Blain’s Morning Porridge 9^th July 2022: Just how overblown are global markets, and how much more volatile might they become?

“It’s not the speed that kills you, but the sudden stop…” 

Markets seem unstoppable – but history is about mean reversions; usually through a deep correction or damaging crash. Storm clouds are on the horizon as the US election presages a period of inclement uncertain conditions. The next 4 years will be “interesting”, but let’s get through the next 4 potentially volatile months first.

There is a mountain right in the middle of Scotland called Schiehallion – it’s a slog to climb as it’s got as many false summits as the US stock market has recently made new highs. You keep thinking the next crest is it, but no… there is another still ahead of you. The view from the top is superb and massively rewarding; West across Rannoch to The Ben, North to the Cairngorms, East to follow the Tay to the sea, and South to the Ochills, but I would not know any of that as the three times I’ve been up there it’s been pouring with rain, swirling in cloud, or a near whiteout one winter. I remember a particularly nasty winter day some 40 years ago where we squelched our way upwards in sleet, got to the top in a blizzard, and immediately headed straight back down to go to the pub near Killin – and it was shut!

That memory came back to me suddenly this morning as I looked at the S&P500 chart. Lower highs tell us something.

Climbing Schiehallion is almost as pointless and foolish as believing stock markets will rally forever. On the basis “Markets have no memory” they are doomed to repeat the same mistakes repeatedly, at some point there will inevitably be a reckoning. Remember: “Markets have but one objective…” according to Blain’s Mantra No 1; “..to inflict the maximum amount of pain on the maximum amount of participants.”

The signs and portents look blindingly obvious:

• 3/5 of young Americans are apparently playing (I use the word deliberately) the stock market on their Robin Hood mobile phone apps. The dice are loaded against them.
• Analysts are predicting massive upside from stocks that saw their Q2 sales plummet less than expected. Dream on: Tesla is on a tear on the basis its selling less cars, is falling behind in an incredibly competitive market, but don’t worry.. the reason its rising it’s really a robo-taxi firm about to make gazillions.. Really? Take the blue pill.
• Analysts are predicting a strong earnings season – clue: they always do.
• Analysts are predicting the Fed will shortly ease rates!
• Bond and Fed watchers say.. er, no.. not during an election cycle and while sticky inflation remains a threat. Both Fed Head Jay Powell and Treasury Secretary Janet Yellen will be laying out their views on the economy later today.

The US election in November is not the post-debate Trump/Biden slam-down we expect – pollsters think it could be much, much closer.

Breaking down US markets, it looks like a standard triple whammy threat: overvaluation on over-euphoria, misunderstanding the economic reality, and the political aspect – which is not inconsiderable.

Issue no 1 for the US market is the behavioural psychosis driving the market: irrational hopes and expectations trumps rationality at times like these. Folk deliberatey choose to not understand the reality that greed feeds greed and acts like financial gravity, sucking in cash till the moment it goes critical and breaks down. Both public and private markets see the same thing: all the money is flowing into America because – simply put: money follows money. Stocks are rising not because of rising sales, but the amount of money buying stocks.. Doh! They are rising because rising markets rise as more capital fuels the rise… which does not necessarily sound sensible, but is common sense in action.

Another Blain’s Market Mantras states: “It’s better to miss the last 5% of the rally than catch 100% of the inevitable downside.” Inscribe it on a post-it note and stick to your desk.

US stocks are valued massively higher than Europe, Emerging Markets or China. In Europe we have more data and computing scientists and engineers with exactly the same talents, skills and insights as their counterparts in the US, but they ain’t creating the next Nvidia because capital is plentiful in the US, but scarce in Europe. China has some of the largest “addressable” markets, like healthcare, on the planet, but who wants to risk the furore that would accompany being seen to invest in the Middle Kingdom these days?

Going back to my earlier comments on Schiehallion, the Scottish Mountain; at least you can’t really get lost – just follow the path upwards… bit like a tracker fund. Things get dangerous in mountains when you go off-piste, like investing in the clever ways to riches… AI, Nvidia or Bitcoin. This is not the moment for a lecture on the unfulfillable promises or overpromised/underdelivered likelihood on AI, but all the glitters is not gold, and easy paths oft prove dead-ends.

The second aspect is the New Normality – interest rates remaining around 5%, real rates a couple of points higher than inflation. Food and Wages will push inflation higher in coming months. Central Banks and Regulators want normalised interest rates, not the monetary and market distortions created by artificially low interest rates. Its simply too tempting for politicians desperate to secure and sustain electoral success to demand lower rates, but now we increasingly understand the long term consequences around rising inequality and diminished productivity.

Meanwhile, the third known unknown of the current market cycle is the US election.  My Republican chums are telling me it’s a clear Trump win – nothing to worry about. However, recent polls show Biden has clawed back some support – whatever pharmaceuticals “they” prescribed have left him chipper, mobile and awake. He’s fighting back the groundswell of Democrat opinion that he should step down.

The election period could proved highly unstable. Just how damaging could a democrat coup against Biden become? How distracting will rumours he has Parkinson’s become? What will happen in US markets if the election remains too close to call and Biden really does stage a recovery? If the Democrat attack ads on Trump and MAGA as responsible for the reversal of Roe vs Wade are successful? What happens if the key swing demographies return to the Democrat fold? (Soccer mums, Latin Americans and Black Men.)

There was a time when people voted, tellers counted, validated and confirmed the votes, and the winner was announced. Not any more. Just how unstable could markets become if candidates demand recounts in key states, if postal ballots take longer to count, if legal challenges are mounted, and candidates deny the results? Are we going to see a repeat of 2020?

If the polls reconverge – just how uncertain will markets become over a result? And how will markets factor in the likely Trump mega-sulk and the threat of violence, even insurrection or civil war if he loses?

And all this without considering what the long-term implications of Trump V2.0 might be on the US economy, lower taxes and freeing up oil creating a mini-boom hoiking inflation, while debt shoots higher at a time when global treasury investors are contemplating what else to buy except the dollar. The next 4 years are going to be “interesting”, but the next 4 months could become increasingly volatile.

Sorry for shorter than usual comment this morning, but got an urgent call to jump on..

Out of time, and already doing the day job…

Bill Blain

Author of the Morning Porridge

Wind Shift Capital

www.windshift.capital