Markets have been all over the place in the past week, as there have been a lot of things for the market to digest. What is great about the analysis machine that surrounds the current market, is that there is no shortage of data points, analogs, and other pieces of information to ponder. I am not too sure they point to a specific course of investing/trading action at present, which is why I have been paring back risk, including my short fixed income positions and currency positions, which were impacted by the Russian news (or non-news).
Today the markets are falling with more Ukraine/Russia news of an “imminent invasion” vs the other day when the markets lifted after Russia appeared to be moving some of its troops out of Georgia. The other day the markets didn’t care about another high inflation (PPI) print put a bid into the market. Maybe the buy the dip crowd saw this table from DB’s strategist Binky Chadha about these geopolitical flare-ups as being short-lived and good buying opportunities. Of course, it is the overall economic and market environment that ultimately drives the forward return, except on a few occasions did returns worsen and both were in a recessionary, tightening context.
I was having a conversation with a friend this past week about why the market is buying growth stocks, including ARK funds in spite of rates going up, and the argument was: “Fed will hike into slowing growth and will have to stop so as not to tip the economy over, so you want to buy growth names.” So, if I have that logic right, one should buy growth and ignore the double whammy of slower future growth and higher rates, because higher rates may have to get reversed (or won’t lift as high as priced) at some uncertain point in the future and in a slower growth period, you want to own the companies that are growing the fastest. OK, got it. Here is a chart from MS’ Mike Wilson that conveys this logic, which suggests growth is the dominant concern.
Below is a list of the factors that worked well in the past week, in spite of inflation, geopolitical, and growth (consumer sentiment) news! Sometimes the market is driven by short-term flows, unwinds, squeezes, and is less about fundamental positioning. Those are choppy, poor liquidity, adult swim markets, that don’t require large positioning to lose money.
Things that caught my attention this past week:
Flows:
As BAML notes, credit flows are worsening and equity flows are red hot.
Earnings
Estimates for EPS growth are still OK if decelerating. GS this past week revised its 5100 year-end SPX target to 4900, largely on the back of multiple compression, but maintains margins should be ok. Shopify commented that as expected, much of their growth was Covid pull forward and that 2022 would not be as robust. In any event, that 4900 call is 10% above current levels and would mean lowish single-digit total returns. Morgan Stanley has a somewhat similar take on EPS and the range of SPX outcomes as a result. Just so happens that 3900 happens to midpoint of BAML’s Fed Put level!
Goldman’s investment strategy group (rightly IMHO) mentions to stay the course on equities given earnings growth/margins but signaled they were concerned a bit with some new developments.
Yield Curve Inversion & Growth:
If one looks at historical charts of 3m Bills vs 10year UST’s, it is clear that inversions are usually good indicators of future recessions. An old professor of mine, Campbell Harvey, wrote his thesis at Chicago in 1986 on the matter, and here is a piece he wrote on it he wrote a few years back that called the 2020 recession (although hard to know about the pandemic).
And, just for good form, here is the current 3m/10y spread along with the 2y/10y spread. As rates go up in the short end, 3m bills will join along, but we are still far from – at least using this metric – recession worries. Harvey does explain why this one is superior in his piece.
As relates to inflation and to the sensitivity of rates to that factor, GS recently commented in a high value to article-length piece:
I suspect these sensitivities are related to QE and ballast that fixed income plays within investor portfolios. But, this point about the stickiness of easy financial conditions is important, because it suggests the market is a bit complacent (looking through with a benign prior). Again, GS states:
Inflation and consumer sentiment:
One of the things I have been harping on for over a year is that letting inflation genie out of the bottle is not the greatest of ideas, and rolling out AIT when it did gave the CB a lot of latitude in time and magnitude in how it responded. There is no shortage of articles and narratives about this inflation episode which stems from the idea much of inflation was unique to Covid, supply-driven, and should abate over the course of the year. Inflation expectations may be somewhat well anchored for now (although they have moved up beyond the Fed target), but they also maybe just getting started. Input prices, wages, rents, are not moving in the right direction. The question is not whether inflation will peak, because as we saw in the release on consumer sentiment, it is starting to bite and consumers are running through cash (see below). The question is the damage to consumer balance sheets and psychology going forward.
