For more background on our columnist, Dave Newman here was his first post.
Well, here we are in the early weeks of January and the market is showing some signs of concerns over imminent Fed wind-down of QE, rate hikes, and even QT. I am still smarting over the Michigan loss at the Orange Bowl in the college playoffs, a game that I saw live with my wife and two kids, one of which is a Michigan alum. It was over after the first quarter, which made sitting next to a drunk and rowdy Georgia fan in a MAGA hat even worse. Thankfully, by the 2nd half, the stands thinned out and we were able to move closer to the other despondent, maize-wearing wolverine fans, and stadium exit, and traffic was easier to navigate.
Investing and trading are not like a football game with a time clock, even it can sometimes have a similar feel of violence at times. It is a game that never ends, where the participants are often playing in a dark soup of noise. On break, I read a good book by Niall Ferguson called “Doom – The Politics of Catastrophe” and while it covers a number of historical periods, it goes deeply into the CoVid pandemic and the obvious and ongoing awful preparedness and performance of most nations in combatting the issue say relative to Eisenhower during the 1957 pandemic – which had similar mortality (adjusted for age) statistics. In his view, it is this failure to diagnose threats, design and communicate a credible plan of action – the time wasted reporting, identifying, and spinning political nonsense – that is different in this episode. The sad thing is, it is not like we have not had potential pandemic scares many times over the last twenty years, (SARS, MERS, Ebola) to focus the minds. To segue this back to markets, it is this general inability to do things at scale well (on either side of the aisle) in the face of a monetary and fiscal sea change that is darkening the soup further.
When I was at hedge funds, we used the term “adult swim” when things got a little funky. In those times the mantra was to conserve energy, remain calm. Every year has its difficult moments, and 2022 is not going to be any different. Will it is more of an “adult swim” on average than is typical after three really great years and an awesome run from the bottom of the global financial crisis for risky assets (see below) US equities in particular – and somewhat concerning valuations, is the question that is on the minds of many. Some experts are projecting 2022 to be more “challenging” with the common refrain “the one thing we know for sure is that volatility is going to pick up.” People literally get paid for such vapidity.
My view – which I articulated in my last piece of 2021 – is that if challenging means single-digit positive returns then yeah, it is probably going to be more difficult than the past few. But, when all is said and done, it is likely, absent a recession, to be a year governed by decent earnings growth, capital return, and some spread compression due to higher rates and inflation uncertainty. Dan Niles made a good point recently, which is that if 2021 was a year of storytelling, 2022 will be a story of show me the money and return to investing normalcy – and we are seeing it play out already in value spreads (difference of growth vs value reverts). That may teeter over into some market/sector events, but that need not be indicative of a broad bear market. Because the mouthpieces/media drone on quite a bit about “market in crisis” when we move down a few percent or if a favored name or fund manager/style goes out of favor, we do need perspective. It is the first week of the year in a game that never ends – conserve energy, stay calm!
Things that caught my attention over these past few weeks:
In one of my first pieces for HFT, I wrote about Cathie Woods and the ARK funds, and have remarked that I have been long Jan 21, 22 100 puts for a while. NYU’s Aswath Damadoran mentioned recently that Cathie is good at the macro (I presume around disruptive technology, deflation), and not so hot at stock picking. I think that is a good synopsis, but would add a quote from my old boss Louis Bacon, which is that “you don’t ever want to be the game.” And, that is precisely what she has become. This may just be the case of flying too close to the sun.
Not that anybody is going to hold a telethon for her given her firm pulled in a very large haul (back of the envelope >$250m in fees in 2021 for underperforming the QQQ by >50%), but her investors – 2/3rd of which got engaged at much higher levels – have to do some soul searching as well.
I am not sure exactly who did this work, but it has been retweeted a bit by people I respect, and it looks about right. It is well worth going through. . The overall market capitalization for US equities is far, far greater than the ARK funds, even accounting for copycats and structured products tied to her funds’ performance, so while her funds are likely to ride the elevator down a bit more, it is unlikely to be a 2000 type event, largely because we have a very different equity risk premium setup overall (ie. rates much lower). But, sure, there are some excesses in parts of the market that are getting their comeuppance. Just like zero-coupon bonds have more sensitivity to rates, so do Cathie’s funds.
