are further downside valuation adjustments to come. But a correction is not the end of the world. At some point – sooner than most folk think – it will probably turn into a buying opportunity. The flip moment will go unnoticed by most market participants until the new trend is clearly established.
Why “probably”? There is always the possibility the current stressed markets will go into full meltdown – but hopefully not. (Hope is never a strategy – btw.)
We’re all predicting recession, but it’s likely to be thin – especially in the US. Supply chains are currently in crisis, but will be resolved. Global trade is conflicted, but remains in everyone’s interest. If we strip away exogenous shocks, with the exception of Southern Europe, the global economy is in fairly robust health. Consider the post pandemic boom – how it was stemmed by supply chain crisis and the Ukraine war, and then figure out just how strongly the global economy will bounce back once these are resolved.
There are risks. The UK and US are both close to full employment. The US appears on the edge of overheating today – yet is looking at recession tomorrow. But it is largely immune to Energy and Food shocks as an internalised economy. Recession is already here in the UK. The major known risks are the likely social and political tensions likely to arise from industrial strife as workers demand higher wages to compensate for inflation.
As the token Socialist in the City of London, I have to say workers have a point to make. For the last 12 years the owner classes have benefited massively from financial asset inflation boosting stocks and performance based earnings for managers, while wage growth for the workers has been constrained. To expect workers to tighten their belts as higher taxes are imposed and lower wages are eaten away by inflation isn’t going to sell well. Industrial strife? It’s absolutely nailed on.
Countries that fail to cope with these tensions face a fail on my Virtuous Sovereign Trinity theory, the relationship between confidence, bond yields and currency.
There is still a possibility a sudden endogenous shocks – an unexpected fund meltdown, a corporate default, a sovereign debt crisis, or similar – could trigger a chaotic breakout. That’s the thing about no-see-ums – you don’t see them coming. But, the key is markets are not as vulnerable to the risks that floored them in 2008. Banks are de-risked and strongly capitalised. And we’ve already identified all the main threats.
Its what’s off the field that matters.
One major new risk is how the credit and market risks the banking sector once carried have been dissipated, transferred and distributed across the asset management industry – meaning its pensioners and savers who now face losses when the inevitable corporate bond meltdown comes. Consumer risk? Well ask Klarna how well things are going for them.
Meanwhile, for an illustration how bad its already gone:
Since I called the top of market stupidity late last year, my “Idiot ETF” is doing handsomely badly:
- ARK – down 75% since Feb 2021
- Telsa – down 46% since Nov 2021
- Buttcon – down 68% since Nov 2021
Ultimately Bitcoin is worth only what the next idiot will pay for it – greater fool theory. No one yet has suggested a single thing crypto can do better than real money – thus I predict an eventual value close to zero. And as for an inflation hedge – turns out avocados are better.
As for Tesla, the best performer and the stock that’s let me down, there are rumours circulating it might have been massaging production numbers. Really? Nothing would surprise me. How a company that fails every single aspect of ESG on multiple levels is still the stock market’s darling I will never understand.
Five Things to Read This Morning
Forbes – ARK Invest CEO Cathie Wood’s Net Worth Slashed by 65% as Tech Bets Sour
BBerg – Goldman Investigation Tarnishes ESG Halo as Investors Bail
FT – Brexit trade friction caused 15% fall in UK-EU exports in first half of 2021
Thunderer – ECB takes emergency action to avoid bond market rout
WSJ – The Fed Pushes the Envelope
Out of time, and back to the day job..
“Crispin Odey’s 110% contrarian gain this year – betting against Gilts, ”
Imagine, 110% profit on shorting gilts to the End of May!! When 10yr yield was still 2.10%
Another 54 basis points since then (including 18 this morning)
63% down, then 110% up, he’ll be breaking even soon! But how much further can yields go?
Put it another way, <10% interest rates given current inflation implies the BofE is willing to sacrifice the Real value of the currency in an attempt to rescue the economy.
I suspect they aren't targeting the value of the pound (tenner) in your pocket, just FX rates as they always did. If the ECB and Fed don't raise rates we will all go to inflatonary hell.
As a climate skeptic it pains me to say it but the no see um we know we will see is the big slow moving hurricane heading towards the US coast between the mouth of the Mississippi and Houston. This is the heartland of America’s refinery, chemical and LNG production. The last Category 5 to visit the northern Gulf ( Michael ) hit an unimportant piece of the Florida panhandle. Given Europe’s energy predicament a major hurricane may hurt Europe’s economy more than America’s. Biden seems to have the reverse Midas touch ( he’s already drained our Strategic Petroleum Reserve ) and our refinery capacity is strained even with them all up and running so if a bit of that special Biden magic takes the form of a big September hurricane heading towards the Lousiana Texas border and a physical shortage of LNG, gasoline and diesel is the result. Well Americans don’t like gas lines and rationing. How about Europe?
The USA is basically energy and food independent but that doesn’t mean that we won’t have inflation shocks. We still are a free market economy and the prices of these commodities are set in the world market and therefore we pay world prices. Of course we don’t have the added costs of tariffs.
I think that we will have a Q3 recession if we aren’t in one now. The lower 80th percentile (if not the 90th percentile) is stretched quite thin, like butter scraped over too much bread.
One political response we are beginning to see is national governments limiting specific exports to keep their home markets oversupplied as a means of trying to dampen domestic inflation. I can foresee a conversation going something like this…..
“I’m gonna get my *ss handed to me in the mid terms if you don’t get on top of inflation”- Biden.
“If I raise rates any harder it will smash the economy. You could try doing something to help”- Powell.
“Fine. I’ll limit energy exports. That fire at the LNG terminal will give me some cover. I need to top up the strategic reserve anyway. That should help for a while”- Biden
“Oh f*ck…………….”- EU
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