I have highlighted before that frequently purchased consumer items can play a big role in the inflation equation, and here is a graphic suggesting gasoline plays such a role.
One point that Ray Dalio made recently on his LinkedIn page was instructive for thinking this is all a benign experiment that will just fade away and the challenges it poses.
And, Jason Furman points out that while goods inflation is likely to subside, services inflation (bigger % of the economy) is edging up.
One final point on inflation is that the US now exceeds Mexico on that score. Fwiw, the official overnight rate is much higher than in the US, and 3% from the cycle bottom.
Other Tidbits:
Asset Manager Capitalism:
Fascinating take by Adam Tooze from Columbia on the evolution in our markets and the outsized role that asset managers now play and its impact. One of the presentations is from a Brown University professor (warning, thick Scottish accent), but well worth watching as he talks about the issues this form of capitalism causes, perpetuates. I thought this table below was useful to picture the evolution.
For investors, much has been written about how passive and concentrated can create some odd circumstances for individual names and difficulties with active discretionary risk-taking.
One point made by Tooze is that asset managers are “universal owners” and as such, they own a slice of the economy generally, and are less concerned about the performance of any one stock or portfolio. That contrasts with robber baron days, which were much more engaged with the workings of a particular company or industry. The other contrast relates to “no exit” as a means to push for adjustments. In other words, they don’t really get to choose if they exit or not, so that threat is of limited use nowadays. They can use some light persuasion, take out full-page ads, but it is largely hollow.
On that score, given the role that the ESG revolution has played in moving money to certain pockets, here is a piece (embedded in the Tooze piece) that makes the point of a lot of bark, but little bite.
What is also interesting is that some firms themselves are recipients of ESG inflows while others, in spite of better scores, struggle as there is not a whole lot of clarity, uniformity of how money flows in that space, other than to fund providers like Blackrock. Here is a snippet about that situation in Japan.
Alan Blinder and Soft Landings:
Ex Fed governor and Princeton economics professor Alan Blinder gave a presentation at Princeton’s Bendheim Center of Finance on whether the Fed could engineer a soft landing. It so happens that he is coming out with a book shortly on the matter called “A Monetary and Fiscal History of the United States, 1961-2021” (it is supposed to follow up from the classic Friedman/Schwartz piece that took us to 1960), so he is very well versed academic and practitioner (having been at the Fed for a while) to discuss whether the Fed can in fact engineer a soft landing. It is worth watching, and this chart below would suggest such things are possible. One side note is that the bond market went haywire in 1994, even if economic growth did not fall into recession territory.
Stanford University Guest Lecturer:
Granted, I don’t know all that much about crypto, Web 3 other than I seem to be inundated with ads for it, and evangelicals talking about this all as if it is a panacea for whatever ails us (or ailed us after the GFC). I am not entirely skeptical given the amount of money/brainpower pouring in to the space and unmet needs particularly in cross-border payments, etc, but not entirely sure it is all it is cracked up to be. Here is a lecture was given to Stanford engineering students by David Rosenthal, an experienced engineer/entrepreneur in space that would suggest there is a lot of misinformation, spin, and a lot of hurdles ahead.
Elizabeth Warren and Corporate Greed:
Inflation is a complicated phenomenon, and corporations eventually will be faced with pressure points, margin impacts given PPI, wages, and more demand elasticity over time. Elizabeth Warren has the view that corporations are the devil and to shareholder versus broad society centric. She may be right, but the trends for margin expansion in the US were in place prior to Covid and relate to other factors such as company efficiency, automation, globalization, excess labor supply, market concentration, etc. She thinks corporate greed is playing a role. Noah Smith created this chart to highlight the silliness of her viewpoint of trying to shame corporations into submission on price growth. Obviously, one needs to run margins against this series, but using logic, it is clear that inflation can hardly be explained by corporate greed.