Astute readers will note that in the ERP chart above, we are not in a period of stable inflation. The chart above assumes stable inflation is 1-3% PCE. And, while the jury is still out as to the timing of reversion and stickiness of some price/wage gains given a. housing supply/vacancy rates; b. oil demand/underinvestment; c. wage pressures, d. generally strong corporate and household balance sheets on aggregate, e. policies that have been too demand-focused (fighting the last war) amidst pandemic, we do appear to be turning the corner a tad. It will likely take the balance of 2022 to see inflation revert towards Fed objectives, and I expect the vast bulk of the hiccups in the market will be around how that materializes, and whether the Fed is actually willing to tighten enough to stem the inflation tide. Obviously, It is not great to hear dumb AF ideas about instituting price controls which typically cause shortages, or using anti-trust/monopoly as an inflation fighting tool (even if market power/concentration is an issue) but these days you hear a lot of crazy things. Anyway, for some perspective on the inflation episode, see the following
Now, I do subscribe to some services that can be very dour and have remarked that we are going to have a large fiscal and monetary drag this year, and with it, some concerns about tipping into recession. But, if inflation is a key worry for the foreseeable future, it is a bit less so given these policy headwinds. Anyway, here is a snippet from David Rosenberg on the matter, although I don’t agree that recession is likely (particularly given we are in an election year):
I am not a car expert or even an enthusiast. I drive a 2019 BMW X5, my wife drives a Porsche Macan, and my daughter a Jeep Grand Cherokee. All of these cars are very good and functional. As long as they have Apple’s Car Play, Sirius XM, and good service – and they do – I am happy. I doubt the average auto buyer out there is dramatically different than I am.
So, this all raises the question of why the auto sector has mushroomed in value over these past few years.
There are roughly 95m autos sold each year, and that hasn’t really changed all that much, and sure, there may be some more profitability given shortages, but that is broadly a short-term issue. Longer-term, there appears to be a re-pricing in the sector (that above does not include component suppliers) and that may be accounted for by autonomous, cost efficiencies, direct to consumer, etc, or some other subscription opportunities that reduce capital intensity. Either way, the valuation on those same units has moved up quite a bit – and it is not just Tesla.
I am long Ford and GM vs being short Tesla via an options position. I suspect in a year in which much more competition is coming on stream, from new entrants and existing manufacturers and chip issues resolve themselves, and Tesla revenue and EPS growth flatten a bit, we will see compression broadly in this sector.
Our political discourse: I found/find the performances this week of Biden/Harris/Pelosi around the anniversary of Jan 6 2021 to be just absurd. Everybody understands the gravity of it, but to put it on par with Pearl Harbor and 9/11 is frankly pathetic. The bottom line is the Democrats are on the ropes, and spin control, finger-pointing is likely to go into overdrive.
China: I wrote quite a bit last year about Evergrande. Property development is a very large part of the Chinese economy, so the controlled demolition of the sector was always going to be a challenge. We are seeing that play itself out a bit more, and it bears watching.
Rules for thee but not for me: Rich Clarida has some serious explaining to do based upon reporting of his sell and then buy of equities in Feb 2020 around Fed actions. And once again, if we cannot get the simple stuff right, how can we get the big stuff right? If you are a public official, your investing activities should be managed blindly while in office. (note late yesterday Clarida announced he would leave the Fed this week – two weeks of his scheduled retirement at the end of the month)
Entitlements: As our children get older, we talk a bit about how to manage our kids and their expectations of us. It comes up a lot around Christmas because we probably (ok, definitely) overdid the gift-giving when they were younger. Now we are trying to find a new equilibrium. Anyhow, the point is that our entitlement/welfare state – and this is not unique to the US – has a tendency to start out with good intentions, drift, and enlarge itself. Here is a good (short) article on this, and it obviously has some inflationary / crowding-out issues.