Blain’s Morning Porridge – 27 May 2020: The Power of Headology

Blain’s Morning Porridge – 27th May 2020 – Time to Learn Headology

“Mumbled words and weird drawings in old books in the wrong hands is dangerous as hell, but not half as dangerous as they could be in the right hands…”

Sorry for being bit late this morning, but early morning call with Asia overran. HK is not going to end well.

I am watching the market moves and shaking my head. Up, Up, Down…  The Dow broke 3000 on unconstrained optimism before Trump pulled it down with threats of China sanctions.. Shake it all about. Do the hokey cokey…

There are so many strands of news flow pushing prices: credit markets are strong, US housing came in stronger than expected, there is a perception global lockdown is ending and of economies being able to reopen, fears of second wave infections, massively rising global stress and trade risks from the mounting China/US tensions, “optimism with respect to a vaccine”, and the massive volumes of central bank easing, QE and government bailouts of failing industries – which seem to be negating all the negative connotations about debt, job-losses and tumbling GDP. As prices rise, the market is being fuelled by a particularly strong sense of “FOMO”. Another oil shock doesn’t look on the cards.

But, there are some particularly sickening stories out there – including Hertz executives paying themselves $16 mm in bonuses shortly before declaring bankruptcy and laying off 10,000 workers with minimum payments. I predict a series of political lynchings will shortly follow.. What next? Free cake on the dole queues? I suggest not.

All these factors influence how markets are reacting. They don’t necessarily need to make any sense. Many of the factors driving today’s market optimism – like the ease with which large corporates have been able to raise debt from bond markets are unlikely to be sustained. The backlash against “unacceptable market behaviour” in the form of bonuses and buybacks is growing. At some point.. the Fed and other central banks are going to stop juicing markets… Governments are already fretting about how long they can keep the money spiggots open.

Cold Turkey will hurt, but that moment could be years down the road. (While some governments are trying to balance running out of money before they expend credibility, what central banks will eventually have to decide depends on the known unknowns like the deflation vs inflation debate currently underway.)

At this point I would simply remind readers of some of the key Blain’s Market Mantras:

No 1 – The market has but one objective: to inflict the maximum amount of pain on the maximum number of participants.

No 3 – The market has no memory

No 11 – The first cut is the cheapest

No17 – The only thing worse than too little capital is too much

Draw your own conclusions..

(For the sake of disclosure… I’ve been a participant in the rally, sticking to a few stocks I think are best positioned in terms of balance sheet strength, product resilience to the virus effects, and long-term outlook. They have all done fine… Most other stuff I won’t touch, and my stock position is lower than bonds and gold!) 

Perhaps it’s time to share 35 years of market experience… and explain the key force in markets: the power of belief. 

The market is a never-ending random walk. There are no deep secrets about how it moves. Markets go up and markets go down. The market is the sum of traders buying and traders selling. Investors put bets on the table, leave them there, and pull them off. Its really as simple as that..

What’s interesting is the reasons why market practitioners decide to buy, hold or sell. It all boils down to how they perceive the market story developing. That’s where it all gets a bit murky – its more complex than behavioural economics, or the “peculiar madness of crowds.” Let me share a secret: the movement of markets all boils down the fine art of “headology”.

Headology is a fascinating concept, first quantified by the brilliant social commentator Terry Pratchett. Its very different to psychology – which has connotations of something bad, aka a “psychological problem”.

Headology has a very simple guiding principle: What people believe is what is real.

Headology simply explains why investors will invest in this market; believing 24 times Price/Earnings ratios are justified (ie real) in the face of potentially the deepest sharpest recession of all time. They believe because they also understand the imperative facing central banks and governments to support markets and bail failing companies to avoid social calamity.

Traders believe these same forces to also be real – and therefore buy and sell accordingly. At this point the reality of what is real will be changing – the financial force known as FOMO exerts a strong influence on markets at all times, causing prices to orbit what participants will believe in predictable ways: if a market is going up and you don’t understand why, then you will quickly change what you believe in order not to miss a rally.

The best and worst traders are those who don’t have strong beliefs and therefore don’t maket decisions based on what they believe – i.e. those too clever or too stupid to be susceptible to headology. These are the contrarians who can avoid being sucked into Long or Short positions after being sucked into mass group beliefs trigged by market forces, the strongest of which is FOMO. A contrarian will believe what others do not – but as often as not that is the wrong belief. (Which is why yesterday’s brilliant market strategist who made trillions on the last crash is often broke on this one..)

With me so far?

Pratchett described the difference between psychiatry and headology as follows: If you are convinced you are being chased by a monster, a psychiatrist will endeavour to convince you monsters are not real and are therefore not chasing you. A headologist will hand you a bat and a chair to stand on.

Five Things to Read This Morning

FT – Top-Rated Companies raise $1 trn to fill “war chests” (to be fair, if you read the porridge, you already knew that as I’ve been talking about burgeoning debt issuance for months!)

BBerg – Banks in Denmark May be Facing a $24 bln Capital Shortfall

WSJ – As its Economy Slows, China Embraces a Weaker Currency

Torygraph – Pandemic forces 1.5 million people to delay retirement. (*g(b .

Garuniad – Tory privatisation is at the heart of the UK’s disasterous coronavirus response..(As the last communist working in the City of London, I would love to believe this – but I suspect the real reason is nobody knew..)

Out of time, and back to the day job…

Bill Blain

Shard Capital.